[Opinion] Ind AS Audit for Aerospace and Defence Sector

Parveen Kumar & Abhishek Babbar – [2025] 174 taxmann.com 280 (Article)

The Aerospace and Defence (A&D) sector is an important industry in any country, playing a significant role in national security and economic development. This sector includes manufacturing and service activities besides research or development and deals in Aircraft, ships, spacecraft, weapon systems, and defence equipment etc.

Key Indian players in A&D sector include public sector undertakings like Hindustan Aeronautics Limited, Bharat Electronics Limited, and Bharat Dynamics Limited besides private sector players such as Tata Advanced Systems, Reliance Defence, Mahindra Aerospace, and L&T Aerospace.

While there are huge opportunities of growth in this sector, despite challenges on regulatory and operational front, in this article we will focus on a few accounting matters specific to this industry, to understand approach of an auditor while dealing with such matters before forming an opinion on whether financial statements of entities in this sector are presenting true and fair view. Of course, the auditor will need to identify risks and plan audit procedures, creating documentation as required under the Standards on Auditing framework. Our discussion is based on the assumption that the entities in this sector are mostly using IndAS framework of accounting, which is the latest Indian Accounting Standards, almost similar to International Financial Reporting Standards (IFRS).

Manufacturing Costs

Entities in A&D sector face challenge in recognizing and accounting for the costs associated with manufacturing. Accounting team struggles to record transactions like progressive payments from buyers or issue of recognising financing components, and the need to properly allocate direct and indirect manufacturing costs.

Generally, the period between performance and payment for that performance is more than a year. This means the cost indirectly includes finance cost, which must be recorded separately from the revenue from sale of the products in IndAS environment.

Another challenge involves accounting of research and development (R&D) cost, which can be substantial in the aerospace sector. Also, warranty provisions and other future maintenance obligations must be taken into account. Depending upon whether warranty is about service or assurance.

Auditor’s Approach

1. Verification of progressive payments – Auditors need to ensure that progressive payments received from the buyer align with appropriate revenue recognition method like percentage-of-completion. Accounting policy of revenue recognition should also be challenged.
2. Interest income on delayed payments – If the buyer has negotiated extended payment terms, auditors will need to review if the manufacturer has calculated the present value of future payments and recognised the difference as interest income over the contract period. Financing component should be appropriately separated from sale.
3. Direct and indirect manufacturing costs – Auditors need to review whether direct costs such as labour, raw materials, and production overheads are capitalised, as required and permitted by the accounting standards during the manufacturing process.
4. R&D and customisation costs – Auditors should review if the R&D costs to observe, if only those directly attributable to the production of the aircraft are capitalised. Similarly, customisation or modification costs requested by the buyer should be appropriately capitalised rather than treated as separate expenses.
5. Warranty provisions and maintenance obligations – Auditors need to review if the manufacturer has adequately estimated accrued warranty provisions and future maintenance costs.
6. Deferred costs and completion stage – If manufacturing of a product like aircraft is not completed by the end of the reporting period, auditors should review if deferred production costs are properly capitalized and reflected as work in progress.

Accounting for Intangibles

In the aerospace sector, intangible assets and development costs are significant due to long development cycles and the substantial investment in research and technology. These costs include expenditures on product development, engineering designs, software, patents, and licenses etc.

Accounting for these assets presents challenges in determining whether costs should be capitalised as intangible assets or recorded as expenses. Under Ind AS, intangible assets are recognised when they meet specific criteria, e.g. they must be controlled by the entity, have an identifiable future economic benefit, and have a finite useful life.

Similarly, they have substantial investments in software for systems that support flight operations, fleet management, maintenance systems, and compliance with aviation regulations. These software systems, once developed or acquired, must be capitalised as intangible assets. This involves judgment on determining the useful life, amortisation methods, and assessing impairment risks, especially when technological advancements or changes in regulations occur.

Auditor’s Approach

1. Capitalisation of development costs – Careful assessment is required to ensure whether development costs meet the capitalisation criteria. This includes challenging the assumptions used by management to assess the project’s technical feasibility and whether the company has the intention and ability to complete it and use it in operations.
2. Amortisation and useful life of Intangible assets – Auditors should also review the amortisation policies for intangible assets, particularly in light of the industry’s rapid technological advancements. Additionally, auditors should ensure that amortisation is being applied consistently, in line with the expected consumption of economic benefits from the intangible asset.
3. Impairment of Intangible assets – Given the long development timelines and high capital investment in the aerospace sector, auditors must pay close attention to potential impairment issues related to intangible assets.

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