AUDIT OF PPE

Common audit procedures:

1. Request a schedule of fixed assets/lapsing schedule which shows the beginning balance of the fixed
assets (cost, accumulated depreciation and carrying amounts and any impairment losses), ending
balances of fixed assets and movements (additions and disposals and any transfers)
2. Asset verification – physical inspection of fixed assets (floor to list testing – completeness of the list;
and list to floor testing – existence of the fixed assets)
3. Beginning balances of the lapsing schedule will be tied out to the audited FS last year or PY working
paper (if new client, performing tests of the beginning balances)
4. Test of details for additions and disposals during the year (vouch to supporting documents)
a. Additions – vouch to the sales invoice received, delivery receipt, authorization, requisition
and purchase order (did the purchase actually occur and asset actually received? Was the
acquisition properly authorized?)
b. Disposals – vouch to the official receipt (if sold), asset disposal form
5. Test of capitalized/capitalizable subsequent costs
a. Costs capitalized as fixed assets – starting point: costs debited to fixed assets – assessing the
nature of the costs to determine if these are properly capitalized or should have been
expensed based on IAS 16, Property, Plant and Equipment and client’s capitalization criteria
(capitalize if the productivity of the asset or useful life of the asset improves and if
>monetary threshold of the client)
b. Costs capitalizable as fixed assets – starting point: costs charged to Repairs and Maintenance
Expense – assessing the nature of the costs to determine if these are properly expensed or
should have been capitalized
6. Test reasonableness of useful lives used by the client – through a memo and comparing with industry
standards
7. Depreciation expense tested using substantive analytical procedures (SAP)
a. Understanding whether SAP can be performed such as depreciation
b. Develop an estimation of depreciation expense using inputs
Example:
• (Beg Cost + Ending Cost)/2 = Average Cost of PPE divide by Useful Life =
Expected Depreciation
• (Beg. CV + End CV)/2 = Average CV of PPE divided by Average Remaining
Life = Expected Depreciation
• (Beg. CV – Disposals During the year) divided by useful life + Additions divided
by 2 divided by useful life + Disposals during the year divided by 2 divided by
useful life = Expected Depreciation
c. Determine the difference/variance between recorded depreciation by the client and expected
depreciation of the audit team
• If the variance is > “threshold” = test further – one by one computation of
depreciation for selected samples
• If the variance is < “threshold” = no further testing
8. Impairment testing
a. If there are no indicators of impairment – prepare a memo highlighting the assessment that
there are no indicators of impairment
b. If there are indicators of impairment – testing the impairment valuation through testing the
reasonableness of the fair value or value in use, whichever is higher (test of assumptions, test
of cash flow projections, etc.)
PROBLEM 1:
You were assigned to do the audit of property, plant and equipment section of ABC Corporation’s statement
of financial position at December 31, 2022. You requested for the schedule of additions made during the year
and reviewed the reasonableness and accuracy of the postings made to each account. You were provided with
the following information:
Year-end balances
Land P13,900,000
Land Improvements P560,000
Building 12,740,000
Machinery and equipment 15,880,000

Land
Beginning Balance (audited) P2,500,000
Cash paid on purchase of land 10,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Ending Balance P13,900,000
The entity paid the mortgage on the land bought, including interest at 16% worth P16,000,000 and costs to
relocate persons squatting on the property worth P400,000. Both items were recognized as outright expense
upon payment.

PC PA PAJE
Expense 16,000,000 Land 16,000,000 Land 16,000,000
Mortgage payable (16,000,000) Mortgage payable (16,000,000) Expense (16,000,000)

Mortgage payable 16,000,000 Mortgage payable 16,000,000 No entry

Cash (16,000,000) Cash (16,000,000)

Expense 400,000 Land 400,000 Land 400,000

Cash (400,000) Cash (400,000) Expense (400,000)

Land Improvements
There were no changes made to this account during the year.

