College of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines “The Universigy of Mindana Pane Ne (082) 906 0046 Auditing Problem: Session 4 ‘Audit of Investing Cycle: Audit of Property, Plant, and Equipment, and Intangibles AUDIT OF PROPERTY, PLANT, AND EQUIPMENT The term property, plant, and equipment includes all tangible assets with a service life of more than one year that are used in the operation of the business and are not acquired for the purpose of resale. Three major subgroups of such assets are generally recognized: 1. Land, such as property used in the operation ofthe business, has the significant characteristic of not being subject to depreciation. 2. Buildings, machinery, equipment, and land improvements, such as fences and parking lots, have limited service lives and are subject to depreciation. 3. Natural resources (wasting assets), such as ol wells, coal mines, and tracts of timber, are subject to depletion as the natural resources are extracted or removed. ‘Acquisitions and disposals of property, plant, and equipment are usually large in peso amount, but concentrated in only a few transactions. Individual items of plant and equipment may remain unchanged in the accounts for many years. INTERNAL CONTROL ‘The amounts invested in plant and equipment represent 2 large portion of the total assets of many industrial concerns. Maintenance, rearrangement, and depreciation of these assets are major expenses in the income statement. The total expenditures for the assets and related expenses make strong internal control essential to the preparation of reliable financial statements. Errors in measurement of income may be material if assets are scrapped without their cost being removed from the accounts, or ifthe distinction between capital and revenue expenditures is not maintained consistently, The losses that inevitably arise from uncontrolled methods of acquiring, maintaining, and retiring plant and equipment are often greater than the losses from fraud in cash handling, In large enterprises, the auditors may expect to find an annual plant budget used to forecast and control ‘acquisitions and retirements of plant and equipment. Many small companies also forecast expenditures for plant assets. Successful utilization of a plant budget presupposes the existence of reliable and detailed ‘accounting records for plant and equipment. A detailed knowledge of the kinds, quantities, and condition of existing equipment is an essential basis for intelligent forecasting ofthe need for replacements and additions to the plant. ‘SUBSTANTIVE TESTING Accounting considerations. Many PP&E acquisitions involve trades of used assets. PAS 16 points that most nonmonetary exchanges of these assets are recorded using the fair value of the asset exchanged. Assets constructed by a company for its own use should be recorded at the cost of direct material, direct labor, and applicable overhead. Recall that interest may be capitalized. PP&E should be tested for impairment when facts ‘and circumstances indicate that the asset's value may be impaired. Overalll approach. The reasonableness of the entire account balance should be audited in detail for a client that has not previously been audited. When a predecessor auditor exists, the successor will normally review that auditor’s workpapers. For a continuing audit cient, the audit of PP&E consists largely of an analysis of the year’s acquisitions and disposals (an input and output approach). Subsequent to the first year, the account's slow rate of turn over generally permits effective auditing of the account in less time than accounts of comparable size.College of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines “The Universigy of Mindana Pane Ne (082) 906 0046 Relationship with repairs and maintenance. A number of CPA questions address this area. A P&E acquisition may improperty be recorded in the repair and maintenance expense account. Therefore, an analysis of repairs and maintenance may detect understatements of PP&E. Alternatively, an analysis of PP&E may disclose repairs and maintenance that have improperly been capitalized, thereby resulting in overstatements of PP&E. Expenditures that make the asset more productive or extend its useful life should be capitalized in the asset account (betterment) or as a debit to accumulated depreciation (life extension). Unrecorded retirements . Disposals may occur due to retirements or thefts of PP8E items. Simple retirements of equipment are often difficult to detect since no journal entry may have been recorded to reflect the event. Unrecorded or improperly recorded retirements (and thefts) may be discovered through ‘examination of changes in insurance policies, consideration of the purpose of recorded acquisition, ‘examination of property tax files, discussions, observation, or through an examination of debits to accumulated depreciation and of credits to miscellaneous revenue accounts. Inquiry of the plant manager may disclose unrecorded retirements and/or obsolete equipment. AUDIT PROCEDURES ‘The following steps indicate the general pattern of work performed by the auditors in the verification of property, plant, and equipment. Selection of the most appropriate procedures for a particular audit will be ‘uided by the nature of the controls that have been implemented and by the results of the auditors’ risk ‘assessments. ‘A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to property, plant, and equipment. Obtain an understanding of internal control over property, plant, and equipment. Assess the risks of material misstatement and design further audit procedures. Perform further audit procedures—tests of controls. 