The Quality of the Audit Which is Related to the Capitalization of the Cost

Running Head: AUDIT
Audit
Name of the Student:
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Executive summary
This literature review is based on the issues relating to the quality of the audit which is related to
the capitalization of the cost. Then the capitalization cost is described while identifying the audit
evidence after collecting the techniques of capitalization cost. Recommendation for the issues
has also been explained.

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Table of Contents
Introduction..........................................................................................................................3
Capitalized cost....................................................................................................................3
Audit evidence collection techniques..................................................................................4
Review of the real cases associated with the capitalized cost.............................................5
Recommendation.................................................................................................................8
Conclusion.........................................................................................................................10
Reference list.....................................................................................................................11

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Introduction
This literature review is focused on the identification of the important factors that could
affect the auditing quality related to the capitalization cost. It provides the concerned with the
audit quality which directly reflects whether the financial statement is made properly or not.
Auditor plays an important role in an organization by performing some necessary and important
task. According to the International Auditing Standard quality of audit consist of the process
which helps in reviewing the business elements with the standards. The research studies related
to the audit quality of evidence relating to the capitalizing of the cost. With the proper quality of
evidence different problem can be solved related to a business (Aliyu & Yusof, 2016).
The purpose of this paper is to summarize the auditor quality of evidence regarding the
capitalized cost and its influence which can affect the both internal and external factors of the
business. furthermost, this article consist of some suggestion for the future studies related to the
quality of audit evidence.
Capitalized cost
Capitalized cost is an expenses which is the part of the fixed asset which is charged to the
expenses of the period it is incurred. It is added to the cost basis of the fixed asset on the
company’s balancer sheet. It is incurred when there is a purchase of fixed asset and this expenses
is recognized over a long period of time. Capitalization is used when an item is expected to be
consumed for a long period of time. When the cost is capitalized, then the expenses charged over
it need to be amortized or depreciated. After the cost capitalization the monetary value that the
company used for purchasing the item stays within the company as it is retained in the form of

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intangible asset. The main purpose of capitalization of cost is for lining up the cost of asset for
the length of time until the asset is generating any revenue (Anifowose, Rashid & Annuar, 2017)
During the capitalizing cost a company uses matching principle of accounting which
records expenses in the same period when the revenue is generating. Long-term assets will be
generating revenue for a long period so the cost of it need to be depreciated or amortized for the
long period of time.
Audit evidence collection techniques
According to the Craig Cochran collecting the audit evidence is the part of the audit
evidence which is also the part of the audit evidence techniques. It includes various process like
visual observation, examination of the record and many others (Boslett, Guilfoos & Lang, 2019).
Audit is like the fabric that need to be woven by a skillful hand and techniques.
 Visual observation is the most basic way to collect the audit evidence by simply
observing and understanding the organization work. This method helps in getting the
uncontrolled documents which sometimes provide valuable information like product
requirement, decision making criteria and process control guidelines. Some products are
kept aside to ignore it which is needed to be processed according to the requirement.
 Measuring the instruments is also necessary to find out what they are sued for and it
requires complex measurement device. With the presence of the measuring equipment
helps to give it an important characteristics that can verify the items.
 Examination of the records of pasts need to be checked in order to get important facts.
Sampling of the evidence need to done to make accurate inspection of the data’s (Chen,
Gavious & Lev, 2017).

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According to the ISA 500 audit evidence which describes the procedures that the auditor can
adopt to obtain the audit evidence regarding the capitalized cost consist of the eight techniques
which are as follows:
 Inspection of the document and records – It gives the evidence of ownership, control of
operation, invoice, purchase cost and sale value.
 Inspection of the tangible assets – It helps to give evidence for the existence of the asset
and the valuation of the asset (Dagher, 2016).
 Observation – It involves looking into the process or procedure of revaluation or
valuation and also provide the evidence which will control the operation.
 Enquiry – It is the way of finding the major source of evidence with the help of audit
procedures. Management plays an important part in the enquiry process which will help
to obtain the enquiry report.
 Confirmation – It refers to the Auditor direct response to the third party which may
include confirmation of bank balance, inventories, penalties and receivable.
 Recalculation – It involves checking the arithmetical accuracy of all adjustments.
 Re-performance – It involves re-performing the client procedures like test checking
process.
 Analytical procedures – It consist a set of data’s which will help in identifying and
understanding the relationship between the set of data’s
Review of the real cases associated with the capitalized cost
Auditor quality of evidence is regulated by the International Auditing Standard where a
systematic independent examination of different items in the books are done. There is a huge
body of literature review which is related to the audit quality and its measurement. Auditor is

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responsible for delivering, discovering and reporting of the client’s accountings system.
Discovery of misstatement related to the capitalization cost to report the misstatement. Despite to
the lack of the comprehensive evidence audit quality covering all types of audit. Capitalization of
the cost are the components of sustainable business model in which the author think about the
meaning of the non-profit organization. The four main ways that the auditor can take to examine
the capitalization cost is by checking the long term sources of fund, specifying the need of the
finance, theories of debt, cumulative net income and forms of capitalization. Capitalize cost
drives the economic benefit from the asset which is beyond the current year (De Waegenaere,
Sansing & Wielhouwer, 2017). It consist of the items which are not used in the normal course of
operation. Like inventory cannot be called as the capital assets as the companies are ordinarily
expected to sell their inventories within a year or more. Capitalized cost are also amortized over
certain period of time as their effect on the company can be seen in the income statement. It
cannot be seen immediately instead it is spread throughout the useful life of the assets. Cash
affect the capitalization cost immediately with the amortization expenses charged as the non-cash
items. Sometime companies incur expenses which is incurred when the asset is put to use. It is
included as the part of the cost basis of all the fixed assets.
If a company borrows fund to purchase an asset or any real-estate then the interest
expenses incurred with the financing cost is allowed to be capitalized while the company can
capitalize some other costs like labor, sales, transportation, testing and other material used for
any construction of the capital assets. Maintenance cost is also associated with purchase of fixed
assets which is to be incurred by the company (Dinh et al., 2020). Sometime companies are also
need to capitalize the cost which is associated with the patents, trademark and copyright which is
allowed to incur cost. Companies can also capitalize the purchase price of the intangible assets.