Building
Beginning Balance (audited) P3,600,000
Cost of tearing down an old building on the land (demolition costs) 300,000
Amount recovered from the salvage of the building demolished (600,000)
Cost of fencing the property (should be land improvement) 440,000
Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Interest that would have been earned had the money used during the period
of construction been invested in the money market (opportunity cost) 600,000
Ending Balance P12,740,000

PC PA PAJE
Building 300,000 Building 300,000 No entry
Cash (300,000) Cash (300,000)
 Cash 600,000 Cash 600,000 Building 300,000
Building 600,000 Building (300,000) Other income (300,000)
Other income (300,000)

Building 440,000 Land improvement 440,000 Land improvement 440,000

Cash (440,000) Cash (440,000) Building (440,000)

Building 600,000 No entry ??? 600,000

??? (600,000) Building (600,000)

Machinery & Equipment

Beginning Balance (audited) P6,600,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading and delivery charges 240,000
Customs duties and other charges 560,000
Royalty payments on machines purchased (based on units produced and
sold) (royalty payments are subsequent expenditures that do not improve 480,000
productivity or extend useful life – expensed)
Ending Balance P15,880,000

The entity paid allowances, hotel accommodations, etc. paid to foreign technicians during installation and test
run of machines worth P1,600,000 and was charged to operating expense.

PC PA PAJE
Machinery 480,000 Expense 480,000 Expense 480,000
Cash (480,000) Cash (480,000) Machinery (480,000)

Expense 1,600,000 Machinery 1,600,000 Machinery 1,600,000

Cash (1,600,000) Cash (1,600,000) Expense (1,600,000)

Required: Based on the above and the result of your audit, compute for correct amount for the following accounts as of December
31, 2022:
1. Land – 30,300,000
2. Land Improvements – 1,000,000
3. Building – 12,000,000
4. Machinery and Equipment – 17,000,000
5. Total depreciable property, plant and equipment – 1,000,000 + 12,000,000 + 17,000,000 = 30,000,000

Solution #1:
Land Land Building Machinery
Improvements and Equipment
Beginning audited balance 2,500,000 560,000 3,600,000 6,600,000
Cash paid on purchase of land 10,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Mortgage assumed on land 16,000,000
Payment to squatters 400,000
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building demolished (300,000)
Cost of fencing the property 440,000
Amount paid to a contractor for the building erected 8,000,000
 Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading and delivery charges 240,000
Customs duties and other charges 560,000
Installation and test run 1,600,000
Ending balance 30,300,000 1,000,000 12,000,000 17,000,000

Solution #2:
Land Land Building Machinery
Improvements and Equipment
Unaudited ending balance 13,900,000 560,000 12,740,000 15,880,000
Audit adjustments
Mortgage assumed on land 16,000,000
Payment to squatters 400,000
Excess salvage proceeds 300,000
Cost of fencing 440,000 (440,000)
Opportunity cost (600,000)
Royalty payments (480,000)
Installation and test run 1,600,000
Audited ending balance 30,300,000 1,000,000 12,000,000 17,000,000

PROBLEM 2: (please answer over the break)

ABC Corporation was incorporated on January 2, 2022, but was unable to begin manufacturing activities until
July 1, 2022 (start of depreciation; depreciation starts once the asset is available for intended use) because the
new factory facilities were not completed until that date.

The “Land and Building” (land and building should be accounted for in separate accounts because land is
generally not depreciated) account at December 31, 2022 follows:
Date Particulars Amount
Jan. 31 Land and building (to be allocated) P1,098,000 Land
Feb. 28 Cost of removal of old building (demolition costs) 60,000 Building
May 2 Partial payment on new construction 700,000 Building
May 2 Legal fees paid (refer to item B) 15,000 4,000 –
Land
1,500 -
Building
Jun. 1 Second payment on new construction 600,000 Building
Jul. 1 Claims for damages sustained during the construction of 26,000
building (expense)
Jul. 1 Final payment on new construction 200,000 Building
Dec. 31 Asset revaluation surplus (no revaluation under the cost model) 500,000
P3,199,000
Dec. 31 Depreciation – 2022 at 1% of account balance (to be 31,990
recomputed)
P3,167,010

You were able to gather the following during your audit:

A. To acquire land and building, the company paid P98,000 cash and 10,000 shares of its 9% cumulative
preferred shares, P100 par value per share. The shares were then selling at P120.
B. Legal fees covered the following:
Cost of incorporation (expense) P9,500
Examination of title covering purchase of land 4,000
Legal work in connection with construction contract 1,500
Total P15,000

C. Because of a general increase in construction materials costs after entering into the building contract, the
board of directors increased the value of the building by P500,000, believing such increase is justified (for
accounting purposes, this is not a valid basis for revaluation even under the revaluation model) to reflect
current market value at the time the building was completed. Retained earnings was credited for this
amount.

