DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
Unit 5: Audit of Fixed Assets
Meaning of Asset:
An asset is a resource or property having a monetary/economic value possessed by an individual
or entity, which is capable of producing some future economic benefit. Assets are generally
brought in business to benefit from them and to increase the value of a business.

In simple language, it means anything that a person “owns” say a house or equipment. In
accounting context, an asset is a resource that can generate cash flows. Assets are found on the
right-hand side of the balance sheet and can also be referred to as “Sources of Funds”.

Definition of Asset:

Assets are any property owned by a person or business. They can be fixed or current, tangible or
intangible. Tangible assets include money, land, building, investments, inventory, cars, trucks,
boats, or other valuables. Intangibles such as goodwill are also considered to be assets.

Classification of Asset:

Assets are generally classified in to three ways depending upon nature and type namely
Convertibility, Physical Existence and Usage.

1. Convertibility:

One way of classification of assets is based on their easy convertibility into cash. According to
this classification, total assets are classified either Current Assets or Fixed Assets.

a. Current Assets: Assets which are easily convertible into cash like stock, inventory,
marketable securities, short-term investments, fixed deposits, accrued incomes, bank
balances, debtors, prepaid expenses etc. are classified as current assets. Current assets
are generally of a shorter life span as compared to fixed assets which last for a longer
period. Current assets can also be termed as liquid assets.

b. Fixed Assets: Fixed assets are of a fixed nature in the context that they are not readily
convertible into cash. They require elaborate procedure and time for their sale and
converted into cash. Land, building, plant, machinery, equipment and furniture are some
examples of fixed assets. Other names used for fixed assets are non-current assets, long-
term assets or hard assets. Generally, the value of fixed assets generally reduces over a
period of time (known as depreciation).

2. Physical Existence:
Another classification of assets is based on their physical existence. According to this
classification, an asset is either a tangible asset or intangible asset.

a. Tangible Assets: Tangible assets are those assets which we can touch, see and feel. All
fixed assets are tangible. Moreover, some current assets like inventory and cash fall
under the category of tangible assets too.

b. Intangible Assets: Intangible assets cannot be seen, felt or touched physically by us.

Some examples of intangible assets are goodwill, franchise agreements, patents,
copyrights, brands, trademarks etc.

These are also classified under assets because the business owners reap monetary gains with the
help of these intangible assets. A company’s trademark, brand and goodwill contribute to its
marketing and sale of its products. Many buyers purchase goods only by seeing its trademark
and brand in the market.

3. Usage

According to a third way of classification, assets are either operating or non-operating. This
classification is based on usage of the asset for business operation. Assets which are
predominantly used for day-to-day business are classified as operating assets and other assets
which are not used in operation are classified as non-operating.

A. Operating Assets: All assets required for the current day-to-day transaction of business
are known as operating assets. In simple words, the assets that a company uses for
producing a product or service are operating assets. These include cash, bank balance,
inventory, plant, equipment etc.

B. Non-operating Assets: All assets which are of no use for daily business operations but
are essential for the establishment of business and for its future needs are termed as non-
operational. This could include some real estate purchased to earn from its appreciation
or excess cash in business, which is not used in an operation.

Definition of Fixed Assets

A fixed asset is an item with a useful life greater than one reporting period, and which exceeds
an entity's minimum capitalization limit. 

A fixed asset is not purchased with the intent of immediate resale, but rather for productive use
within the entity.  An inventory item cannot be considered a fixed asset, since it is purchased with
the intent of either reselling it directly or incorporating it into a product that is then sold.

For examples of general categories of fixed assets: Buildings, Computer equipment, Computer
software, Furniture and fixtures, Intangible assets, Land, Leasehold improvements, Machinery,
Vehicles
Capital Asset:

Capital Asset is also known as Fixed Assets, capital assets are those assets acquired to carry on
the business of a company with a life exceeding one year. For Examples include: Land,
buildings, vehicles, boats, aircraft, tools, machinery, computer hardware, mobile phones, etc.
and equipment.

Businesses that have a high ratio of capital costs to labor costs are known as Capital
Intensive businesses; that is, they require a large financial investment in capital assets to
produce goods or services. Examples of capital intensive industries include mining, farming,
airlines, oil and gas, fishing, etc.

