Which two of the following assertions is the auditor most concerned with when testing property, plant and equipment?

In this article, we will cover the audit procedures for Property Plant and Equipment (PPE). This is also commonly called the audit procedures for Non-Current Assets or Fixed Assets. It is really important to perform proper audit procedures for Fixed Assets in order to obtain sufficient appropriate evidence. Property, Plant Equipment are material items on the balance sheet. There are inherent risks on PPE and auditors should be more concerned about these items during the audit.

Before going into detail about the detailed audit procedures for Property Plant and Equipment, let’s understand the objectives of the audit on PPE as well as the risks and control deficiencies that the auditor should be aware of.

Objective of Property Plant and Equipment (PPE) Audit

The objectives of the audit of property, plant, and equipment (PPE) audit are to determine that:

• The property plant and equipment (PPE) exists and owned by the business organization;
• The PPE addition are authentic and it is recorded properly at its cost while such costs are being able to distinguish from the repairs and maintenance expenses. This means that such repair and maintenance expense shall be treated as expenses directly in the Profit or Loss account;
• Any disposal or retirements of PPE as well as the sales proceeds and other related costs for such disposal are properly recognized and recorded in the accounting book; and
• Last but not least, there is proper depreciation expense in relation to the PPE are properly calculated and allocated based on its costs as well as the expected life expectancy or estimated useful life and scraped value. In addition, it is to ensure that the entity has consistently applied the use of acceptable depreciation methods for each relevant assets.

Typically, in most organizations, PPE is a risk area and the auditor should assure sufficient control testing and substantive testing on PPE.

Risks and Control Deficiencies in Relation to PPE

In this section, we cover the risks for the PPE as well as the control deficiencies (sometimes called internal control deficiencies) that may happen for the accounting and management of PPE.

Below are the key risks associated with the PPE that we commonly encounter so far:

• An entity or management may intentionally account for or overstate the PPE as well as the depreciation on such PPE.
• Some other expenses that should not be capitalized may have been incorrectly capitalized.
• The depreciation method and the assessment of useful life of assets may be used resulting the overstatement or understatement of the depreciation charge into the profit and loss account.
• The capitalization of borrowing costs may have been incorrectly calculated and capitalized as asset value.
• Assets may have loss but still recorded in the accounting book and recorded the depreciation expense.

In addition, there are also control deficiencies that auditors should assess and detect. The control deficiencies give rise to possible fraud as well as other problems that result in the misstatement of PPE and depreciation expense recorded and presented in the Balance Sheet and Profit and Loss Account. Below are the examples of control deficiencies that we commonly encounter during the course of the audit:

• There is no properly physical count of the assets. This raise doubt in the existence of the assets.
• There is properly process and procedure for the disposal of assets.
• The segregation of duties have not been properly allocated for the authorization of purchased, recording the assets as well as the depreciation expense in the General Ledger (GL). In addition, there is no proper segregation of duties for those who perform the physical count and reconciliation process.
• Lack of competent person who manage and calculate the depreciation schedule that may have doubt in the incurred depreciation recorded. In addition, there is no additional reviewer to review such deprecation schedule before posting to GL.
• There is no proper control on the reconciliation process between the assets and depreciation schedule to the GL or Trial Balance (TB)
• No properly asset code tagged on each item of the assets resulting in difficulty of performing the physical count of assets.

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The above problems both on risk and control deficiencies are the key areas that shall need to take into account and perform the relevant audit procedures for the audit of Property Plant and Equipment.

In the later section of this article, we will cover the key assertions as well as the audit procedures for the audit of PPE as well as the recording of depreciation expense in relation to such PPE.  

Key Assertions for Property Plant and Equipment (PPE) Audit

Key assertions for the audit of property, plant, and equipment are described below:

Existence and Occurrence

The existence and occurrence assertion means that the property, plant and equipment balance recognized in the financial statements actually exists at the reporting date. Any addition or disposal of assets represented the asset acquired and sold or scraped in the reporting year.

