Audit of Property, Plant, and Equipment and the Related

Depreciation

4.1. Overview of property, plant and equipment

The term property, plant and equipment (fixed assets) include 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 characteristics of not being subject to depreciation.
2) Building 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.

Fixed asset constitute a significant proportion of the total assets of many

organizations particularly those engaged in manufacturing activities.
Audit of fixed asset is, therefore generally considered to be an important
part of an independent financial audit. Though the number of
transactions involving fixed assets is smaller in number, the amount
involved in these transactions will be very high. Hence the auditor has
to give more attention while auditing the transactions relating to fixed
asset.

4.2. Auditors’ objectives in auditing property, plant and equipment

The auditor’s objectives in the audit of fixed assets are

1. Consider internal control over property, plant and equipments.

 2. Determine the existence of recorded property, plant and
equipment.
3. Establish the completeness of recorded property, plant and
equipment.
4. Establish that the client has ownership rights to the recorded
property, plant and equipments
5. Establish the clerical accuracy of schedules of property, plant, and
equipment.
6. Determine that the valuation or allocation of the cost of property,
plant, and equipment is in accordance with generally accepted
accounting principles.
7. Determine that the presentation and disclosures of property,
plant, and equipment, including disclosure of depreciation methods
is appropriate.

In conjunction with the audit of property, plant, and equipment, the

auditors also obtain evidence about the related accounts of depreciation
expenses, accumulated depreciation, and repair and maintenance
expenses.

4.3. Internal controls relating to fixed assets

The auditor studies and evaluates the accounting system and the
effectiveness of internal control relating to fixed assets. The auditor’s
study and evaluation of internal control relating to fixed assets covers
the following aspects:
1. Segregation and rotation of duties.
2. Authorization of acquisition, transfer and disposal of fixed assets
3. Maintenance and record of documents.
4. Accountability for and safeguarding of fixed assets.
5. Independent checks.
 1. Segregation and rotation of duties: The auditor has to see whether
there is proper segregation of various duties relating to fixed assets
such as
 Authorization of acquisition and disposals
 Execution of transactions relating to execution and disposals.
 Recording of transactions
 Physical custody of items.

The auditor also has to see whether the duties of various persons relating
to fixed assets are rotated periodically or not.

2. Authorization of acquisition, transfer and disposal of fixed

assets:
a) The auditor has to check the internal control relating to capital
budgeting. i.e., whether the proposal for capital expenditure has
been received in time in the proper format, approved by the top
management and whether it is properly communicated to the
various departments after the approval.
b) Whether a written authorization from a senior level of the
management is included in the budget.
c) Whether the organization have laid down proper procedures for
acquisition of fixed assets i.e. for inviting quotations, selection of
suppliers, approval of prices, payment terms, safeguard for timely
delivery etc.
d) Whether the purchases are made on the basis of competitive bids.
And whether there is requirement for documenting the reasons
for making purchases other than at lowest price.
e) Whether the control over receipt of fixed assets are effective ie.,
whether the technical specifications of the assets received are
verified with the purchase orders before accepting and if rejected
whether the debit notes are raised promptly.
f) Whether periodic comparisons of the actual expenditures of the
fixed assets are compared with the capital expenditure budget and
 whether approval from the competent authority is received if
there is a deviation form the budget.
g) Whether there any system of getting prior approval from the
competent authority in case of transfer of fixed assets from one
department to another?
h) Whether adequate controls exist for the disposal of fixed assets
i.e. with proper authorization, the invitation of quotations,
approval of prices, proper documentation, etc
3. Maintenance of records and documents

a) The auditor has to check whether the company maintains

proper records of fixed assets, including those items, which are
fully depreciated.
b) Whether the organization maintains the record of assets given
on lease or used by the organization but owned by others.
c) Whether a register containing title deeds of the assets are
maintained properly.
d) Whether the title deeds or registration documents are kept in
safe custody and verified periodically.
e) Whether the organization maintained a detail record of
projects which are in progress.
f) Whether the expenditures incurred are properly allocated
between capital and revenue.

