Audit of other assets (and related items)

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Audit of other assets (and related items)

McGraw-Hill/Irwin

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Assets

Cash

Investments

Receivables

Prepaids

Inventory

PP and E

Other assets -intangibles

Liabilities and Equity

Accounts payable

Accrued liabilities

Debt

Common stock

Retained earnings

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Prepaid expenses – current

Intangible assets – long term

Property, plant and equipment – long term

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Auditing Prepaid ExpensesOther assets that provide economic benefit for

less than a year are classified as current

assets and are called prepaid expenses.

Examples include:

1.Prepaid insurance.

2.Prepaid rent.

3.Prepaid interest.

LO# 1

Insurance

Policy

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Inherent Risk Assessment – Prepaid ExpensesThe inherent risk associated with prepaid expenses

is generally assessed as low because the accounts

do not involve any complex or contentious

accounting issues.

LO# 1

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Control Risk Assessment – Prepaid Expenses

Because prepaid expenses are normally processed

through the purchasing process, control procedures

in purchasing should ensure that each item is

properly authorized and recorded.

LO# 1

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Substantive Procedures – Prepaid Insurance

Tests of Details of the Prepaid Insurance Account

Audit testing begins by obtaining a detail

schedule of the prepaid insurance account.

Existence and

Completeness

Confirm policy with

insurance broker,

examine supporting

source documents.

Rights and

Obligations

Confirm policy

beneficiary with

the insurance broker.

Valuation

Determine unexpired portion

of policy and

insurance expense.

Classification

Determine propriety of distribution between

manufacturing overhead and SG&A expense.

LO# 2

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Auditing Intangible AssetsIntangible assets are assets that provide economic

benefit for longer than a year, but lack physical

substance. The following list includes examples

of five general categories of intangible assets:1. Marketing – trademark, brand name, and Internet

domain names.

2. Customer – customer lists, order backlogs, and

customer relationships.

3. Artistic – items protected by copyright.

4. Contract – licenses, franchises and broadcast rights.

5. Technology – patented and unpatented technology.

LO# 1 & 2

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Inherent Risk Assessment – Intangible Assets

The inherent risk associated with intangible assets

raises serious risk considerations. The accounting

rules are complex and the transactions are difficult

to audit. Accounting standards require different

asset impairment tests for different classes of

intangible assets (FAS 142). With the judgment and

complexity association with valuation and

estimation of intangible assets, the auditor would

likely assess the inherent risk as high.

LO#

1 & 2

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Control Risk Assessment – Intangible Assets

In assessing control risk, the auditor considers factors such as:

1. The expertise and experience of those determining the fair value of the

assets.

2. Controls over the process used to determine fair value measurements,

including controls over data and segregation of duties between those

committing the client to the purchase and those undertaking the

valuation.

3. The extent to which the entity engages or employs valuation

specialists.

4. The significant management assumptions used in determining fair value.

5. The integrity of change controls and security procedures for valuation

models and relevant information systems, including approval processes

(AU 328).

LO#

1 & 2

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Using the work of a specialist SAS #73The auditor should consider the following:

Professional certification of specialist

Reputation and standing

Experience and expertise

Objectives and scope of the work

Relationship to the client ( Independence!)

Methods and assumptions used

Other

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Substantive Procedures – Intangible Assets

Tests of Details of Intangible AssetsTests of details associated with valuation and impairment of

intangible assets are often necessary because the complexity

and degree of judgment increase the risk of material

misstatement. Some substantive evidence is required for all

significant accounts, and, as noted above, substantive analytical

procedures are not likely to provide sufficient, appropriate

evidence for significant transactions involving intangible assets.

Four assertions are normally considered for tests of details of

intangible assets:

1. Existence and completeness.

2. Valuation.

3. Rights and obligations.

4. Classification.

LO# 2

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Auditing the Property Management Process

Property, plant, and equipment usually represents a

material amount in the financial statements.

Recurring EngagementThe auditor is able to focus

on additions and retirements

in the current period because

amounts from prior periods have

been subject to audit procedures.

New EngagementThe auditor has to verify the

assets that make up the

beginning balance in property,

plant, and equipment.

LO# 3

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Communication between predecessor and successor auditors ( SAS # 84)Successor auditor should consider the following:

Information regarding integrity of management

Disagreements with management about accounting principles

Communications to audit committees about fraud and IC issues

Predecessor auditor’s understanding regarding the reasons for the change.

Adequacy of the work performed

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Property Management Process at EarthWear Clothiers

Physical Plant IT Department

Specialized

PP&E

transactions

Review for

proper

recording

Input

From

purchasing

process

PP&E

transaction

file

PP&E

master

file

PP&E

program

General

ledger

master file

General

ledger

program

General

ledger

report

PP&E

transaction

report

PP&E

subledger

Reconcile to

general ledger

Monthly

LO# 3

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Types of TransactionsFour types of PP&E transactions may occur:

1. Acquisition of capital assets for cash or other

nonmonetary considerations.

2. Disposition of capital assets through sale,

exchange, retirement, or abandonment.

3. Depreciation of capital assets over their useful

economic life.

4. Leasing of capital assets.

LO# 4

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Inherent Risk Assessment – Property Management Process

There are three inherent risk factors that must be

considered by the auditor.

Complex

accounting

issues.Difficult-to-audit

transactions.Misstatements

detected in

prior audits.

LO# 5

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Complex Accounting Issues

Lease accounting, self-constructed assets, and

interest capitalization are vivid examples of some of

the complex accounting issues faced by auditors.