Completeness

Completeness is ensuring that the PPE reported on the balance sheet includes all PPE transactions occurring during the period. In addition, any additions or disposal incurred during the year should have been recorded

Rights and Obligations

The rights and obligations assertion means that the PPE included in the financial statements at the reporting date belongs to the entity.

Valuation

The valuation assertion is ensuring that the PPE balance included in the financial statement truly reflects its economic value at the reporting date. In this assertion, the concern is about the net present or net book value of the PPE and there are risks of overstatement of certain assets.

Thus the PPE should have been correctly stated at cost less accumulated depreciation and presented in the Balance Sheet at net book value.

Accuracy

In this assertion, all asset additions or disposals should have been recorded correctly.

Classification

In this assertion, the concern is that there should be a proper classification between fixed assets or non-current assets and current assets.

Presentation and Disclosure

In this assertion, the concern is to ensure all necessary disclosure has been made in compliance with accounting policies and procedures.

Below is the summary of audit objectives for PPE including the financial statement assertions:

Key Audit Procedures for Property Plant and Equipment (PPE) Audit

In order to easily understand each type of audit procedure for Property Plant and Equipment, we will group all those audit procedures into 9 categories as below:

Completeness

Under this section, the auditor performs the audit procedures to ensure and confirm the completeness of the PPE. Below are the audit procedures that the audit may carry out to ensure this assertion.

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At first, the auditor should confirm the opening balances with prior year financial statements. The review should cover costs, accumulated depreciation, and the net book value of the PPE.

The auditor should obtain the entity’s Trial Balance, General Ledger, and Financial Statements, as well as the assets, register for the period they are auditing. It is necessary for the auditor to check whether General Ledger and Trial Balance are linked to fixed asset book value and they should reconcile the book value of assets to General Ledger and Trial Balance and assets register accordingly. Then, the auditor shall obtain an explanation for any discrepancies.

They should review that a fixed asset register has been maintained properly and the reliability of fixed asset listing.

The auditor shall perform the reconciliation to agree with the sample of assets that physically exist as per the physical count procedure to the assets register.

Existence

Under this section, the auditor performs the audit procedures to ensure and confirm the Existence of the PPE. Below are the audit procedures that the audit may carry out to ensure this assertion.

• The auditor should perform a physical count on those major assets acquired during the year under audit and compare the physical assets with the entity’s record.
• For the physical inspections, auditor shall pay attention to whether the asset exist, are in use and in good condition. In addition, auditor shall ensure that those assets are properly tagged with unique serial number.

Valuation

Under this section, the auditor performs the audit procedures to ensure and confirm the Valuation of the PPE. Below are the audit procedures that the audit may carry out to ensure this assertion.

They should review the procedures and processes as per IAS 36 impairment has been followed to assess impairment of asset every year.

They should test the client’s provision for depreciation by developing an estimate of the amounts to comparing to the estimate of management.

If the entity being audited adopted the revaluation model, the auditor shall review and verify the valuation and agree to the valuation certificate if any. In addition, the auditor shall also assess the reasonableness of the valuation by reviewing the competency and experience of the valuer, the scope of the valuation, the method and assumptions used in the valuation as well as whether the valuation is in accordance with accounting standards or not.

The auditor shall need to reperform or recalculate the revaluation surplus carried out by the valuer

If the entity adopted the revaluation model, the auditor shall confirm that the valuation is performed on all assets. In addition, the valuation shall perform on a regular basis. Commonly, the full revaluation shall be carried out every 5 years while the interim revaluation can be carried out every 3 years.

Depreciation

Under this section, the auditor performs the audit procedures to ensure and confirm certain assertions such as completeness and accuracy as well as the presentation and disclosure of such depreciation charges of the PPE. Below are the audit procedures that the audit may carry out to ensure this assertion.

The auditor should review the depreciation schedule, the reasonableness of the depreciation rate, and the calculations. In addition, make sure that the company accounts for depreciation for all assets.

Auditors may perform analytical audit procedures like trend analysis and ratio analysis to judge the reasonableness of depreciation expense of property, plant and equipment. This is done by comparing the depreciation of the current year to previous years.