4. Accountability for and safeguarding of fixed assets

a) Whether there is any system for identification of fixed assets.

b) Whether adequate safeguards are made to protect the fixed
assets from fire, theft accessibility to unauthorized persons,
and use of locks, burglar alarms, etc.
c) Whether the fixed assets are properly insured and the auditor
has to check regarding the adequacy of the cover the time
period, etc.
d) Whether the fixed assets are physically verified on a periodic
basis including those assets lying with third parties.
 e) Whether follow up action has been taken for the discrepancies
between the record books and physical verifications.
f) Whether there is any system for identifying and reporting
damaged, obsolete and idle fixed assets.

5. Independent checks:
The auditor has to see whether there is any internal audit for fixed
assets and determining the coverage and effectiveness of the internal
audit. The auditor has to examine the scope of the work of the
internal auditors and their reports.

Substantive procedures for fixed assets

The auditor determines the nature timing and extent of substantive

procedures relating to fixed assets after evaluating the effectiveness
of internal controls. The procedures normally followed are the
following

(A). Examination of records and documents.

1. Verify the opening balances from the previous years financial

statements or ledger accounts.
2. Verify the additions made during the year from the approval of
appropriate authority copies of purchase orders, invoices
receiving reports, acknowledgement form the supplier and bank
statement.
3. Verify the assets constructed during the year by examining work
order records, statement of allocation and apportionments of
costs, certificate of work performed, contractors bills, invoices
of suppliers of materials, bank statement etc.
4. Verify the major repairs and maintenance to ensure no revenue
expenditure related to the capital assets is included.
5. Verify the disposal or retirement of fixed assets by examining
the approval of appropriate authority, quotations invited from
 buyers, contract with the buyer, copy of the sale bills, evidence
of physical deliveries etc.
6. Examine whether the book values and accumulated depreciation
of the fixed assets disposed or discarded are properly adjusted
accounting the resulting gains or losses properly.
7. Verify the minutes of the board of directors, agreements, and
correspondence with lawyers to identify any charges or
encumbrances on the fixed assets.
8. Verify the arithmetical accuracy of the fixed asset records.
9. Verify whether the value shown in the financial statement is
after charging adequate depreciation.
10. Examine the evidence of ownership of fixed assets.

(B). Review or observation of a second verification

Though the physical verification is the duty of the management, the

auditor can review or observe the verification by examining the
documents relating to the physical verification.

The procedures followed are:

1. Review the instructions issued to the staff entrusted with the
responsibility of physical verification and judges the
appropriateness and adequacy of the instructions.
2. Assess the competence of the personnel conducting the physical
verification.
3. Examine the frequency of the verification and verify whether it
is reasonable in the circumstances of the case.
4. When direct physical verification is not possible examine any
indirect evidence of the existence of the fixed assets.
5. Tests check the fixed asset record with the physical verification
records.
6. Examine the appropriate follow up action taken for the
discrepancies revealed by physical verification with the fixed
asset records.
 7. Examine whether appropriate adjustments have been made in
the fixed asset records and financial accounts for obsolescence,
damage, or other losses reveled by the physical verification.

(C). Examination of Valuation and disclosure

1. Examine whether the fixed assets have been valued according to
the generally accepted accounting principles.
2. Examine whether adequate depreciation have been provided.
3. Examine whether the fixed assets have been revalued in a
systematic/ scientific/ appraisal basis considering the future life
and the possibility of obsolescence.
4. Examine the basis on which the consideration has been
approportionated to various assets when several assets have
been purchased for a consolidated price.
5. Examine the relevant documents such as title deeds agreements
etc in order to ascertain the extent of the shares of the
organization when the organization owns assets jointly with
others.

(D). Analytical Procedures: -The analytical procedures employed by

the auditors in the audit of fixed assets are the following:
1. Compare the additions or disposals of fixed assets made during
the year with the budgeted figures.
2. Compare the ratio of depreciation for the current year to the
average book value of the fixed assets with the corresponding
figures of the previous year.
3. Compare the amount of repairs and maintenance of the current
year with the figures of the previous year.
4. Compare the ratio of actual capacity utilization with the
installed capacity of the current year with the figures of the
previous year.

(E). Obtaining Management Representation

The auditor has to obtain an appropriate representation form the
management concerning the fixed assets stating that the fixed assets
 shown in the balance sheet are arrived at after considering all capital
expenditures on additions, eliminating the cost and accumulated
depreciation relating to the items discarded, destroyed and disposed off
and adequate depreciation has been provided for during the current year.

