Are you wondering about how to audit property?
Today, we’ll answer questions such as, “how should we test additions and retirements of property?” and “what should we do in regard to fair value impairments?”
Property is sometimes referred to as plant, property, and equipment or capital assets. In this post, I’ll use the word “property.”
We will cover the following:
The primary relevant property assertions are:
Of these assertions, I believe—in general—existence, occurrence, and classification are most important. So, the client is asserting that property exists, that depreciation calculations are appropriate, and amounts paid for property are capitalized (and not expensed).
As we perform walkthroughs of property, we are looking for ways that property is overstated (though it can also be understated as well). We are asking, “What can go wrong—whether intentionally or by mistake?”
In performing property walkthroughs, ask questions such as:
As we ask questions, we also inspect documents (e.g., depreciation reports) and make observations (e.g., who has access to moveable property?).
If controls weaknesses exist, we create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person purchases property, has physical access to equipment, and performs the related accounting, then we will perform theft-related substantive procedures. Auditors need to understand how capital assets can be stolen.
The directional risk for property is overstatement. So, in performing your audit procedures, perform procedures to ensure that property is not overstated. For example, vouch all significant property additions to invoices.
The primary risks for property are:
In smaller entities, it is common to have the following control deficiencies:
In smaller engagements, I usually assess control risk at high for each assertion. If control risk is assessed at less than high, then controls must be tested to support the lower risk assessment. Assessing risks at high is usually more efficient than testing controls.
When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are existence, occurrence, and valuation. So my RMM for these assertions is usually moderate to high.
My response to higher risk assessments is to perform certain substantive procedures: namely, the vouching of additions to property. As RMM increases I lower the dollar threshold for vouching property additions.
My customary audit tests are as follows:
1. Vouch property additions to related invoices
2. Agree opening property balances in the depreciation schedule to the prior year general ledger balances
3. Review economic lives assigned to new property
4. Review the selected depreciation method in light of the property’s life
5. Compute a ratio of depreciation to property and compare the prior periods
6. Review new lease agreements to determine if they should be capitalized
My property work papers normally include the following:
Today, we looked at how to perform property risk assessment procedures, the relevant property assertions, the property risk assessments, and substantive property procedures.
If you audit property differently, please share your ideas in a comment below.
This post is a part of my series titled the Why and What of Audits. If you’ve missed the prior series articles, click here.
Next week, we’ll look at how to audit accounts payable and expenses.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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