auditing the financing and investing process

8/18/2019 auditing the financing and investing process

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Auditing the Financing/Investing Process:

Prepaid Expenses, Intangible Assets, and

Property, Plant, and Equipment


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Balance Sheet

Assets

Cash

Investments

Receivables

Prepaids

Inventory

PP and EOther assets -

intangibles

Liabilities and Equity

Accounts payable

Accrued liabilities

Debt

Common stock

Retained earnings


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Other Assets

Prepaid expenses current

Intangible assets long term

Property! plant and e"uipment long term


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14-4

Auditing Prepaid #xpenses

Other assets that provide economic bene$it $or

less than a year are classi$ied as current

assets and are called prepaid expenses%

#xamples include&'%Prepaid insurance%

(%Prepaid rent%

)%Prepaid interest%

LO# 1

Insurance

Policy


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14-5

Inherent Risk Assessment

Prepaid #xpenses

*he inherent risk associated +ith prepaid expenses

is generally assessed as lo+ because the accounts

do not involve any complex or contentious

accounting issues%

LO# 1


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14-6

Control Risk Assessment Prepaid

#xpensesBecause prepaid expenses are normally processed

through the purchasing process! control procedures

in purchasing should ensure that each item is

properly authori,ed and recorded%

LO# 1


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Substantive Procedures Prepaid

Insurance

*ests o$ Details o$ the Prepaid Insurance Account

Audit testing begins by obtaining a detail

schedule o$ the prepaid insurance account%

Existence and

o!pleteness

Con$irm policy +ith

insurance broker!

examine supportingsource documents%

Existence and

o!pleteness

Con$irm policy +ith

insurance broker!

examine supportingsource documents%

"ights and

Obligations

Con$irm policy

bene$iciary +ith

the insurance broker%

"ights and

Obligations

Con$irm policy

bene$iciary +ith

the insurance broker%

aluation

Determine unexpired portion

o$ policy and

insurance expense%

aluation

Determine unexpired portion

o$ policy and

insurance expense%

lassi$ication

Determine propriety o$ distribution bet+een

manu$acturing overhead and S-.A expense%

lassi$ication

Determine propriety o$ distribution bet+een

manu$acturing overhead and S-.A expense%

LO# %


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Auditing Intangible Assets

Intangible assets are assets that provide economic

bene$it $or longer than a year! but lack physical

substance% *he $ollo+ing list includes examples

o$ $ive general categories o$ intangible assets&'% /arketing trademark! brand name! and Internetdomain names%

(% Customer customer lists! order backlogs! and

customer relationships%

)% Artistic items protected by copyright%

0% Contract licenses! $ranchises and broadcast rights%

1% *echnology patented and unpatented technology%

LO# 1 ' %


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Inherent "is) *ssess!ent

Intangible Assets

*he inherent risk associated +ith intangible assets

raises serious risk considerations% *he accounting

rules are complex and the transactions are di$$icult

to audit% Accounting standards re"uire di$$erentasset impairment tests $or di$$erent classes o$

intangible assets 23AS '0(4% 5ith the 6udgment and

complexity association +ith +aluation and

esti!ation o$ intangible assets! the auditor +ould

likely assess the inherent risk as high%

LO#

1 ' %


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Control Risk Assessment

Intangible Assets

In assessing control risk! the auditor considers $actors such as&

'% *he expertise and experience o$ those determining the $air value o$ theassets%

(% Controls over the process used to determine $air +alue !easure!ents!including controls over data and segregation o$ duties bet+een those

committing the client to the purchase and those undertaking the

valuation%

)% *he extent to +hich the entity engages or employs +aluation

specialists%

0% *he signi$icant management assumptions used in determining $air value%

1% *he integrity o$ change controls and security procedures $or valuation

models and relevant in$ormation systems! including approval processes

2A7 )(84%

LO#

1 ' %


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7sing the +ork o$ a specialist

*he auditor should consider the $ollo+ing&

Pro$essional certi$ication o$ specialist

Reputation and standing#xperience and expertise

Ob6ectives and scope o$ the +ork

Relationship to the client 2 Independence94/ethods and assumptions used

Other


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Substantive Procedures

Intangible Assets

*ests o$ Details o$ Intangible Assets*ests o$ details associated +ith valuation and impairment o$