LO# 5

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Difficult-to-Audit Transactions

When assets are purchased directly from a vendor,

the transaction is relatively easy to audit. However,

transactions involving donated assets, nonmonetary

exchanges, and self-constructed assets are more

difficult to audit.

LO# 5

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Misstatements Detected in Prior Audits

If misstatements in prior audits have been

detected, the auditor should set inherent risk

higher than if few or no misstatements

have been found in the past.

LO# 5

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Control Risk Assessment – Property Management Process

Occurrence and Authorization

Control procedures for the occurrence and

authorization of property, plant, and equipment are

normally part of the purchasing process. However,

large capital asset transactions may be subject to

additional controls. Companies should have an

authorization table for approving capital asset

transactions.

LO# 6

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Completeness

The detailed property, plant, and equipment

subsidiary ledger usually includes the following

information for each capital asset:

1. Description, location, and ID number.

2. Date of acquisition and installed cost.

3. Depreciation methods for book and tax purposes,

salvage value, and estimated useful life.

LO# 6

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Key Segregation of Duties and Possible ErrorsSegregation of Duties Possible Errors or Fraud

The initiation function should be

segregated from the final approval

function.

If one individual is responsible for initiating a capital

asset transaction and also has final approval, fictitious

or unauthorized purchases of assets can occur. This

can result it purchases of unnecessary assets, assets

that do not meet the company's quality control

standards, or illegal payments to suppliers.

The PP&E records function should be

segregated from the general ledger

function.

If one individual is responsible for the PP&E records

and also for the general ledger functions, that

individual can conceal any defalcation that would

normally be detected by reconciling subsidiary records

with the general ledger control account.

The PP&E records function should be

segregated from the custodial function.

If one individual is responsible for the PP&E records

and also has custodial responsibility for the related

assets, items may be stolen, and the theft can be

concealed by adjustment of the accounting records.

If a periodic physical inventory of PP&E

is taken, the individual responsible for

the inventory should be independent of

the custodial and record-keeping

functions.

If one individual who is responsible for the periodic

physical inventory of PP&E is also responsible for the

custodial and record-keeping functions, theft or the

entity's capital assets can be concealed.

LO# 7

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Substantive Analytical Procedures –Property, Plant, and Equipment

The following substantive analytical procedures

can be used in the audit of PP&E:1. Compare prior-year balances in PP&E and depreciation

expense with current-year balances.

2. Compute the ratio of depreciation expense to the related

PP&E accounts and compare to prior years’ ratios.

3. Compute the ratio of repairs and maintenance expense

to the related PP&E accounts and compare to prior

years’ ratios.

4. Compute the ratio of insurance expense to related PP&E

accounts and compare to prior years’ ratio.

5. Review capital budgets and compare the amounts spent

with amounts budgeted.

LO# 8

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Tests of Details of Transactions and Account Balances and Disclosures

CompletenessThe auditor begins the process by obtaining a lead

schedule and detailed schedules of additions and

dispositions of assets. These schedules are footed

and agreed to the general ledger.

LO# 9

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CutoffCutoff is normally part of the accounts payable and

accrued expenses work. Vendor’s invoices from a

few days before and after year-end are examined to

determine if the assets is recorded in the proper

accounting period.

LO# 9


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Classification

First, the auditor must determine that the capital

asset is recorded in the proper account. Second, the

repairs and maintenance account should be

reviewed to determine if any capital assets have

been incorrectly recorded in these accounts. Finally,

each material lease agreement should be reviewed

for proper classification as operating or capital lease.

LO# 9


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ExistenceA list of all major additions should be obtained and

each addition should be vouched to supporting

documentation. For major acquisitions, the auditor

may physically examine the capital asset. This is

often done during the inventory observation. Major

dispositions should be vouched to supporting

documentation and examined for proper

authorization.

LO# 9


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Rights and Obligations

In most cases, rights or ownership can be

determined by examining vendor’s invoices and

other supporting documents. In some cases, the

auditor may wish to confirm property deeds or title

documentation.

LO# 9


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Valuation and AllocationCapital assets are valued at

acquisition cost plus any costs

necessary to make the asset

operational. The auditor tests

the recorded cost of major new

additions to PP&E.

The auditor may

recompute, either

manually or with the aid

of a computer, the proper

depreciation expense for

the period.

The auditor must test for permanent impairment of long-lived

assets. While GAAP requires the comparison of future cash

inflows to the asset’s carrying amount, this process can be

quite difficult. Auditors may look to other sources of

information to learn about impairments.

LO# 9


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Disclosure Issues

Examples of disclosure items:1. Classes of capital assets and valuation bases.

2. Depreciation methods and useful lives for financial reporting and tax

purposes.

3. Nonoperating assets.

4. Construction or purchase commitments.

5. Liens and mortgages.

6. Acquisition or disposal of major operating facilities.

7. Capitalized and other lease arrangements.

LO# 9


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Evaluating the Audit Findings Property, Plant, and EquipmentThe auditor aggregates the likely misstatements and

compares this amount to the tolerable misstatement.

If the likely misstatement is less than

the tolerable misstatement, the evidence indicates

that the PP&E accounts are not materially misstated.

If the likely misstatement is greater than the

tolerable misstatement, the auditor would either require

adjustment of the accounts or issue a qualified audit report.

LO# 10

Audit of other assets (and related items)

Business

Transcript of Audit of other assets (and related items)