Internal Control of Fixed Assets - 2011 - King - Front Matter

Internal Control
of Fixed Assets
10.1002/9781118269107.fmatter, Downloaded from https://onlinelibrary.wiley.com/doi/10.1002/9781118269107.fmatter by National Institutes Of Health Malaysia, Wiley Online Library on [15/12/2023]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
ALFRED M. KING
Internal Control of
Fixed Assets
A Controller and
Auditor’s Guide
John Wiley & Sons, Inc.

Copyright # 2011 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in

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Library of Congress Cataloging-in-Publication Data
King, Alfred M.
Internal control of fixed assets: a controller and auditor’s guide/Alfred M. King.
p. cm.—(Wiley corporate F & A; 564)
Includes index.
ISBN 978-0-470-53940-8 (book); ISBN 9781118028346 (ebk);
ISBN 9781118028353 (ebk); ISBN 9781118028360 (ebk)
1. Capital. 2. Accounting. I. Title.
HD39.K527 2011
658.15 0 2—dc22 2010045645
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
Once again, to the most patient person
and my best friend, my wife,
Mary Jane King.
Contents
Preface xiii
Chapter 1: Internal Control, Sarbanes-Oxley,

and the Public Company Accounting Oversight Board 1
Internal Controls over Property, Plant, and Equipment—Mandatory
but Weak 1
Internal Controls over Working Capital 5
Securities and Exchange Commission and Public Company Accounting
Oversight Board Scrutiny of Financial Statements 6
Why Do Auditors Not Spend More Time on Property, Plant,
and Equipment? 7
Who Is Responsible for Internal Control over Property, Plant,
and Equipment? 9
‘‘What Is So Hard about the Job?’’ 11
Note 12
Chapter 2: Capitalization versus Expense 13

Capitalization Theory 14
Why Capitalization Levels Matter 16
Consequences of Increasing Minimum Capitalization Level 18
What Is the Optimum Capitalization Limit? 22
Summary 24
Note 24
Chapter 3: Asset Life Cycle—Controls and Software 25

Software Is the Key 27
Input, Output, and Reporting Capability 29
How to Evaluate Software Vendors 30
Assign Responsibility for Implementation and Beyond 32
Charging Departments Will Ensure Individual Responsibility 33
Return on Investment Analysis 35
vii
viii & Contents
Summary 36
Note 37
Chapter 4: Depreciation and Amortization for Books and Taxes 38

Internal Control for Depreciable Tangible Assets 39
Determining Useful Lives Whenever New Assets Are Acquired 40
Choosing Accounting Lives 43
How Valuation Specialists Determine Economic Lives 45
Determining Lives for Intangible Assets 46
Changing Lives and Depreciation for Existing Assets 49
Leasing as a Way to Utilize Depreciation 50
Summary 50
Note 51
Chapter 5: Impairment Testing 52

Testing Intangible Assets That Are Not Amortized 54
Testing for Impairment of Property, Plant, and Equipment,
and Amortizable Intangibles 56
Reviewing Lives for Assets Already in Service 59
Testing for Goodwill 60
Reporting Units 61
Determining the Fair Value of a Reporting Unit 62
Phase II Test of Accounting Standards Codification 350 64
Understanding Impairment Charges 65
Summary 66
Note 67
Chapter 6: Physical Control of Property, Plant, and Equipment 68

Tagging of Property, Plant, and Equipment 71
Alternative Tagging Methods 72
Barcode Tagging 73
Radio Frequency Identification Tags 75
Asset Tagging for Expensed Assets 78
Recommendation 79
Summary 80
Notes 80
Chapter 7: Taking a Physical Inventory 81

Planning and Using the Physical Inventory 82
Who Should Be Responsible? 83
Contents & ix
Use Own Staff, or Outsource? 85

What Minimum Dollar Cutoff Should We Use? 86
Initial Effort–Partial Facility versus Total 87
The $64,000 Question—Assets to Listing or Listing to Assets? 89
Reconciliation of the Inventory to the Records 90
Fully Depreciated Assets 91
Reconciliation Process 92
Revised Asset Lives 94
Summary 95
Note 96
Chapter 8: Reconciliation of Physical Inventory

to Accounting Records 97
Two Approaches to Reconciliation 99
Ghost Assets 100
Zombie Assets 102
Netting Out Ghost and Zombie Assets—Is It Permissible? 104
Netting Out Gains and Losses 106
Performing the Inventory and Reconciliation Piecemeal 108
Summary 109
Chapter 9: Fixed Assets in a Business Combination 110

Carryover of Target’s Book Value 111
Applying Indexes to the Target Company’s Asset Register 113
Inaccuracies in the Target’s Asset Property Register 114
Detailed Valuation of Property, Plant, and Equipment 116
Summary 121
Note 121
Chapter 10: Insurance for Fixed Assets 122