Non-capital intensive businesses create wealth in ways that do not require plants, machinery, or
expensive equipment; rather they rely on “Intellectual capital”. Examples include software
development firms, consultants, writers, accountants, etc. Non-capital businesses have much
lower barriers to entry given the minimal startup costs.

Difference between Fixed Asset and Variable Asset

FIXED ASSETS refers to the long term and tangible property that a business owns and/or uses in
producing its income and which is not expected to be converted into cash or consumed within a
period of less than one year. The fixed assets are also referred to as equipment, plant, property,
or non-current assets. 

For examples of fixed assets include: Furniture, Equipment, Land, Computers, Machinery,
Fixtures and Fittings, Motor Vehicles, Real Estate, Office Equipment and Buildings

In general, the long term assets that are not tangible such as patents and trademarks are not
termed as fixed assets.  Instead, they are referred to as the fixed intangible assets.

In accounting, the term “fixed assets” is used to describe the property and assets that are not
easily convertible in to cash. It is the opposite of the liquid assets such as bank accounts and
cash.  In most cases, only those assets that are tangible are referred to as ‘fixed’.

According to the International Accounting Standard (IAS) fixed assets are those assets whose the
future economic benefit is likely to flow into that entity whose cost can reliably be measured.

It is important to note that the cost of the fixed assets is taken as its purchase price, including the
import duty charges and the other deductible rebates and trade discounts. The cost of the fixed
asset may also include the cost of transporting and installing it in the required location.  It may
also include the cost of dismantling and removing the item from the business premises at that
time when they no longer need it on that location.
Variable assets, on the other hand, refer to equipment, inventory and accounts receivable.  The
accounts receivable refers to those current assets that report the amount of money that the
customers owe the business for the services or goods that have been provided on credit terms.

Internal control over Fixed Asset:

Internal control is an accounting system to aid in proper reporting of existing assets and
liabilities.  Internal controls over fixed assets alleviate (ease/relief) two distinct risks.  The
primary risk is physical in nature and relates to the asset getting lost, stolen or damaged thereby
affecting the value as reported on the financial statements. The second risk is financial in nature
related to errors in determining cost basis, useful life, and depreciation assigned; all of which
can affect value.

1. Physical Control:

The goal of physical controls is to verify existence, condition and custody of the respective asset.
Historically fixed assets were considered low risk for any type of financial defalcation (incorrect
financial value, theft, misappropriation or unrecorded damage).  This is mostly due to the
difficulty in stealing (theft/robbery) an asset as most fixed assets have a title to them. 

Furthermore, fixed assets are ranked in groups on the balance sheet and the most valuable is the
land and building.  So the bulk of the financial value resides in an asset that is pretty (attractive)
much immovable.  After the real estate based assets are production equipment such as
specialized manufacturing equipment or large pieces of heavy equipment. 

The pieces of equipment that are more likely to be stolen or misappropriated and this include
vehicles, trailers and tools.  These types of fixed assets require more physical control to ensure
proper use.  For example, office equipment likes computers and laptops. These fixed assets are
the easiest to steal or misappropriate and therefore more scrutiny over them should be exercised
by the management team.

The best tool for this type of equipment is an assignment statement whereby a particular asset is
assigned to an employee and this employee’s acknowledges responsibility by signing a
statement.  The term used in accounting is ‘Custody’ over the equipment.

Key Physical control include…

• Is there a fixed assets ledger identifying the particular asset, date of purchase, model
number, serial number, acquisition cost, expected life and assignment to any debt
instrument?
• Are the assets accounted for at least annually?
• Is a physical inspection made of those assets that have a high exposure to damage like
vehicles, site development equipment and tools to identify any possible valuation
adjustments?
 • For assets that are used by multiple employees is there a check-in and check-out log?
• Does management review periodically the insurance policies related to the particular
assets that have exposure to damage and loss?
• Are Examples including high risk small mobile and valuable objects locked are have
some form of tracking device like a GPS installed? Cell phones, tablets, laptops, medical
equipment, electronic testing equipment etc. 
2. Financial Control:

The goal of financial controls is to ensure that the fixed asset value as reported on the balance
sheet is accurate. The two drivers (ways) of the value as reported on the balance sheet for fixed
assets are the initial acquisition cost and the depreciation method used. 

If acquisition (purchase) cost is improperly recorded the value as reported will be affected.  The
easiest tool to manage this particular issue is a policy stating how acquisition cost is calculated. 
In general accountants use the initial purchase price, modification costs, delivery, installation
and testing as the value for acquisition. 

