PRACTICAL AUDITING Prepared by: Roda R.

Santos

Module 7
NON-CURRENT OPERATING ASSETS

EXPECTED LEARNING OUTCOMES

After reading this chapter, you should be able to

(a) recall the different financial statement classifications of non-current operating assets and
distinguish them from one another;
(b) identify internal control procedures relating to non-current operating assets;
(c) state the auditor's principal objectives in the audit of non-current operating assets and related
amounts taken to profit or loss and other comprehensive income;
(d) apply audit procedures to establish management's assertions on non-current operating assets
and related income and expenses;
(e) prepare working papers to establish correct balances of non-current operating asset accounts
and related income and expenses;
(f) formulate audit adjustments to bring non-current operating asset accounts and related income
and expenses to correct balances; and
(g) evaluate the appropriateness of the presentation of investments and related income and
expenses in the financial statements.

The Different Non-Current Operating Asset Classifications

Non-current operating assets include the classifications Property, Plant and Equipment,
Investment Property, and for agricultural industries, Biological Assets. The title "Property, Plant
and Equipment" includes tangible assets with a useful life of more than one year, that are held for
use in the production or supply of goods and services, for rental to others, or for administrative
purposes. The major subgroups are land, buildings, machinery, equipment, land improvements,
and natural resources.

Land or building, or both, held by the owner or by the lessee under a finance lease to earn
rentals or for capital appreciation, or both rather than for use in the production or supply of goods
or services or for administrative purposes or sale in the ordinary course of business, are presented
on the face of the statement of financial position under the heading "Investment Property".

Intangible assets are identifiable non-monetary assets without physical substance, to

which the enterprise has economic control and from which economic benefits are expected to
flow to the entity in the form of revenue from sale of products or services, cost savings and other
benefits resulting from their use. Intangible assets include patents, copyrights, trademarks,
licenses, computer software, motion picture films, customer lists and marketing rights, and other
items similar in substance and nature.

Biological assets are living plants and animals, as defined by IAS 41 Agriculture. Examples
of biological assets are cattle, pigs, bushes, trees and plants in a plantation forest, and fruit trees.
Under IAS 16 Property, Plant and Equipment and IAS 41, a living plant that is expected to bear
agricultural produce for more than one period and has a remote likelihood of being sold as
agricultural produce, except for incidental scrap sales, are technically called "bearer plants and
belong to the classification Property, Plant and Equipment.

Audit Objectives

In the audit of non-current operating assets, the auditors' objectives are to:
⮚ consider internal control over non-current operating assets;
⮚ substantiate the existence of recorded non-current operating assets;
⮚ substantiate the rights and obligations relating to these assets;
⮚ establish the completeness of recorded non-current operating assets;
⮚ determine the correctness and accuracy of the recorded depreciation or amortization of,
and other items affecting profit or loss relating to, non-current operating assets;
PRACTICAL AUDITING Prepared by: Roda R. Santos

⮚ determine that the measurement of non-current operating assets is in accordance with

accounting standards; and
⮚ determine that the classification, presentation and disclosure of non current operating
assets is appropriate.

Although the peso amounts are large, the audit work required to verify property accounts is
usually a much smaller proportion of the total audit time spent on the engagement. This results
from the low inherent risk typical for these assets and relatively few transactions that affect the
accounts during the year.

Internal Control Procedures

One of the most important internal controls over non-current operating assets is the
system of authorization for acquisition of, expenditures for, an disposals of these assets. A
method that achieves this control is capital budgeting, which does not merely authorize
acquisition, expenditures and disposals but also compares actual peso amounts incurred and
realized with budgeted figures. Implementing capital budgeting requires a reporting procedure for
prompt disclosure and analysis of variances between authorized expenditures and actual costs.

Fixing accountability and responsibility for units of operating assets leads to proper usage
and maintenance of the assets. Once accountability is established, appropriate records for
custody of the assets are likewise maintained. This also facilitates asset utilization evaluation by
management.

An enterprise shall, likewise establish and maintain a subsidiary ledger of each class of
non-current operating assets. This ensures that reliable information exists for calculating
depreciation, recording gains and losses on disposals of assets, preparing tax returns, filing
insurance claims, monitoring expenditures for repairs and maintenance and review of estimated
useful life.

Physical transfers of fixed assets (say, from one department to another or transfer from
the enterprise for use in special projects) shall be documented. It is the responsibility of the
department head to ensure that all members of company personnel under his supervision adhere
to policies and procedures regarding off campus use of fixed assets and transfer of fixed assets
from one department to another.

An enterprise shall also establish and implement appropriate policy requiring that
purchases of long-lived assets be made through normal purchasing procedures. This ensures
that the enterprise considers prices quoted by different suppliers, quality, and other features of
the asset being purchased.

Each department head shall submit an annual fixed asset report to the company's property
custodian. The report shall contain, among others, a list of full inventory of fixed assets maintained
by the department at the end of the period, major and minor acquisitions, interdepartmental
transfers, disposals made during the year and recommendations for repairs or replacements.

Insurance and warranties must likewise be maintained on assets with very significant cost
of acquisition. A system of serially numbered retirement decisions and actions must likewise be
in place.

