A pharmaceutical company audit's central judgement is whether research and development spend on a given drug or formulation meets Ind AS 38's capitalization criteria — technical feasibility, intent and ability to complete and use or sell the asset, and probable future economic benefit — which for most pharma projects is not met until regulatory approval (or at minimum the final stage of clinical/regulatory trials with a clear and probable path to approval) is close at hand, meaning the large majority of R&D spend in a typical year should be expensed as incurred rather than capitalised, and the audit needs to test this project by project because a portfolio of several R&D programmes rarely sits at the same stage.
Why capitalization is the exception, not the default
Ind AS 38 draws a line between a research phase, where none of the costs can be capitalised because the recognition criteria cannot be demonstrated, and a development phase, where capitalization is required once all six specific criteria in the standard are met. For a pharma product, the development phase in the standard's sense typically doesn't start until late-stage trials with a clear regulatory pathway, because before that point there is genuine uncertainty about whether the product will ever be approved — which is exactly the kind of uncertainty the standard's criteria are designed to filter out.
- 01Get the R&D spend split by individual project, not a single pooled R&D expense lineA capitalization assessment has to be made project by project; a pooled R&D figure hides which specific projects, if any, have actually crossed the threshold.
- 02For each project claimed as capitalised, test each of the six Ind AS 38 criteria specificallyTechnical feasibility, intention to complete, ability to use or sell, how it will generate probable future economic benefit, availability of resources to complete it, and ability to reliably measure the cost — all six, not just the ones management chooses to address.
- 03Check the regulatory trial stage the project has actually reachedCross-reference management's capitalization claim against the actual trial phase and regulatory correspondence (approvals, rejections, additional data requests from the regulator) for that specific product.
- 04Test for projects abandoned or failed during the yearAny previously capitalised amount for a project that failed a trial or was abandoned needs to be written off immediately, in full, in the period the failure or abandonment occurred.
A pharma company capitalising R&D spend across most or all of its active projects, regardless of trial stage, is very likely applying the criteria too loosely — ask specifically which stage each capitalised project has reached and what regulatory correspondence supports the probability of approval.
Regulatory-driven inventory write-offs
Pharma inventory carries obsolescence risk beyond ordinary slow-moving stock: a batch can fail quality testing, a regulator can reject or recall a product, or a formulation can become non-compliant with an updated regulatory requirement, any of which can render an otherwise saleable batch worthless overnight regardless of its remaining shelf life.
| Trigger | What to check |
|---|---|
| Batch failing quality control testing | Quality control rejection records cross-checked against inventory still carried at full value |
| Regulatory rejection or recall | Correspondence from the regulator against the inventory and receivables for the affected product |
| Near-expiry stock | Expiry-date ageing of the full inventory, not a sample, since pharma shelf life is a hard cutoff, not a gradual decline |
| Formulation no longer compliant with a revised standard | Regulatory update tracking against the product master to catch stock that became non-compliant without a formal recall |
Common practice, not a requirement
Expiry-date ageing for pharma inventory is usually best run as a full population check rather than a sample, since the system typically already holds batch-level expiry data — there's little reason to sample when the full population can be tested directly.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Fixed assets & capexInd AS 38: intangible assets, and why most internally generated ones never make the balance sheetResearch is always expensed. Development can be capitalised, but only once six specific conditions are all met — a much stricter bar than it sounds.
- Inventory & stockInventory valuation audit: FIFO, weighted average and cost testingTesting the cost formula actually applied against the one disclosed, NRV testing, and overhead absorption into manufacturing cost.
- Inventory & stockAuditing slow-moving and obsolete inventoryAgeing analysis by SKU, testing the provisioning policy against actual realization, and red flags where a policy is never applied in practice.
- Audit workflow & automationSA 540: auditing accounting estimates, where judgment replaces a verifiable numberAn estimate can't be vouched to a source document the way an invoice can. SA 540 is about what replaces vouching when there's no single right answer to check against.
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