D. Estimated useful life of the building is 25 years.

E. The Company opted to follow the cost model as its accounting policy.

Required:
1. Prepare the necessary adjusting journal entries as of December 31, 2022.
2. Determine the adjusted balances of the following as of December 31, 2022:
a. Land – 1,298,000 + 4,000 = 1,302,000
b. Carrying value of building – 1,561,500 less 31,230 = 1,530,270
c. Land and building - zero
d. Organization cost, net (presented under Noncurrent Assets) - zero

PC PA PAJE
L&B 1,098,000 Land 1,298,000 Land 1,298,000
Cash (98,000) Cash (98,000) L&B (1,098,000)
PSC (1,000,000) PSC (1,000,000) SP – PS (200,000)
SP – PS (200,000)

L&B 60,000 Building – new 60,000 Building – new 60,000

Cash (60,000) Cash (60,000) L&B (60,000)

L&B 700,000 Building – new 700,000 Building – new 700,000

Cash (700,000) Cash (700,000) L&B (700,000)

L&B 15,000 Expense 9,500 Expense 9,500

Cash (15,000) Land 4,000 Land 4,000
Building – new 1,500 Building – new 1,500
Cash (15,000) L&B (15,000)

L&B 600,000 Building – new 600,000 Building – new 600,000

Cash (600,000) Cash (600,000) L&B (600,000)

L&B 26,000 Expense 26,000 Expense 26,000

Cash (26,000) Cash (26,000) L&B (26,000)

L&B 200,000 Building – new 200,000 Building – new 200,000

Cash (200,000) Cash (200,000) L&B (200,000)

L&B 500,000 No entry RE 500,000

RE (500,000) L&B (500,000)

Dep 31,990 Dep 31,230 L&B 31,990

L&B (31,990) Acc. (31,230) Dep. (760)
(1,561,500 divide 25 years x 6/12) Acc. (31,230)
PROBLEM 3:
At the beginning of the year, ABC Company’s noncurrent assets and accumulated depreciation accounts had
the following balances:

Cost Accumulated
Depreciation
Land P 130,000
Buildings 1,200,000 P 263,101
Machinery and Equipment 775,000 200,000
Delivery Equipment 132,000 86,724
Leasehold improvements 230,000 115,000

The company’s policy regarding depreciation is:

Depreciation Method Useful Life
Land Improvements Straight-line 15 years
Buildings 150% declining balance 25 years
Machinery and Equipment Straight-line 10 years
Delivery Equipment 150% declining balance 5 years
Leasehold improvements Straight-line 8 years

Depreciation is to be computed to the nearest month.

Transactions for the current year are as follows:

Jan 1 The leasehold improvements were completed on December 31, 2018 2020. The related lease
was to be terminated on December 31, 2020 2022 (original lease term 2 years). Judith ABC
exercised the renewal option to extend the lease agreement for an additional 4 years.

Original lease term – 2 years (shorter)

Original useful life – 8 years
Cost of leasehold improvement 230,000
Residual value (0)
Depreciable cost 230,000
Divide: Lease term (shorter) 2 years
Annual depreciation 115,000
Multiply: Age as of January 1, 2022 1 year
Accumulated depreciation, January 1, 2022 115,000

January 1, 2022 (1 year depreciated)

Remaining lease term: 2 years – 1 year = 1 year + 4 years additional = 5 years (shorter)
Remaining useful life: 8 years – 1 year = 7 years

Cost of leasehold improvement 230,000

Accumulated depreciation, 1/1/2022 (1 year) (115,000)
Carrying value, 1/1/2022 115,000
Residual value (0)
Remaining depreciable cost 115,000
Divide: Remaining lease term (shorter) 5 years
Revised annual depreciation 23,000
Jan. 6 A plant consisting of land and building was acquired from Salome Company for P600,000.
80% of the selling price was allocated to the building.

Per audit:
Land (600,000 x 20%) 120,000
Building (600,000 x 80%) 480,000
Cash 600,000

IF the old building was demolished

Loss 480,000
Building 480,000
Then capitalize the demolition costs.

April 6 New parking spaces were completed for the new plant at a total cost of P240,000.

Per audit:
Land improvements 240,000
Cash 240,000

July 1 Machinery and equipment were purchased at a total invoice price of P250,000 Delivery and
installation costs of P10,000 and P30,000 were also incurred respectively.