1, Nature of tests of controls. 2. If necessary, revise the risks of material misstatement based on the results of tests of controls. E. Perform further audit procedures—substantive procedures for property, plant, and equipment. Obtain a summary analysis of changes in property owned and reconcile to ledgers. \Vouch additions to property, plant, and equipment during the year. Make a physical inspection of major acquisitions of plant and equipment. ‘Analyze repair and maintenance expense accounts. Investigate the status of property, plant, and equipment not in current use. Test the client's provision for depreciation. Investigate potential impairments of property, plant, and equipment. Investigate retirements of property, plant, and equipment during the year. Examine evidence of legal ownership of property, plant, and equipment. ). Review rental revenue from land, buildings, and equipment owned by the client but leased to others. 11, Examine lease agreements on property, plant, and equipment leased to and from others. 12. Perform analytical procedures for property, plant, and equipment. 13. Evaluate financial statement presentation and disclosure for plant assets and for related revenue and expenses. poeCollege of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines “The Universigy of Mindana Pane Ne (082) 906 0046 REVIEW NOTES ‘Spare parts, standby and servicing equipment: ‘To be sold by the compan Inventory (consumable stores) ‘Spare parts and servicing Spare parts and servicing equipment that support property, equipment. plant and equipment can be carried as inventory but must be treated as property, plant and equipment if they are expected to be used during more than one period. Major spare parts, standby Major spare parts, standby equipment and servicing ‘equipment and servicing equipment (whether or not that it can be used only in equipment connection with an item of property, plant and equipment) is carried as inventory unless it needs the definition of property, plant an equipment under the standard. ‘Old and new installation cost The machinery is moved to new | The undepreciated old installation cost is expensed. location New installation cost is charged to the new equipment. The machinery is removed and | The undepreciated old installation cost is expensed. New retired installation cost it's charged to the new asset. Non recoverable purchase tax: Value-added Tax ‘The value added tax on the purchase is not capitalizable but charged to input tax to be upset against output tax. Royalty payment on machines Royalty payment on machines purchased should be included as part of the manufacturing overhead in the ‘company's income statement, if the same is based on units produced. However if royalty payment is based on Units produced and sold, it should be treated as selling expense, Other items: ‘+ The repair cost of new machine damaged in the process of installation is charged to repairs expense. ‘+The cost of training for personnel will use the machine shall be charged to training expense. ‘+ The cost of removing old machine and the loss on premature retirement is charged to loss on retirement of the machine. The gratuity paid to the operator of old machine, who was laid off is also charged to expense. Option price The price to be paid by an investor for an option contract, based upon the security of the underlying asset and the time left until the option expires. For options, if the option is exercised, the cost is capitalized. If the “option is not exercised, the cost shall be expensed. Earnest money deposit Down payment made by the purchaser of real estate as evidence of good faith; a deposit or partial payment. Earnest money is therefore capitalizable cost of the asset acquired, Legal fees to close escrow ‘An independent third party, who acts as the agent of buyer and seller, or for borrower and lender, carrying ‘out instructions of both and disbursing documents and funds. Escrow closes and the transfer of property and documents is completed upon fulfillment of certain conditions specified in the written instructions, whereupon the necessary deeds and other instruments are recorded.“The Universigy of Mindana Land improvements College of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines ‘Phone No. (082) 305-0645 Not subject to depreciation | Examples: cost of serving, __| Treatment: earing, grading and leveling, | capitalzable cost of the land subdividing Depreciable Examples: fences, water Treatment: systems, drainage systems, _| part of the blueprint of the sidewalks and pavements, building- building landscaping. not part of the blueprint: land improvement Special assessment- capitalizable cost of the land Real property tax- should be expensed when incurred. However, unpaid real property taxes accruing as of the date of acquisition assumed by the buyer, should be capitalized. Land account Land used as a plant site Property, plant and equipment Land held for a currently undetermined use Investment