Chapter 13

Property, Plant,
and Equipment:
Depreciation and
Depletion

McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights

reserved.

Property, plant and equipment

Tangible

assets with a service life of more

than one year that are used in the operation
of the business and are not acquired for the
purpose of resale
Three major subgroups:

Land
Buildings, machinery, equipment and land
improvements
Natural resources
13-2

Objectives for the Audit of Property,

Plant and Equipment
1. Use the understanding of the client and
its environment to consider inherent
risk, including fraud risks, related to
property, plant, and equipment.
2. Obtain an understanding of internal
control over property, plant, and
equipment.

13-3

Objectives cont.
1.

Assess the risks of material misstatement and design

tests of controls and substantive procedures that:
a. Substantiate the existence of property, plant, and
equipment
b. Establish the completeness of recorded property, plant,
and equipment
c. Verify the cutoff of transactions affecting property, plant,
and equipment
d. Determine that the client has rights to recorded property,
plant, and equipment
e. Establish the proper valuation or allocation of property,
plant, and equipment and the accuracy of transactions
affecting property, plant, and equipment
f. Determine that the presentation and disclosure of
property, plant, and equipment are appropriate
13-4

Audit ApproachCurrent Accounts

Versus Noncurrent Account
Cash

Accrued Liabilities

Securities

Accounts Payable

Accounts Receivable

Short-Term Notes

High turnover
accounts
Audit approach
audit the balance

Inventories

Property, Plant
& Equipment

Long-Term
Liabilities

Intangible Assets

Owners Equity
Accounts

Low turnover
accounts
Audit approach
audit the changes
in the accounts
13-5

Controls Over Plant

and Equipment

Use of a plant and equipment capital budget

Maintenance of a subsidiary ledger
A system of authorizations
Analysis of variances from budgeted expenditures
A statement of policy distinguishing between capital and
revenue expenditures
A requirement that purchases of plant and equipment are
subjected to normal purchasing procedures
Periodic physical inventories
A system of retirement authorization and documentation

13-6

Audit Documentation
Working

papers

Summary analysis that emphasizes changes

during the year under audit
Analyses of additions and retirements for the
current year
Analyses of repairs and maintenance
expense accounts
Tests of depreciation

13-7

Initial Audits
Beginning

balances

Substantiated by review of predecessor firms

working papers
If not previously audited, a complete historical
analysis of property accounts is needed
Thorough review of all major charges and credits
to property accounts

13-8

13-9

PPE Audit Steps (1 of 3)

A. Use the understanding of the client and its
environment to consider inherent risks, including fraud
risks, related to property, plant, and equipment.
B. Obtain an understanding of internal control over
property, plant, and equipment.
C. Assess the risks of material misstatement and design
further audit procedures.
D. Perform further audit procedurestests of controls.
1. Nature of tests of controls.
2. If necessary, revise the risks of material misstatement based on the
results of tests of controls.

13-9

PPE Audit Steps (2 of 3)

E. Perform further audit proceduressubstantive procedures for
property, plant, and equipment.
1. Obtain a summary analysis of changes in property owned and
reconcile to ledgers.
2. Vouch additions to property, plant, and equipment during the year.
3. Make a physical inspection of major acquisitions of plant and
equipment.
4. Analyze repair and maintenance expense accounts.
5. Investigate the status of property, plant, and equipment not in
current use.
6. Test the clients provision for depreciation.
7. Investigate potential impairments of property, plant, and
equipment.
8. Investigate retirements of property, plant, and equipment during
the year.
13-10

PPE Audit Steps (3 of 3)

E. Perform further audit procedures (cont.)
9. Examine evidence of legal ownership of property, plant, and
equipment.
10. Review rental revenue from land, buildings, and equipment
owned by the client but leased to others.
11. Examine lease agreements on property, plant, and equipment
leased to and from others.
12. Perform analytical procedures for property, plant, and
equipment.
13. Evaluate financial statement presentation and disclosure for
plant assets and for related revenue and expenses.

13-11

13-12

Summary of Substantive Tests of Property,

Plant, and Equipment

13-13

Vouch Additions (1 of 2)
Specific steps:
a. Review changes during the year in construction in progress and
examine supporting work orders, both incomplete and closed.
b. Trace transfers from the Construction in Progress account to the
property accounts, observing propriety of classification. Determine
that all completed items have been transferred out of the account.
c. On a test basis, vouch purchases of property, plant, and equipment
to invoices, deeds, contracts, or other supporting documents.
Recompute extensions, footings, and treatment of discounts. Make
certain repairs and maintenance expenses were not improperly
capitalized.