4.4. Audit program for auditing fixed assets

The following procedures are typical of the work required in many
engagements for the verification of property, plant and equipments.

A) Consider internal control over property, plant and equipment

1. Obtain an understanding of internal control over property, plant

and equipment.
Auditors may use written description, flow chart or internal control
questionnaire to describe the nature of client’s internal control structure.
After preparing description of internal control, the auditors will
determine whether the controls as described to them have been placed in
operation, whether there is appropriate segregation of duties and
considered the misstatements that may occur.

2. Assess control risk and design additional tests of control for the
assertions about property, plant, and equipment.

Based on an understanding of the client’s internal control over property,

plant and equipment, the auditors develop their planned assessed level of
control risk for the various financial statement assertion assertions and
obtain additional evidences of the operating effectiveness of the client’s
controls by designating additional tests of control.

3. Perform additional tests of controls for those controls that the

auditors plant to consider to support their planned assessed levels of
control risk.
As auditors obtain an understanding of the client’s internal control;
certain tests of control are performed.

E.g. select a sample of purchase of plant and equipment to test the

control related to authorization, receipts and proper recording of the
transactions.

4. Reassess control risk for each of the major financial statements

assertions about property, plant, and equipments based on the results
of tests of controls and, if necessary, modify substantive tests.

The final step in the auditor’s consideration of internal control involves a

reassessment of control risk based on the results of the tests of control.
On the basis of the reassessed level of control risk auditor modify their
planned program of substantive testing procedures for property, plant,
and equipment assertions.

B. Perform substantive tests of property, plant and equipment and

related depreciation transactions and balances

The objective of major substantive testing procedures of

property, plant and equipment balances are given in the following
table.

Subjective Test Primary audit objective

to be addressed
1. Obtain a summary analysis of changes in
property owned and reconcile to ledgers
Clerical accuracy
-The summary analysis shows the
beginning balances of property, plant,
and equipment, additions to and/or
 retirement from property, plant, and
equipments and ending balances of
property plant and equipments. Auditors
reconcile subsidiary ledgers with the
Controlling accounts

2. Vouch additions to property, plant and

equipment during year – The vouching
process utilizes a working paper analysis
of the general ledger controlling
accounts and includes the tracing of
entries through the journal to original
documents such as contracts, Existence and right
valuation or allocation
construction work orders, invoices
canceled checks authorization by
appropriate individuals
3. Make physical inspection of major
acquisitions
 The auditors usually make a physical
inspection of major units of plant
and equipment acquired during the
year under audit by comparing the
physical assets with underlying
records.
 Helps to maintain good working
knowledge of the Client’s operations
and also in interpreting the
accounting entries for both
 additions and retirements.

4. Analyze repair and maintenance

expenses accounts
 The auditors principal objective in in
Valuation and allocation
analyzing repair and maintenance
expense accounts is to discover items
that should have capitalized
 To determine that there is proper repair
and maintenance charges, the auditors
will trace the ledger expenditures to
written authorizations for the
transactions.

5. Investigate the status of property, plant

and equipment
Valuation and allocation
 Auditors investigate plant assets
Presentation and disclosure
currently in use, plant assets not
currently in use but expected to be
used in the future operation
(depreciate at normal rate); and
plant assets dismantled, found to be
unsuitable for future operating
use(should be written down their net
realizable value and should not be
classified as plant assets.

6. Test the client’s provision for

depreciations
  Review and test management’s
process of developing the estimate Valuation and allocation
 Review subsequent events or
transactions bearing on the estimates
 Independently develop an estimate of
the amounts to compare to
management’s estimates
7. Investigate potential impairments of
property, plant, and equipments -
Whenever events or changes in
circumstances indicate that the carrying
amount of long lived assets may not be
recoverable ie if the sum of the expected
future cash flows from the assets is less
than its carrying amounts, an
impairments loss is recognized.

8. Investigate retirement of property, plant

and equipment during the year
 The principal purpose of this procedures
is to determine Whether any property
has been replaced, sold, dismantle or
abandoned without such actions being Existence and right
reflected in the Accounting records.
9. Examine evidence of legal ownership
 To determine that plant assets are
property of the client, the auditors look
for such evidences as a deeds, title,
 insurance policy, property tax bills,
receipts, for payments to mortgages and
fire insurance policies.
10. Review rental revenues-rental
revenues from land, building,
equipments, machinery, and so on
should be reviewed and the party
responsible to pay cost of electricity,
water, telephone should be reconciled
against with provisions of utility
expenses.

