Lecture 20 Notes- Auditing Property, Plant and Equipment PDF

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Lecture 20 - Auditing Property, Plant and Equipment Categories of property, plant and equipment : 1. Land & buildings 2. Plant & machinery 3. Fixtures and fittings 4. Motor vehicles 5. IT equipment 6. Assets in the course of construction – auditor would be most concerned about stage of completion – you would need an expert to establish valuation at each stage. 7. Leased items in respect of the above categories – IFRS 16 Leased Assets – included if the term of the lease is [sorry lost connection here]

Recognition Principle: Key accounting concepts: IAS 16 – Property, Plant & Equipment Items of Property, Plant & Equipment should only be recognised as assets when: •

it is probable that future economic benefits associated with the asset will flow to the entity; AND

•

the cost of the asset can be measured reliably – again use experts in the field to do this.

Auditing Property, Plant and Equipment Inherent Risks 1. The entity may not own the Property, Plant & Equipment on its balance sheet e.g. building which is mortgaged – the audit client may not own the building until the mortgage has been paid completely 2. The Property, Plant & Equipment on the balance sheet may not actually exist – auditor must identify each large value item at least. 3. The Property, Plant & Equipment may be obsolete (due to technological advances, for instance) 4. The carrying value of the Property, Plant & Equipment may be impaired and/or the depreciation rate may no longer be appropriate. See next slide on the

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accounting standard. 5. Property, Plant & Equipment items may be included in repairs and maintenance expense in error. Reverse of WorldCom error who capitalised repairs and maintenance 6. Property, Plant & Equipment revaluations are subjective 7. Self-constructed Property, Plant & Equipment can be difficult to assess – see slide 2 8. Leases may be incorrectly accounted for – lessee should account for this properly by creating proper provisions – pay attention to details of the lease agreement.

Auditing Property, Plant and Equipment  IAS 36 Impairment of Assets seeks to ensure that an entity's assets are not carried at more than their recoverable amount (i.e. the higher of fair value less costs of disposal and value in use) – the client must reduce the value to this recoverable amount. There must be an annual review of goodwill – goodwill will not be examined in this course. Indications of Impairment [IAS 36.12] A great deal of potential for manipulation in this area. Produce workings at coming to these amounts of present value of assets – as an auditor you would probably have to involve an expert. The following may indicate problems with impairments of assets – this is much more problematic these days in time of COVID.  External sources:  market value declines  negative changes in technology, markets, economy, or laws  increases in market interest rates  company inventory price is below book value  Internal sources:  obsolescence or physical damage  asset is part of a restructuring or held for disposal  worse economic performance than expected

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Control Risks- there should not be a lot of activity in this PPE – i.e. this should not be the main part of their business. 1. Property, Plant & Equipment additions and disposals are non-routine transactions and therefore may not be subject to the same controls as routine purchases 2. Disposals or additions may not be recorded as such 3. There may not be an up-to-date Property, Plant & Equipment /Fixed Asset Register (see next slide) – this provides control but it does need to be kept up to date. E.g. high value equipment needs to be protected. 4. Controls over the physical safeguarding of desirable assets may be weak – it may need to be kept in a secure area.  N. B.

The volume of transactions is usually low therefore a substantive

audit approach is usually more efficient. One control in place is that of a say, a computerised listing of all the PPE including the purchase price, date of purchase, details of depreciation, organisations will group similar assets together e.g. office equipment as in Queen’s – every computer will have a bar code and serial number. This is nothing to do with double entry – it is separate from the nominal ledger as so is an extra control.

Fixed Asset/Non-current Asset or PPE Register •

To control property, plant and equipment, many companies use a Property, Plant & Equipment Rregister. This usually takes the form of a computerised database containing details of all items of Property, Plant & Equipment

held

including: a description, original cost, date of acquisition and accumulated depreciation together with other details such as location, authorising department, budget code etc.  The Property, Plant & Equipment Rregister itself does not form part of the accounting records of the company but it is reconciled to the property, plant and equipment accounts within the nominal/general ledger.

