How do auditors audit property, plant and equipment (PPE) or the one used to be called fixed assets?
Since audit is an art, each accounting firm has their
own procedures to audit property, plant and equipment. Different audit might point different significant points to audit each area.
Here is a quick look based on my experience:
There are several mandatory procedures that we have to perform:
1.
Obtain
the list of PPE accounts
This list
consists of all outstanding fixed assets.
Purpose: to understand the nature of outstanding PPE and for recalculating the depreciation expense (related with audit procedures for operating expense).
2.
Obtain
the list and movement of PPE
Agree listing to PPE account balance
Client should
provide the list of all PPE owned by the Company. These fixed assets should be
categorized based on the PPE accounts so that we can tie up the total amount of
assets in PPE listing to the balance of PPE account.
We also have to
prepare movement of PPE. This movement will be presented in notes to financial
statement. The general PPE movement format is usually like this:
Coloumn
beginning balance consists of the amount of PPE on the beginning of the
financial year. For example, the audited financial year is 1 January 2012 - 31
December 2012, beginning balance will consists the amount of PPE on 1 January
2012.
Coloumn
additions consists of the amount of PPE purchase during the year.
Coloumn
reclassifications informs any reclassification between PPE accounts. The
general reclassification in PPE is from Construction in Progress to each PPE
accounts (such as Building or Machinery).
Coloumn disposal
includes all disposal due to sales or due to termination of use.
Understanding PPE nature
While receiving
the listing, auditors need to perform scanning analytic as well. In this
procedure, we scan the items of PPE so that we can understand the nature of
assets owned by the Company. We need to be aware of any significant variance
during the year. For example, significant increase in Machine category existed
during the year. We need to perform inquiry to client wheter there are any
special reasons that triggers the signficant increase (such as the opening of
new plant, addition of product line). This understanding will enrich our
understanding of the Company as a whole.
The same goes
for disposal. If there were significant disposals during the year, we need to
perform inquiry to client to understand the reasons of disposal. For example,
if the reason is because the machines broke down, we need to assess whether
this condition triggers to the impairment of other assets, whether the
estimated useful life set by the management is proper or not.
3.
Understand
and evaluate accounting policies
These accounting
policies are important because they will affect the next procedures for PPE and
also presented in the notes to financial statements.
There are some
important accounting policies for PPE:
-
Capitalization policy
Some companies apply minimum amount for PPE. For example,
for assets with price below USD 1,000 will be directly expensed
-
Depreciation method: straight line, double
declining balance or sum of year digit
-
Estimated useful life for each fixed assets
category
-
Capitalization of borrowing cost
4.
Test
depreciation expense
There are two
ways to test depreciation expense:
a.
By recalculating the depreciation expense
b.
Analytical procedures
In this option, we will try to get the triggers that
will affect the balance of depreciation expense. For example, we will look at the
connection between the increase of depreciation expense with the addition of
PPE.
5.
Test
additions of PPE
In this testing,
the population includes all additions of PPE.
Audit procedures
that are usually used in test additions of PPE are analytical scanning for
significant additions, pick samples and vouch to documents.
The main
assertions that we want to capture in test additions are: accuracy and
existence.
Make sure that
all PPE additions recorded during the year are proper:
-
How they calculate PPE additions in foreign currency?
Small difference of exchange rate used might triggers
significant difference if the PPE additions during the year are significant.
-
Have they used proper capitalization policy?
-
Have they recorded the addition in the proper
timing? (this will affect the depreciation)
6.
Test
transfer of construction in progress (CIP)
Population in
this testing includes all off CIP transfer to other PPE categories during the
year.
Audit procedures
that are usually used in the testing are analytical scanning for significant
additions, pick samples and vouch to documents.
Most important
document to vouch in this testing is: hand over / completion report. This
document will trigger the transfer of CIP. Date of CIP transfer has to be based
on this document. If the date of CIP transfer is not based on that document, we
may not jump to conclusion, but we need to inquiry further to client.
For example: the
Company is constructing a new production line which consists of Machine A, B and
C. The Company purchase Machine A, B and C on 30 August 2014. Machine A and B
have been completely installed on 2 Oct 2014, however, machine C has just been
completely installed on 1 Nov 2014. After machine C is completely installed,
the product line is ready to be used.
How should we
record the transactions?
30 August 2014
CIP – Machine A
CIP – Machine B
CIP – Machine C
Cash/
AP
2 Oct 2014
No journal
entries. (Machine A and B are completely installed, but not yet ready to use
since the production line is not yet ready).
1 Nov 2014 (transferring the CIP to
Machine)
Machine A
Machine B
Machine C
CIP
– Machine A
CIP
– Machine B
CIP
– Machine C
7.
Examine
repairs and maintenance
In this testing,
the main purpose is to make sure that the Company has followed the proper
capitalization policy. Make sure that:
-
The transactions only include expenses that do
not increase the value of assets.
-
Some expenses may increase the value of the
assets. However, if the amounts are considered immaterial based on the Company’s
capitalization policies, they can be directly expensed.
Note: the above explanation is based on my own experience. Any inputs and opinions are appreciated. :)
