Fixed assets are long-term tangible assets that are used by a company in its operations, such as buildings, machinery, equipment, and vehicles. They play an important role in the financial statements of a company and are subject to significant audit risks.
In this article, we will cover the accounting treatment of fixed assets, audit risks associated with fixed assets, and audit assertions related to fixed assets.
Accounting Treatment:
Fixed assets are typically accounted for using the cost model, where the cost of the asset is recorded at the time of acquisition and is then depreciated over its useful life.
The cost of a fixed asset typically includes the purchase price, any installation costs, and any other costs incurred in bringing the asset to a condition that is ready for its intended use.
Fixed assets are usually recorded in the balance sheet as property, plant, and equipment (PP&E). The PP&E account is divided into several sub-categories, such as land, buildings, machinery, and equipment. The depreciation of fixed assets is recorded in the income statement as an expense, which reduces the company’s taxable income.
Audit Risks:
- Inaccurate cost and depreciation calculations: The cost and depreciation calculations of fixed assets can be complex and subject to material misstatements.
- Misclassification of fixed assets: Fixed assets can be misclassified as current assets or as intangible assets, which can result in material misstatements in the financial statements.
- Unrecorded fixed assets: Fixed assets may be acquired but not recorded in the financial statements, which can result in material misstatements.
- Improper disposal of fixed assets: Fixed assets that are no longer in use should be disposed of properly and recorded in the financial statements. Improper disposal of fixed assets can result in material misstatements.
- Improper impairment of fixed assets: Fixed assets should be impaired if their carrying value exceeds their recoverable amount. Improper impairment of fixed assets can result in material misstatements.
- Unrecorded liabilities related to fixed assets: Liabilities related to fixed assets, such as loans or leases, may not be recorded in the financial statements, which can result in material misstatements.
- Depreciation errors: Depreciation errors, such as incorrect useful lives or depreciation rates, can result in material misstatements in the financial statements.
- Unreliable source documents: The source documents used to support the cost and depreciation calculations of fixed assets may be unreliable, which can result in material misstatements.
- Unauthorized fixed asset transactions: Fixed asset transactions may be unauthorized, which can result in material misstatements in the financial statements.
- Fraudulent fixed asset transactions: Fraudulent fixed asset transactions, such as the creation of fake invoices or the theft of fixed assets, can result in material misstatements in the financial statements.
Audit Assertions:
- Existence: The auditor must verify the existence of fixed assets and ensure that they are recorded in the financial statements.
- Rights and obligations: The auditor must verify that the company has the right to use the fixed assets and that it is legally obligated to pay for them.
- Valuation: The auditor must verify that the carrying value of fixed assets is properly calculated and that the assets are not overvalued.
- Allocation: The auditor must verify that the cost of fixed assets is allocated appropriately to the balance sheet and the income statement.
- Completeness: The auditor must verify that all fixed assets are recorded in the financial statements.
Walkthrough Testing
Walkthrough testing is an important part of the audit procedure for fixed assets. This testing helps to understand the processes and controls in place to manage the fixed assets of an entity. The objective of walkthrough testing is to obtain an understanding of the flow of transactions and to assess the controls surrounding the transactions. Walkthrough testing typically involves the following steps:
- Understanding the entity’s system of internal control related to fixed assets
- Observing and documenting the physical existence and identification of fixed assets
- Tracing transactions from source documents to the general ledger and to the financial statements
- Reviewing the accuracy of fixed assets accounts, including calculation of depreciation and maintenance of accurate records
- Verifying the completeness of fixed assets by performing an interim count and reconciling the results with the accounts
Test of Control
Test of control is a part of the substantive audit procedures that focuses on evaluating the effectiveness of the entity’s system of internal control related to fixed assets. The objective of test of control is to assess the design and operating effectiveness of the controls. This test typically involves the following steps:
- Evaluating the existence of physical controls such as tagging, sealing, and locking systems
- Assessing the accuracy of the fixed assets inventory record keeping
- Evaluating the completeness of the fixed assets inventory listing and whether it includes all assets owned by the entity
- Testing the accuracy of depreciation calculations
- Evaluating the accuracy of fixed asset transactions recorded in the general ledger
Substantive Audit Procedures
Substantive audit procedures are the procedures that are performed to obtain sufficient and appropriate audit evidence to support the audit opinions. The following are some of the substantive audit procedures for fixed assets:
- Performing physical inspection of fixed assets and verifying the existence and ownership of the assets
- Reviewing the detailed records and maintenance schedules for fixed assets
- Testing the accuracy of depreciation calculations
- Testing the classification of assets in the financial statements
- Verifying the accuracy of recorded disposals and sales of fixed assets
- Performing comparison of the balance of the fixed assets with previous periods and other related records
- Verifying the accuracy of insurance coverage for fixed assets
- Performing detailed testing of the additions and retirements of fixed assets
- Verifying the accuracy of the impairment assessment of fixed assets
- Assessing the valuation of the fixed assets in accordance with the GAAP and company policies.
