 In this presentation, we will take a look at the auditing process related to property, plant and equipment, PP and E, also known or sometimes called fixed assets or depreciable assets. When considering the audit process for property, plant and equipment, those depreciable assets, those things like land, things like equipment, things like buildings. First, a word from our sponsor. Well, actually, these are just items that we picked from the YouTube Shopping Affiliate Program, but that's actually good for you because these aren't things that were just given to us from some large corporation which we don't even use in exchange for us selling them to you. These are things that we actually researched, purchased and used ourselves. Bayer Dynamic? Not sure if I said that right, but this is the DT770 Pro 250 OHM Studio Reference Closed Back Headphones. I wear headphones basically every day for a large part of the day. They are important to me. 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If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com, where we have many different courses. You can purchase one at a time or have a subscription model, giving you access to all the courses, courses which are well organized, have other resources like Excel files and PDF files to download and no commercials. These are going to be things that will typically be significant. They're going to be large amounts on the financial statements, so they're going to be something that's going to warrant our concern. Of course, as the auditor, they will in other words be material factors that we need to consider. Now, there are characteristics of property plants and equipment that can make them easier in some situations, such as an audit where it's a recurring engagement. Normally that's the case. Normally we have an engagement, hopefully, that we've been auditing the same client for some time now, and therefore it's a recurring engagement, and we can rely to some degree with regards to property plant and equipment on prior year types of transactions, because these, of course, are long lived type of assets from prior year. Auditor can focus on additions and retirements in the current year. Therefore, amounts from prior periods will have been subject to audit procedures in the prior years. In other words, property plant and equipment, things that last for many, many years, we're going to have a schedule of the property plant and equipment. The things that have been purchased in the past are things that were subject to some degree to audits in the past, and therefore we don't have to really audit the purchasing process, again, as we would in, say, new engagements. We can therefore focus on the types of transactions that are new, the types of transactions that happened during the time period. Those include additions that happened during the time period, things that were deleted or things that went away, sales that happened, or the disposals that happened for property plant and equipment, and the calculation of depreciation related to property plant and equipment. So although then property plant and equipment is a very significant account on the financial statements, we may be able to limit the amount of testing and can be quite complex, by the way, because of course, we're talking about, we could have a lot of different types of property plants and equipment. We could have a very large schedule of property plants and equipment that represents different types of assets that are there. We have different types of depreciation methods that may be used, and we may have different types of depreciation methods, we almost certainly will, between the book value and the tax depreciation. Of course, tax depreciation schedules will differ from some degree. We may have differences between tax depreciation of different countries and different states as well. So it can be a complex system. However, the amount of transactions related to property plant and equipment in the current year, somewhat limited. In other words, we're not buying property and plant and equipment every day as we are with other types of things. It's not a daily kind of process. And therefore, we can audit a lot of the transactions, maybe all of the transactions related to things like purchases and disposals of property plant and equipment a lot more easily that where there's no way we can audit all of the transactions for some other type of accounts. So if we have a new engagement, however, auditor must verify assets that make up the beginning balance in property plant and equipment because they have not been subject to audit in prior years. In other words, new engagements, if we're taking on a new client that we didn't audit last year, going to be much more complex with regards to property plant and equipment because we can't rely on prior year audits for the beginning balances and therefore simply test for the most part or focus most of our testing on the addition, subtractions, calculations such as depreciation as we would in a recurring audit. We have to get that schedule. We have to do more testing for the beginning balance items. And that of course can take more time. Transaction types, what types of transactions do we have for property plant and equipment? We have the acquisition of capital assets for cash or other form of compensation. So we have the purchases of property plant and equipment. Again, there's going to be less of them. So notice when we consider the auditing of these transactions of purchases for smaller companies, we could probably audit basically all the purchases of property plant and equipment to some degree in terms of substantive testing. If we're talking about