Capital allowances vs. Depreciation
Whether the client can prove such they will keep the existing levels of investment in original terms, then there may be justification to accept a reduction of this type of category of deferred taxation although if investments begin to decline after that deferred taxation could be crystallized.
The maintenance of existing capital expenditure levels is dependent on the profitability and sales of the company; hence the auditor is used effectively to perform an audit of the profit forecast for at least three years ahead. This would look to be against usually accepted accounting principles that advice against auditing of profit forecasts since in a profit forecast many factors are outside the control of the directors. Inventory levels and Capital expenditure are to a certain extent during the control of the directors. This may look to be a weak argument since profitability affects capital expenditure as well as there is little likelihood of profit whether the directors do not invest prudently, however it may well be during their control to do so. Therefore we only utilized the auditor to assess where profitability is probable to fall or not rise enough to warrant or support plant capital expenditure. So we do not expect him to assess precisely what such profitability is going to be. Evidence is based largely on longer term forecasts and the company's budgets. The process the auditor adopts are as follow:
a) Assess the trend of past capital expenditure to see where it is rising or falling or where there is no consistent pattern.
b) Assess the company's past profit performance to see where it is falling or rising and compare this performance along with the company's previous budgets and calculates to determine its ability in forecasting as good forecasting in the past gives more confidence for the present.
c) Assess the company's capital, profit and cash forecasts for reliability. This includes determining where they have been made on the basis of reasonable data or where they are mere estimate work.
d) Examine the directors minutes for evidence of policy changes that might affect future capital expenditure.
e) Take into consideration the economic situation mainly as it affects the client's own industry and the company's exposure to labour disruption to economic or legislative changes or components or material shortages.