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Auditing Property, Plant and Equipment Examples of analytical procedures 1. Develop an expectation of depreciation by reference to prior year charge adjusted for additions, disposals and fully depreciated assets – look at last year’s depreciation charge – have a best guess approximation or estimation. 2. Compare additions/disposals to capital budget – the auditor should look at this to establish what has been decided upon – did they buy what they said they would? Are there problems with liquidity if they decided not to buy some item of plant? 3. Compare repairs and maintenance costs to prior year and budget 4. Review industry norms for depreciation, addition/disposal patterns and compare to client – is your audit client buying similar types of PPE to other companies in the industry? Auditing Property, Plant and Equipment Assess the audit client’s policies for appropriateness. There are a lot of standards and legal points which affect this area. The auditor has to be familiar with these – he is an expert too. The auditor could compare opening balances with closing ones from last year. Look at the nominal ledger on their computer system – you could do a 100% check on these. Financial Statement Assertions (ISA (UK) 315) Transactions during year

Year end balances

Occurrence (O)

Existence (E) Rights & obligations (R/O) Valuation (V) ----------Accuracy (A) ------------------- Cut-off (C/O) ------------------- Completeness (C) ------------------- Classification (CL) ------------------- Presentation (P) ----------

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Auditing Property, Plant & Equipment - Examples of Substantive Tests of Details #

Test

Assertion(s)

1

Ensure accounting policies are appropriate

V, A, C/O, P, CL

2

Compare the current year’s opening balances with last year’s closing balances.

V, A, C, C/O, P

3

Select a sample of __items and trace to the Property, Plant & Equipment register (and reverse the test)

C,A, V, P

4

Vouch additions to supplier invoice – is it really a capital item? You can capitalise costs of delivery but not costs of removal of the old equipment. Direct costs of new equipment testing can be capitalised.

O, A, C/O, E, R/O

5

Inspect supplier deliver note to confirm delivery before year end

O, C/O

6

Inspect requisition, purchase order, and other evidence to confirm purchase approval – this should be done with the client’s approval – have the staff been buying plant for themselves?

O, R/O

7

Physically inspect additions to confirm description and serial number to invoice – does the item exist? Or check chassis number on say, a car.

O, A,E

8

For internally generated additions, vouch to supporting documents e.g. raw material invoices, employee time records

O, A, C/O, E, R/O

9

Vouch disposals to supporting documents e.g. sales invoice, bank statement – confirmation of value of items being constructed – you would need expert advice on incomplete buildings etc. See audit trail – see entry in cash/ bank.

O, A, C/O, R/O

10

Vouch revalued assets to supporting documents e.g. the valuer’s report

V, C/O

11

Obtain confirmation of revalued amount from suitably qualified independent expert – auditor should check these qualifications.

V

12

Review client’s consideration of impairment and identify any indications of impairment. E.g. how has the client determined the recoverable amount? Be wary of bias creeping into estimations.

V, C/O

13

Review repairs and maintenance account and identify items that might be capital expenditure – compare to invoice details.

C,A,V,P, CL

14

Inspect title deeds or obtain confirmation from third parties (if not held by client) – for property – who owns it? If a mortgage the mortgage provider will hold the title deeds – difficult to replace if lost – often held by a solicitor in a fireproof safe.

E, R/O

15

Inspect vehicle registration documents – check listed owners and chassis numbers listed

E, R/O

16

Ensure assets are correctly classified including assets in the course of

P, CL

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construction – particularly important for depreciation policy – is the asset likely to last a number of years. What is its useful life? 17

Make sure that ‘right-to-use’ assets are treated as other PPE by the lessee – right to use assets – treat them as their own property – substance over form here.

A, V, C, CL

18

Conclude on appropriateness of depreciation rates and recalculate – auditor has to spend time focusing on depreciation as it affects carrying value of an asset and the income statement. Remember Waste Management. Residual value should be what you would get for a 10 year old asset today – make sure the client understands this.

A, V, C/O

19

Ensure all appropriate disclosures are made (capital commitments, security for loans etc)

P

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