larger clients, publicly traded businesses, then again, still the amount of transactions related to purchases of property plants and equipment are going to be less than other types of transactions. So we can audit a higher significant portion of them. And of course, the purchase of property plants and equipment is much more likely to be material or a relevant factor, however, because we're purchasing larger items, larger items that will be capitalized, we may be paying cash for them. We may be paying in some other way, we may be financing the property plants and equipment. If we are, then it's a bit more complex because we have to consider, of course, the financing option with the purchase process as well and the valuation of the property plants and equipment with relation to that disposition of capital assets through sale, exchange, retirement or abandonment. So the property plants and equipment may be leaving the organization. That's another type of transaction that can happen. That could happen through the sale. They might sell property plants and equipment. Remember, property plants and equipment is not a normal sale within the normal type of business processes. We're not selling inventory. We're selling some type of equipment like a forklift or something. That's going to be more of an unusual type of a transaction. We could exchange it, which could be a little bit more complex because we have that exchange process happening instead of just basically selling it for cash. We could retire it, meaning we basically retired it and in essence disposed of it or we could abandon it, which would be a similar type of process. Notice that the retirement and abandonment items are things that we're concerned with as an auditor that may have happened and yet not have been recorded. In other words, if someone just abandoned the property plants and equipment or are no longer using it, it may still be on the books and may be fully depreciated. So the book value of it, asset, the amount minus the accumulated depreciation might be zero, but we still have the asset on the books and we have the accumulated depreciation on the books and we should have both of them removed typically. So that's one of the things that could cause some concern, although from a dollar point standpoint might not be a material misstatement. Depreciation of capital assets over their useful economic life. So then we're going to have of course the depreciation process. We're going to have to calculate the depreciation. That's going to be one of the transactions the company does. We're going to be needing to test that calculation. Notice that they only record depreciation periodically. It's usually an adjusting entry at the end of a period, such as a month. So there's not going to be too many of those calculations as well, those types of transactions. So it should be easier for us to audit given the number of them. Leasing of capital assets. So it's possible to have capital leases and the capital leases of course result in a capital asset and they're going to be a bit more complex. So when we see the capital lease, we might want to look into that because the valuation process is going to be a bit more complex to consider. Factors to consider with regard to inherent risk for property plants and equipment. Remember our process here. We want to consider inherent risk, control risk and then set detection risk related to substantive testing inherent risks. You can think of those risk factors as if you took away the internal control. How inherently risky are these items? If we are the company, sometimes it's useful to be able to compare inherent risk factors to different areas. If we had inherent risk related to cash, for example, obviously that's going to be much more inherently risky because it's more liquid. People are more easily to basically want to steal cash or be able to steal cash and be able to use the cash. If we think about property plants and equipment, it's probably more difficult to basically steal a forklift or something like that, a large piece of equipment or building. And it's going to be less easy for someone to basically spend or consume the forklift personally. So notice when we think the inherent risks, those are the types of things we want to consider. Doesn't mean there's not still inherent risk with the forklifts, but the inherent risk factors of course will be different. We want to consider what the inherent risk factors will be with regard to property plants and equipment. Consider the internal controls then that the company has put into place and then how can we do substantive tests that being related to it? So the complexity of the accounting issues is going to be one thing that we might want to consider with regard to inherent risk. It basically depends on the type of transactions involved with property plants and equipment. But because they're larger dollar amounts, they could be material. And if we have some types of transactions related to them, they can be more complex such as a transaction like a capital lease. It could be a little bit more difficult for us to consider. Difficulty to auditing transactions. So we want to consider the factor of inherent risk. How easy it is it going to be for us to audit basically the transactions related to property plants and equipment? Do we have the documentation, all the documentation that is necessary for it? And can we observe basically what the process is that happened? Possibly can we observe the actual equipment itself? Are we in the location that we could observe it? Or is it some location that we can't basically observe? Misstatement detected in the prior years. So if there's