Audit - Ch. 13 - PPE, Depreciation and Depletion (highlighted notes from book)

Other Key Controls to plant and equipment...#1 is most important

1) *A subsidiary ledger consisting of a separate record for each unit of property. An adequate plant and equipment ledger facilitates the auditors' work in analyzing additions and retirements, in verifying the depreciation provision and maintenance expenses, and in comparing authorizations with actual expenditures.* 2) A system of authorizations requiring advance executive approval of all plant and equipment acquisitions, whether by purchase, lease, or construction. Serially numbered *capital work orders* are a convenient means of recording authorizations. 3) A required review of construction and lease contracts by competent personnel 4) A reporting procedure assuring prompt disclosure and analysis of variances between authorized expenditures and actual costs. 5) An authoritative written statement of company policy distinguishing between *capital expenditures* and *revenue expenditures.* A dollar minimum ordinarily will be established for capitalization; any expenditures of a lesser amount automatically are classified as charges against current revenue. 6) A policy requiring all purchases of plant and equipment to be handled through the purchasing department. 7) Periodic physical inventories designed to verify the existence, location, and condition of all property listed in the accounts and to disclose the existence of any unrecorded units. When the assets are mobile and of high value, a radio frequency identification or global positioning system may be used to track the movement of the assets and help prevent theft. 8) A system of retirement procedures, including serially numbered retirement work orders stating reasons for retirement and bearing appropriate approvals.

The term property, plant, and equipment includes all 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 of such assets are generally recognized:

1) Land, such as property used in the operation of the business, has the significant characteristic of not being subject to depreciation. 2) Buildings, machinery, equipment, and land improvements, such as fences and parking lots, have limited service lives and are subject to depreciation. 3) Natural resources (wasting assets), such as oil wells, coal mines, and tracts of timber, are subject to depletion as the natural resources are extracted or removed. **Acquisitions and disposals of property, plant, and equipment are usually large in dollar amount.

An overall test of the annual provision for depreciation requires the auditors to perform the following steps:

1) List the balances in the various asset accounts at the beginning of the year. 2) Deduct any fully depreciated assets because these items should no longer be subject to depreciation. 3) Add one-half of the asset additions for the year. 4) Deduct one-half of the asset retirements for the year (exclusive of any fully depreciated assets).

Substantive procedures to be performed by the auditors in reviewing depreciation

1) Review the depreciation policies set forth in company manuals or other management directives. Determine whether the methods in use are designed to allocate costs of plant and equipment assets systematically over their service lives. a) Inquire whether any extra working shifts or other conditions of accelerated production are present that might warrant adjustment of normal depreciation rates. b) Discuss with executives the possible need for recognition of obsolescence resulting from technological or economic developments. For example, assume that a new, improved model of computer has recently become available and that it would fit the company's needs more effectively. Should the remaining estimated useful life of an older computer presently owned by the company be reevaluated in the light of this technological advance? 2) Obtain or prepare a summary analysis (see Figure 13.1) of accumulated depreciation for the major property classifications as shown by the general ledger control accounts, listing beginning balances, provisions for depreciation during the year, retirements, and ending balances. a) Compare beginning balances with the audited amounts in last year's working papers.Page 592 b) Determine that the totals of accumulated depreciation recorded in the plant and equipment subsidiary records agree with the applicable general ledger controlling accounts. 3) Test the provisions for depreciation a) Compare rates used in the current year with those employed in prior years and investigate any variances. b) Test computations of depreciation provisions for a representative number of units and trace to individual records in the property ledger. Be alert for excessive depreciation on fully depreciated assets. Generalized audit software can be used to test the depreciation calculations in the client's records if the client maintains computer-based records. c) Compare credits to accumulated depreciation accounts for the year's depreciation provisions with debit entries in related depreciation expense accounts. 4) Test deductions from accumulated depreciation for assets retired. a) Trace deductions to the working paper analyzing retirements of assets during the year. b) Test the accuracy of accumulated depreciation to date of retirement. 5) Perform analytical procedures for depreciation. a) Compute the ratio of depreciation expense to total cost of plant and compare with prior years. b) Compare the percentage relationships between accumulated depreciation and related property accounts with those prevailing in prior years. Discuss significant variations from the normal depreciation program with appropriate members of management.

