SAINT COLUMBAN COLLEGE

COLLEGE OF BUSINESS EDUCATION

PAGADIAN CITY

SUBSTANTIVE TEST OF PROPERTY, PLANT AND EQUIPMENT (PPE)

This chapter discusses the audit of property, plant and equipment, its objectives and procedures as well
as the management assertions relating to PPE.

Introduction

Property, plant and equipment (PPE) are one of the most significant portions of an entity's non-current
asset; hence, before acquiring a property, plant and equipment, they should be carefully planned and
analyzed.

When planning for the audit of PPE, the auditor should consider that the amounts for this PPE is
material to the statement of financial position and expect that the account balances do not necessarily
change significantly from year to year. The auditor normally assesses control risk at a maximum level
and performs extensive substantive tests which emphasize the review of significant additions and
disposals, and analytical procedures to test the provisions for depreciation and depletion.

In conjunction with the audit of property, plant and equipment, the auditors also obtain evidence about
the related accounts of depreciation expense, accumulated depreciation, lease (rent) expense,
impairment loss (if any) and repairs and maintenance expense.

Audit Objectives

When auditing property, plant and equipment, the principal objective for the substantive tests is to
determine the following:
Assertion Category Account Balances Audit Objectives
Existence All PPE on the statement of financial position (including assets leased
under finance lease) exist.

Completeness All PPE owned or leased under finance lease by the entity at the
reporting date is included on the statement of financial position.

Valuation and Allocation PPE is carried at the appropriate amount taking into account the
requirements of PAS 16 Property, Plant and Equipment and PAS 36
Impairment of Assets.

Rights and Obligations The entity owns, or has a legal right to, all the PPE on the statement of
financial position at the reporting date.

Presentation and PPE and related accounts are properly classified, described and
Disclosure disclosed in the financial statements, including notes, in accordance
with PFRSs.

Liens, pledges, security interests and restrictions to PPE are identified

and properly disclosed.
Audit of Property, Plant and Equipment (PPE)

The auditor's primary substantive procedures for property, plant and equipment will typically include
the following:
1. Obtaining a summary analysis of changes in property owned and reconcile with ledgers;
2. Vouching for additions and disposals (including retirements) of PPE during the year;
3. Physical inspection of major acquisition of PPE during the year;
4. Examining proof of ownership of PPE;
5. Analyzing lease, repair and maintenance expense accounts;
6. Testing for the accuracy and reasonableness for provision on depreciation or depletion;

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7. Investigating current and potential impairments of PPE;
8. Performing analytical procedures to check for reasonableness of PPE and related expense reported in
the financial statements; and
9. Evaluating financial statement presentation and disclosures for an item of PPE including its related
revenue and expense.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
(b) are expected to be used during more than one period.

INITIAL RECOGNITION

Items of property, plant, and equipment should be recognized as assets when it is probable that:
a) The future economic benefits associated with the asset will flow to the enterprise; and
b) The cost of the asset can be measured reliably.

This recognition principle is applied to all property, plant, and equipment costs at the time they are
incurred. This includes costs incurred initially to acquire or construct an item of property, plant and
equipment and costs incurred subsequently to add to, replace part of, or service it.

INITIAL MEASUREMENT

An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at
its cost. Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration
given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount
attributed to that asset when initially recognized in accordance with the specific requirements of other
PFRSs.

Components of Cost

Purchase price, including import duties and nonrefundable purchase taxes and any directly
attributable cost of bringing the asset to working conditions for its intended use. Any trade discounts
and rebates are deducted in arriving at the purchase price.

Directly Attributable Costs

Examples of directly attributable costs include:
1) Costs of Testing whether the asset is functioning properly, after deducting the net proceeds from
selling any items produced while bringing the asset to that location and condition (such as samples
produced when testing equipment);
2) Cost of site Preparation;
3) Professional fees of architects and engineers;
4) Estimated cost of dismantling and Removing the asset and Restoring the site, to the extent that it is
recognized as a provision (this is popularly known as "asset retirement obligation" and this obligation
is incurred in the act of acquiring a long-term operating asset to restore costs in the future when the
asset is retired. Required to be recognized at its estimated fair value when it is incurred and be added to
the cost of acquiring the long-term operating asset.);
5) Installation and assembly cost;
6) Initial Delivery and handling cost;
7) Costs of Employee benefits arising directly from the construction or acquisition of the item of
property, plant and equipment.

Cost of Machinery When Purchased

1) Nonrefundable Sales tax;

2) Cost of Water device to keep machine cool;
3) Cost of Adjustment to machinery for operational efficiency and to increase capacity;

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4) Construction of base (Cost of safety rail and platform surrounding machine);
5) Purchase Price;
6) Insurance while in transit;
7) Freight, handling, storage and other cost related to the acquisition;
8) Installation cost, including site preparation and assembling;
9) Cost of Testing and Trial run, and other cost necessary in preparing the machinery for use;
10) Fees paid to Consultants for advice on acquisition of the machinery;
11) Unloading charge;
12) Initial estimate of cost of Dismantling and removing the machinery and restoring the site on which
it is located.

