CHAPTER 5: FIXED ASSET AUDIT

INTERNAL CONTROL OVER FIXED ASSETS

5.1 INTRODUCTION
The term property, plant, and equipment include all tangible assets with a service life of more than one
year that is 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 and the concepts are given in the glossary part of
this chapter.
For most entities, property, plant and equipment represent a material amount in the financial statements.
When the audit is on going engagement, the auditor is able to focus his or her efforts on the current year’s
activity since the assets acquired in earlier years were subjected to audit tests at the time of acquisitions.
There are four types of property, plant, and equipment transactions in fixed assets.
• Acquisition of capital assets for cash, or other non monetary considerations (exchange by other
fixed assets)
• Disposition of capital (fixed assets) through sale, exchange, retirement, or abandonment.
• Depreciation of capital assets over their useful economic life
• Leasing of capital assets
The property, plant and equipment subsidiary ledger is are record of all capital assets owned by the entity.
It contains information of the cost of the asset, the date acquired, the method of depreciation, and
accumulated depreciation. The subsidiary ledger also includes the calculation of depreciation expense for
both financial statements and income tax purposes. The subsidiary ledger should be reconciled to the
general ledger control account on a monthly basis.
5.2 NATURE OF INTERNAL CONTROL OVER FIXED ASSETS
Key control procedures, and tests of controls that relate directly to property, plant, and equipment were
discussed as part of the purchasing cycle. More over, the following control procedures are discoursed as
follows:
1.2.1. Validity and Authorization
The control procedures for the validity and Authorization objectives are normally part of the purchasing
cycle. Purchase reacquisition are initiated in relevant departments and authorized at the appropriate level
within the entity. How ever large capital asset transactions may be subject to control procedures out side
the purchasing cycle for example, highly specialized equipment may require skilled engineers approval for
the technical specifications for the equipment, for such transactions, the auditor may need to examine
more than the vendors invoices to test validity; review of additional documentations, such as capital –
budgeting documents and engineering specifications may be needed.
1.2.2. Completeness
The control procedures used in the purchasing cycle for ensuring completeness provide some assurance
that all capital asset transactions are recorded in the property, plant, and equipment subsidiary ledger and
general ledger. One procedure that helps to ensure that this objective is met is reconciliation of the
property, plant and equipment subsidiary ledger to the general ledger one procedure that helps to ensure
that this objective is met is reconciliation of the property, plant and equipment subsidiary ledger to the
general ledger control accounts on monthly basis. Another control procedure that on entity may use to
ensure that all capital assets are recorded is periodic comparison of the detailed records in the subsidiary
ledger with the existing capital assets. The client may take a complete physical examination of property,
plant, and equipment on periodic or rotating basis and compare the physical asset to the subsidiary ledger.
1.3. SEGREGATION OF DUTIES
The existence of adequate segregation of duties for property, plant and equipment within an entity
depends on the volume and significance of the transaction processed. For example, If an entity purchases
large quantities of machinery and equipment, or if it has large capital projects under construction, there is

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a likely to be a formal internal control system. On the other hand, if an entity has few capital purchases,
the entity will generally not have formal control system.
The following notes show the key segregation of duties for property, plant, and equipment transactions
and examples of possible errors or irregularities that can result form conflicts in duties.
(a) If one individual is responsible for initiating a capital asset transaction and also has final
approval, it is possible for fictitious or unauthorized purchases of assets to occur. This can
result in purchases of unnecessary assets, assets that do not meet the company’s quality control
standards, or illegal payments to suppliers or contractors. Thus, there must be final approval
functions.
(b) If one individual is responsible for the records and also for the general ledger functions, It is
possible for that individual to conceal (fraud) any defalcation that world normally be detected
by reconciling subsidiary records with the general ledger control account. Thus, the recording
function should be segregated from the general ledger function.
(c) If one Individual is responsible for the records and also has custodian responsibility for the
related assets, it is possible for tools and equipment to be stolen and for the theft to be
concealed by adjustment of the accounting records. Thus, the recording functions should be
segregated from the custodian function.
(d) If the individual who is responsible for the periodic physical inventory fixed assets, is also
responsible for the custodian and record – keeping functions, it is possible for theft of the
entity’s capital assets to be concealed. Thus, individual responsible for the inventory should be
independent of the custodian and record – keeping functions.
.Exercise
1. To strengthen internal control over the custody of heavy mobile equipment, the client would most
likely institute a policy requiring a period.
a. Increase in insurance coverage
b. Inspection of equipment and reconciliation with accounting records.
c. Verification of liens, pledges, and collateralizations.
d. Accounting for work orders.
2. A weakness in internal control over recording retirement of equipment may cause an auditor to.
a. Trace additions to the “other assets” account to search for equipment that is still on hand but no
longer being used
b. Select certain items of equipment from the accounting records and locate them in the plant.
c. Inspect certain items of equipment in the plant and trace those items to the accounting records.
d. Review the subsidiary ledger to ascertain whether depreciation was taken on each item of
equipment during the year.
3. Which of the following procedures is most likely to prevent the improper disposition of equipment?
a. Separation of duties between those authorized to dispose of equipment and those authorized to
approve work orders.
b. The use of serial numbers to identify equipment that could be sold
c. Periodic comparison of removal work orders to authorizing do documentation.
d. Periodic analysis of the scrape sales and the repairs and maintenance accounts
4. Which of the following combinations of procedures would an auditor be most likely to perform to
obtain evidence about fixed asset additions?
a. Inspection of documents and physical examination of assets.
b. Re computation of calculations and obtaining of written management representations
c. Observation of operating activities and comparison of balances to prior period balances.
d. Confirmation of ownership and corroborating of transaction through inquiries of client
personnel.
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