Chapter 13 Summary (5 points)

1) The financial statement caption "Property, Plant, and Equipment" includes tangible assets with a useful life of more than one year that are used in operations. In the audit of property, plant, and equipment, the auditors' primary substantive procedure objectives are to (a) substantiate the existence of property, plant, and equipment and the occurrence of related transactions; (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 the recorded property, plant, and equipment; (e) establish the proper valuation or allocation of property, plant, and equipment and the accuracy of related transactions; and (f) evaluate the adequacy of presentation and disclosure for property, plant, and equipment. 2) Key controls over property, plant, and equipment should include proper authorization of acquisitions, adequate records for the various units of property, periodic physical inspection of property, and the use of serially numbered retirement work orders. 3) In the audit of property, plant, and equipment for a continuing client, the emphasis of the testing is on transactions that occurred during the year, as contrasted to an emphasis on ending balances. Depreciation expense is often tested by recomputation or through the use of analytical procedures. 4) The auditors' objectives for the audit of natural resources and intangible assets are similar to those for property, plant, and equipment. Often in auditing the depletion of natural resources, the auditors should rely upon specialists to estimate the quantity and quality of the resource. The audit of intangible assets typically involves vouching the cost of the assets and evaluating and testing the allocation methods used by the client. Under current accounting, virtually all leases are capitalized at the present value of the future payments. The right-of-use asset is amortized over the period the client is expected to have control over the asset. 5) In some audits, a substantial risk with respect to property, plant, and equipment and intangible assets is the risk of unrecognized impairment.

Auditors' objectives in auditing PPE

1) Use the understanding of the client and its environment to *consider inherent risks*, including fraud risks, related to property, plant, and equipment. Obtain an *understanding of internal control* over property, plant, and equipment. Assess the risks of material misstatement and design tests of controls and substantive procedures that a) Substantiate the *existence* of property, plant, and equipment and the occurrence of the related transactions. 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 the 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 information about property, plant, and equipment are appropriate, including disclosure of depreciation methods. **also obtain evidence about the related accounts of *depreciation expense, accumulated depreciation, and repairs and maintenance expense.*

Work Order

A serially numbered accounting document authorizing the acquisition of plant assets. A separate series of retirement work orders may be used to authorize the retirement or disposal of plant assets, and a third variety consists of documents authorizing repair or maintenance of plant assets.

Investigate Potential Impairments of PPE (valuation)

Accounting standards require that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In these circumstances, if the sum of the expected undiscounted future cash flows from the asset is less than its carrying amount, an impairment loss is recognized. *The impairment loss is equal to the difference between the book value and the fair market value of the asset.* Auditors should be alert for any changes in circumstances that may affect the recoverability of property, plant, and equipment as well as long-lived intangible assets. Examples of changes in circumstances that should result in a test of impairment include a significant decrease in the market value of the asset, a significant adverse change in the way the asset is used, or an adverse change in the physical condition of the asset. If specific assets appear to be impaired, the auditors should evaluate the reasonableness of management's determination of the impairment loss. The determination of the amount of an impairment loss often involves subjective estimates as to the fair value of assets. Recall from the discussion in Chapter 5 that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The best evidence about fair value is obtained when there is an active market for the asset and the value of the asset may be determined by reference to sales of identical assets. However, in many cases, an active market does not exist for the specific asset, and fair value must be determined through the application of a valuation model, often involving discounted cash flows. The accuracy of these estimates of fair value depends on the reasonableness of the model's underlying assumptions. The audit of estimates of fair values often involves substantial risks of material misstatement