misstatements, of course, in the prior year regarding inherent risk, regarding property plants and equipment, then we're going to increase the inherent risk in the current year. Now complexity, if we have a straightforward type of transaction with property plants and equipment like they bought property plant and equipment and they paid cash for it, well, that's pretty straightforward. That's not too difficult for us to consider complexity-wise, although the transaction would be material and therefore something we would want to consider. If they bought it for a loan, then they financed part of it, bought a forklift, paid some cash, financed part of it. Well, that's still not too unusual. We could probably consider that leasing if they bought it as a capital lease or if they self-constructed the capital asset, they made it themselves. Those are two types of things that can be far more complex for us to consider. The lease in the format of a lease as opposed to a purchase, and then we're going to want to put it on the books as a purchase because in substance we believe it is one with regards to a capital lease can be a bit more difficult for us to think about the accounting issues related to it. If they made the capital asset themselves, they constructed it and then used it. They made it not inventory. They made the capital asset property plant and equipment to value that can be a little bit more confusing as well. Difficulty to audit the transactions. The easy type of transaction to audit is an asset purchased directly from the vendor. Again, if you had a transaction where they just said, hey, I need a forklift. They went to the vendor. They bought the forklift. They bought a big piece of equipment. They went to basically Home Depot and bought the equipment. Then it's pretty straightforward types of transaction. Again, it might be material, something we want to consider, but not too difficult. The more difficult types of transactions are transactions involving something like a donated property. If something was donated, how do we know what the value is because it's not on a market transaction? We want to consider that non-monetary exchanges. If there wasn't money exchanging hands, then that's going to increase the complexity. Obviously, we would consider if it was an arm length transaction that something was exchanged to help us to basically value on a market value method. Then the self-constructed assets, again, that's going to be more difficult if they made the asset. Misstatements detected in the prior year's audit. So of course, when misstatements are found in the prior year, the auditor will increase the inherent risk factor in the current year. Now we want to consider control risk. So recall, we think about inherent risk, then the control risk to then set detection risk. That's the amount of testing that we're going to do. So control risk, control procedures generally part of the purchasing process. When we think of controls and in other words, we've thought about the purchasing process, the controls should be much the same for the purchasing of property planting equipment, considering the fact that it's going to be part of the purchasing process with regard to the assertion of occurrence and authorization over property planting equipment. However, larger capital asset transactions may be subject to additional controls. In other words, the company may have something in place where they're going to say this is the normal purchasing process for normal purchases. If however you purchase something, say over a certain dollar amount, you need additional approval, additional authorization for those types of purchases. So we might have, you know, more type of things that we would have to test over and above the traditional purchasing process with regard to property planting equipment. Business will have an authorization table for approving capital asset transactions. Control activities will also need to identify assets no longer in use. So notice that's going to be another key concern for us as the auditor. Those assets that are now obsolete or not being used that are property plants and equipment, they should be removed. And remember, they're not always removed. And sometimes it doesn't create a significant amount or effect on the financial statements from a net perspective, because the items on the books as an asset, and maybe it's fully depreciated, therefore the book value is zero. But still the equipment's on the books overstated, the accumulation, accumulated depreciation is on the books overstated. And therefore, although the net is zero for that asset, we would still need to dispose of it. So even if the, and that might not be the case, it might still have valuation on the books and they're not using it as obsolete for some reason. So even if it's a net book of zero, we want to have consideration to look at those property plant and equipment assets and remove them from the books. They shouldn't be, you know, on the books. Now, when we consider the property plants and equipment, what we're going to do is we're going to get a subsidiary ledger, of course. So when we think about the property plants and equipment, we think on the balance sheet, we have the asset of the property plants and equipment or the list of assets that are property plants, equipment categorized out by land, building, equipment, and so on. And we have the accumulated depreciation, but those are all lumped together within those categories. We need then a subsidiary ledger, some type of ledger that's going to be breaking out in detail, the supporting type of documentation. We have to have this information because we need to know what's actually