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Auditing Plant, Property, and Equipment: The Why

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By Charles Hall | Auditing

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Sep Today, I tell you how to audit plant, property, and equipment (or capital assets if Search...
25 you work with governments).

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Plant, property, and equipment is often the largest item on a balance sheet. But
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the risk is often low to moderate. After all, it’s difficult to steal land or a building.
And the accounting is usually not difficult. So the dollar amount can be high but CPE
the risk low.
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Fraud is for both the profess
In this post, we’ll answer questions such as, “how should we test additions and
fraud examiner and layman a
retirements of property?” and “what should we do in regard to fair value
Even if you know little about
impairments?” 
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Auditing Plant, Property, and government-fraud

Equipment — An Overview
ABOUT CHARLES HALL
I will—at times in this article—refer to plant, property, and equipment as
property. Governments use the term capital assets to refer to plant, property
I am a practicing CPA and Ce
and equipment, but again, I will, for the most part, use the term property in this
Fraud Examiner. For the last
article. years, I have primarily audite
governments, nonprofits, and
Property is purchased for use in a business. For example, a corporate office businesses.

might be bought or constructed. The building is an asset that is depreciated

over its economic life. As depreciation is recorded, the book value (cost less My sweet spot is governmen
accumulated depreciation) of the building decreases as depreciation is nonprofit fraud prevention. I

recognized. In other words, you expense the building as it is used. author of The Little Book of L
Government Fraud Preventio
 In most reporting frameworks, including GAAP, assets are recorded at cost. Preparation of Financial State
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Appreciation in market value is not recorded, but significant decreases, known & Compilation Engagements

as impairments, are booked. Property improvements (e.g., adding a new room frequently speak at continuin

to an existing building) are capitalized and depreciated. Repairs (e.g., painting a education events.

room) that don’t extend the life of an asset are expensed.

I am the quality control partn
our CPA firm where I provide
Also, most businesses elect to use a capitalization threshold such as $5,000.
audit and accounting assista
For these entities, amounts paid below the threshold are not capitalized, even if
over 65 CPAs. In addition, I co
they extend the life of the asset. The amounts below the threshold are with other CPA firms, assistin
expensed as incurred. with auditing and accounting
Read my full bio…

So, how do most entities track property purchases and compute the related
depreciation? They use depreciation software. Then when property is
purchased, it is added to the depreciation software and an economic life (e.g., CONTACT ME
ten years) is assigned.

Charles B. Hall
Below we will cover the following: McNair, McLemore, Middleb
Co., LLC
Post Office Box One
Macon, Georgia 31202
Primary property assertions Email Me

Property walkthroughs

Directional risk for property MCNAIR, MCLEMORE,

MIDDLEBROOKS & CO., LL
Primary risks for property

Common property control deficiencies 389 Mulberry Street

Macon, Georgia 31201

Risk of material misstatement for property

Substantive procedures for property

TOPICS
Common property work papers
Accounts payable

Adobe Acrobat
Primary Property Assertions Agreed Upon Procedu

The primary relevant property assertions are: Benefit plans

Bookkeeping
Existence and occurrence
Capital Assets

Completeness Consulting Engagemen

Valuation Debt Ethics

Evernote
Classification
Financial Statements
Of these assertions, I believe—in general—existence, occurrence, and
Going Concern
classification are most important. So, the client is asserting that property exists,
that depreciation expense is appropriate, and that amounts paid for property Government

are capitalized (and not expensed). Independence

Internal Controls

Property Walkthroughs
HOME
Property Walkthroughs
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As we perform walkthroughs of property, we are looking for ways that property Payroll Fraud

might be overstated (though understatements can occur as well).  Peer Reviews

Practice Management
As we perform the property walkthrough, we ask, “what can go wrong, whether
Preparation of Financia
intentionally or by mistake?” Statements

Productivity
In performing the walkthrough, ask questions such as:
Project Management

Are property ledgers reconciled to the general ledger? Risk Assessment

Segregation of Duties
Does the entity use reasonable and consistent depreciation methods?
Supplementary
Are the depreciation methods in accordance with the reporting Information
framework (e.g., straight line for GAAP or accelerated for tax basis) Tax Basis

Who records depreciation?  Work Papers

Yellow Book
Are the economic lives assigned to property appropriate?

What controls ensure that property is recorded in the right period?

What controls ensure that capital leases are capitalized as property (if BLOG ARCHIVES
applicable, see GAAP lease standards)?
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Is there appropriate segregation of duties between persons that
purchase, record, reconcile, and physically possess property?

What software is used to compute depreciation?

Does the company perform periodic physical inventories of property?

Are assets removed from the depreciation schedule upon sale?

What controls ensure that property purchases are added to the

depreciation schedule (and not expensed as repairs and maintenance)?

What controls ensure that repair expenses are not capitalized as

property?

What is the capitalization threshold (e.g., $5,000)?

