INTERNAL CONTROLOF FIXED ASSETS

From Guide of Internal Control of the National Council of

Social Service

Sherinne Christie Ann Z. Albao

Reporter, 2012

OVERVIEWPolicies and procedures applied to fixed assets should be formalized. The roles and responsibility of the staff involved in different processes should be clearly defined. Policies should be established on the fixed asset capitalization limit, asset categorization and depreciation policy. Guidelines should be established on the treatment of the fixed assets that are obsolete, expired or spoiled. This will safeguard and ensure consistency in accounting of fixed assets. Lack of internal controls may lead to: Unauthorized movement of assets Inaccurate or misleading recording and reporting of

fixed assets (including supplies and inventories)

REQUISITION & ISSUE OF FIXED ASSETSThe lack of controls may lead to unauthorized requisition or movement of assets and this may lead to unaccounted, missing or misappropriation of assets.

Segregation of Duties – requesting for assets should not be the same staff in charge of the store or issuing the supplies & inventories. If possible, the supervisor or board member should be involved.

Proper Authorization – requisition of assets should be submitted and approved accordingly.

Supporting Documents – Requisition and issue records should be maintained.

RECEIPT OF FIXED ASSETSThe lack of proper control may lead to fixed assets not ordered or improperly ordered. This facilitate the misappropriation of fixed assets received from the suppliers.

Segregation of Duties - for staffs in-charged of received purchases and making requisition.

Verification – Deliver receipts should be determined; loading operations are to be supervised. Check delivery is according to specification in purchase order.

Acceptance – should be received in good order and indicated and signed on the delivery reports.

Supporting Documents – purchase order, delivery orders, acknowledgement of donated assets should be filed.

CUSTODY OF FIXED ASSETSThe lack of control may lead to unauthorized access and usage of fixed assets.

Storage and Access to Store – proper storage, authorization and access to fixed assets. Stricter measures for assets having high value or pilferage rate.

Fixed Asset Register – a record of fixed assets should be maintained with complete details (purchase date, description, etc.)

Insurance Coverage Periodical Physical check – check for damage,

maintenance, obsolete and discrepancies in assets. Annual Review Supporting Documents – documentary records

TRANSFER, DISPOSAL OR LOSS OF ASSETS Proper Authorization – transfer, disposal (sale,

condemned, obsolete or redundant) or loss of assets should be submitted for approval and inspection by the supervisor or person appointed by the board with updated accounting records.

Supporting Documents – Approval to transfer or dispose assets and documents to evidence actual transfer, disposal or loss should be kept.

CHAPTER 7:Long-Lived Nonmonetary Assets

and Their Amortization

(Part Two)

SIGNIFICANCE OF DEPRECIATION Does not represent the “accumulation”

of any tangible thing. (Not money) Funding Depreciation – is a financing

transaction (unrelated to recording depreciation).

Not a means of automatically creating a fund for replacing assets.

A systematic allocation of the original cost of an asset to the periods in which the asset provides benefits to the entity.

WASTING ASSETS Material objects of economic value and

utility to man produced by nature. Natural Resources It cannot be produced by man. Coal, oil, gas, ore, precious metals &

gems, minerals, timber and so on. Physically consumed Irreplaceable

COST OF WASTING ASSETS Acquisition cost – price paid to obtain

a property containing the natural resource.

Exploration cost – incurred in the attempt to locate the natural resource that has economic value.

Development cost – is the cost incurred to exploit or extract the natural resource discovered through successful exploration.

Restoration cost – necessary to bring the property to its present/original condition.

NATURAL RESOURCES They are also assets of the company

that owns the right to extract them. (e.g. coal, oil, minerals, gas).

Measuring the cost of these wasting assets are the same as those for tangible assets.

TWO METHODS OF EXPLORATION COST:

Full cost method Successful efforts method

NATURAL RESOURCES Full cost method – all exploration cost

should be capitalized as asset value of the reserves during the year.

Successful efforts method – only cost incurred at discovered reserves should be capitalized and the “dry hole” costs should be an expense.

Depletion – the process of amortizing the cost of natural resources in the accounting period (same as depreciation).

A petroleum company explores 10 location, incurring costs of $ 10 million each. It discovers oil and gas at three of these locations.

Full cost method – recorded as $ 100 million Successful cost method – asset recorded is $ 30

million and

$ 70 million will be charged as expense.

If an oil property cost $ 250 million and is estimated to contain 50 million barrels of oil. The company produced 8 million barrels of oil for that year.

Depletion for a period = (cost of reserve/estimated no. of units, let say barrels) * no. of units extracted during the period.

= ($ 250 million/50 million barrels)* 8 million barrels

= $ 5 per barrel (depletion rate) * 8 million barrels

= $ 40 million is the total depletion for the year.

An entity has acquired the right to use a property to explore a land with possible oil. The acquisition cost is P 3,000,000, exploration cost P 2,000,000 and the development cost are P 5,000,000. The total cost of the wasting asset is P 10 million. It is estimated that the natural resource can produce 1 million units.

Depletion rate per unit = cost of reserve/no. of estimated units.