Auditors' Perspective towards Depreciation

Among the methods of computing depreciation expense most frequently encountered are the straight-line method and the declining-balance method. Far less common, although quite acceptable, are methods based on units of output or hours of service. The most widely adopted types of accelerated depreciation methods are fixed percentage of declining balance and sum-of-the-years' digits. The essential characteristic of these and other similar methods is that depreciation is greatest in the first year and becomes smaller in succeeding years. CPAs often encounter clients maintaining their records using federal income tax rules, such as the modified accelerated cost recovery system (MACRS). Although such methods are considered a systematic method of depreciating the cost of an asset, the depreciable lives of the assets are often much shorter than their useful economic lives. If the recovery periods are not reasonable, depreciation expense may be materially misstated and the auditors will not be in a position to issue an unqualified opinion on the financial statements.

Capital expenditure (T/F question)

An expenditure for PPE that is properly charged to an *asset account.*

Revenue expenditure (T/F question)

An expenditure for PPE that is properly charged to an *expense account.*

Internal Control over Plant and Equipment **Errors in measurement of income may be material if assets are scrapped without their cost being removed from the accounts, or if the distinction between capital and revenue expenditures is not maintained consistently

Annual Plant Budget - In large enterprises, the auditors may expect to find an annual plant budget used to forecast and control acquisitions and retirements of plant and equipment. *Successful utilization of a plant budget presupposes the existence of reliable and detailed accounting records for plant and equipment*. A detailed knowledge of the kinds, quantities, and condition of existing equipment is an essential basis for intelligent forecasting of the need for replacements and additions to the plant.

Related Party Transactions

Assets acquired from affiliated corporations, from promoters or stockholders, or by any other type of related party transaction not involving arm's-length bargaining between buyer and seller *have sometimes been recorded at inflated amounts* The auditors should inquire into the methods by which the sales price was determined, the cost of the property to the vendor, length of ownership by the vendor, and any other available evidence that might indicate an arbitrarily determined valuation. Material related-party transactions must be disclosed in the notes to the financial statements.

Auditors' Objective in Auditing Depreciation

Depreciation is an accounting estimate. Recall from Chapter 5 that, in evaluating the reasonableness of accounting estimates, auditors first obtain an understanding of the client's processes and controls. Then, they use one or more of the following three basic approaches: 1) Review and test management's process of developing the estimate. 2) Review subsequent events or transactions bearing on the estimate. 3) Independently develop an estimate of the amount to compare to management's estimate. For depreciation, while a combination of the three approaches may be used, the emphasis is ordinarily upon the first basic approach—reviewing and testing management's process for calculating depreciation. As we discussed earlier, depreciation relates most directly to the valuation or allocation audit objective. To meet this objective, the auditors, in examining management's process for calculating depreciation, determine that (1) the methods in use are acceptable, (2) the methods are being followed consistently, and (3) the calculations required by the chosen methods are accurate. The audit program in the following section conveys a more detailed picture of the auditors' objectives.

Contrast with audit of Current Assets: In many companies, the investment in plant and equipment amounts to 50 percent or more of the total assets. However, the audit work required to verify these properties is usually a much smaller proportion of the total audit time spent on the engagement. The verification of plant and equipment is facilitated by several factors not applicable to audit work on current assets.

First, a typical unit of property or equipment has a *high dollar value, and relatively few transactions* may lie behind a large balance sheet amount. Second, there is *usually relatively little change in the property accounts from year to year*. The Land account often remains unchanged for a long span of years. The durable nature of buildings and equipment also tends to hold accounting activity to a minimum for these accounts. *By way of contrast, such current assets as accounts receivable and inventory may have a complete turnover several times a year.* A third point of contrast between the audit of plant assets and the audit of current assets *is the significance of the year-end cutoff of transactions on net income.* For current assets, the year-end cutoff is a critical issue; for plant assets, it is of lesser importance. **For example, in our discussion of inventories in Chapter 12, we emphasized the importance of an accurate year-end cutoff of the transactions for purchases and sales of merchandise. An error in the cutoff of a $50,000 purchase or sales transaction may cause a $50,000 error in the year's pretax net income. The possibility of such errors is substantial because a large volume of merchandise transactions is normal at year-end. For plant assets, on the other hand, a year-end cutoff error in recording an acquisition or retirement ordinarily will not affect net income for the year. *The problem of year-end cutoff for plant assets, however, should be considered of less importance in contrast to the audit of current assets.*