intangible assets are o$ten necessary because the complexity

and degree o$ 6udgment increase the risk o$ material

misstatement% Some substantive evidence is re"uired $or all

signi$icant accounts! and! as noted above! substantive analytical

procedures are not likely to provide su$$icient! appropriate

evidence $or signi$icant transactions involving intangible assets%

3our assertions are normally considered $or tests o$ details o$

intangible assets&'% #xistence and completeness%

(% :aluation%

)% Rights and obligations%

0% Classi$ication%

LO# %


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14-1

Auditing the Property /anagement

ProcessProperty! plant! and e"uipment usually represents a

material amount in the $inancial statements%

ecurring Engagement *he auditor is able to $ocus

on additions and retirements

in the current period because

amounts $rom prior periods have

been sub6ect to audit procedures%

ecurring Engagement *he auditor is able to $ocuson additions and retirements

in the current period because

amounts $rom prior periods have

been sub6ect to audit procedures%

!e" Engagement *he auditor has to veri$y the

assets that make up the

beginning balance in property!

plant! and e"uipment%

!e" Engagement *he auditor has to veri$y theassets that make up the

beginning balance in property!

plant! and e"uipment%

LO#


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Communication bet+een predecessor and

successor auditors 2 SAS ; 804

Successor auditor should consider the $ollo+ing&

In$ormation regarding integrity o$ management

Disagreements +ith management about

accounting principlesCommunications to audit committees about

$raud and IC issues

Predecessor auditor


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Property /anagement Process

at #arth5ear ClothiersPhysical Plant I* Department

Speciali,ed

PP.#

transactions

Revie+ $or

proper

recording

Input

3rom

purchasing

process

PP.#transaction

$ile

PP.#master

$ile

PP.#

program

-eneral

ledger

master $ile

-eneral

ledger

program

-eneral

ledger

report

PP.#

transaction

report

PP.#

subledger

Reconcile to

general ledger

/onthly

LO#


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*ypes o$ *ransactions

3our types o$ PP.# transactions may occur&

'% Ac"uisition o$ capital assets $or cash or other

nonmonetary considerations%

(% Disposition o$ capital assets through sale!exchange! retirement! or abandonment%

)% Depreciation o$ capital assets over their use$ul

economic li$e%

0% =easing o$ capital assets%

3our types o$ PP.# transactions may occur&

'% Ac"uisition o$ capital assets $or cash or other

nonmonetary considerations%

(% Disposition o$ capital assets through sale!exchange! retirement! or abandonment%

)% Depreciation o$ capital assets over their use$ul

economic li$e%

0% =easing o$ capital assets%

LO# 4


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*here are three inherent risk $actors that must be

considered by the auditor%

Complexaccounting

issues%

Complexaccounting

issues%Di$$icult>to>audit

transactions%

Di$$icult>to>audit

transactions%/isstatements

detected in

prior audits%

/isstatementsdetected in

prior audits%

LO# 5


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14-1&



Complex Accounting Issues

=ease accounting! sel$>constructed assets! and

interest capitali,ation are vivid examples o$ some o$

the complex accounting issues $aced by auditors%

LO# 5


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Di$$icult>to>Audit *ransactions

5hen assets are purchased directly $rom a vendor!

the transaction is relatively easy to audit% ?o+ever!

transactions involving donated assets!

nonmonetary exchanges! and sel$>constructed

assets are more di$$icult to audit%

LO# 5


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14-%,



/isstatements Detected in Prior Audits

I$ misstatements in prior audits have been

detected! the auditor should set inherent riskhigher than i$ $e+ or no misstatements

have been $ound in the past%

LO# 5


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14-%1



Occurrence and Authori,ation

Control procedures $or the occurrence and

authori,ation o$ property! plant! and e"uipment are

normally part o$ the purchasing process% ?o+ever!large capital asset transactions may be sub6ect to

additional controls% Companies should have an

authori,ation table $or approving capital asset

transactions%

LO# 6


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14-%%



o!pleteness

*he detailed property! plant! and e"uipment

subsidiary ledger usually includes the $ollo+ingin$ormation $or each capital asset&

'% Description! location! and ID number%

(% Date o$ ac"uisition and installed cost%

)% Depreciation methods $or book and tax purposes!

salvage value! and estimated use$ul li$e%

LO# 6


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@ey Segregation o$ Duties and Possible #rrors

