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Obtain a summary analysis in changes in property owned and reconcile to ledgers.
The auditors may be verify the balances of plant and equipment assets by reference to the prior year’s audit working papers. In addition to beginning balances, the summary analysis will show the additions and retirements of plant and equipment during the year under audit. As the audit progresses, the auditors will examine a sample of these additions and retirements. The detailed working papers showing this verification will support and be crossindexed to the summary analysis worksheet. Before making a detailed analysis of changes in property accounts during the year, the auditors will want to be sure the amounts in the subsidiary ledgers agree in total with the balances in the controlling accounts. Reconciliation of the subsidiary ledgers with the controlling accounts can be performed very quickly with the use of generalized audit software. 2. Vouch additions property, plant, and equipment during the year. The vouching of additions to the property, plant and equipment accounts during the period under audit is one of the most important substantive tests. The extent of the vouching is dependent upon the auditors’ assessment of control risk for the existence and valuation of plant and equipment. The vouching process utilizes a working paper analysis of the general ledger controlling accounts and includes the tracing of the entries trough the journals to original documents, such as contracts, deeds, construction work orders, invoices, canceled checks, and authorization by appropriate individuals. The specific steps to be taken in investigating the year’s addition usually will include the following: 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. c. On a test basis, vouch purchases of plant property, and equipment to invoices, deeds, contracts, or other supporting documents. Recompute extensions, footings, and treatment of discounts. Make certain revenue expenditures were not improperly capitalized. d. Investigate all instances in which the actual costs of acquisitions substantially exceed 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 unpaid installments are set up as liabilities. Ascertain that all plant and equipment leases that, in effect,
are installment purchases are capitalized. Interest charges should not be capitalized as a cost of the asset required. The accounting for plant asset acquired in a trade-in or other exchange is specified by ABP Opinion No. 29, “ Accounting for an Nonmonetary Transactions.” No gain is recognized when a plant asset is exchanged for a similar plant asset. The asset required in the exchange is valued at the carrying amount of the asset given up plus any additional cash paid or amount financed. Asset constructed by a company for its own use should be recorded at the cost of direct material, direct labor, and applicable overhead cost. However, auditors may apply the additional test of comparing the total cost of self-constructed equipment with bids or estimated purchase prices for similar equipment from outside suppliers; excess cost of selfconstructed asset should be expensed in the period that construction is completed. Related Party Transactions. Assets acquired from affiliated corporations, from promoters or stockholders, or by any type of related-party transaction not involving arm’s-length bargaining between buyer and seller have sometimes been recorded at inflated amounts. The auditor should inquire into the methods by which the sales price was determined, the cost of the property to e vendor, length of ownership by the vendor, and any other available evidence that might indicate an arbitrarily determined valuation. Material related party transactions must be disclosed in the notes to the financial statements. 3. Make a physical inspection of major acquisition of plant and equipment. The auditors usually make a physical inspection of major units of plant and equipment acquired during the year under audit. This step is helpful in maintaining a good working knowledge of the client’s operation and also in interpreting the accounting entries for both addition and retirements. The audit procedure of physical inspection may flow in either direction between the plant assets and records of plant assets. By tracing items in the plant ledger to the physical assets, the auditors prove that the assets shown in the accounting records actually exist and are in the current use. The alternative testing procedure is to inspect selected assets in the in the plant and trace these assets to the detailed records. This test provides evidence that existing assets are recorded. The physical inspection of plant assets may be limited to major units acquired during the year or maybe extended to include tests of older equipment as well. In a few situations (especially when control risk is very high), the auditors may conclude that the taking of completely physical inventory is needed. Bear in mind, however, that a complete physical inventory of plant and equipment is a rare event. If such inventory is required, the auditors’ role is to observe the physical inventory. Let us consider an example of a situation in which the auditors might conclude that a complete physical inventory of equipment is needed. Assume that a client is engaged in
commercial construction work and that the client owns and operates a great many units of costly mobile equipment. Such equipment may often be scrapped or sold upon the authorization of a field supervisor. Under these circumstances, the auditor might regard a complete physical inventory of plant and equipment as essential. Similarly, in the audit of clients owning a large number of automobile and trucks, the auditors may insist upon observing a physical count as well as examining legal title. Some large companies, as part of their internal control, perform occasional physical inventories of plant and equipment at certain location or in selected departments. The observation of these limited counts is often carried out by the clients internal auditing staff rather than by the independent auditors. 4. Analyze repair and maintenance expense accounts. The auditors principal objective in analyzing repair and maintenance expense accounts is to discover items that should have been capitalized. Many companies have a written policy setting the minimum expenditure to be capitalized. For example, company policy may prescribe that no expenditure for less than $300 shall be capitalized regardless of the service life of the item purchased. In such cases, the auditors will analyze the repair and maintenance accounts with a view toward determining the consistency of application of this policy as well as compliance with generally accepted accounting principles. To determine that the accounts contains only proper repair and maintenance charges, the auditors will trace the larger expenditures to written authorizations for transaction. The accuracy of the client’s accounting for the expenditures maybe verified by reference the vendors invoices, to material requisitions, and to labor time records. One useful means of identifying any capital expenditures that are included in the repair and maintenance accounts is to obtain or to prepare an analysis of monthly amounts of expense with corresponding amount listed for the preceding years should be fully investigated. If maintenance expense is classified by the departments serviced, the variations are especially noticeable. 