ACC802 Lecture

Audit of Property, Plant and

Equipment and Related Expense
Accounts
Relevant Professional Standards

 ASA 510 Initial Engagements - Opening Balances

 ASA 540 Audit of Accounting Estimates
 ASA 545 Audit of Fair Value Measurements and Disclosures
 ASA 630 Using the Work of an Expert
 AGS 1036 Consideration of Environmental Matters in the Audit of a Financial Report
 AGS 1030 Auditing Derivative Financial Instruments
Relevant Professional Standards (cont.)

 AASB 6 Exploration for and Evaluation of Mineral Resources

 AASB 116 Property, Plant and Equipment
 AASB 117 Leases
 AASB 136 Impairment of Assets
 AASB 137 Provisions, Contingent Liabilities and Contingent Assets
 AASB 138 Intangible Assets
 Business Risk and Business Environment

 Property, plant and equipment (PPE) are often the large category of assets.
 Because there is typically limited activity in PPE, unlike accounts receivable or
payable:
 auditors usually focus on testing transactions rather than
account balances
 audit period transactions include additions, disposals,
write-offs and depreciation.
 Earnings Management

 PPE assets can be used to manage earnings by:

 changing estimated useful lives and residual values

 capitalising costs that should be expensed, such as repairs
and maintenance
 accounting for capital leases as operating leases.
 Risks Associated with PPE and

Related
Unrecorded asset disposals
Expenses
 Environmental issues
 Obsolescence or impairment of assets
 Restructuring charges related to changes in the nature of the business
 Incorrect recording of assets, hidden by complex ownership structures designed to
keep assets (and related liabilities) off the books
 Incorrect valuation of assets acquired as part of a group purchase
Risks Associated with PPE and Related
Expenses (cont.)
 Amortisation or depreciation which does not reflect the economic use of the
asset
 Failure to recognise impairments in value
 Incorrect computation of gains/losses on asset disposal
 Improper recording of capital leases as operating leases
 Capitalisation of costs that should be expensed
 Becoming aware of the risks
 The auditor will normally be aware of these risks through review of:

 industry trends, technological advances and changes in

location of production facilities
 business plan for major acquisitions
 major contracts regarding capital investments or joint
ventures
 minutes of board of directors meetings
 company filings with ASIC or ASX describing actions,
risks, strategies.
 Analysis for Likely

Misstatements
Analyse industry trends and changes in product lines

 Helps identify assets that are not as useful as in previous

years
 Tour the plant and note idle equipment
 Analyse depreciation for consistency and economic activity
 Review gains/losses on equipment disposals
 Perform analytical estimate of depreciation
 Evaluating Control Risk and
Control Effectiveness
 Controls should include:
 periodic inventories of physical assets, which are reconciled
to the equipment subsidiary ledger
 ensuring all purchases are authorised and properly valued
 classifying new equipment according to expected use and
useful life
 periodic reviews of estimates
 identifying obsolete or scrapped equipment and write down to
scrap value
 Evaluating Control Risk and
Control Effectiveness (cont.)
 Controls should include:
 safeguarding assets
 preventing unauthorised journal entries
 periodic reviews of management strategy to determine
continued usefulness of equipment.
 The auditor should assess both the existence and effectiveness of client
controls in determining which direct tests need to be performed.
 Tests of Property Additions and Disposals

 If the beginning balance is established through previous audit work, testing can be
limited to additions and disposals during the year.
 Additions:
 Auditor can usually test existence and valuation by the
same procedures.
 Schedule of property additions is agreed to; additions
shown in the ledger to ensure schedule is complete.
 Auditor vouches recorded additions to supplier invoice and
other supporting documentation (existence and valuation).
Tests of Property Additions and Disposals
(cont.)
 Additions
Auditor may trace recorded additions to the physical
assets to establish existence (particularly if client
controls are weak).
Auditor should vouch fixed asset additions and repair
and maintenance expense transactions to supplier
invoices or other supporting documentation to determine
if transactions are properly recorded.
Auditor should review lease contracts signed during the
audit year to determine if they are properly recorded.
 Disposals and Fully Depreciated
Equipment
 Many organisations do not exercise the same degree of control over asset disposals as
they do for acquisitions.
 Audit procedures are designed to test that all disposals have been recorded.
 Select a sample of (nearly) fully depreciated property from the
property ledger and trace to the physical assets to determine
existence.
 Review acquisition documents for trade-ins. Review the
property ledger to make sure that the traded-in asset has been
removed.
 Ask the client about any assets that have been removed. Trace
to the property ledger to make sure asset has been removed.
 Asset Impairment