11. Examine lease agreements on

property, plant and equipments i.e. lease
to and/ or form other party. The auditors
should carefully examine lease Existence and right
agreements to determine whether the Completeness
accounting for assets involved in proper Valuation or allocation
(in accordance with the requirements of
GAAP)
E.G Capitalization of assets leased by the
client company.

12. Perform analytical procedures for

property, plant, and equipments
 Auditors may use trends and ratios to
judge the reasonableness of recorded
 amounts for plant and equipments
e.g. - Cost of plant assets/ annual output in
peso.
 Monthly repair and maintenance
expense to yearly amounts
 Compare acquisition and retirements of
current year to prior years.

13. Evaluate financial statements Presentation and disclosure

presentation and disclosure for property,
plant and equipment and for related
revenues and expenses.
 The balance sheet or accompanying
notes should disclose balances of
major classes of depreciable assets,
accumulated depreciation, method(s)
for computing depreciation, base of
valuation, property pledged and
property not in current use.

4.5 Auditors perspective towards depreciation

Depreciation is the decrease in the value of the asset due to wear and
tear, obsolescence, lapse of time etc. Fixed assets are to be disclosed in
the balance sheet at their cost or at the revalued amount less depreciation
 Determining the annual depreciation expense involves two rather
arbitrary decisions by the client company:
 first, an estimate of the useful economic lives of various groups of
assets.
 second, a choice among several depreciation methods, each of
which would lead to a different answers.
The wide range of possible amounts for annual depreciation expense
because of these decisions by the client suggests that the auditors should
maintain a perspective of looking for assurance of overall
reasonableness. Specifically, overall tests of the year/s depreciation
expense are of special importance.

Accordingly, the auditor has to examine whether adequate depreciation

has been provided in the books in respect of all depreciable assets
according to the provisions of the relevant statutes.

While auditing depreciation, the auditor has to examine the following

points in respect of depreciation

1. Whether adequate depreciation has been provided during the

current year.
2. Whether the depreciation has been calculated by appropriate
methods.
3. Whether appropriate method has been selected after considering
the useful life of the asset and salvage value.
4. Whether the method of calculating depreciation has been
consistent over the years.
5. Whether any change in the method has been properly disclosed in
the financial statements.
6. Whether accumulated depreciation in respect of discarded or
disposed assets have been adjusted in the accumulated depreciation
amount.
 7. Whether depreciation has been provided properly on the assets
added or disposed of during the current year.
8. Whether depreciation has been provided on revalued assets
9. Whether the depreciation has been properly disclosed in the
financial statements.

4.5.1 The auditors’ objectives in auditing depreciation

When evaluating the reasonableness of depreciation (with accounting

estimate), auditors use one or more of the following three basic
approaches.
1). Review and test management’s process of developing the estimates
2). Review subsequent events or transactions that might have bearing on
the estimate to management’s estimate
3). Independently develop an estimate of the amounts to compare to
managements estimate.

4.5.2 Audit program-Depreciation expense and accumulated

depreciation

The following outlines of substantive tests to be performed by the

auditors in reviewing depreciation are stated in sufficient detail to be
largely self-explanatory.

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 technology or economic
developments.
2) Obtain or prepare a summary analysis of accumulated depreciation
for the major property classification as shown by general ledger
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.
b) Determine that the totals accumulated depreciation recorded in the
plant and equipment subsidiary records agree with the applicable
general ledger controlling accounts.

3). Test the provisions for depreciations

(a). Compare rates used in prior years and investigate any variance.
(b). Test computations of depreciations for provisions for a
representatives number of units and trace to individuals records in
the property ledger. Be alert for excessive depreciation on fully
depreciated assets.
(c). Compare credits to accumulated depreciation accounts the
year’s depreciation provisions with debits entries in related
depreciation expenses 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
retirements.

5). Perform analytical procedures for depreciation

(a) Compute the ratio of depreciation expenses to total cost of plant
and compare with prior years.
(b). Compare the percentage relationships between accumulated
depreciation and related property accounts with that prevailing in
prior years.

Discuss significant variations from normal depreciation program with

appropriate members of managements.