Using the Master Property Record for Insurance 123
Insurable Values Are NOT Fair Value or Fair Market Value 124
How Appraisers Determine Insurable Values 125
Indexing 129
Proof of Loss 131
Summary 132
Chapter 11: Property Taxes—Personal Property and Real Estate 133

Reporting Fair Market Values upon Acquisition 134
Equity among Taxpayers 137
x & Contents
Appealing Personal Property Tax Assessments 138

Indexed Costs May Not Reflect Fair Market Value of Property, Plant,
and Equipment 139
Real Estate Taxes and Appeals 143
‘‘Contingency’’ Consultants 146
Summary 147
Note 147
Chapter 12: Developing the Fair Value of Fixed Assets 148

What Is the Fair Value of Property, Plant, and Equipment? 149
Value in-Use of Property, Plant, and Equipment 151
What Would Happen if Fair Value Reporting for Property, Plant, and
Equipment Was Required? 152
Connection between Fair Value and Book Value 153
What Would Investors Learn from Fair Value Disclosures
of Property, Plant, and Equipment? 155
Summary 157
Chapter 13: Control of Fixed Assets under International Financial

Reporting Standards 158
Component Depreciation 159
Asset Revaluation 162
Investment Property 165
What Is the ‘‘Cost’’ of Property, Plant, and Equipment? 166
Summary 167
Note 167
Chapter 14: Component Depreciation for Buildings 168

International Financial Reporting Standards
Has a Different Approach 169
Component Depreciation for Taxes 170
Complying with Internal Revenue Service Requirements 171
Internal Revenue Service Review of a Cost Segregation Study 175
Cost Segregation Study for New Construction 176
Will Cost Segregation Lower My Property Tax Expenses? 177
Componentization for Financial Reporting 178
Summary 179
Note 179
xi
181
182
182
182
181
184
187
What Are the Attributes of Various Cost Segregation Methodologies?
&
Contents
Detailed Engineering Approach from Actual Cost Records

What Are the Most Common Methodologies Utilized for
Appendix: Excerpt of Internal Revenue Service Cost
Cost Segregation Studies?

Segregation Audit Guide
About the Author

Introduction
Index
Preface
F
O R M A N Y C O M P A N I E S , F I X E D assets, sometimes referred to as
Property, Plant, and Equipment (PP&E) represent the largest single
asset category on the balance sheet. Yet rarely do fixed assets command
management time that is proportionate to the magnitude of the investment.
Companies may devote significant resources to capital expenditure budgeting
and approval, making extremely detailed calculations about proposed capital
outlays. But once the project is completed, and in operation, subsequent record
keeping and controls are often lax.
Management usually assumes that since fixed assets are ‘‘fixed’’ there should
be little trouble monitoring what is going on. Accountants are concerned with
calculating annual depreciation charges, for their company’s books and taxes.
Occasionally, the property record will be the basis of decisions on insurance
coverage for the assets. Even less frequently, property tax assessments may be
challenged, but this is often the responsibility of the tax department.
So while there are many uses, and many users, of a good property tax
accounting system, the one thing that is usually lacking is a reconciliation of
the books of account to the assets actually present physically. While every
company takes a physical inventory of raw materials, work in process, and
finished goods, very few actually take a look at their ‘‘fixed’’ assets and compare
what is there with what the property record says is there.
In short, there is a gap here in Internal Control, a gap that goes on year
after year. The assumption is often made, ‘‘Well our records might not be
perfect, but they were good enough to get by our audit last year, nothing has
changed, so we should be okay this year.’’ Further, auditors and managements
often are more interested in year to year comparisons rather than the value of
absolute amounts. So if this year’s depreciation expense can be reconciled to
last year’s depreciation expense, allowing for additions and deletions, every-
thing is assumed to be correct.
xiii
xiv & Preface
Compounding the issue is that while the subject of Internal Control has
generated tremendous interest following adoption of Sarbanes-Oxley (SOX),
most efforts have been devoted to areas such as revenue recognition and
financial instruments. By and large independent auditors review fixed-asset
accounting controls, make sure there have been no changes since the previous
audit, and wish for the client to take and reconcile a physical inventory. Many
management letters from auditors to audit committees and the Chief Financial
Officer (CFO) have almost a boilerplate recommendation that such an audit
should be undertaken.
Taking, and reconciling, an inventory of PP&E is a major project. Particu-
larly in a period of retrenchment, when the company has to ‘‘do more with
less,’’ the priority of a physical inventory of PP&E inevitably ‘‘slips’’ until the
next year comes around and the process starts again. This state of affairs
continues because PP&E is seen as having a lower priority than many other
aspects of Internal Control. Items which command the attention of auditors
become a priority of the audit committee. In turn, auditors’ priorities are set by
their perception of what the Public Company Accounting Oversight Board
(PCAOB) is focusing on. And, to date, PCAOB has not put emphasis on their
reviews on what the audit firms did with client PP&E. As noted, revenue
recognition and financial instruments at fair value seem to have a much higher
PCAOB priority.
But what if the PCAOB starts to review auditor workpapers dealing with
PP&E on a more intensive basis? Most auditors’ workpapers would likely come
up short. Unfortunately, if the PCAOB was to start putting PP&E on a priority
basis, companies would feel intensive pressure from their external auditors.
As will be discussed in this book, developing a sound system of internal
control for fixed assets, and cleaning up past errors and omissions, are not
trivial efforts. Realistically they really cannot be done in less than one to two
years, assuming that all other financial and operating functions of the business
must continue to be carried on at current rates. Put another way, extra
resources will inevitably have to be devoted to fixing existing fixed-asset
systems. This will cost time and money, which most management will
begrudge—which of course is the reason we are where we are today.
This is the first comprehensive book to focus on Internal Controls for Fixed
Assets. It is a step-by-step guide to developing and maintaining a functioning
internal control system that will withstand the closest scrutiny from indepen-
dent public accountants and ultimately the PCAOB.
We recommend strong internal audit involvement in diagnosing the
current condition of the present fixed-asset accounting system. Internal audit
Preface & xv
should also be involved in the development of specific recommendations for the

