Efficient Tests of Balances Series—No. 22: Modifying the Audit Plan for Fixed Assets

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Illustrative tests of balances procedures for fixed assets follow. Boxed comments following the procedures reflect the opportunities for modifying the procedures to apply the most cost-beneficial audit strategy as a result of performing risk assessment procedures. Parenthetical references pertain to the acronym for financial statement assertions discussed in a previous blog.
 A.       Review the results of the applicable sections of the
            Internal Control Deficiency Worksheet, the Risk of
Material Misstatements Form, the Linking Working
Paper and the Small Audits Analytical Proce dures
Program and determine the impact on tests
            of balances. (E, C, O, R, and V)          
The assessed level of risk of misstatement will usually be high for fixed assets in small to medium-sized entities. Unless a person of authority provides entity-level controls over fixed assets, the risk of accounting error or theft is usually high.
B.         Obtain a schedule of fixed assets showing cost,
            accumulated depreciation, and amortization by 
            beginning balance, additions, retirements, and   
            ending balances. Foot (if client’s IT system hasn’t
been tested) and tie to the general ledger.
(E, C, O, V, and D)                                                     
The auditor is required to have an understanding of the impact of the client’s IT system on its internal control. For out-of-the-box accounting software systems, the auditor should document an understanding of the basic features of the system and circumstances that could be indicators of error or fraud. For accounting software that provides users with source codes (developmental or modification capability), auditing standards require tests of the processes and controls over these systems.
C.        Obtain detailed schedules of additions and
            disposals, and ----
1.   Foot and tie to fixed assets schedule (if not
      generated from accounting software that is
      out-of-the-box and/or tested). (C)                         
            2.   Vouch major additions to vendors’ invoices,
                  construction cost records, titles or deeds,
                  or contracts to determine that fixed assets
                 are properly recorded. (E and V)                           
The calculated lower limit for individually significant items at the financial statement classification level (which is based on the assessed level of risk) should ordinarily be used to select transactions and balances for support tests.
            3.   Physically inspect ________ assets and/or
                  examine tax bills, deeds, licenses, etc. (E)
The number of assets selected for inspection will depend on the nature of the assets, the assessed level of risk and the results of related tests performed in the prior year’s audit.   
            4.   Determine that the capitalization policy is
                  consistently applied. (V and D)                              
The review of the capitalization limit should include the property and equipment accounts and the repairs, maintenance, supplies and small tools accounts and other related expense accounts.
D.        Obtain or prepare a schedule of gains and losses
            on sales of fixed assets. Foot and tie to the general
            ledger. Trace major amounts to supporting docu-
            ments and records and review for reasonableness.
            (E, V, and D)                                                              
E.         Review repairs and maintenance, supplies, small
            tools, and other expense accounts for any assets
            that should be capitalized. (C) and (V)
This procedure should ordinarily be performed when the auditor reads, or scans, the general ledger during engagement planning.   
F.         Determine the carrying amount of assets pledged
            on notes or other indebtedness. (Ob and (D)                
G.        Determine the cost of any significant fully-
            depreciated assets being carried in the accounts,
            and determine if disclosure is appropriate. (D)  
H.        Determine that any impairment of the carrying amounts of fixed
            assets have been properly recognized. (V)                    
I.          When any events or changes in circumstances
have occurred indicating that the carrying amount
of a long-lived asset may not be recoverable:
            1.   Determine if an impairment loss should be recog-
                  nized. [An impairment loss should be recognized
                  if the carrying amount of an asset exceeds
                  estimated future cash flows (undiscounted and
                  without interest charges) or if the value of the
      asset isn’t recoverable through future cash flows].
                  a. Review the estimate of future cash flows for
                        mathematical accuracy and, through discussion
                        with management and review of any supporting
                        documentation, determine that assumptions
                        used are reasonable.                                        
            2.   If an impairment loss should be recognized, test
                  the calculation of the loss. (Impairment loss is
                  measured as the amount by which the asset’s
                  carrying amount exceeds its fair value.)                   
                  a.   Test the fair value used in the calculation by
                        determining the level of input and assessing
the reasonableness of the valuation process.
                  b.   If the fair value is based on a level three
unobservable input such as the present value
                        of estimated future cash flows, test for mathe-
                        matical accuracy and ensure that the assumptions
                        used in the present value calculation, including
                        the discount rate, are reasonable.                     
J.          Inquire about any significant expansion plans. (D)         
K.        Review rental income and expense accounts to deter-
            mine that leased and subleased assets are properly
            recorded. (D)                                                              
L.         Read client’s depreciation schedules for consistency
            of methods and reasonableness. Test a selection of
            ________ computations. Agree schedule to general     
            ledger. (V and D)                                                        
When reasonableness test of depreciation are performed with acceptable results, detailed tests of depreciation calculation may not be necessary. When reviewing depreciation schedules, however, the auditor may decide to corroborate the reasonableness tests with five to ten calculations of depreciation amounts.
M.        Review lease agreements to determine if leases meet
            criteria for capitalization. (E, R, and V)             
N.        Gather and document information for report disclosure
            and tax return preparation. (D)                         
O.        Consider and compute any capitalized interest. (V)       
P.         Additional Procedures:
Efficient substantive procedures for fixed assets and other account classifications resulting from audit program modifications are discussed in my live and on-demand webcasts which can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.

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