comprising the pieces of equipment that are on the books. Now, this can be a detailed and confusing report. We need to understand that. And we also need to understand that there could be, when you consider the creation of the subsidiary ledger for depreciation and equipment, then typically you have to do that for what we're considering, the book value. And there's going to be other types of calculations that are going to be necessary, at least for the taxes, because the accumulated depreciation will be different typically for taxes. So it could be a complex schedule. Information we're going to need on it is going to be the description of the property plants and equipment. So we need to have a list of the property plants and equipment on there. And it should notice that when you're putting together a property plants and equipment, if you're recording property plant and equipment on the GL side of things as well, just note that unlike financial accounting, where we often just put something on the books as equipment, we debit equipment. When we put it on the books in real life, we want to have the description. What is this? This is a cat, forklift, blah, blah. This maybe have a serial number on it. We want to know the description of what is on there. And what we also do not want to do is put something on the books as equipment and lump together five things. So if we bought like five forklifts and one, you don't put the thing on there is five forklifts and debit property plant and equipment for the value of five forklifts because the subsidiary ledger isn't going to give us the detail. We need the detail of all of all the actual equipment broken out because if you sell one of those forklifts and not all five of them, for example, that that would be a problem because now it's on the books as a lump sum one kind of thing. So we need the description on there. We want the location, any ID number. So again, we don't put the books as a journal entry that we typically do with financial account and just debit like equipment. We need the, you know, it's in the subsidiary ledger, it's a forklift. And here's the ID number related to that item. If we're going to sell it, we're not going to use a first in, first out method of flow method. Typically, we're going to identify specifically specific identification of the item, the piece of equipment that we are selling to do that. We need to identify it in some way, such as an identification number. Date of acquisition, obviously we need the acquisition date. That'll help us to consider the depreciation that will be considered on it. Depreciation methods for the books, depreciation method for taxes. So notice we're going to have at least two depreciation methods. It could be quite confusing because different classes of assets are going to have different lives, could have different depreciation methods used possibly given the different classes. And there will certainly be different depreciation methods used between the book depreciation done in accordance with something like generally accepted accounting principles and the depreciation done by the tax code, which is completely different. So we're going to, we want to consider both of those items. We are testing for the book depreciation, generally accepted accounting, but we also wanted as part of our testing to consider and possibly reconcile to the tax in some way, because that's going to be a verification process or can help us to verify considering the taxes are another form of reporting that has been done. We can tie out at least do the total amount of property, property equipment and each category tie out on taxes and on our books. And we can consider the reconciliation of the depreciation methods, salvage value. That's the value that it's going to have when at the end, the estimated value at the end of the useful life that we consider at least the scrap value sometimes called. And then we're going to have the estimated useful life, of course, and that's useful life, the salvage value and the costs are things that are going to help us to consider whether or not the depreciation calculation was done correctly. Now we're going to consider the segregation of duties related to property, plant and equipment. So separation of duties, segregation of duties, key internal control, whenever we think of internal controls, one of the first things we want to think of is the separation segregation of duties. Obviously larger companies are going to be able to have more separation segregation of duties than smaller companies, given the fact that they should have more staff to do so. So first item, function of initiating the purchase of a capital asset is segregated from the approval function. So notice part of this, you're going to see some overlap, of course, with the purchasing process with the consideration of purchasing property, planting equipment. Now why would we need that? Because if it was not segregated, if those functions were not separated, fictitious or unauthorized purchases of assets can occur. This can result in purchases of unnecessary assets, assets that may not meet the company's quality control standards or illegal payments to suppliers. Again, as we consider these, the separation of duties, the segregation of duties, remember that you might often think that, Hey, you know, my employees wouldn't do that. I'm going to hire good people that's not going to happen in my area. But just note, again, as companies grow, you're going to need more separation of duties. And even if you're small, what you want to do is remove any risk factors. The temptation, the fact that an employee can look at something and say, I could commit fraud right