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They are even allowed to capitalize the development cost associated with the software
application. Feasibility of the technology attains all necessary coding and designing and also
testing the software application for designing the specification. When a company cannot
demonstrate the link between the cost which need to be expand immediately while the
development of software is also associated with the cost incurred prior of the technology
development. Research and development cost is another example of exposing due to the higher
risk of profile and uncertainty for the future benefit of the costs made (Gissel, 2016).
Capitalization of the cost will naturally affect the company’s financial statement as they
have many areas involved with the capitalization cost like net income, stockholder’s equity, and
cash flow from operation, reported assets and financial ratio. There are few drawback with the
capitalization of the like in the research and development the cost used in it cannot be capitalized
though the asset is providing long-term income for the companies. Many countries does not
allows to capitalize the cost as it will led to the uncertainty of the benefits. Calculating the future
benefit will become difficult to calculate. The decision for capitalizing the cost may affect the
cost of the company’s balance sheet and may influence the financial statement. It is crucial to
remember the cost of inventory which are to be utilized for a long period of time and there is no
intention of selling until the next business cycle (Kharabadze & Andghuladze, 2019).
When the expense is done for the purchase of the asset which could limit the other
expenses. Only those cost having long-term benefit are idle for increasing the value of the asset
which can be expanded. Mainly deciding whether to capitalize or not, the cost which might
affect the capitalization which could be better than finance with the expenses. Many accounting
practice prefer the minimum rule where the items which are capitalized are shown as expense
when they does not signifies in the balance sheet. These expense forms a large part of total

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expense an decreases the total income. Capitalization decision effect the expenses which impacts
the financial accounts and mainly effect the key expensing costs.
Companies need to be find alternative in shifting the capitalization expense from the
companies’ income statement. Problem may also arise during the capitalization as it can increase
the assets income and indirectly boost the company’s income. Companies can try to bring down
the income by showing the expenses due to capitalizing the expenses. There must be an
aggressive accounting practice with the sudden improvement of the company’s profit margin
which can be due to the increase in the asset (Paseková et al., 2017). Sometime the net asset of
the company’s balance sheet does not shows the appropriate value with the increase of the asset.
There could be a sharp decline of cash flow from operation due to the unexpected market
condition. There must be overcapitalizing of the cost when the part of the capitalization becomes
the part of the research cost. So in order to avoid the inappropriate capitalization and expense
there are few methods which is necessary to be kept in the mind like examining the guidelines
for the capitalization, accounting policies must be maintained, understanding the capitalization
policies for every specific industry, following the minimum rule and maintaining a written
capitalization policy. While developing the accounting policies the size of the business and the
nature of the business need to be considered.
Recommendation
Business owner sometime has to take important decisions about the
companies cost which is one of the important decision. Whenever the company spend money
they are often able to understand the cost of the capitalization which is required to be made. This
decision will make impact on the company’s balance sheet. There is a requirement of guidance
when a companies need to be capitalize its expenses. Any inappropriate use of this system may

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led to the falling in the legal frameworks. Whenever a company chooses to capitalize their cots
expenses than the cost need to be added to the income statement and subtracted from the
business if there is the requirement of finding the actual profit. There must be a proper guild lien
to help the business to decide which cost need to be capitalized and which cost need to be shown
as expenses. There is no mandatory rule to do so as there are few legal loopholes which the
company need to be aware of before any further proceeds. There must be a listed advantage and
disadvantage of the about the capitalization of the expense which will further guide the
companies. It could create the opportunities which will influence the company’s profit by
directly influencing the income statement. There are many instance when the companies has used
the capitalization expenses against the expenses which are against the common accounting
problems as it influences the short-term profit of the company.
It will be easy for the company to decide whether the cost need to be
capitalized or shown as expenses which is often the simplest method of dividing it into two
categories which is asset producing future benefits and set not producing any future benefit.
Some costs of the company need to provide value for the company which is typically shown as
the cost expenses as the business won’t enjoy any future benefit. Companies can capitalize the
cost of the asset when the resources is acquired for getting future benefits and they are the main
resources which is beneficial for the business in their operating cycle. Companies making the
expenses can record the asset in their balance sheet so that the cost will be shown on the balance
sheet. They can also consider the capitalizing cost when it is added to the significant value of the
existing resources. In many cases fixed asset is capitalized as they are continuously providing
benefit to the company. They can also deal with the intangible assets which can be capitalized by

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including the full cost of acquisition for the patent, copyrights and trademarks. Even software
development cost can also be included as they are feasible for more than one operating cycle.
Conclusion
According to the studies when the high value items are capitalized then the expenses are
effectively smoothed over multiple period which will allow the companies not to make
expensive purchase on assets like property, plant and equipment’s. Companies initially shows
higher profit for which it will have to pay more tax. Capitalizing the cost inappropriately may
lead to make believe that the company is having a higher profit margin which is higher than they
are actually. Capitalization may lead to meet the matching principle which can be recognized as
expenses while also recognizing the revenue. It impacts the profit for multiple reporting in the
future while the cash flow may impact immediately. According to the studies if cost are paid
with the subsequent amortization which is a non-cash expenses than the capitalization cost will
cause to make an impact on the profit level.

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