required remedial work. Performing the actual required work should probably
be managed by existing accounting and operations staff often with the help of
outside consultants. Depending on the speed with which the company wishes
to finish the task, some temporary help may be necessary, and use of an outside
consultant may be cost effective.
At the time this is written it is not clear whether the United States will or
will not have adopted International Financial Reporting Standards (IFRS).
Nonetheless, and in order for this to be valuable even to U.S. subsidiaries that do
have to report under IFRS, throughout the book similarities and differences
between IFRS and Generally Accepted Accounting Principles (GAAP) will be
covered. Two major differences are that under IFRS companies are permitted,
although not required, to write up certain assets and investment properties.
Second, in case an impairment charge has been taken, a subsequent improve-
ment in the value can be booked, thus reversing the prior impairment charge.
Neither of these is currently permitted under GAAP.
As the Financial Accounting Standards Board (FASB) increases the use of
fair value, it is possible that PP&E at some time may have to be written up in the
United States to current fair value. We briefly touch on this topic, although
other books cover this specific subject of fair value in much greater detail. We
do cover in detail present requirements for testing for impairment, because this
is a subject which potentially affects almost every company.
The primary focus of this book is PP&E, but we also cover briefly certain
aspects of intangible assets, primarily those that arise in a business combination.
Because of the importance of SOX compliance, we focus on the role of
internal auditing in making sure that companies come as close as possible to
full compliance. If independent accountants, given a push from the PCAOB,
start to focus on internal controls dealing with PP&E, it will be critical for
internal audit staffs to become intimately involved. While the primary emphasis
is on the accounting and management control aspects, it is clear that internal
audit must be fully knowledgeable of what the current state of affairs is, and what
the ultimate goal should be.
Inasmuch as this is probably one of the first books written on the subject,
the author will welcome comments and suggestions from readers for subse-
quent editions (aking@marshall-stevens.com). It is impossible to cover every-
thing of importance and undoubtedly certain topics will have been
inadvertently left out. All help will be graciously accepted.
Readers are not expected to sit down and read this book from cover to
cover. Rather it should be considered an overall guide to the total subject. Each
are given. Nonetheless, there is some overlap, and this represents a conscious
April 2011
chapter more or less stands on its own. References to material in other chapters
Alfred M. King
decision to make the book as user friendly as possible.
Preface
&
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Internal Control

John Wiley & Sons, Inc.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in

Library of Congress Cataloging-in-Publication Data

Printed in the United States of America

Chapter 1: Internal Control, Sarbanes-Oxley,

Chapter 2: Capitalization versus Expense 13

Chapter 3: Asset Life Cycle—Controls and Software 25

Chapter 4: Depreciation and Amortization for Books and Taxes 38

Chapter 5: Impairment Testing 52

Chapter 6: Physical Control of Property, Plant, and Equipment 68

Chapter 7: Taking a Physical Inventory 81

Use Own Staff, or Outsource? 85

Chapter 8: Reconciliation of Physical Inventory

Chapter 9: Fixed Assets in a Business Combination 110

Chapter 10: Insurance for Fixed Assets 122

Chapter 11: Property Taxes—Personal Property and Real Estate 133

Appealing Personal Property Tax Assessments 138

Chapter 12: Developing the Fair Value of Fixed Assets 148

Chapter 13: Control of Fixed Assets under International Financial

Chapter 14: Component Depreciation for Buildings 168

Detailed Engineering Approach from Actual Cost Records

Cost Segregation Studies?

About the Author

should also be involved in the development of speciﬁc recommendations for the

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