= P 10 million/ 1 million units

= P 10 per unit

In the first year: P 250,000 units were extracted.

Depletion 2,500,000

Accumulated Depreciation 2,500,000

ACCRETION The increase in the value arising

through natural process of growth or aging. (e.g. timberland, cattle, tobacco, wine and other agricultural products).

Not recognized in accounts until sold. Cost incurred in the growing or aging

process are added to the asset value (similar in the case of cost incurred un the manufacturing of goods).

APPRECIATION Also an increase in the value of asset. Not the opposite of depreciation Recognized in unusual circumstances. e.g. Buying a company and current

value of assets is above book value – These assets are written up to their current value.

Increase in value is recognized in accounts only when revenue is realized.

Not recorded until asset has been sold.

INTANGIBLE ASSETS

Limited Useful Life Indefinite Useful Life Good will

An identifiable nonmonetary asset without physical substance.

Must be controlled by the entity as a result of past event and from which future economic benefits are expected to flow to the entity.

LIMITED USEFUL LIFE Patents, Copyrights, Franchise, Licenses

and Lease. Usually converted into expense over a

number of accounting periods. The systematic allocation of the costs of

these assets to the periods in which they provide benefits is called amortization.

Amortization is the same process as the depreciation of tangible assets.

Intangible Asset Term

Patents 20 years (R.A. No 8293)

Copyrights Life of author and 50 years after his or her death

Licenses Depends upon the licenses one to five years at best

Franchise Depends upon the contract

Lease Depends upon the contract

An entity developed a patent at cost of P200,000 and spent P120,000 for licensing of patent including legal fees and cost of models and drawings that accompany the registration on January 1, 2011.

Patent P 120,000.00

Research and Development Expense* P 200,000.00

Cash P320,000.00

Amortization (of Patent for 2012) P 6000.00

Patent P 6000.00

INDEFINITE USEFUL LIFE Broadcasting License and Trademarks. Recognized as long lived assets with

indefinite useful lives that are not amortized.

They are subjected to periodic impairment tests.

It is considered indefinite if there are no legal, regulatory, contractual, competitive, economic or other factors that limits its life.Intangible Term Impairment

Franchise/License

Depends upon contract

Annually

Trademark 10 years Every 10 years

GOODWILL The excess of acquisition cost over net

assets required. Often referred to as the most “intangible”

of all intangible assets. Not specifically identifiable, indeterminate

life, inherent in continuing business and relates to an entity as a whole.

Arises as part of a purchase transaction*. Cannot be amortized under any

circumstances. Subjected to annual impairment test. Any write down due to impairment is charge to income.

PATENTS Initially recorded at their cost. If acquired by purchase the cost

includes purchase price and direct attributable expenditure.

If developed internally cost also includes licensing and other legal fees. All related research and development cost is expense*

Any engineering and consulting costs to develop the patent and design changes require by the patent authority is patent cost.

Technology-based intangible asset Legal fees and other costs of successfully

prosecuting or defending a patent is expense.

If litigation is unsuccessful, the legal and remaining costs of the patent is written as loss.

Can be renewed for life extension as a new patent with improvement and changes.

Useful life limited by agreement and law. But due to technological advancement or

other reasons, practical life will be shorter than legal age.

COPYRIGHTS Also initially recorded at their cost. Artistic related intangible asset Cost consist of all expenses incurred in

the production of the work including those require to established or obtain the right.

If copyright is purchased the cost includes cash paid and direct attribute costs for its use.

The useful life is that period in which benefits, royalties and sales are expected.

Usually advisable to write cost of copyright against the revenue of the first printing.

LEASEHOLD Reverts the owner at the end of the period. Any improvements of the property

belonged to the owner; not to the lessee. The useful life of the improvements

corresponds to the period of the lease. Even though improvements are capitalized,

the useful life of these improvements is not determined by the physical characteristics of the improvement but by the terms of the lease agreement.

DEFERRED CHARGES Same as prepaid expenses. Included as long-lived assets only if they

have a relatively long life. Long-lived assets subject to

amortization are deferred charges in the literal sense.

Restricted to long-lived tangibles. Practice varies greatly in companies. Some companies charge them as

expense even though there is no offsetting revenue and some capitalized them.

RESEARCH & DEVELOPMENT COST Cost incurred to developed new

knowledge, products or innovations, services and processes.

Can help increase revenues or lower cost.

Previously capitalized & amortized but it is no longer permitted.

R&D efforts are highly uncertain and efforts can be unsuccessful and cannot be identified in advance.

SOFTWARE DEVELOPMENT A type of research and development

cost. Incurred until technological feasibility

has been established. But are expected to be recovered from

future sales, which is capitalized once the product’s technical feasibility is established and costs of software developed for internal use, once that commitment is made to develop it.

ANALYSIS OF NONMONETARY ASSETS

Average age of depreciationAccumulated depreciation/Annual Depreciation Expense

Asset’s depreciation periodCost/ Annual depreciation expense

Annual expenditure for an intangible assetAnnual amortization expense +/- increase or decrease in asset’s balance.

The result is the estimated expenditure amount.

