What is the relationship between the audit of property plant and equipment accounts?

There are many cases where corporate scams/frauds includes fake property, plant and equipment. This is one of the most sensitive area of an audit.

Auditing property, plant and equipment for manufacturing industry can be a tedious job. In some trading and distribution organisations assets will be placed all over the operating area. I am going to discuss about the basic audit procedures of auditing property, plant and equipment’s below. The basic audit procedures are as follows:

1.   Physical verification of fixed assets.

2.   Test of controls on purchasing of fixed assets to booking of assets on fixed asset register.

3.   Substantive audit procedures on newly built/purchased asset.

4.   Substantive audit procedures on disposal (This is important if there are any profit/loss on disposal of assets during the auditing period)

5.   Substantive Analytical audit procedure on depreciation. (Calculating the depreciation based on the company policy to see if the depreciation amount makes sense)

Physical verification of fixed assets:

That is one of the easiest way to see if the assets in the company’s fixed asset register actually exists! If audit engagement date is before the year end date and auditors can verify the assets at year end date, the simplest way will be asking the management to provide the updated fixed asset register available at year end date and verify the assets. If assets are located in multiple locations, based on the output of various sampling method auditors can choose different locations and send audit teams to verify the assets.

Make sure that consumable spare parts are not included in the fixed asset register.

Different audit firms have different methodologies. Most common are floor to sheet and sheet to floor.

For “Sheet to Floor”, verification is done on verifying assets from asset register. Samples can be choose by different sampling methodologies. Some audit firms use sampling software to pick the samples. If assets are in different locations, you can pick samples location wise or asset class wise. Once you select your samples, you will have to check and verify all the assets that came up in your sample plan and tag those assets. You need to check whether if the all the assets are properly tagged, are in good working condition and are in use. If any of those criteria doesn’t meet, you need to highlight it and report it to your audit supervisor/team leader for further discussion with the management.   

For “Floor to Sheet”, verification is done on random sampling method at auditor’s own discretion. From my personal experience, this should be done after performing “Sheet to Floor” physical verification to ensure that we are not verifying an item twice. If you have already performed “Sheet to Floor” and tagged the already verified assets, you can now go on to “Floor to Sheet” method and pick an asset randomly and cross match it with the fixed asset register that have been provided to you by the management. Always take a management representative with you during this procedure. During this physical verification, you will not only ensure the existence of the asset but also the condition of the asset (whether in working condition or not, damaged or obsolete). During your audit, you may encounter finding difficulties in tracing back the asset in the asset register as the asset can be a part of another asset. During your verification, you will have to see if the assets are properly tagged.

To summarise, the main points to physical verification of fixed assets would be:

i.             Assets do exists.

ii.           Assets are in good working condition and are in use by the management. (If not in use, inquire the management)

iii.          Assets are properly tagged.

Test of controls on purchasing of fixed assets to booking of assets on fixed asset register:

If the volume of newly built or purchased fixed assets is large (Consider materiality and apply judgment) and if there are policy and controls regarding purchasing of fixed assets, you can perform a control test to check whether if all the internal controls regarding asset procurement are working properly.

Again, the samples will be based on random sampling or specific selection or software based sampling. To do this procedure, first you will need to make a detailed fixed asset procurement process which will include all the authorization required to procure or built a fixed asset to book/register a fixed asset in the company books according to the classification of assets of the company policy.

The objective of this test will be solely to check whether the controls are properly implement and working. Control points will depend on the fixed asset procurement process that you have listed. Make sure to get a confirmation of your fixed asset procurement process through a discussion with the management team.

Highlight and raise any concerns that you will find during your test.

Substantive Audit Procedures on newly purchased/built fixed Assets:

Substantive audit procedure on newly purchased or built fixed asset will include a details check of the relevant vouchers to book an asset in the fixed asset register.

The sampling will depend on your firm’s sampling policy and materiality level.

Just to give you an example, if your client have purchased a laptop during the period under audit scope, check all relevant purchased requisitions, business case (if available), authorizations, selection of vendors, supplier invoice, goods received note, payments to suppliers, asset classification, depreciation rate and fixed asset register. One more important thing to check is to tax and vat payments regarding procurement of assets. Ensure that assets are capitalized as per IAS 16 and IAS 23 (for the assets purchased through loan financing).

Take note if you find any irregularities and raise the issue in your team.

Substantive audit procedures on disposal:

If you see any items in the disposal list, make sure that you check the disposal documents. This is important because the profit/loss on disposal will be reflected in the income statement.

For disposal of assets, you will have to check asset disposal authorization, selection of customers (if sold through tender), and receipt of money, accumulated depreciation and net book value at disposal date and profit or loss on disposal. You will have to check whether if the asset have been removed from the fixed asset register and subsequent adjustments were made on the accumulated depreciation.

Substantive Analytical audit procedure on depreciation:

This is one of the most important audit procedure for property, plant and equipment’s.

To run this test you need the following information:

i.             Opening Historical value of asset

ii.           Opening accumulated depreciation

iii.          Fixed assets already been fully depreciated at the beginning of the year

iv.          Fixed assets fully depreciated during the year

v.           Addition of assets during the year

vi.          Disposal of assets during the year

vii.         Closing historical book value of the asset

viii.       Closing net book value of the assets

You will get all these from the asset register. The calculation will be simple:

= (i-iii)/Useful life + ((v/useful life) * 0.5) – ((iv/useful life)*0.5)

(“0.5” this indicates depreciation charged for 6 months on average for newly purchased assets. You can change this according to your scenario. For example if all the assets are purchased on the 9th month, divide 12 by 9)

This way you can calculated an expected depreciation charge for any asset class and check it back with the financials. If the difference is not material, you can assume that the depreciation charge in the financial statement is reasonable.

Remember to raise any issues that you will face during your audit. Always review your work papers by your seniors before you present those to your engagement manager and partner for further review.

Asset Under Construction:

In my audit experience, I have seen that for large construction projects, the management sometimes failed to capitalize an asset although they are using it. In some cases, once a project is completed, all the assets procured for the project purpose, capitalized at once. You can perform substantive audit procedure for addition of assets under construction and run a physical verification at year end to see whether the assets are already been used by the management. Once in a large manufacturing company, I have seen that the company didn’t capitalized forklifts at the yearend which they were using it for quite some time.

In the end, after doing all these you will have to recalculate and create a fixed asset schedule and check if it matches with the management’s financials.

Those are the basic audit procedures for fixed assets. There could much more complex situations in real life.

Please discuss with your seniors team members before applying any of the audit procedures stated above. Some firms may have their own methodologies for audit.

What are the objectives of audit property, plant and equipment?

How is auditing and accounting related to each other?

When auditing PPE The auditor's approach is generally to?

How information about the entity's property, plant and equipment is relevant to investors?