Initial Audits and Repeat Engagements: In the auditors' first audit of a new client that has changed auditors, a review of the predecessor auditor's audit documentation may provide substantial audit evidence about opening balances and consistency of accounting principles. However, the nature, timing, and extent of audit work performed and conclusions reached are the responsibility of the successor auditor. Nonetheless, if previous audits were performed by a reputable CPA firm, that firm's work will be extremely helpful to the successor auditor.

In a first audit of a company that has not previously been audited, *the ideal approach is a complete historical analysis of the property accounts. By thorough review of all major charges and credits to the property accounts since their inception, the auditors can establish the validity of the beginning balances of property, plant, and equipment and accumulated depreciation.* (IMPORTANT) If the client has been in business for many years, the review of transactions in earlier years necessarily should be performed on a test basis in order to stay within reasonable time limits. *However, the importance of an analysis of transactions of prior years deserves emphasis. Only by this approach can the auditors be in a sound position to express an opinion as to the propriety of the current period's depreciation. If repair and maintenance expenses have been capitalized, or asset additions have been recorded as operating expenses, or retirements of property have gone unrecorded, the depreciation expense will be misstated regardless of the care taken in the selection of depreciation rates.* The auditors should make clear to the client that the initial examination of plant and equipment requires procedures that need not be duplicated in subsequent engagements.

Obtain an Understanding of Internal Control over PPE

In obtaining an understanding of internal control over property, plant, and equipment, the auditors may utilize a written description, flowcharts, or an internal control questionnaire. The following are typical of the questions included in a questionnaire: 1) Are plant ledgers regularly reconciled with general ledger control accounts? 2) Are periodic physical inventories of plant assets compared with the plant ledgers? 3) Are variances between plant budgets and actual expenditures for plant assets subject to review and approval of executives? 4) Does the sale, transfer, or dismantling of equipment require written executive approval on a serially numbered retirement work order? 5) Is there a written policy for distinguishing between capital expenditures and revenue expenditures? After preparing a description of internal control, the auditors will determine whether the controls as described to them have been implemented. *To confirm their understanding of these policies and procedures, they will observe whether there is an appropriate segregation of duties over the acquisition of plant assets and inquire as to who performed various functions throughout the period.* They will also inspect the subsidiary ledger of property, plant, and equipment; the serially numbered work orders; and the plant and equipment budget and examine evidence of the follow-up on variances from the budget. These procedures may provide the auditors with sufficient evidence to assess control risk for certain financial statement assertions about PPE as being at less than the maximum.

Review Rental Revenue from Land, Buildings, and Equipment Owned by the Client but Leased to Others (existence, rights)

In testing rental revenue from land and buildings, it is often desirable for the auditors to obtain or to sketch a map of the property and to make a physical inspection of each unit. This may disclose that premises reported as vacant are in fact occupied by lessees and are producing revenue not reflected in the accounting records. If the client's property includes an office or apartment building, the auditors should obtain a floor plan of the building as well as copies of all lease contracts. In this way, they can account for all available rental space as revenue-producing or vacant and can verify reported vacancies by physical inspection at the balance sheet date. If interim audit work is being performed, vacancies should also be verified by inspection and discussion with management during the year. Examination of leases will indicate whether tenants are responsible for the cost of electricity, water, gas, and telephone service. These provisions should be reconciled with utility expense accounts. Rental revenue accounts should be analyzed in all cases and the amount compared with lease agreements and cash records. Finally, the auditors should determine that the client is applying the appropriate accounting standards depending on whether the lease terms indicate a sales-type, direct financing, or operating lease. When the lease involves variable payments, the auditors must carefully evaluate when the variable payments should be recognized.