 There may be significant declines in the value of fixed assets due to technological
obsolescence or new manufacturing techniques.
 If there is evidence of asset impairment, valuation must be assessed.
 The accounting standards include two approaches to valuing impaired assets:
estimate the future economic benefits to be derived from
the asset
obtain an independent assessment of the value of the
asset.
 Asset Impairment (cont.)
 For the first approach, auditors perform a recoverability test to determine if asset is impaired.
If future cash flows exceed the asset’s carrying value, the asset is not
impaired.
If future cash flows do not exceed the carrying value, the asset is
impaired.
The amount of impairment is the difference between the net present
value of future cash flows and the asset’s carrying value.
 For the second approach, the auditor may
obtain appraisal from an independent and qualified appraisal firm
review current transactions to determine if there has been a decrease
in purchase price.
 Discontinued Operations

 The company should write net assets down to net realisable value.
 In assessing fair market value, the auditor will normally:

 request an estimate of value from an investment broker

 discount estimated future cash flows to develop an estimate
of value.
 The nature of the discontinuance decision and the amount of write-down should be
fully disclosed in the notes to the financial statements.
 First-Time Audits

 During first-time audit of a new client, the auditor will need to verify the beginning
balances.
 If the client has been audited before, the predecessor auditor should be contacted.
 If the predecessor documentation cannot be used, or if this is the client’s first audit:
Auditor should sample property in the beginning balance.
Vouch back to supporting documents to verify cost.
Trace back to physical assets to verify existence.
 Auditor should also recalculate depreciation expense and accumulated depreciation.
 Depreciation Expense and Accumulated
Deprecation
 The procedures used to test deprecation will depend on the controls over depreciation and
the risk associated with the engagement and account balance.
 Low risk: analytical procedures
 Calculate current estimate of depreciation and modify for
additions and disposals during the year.
 Compute ratios to determine reasonableness of current
deprecation.
 High risk: test the details
 Foot the property ledger and agree to the general ledger.
 Recalculate depreciation for sample of items.
 Intangible Assets
 May be difficult to determine which costs should be capitalised, especially for internally
developed intangibles.
Auditor should review client accounting to ensure AASB 138
compliance.
 May be difficult to determine appropriate amortisation period.
Expected economic life or legal life, whichever is shorter.
Auditor should review trade publications for competition and
new product introductions.
Auditor should make inquiries of client and legal counsel.
Auditor should review client procedures for determining when
intangibles become impaired.
 Mineral Resources

 May be difficult to determine which costs should be capitalised.

 Most companies have procedures for identifying costs.
 Auditor should test capitalisation of new assets by examining documents.
 May be difficult to estimate the amount of the natural resource.
 Many companies use geologists to estimate amount of
natural resources.
 The auditor may hire a specialist to review any geological
analysis.
Mineral Resources (cont.)
 Depletion should be based on amount extracted during the year.
 Depletion is based on units of production approach.
 Auditor may use analytics such as current depletion
compared to prior years.
 Auditor may analyse production data and then recompute
depletion.
 May be difficult to estimate reclamation expenses.
 Auditor should examine the reasonableness
of procedures used by management to
estimate cost.
Leases: A Special Consideration

 Motivation to lease
 to finance the use of an asset
 to acquire short-term use of an asset
 to attempt to keep an asset and related
liability off the balance sheet.
 Proper accounting treatment is provided by AASB 117, which
gives conditions for capitalising leases.
Leases: Audit Approach
 Obtain copies of lease agreements.
 Review agreements to determine if capital or operating
leases.
 Review client records to determine if leases properly
accounted for.
 Review lease expense account.
 Select entries and review to make sure they are for
operating leases.
Leases: Audit Approach (cont.)

 For all capital leases:

 determine assets and obligations are recorded at net
present value
 determine the economic life of the asset
 calculate amortisation and interest expense
 consider bargain purchase agreements to determine
economic life.
Thank You
Questions?