auditing the financing/investing process

8/9/2019 Auditing the Financing/Investing Process

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Chapter 14

Auditing the Financing/Investing Process:

Prepaid Expenses, Intangible Assets, and

Property, Plant, and Equipment

McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved


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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

repaid e!penses " current

Intangible assets " long term

roperty# plant and e$uipment " long term


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Auditing repaid %!penses

Other assets that provide economic bene&it &or

less than a year are classi&ied as current

assets and are called prepaid expenses'

%!amples include(1'repaid insurance'

)'repaid rent'

*'repaid interest'

LO# 1

Insurance

Policy


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Inherent Risk Assessment "

repaid %!penses

+he inherent risk associated ,ith prepaid e!penses

is generally assessed as lo, because the accounts

do not involve any comple! or contentious

accounting issues'

LO# 1


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Control Risk Assessment " repaid

%!pensesBecause prepaid e!penses 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 rocedures " repaid

Insurance

+ests o& Details o& the repaid 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#

e!amine supportingsource documents'

Existence and

o!pleteness

Con&irm policy ,ith

insurance broker#

e!amine 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 une!pired portion

o& policy and

insurance e!pense'

aluation

Determine une!pired portion

o& policy and

insurance e!pense'

lassi$ication

Determine propriety o& distribution bet,een

manu&acturing overhead and S./A e!pense'

lassi$ication

Determine propriety o& distribution bet,een

manu&acturing overhead and S./A e!pense'

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 e!amples

o& &ive general categories o& intangible assets(1' 0arketing " trademark# brand name# and Internetdomain names'

)' Customer " customer lists# order backlogs# and

customer relationships'

*' Artistic " items protected by copyright'

4' Contract " licenses# &ranchises and broadcast rights'

' +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 comple! and the transactions are di&&icult

to audit' Accounting standards re$uire di&&erentasset impairment tests &or di&&erent classes o&

intangible assets 23AS 14)' 5ith the 6udgment and

comple!ity 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(

1' +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 e!tent to ,hich the entity engages or employs +aluation

specialists'

4' +he signi&icant management assumptions used in determining &air value'

' +he integrity o& change controls and security procedures &or valuation

models and relevant in&ormation systems# including approval processes

2A7 *)8'

LO#

1 ' %


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7sing the ,ork o& a specialist

SAS 9:*

+he auditor should consider the &ollo,ing(

ro&essional certi&ication o& specialist

Reputation and standing%!perience and e!pertise

Ob6ectives and scope o& the ,ork

Relationship to the client 2 Independence;0ethods and assumptions used

Other


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Substantive rocedures "

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 comple!ity

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(1' %!istence and completeness'

)'


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Auditing the roperty 0anagement

rocessroperty# 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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roperty 0anagement rocess

at %arth5ear Clothiershysical lant I+ Department

Speciali-ed

/%

transactions

Revie, &or

proper

recording

Input

3rom

purchasing

process

/%transaction

&ile

/%master

&ile

/%

program

.eneral

ledger

master &ile

.eneral

ledger

program

.eneral

ledger

report

/%

transaction

report

/%

subledger

Reconcile to

general ledger

0onthly

LO#


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+ypes o& +ransactions

3our types o& /% transactions may occur(

1' Ac$uisition o& capital assets &or cash or other

nonmonetary considerations'

)' Disposition o& capital assets through sale#e!change# retirement# or abandonment'

*' Depreciation o& capital assets over their use&ul

economic li&e'

4' >easing o& capital assets'

3our types o& /% transactions may occur(

1' Ac$uisition o& capital assets &or cash or other

nonmonetary considerations'

)' Disposition o& capital assets through sale#e!change# retirement# or abandonment'

*' Depreciation o& capital assets over their use&ul

economic li&e'

4' >easing o& capital assets'

LO# 4


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Comple! Accounting Issues

>ease accounting# sel&?constructed assets# and

interest capitali-ation are vivid e!amples o& some o&

the comple! 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 e!changes# and sel&?constructed

assets are more di&&icult to audit'

LO# 5


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0isstatements Detected in rior 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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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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o!pleteness

+he detailed property# plant# and e$uipment

subsidiary ledger usually includes the &ollo,ingin&ormation &or each capital asset(

1' Description# location# and ID number'

)' Date o& ac$uisition and installed cost'

*' Depreciation methods &or book and ta! purposes#

salvage value# and estimated use&ul li&e'

LO# 6


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ey Segregation o& Duties and ossible %rrors

LO# 7

LO# &


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Substantive Analytical rocedures

" roperty# lant# and %$uipment

+he &ollo,ing substantive analytical procedures

can be used in the audit o& /%(

+he &ollo,ing substantive analytical procedures

can be used in the audit o& /%(

1' Compare prior?year balances in /% and depreciation

e!pense ,ith current?year balances'

)' Compute the ratio o& depreciation e!pense to the related

/% accounts and compare to prior years= ratios'

*' Compute the ratio o& repairs and maintenance e!pense

to the related /% accounts and compare to prior

years= ratios'4' Compute the ratio o& insurance e!pense to related /%

accounts and compare to prior years= ratio'

' Revie, capital budgets and compare the amounts spent

,ith amounts budgeted'

1' Compare prior?year balances in /% and depreciation

e!pense ,ith current?year balances'

)' Compute the ratio o& depreciation e!pense to the related

/% accounts and compare to prior years= ratios'

*' Compute the ratio o& repairs and maintenance e!pense

to the related /% accounts and compare to prior

years= ratios'4' Compute the ratio o& insurance e!pense to related /%

accounts and compare to prior years= ratio'

' Revie, capital budgets and compare the amounts spent

,ith amounts budgeted'

LO# &

LO# (


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

accrued e!penses ,ork'


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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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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 e!amine the capital asset' +his is

o&ten done during the inventory observation' 0a6or

dispositions should be vouched to supportingdocumentation and e!amined &or proper

authori-ation'

LO# (



LO# (


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"ights and Obligations

In most cases# rights or o,nership can be

determined by e!amining vendor=s invoices andother supporting documents' In some cases# the

auditor may ,ish to con&irm property deeds or title

documentation'

LO# (



LO# (


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Disclosure Issues

%!amples o& disclosure items(1' Classes o& capital assets and valuation bases'

)' Depreciation methods and use&ul lives &or &inancial reporting and ta!purposes'

*' onoperating assets'

4' Construction or purchase commitments'

' >iens and mortgages'

' Ac$uisition or disposal o& ma6or operating &acilities':' Capitali-ed and other lease arrangements'

%!amples o& disclosure items(1' Classes o& capital assets and valuation bases'

)' Depreciation methods and use&ul lives &or &inancial reporting and ta!purposes'

*' onoperating assets'

4' Construction or purchase commitments'

' >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

roperty# lant# 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 /% 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 /% 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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%nd o& Chapter 14

auditing the financing/investing process

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