Auditing Special Purpose Frameworks: Auditing Property and Equipmentby
Auditors are required to evaluate the appropriateness and reasonableness of an entity's applicable financial reporting framework and the policies selected for presenting financial statements. Auditors incorporate an entity's accounting policies into the design of their audit strategies and audit plans. A summary of basic accounting policies and applicable auditing standards and procedures for the AICPA's Financial Reporting Framework for Small- and Medium-Sized Entities, are presented in this article.
Property, plant, and equipment are recorded under the FRF for SMEs in a similar manner to U.S. GAAP—that is, at acquisition costs. These costs including the following among others:
- Purchase prices.
- Shipping charges.
- Installation and testing costs.
- Real estate commissions and legal fees.
- Other costs related to acquiring and preparing fixed assets for use.
- Market values of assets received in non-monetary exchanges.
For fixed assets constructed or developed by an entity, all direct costs, overhead costs, and interest or carrying costs related to the fixed asset are capitalized as its carrying amount.
Costs incurred to increase the life or capacities of a fixed asset are considered improvements and, along with the remaining carrying amount of the asset, are depreciated over its extended useful life. (This is similar to the "improvement or betterment rule" used in practice under U.S. GAAP.) Costs to maintain the service potential of a fixed asset are recorded as repairs and maintenance in the period incurred.
Depreciation expense of the carrying amount is calculated in a systematic and rational way over an asset's useful life. The useful life of an asset is limited to the shortest of its physical, technological, commercial, or legal life. Straight-line and variable methods of depreciation may be used, provided they are representative of a fixed asset's economic return or use in the operations of an entity.
Depreciation methods and the lives of property, plant, and equipment should be reviewed periodically to determine any changes in the use of an asset, changes in technology affecting productivity, impairments to the operation or use of the asset, and other events that could change the expected use of fixed assets. Depreciation methods and useful lives should be adjusted prospectively.
Asset retirement obligations should be included in the carrying amounts of property, plant, and equipment. For example, the cost of replacing underground gasoline storage tanks as required by a state law, if probable and capable of being estimated, should be included in the acquisition costs of a convenience store.
Assets may be leased under operating or capital lease agreements. Leased assets meeting the criteria for capital leases under the FRF for SMEs (which are similar to current U.S. GAAP requirements) should be capitalized and carried at the discounted present value of future minimum payments. These policies were summarized in a previous article in this series.
The Clarified Auditing Standard specifically applicable to property and equipment is included in AU-C 540, Auditing Accounting Estimates, including Fair Value Accounting Estimates, and Related Disclosures.
The principal issues in AU-C 540 affecting property and equipment recorded under the FRF for SMEs would be connected with the valuation of assets received in non-monetary exchanges and with the determination of market values for comparison to carrying amounts when a triggering event occurs, such as a technological change. The auditor must evaluate the reasonableness of management's determination of market values assigned to assets, and determine any impairment loss, in these circumstances.
Other principal audit issues for property and equipment relate to the useful lives and residual values of depreciable assets and their depreciation and amortization methods. The auditor must determine that these estimates are reasonable and appropriate under the FRF for SMEs accounting principles adopted by a reporting entity.
Other customary auditing procedures for property and equipment include the following:
- Determining that acquisition costs are recorded properly, including costs assigned to internally constructed fixed assets.
- Inspecting property and equipment to gather evidence for the existence assertion and to identify any unrecorded equipment (completeness assertion).
- Determining if any repairs of assets meet the improvement or betterment rule and should be capitalized.
- Analyzing repairs and maintenance, supplies, small tools, and other related accounts to determine capitalization limits have been met.
- Reviewing management's depreciation methods and rates.
- Identifying any idle equipment, fully depreciated equipment, or property related to discontinued operations for separate accounting and reporting.
- Reading lease agreements to identify any capitalizable leased assets and to evaluate management's applicable accounting policies.
- Analyzing rental income and expense for the existence of other leases and subleases.
- Reviewing the calculations of gain or loss on any disposals of property and equipment.
Other Resource Materials
For live and on-demand two-hour webcasts on this and other of my accounting and auditing subjects, click on the applicable box on the left side of my home page, www.cpafirmsupport.com. My two new auditing books are also available under the "eBooks" tab.
Registered users on my website receive a 20 percent discount on all live and on-demand webcast courses offered by a major publisher from many qualified authors and presenters. Also, check the Webinars page on AccountingWeb.com for free one-hour webcasts to be presented by me and others.