AUDIT OF PROPERTY, PLANT AND EQUIPMENT (PPE)
NATURE OF PROPERTY, PLANT AND EQUIPMENT PPE are assets that have an expected lifespan of more than 1 year, are used in the business and are not acquired for resale.
Fixed Assets Master File • The primary record for PPE • Includes a detailed record of each piece of equipment and property owned • The totals for all records in master file equal the general ledger balances for related account • It also contains information about property acquired and disposed during the year
• Auditors verify manufacturing equipment differently from current asset accounts for : – Usually fewer current period acquisition of manufacturing equipment – The amount of any given acquisition is often material – The equipment is likely to be kept and maintained in the accounting records for several years
Verifying depreciation expenses Verifying the ending balance in accumulated depreciation
Analytic procedures
Test Categories Verifying the ending balance in the assets account
Verifying current year acquisitions
Verifying current year disposal
Analytic Procedure
• Include comparison of financial information with :– Prior periods – Budgets – Forecasts – Similar industries
• Includes consideration of predictable relationships, such as :– Gross profit to sales – Payroll costs to employees – Financial information and non-financial information, for examples the CEO’s reports and the industry news.
• Possible sources of information about the client include: – – – – – – –
Interim financial information Budgets Management accounts Non-financial information Bank and cash records Board minutes Discussion or correspondence with the client at they year-end
• Table below show type of ratio and trend analysis often performed for manufacturing equipment
Analytic procedures
Possible misstatement
Compare depreciation expenses divided by gross manufacturing equipment cost with previous year
Misstatement in depreciation expenses and accumulated depreciation
Compare accumulated depreciation divided by gross manufacturing equipment cost with previous years
Misstatement in accumulated depreciation
Compare annually or monthly repairs and maintenance, supplies expenses, small tool expenses and similar acc with previous years
Expensing amount that should be capitalized
Compare gross manufacturing cost divided some measure of production with previous years
Idle equipment or equipment that was disposed of but not written off
Verifying Current Year Acquisition
• Long term effect on the financial statement • Improper amount will affects :– The balance sheet until the company dispose of the asset – Income statement effects until the asset fully depreciated
Example of procedure
Select a sample of entries in the acquisitions journal and trace to capital asset master file Select a sample of entries in the acquisitions journal and trace to vendor invoices and receiving reports
Select a sample of entries in the acquisitions journal and physically examine the related assets
• Testing acquisition :– Auditor must know the client’s capitalisation policies to make sure that :• It is record accordance to accounting standard • Treated consistently in the preceedings year For example : Client expenses items that less than certain amount, such as RM1000 So, auditor should alerts for the transportation and installation cost.
• Reviewing recorded transactions for proper classification For example : – Amount recorded as manufacturing equipment should be classified as office equipment or part of the building – Possibility for client to improperly capitalised repairs, rent or other expenses
Verifying Current Year Disposal
• Existing disposal The auditor’s main are recorded objectives in the verification of sale, • Disposals are trade-in, accurately recorded
abandonment are :-
Client’s Schedule of Recorded Disposals
• It is the starting point to verify client disposal • Includes date of disposals, name of person who acquire the assets, selling price, original cost of assets, acquisition date and accumulate depreciation of asset • Detail tie-in tests of the schedule is necessary, including footing the schedule, tracing the totals on the schedule to be recorded disposals in the general ledger, and tracing the cost and accumulate depreciation of the disposals to the property master file
The search for unrecorded disposals is essential. The nature and adequacy of the controls over disposals affect the extent of the search. The following procedures are often used to verify disposals. • Review whether newly acquired assets replace existing assets • Analyze gains, losses and miscellaneous income from the disposals of assets • Review plant modifications and changes in product line, property taxes, or insurance coverage • Make inquiries of management and production personnel about the possibility of the disposal of assets
Verifying Ending Balance of Asset Account
Auditor’s objectives when auditing manufacturing equipment include determining that :• Existence - all recorded equipment physically exists on the balance sheet date • Completeness – all equipment owned is recorded
• Auditor have to consider the nature of internal controls over the manufacturing company • This is including the use of master file for individual fixed asset, adequate physical controls over assets that are easily movable, assignment of identification numbers to each plant asset and periodic physical amount to fixed asset • A formal method of informing the accounting department of all disposals of fixed asset is also an important control over the balance of fixed asset carried forward into the current year
• After assessing the control risk for the existence objective, the auditors have to decide whether its necessary to verify the existence of individual item of the manufacturing equipment • If there is a high likelihood of material missing fixed asset still included in the master file, the auditor can select a sample from the master file and examine the actual assets • In rare cases, the auditor may decide it is necessary for the client to take a complete physical inventory of fixed assets to make sure they all exist
• The auditor normally doesn’t need to test the accuracy or classification of fixed assets recorded in prior periods because they were verified in previous audits at the time they were required • But the auditor should be aware that companies may occasionally have manufacturing equipment on hand that is no longer used in operations
• In addition to performing procedures to obtain evidence related to balanced-related audit objectives for fixed assets, auditors also perform audit procedures related to the four presentation and disclosure objectives for fixed assets • A major consideration in verifying disclosures related to fixed assets is the possibility of legal encumbrances
• Next, the proper presentation and disclosure of manufacturing equipment in the financial statement must be evaluated carefully to make sure that accounting standards are followed • Manufacturing equipment should include the gross cost and should ordinarily be separated from other fixed assets • Leased property should also be disclosed separately and all liens on property must be included in the footnotes
Verifying Depreciation Expense
Not verified as part of tests of control and substantive tests of transactions
Recorded amounts are determined by internal allocations
Most important balance-related audit objective-accuracy
Auditors focus on determining whether the client followed consistent depreciation policy and the client’s calculation are correct
The policy of depreciating assets in the year of acquisition and disposition
The useful life of current period acquisitions
Auditors weight for consideration
The method of depreciation
The estimated salvage value
Reasonableness test Auditor must consider the physical life if the asset, the expected lifespan and established company policies on trading in equipment Made by un-depreciated fixed assets by depreciation rate for the year - make adjustments If cannot be accomplished - more detailed tests are needed (recomputing, reconciliation)
Verifying Ending Balance In Accumulated Depreciation
It is necessary to evaluate the adequacy of the allowances for accumulated depreciation each year – to ensure NBV not > realizable value of the assets
Debit – tested as a part of the audit of disposals of assets
Credit – as a part of depreciation expenses
Modification in operation Reduction in customer demands for product
Unexpected physical deterioration Life manufacturing equipment may be significantly reduced because of possibilities of
2 objectives are usually emphasized in the audit of the ending balance in accumulated depreciation
Accumulated depreciation as stated in the property master file agrees with the general ledger. This objective can be satisfied by test footing the accumulated depreciation in property master file and tracing the total to the general ledger
Accumulated depreciation in the master file is accurate
