Auditing Principles - CH 13 - PPE: Depreciation and Depletion
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Property, plant and equipment
- ØTangible 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
- ØThree major subgroups:
- lBuildings, machinery, equipment and land improvements
- lNatural resources
Assess the risks of material misstatement and design tests of controls and substantive procedures that
Substantiate the existence of property, plant, and equipment
Establish the completeness of recorded property, plant, and equipment
Verify the cutoff of transactions affecting property, plant, and equipment
Determine that the client has rights to recorded property, plant, and equipment
Establish the proper valuation or allocation of property, plant, and equipment and the accuracy of transactions affecting property, plant, and equipment
Determine that the presentation and disclosure of property, plant, and equipment are appropriate
High turnover accounts
Audit approach—audit the balance
Low turnover accounts
Audit approach—audit the changesin the accounts
Property, Plant & Equipment
Owner’s Equity Accounts
Controls Over Plant and Equipment
ØUse of a plant and equipment capital budget
ØMaintenance of a subsidiary ledger
ØA system of authorizations
ØAnalysis of variances from budgeted expenditures
ØA statement of policy distinguishing between capital and revenue expenditures
- ØA requirement that purchases of plant and
- equipment are subjected to normal purchasing procedures
ØPeriodic physical inventories
- ØA system of retirement authorization and
lSummary analysis that emphasizes changes during the year under audit
lAnalyses of additions and retirements for the current year
lAnalyses of repairs and maintenance expense accounts
lTests of depreciation
lSubstantiated by review of predecessor firm’s working papers
lIf not previously audited, a complete historical analysis of property accounts is needed
- •Thorough review of all major charges and
- credits to property accounts
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
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
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
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
Analyze Expense Accounts
ØAnalyze repairs and maintenance expense accounts to:
- lDiscover items that should have been capitalized
- lUse company policy to determine consistency in application
- lAnalyze monthly amounts for significant variations from:
- •Month to month
- •Between corresponding months of two years
Impairment of Long-Lived Assets
ØLong-lived assets must be reviewed for impairment whenever events or changes in circumstances indicate that carrying value may not be recoverable
ØTest involves projecting future cash flows
ØIf impairment is indicated by cash flows asset must be written down to fair value
ØMay require the use of a valuation specialist
ØDetermine if property sold, dismantled, or abandoned without being reflected in accounting records
ØSteps to discover unrecorded retirements:
1.For new additions, determine status of old equipment
2.Analyze miscellaneous revenue account for cash proceeds
3.If company’s products discontinued, investigate disposition of plant facilities
4.Inquire of executives and supervisors of plant asset retirements
5.Examine retirement work orders for proper authorization
6.Investigate any reduction in insurance coverage
- Ratios and trends for overall reasonableness of recorded amounts
- a. 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.
Presentation and Disclosure
ØDisclose major classes of depreciable assets
- 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.
Auditors’ Approach for Depreciation
lReview and test management’s process of developing the estimate
lReview subsequent events or transactions bearing on the estimate
lIndependently develop an estimate of the amount to compare to management’s estimate
ØProperties subject to depletion
ØSimilar to depreciation
lRecorded consistently and in accordance with GAAP
lTest mathematical accuracy
lOften rely on specialists for valuation
Audit of Intangibles
ØAssets with definite useful lives are audited similar to property, plant and equipment
ØAssets with indefinite useful lives (e.g., goodwill) must be tested for impairment
ØAuditors generally rely on business valuation specialists to value goodwill for tests of impairment
Audit of PPE—Advance Work
ØMost work can be done in advance
ØConsideration of internal control can be carried out at any convenient time
ØMany firms audit during interim work in October and November
ØAfter balance sheet date, only need to exam transaction for final two or three months
Audit Program – Depreciation
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.
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.
- 3. Test the provisions for depreciation.
- a. Compare rates used in the current year with those employed in prior years and investigate any variances
- 4. Test deductions from accumulated depreciation for assets retired.
- a. Trace deductions to the working paper analyzing retirements of assets during the year.
- 5. Perform analytical procedures for depreciation.
- a. Compute the ratio of depreciation expense to total cost of plant and compare with prior years
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