Audit Procedures

The auditors' approach to auditing non-current operating assets is to verify the changes
(acquisitions and retirements) during the current period. In the case of investment property
measured at fair value and biological assets, care must be taken in the measurement to fair value
at the reporting date. The auditor shall consider the internal control procedures adopted by the
client for fixed assets, particularly those controls relating to expenditures at date and subsequent
to acquisitions, accountability and utilization, safeguarding of assets, and information on the
assets.
PRACTICAL AUDITING Prepared by: Roda R. Santos

To establish beginning balances of non-current operating assets of a new client, the

auditor may conduct historical analysis of the accounts. in repeat engagements, the auditors can
concentrate on additions, depreciation and amortization, change in fair value and retirements
during the year under audit.

To determine that long-lived assets are controlled by the client, the auditors examine
invoices, deeds, and title insurance policies. Current property tax bills, fire insurance policies, rent
receipts from lessees, and mortgage payments for the year and lease contracts must likewise be
examined. A complete annual physical inventory is not always necessary but auditors usually
make a physical inspection of property acquired during the year.

Physical verification of non-monetary assets is the responsibility of the management to

ensure that the assets are in actual existence. The auditor shall, however, verify that physical
inspection is conducted by an employee or an outsider with the necessary qualifications. In some
instances, however, actual physical inspection and verification may not be practical, especially
so, when the assets are in continuous use in production or for provision of service.

To test the mathematical accuracy of non-current operating asset records, the auditor
obtains from the client a schedule, which includes beginning balances, additions, depreciation
and amortization, disposals and ending balances. The auditor should reconcile the beginning
balances with the balances in the prior year's financial statements and should be alert for all new
assets that may represent unrecorded additions and for assets that have been removed.

The charges for repair and maintenance expense must likewise be analyzed to determine
whether the costs are properly treated as expenses rather than capitalized. Other subsequent
expenditures relating to long-lived assets must be reviewed to determine whether they are
appropriately capitalized or expensed. An error in recording these expenditures will affect not only
the reported profit during the period of expenditure but also the profit in the subsequent period.

The auditors often perform the following audit procedures to locate unrecorded retirements
of plant and equipment and investment property:

⮚ Determine whether old equipment was traded in or replaced by the new units
⮚ Analyze the Miscellaneous Revenue account to locate cash proceeds from the sale of
retired assets;
⮚ Investigate retirements related to any discontinued product lines or services;
⮚ Make inquiries of executives and supervisors regarding retired assets;
⮚ Examine retirement work orders prepared during the year; and
⮚ Investigate any reduction of insurance coverage to determine whether this was caused by
retired assets.

Analytical procedures may be used to judge the overall reasonableness of recorded amounts
of non-current operating assets.

The auditors should review depreciation charges to determine that:

⮚ the methods in use are appropriate,
⮚ the methods are being followed consistently, and
⮚ the computations have been accurately made.

The auditors have to determine whether the depreciation methods are consistent with the
policies set forth in company manuals or policy statements. The next step is to prepare a summary
of the amounts of accumulated depreciation for the various groups of assets at the beginning of
the year, the amounts provided for depreciation during the year, the amounts removed because
of asset retirements or of reclassifications into assets held for sale, and the ending balances.

Depreciation rates used during the current period are usually compared with those used in
the prior years. Computations may then be reviewed for a representative number of units and
traced to both the expense accounts and accumulated depreciation accounts.
PRACTICAL AUDITING Prepared by: Roda R. Santos

Audit programs for depreciation expense and accumulated depreciation emphasize the use
of analytical procedures to test the overall reasonableness of the amounts. Depreciation may
have been incorrectly calculated by the client on account of factors such as mechanical error,
incorrect application of accounting policies, Inappropriate assessment of remaining useful life,
inappropriate assessment of residual values or incorrect classification of the asset.

The validity and existence of intangible assets are established by verifying evidence of
ownership and contractual rights. Evidence includes purchase agreements, patent letters,
memoranda of agreement, contracts, franchise grants and copyright and trademark registrations.
The auditor has to obtain copies of underlying evidence, which become part of the audit firm's
permanent file.

In a first time engagement, it may be necessary to establish the beginning carrying value of each
Intangible asset by reviewing the transactions from the date of acquisition to establish important
information, such as cost, estimated useful life, change in useful life, and other circumstances
that affect the measurement of the intangibles.

Changes in the carrying value of the intangibles during the audit period must be
summarized in a work paper to arrive at the ending balances and to determine the reasonableness
of amortization and impairment that are taken to profit or loss or charged as part of the company's
product cost.

Long-lived assets must be reviewed for impairment whenever circumstances or changes

in circumstances indicate that the carrying amount of the assets may not be recoverable. In testing
for asset impairment, the auditor may apply future cash flow projections and/or may require the
use of a valuation specialist. Auditors generally rely on business specialists to test whether
goodwill is impaired. The specialist may be someone engaged by the client or engaged by the
audit firm. In either case, the auditor still has to test the reasonableness of the amounts provided
by the specialist.

For assets that are measured at revalued amounts and fair value, the auditor must trace
the recorded revalued amount from the last revaluation report of the independent appraiser and
ensure that the revaluation and subsequent depreciation have been properly recorded in the
books. In case of investment property and biological assets, the auditor shall review the basis
used by the management for determining fair value, which can be obtained from quoted prices by
real estate brokers or dealers, recent prices of similar properties, and discounted cash flow
projections.

The auditor has to review whether the assets are properly classified and presented on the
statement of financial position, and that depreciation has been properly charged as expense,
product cost, or cost of another asset.

Since the auditors' approach to the audit of long-lived assets is to audit the changes due
in the accounts, much of the work can be performed in advance of the reporting date.