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

Auditors’ objectives in auditing property, plant and equipment

1. Consider internal control over property, plant and equipment.
2. Determine the existence of recorded property, plant and equipment.
3. Establish the completeness of recorded property, plant and equipment.
4. Establish that the client has ownership rights to the recorded property, plant and equipment
5. Establish the clerical accuracy of schedules of property, plant, and equipment.
6. Determine that the valuation or allocation of the cost of property, plant, and equipment is in
accordance with generally accepted accounting principles.
7. Determine that the presentation and disclosures of property, plant, and equipment, including
disclosure of depreciation methods is appropriate.
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.

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?

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 IFRS 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.