Examination of Natural Resources

In the audit of companies' operating properties subject to depletion (mines, oil and gas deposits, timberlands, and other natural resources), the auditors follow a pattern similar to that used in evaluating the provision for depreciation expense and accumulated depreciation. They determine whether depletion has been recorded consistently and in accordance with generally accepted accounting principles, and they test the mathematical accuracy of the client's computations. The depletion of timberlands is usually based on physical quantities established by *cruising*. (The term cruising means the inspection of a tract of forestland for the purpose of estimating the total lumber yield.) For areas that are difficult to access the client or the auditors might use drones to assess the yield. The determination of physical quantities to use as a basis for depletion is more difficult in many mining ventures and for oil and gas deposits. The auditors often rely upon the opinions of such specialists as mining engineers and geologists about the reasonableness of the depletion rates being used for such resources

Investigate the Status of PPE Not in Current Use. (valuation, presentation)

Land, buildings, and equipment not in current use should be investigated thoroughly to determine the prospects for their future use in operations. Plant assets that are temporarily idle need not be reclassified, and depreciation may be continued at normal rates. On the other hand, idle equipment that has been dismantled, or that for any reason appears unsuitable for future operating use, should be written down to an estimated realizable value and excluded from the plant and equipment classification. In the case of standby equipment and other property not needed at present or prospective levels of operation, the auditors should consider whether the carrying value is recoverable through future use in operations.

Substantive Procedures for PPE

Obtain a summary analysis of changes in property owned and reconcile to ledgers. Vouch additions to property, plant, and equipment during the year. Make a physical inspection of major acquisitions of plant and equipment. Analyze repair and maintenance expense accounts. Investigate the status of property, plant, and equipment not in current use. Test the client's provision for depreciation. Investigate potential impairments of property, plant, and equipment. Investigate retirements of property, plant, and equipment during the year. Examine evidence of legal ownership of property, plant, and equipment. Review rental revenue from land, buildings, and equipment owned by the client but leased to others. Examine lease agreements on property, plant, and equipment leased to and from others. Perform analytical procedures for property, plant, and equipment. Evaluate financial statement presentation and disclosure for plant assets and for related revenue and expenses.

Test client's provision for depreciation (valuation)

See the separate depreciation program following this audit program.

Review chart on page 584 about RMM and potential misstatements regarding PPE

Some of the risks identified by the auditors may be considered to be significant risks that require special audit consideration. The auditors should design procedures that are focused on these significant risks. In addition, the auditors: 1) Should evaluate the design of the related controls and determine that they are being implemented. 2) May not rely solely on analytical procedures to address the risk. 3) May not rely on evidence obtained in prior periods regarding the operating effectiveness of the related controls.

Test of Controls

Tests directed toward the effectiveness of controls are used to evaluate the client's internal control and determine whether the auditors can justify their planned assessed levels of control risk for the assertions about property, plant, and equipment accounts. Certain tests of controls are performed as the auditors obtain an understanding of the client's internal control; these tests were described in our discussion of that process. Additional tests of controls, for example, might include selecting a sample of purchases of plant and equipment to test the controls related to authorization, receipt, and proper recording of the transactions. A sample of recorded retirements also may be tested for proper authorization and supporting retirement work orders. These tests often will be combined with the substantive tests of additions and retirements described in the following sections.