REFERENCESAnthony, Robert N., et.al. Accounting: Text and Cases 13th

Edition, (McGraw-Hill Companies, Inc © 2011), pp. 186-198.

Valix, Conrado T., et.al. Financial Accounting: 2010 Volume One, (GIC Enterprises & Co., Inc. © 2010), pp. 1125-1239.

www.ipophil.gov.ph, Intellectual Property of the Philippines Website, (Philippine Government., © 2012), Last access: July 19, 2012.

PROBLEMS & CASESLong-Lived Nonmonetary Assets

and Their Amortization

Problem 7-1Problem 7-4Case 7-2

PROBLEM 7-1 Machine cost: $ 300,000 Estimated Useful Life: 6 years Residual Value: $ 18,000 Expected number of units to be

produced during it’s useful life: 3,525,000 units

Net cost: $ 282,000

PROBLEM 7-1(a) Units of Production Method:

= $ 282,000/3,525,000 units= $ 0.08 per unit (Depreciation Rate)

*Depreciation Charge = No. of units in Year n * Depreciation Rate

Year UnitsDepreciation

Charge*

1 930,000 $74,400.002 800,000 $64,000.003 580,000 $46,400.004 500,000 $40,000.005 415,000 $33,200.006 300,000 $24,000.00

PROBLEM 7-1(b) Sum-of-the-years’ digits method

SYD = n((n+1)/2)= 6 ((6+1)/2)= 6 (7/2)= 6 (3.5)= 21

Depreciation Rate for Year 1 is 6/21.

Year

UnitsDepreciation Charge

(UPM) SYD

Depreciation Charge (SYD)

1 930,000 $74,400.00 6/21 $80,571.432 800,000 $64,000.00 5/21 $67,142.863 580,000 $46,400.00 4/21 $53,714.294 500,000 $40,000.00 3/21 $40,285.715 415,000 $33,200.00 2/21 $26,857.146 300,000 $24,000.00 1/21 $13,428.57

The units-of-production method showed a difference in depreciation charges in each year than the sum-of-the-years’ digits method.

PROBLEM 7-4Land was purchased for $ 75,000 cash. This land was to be used for a new office building. It was agreed that Chipper Company would pay for the razing of the building currently on the land; this cost $ 5,600 in cash.

Land 80,600

Cash 80,600

Chipper Company contracted with Cody construction to build the new office building. It was agreed that Chipper would pay Cody with 3,000 shares of the company’s common stock currently selling in $ 30 per share, a $ 16,000 note and $ 32,000 in cash.

Building 138,000Ordinary Share 90,000

Notes Payable 16,000

Cash 32,000

Chipper purchased some office equipment from Northern Office Equipment for $ 9,600 cash. Mr. Chipper was a close friend of the owner and was sold this price lower than normally would be charged. The prices charged to “normal” customers would total to be $ 12,000.

Office Equipment 9,600

Cash 9,600

PROBLEM 7-4

CASE 7-2 JOAN HOLTZ (C) -1

a. Architect’s Fees Capitalized as additional cost of the additional wing of the factory building

b. Cost of snow removal during construction.

Capitalized as additional cost of the additional wing of the factory building

c. Cash discounts earned for prompt payment on materials purchased for construction.

The cash discount will be deducted from the Building cost

d. The cost of building a combined construction office and tool shed that would be torn down once the factory wing is completed.

Capitalized as additional cost of the additional wing of the factory building

e. Interest on money borrowed to finance construction.

Capitalized as additional cost of the additional wing of the factory building

CASE 7-2 JOAN HOLTZ (C) -1

f. Local real estate taxes for the period of construction on the portion of land to be occupied by the new wing.

Expense

g. The cost of mistakes during construction

Expense

h. The overhead costs of the maintenance department.

Expense

i. Cost of insurance during construction and the cost of damages or losses on any injuries and losses not covered by insurance.

The insurance cost is capitalized as additional cost of the additional wing of the factory building while the cost of the damages, injuries and loss is expensed.

CASE 7-2 JOAN HOLTZ (C) -2a.)The Archer company bought the land

and the buildings at a single cost. The Archer company wanted to razed the buildings. The costs of the buildings will be attributed to the cost of the land.

b.)The cost of the razing of the buildings will be added to the cost of the land since any additional cost incurred to bring the asset to its present location, condition or form is added to the cost of the asset.

CASE 7-2 JOAN HOLTZ (C) -2c.) The company owned these assets for a

while and the accounts for both land and buildings are separated.

The cost of the razing of the old buildings will be charged as loss on retirement of old building and is not allowed to be charged as additional cost for the construction of the new buildings because this is part of a service cost related to the old building when retired from use.

CASE 7-2 JOAN HOLTZ (C) -2 This differ from the answers of the previous

questions because the first case, the company bought the land and has intentions to razed the buildings. It’s interests is on the land itself and to bring it to it’s original form they razed it. Any cost incurred to bring it to asset to its present form is added to cost of the asset while the latter case the buildings and land are separate accounts and the carrying amount of the old building and the net cost of the razing shall be charged to the loss on retirement of the old building. (These are stated in the specific principles on land and building)

THANK YOU!