5. Investigate the status of property, plant and equipment not in current use. Land, buildings, and equipment not in current use should be investigated thoroughly to determine the prospects for their future use in operations. Plant assets that are temporarily idle need not be reclassified, and depreciation may be continued at normal rates. On the other hand idle equipment that has been dismantled, or that for any reason appears unsuitable for the future operating use, should be written down to an estimated realizable value and excluded from the plant and equipment classification. In the case of standby equipment and other property not needed at present or prospective levels of operation, the auditors should consider whether the carrying value is recoverable through future use in operations. ILLUSTRATIVE CASE During 1970’s, many larger public utility companies began he construction of nuclear power plants which were believed to be the best source of electricity for the future. By the mid1980’s, however, number of these projects had turned into financial nightmares. In many
cases the cost to date of a half-completed nuclear plants was several times the original estimate of total cost. Construction had ground virtually to a halt, and the prospects for getting these nuclear plants into operation will dim. Efforts of antinuclear lobby and legal battles combined with engineering problems to raise doubts whether nuclear plants representing investments in the billions would ever become operational. These developments created a most difficult situation for the CPA firms having “nuclear utilities” as clients. Should the costly nuclear facilities be written off even though such action would wipe out the stockholders’ equity? Should the uncompleted facilities be carried at cot in the companies’ financial statements despite the distinct possibility they would never be completed? Most auditing firms felt that they must modify their audit reports to indicate that the future solvency of the client company rested on a favorable solution to the problem of the uncompleted nuclear plant. 6. Test the client’s provision for depreciation. See the separate depreciation program following this audit program. 7. Investigate retirements of property, plant, and equipment during the year. The principal purpose of this procedure is to determine whether any property has been replaced, sold, dismantled, or abandoned without such action being reflected in the accounting records. Nearly even thorough physical inventory of plant and equipment reveals missing unit of property-units disposed of without a corresponding reduction of the accounts. If a machine is sold for cash or a traded in on a new machine, the transaction generally will involve the use of documents, such as a cash receipts form or a purchase order; the processing of these documents may be bring the retirement to the attention of accounting personnel. However, plant assets may be scrapped rather than sold or traded in on a new equipment consequently, there may be no paperwork to evidence the disappearance of a machine. How is the accounting department expected to know when the asset has been retired? One method of guarding against unrecorded retirements is enforcement of a company-wide policy that no plant asset should be retired from use without prior approval on a special type of serially numbered work order. A copy of retirement work order is routed to the accounting department, thus providing some assurance that retirements will be reflected in the accounting records. What specific steps should the auditors take to discover any unrecorded retirements? The following measures often are effective: a. If major additions of plant and equipment have been made during the year, ascertain whether old equipment was traded in or replaced by the new units. b. Analyze the Miscellaneous Revenue account to locate any cash proceeds from sale of plant assets. c. If any of the company’s products have been discontinued during the year, investigate the disposition of plant facilities formerly used in manufacturing such products.
d. Inquire of executives and supervisors whether any plant assets have been retired during the year. e. Examine retirement work orders or other source documents for authorization by the appropriate official or committee. f. Investigate any reduction of insurance coverage to determine whether this was caused by retirement of plant assets. 8. Examine evidence of legal ownership of property, plant, and equipment. To determine that plant assets are the property of the client, the auditors look for such evidence as deed, title insurance policy, property tax bills, receipts for payments to mortgagee, and fire insurance policies. Additionally, the fact that rental payments are not being made is supporting evidence of ownership. It is sometimes suggested that the auditors may verify ownership of real property and the absence liens by examination of public records. This step is seldom taken. Inspection of the documentary evidence listed above usually provides adequate proof of ownership. If some doubt exists as to whether the client has clear title to property, the auditor should obtain the opinion of the client’s legal counsel or request that a title search be performed by a title insurance company. Possession of a deed is not a proof of present ownership because when real property is sold, a new deed is prepared and the old one is retained by the seller. This is true of title insurance policies as well. Better evidence of continuing ownership is found in property tax bills made out in the name of the client and in fire insurance policies, rent receipts from lessees, and regular payments of principal and interest to a mortgagee or trustee. The disclosure of liens on property is considered during the examinations of liabilities, but in the audit work on plant and equipment the auditors should be alert the evidence indicating the existence of liens. Purchased contacts examined in verifying the cost of property may reveal unpaid balances. Insurance policies may contain loss payable endorsements in favor of a secured party. The ownership of automobiles and trucks can readily be ascertained by the auditors by reference to certificates of title and registration documents. This ease of transfer of title to automotive equipment, plus the fact that it is often used as collateral for loans, makes it important that the auditors examine the title to such property.
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