Auditing - Property, Plant and Equipment

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. :)