LO# 7

LO# &


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14-%4

Substantive Analytical Procedures

Property! Plant! and #"uipment

*he $ollo+ing substantive analytical procedures

can be used in the audit o$ PP.#&

*he $ollo+ing substantive analytical procedures

can be used in the audit o$ PP.#&

'% Compare prior>year balances in PP.# and depreciation

expense +ith current>year balances%

(% Compute the ratio o$ depreciation expense to the related

PP.# accounts and compare to prior years< ratios%

)% Compute the ratio o$ repairs and maintenance expense

to the related PP.# accounts and compare to prior

years< ratios%0% Compute the ratio o$ insurance expense to related PP.#

accounts and compare to prior years< ratio%

1% Revie+ capital budgets and compare the amounts spent

+ith amounts budgeted%

'% Compare prior>year balances in PP.# and depreciation

expense +ith current>year balances%

(% Compute the ratio o$ depreciation expense to the related

PP.# accounts and compare to prior years< ratios%

)% Compute the ratio o$ repairs and maintenance expense

to the related PP.# accounts and compare to prior

years< ratios%0% Compute the ratio o$ insurance expense to related PP.#

accounts and compare to prior years< ratio%

1% Revie+ capital budgets and compare the amounts spent

+ith amounts budgeted%

LO# &

LO# (


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14-%5

*ests o$ Details o$ *ransactions and

Account Balances and Disclosures

o!pleteness*he auditor begins the process by obtaining a lead

schedule and detailed schedules o$ additions and

dispositions o$ assets% *hese schedules are $ootedand agreed to the general ledger%

LO# (

LO# (


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14-%6

uto$$ Cuto$$ is normally part o$ the accounts payable and

accrued expenses +ork% :endorend are examined todetermine i$ the assets is recorded in the proper

accounting period%

LO# (



.ece!ber

%&

%,,7

/anuar y

4

%,,&

LO# (


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14-%7

lassi$ication

3irst! the auditor must determine that the capital

asset is recorded in the proper account% Second! the

repairs and maintenance account should berevie+ed to determine i$ any capital assets have

been incorrectly recorded in these accounts% 3inally!

each material lease agreement should be revie+ed

$or proper classi$ication as operating or capital lease%

LO# (



LO# (


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14-%&

Existence A list o$ all ma6or additions should be obtained and

each addition should be vouched to supportingdocumentation% 3or ma6or ac"uisitions! the auditor

may physically examine the capital asset% *his is

o$ten done during the inventory observation% /a6or

dispositions should be vouched to supportingdocumentation and examined $or proper

authori,ation%

LO# (



LO# (


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14-%(

"ights and Obligations

In most cases! rights or o+nership can be

determined by examining vendor


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14-,

:aluation and Allocation

Capital assets are valued at

ac"uisition cost plus any costs

necessary to make the assetoperational% *he auditor tests

the recorded cost o$ ma6or ne+

additions to PP.#%

Capital assets are valued at

ac"uisition cost plus any costs

necessary to make the assetoperational% *he auditor tests

the recorded cost o$ ma6or ne+

additions to PP.#%

*he auditor may

recompute! either

manually or +ith the aid o$a computer! the proper

depreciation expense $or

the period%

*he auditor may

recompute! either

manually or +ith the aid o$a computer! the proper

depreciation expense $or

the period%

*he auditor must test $or permanent impairment o$ long>livedassets% 5hile -AAP re"uires the comparison o$ $uture cash

in$lo+s to the asset


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14-1

Disclosure Issues

#xamples o$ disclosure items&'% Classes o$ capital assets and valuation bases%

(% Depreciation methods and use$ul lives $or $inancial reporting and taxpurposes%

)% onoperating assets%

0% Construction or purchase commitments%

1% =iens and mortgages%

% Ac"uisition or disposal o$ ma6or operating $acilities%% Capitali,ed and other lease arrangements%

#xamples o$ disclosure items&'% Classes o$ capital assets and valuation bases%

(% Depreciation methods and use$ul lives $or $inancial reporting and taxpurposes%

)% onoperating assets%

0% Construction or purchase commitments%

1% =iens and mortgages%

% Ac"uisition or disposal o$ ma6or operating $acilities%% Capitali,ed and other lease arrangements%

LO# (



LO# 1,


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14-%

#valuating the Audit 3indings

Property! Plant! and #"uipment

*he auditor aggregates the likely misstatements and

compares this amount to the tolerable misstatement%

I$ the likely misstatement is less than

the tolerable misstatement! the evidence indicates

that the PP.# accounts are not materially misstated%

I$ the likely misstatement is greater than the

tolerable misstatement! the auditor +ould either re"uiread6ustment o$ the accounts or issue a "uali$ied audit report%

*he auditor aggregates the likely misstatements and

compares this amount to the tolerable misstatement%

I$ the likely misstatement is less than

the tolerable misstatement! the evidence indicatesthat the PP.# accounts are not materially misstated%

I$ the likely misstatement is greater than the

tolerable misstatement! the auditor +ould either re"uiread6ustment o$ the accounts or issue a "uali$ied audit report%

LO# 1,


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14-

uestions


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auditing the financing and investing process

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