2 Property, plant and equipment Tangible assets with a service life of more than one year that are used in the operation of the business and are not acquired for the purpose of resaleThree major subgroups:LandBuildings, machinery, equipment and land improvementsNatural resources
3 Objectives for the Audit of Property, Plant and Equipment 1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to property, plant, and equipment.2. Obtain an understanding of internal control over property, plant, and equipment.73
4 Objectives cont.Assess the risks of material misstatement and design tests of controls and substantive procedures that:Substantiate the existence of property, plant, and equipmentEstablish the completeness of recorded property, plant, and equipmentVerify the cutoff of transactions affecting property, plant, and equipmentDetermine that the client has rights to recorded property, plant, and equipmentEstablish the proper valuation or allocation of property, plant, and equipment and the accuracy of transactions affecting property, plant, and equipmentDetermine that the presentation and disclosure of property, plant, and equipment are appropriate
5 Audit Approach—Current Accounts Versus Noncurrent Account CashSecuritiesAccounts ReceivableInventoriesAccrued LiabilitiesAccounts PayableShort-Term NotesProperty, Plant& EquipmentIntangible AssetsLong-Term LiabilitiesOwner’s Equity AccountsHigh turnover accountsAudit approach—audit the balanceLow turnover accountsAudit approach—audit the changes in the accounts1012
6 Controls Over Plant and Equipment Use of a plant and equipment capital budgetMaintenance of a subsidiary ledgerA system of authorizationsAnalysis of variances from budgeted expendituresA statement of policy distinguishing between capital and revenue expendituresA requirement that purchases of plant and equipment are subjected to normal purchasing proceduresPeriodic physical inventoriesA system of retirement authorization and documentation62
7 Audit Documentation Working papers Summary analysis that emphasizes changes during the year under auditAnalyses of additions and retirements for the current yearAnalyses of repairs and maintenance expense accountsTests of depreciation
8 Initial Audits Beginning balances Substantiated by review of predecessor firm’s working papersIf not previously audited, a complete historical analysis of property accounts is neededThorough review of all major charges and credits to property accounts
9 PPE Audit Steps (1 of 3)A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to property, plant, and equipment.B. Obtain an understanding of internal control over property, plant, and equipment.C. Assess the risks of material misstatement and design further audit procedures.D. Perform further audit procedures—tests of controls.1. Nature of tests of controls.2. If necessary, revise the risks of material misstatement based on the results of tests of controls.
10 PPE Audit Steps (2 of 3)E. Perform further audit procedures—substantive procedures for property, plant, and equipment. 1. Obtain a summary analysis of changes in property owned and reconcile to ledgers. 2. Vouch additions to property, plant, and equipment during the year. 3. Make a physical inspection of major acquisitions of plant and equipment. 4. Analyze repair and maintenance expense accounts. 5. Investigate the status of property, plant, and equipment not in current use. 6. Test the client’s provision for depreciation. 7. Investigate potential impairments of property, plant, and equipment. 8. Investigate retirements of property, plant, and equipment during the year.
11 PPE Audit Steps (3 of 3) E. Perform further audit procedures (cont.) 9. Examine evidence of legal ownership of property, plant, and equipment.10. Review rental revenue from land, buildings, and equipment owned by the client but leased to others.11. Examine lease agreements on property, plant, and equipment leased to and from others.12. Perform analytical procedures for property, plant, and equipment.13. Evaluate financial statement presentation and disclosure for plant assets and for related revenue and expenses.
13 Summary of Substantive Tests of Property, Plant, and Equipment 95
14 Vouch Additions (1 of 2) Specific steps: a. Review changes during the year in construction in progress and examine supporting work orders, both incomplete and closed.b. Trace transfers from the Construction in Progress account to the property accounts, observing propriety of classification. Determine that all completed items have been transferred out of the account.c. On a test basis, vouch purchases of property, plant, and equipment to invoices, deeds, contracts, or other supporting documents. Recompute extensions, footings, and treatment of discounts. Make certain repairs and maintenance expenses were not improperly capitalized.
15 Vouch Additions (2 of 2)Specific steps (cont.) d. Investigate all instances in which the actual cost of acquisitions substantially exceeded authorized amounts. Determine whether such excess expenditures were analyzed and approved by appropriate officials. e Investigate fully any debits to property, plant, and equipment accounts not arising from acquisition of physical assets. f. Determine that the total cost of any plant and equipment assets purchased on the installment plan is reflected in the asset accounts and that the unpaid installments are set up as liabilities.