For example, when a vehicle is purchased by a business the total costs of the vehicle includes
Initial purchase price, Delivery fee, Sales tax, Title fee, Registration fee and Tag Fee.

For the purposes of the balance sheet the fixed asset acquisition cost includes the initial
purchase price, the delivery fee, sales tax and title fee.  The two remaining items are annual fees
and therefore are expensed to the profit and loss statement as the fees are only good for one
year.  The balance is spread over the expected life of the asset.

The best financial control is a policy that defines acquisition cost for most of the typical assets
this type of business will purchase.  This is then used by the accounting staff to record the
purchase appropriately. 

Once the asset is recorded to the books now a depreciation method needs to be assigned to the
respective asset. 

You should choose a method of depreciation that most closely resembles (similar) the expected
value adjustment for the particular asset.  If you select a method that decreases the value too
quickly, the financial statement will display a lower value for the fixed assets; too little and the
fixed assets may be overstated in value. The following are appropriate examples:

• Commercial Buildings – 40 years

• Manufacturing Equipment – 7 to 10 years
• Animals – about 75% of their expected life
• Vehicles – five to seven years depending on the respective use
• Technology Equipment – three years
Basic set of financial control
 • Do the owners initiate and/or approve of requests for fixed asset purchases?
• Is there a policy in place that sets the requirements for capitalization of an asset, i.e.
minimum dollar amount and life expectancy?
• Is there a policy and a corresponding set of procedures to follow to determine the
depreciation formula and the frequency of journal entries related to depreciation?
• Is there an inventory conducted of all fixed assets (see physical controls above) on a
maximum of an annual basis?
• Are disposals of assets approved by management and then properly recorded to the
books of record?
Plant and Equipment Budget
The Fixed Asset Budget consists of Five Parts.
• Determine the Fixed Assets you plan to invest into your business
• Determine the Fixed assets required for your business
• Estimate each Fixed Asset’s Depreciation for each Forecasted year
• Determine the Accumulated Depreciation of each Fixed Asset Category
• Determine the Forecasted Current Market Value of each Fixed Asset Category
1. Determine the Fixed Assets You Plan to Invest into the Business:
Often entrepreneurs have personal fixed assets that can be used in their businesses. For
example, many entrepreneurs invest their personal computer, their photocopier, their fax
machine, a building, land, their car, and so on, into their business. Once such assets are
recorded on the company's books, they're no longer considered personal assets; that is, they
become the property of the business.

If you plan to invest any personal fixed assets into your company, each asset must be appraised.
Appraisals simply determine the Current Market Value of each fixed asset. Lets assume, Mr.
Jacob plans to invest his automobile, computer, printer, and other computer accessories into his
company. Let’s further assume, the "Automobile" was appraised at ETB 6,000 and the
"Computer & Accessories" were appraised at ETB 3,900. As a result, the total value of the fixed
assets Mr. Jacob plans to invest into his company is ETB 9,900.

2. Determine the Fixed Assets Required for your Business:

The next section of the Fixed Asset Budget is to determine your Fixed Asset Requirement for
each forecasted business year. This involves determining what fixed assets you need, how much
each fixed asset will cost, the month(s) you plan to order each fixed asset, and the month (s) you
are required to pay for each fixed asset.

Since Mr. Jacob forecasted periods are 2000 and 2001, he must determine the Fixed Assets his
business will require during this time frame. Let’s assume, the only other fixed assets Mr.
Jacob’s business requires in 2000 and in 2001 is a photocopier and a laser printer. The
Photocopier will be ordered in June 2000 and paid for and received in July of 2000. The Laser
printer will be ordered in January 2001 and will also be paid for in January 2001. Therefore,
Mr. Jacob would develop the following Fixed Asset Budget for 2000 and 2001.