As we ask questions, we also inspect documents (e.g., depreciation reports)

and make observations (e.g., who has access to moveable property?).

If control weaknesses exist, we create audit procedures to respond to them. For

example, if—during the walkthrough—we see that one person purchases
property, has physical access to equipment, and performs the related
accounting, then we will perform theft-related substantive procedures.

Directional Risk for Property

The directional risk for property is overstatement. So, in performing your audit
 procedures, perform procedures to ensure that property is not overstated. For
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example, vouch all significant property additions to invoices. See if the amounts
added are equal to or greater than the capitalization threshold (e.g., $5,000).

Primary Risks for Property

The primary risks for property are:

1. Property is intentionally overstated

2. Repair expenses (or any other expenses) are improperly capitalized as

property

3. Purchases that should be recorded as property are expensed

4. Depreciation is improperly computed and recorded (e.g., accelerated

depreciation is used when straight-line is more appropriate)

5. Moveable property (e.g., equipment) is stolen

Common Property Control

Deficiencies

In smaller entities, it is common to have the following control deficiencies:

One person performs more than one of the following:

Authorizes the purchase of property

Enters the property in the general ledger and depreciation

schedule

Has physical custody of the property

Has responsibility for reconciling the depreciation schedule to

the general ledger

The person computing depreciation doesn’t have sufficient knowledge

t d
 to do so 
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A second person does not review the depreciation methods for
appropriateness and economic lives assigned to each property

No one performs surprise audits of property

No one performs physical inventories of property

There are no controls over the disposal of property

Appropriate bidding procedures are not used

No one reconciles the depreciation schedule to the general ledger

Property is not reviewed for potential impairments of value

(See my article providing you with ways to prevent the theft of capital assets.)

Risk of Material Misstatement for

Property
In smaller engagements, I usually assess control risk at high for each assertion.
If control risk is assessed at less than high, then controls must be tested to
support the lower risk assessment. Assessing risks at high is usually more
efficient than testing controls.

When control risk is assessed at high, inherent risk becomes the driver of the
risk of material misstatement (controls risk X inherent risk = risk of material
misstatement). The assertions that concern me the most are existence (for
additions to property), occurrence (for depreciation), and classification (of
property). With regard to classification, the business determines whether the
amount should be capitalized or expensed. So my RMM for these assertions is
usually moderate to high.

My response to higher risk assessments is to perform certain substantive

procedures: namely, the vouching of additions to property. As RMM increases I
lower the dollar threshold for vouching property additions.  

If controls related to bids are weak, your RMM for existence can be high. Bid
rigging or kickbacks—fraudulent vendor actions—can result in overstatements
of asset additions. 

Substantive Procedures for

Property
My customary audit tests are as follows:
 1. Vouch property additions to related invoices
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2. Agree opening property balances in the depreciation schedule to the prior

year ending balances

3. Review economic lives assigned to new property for appropriateness

4. Review the selected depreciation method in light of the property’s life

5. Compute a ratio of depreciation to property and compare the result with

prior periods

6. Review new lease agreements to determine if they should be capitalized

7. Inquire about potential decreases in the value of property and request

valuations if necessary

Common Property Work Papers

My property work papers normally include the following:

An understanding of property-related internal controls

Risk assessment of property at the assertion level

Documentation of control deficiencies related to property

Property audit program

A copy of the depreciation schedule that agrees to the general ledger

A summary of additions and retirements of property in the current audit

period

Bid documents for significant construction projects or other property

purchases

A valuation of a significant asset by a valuation specialist, if merited

(potential impairment)

In Summary
In this article, we looked at how to perform property risk assessment
procedures, the relevant property assertions, the property risk assessments,
and substantive property procedures.

Next it’s time to turn our attention to the audit of accounts payable and
expenses.
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About the Author
Charles Hall is a practicing CPA and Certified Fraud
Examiner. For the last thirty years, he has primarily
audited governments, nonprofits, and small
businesses.He is the author of The Little Book of Local
Government Fraud Prevention and Preparation of
Financial Statements & Compilation Engagements. He
frequently speaks at continuing education
events.Charles is the quality control partner for McNair,
McLemore, Middlebrooks & Co. where he provides daily
audit and accounting assistance to over 65 CPAs. In
addition, he consults with other CPA firms, assisting
them with auditing and accounting issues.

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(2) comments
 Chika y March 15, 2019
HOME ABOUT ACCOUNTING & AUDITING PREPARATION, COMPILATION & REVIEW FRAUD TECHNOLOGY ONLINE COURSES

Wow Sir I must say I really gained a lot today. In my little experience in
audit I am aware of most of the procedures but there a quite a number
that I am not aware of. In the light of my new discovery I intend to follow
through.But the challenge I usually experience is the short time span to
complete an audit and the fact that my firm still prefers to use manual
methods.

B Reply

Charles Hall y March 15, 2019

Chika, glad you learned a lot from the post. Thanks.

B Reply

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