Audit Depreciation

Introduction
As auditors, we usually perform substantive analytical procedures in the audit of
depreciation. However, where the risk is high in this area and we assess that the
internal control cannot rely upon, we might need to perform the test of details
instead. 
In the accounting or audit, depreciation is the way the company spread the cost
of a fixed asset over the useful life of the asset. The spreading cost is based on
the economic value that the asset provides to the company.
Likewise, there are several commonly seen depreciation methods of the fixed
asset that we may need to know when we audit depreciation. In this case, such
depreciation methods may include the straight-line depreciation method,
declining balance, units of production, and sum of the years’ digits.
The primary inherent risk of depreciation in the financial statements is that the
depreciation expense may be understated. This can be due to the company may
use the inappropriate depreciation method and the estimated useful life of the
assets to manipulate depreciation expenses in order to increase the company’s
profit in the current year.
Hence, it is important for us to carefully assess the reasonableness of the
depreciation method and the estimated useful life that the client used in the
calculation of the fixed asset depreciation.

Audit Procedures for Depreciation

As auditors, we have responsibility to design appropriate audit procedures in
order to obtain sufficient appropriate audit evidence to support our opinion. In
this case, the type of audit procedures for depreciation may depend entirely on
the risk of material misstatement that can occur in the depreciation expense
accounts.
Hence, based on the risk level of the depreciation expense that is exposed to the
client’s financial statements, we may perform either analytical procedures or
substantive tests of details. 
Usually, we perform analytical procedures on depreciation expense when the
assessed risk in this area is low. On the other hand, we need to perform the test
of details in order to gather sufficient audit evidence to make a conclusion on
depreciation expense account if the assessed risk of material misstatement here
is high.
Analytical Procedures for Depreciation
When we determine that the risk is low and the client has proper internal control
on fixed assets and depreciation, we usually audit depreciation by performing
substantive analytical procedures. In this case, substantive analytical procedures
for the audit of depreciation may include the reasonableness test, trend analysis,
and examining the related accounts. 
Like other accounts, we usually perform the substantive analytical procedures for
depreciation by starting with building our expectations; and then we compare
our expectations with the client’s record. 
However, it is useful to note that we should always consider the reliability of the
data that we use to build our expectations when performing analytical
procedures. Also, we need to properly determine the suitability of particular
procedures in testing certain assertions. 
Example of Analytical Procedures for Depreciation
For example, we audit depreciation by performing a reasonableness test on the
assets that use the straight-line method. To do this, we build our expectations
with the estimated amount of depreciation by using the average depreciation
rate and the average cost of fixed assets. 
In this case, fixed assets should be breakdown by types of assets as they should
have some differences in depreciation rate. Also, new added fixed assets and
fixed assets disposal should be taken into account as the adjustment to the
estimate depreciation. 

Then we compare the result with the depreciation expense in the client’s record.
If there is a significant difference that is outside of our expected range, we will
investigate further e.g. by performing the test of details. 
Other procedures may also be performed including: 
 Comparing the current year depreciation expense with the previous year
 Reviewing the relationship and fluctuation of depreciation expense
comparing those of fixed asset costs
 Reviewing the average age of fixed assets comparing to our estimate of
fixed asset depreciation rate
Test of Details for Depreciation
In a situation where we determine that there are high risk and no proper internal
control in place to prevent or detect material misstatement related to
depreciation expense accounts, we usually audit depreciation by performing the
test of details.
In this case, we usually perform the test of details by selecting a sample of
depreciation recorded in the general ledger and perform the recalculation
procedure.
Below is an example of test of details for depreciation:
 Obtain fixed assets register or listing containing all important information
including fixed assets cost, estimated useful life, residual value and
depreciation method.
 Reconcile fixed assets register to the general ledger
 Select a sample of fixed assets in the fixed assets register
 Recalculate depreciation expense on the selected sample of the fixed asset
 Compare the result of recalculation to the client’s record of each selected
fixed assets