Fixed assets budgets forecasted year 2000 & 2001

Year Fixed Asset Item Cost of Item Month ordered Month received and paid for
200 Photo copier 4500 June 200 July 2000
0
200 Laser Printer 1200 January 2001 January 2001
1
The dates and values shown in the above chart are extremely important. Moreover, the
photocopier and its cost will appear under the Fixed Assets section of Mr. Jacob’s
2000 Forecasted Balance Sheet . In addition, his 2000 Forecasted Cash Flow Statement will
show cash of 4,500 leaving the company in July to pay for the photocopier. The Laser printer
and its cost will appear under the Fixed Assets section of Mr. Jacob’s 2001 Forecasted Balance
Sheet . In addition, his 2001 Forecasted Cash Flow Statement will show cash of 1,200 leaving
the company in January to pay for the Laser Printer. 
3. Estimate each Fixed Asset's Deprecation for each Forecasted Year

As fixed assets are used, their values decrease. There are four methods you may choose from to
estimate the reduction in value of fixed assets. These methods are: straight-line depreciation,
units-of-production depreciation, declining-balance depreciation, and sum-of-the-years
depreciation.

The simplest method, straight-line deprecation, tends to be the most frequently used when
forecasting financial statements. When this method is used, the "Cost of the Asset" (or appraised
value of the asset) minus its "Salvage Value" is divided by the asset's estimated "Useful Life".
Useful Life refers to the number of years an asset is expected to be "used" in the business. The
Salvage Value (the act of saving anything in danger) is the estimated value of an asset at the end
of its Useful Life. For simplicity, many forecasters assume a salvage value of ZERO. For
example by using the Straight-line Method of Deprecation

Assume you plan to purchase a computer for your business on January 1, 2000. Also assume, the
computer is expected to cost 4,000 and have a useful life of four (4) years, at which time, it is
expected to be worth nothing (IE salvage value = 0.00). How much will the computer
depreciation (reduce in value) by December 31, 2000? To determine the depreciation expense of
the computer, simply take Cost of the computer (4,000) and minus its Salvage Value (0.00) and
then divided by the computer's estimated Useful Life (4 years).
Cost of the Fixed Asset - Salvage Value  =    4,000 + 0.00 =   1,000 
Useful Life of the Fixed Asset 4 years
Therefore, the computer is expected to deprecate or reduce in value by 1,000 each year. If you
purchased the computer on June 30, 2000 instead of January 1, 2000, then its estimated
reduction in value or depreciation expense would be 500 (half of one full year). Therefore, the
timing of each purchase is very important when estimating the deprecation of any fixed asset.
In our example, Mr. Jacob must determine the depreciation expense of each of his fixed asset. To
do this he must;
1. Determine the appraised values of each fixed asset invested into his company; 
2. Estimate the cost of each fixed asset he plans to purchase for his company; 
3.   Estimate the useful life of each asset; and 
4.   Estimate the salvage value of each fixed asset.
Mr. Jacob decided to invest his automobile and his computer & accessories into the company.
The appraised value of automobile is 6,000 and the appraised value of the computer &
accessories is 3,900. Mr. Jacob plans to purchase a Photocopier valued at 4,500 on July 1, 2000
and a Laser Printer valued at 1,200 on January 1, 2001.
Let’s assume, Mr. Jacob estimates the useful life of the Automobile, the Computer & Accessories,
the Photocopier, and the Laser Printer to be 3 years. Also assume that Mr. Jacob estimates the
salvage value of all assets will be Zero at the end of their useful lives.
Mr. Jacob can estimate each asset's annual deprecation as follows
Fixed Asset Market Useful life Depreciation expenses Depreciation expenses
value (in years) (Per year) (Six month)