Review the depreciation rate used by the entity being audited and perform the recalculation to ensure that the entity calculated the depreciation expenses correctly.

If the entity adopted the revaluation model, the auditor shall ensure that the entity calculates the deprecation on such revalue amount of the assets.

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The auditor shall obtain the accounting policy in relation to the depreciation and ensure that the deprecation is in line with such policy. In addition, this shall be properly disclosed in the financial statements.

Rights and Obligations

Under this section, the auditor performs the audit procedures to ensure and confirm the rights and obligations of the PPE. Below are the audit procedures that the audit may carry out to ensure this assertion.

They should carefully examine lease agreements on property, plant and equipment to determine whether relevant accounting standards have been followed.

For land and building, the auditor shall need to verify the ownership by inspecting the title deeds, the certificate of the registration of land as well as the lease agreement if such assets were leased from third parties.

For vehicles, the auditor shall obtain the registration documents. Then perform the inspection to ensure that the name of the entity being audited is shown in the registration documents.

Confirm with management if such vehicles are solely used for the purpose of the business of the entity.

For other assets, the auditor shall examine the documents the proof the ownership of such assets by inspecting the purchase invoices and other relevant supporting documents.

Additions

Under this section, the auditor performs the audit procedures to ensure and confirm certain assertions such as rights and obligations, valuation, and completeness. Below are the audit procedures that the audit may carry out to test the additions of PPE.

The auditor should obtain a list of PPE additions during the year which reconciles with the total additions in the financial statements.

They should review the nature of PPE items from the list of additions and for a sample of additions perform vouching to confirm the ownership and authorization of those additions.

They should review the acquisition of fixed assets and check all necessary costs are capitalized as per IAS 16.

For the capitalization of expenditures, the auditor shall obtain relevant supporting documents and review them to ensure that those expenses have been capitalized correctly.

Self-Constructed Assets

Under this section, the auditor performs the audit procedures to ensure and confirm certain assertions such as valuation and completeness. Below are the audit procedures that the audit may carry out to test the self-constructed assets of PPE.

Auditors shall obtain all relevant costs associated with the self-constructed assets such as direct materials, direct labor as well as other overheads. Then, they shall verify the relevant invoices to ensure that those costs are correct.

For any expenditures that the entity capitalized as self-constructed assets, the auditor shall review and ensure as follow:

 Such expenditures help to enhance the economic benefit of the assets

Those expenditures are incurred to replace or restore portion components of assets being self-constructed.

Those expenditures play a major part in the overhaul in order to restore the assets’ future economic benefits.

The auditor shall ensure that there are any expenditures associated with the profit elements included in the capitalization.

In addition, where applicable, the borrowing costs related to the self-constructed assets shall be determined. For the accounting for the borrowing costs, please refer to another article on “Accounting for Borrowing Costs: Overview and Example”.

Disposals

Under this section, the auditor performs the audit procedures to ensure and confirm certain assertions such as completeness, occurrence, rights and obligations as well as accuracy. Below are the audit procedures that the audit may carry out to test the disposals of PPE.

The auditor should investigate the retirement of property, plant and equipment to determine whether any property has been sold, replaced, and abandoned without proper reflection in the accounting records. If the assets were sold, the auditor shall assess the reasonableness of the sales proceed. The profit on the disposal should also be recalculated to ensure the completeness and accuracy of gain or loss recorded in the profit and loss statement.

They should ensure the de-recognition of assets in the financial statements that had been disposed of and written off.

Presentation and Disclosure

Under this section, the auditor performs the audit procedures to ensure and confirm certain assertions such as presentation and disclosure including the classification and understandability. Below are the audit procedures that the audit may carry out for these assertions.

• They should analyze the repair and maintenance accounts to ensure proper expense has been charged and the classification of those costs is correct. They should check the authorization of transactions from the general ledger.
• They should check the presentation and disclosure for property, plant and equipment in the financial statement. The notes should disclose balances of assets, their classes, accumulated depreciation, base of valuation etc.