Examine Lease Agreements on Property, Plant, and Equipment Leased to and from Others. (existence, completeness, rights, valuation)

The auditors also should be aware that generally accepted accounting principles require differing accounting treatments by lessees for operating and finance leases

Obtain a Summary Analysis of Changes in Property Owned and Reconcile to Ledgers (valuation)

The auditors may verify the beginning balances of plant and equipment assets by reference to the prior year's audit working papers. In addition to beginning balances, the summary analysis will show the additions and retirements of plant and equipment during the year under audit. As the audit progresses, the auditors will examine a sample of these additions and retirements. The detailed working papers showing this verification will support and be cross-indexed to the summary analysis worksheet. Before making a detailed analysis of changes in property accounts during the year, the auditors will want to be sure that the amounts in the subsidiary ledgers agree in total with the balances in the controlling accounts. Reconciliation of the subsidiary ledgers with the controlling accounts can be performed very quickly with the use of generalized audit software.

Make a Physical Inspection of Major Acquisitions of Plant and Equipment. (all assertions)

The auditors usually make a physical inspection of major units of plant and equipment acquired during the year under audit. This step is helpful in maintaining a good working knowledge of the client's operations and also in interpreting the accounting entries for both additions and retirements. *The audit procedure of physical inspection may flow in either direction between the plant assets and the records of plant assets. By tracing items in the plant ledger to the physical assets, the auditors prove that the assets shown in the accounting records actually exist and are in current use.* The alternative testing procedure is to inspect selected assets in the plant and trace these assets to the detailed records. This test provides evidence that existing assets are recorded (completeness).

Analyze Repair and Maintenance Expense Accounts (valuation)

The auditors' principal objective in analyzing repair and maintenance expense accounts is to discover expenditures for fixed assets or other items that should have been capitalized. In performing this procedure, the auditors should be aware of the company's policy regarding the minimum expenditure to be capitalized. For example, company policy may prescribe that no expenditure for less than $5,000 shall be capitalized regardless of the service life of the item purchased. In such cases, the auditors will analyze the repair and maintenance accounts with a view toward determining the consistency of application of this policy as well as compliance with generally accepted accounting principles.

Audit of Intangible Assets

The balance sheet caption "Intangible Assets" includes a variety of assets. All intangible assets are characterized by a lack of physical substance. Furthermore, they do not qualify as current assets, and they are nonmonetary—that is, they do not represent fixed claims to cash. Among the more prominent intangible assets are goodwill, patents, trademarks, franchises, and leases. An intangible asset's value lies in the rights or economic advantages afforded in its ownership. Because of the intangible nature of these assets, they may be more difficult to identify than physical assets. When a client treats an expenditure as creating an intangible asset, the auditors should look for objective evidence that a genuine asset has come into existence.

Evaluate Financial Statement Presentation and Disclosure for Plant Assets and for Related Revenue and Expenses. (presentation)

The balance sheet or accompanying notes should disclose balances of major classes of depreciable assets. Accumulated depreciation may be shown by major class or in total, and the method or methods of computing depreciation should be stated. The total amount of depreciation should be disclosed in the income statement or supporting notes. In addition, adequate financial statement presentation and disclosure will ordinarily reflect the following principles: 1) 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. 2) Property pledged to secure loans should be clearly identified. 3) Property not in current use should be segregated in the balance sheet.

Audit Documentation pg. 580

The key audit working paper for property, plant, and equipment is a summary analysis such as that illustrated in Figure 13.1. This working paper follows the approach we have previously described of emphasizing changes during the year under audit. The working paper shows: 1) the beginning balances for the various types of plant assets; these amounts are the ending balances shown in the prior year's working papers. 2) *the working paper shows the additions and retirements during the year. These are the transactions upon which the auditors' attention will be focused.* 3) A final column shows the ending balances that must equal the beginning balances plus the additions and minus the retirements. 4) A similar set of four columns is used to summarize the changes in the accounts for accumulated depreciation.