Computer 3,900 3 1,300 650

Accessories
Photocopier 4,500 3 1,500 750
Laser Printer 1,200 3 400 Not required
Automobile 6,000 3 2,000 1,000
Mr. Jacob used the Photocopier for one full business year, it's expected to reduce in value by
1,500. Therefore, the photocopier's depreciation expense would be 1,500 for one full business
year. In 2000, however, the fixed assets INVESTED in the company on July 1 and the fixed assets
PURCHASED on July, 1 will be used for only half of the 2000 business year (IE July 1 to
December 31, 2000). As a result, in 2000 these assets will deprecate by half the yearly rate
(illustrated in the last column of the chart above).
4. Determine the Accumulated Depreciation of each Fixed Asset Category:
Accumulated Depreciation is an account that "tallies" a fixed asset's depreciation expense
during its useful life. In other words, it accumulates a fixed asset's reduction in value during its
useful life. In our example, Mr. Jacob estimated the Automobile would depreciate ETB 1,000 in
2000 (six month period) and ETB 2,000 in 2001 (12 month period). As a result, the accumulated
depreciation for the automobile on December 31, 2000, would be 1,000, while the Accumulated
depreciation on December 31, 2001 would be 3,000 (1,000 in 2000 plus 2,000 in 2001 = 3,000).
On December 31, 2002, the Automobile's accumulated depreciation would be 5,000 (1,000 in
2000 plus 2,000 in 2001 plus 2,000 in 2002 = 5,000). 
Recall from the previous discussions, Mr. Jacob estimated the Office Equipment would
depreciate 1,400 in 2000 and 3,200 in 2001 As a result, the accumulated depreciation for the
computer & Accessories as of December 31, 2000 would be 1,400, while the accumulated
depreciation as of December 31, 2001 would be 4,600 (1,400 in 2000 plus 3,200 in 2001 =
4,600). Assuming no additional purchases were made into this fixed asset category, the Office
Equipment's December 31, 2002 accumulated depreciation would be 7,800 (1,400 in 2000 plus
3,200 in 2001 plus 3,200 in 2002 = 7,800).
The above accumulated deprecations will appear under the Fixed Asset Section of Mr. Jacob’s
2000 and 2001 Forecasted Balance Sheet.
5. Determine the Forecasted Current Market Value of each Fixed Asset Category:
The Forecasted Current Market Value refers to the estimated worth of your fixed assets on the
last day of each forecasted business year (IE your yearend). Therefore, Mr. Jacob must
determine the estimated value of his fixed assets on December 31, 2000 and on December 31,
2001. To do this, simply subtract each category's accumulated depreciation from the cost of each
fixed asset (or appraised values, if any).
Fixed Assets Category
Fixed Asset Category 2000 2001
Auto mobile 6000 6000
Less: Accumulated Depreciation 1000 3000
Market value for Automobile 5000 3000
As you can see, the market value of the automobile on December 31, 2000 is estimated to be
5,000. The market value of the automobile on December 31, 2001 is estimated to be 3,000 (IE
1,000 depreciation expense for 2000 + 2,000 depreciation expense for 2001 = 3,000). The above
calculations will appear under the Fixed Asset Section of Mr. Jacob’s 2000 and 2001 Forecasted
Balance sheet.
Fixed Assets Category
Fixed Asset Category 2000 2001
Office Equipment 8400 9600
Less: Accumulated Depreciation 1400 4600
Market value for Automobile 7000 5000
As you can see, the market value of the office equipment on December 31, 2000 is estimated to
be 7,000. The market value of the office equipment on December 31, 2001 is estimated to be
5,000. The above calculations will appear under the Fixed Asset section of Mr. Jacob's 2000 and
2001 Forecasted Balance Sheet.
Audit program for Plant, Property and Equipment:
The following are the important audit program related to PPE.
1. Analytical review:
Obtain an understanding of the accounting policies relevant to property, plant and equipment
and depreciation. Obtain or prepare an analysis of those accounts, including:
a) Description of accounts by classification.
 b) Balances at beginning of period.
c) Additions and depreciation expense during the period.
d) Disposals (e.g., assets sold, abandoned, written off) including related gain or loss and
related adjustments to Accumulated depreciation during the period.
e) Balances at end of period.
2. Reconciliation:
a) Examine documentation (e.g., invoices, purchase agreements, etc) that supports property,
plant and equipment additions.
b) Examine documentation (e.g., bills of sale, authorizations) that supports asset disposals and
related adjustments to accumulated depreciation.
c) Reconcile the analysis to detailed records of property, plant and equipment.
3. Depreciation:
Determine whether the depreciation practices followed by the company are in conformity with
GAAP and consistent with the prior period (i.e. estimates of useful lives and salvage values,
procedures for the depreciation of additions and retirements, etc)
Identify fully depreciated assets carried in the property records. Obtain assurance that such
assets are still utilized (i.e., that they have not been discarded or abandoned).
4. Charges and credits:
Compare amounts charged against (e.g., write-offs, loss on disposal) or credited to (e.g., gain on
disposal) income with income statement accounts. Investigate significant differences.
5. Repairs & maintenance:
Review fluctuations the repair and maintenance accounts for unusual fluctuations and, where
appropriate, examining charges to determine whether amounts should be capitalized.
6. Physical inspection:
Review the procedures for ascertaining the existence and ownership of recorded assets.
Consider the independently testing the physical existence of and, if appropriate, the title to
property, plant and equipment.

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