16 Analyze Expense Accounts Analyze repairs and maintenance expense accounts to:Discover items that should have been capitalizedUse company policy to determine consistency in applicationAnalyze monthly amounts for significant variations from:Month to monthBetween corresponding months of two years
17 Impairment of Long-Lived Assets Long-lived assets must be reviewed for impairment whenever events or changes in circumstances indicate that carrying value may not be recoverableTest involves projecting future cash flowsIf impairment is indicated by cash flows asset must be written down to fair valueMay require the use of a valuation specialist
18 Investigate Retirements Determine if property sold, dismantled, or abandoned without being reflected in accounting recordsSteps to discover unrecorded retirements:For new additions, determine status of old equipmentAnalyze miscellaneous revenue account for cash proceedsIf company’s products discontinued, investigate disposition of plant facilitiesInquire of executives and supervisors of plant asset retirementsExamine retirement work orders for proper authorizationInvestigate any reduction in insurance coverage
19 Analytical Procedures Ratios and trends for overall reasonableness of recorded amountsa. Total cost of plant assets divided by annual output in dollars, pounds, or other units.b. Total cost of plant assets divided by cost of goods sold.c. Comparison of repairs and maintenance expense on a monthly basis and from year to year.d. Comparison of acquisitions for the current year with prior years.e. Comparison of retirements for the current year with prior years.
20 Presentation and Disclosure Disclose major classes of depreciable assetsAccumulated depreciationPrinciples:a. The basis of valuation should be explicitly stated. At present, cost is the generally accepted basis of valuation for plant and equipment; property not in use should be valued at the lower of cost or estimated realizable value.b. Property pledged to secure loans should be clearly identified.c. Property not in current use should be segregated in the balance sheet.
22 Auditors’ Approach for Depreciation Important because depreciation is an estimate.Client makesEstimate of useful economic lifeChoice of several depreciation methodsAudit approach for estimateReview and test management’s process of developing the estimateReview subsequent events or transactions bearing on the estimateIndependently develop an estimate of the amount to compare to management’s estimate
23 Audit Program – Depreciation (1 of 5) 1. Review the depreciation policies set forth in company manuals or other management directives. Determine whether the methods in use are designed to allocate costs of plant and equipment assets systematically over their service lives.a. Inquire whether any extra working shifts or other conditions of accelerated production are present that might warrant adjustment of normal depreciation rates.b. Discuss with executives the possible need for recognition of obsolescence resulting from technological or economic developments.
24 Audit Program – Depreciation (2 of 5) 2. Obtain or prepare a summary analysis (see Figure 13.1) of accumulated depreciation for the major property classifications as shown by the general ledger control accounts, listing beginning balances, provisions for depreciation during the year, retirements, and ending balances. a. Compare beginning balances with the audited amounts in last year’s working papers. b. Determine that the totals of accumulated depreciation recorded in the plant and equipment subsidiary records agree with the applicable general ledger controlling accounts.
25 Audit Program – Depreciation (3 of 5) 3. Test the provisions for depreciation.a. Compare rates used in the current year with those employed in prior years and investigate any variances.b. Test computations of depreciation provisions for a representative number of units and trace to individual records in the property ledger. Be alert for excessive depreciation on fully depreciated assets. Generalized audit software can be used to test the depreciation calculations in the client’s records if the client maintains computer based records.c. Compare credits to accumulated depreciation accounts for the year’s depreciation provisions with debit entries in related depreciation expense accounts.
26 Audit Program – Depreciation (4 of 5) 4. Test deductions from accumulated depreciation for assets retired.a. Trace deductions to the working paper analyzing retirements of assets during the year.b. Test the accuracy of accumulated depreciation to date of retirement.5. Perform analytical procedures for depreciation.a. Compute the ratio of depreciation expense to total cost of plant and compare with prior years.b. Compare the percentage relationships between accumulated depreciation and related property accounts with those prevailing in prior years. Discuss significant variations from the normal depreciation program with appropriate members of management.
27 Audit Program – Depreciation (5 of 5) Overall test1. List the balances in the various asset accounts at the beginning of the year.2. Deduct any fully depreciated assets, since these items should no longer be subject to depreciation.3. Add one-half of the asset additions for the year.4. Deduct one-half of the asset retirements for the year (exclusive of any fully depreciated assets).
28 Natural Resources Properties subject to depletion Similar to depreciationRecorded consistently and in accordance with GAAPTest mathematical accuracyOften rely on specialists for valuationEstablish ownership
29 Audit of IntangiblesAssets with definite useful lives are audited similar to property, plant and equipmentAssets with indefinite useful lives (e.g., goodwill) must be tested for impairmentAuditors generally rely on business valuation specialists to value goodwill for tests of impairment
30 Audit of PPE in Advance Most work can be done in advance Consideration of internal control can be carried out at any convenient timeMany firms audit during interim work in October and NovemberAfter balance sheet date, only need to exam transaction for final two or three months