property Land held for long term capital appreciation Investment property Land held as a site for a building being constructed or developed for future use as investment property Investment property Land leased out under operating lease Tnvestment property Land leased out under finance lease Not reported by the lessor Land definitely as a future plant site ‘Owner occupied property (property, plant and equipment) and not an investment property Land sold in the ordinary course of business Current assets under inventory Land held for sale under PERS 5 Classified as non-current asset held for sale and treated as current asset Building account Building used as a plant site Property, plant and equipment Building being constructed or developed for future use as investment property Tavestment property Building owned by the company and leased ‘out under operating lease Tavestment property Building owned by the company and leased ‘out under finance lease Not reported in the books of the company Building sold in the ordinary course of business Current assets under inventory Building held for sale under pfrs 5 Classified as rion current asset held for sale and treated as current asset ‘Acquisition of PPE Issuance of Shares | Issuance of Bonds | Exchange Transaction with commercial substance ist FV of Asset FV of Bonds FV of Asset Given 2nd FV of Shares FV of Asset. FV of Asset Received 3rd Par value of Shares | Face value of BP BY of Asset GivenCollege of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines The University of Mindanao Pane Ne (082) 906 0046 Asset donated by a shareholder Recorded at the fair value of the asset. An equity account “Donated Capital” shall be credited which is part of share premium. However, cost incurred to transfer the title paid by the recipient shall not be capitalized, instead debited from Donated Capital. Asset donated by a non-shareholder Either credit to subsidies or liability account until the restrictions are met. incurrence or payment of direct ‘expenses shall be added to the cost of asset donated. Asset from a government grant ‘Also recorded at fair value. Income shall be credited if there are no conditions attached and cost incurred to transfer the title shall be recognized as an expense. Self-Constructed asset Includes the cost of materials, direct labor and overhead specifically attributable to the construction. Savings from the construction, meaning lower total cost compared if the assets was purchased are not included in the cost and shall not be recognized as income. Insurance cost If taken during construction- part of the cost of the building Not taken and there is a claim for damages- treated as expense Building fixtures Immovable- part of the cost of the building Movable- charged to furniture and fixtures and depreciated over its useful life PIC Q&A No, 2021 SUMMARY If the company purchased a land with an old building with the intention to demolish it to construct a new building, what should be the treatment of the cost of the old building? SCENARIO ‘TREATMENT Old building is unusable or to be demolished Purchase price is allocated entirely to the land right away (including demolition cost). Old building is usable, but the entity will not Use the old building prior to demolition. Consider the ciassifcation ofthe new building, If the new building is: PPE ‘Allocate the purchase price to the land and old building using its relative fair value, meaning ‘capitalize. When the old building is demolished, the value of the old building will be expensed. Inventories Land and old building will be classified as one item under inventory, meaning capitalize. When the old building is demolished, the value of the building is charged to inventory. Investment Property at cost model ‘Allocate the purchase price to the land and old bulding using its relative fair value. When the ‘ld building is demolished, the value of the old building will be expensed. Investment Property at fair value model Land and old building will be classified as one item under investment property. When the old building is demolished, the value of the old building will be expensed.College of Accounting Education ‘UE F. Facundo Hal B& E Bid, Mavna, Davao Cty Phipines The Universtiy of Mindanao Phone Na. (082) 308-0645 Old building is usable, and the entity used the old building. Consider the classification of the new building. If the new building PPE ‘Allocate the purchase price to the land and old Inventories building using its relative fair value, meaning Investment property at cost/fair value capitalize. Depreciate the old building over its model life. When the old building is demolished, the value of the old building will be expensed. PFRS for SME Property, Plant, and Equipment ‘An SME shall account for its property, plant, and equipment at historical cost-depreciation-impairment only. ‘An annual review of depreciation method, useful life, and residual value is performed if there is a significant change. Government grants Government grants for SME are recognized only when the conditions are actually satisfied. If the grant is: = Without future performance conditions- recognize in P/L when proceeds are receivable. = With performance conditions- recognize in P/L when conditions are met. Borrowing cost All borrowing cost incurred by SME are expensed immediately.