Chapter 13

Property, Plant, and Equipment: Depreciation and Depletion

McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Property, plant and equipmentProperty, plant and equipment

Tangible assets with a service life of more than one year that are used in the operation of the business and are not acquired for the purpose of resale

Three major subgroups: Land Buildings, machinery, equipment and land

improvements Natural resources

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Objectives for the Audit of Property, Objectives for the Audit of Property, Plant and EquipmentPlant and Equipment

1.Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to property, plant, and equipment.

2.Obtain an understanding of internal control over property, plant, and equipment.

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Objectives Objectives contcont..

1. Assess the risks of material misstatement and design tests of controls and substantive procedures that:

a. Substantiate the existence of property, plant, and equipment

b. Establish the completeness of recorded property, plant, and equipment

c. Verify the cutoff of transactions affecting property, plant, and equipment

d. Determine that the client has rights to recorded property, plant, and equipment

e. Establish the proper valuation or allocation of property, plant, and equipment and the accuracy of transactions affecting property, plant, and equipment

f. Determine that the presentation and disclosure of property, plant, and equipment are appropriate

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Controls Over Plant Controls Over Plant and Equipmentand Equipment

Use of a plant and equipment capital budget Maintenance of a subsidiary ledger A system of authorizations Analysis of variances from budgeted expenditures A statement of policy distinguishing between capital and

revenue expenditures A requirement that purchases of plant and equipment are

subjected to normal purchasing procedures Periodic physical inventories A system of retirement authorization and documentation

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PPE Audit Steps PPE Audit Steps (1 of 3)(1 of 3)

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to property, plant, and equipment.

B. Obtain an understanding of internal control over property, plant, and equipment.

C. Assess the risks of material misstatement and design further audit procedures.

D. Perform further audit procedures—tests of controls.1. Nature of tests of controls.

2. If necessary, revise the risks of material misstatement based on the results of tests of controls.

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PPE Audit Steps PPE Audit Steps (2 of 3)(2 of 3)

E. Perform further audit procedures—substantive procedures for property, plant, and equipment.

1. Obtain a summary analysis of changes in property owned and reconcile to ledgers.

2. Vouch additions to property, plant, and equipment during the year.

3. Make a physical inspection of major acquisitions of plant and equipment.

4. Analyze repair and maintenance expense accounts.

5. Investigate the status of property, plant, and equipment not in current use.

6. Test the client’s provision for depreciation.

7. Investigate potential impairments of property, plant, and equipment.

8. Investigate retirements of property, plant, and equipment during the year.

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PPE Audit Steps PPE Audit Steps (3 of 3)(3 of 3)

E. Perform further audit procedures (cont.)9. Examine evidence of legal ownership of property, plant, and

equipment.

10. Review rental revenue from land, buildings, and equipment owned by the client but leased to others.

11. Examine lease agreements on property, plant, and equipment leased to and from others.

12. Perform analytical procedures for property, plant, and equipment.

13. Evaluate financial statement presentation and disclosure for plant assets and for related revenue and expenses.

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Vouch Additions Vouch Additions (1 of 2)(1 of 2)

Specific steps:a. Review changes during the year in construction in progress and

examine supporting work orders, both incomplete and closed.

b. Trace transfers from the Construction in Progress account to the property accounts, observing propriety of classification. Determine that all completed items have been transferred out of the account.

c. On a test basis, vouch purchases of property, plant, and equipment to invoices, deeds, contracts, or other supporting documents. Recompute extensions, footings, and treatment of discounts. Make certain repairs and maintenance expenses were not improperly capitalized.

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Vouch Additions Vouch Additions (2 of 2)(2 of 2)

Specific steps (cont.)

d. Investigate all instances in which the actual cost of acquisitions substantially exceeded authorized amounts. Determine whether such excess expenditures were analyzed and approved by appropriate officials.

e Investigate fully any debits to property, plant, and equipment accounts not arising from acquisition of physical assets.

f. Determine that the total cost of any plant and equipment assets purchased on the installment plan is reflected in the asset accounts and that the unpaid installments are set up as liabilities.

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Analyze Expense AccountsAnalyze Expense Accounts

Analyze repairs and maintenance expense accounts to: Discover items that should have been

capitalized Use company policy to determine consistency

in application Analyze monthly amounts for significant

variations from:• Month to month• Between corresponding months of two years

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Impairment of Long-Lived AssetsImpairment of Long-Lived Assets

Long-lived assets must be reviewed for impairment whenever events or changes in circumstances indicate that carrying value may not be recoverable

Test involves projecting future cash flows If impairment is indicated by cash flows

asset must be written down to fair value May require the use of a valuation

specialist

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Investigate RetirementsInvestigate Retirements

Determine if property sold, dismantled, or abandoned without being reflected in accounting records

Steps to discover unrecorded retirements:1. For new additions, determine status of old equipment

2. Analyze miscellaneous revenue account for cash proceeds

3. If company’s products discontinued, investigate disposition of plant facilities

4. Inquire of executives and supervisors of plant asset retirements

5. Examine retirement work orders for proper authorization

6. Investigate any reduction in insurance coverage

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Presentation and DisclosurePresentation and Disclosure

Disclose major classes of depreciable assets Accumulated depreciation Principles:

a. The basis of valuation should be explicitly stated. At present, cost is the generally accepted basis of valuation for plant and equipment; property not in use should be valued at the lower of cost or estimated realizable value.

b. Property pledged to secure loans should be clearly identified.

c. Property not in current use should be segregated in the balance sheet.

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Auditors’ Approach for DepreciationAuditors’ Approach for Depreciation

Important because depreciation is an estimate. Client makes

Estimate of useful economic life Choice of several depreciation methods

Audit approach for estimate Review and test management’s process of developing

the estimate Review subsequent events or transactions bearing on

the estimate Independently develop an estimate of the amount to

compare to management’s estimate

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Natural ResourcesNatural Resources

Properties subject to depletion Similar to depreciation

Recorded consistently and in accordance with GAAP

Test mathematical accuracy Often rely on specialists for valuation Establish ownership

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Audit of PPE—Advance WorkAudit of PPE—Advance Work

Most work can be done in advance Consideration of internal control can be

carried out at any convenient time Many firms audit during interim work in

October and November After balance sheet date, only need to

exam transaction for final two or three months

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Audit of IntangiblesAudit of Intangibles

Assets with definite useful lives are audited similar to property, plant and equipment

Assets with indefinite useful lives (e.g., goodwill) must be tested for impairment

Auditors generally rely on business valuation specialists to value goodwill for tests of impairment

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