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(i) Development costs
The capitalisation of the development costs appears to be appropriate and in accordance with IAS 38, however IAS 38 also states that once the asset is ready for commercial production/ use, it should be amortised over its useful life.
To date no amortisation has been charged which is contrary to IAS 38.
The asset is deemed to have a useful life of 3 years being consumed 60% in year 1 and 20% in years 2 and 3 and so the financial statements should therefore show an amortisation charge of:
$2,000,000 × 60% × 3/12 = $300,000.
The amortisation charge would reduce both profit before tax and the carrying value of the asset by $300,000.
This error amounts to 5% of profit before tax ($300,000 / $6,000,000) and so is likely to be material, hence management should charge the amortisation in the financial statements.
If management refuse to amend this error then the auditor’s report would be modified. As management has not complied with IAS 38 and the error is material but not pervasive then a qualified opinion would be necessary.
A basis for qualified opinion paragraph would need to be included explaining the material misstatement in relation to the non-amortisation of development costs and the effect on the financial statements.
The opinion paragraph would be qualified “except for” - due to material misstatement.