Illustration:

Sammer Co. acquired a new machine. Details of the acquisition are as follows:

Cash paid for machine including VAT of P60,000 560,000

Royalty payment base on units produced 19,000
Cost of transporting machine 15,000
Cost of installation by expert fitter 40,000
Labor of testing machine 20,000
Materials used and damaged as a result of testing the machine 10,000
Repair cost of new machine damaged in the process of installation 12,000
Cost of training for personnel who will use the machine 25,000
Cost of safety rails and platforms surrounding machine 50,000
Cost of water device to keep machine cool 70,000
Cost of adjustment to machine to make it operate more efficiently 57,000
Estimated dismantling cost be incurred as required by contract 65,000
Cost of removing old machine 10,000
Loss on premature retirement-old machine 120,000
Gratuity paid to operator of old machine, who was laid off 20,000

Compute the total cost of new machine.

Costs Chargeable To Land

1) Survey cost
2) Purchase price:
3) Liabilities on the land assumed by the buyer (eg, mortgages, encumbrances and interest on such
mortgages assumed by buyer.)
4) Unpaid real property taxes on the land up to the date of acquisition assumed by the buyer,
5) Option cost of the land acquired. If the land is not acquired, the cost of option is treated as expensed;
Option price
The price to be paid by an investor for an option contract, based upon the security of the underlying
asset and the time left until the option expires

Earnest Money Deposit

Down payment made by a purchaser of real estate as evidence of good faith; a deposit or partial
payment. Earnest money therefore is capitalizable cost of the asset acquired.

6) Cost of permanent improvement such as draining cost, cost of filling the land, cost of grading and
leveling:
7) Commission cost paid to brokers or agents;
8) Legal fees to close escrow;
9) Payments to tenants to convince them to vacate the premises;
10) Cost to relocate or reconstruct property of others occupying the land so as to obtain ownership;
11) Cost to register the land and other cost of transferring the title in the name of the buyer;
12) Legal Fees and other expenditures for establishing clean title;
13) Cost of clearing unwanted old structures, excluding demolition cost;

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Special Notes:
1. Land improvements
a. Not subject to depreciation
Examples: Cost of surveying, clearing grading and leveling, subdividing.
Treatment: capitalizable cost of the land

b. Depreciable
Examples: Fences, water systems, drainage systems, side-walks and pavements, landscaping.
Treatment:
1) Part of blueprint of the building - building
2) Not part of the blueprint - land improvement

2. Special assessment - this is capitalizable cost of the land.

3. Real property tax - this should be expensed when incurred. However, unpaid real property taxes
accruing as of the date of acquisition assumed by the buyer, should be capitalized.

Land Account
Statement of financial position classification
Items Treatment
1. Land used as a plant site

2. Land held for undetermined use a currently

3. Land held for long-term capital appreciation

4. Land held as a site for a building being

constructed or developed for future use as
investment property
5. Land leased out under operating lease

6. Land leased out under finance lease

7. Land held definitely as a future plant site

8. Land held for sale in the ordinary course of

business
9. Land held for sale under PFRS 5

Building Account
Statement of financial position classification
Item Accounting Treatment
1. Building used as a plant site

2. Building being constructed or as developed for

future use as investment property

3. Building owned by the company and leased

out under operating lease
4. Building owned by the company and leased
out under finance lease
5. Building held for sale in the ordinary course of
business

6.Building held for sale under PFRS 5

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Costs Chargeable To Building When Purchased
Examples of costs chargeable to building when purchased include the following:

1) Purchase price;
2) Legal fees and other expenses incurred in connection with the purchase;
3) Liabilities on the building assumed by the buyer including unpaid real property taxes on the building
up to the date of acquisition assumed by the buyer;
4) Renovation and remodeling cost on the building to make it suitable for its intended use;
5) Payments to tenants to convince them to vacate the premises.

Cost of Building When Constructed

Examples of costs chargeable to building when constructed include the following:

1) Fees paid for supervision;

2) Building permit and license;
3) Architect fee;
4) Construction cost (materials, labor employed and overhead incurred during the construction;
5) Expenditures for service equipment and fixtures made a permanent part of the structure;
6) Expenditures incurred during the construction period such as interest on construction loans and
insurance;
7) Cost of demolishing old building;
Demolition cost treatment:
1. Old building to be demolished so as to make room for the construction of the new building
during the same period - Part of the cost of the new building
2. Old building to be demolished but the construction of the new building is to be made the land
next accounting period - Part of the cost of land

8) Excavation cost;
9) Cost of Security fences while construction and other temporary buildings to house constructions
materials and tools.

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