now. And if I wanted to, it's actually stressful, you know, because, you know, they're involved in two areas, they can actually say it's possible for that to happen. People could perceive that I'm that that that maybe I am doing, they wouldn't know because I'm involved in these two things. So you want to basically remove that as much as possible, as much as you're capable of doing, as long as it is to the degree that it doesn't increase any problem with the functioning of the organization, remove any, any, any risk factors or any, any temptation to commit, you know, fraud or anything that is there. I mean, you know, don't set the money in the middle of the cafeteria table and expect people to, you know, you're going to be taxing them on their willpower, just not to pick up the $100 that's sitting in the middle of the table. So you want the separation of duties as basically a benefit as well, if it's possible to be putting those in place. Property, plant and equipment records function is segregated from the general ledger function. If this was not segregated, an individual can conceal any defulcation that would normally be detected by reconciling subsidiary records with the general ledger control account. So that reconciliation process, the subsidiary ledger to the control account should be a good control to have. If we have the same person involved, they could adjust those accounts. Then of course, they got that control would be less effective. The property and plant and equipment, PP and E records function is segregated from the custodial function. So the PP and E records, and then the custodial, the people that are basically taking care of or overseeing the actual maintenance or the caretaking of the property, plant and equipment, you could consider them having basically possession in some sense of the property plant and equipment. If this was not segregated tools and equipment can be stolen and the theft can be concealed by adjusting the accounting records. Then we have when a periodic physical inventory of PP and E is done. This should happen periodically. Notice the property, plant and equipment is going to be physical type of inventory or physical type of things similar to inventory in that it has a physical presence. Inventory is something we count for sure. The property, plant and equipment because it's larger and whatnot may not have the physical count as often, but we should still have basically that physical count just to verify the presence of the property, plant and equipment. So when a periodic physical inventory of PP is done, the individual responsible for the inventory needs to be independent of the custodial and record keeping function. And again, remember when we're thinking inventory here, we're thinking inventory of property, plant and equipment, not inventory, the things that we're selling type of inventory. If this is not segregated theft of the entities, capital assets can then be concealed. Now we'll consider the substantive analytical procedures related to PP and E property, plant and equipment. These are the substantive tests. So we've talked about inherent risk control risk. And now we're thinking about the substantive tests related to the detection risk. So these are substantive testing, but they're analytical substantive testings. Remember, these are things like comparing ratios. These are things when I would think of myself as basically or the cozy auditor that's in my own office and the audit firm comparing just numbers and ratios and whatnot. It's instead of the substantive tests that we would typically think of as substantive tests going out, for example, and seeing that the that these property, plant and equipment are there pulling invoices being at the business's office. So these are analytical procedures. We could prepare prior year balances and current year balances in property, plant and equipment and depreciation. So that's our standard kind of thing. What happened last year, what happened this year, what's the difference between the two, what's the dollar change, what's the percentage change that could give us some idea of if the change is significant and what's going on with them. Then we can compute the ratio of depreciation expense to the related PP and E property, plant and equipment accounts. So depreciation expense to PP and E and compared to the prior year's ratios as well. So we can do that ratio analysis and compare our results to prior year compute the ratio of repairs and maintenance expense to the related PP and E accounts. Remember that repairs and maintenance is something that we want to we want to consider because we also want to consider things like is something recorded to repairs and maintenance that should have been capitalized. So this kind of ratio of repairs and maintenance, for example, what if they completely overhauled the entire piece of equipment, then you would think, well, maybe it shouldn't be repairs and maintenance as an expense, maybe it should be something that should be capitalized as as part of an improvement to the actual asset. So that's something that we want to be considered of that's this ratio will give us some idea possibly of that as well. We can compare that to prior years compute the ratio of insurance expense to related PP and E accounts. So insurance related to the PP and E and we can compare that to prior years. And we can review the capital budget. So they should have a budget if you're talking about publicly traded companies, they should have a capital budget, meaning how much they plan on spending for things like capital assets. And we could take that capital budget and compare amounts spent with amounts budgeted to spend.