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CA Intermediate · Auditing and Ethics · Audit of Items of Financial Statements

In auditing Narmada Engineering Ltd, the auditor finds that the company has capitalised Rs 40 lakh of repair and maintenance expenses that merely restore the existing machinery to its original working condition without increasing its future benefits or standard of performance. Which audit conclusion is correct?

The expenditure merely maintains existing performance and is therefore revenue in nature. Capitalising it overstates both fixed assets and profit. The auditor should ask management to correct it and, if the material misstatement remains uncorrected, modify the audit opinion.

  1. AThe capitalisation is correct because all expenditure on machinery is capital in nature
  2. BThe expenditure should be treated as revenue expense, so profit and fixed assets are overstated and the auditor should seek correction or modify the opinionCorrect
  3. CThe expenditure should be shown as a contingent asset in the notes
  4. DThe item affects only classification in the cash flow statement and not the profit

Explanation

Expenditure that only maintains the previously assessed standard of performance is a revenue expense under the accounting standard on PPE. Capitalising it overstates assets and profit by Rs 40 lakh. The auditor requests an adjustment and, if management refuses and the effect is material, modifies the opinion.

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