Per audit:
Machinery and Equipment 290,000
Cash 290,000
(250,000 + 10,000 freight + 30,000 installation)

Aug. 30 A new delivery equipment was purchased for P15,000.

Per audit:
Delivery Equipment 15,000
Cash 15,000

Sept. 30 A delivery equipment with a cost of P24,000 and a carrying amount of P9,114 on the date of
sale (already includes CY depreciation) was sold for P12,000. Depreciation for the 9 months
ended September 30, 2022 (January 1 to September 30) was P2,646.

Per audit:
Cash 12,000
Accumulated Depreciation (24,000 – 9,114) 14,886
Delivery Equipment 24,000
Gain on sale (12,000 – 9,114) 2,886

Dec. 20 A machine with a cost of P20,000 and a carrying amount of 5,000 at date of disposition (already
includes CY depreciation) was scrapped (disposed of for no or minimal value).

Per audit:
Loss 5,000
Accumulated Depreciation (20,000 – 5,000) 15,000
Machinery and Equipment 20,000

1. How much is the depreciation expense on land improvements for 2022? 12,000
2. How much is the depreciation expense on building for 2022? 85,013.94
3. How much is the depreciation expense on machinery and equipment for 2022? 92,000
4. How much is the carrying amount on January 1 of the delivery equipment sold on September 30? 11,760
5. How much is the depreciation expense for 2022 on delivery equipment? 14,200.80
6. How much is the depreciation expense on leasehold improvements for 2022? 23,000
7. How much is the total depreciation expense for 2022? 226,214.74
8. How much is the carrying amount of the machinery and equipment on December 31, 2022? 768,000

Computation of depreciation:
Compute depreciation separately for each of the following:
1. From beginning balance and unsold/undisposed as of year-end (depreciate for 12 months)
2. Newly acquired during the year (depreciate from date of purchase to year-end)
3. Sold/Disposed (depreciate from January 1 to date of sale or disposal)

LAND IMPROVEMENT:
Beg. and Unsold Purchased Sold
Cost 0 240,000 0
Residual value (0) (0) (0)
Depreciable cost 0 240,000 0
Divide: Useful life 15 years 15 years 15 years
Annual depreciation 0 16,000 0
Multiply: Fractional year 12/12 9/12 ?/12
Depreciation for the year 0 12,000 0

BUILDING:
Beg. and Unsold Purchased Sold
Carrying value 936,899.00 480,000.00 0.00
Multiply: Factor (1.5 over useful life) 1.5/25 1.5/25 1.5/25
Depreciation for one year 56,213.94 28,800.00 0.00
Multiply: Fractional year 12/12 12/12 ?/12
Depreciation for the year 56,213.94 28,800.00 0.00

MACHINERY AND EQUIPMENT

Cost of beginning 775,000
Cost of machinery disposed (20,000)
Cost of beginning and unsold 755,000

Beg. and Unsold Purchased Sold

Cost 755,000 290,000 20,000
Residual value (0) (0) (0)
Depreciable cost 755,000 290,000 20,000
Divide: Useful life 10 years 10 years 10 years
Annual depreciation 75,500 29,000 2,000
Multiply: Fractional year 12/12 6/12 12/12
Depreciation for the year 75,500 14,500 2,000

DELIVERY EQUIPMENT
Carrying value, January 1 of delivery equipment sold 11,760
Depreciation, January 1 to September 30 (2,646)
Carrying value, September 30 9,114
 Carrying value, January 1 45,276
Carrying value of the sold as of January 1 (11,760)
Carrying value, beginning and unsold 33,516

Beg. and Unsold Purchased Sold

Carrying value 33,516.00 15,000.00
Multiply: Factor (1.5 over useful life) 1.5/5 1.5/5
Depreciation for one year 10,054.80 4,500.00
Multiply: Fractional year 12/12 4/12
Depreciation for the year 10,054.80 1,500.00 2,646 (given)

Cost, beginning 775,000

Cost of sold (20,000)
Cost of purchased 290,000
Cost, ending 1,045,000
Accumulated depreciation, ending
Beginning 200,000
Depreciation for the year 92,000
Accumulated depreciation of sold (15,000) (277,000)
Carrying value, ending 768,000

Alternative solution:
Carrying value, beginning (775,000 – 200,000) 575,000
Machinery purchased 290,000
Carrying value, sold (5,000)
Depreciation for the year (92,000)
Carrying value, ending 768,000