Investigate Retirements of Property, Plant, and Equipment during the Year. (existence, rights)

The principal purpose of this procedure is to determine whether any property has been replaced, sold, dismantled, or abandoned without such action being reflected in the accounting records. Nearly every thorough physical inventory of plant and equipment reveals missing units of property—units disposed of without a corresponding reduction of the accounts. If a machine is sold for cash or traded in on a new machine, the transaction generally will involve the use of documents, such as a cash receipts form or a purchase order; the processing of these documents may bring the retirement to the attention of accounting personnel. However, plant assets may be scrapped rather than sold or traded in on new equipment; consequently, there may be no paperwork related to the disappearance of a machine. How is the accounting department expected to know when the asset has been retired? As explained previously, one method of preventing unrecorded retirements is enforcement of a companywide policy that no plant asset shall be retired from use without prior approval on a special type of serially numbered retirement work order. A copy of the retirement work order is routed to the accounting department, thus providing some assurance that retirements will be reflected in the accounting records. What specific steps should the auditors take to discover any unrecorded retirements? The following measures often are effective: 1) If major additions of plant and equipment have been made during the year, determine whether old equipment was traded in or replaced by the new units. 2) Analyze the Miscellaneous Revenue account to locate any cash proceeds from the sale of plant assets. 3) If any of the company's products have been discontinued during the year, investigate the disposition of plant facilities formerly used in manufacturing such products. 4) Inquire of executives and supervisors whether any plant assets have been retired during the year. 5) Examine retirement work orders or other source documents for authorization by the appropriate official or committee. 6) Investigate any reduction of insurance coverage to determine whether this was caused by retirement of plant assets.

Perform Analytical Procedures for PPE (existence, completeness, rights, valuation)

The specific trends and ratios used in judging the overall reasonableness of recorded amounts for plant and equipment will vary with the nature of the client's operations. Among the ratios and trends used by auditors for this purpose are the following: 1) Total cost of plant assets divided by annual output in dollars, pounds, or other units. 2) Total cost of plant assets divided by cost of goods sold. 3) Comparison of repairs and maintenance expense on a monthly basis and from year to year. 4) Comparison of acquisitions for the current year with prior years. 5) Comparison of retirements for the current year with prior years.

Vouch Additions to PPE during the Year. *Important* (all assertions)

The vouching of additions to the property, plant, and equipment accounts during the period under audit *is one of the most important substantive tests.* The extent of the vouching is dependent upon the auditors' assessment of control risk for the existence and valuation of plant and equipment. *The vouching process utilizes a working paper analysis of the general ledger control accounts and includes the tracing of entries through the journals to original documents, such as contracts, deeds, construction work orders, invoices, canceled checks, and authorization by appropriate individuals.* The specific steps to be taken in investigating the year's additions usually will include the following: 1) 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 (or other expenses) were not improperly capitalized. 2) 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. 3) Investigate fully any debits to property, plant, and equipment accounts not arising from acquisition of physical assets. 4) 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. 5) Review changes during the year in construction in progress and examine supporting work orders, both incomplete and closed. 6) 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. **generally these assets are recorded at fair value. Assets constructed by a company for its own use should be recorded at the cost of direct materials, direct labor, and applicable overhead cost.

Examine Evidence of Legal Ownership of PPE (existence, rights)

To determine that plant assets are the property of the client, the auditors look for such evidence as a deed, a title insurance policy, property tax bills, receipts for payments to a mortgagee, and fire insurance policies. Additionally, the fact that rental payments are not being made is supporting evidence of ownership. It is sometimes suggested that the auditors may verify ownership of real property and the absence of liens by examination of public records. This step is seldom taken. Inspection of the documentary evidence listed in the preceding section usually provides adequate proof of ownership. If some doubt exists as to whether the client has clear title to property, the auditors should obtain the opinion of the client's legal counsel or request that a title search be performed by a title insurance company. Possession of a deed is not proof of present ownership because when real property is sold, a new deed is prepared and the seller retains the old one. This is true of title insurance policies as well. Better evidence of continuing ownership is found in property tax bills made out in the name of the client and in fire insurance policies, rent receipts from lessees, and regular payments of principal and interest to a mortgagee or trustee.