13-14

Vouch Additions (2 of 2)
Specific steps (cont.)
d. Investigate all instances in which the actual cost of
acquisitions substantially exceeded authorized amounts.
Determine whether such excess expenditures were
analyzed and approved by appropriate officials.
e Investigate fully any debits to property, plant, and
equipment accounts not arising from acquisition of physical
assets.
f. Determine that the total cost of any plant and equipment
assets purchased on the installment plan is reflected in the
asset accounts and that the unpaid installments are set up
as liabilities.
13-15

Analyze Expense Accounts

Analyze

repairs and maintenance expense

accounts to:

Discover items that should have been capitalized

Use company policy to determine consistency in
application
Analyze monthly amounts for significant
variations from:
Month to month
Between corresponding months of two years

13-16

Impairment of Long-Lived Assets

Long-lived

assets must be reviewed for

impairment whenever events or changes in
circumstances indicate that carrying value
may not be recoverable
Test involves projecting future cash flows
If impairment is indicated by cash flows
asset must be written down to fair value
May require the use of a valuation specialist
13-17

Investigate Retirements

Determine if property sold, dismantled, or abandoned

without being reflected in accounting records
Steps to discover unrecorded retirements:
1.
2.
3.

4.
5.
6.

For new additions, determine status of old equipment

Analyze miscellaneous revenue account for cash proceeds
If companys products discontinued, investigate disposition of
plant facilities
Inquire of executives and supervisors of plant asset retirements
Examine retirement work orders for proper authorization
Investigate any reduction in insurance coverage

13-18

Analytical Procedures
Ratios and trends for overall reasonableness of
recorded amounts
a. Total cost of plant assets divided by annual output in
dollars, pounds, or other units.
b. Total cost of plant assets divided by cost of goods
sold.
c. Comparison of repairs and maintenance expense on
a monthly basis and from year to year.
d. Comparison of acquisitions for the current year with
prior years.
e. Comparison of retirements for the current year with
prior years.
13-19

Presentation and Disclosure

Disclose major classes of depreciable assets

Accumulated depreciation
Principles:
a. The basis of valuation should be explicitly stated. At present, cost is the
generally accepted basis of valuation for plant and equipment; property
not in use should be valued at the lower of cost or estimated realizable
value.
b. Property pledged to secure loans should be clearly identified.
c. Property not in current use should be segregated in the balance sheet.

13-20

13-21

Auditors Approach for Depreciation

Important because depreciation is an estimate.

Client makes

Estimate of useful economic life

Choice of several depreciation methods

Audit approach for estimate

Review and test managements process of developing

the estimate

Review subsequent events or transactions bearing on

the estimate

Independently develop an estimate of the amount to

compare to managements estimate
13-22

Audit Program Depreciation

(1 of 5)
1. Review the depreciation policies set forth in company
manuals or other management directives. Determine
whether the methods in use are designed to allocate
costs of plant and equipment assets systematically
over their service lives.
a. Inquire whether any extra working shifts or other conditions
of accelerated production are present that might warrant
adjustment of normal depreciation rates.
b. Discuss with executives the possible need for recognition of
obsolescence resulting from technological or economic
developments.

13-23

Audit Program Depreciation

(2 of 5)
2.

Obtain or prepare a summary analysis (see Figure 13.1)

of accumulated depreciation for the major property
classifications as shown by the general ledger control
accounts, listing beginning balances, provisions for
depreciation during the year, retirements, and ending
balances.
a. Compare beginning balances with the audited amounts in
last years working papers.
b. Determine that the totals of accumulated depreciation
recorded in the plant and equipment subsidiary records
agree with the applicable general ledger controlling
accounts.

13-24

Audit Program Depreciation

(3 of 5)
3. Test the provisions for depreciation.
a. Compare rates used in the current year with those employed in
prior years and investigate any variances.
b. Test computations of depreciation provisions for a representative
number of units and trace to individual records in the property
ledger. Be alert for excessive depreciation on fully depreciated
assets. Generalized audit software can be used to test the
depreciation calculations in the clients records if the client
maintains computer based records.
c. Compare credits to accumulated depreciation accounts for the
years depreciation provisions with debit entries in related
depreciation expense accounts.

13-25

Audit Program Depreciation

(4 of 5)
4. Test deductions from accumulated depreciation for assets
retired.
a. Trace deductions to the working paper analyzing retirements of
assets during the year.
b. Test the accuracy of accumulated depreciation to date of
retirement.

5. Perform analytical procedures for depreciation.

a. Compute the ratio of depreciation expense to total cost of plant
and compare with prior years.
b. Compare the percentage relationships between accumulated
depreciation and related property accounts with those prevailing in
prior years. Discuss significant variations from the normal
depreciation program with appropriate members of management.
13-26

Audit Program Depreciation

(5 of 5)
Overall test
1. List the balances in the various asset accounts at the
beginning of the year.
2. Deduct any fully depreciated assets, since these items
should no longer be subject to depreciation.
3. Add one-half of the asset additions for the year.
4. Deduct one-half of the asset retirements for the year
(exclusive of any fully depreciated assets).

13-27

Natural Resources
Properties

subject to depletion
Similar to depreciation

Recorded consistently and in accordance with

GAAP
Test mathematical accuracy
Often rely on specialists for valuation
Establish ownership

13-28

Audit of Intangibles
Assets

with definite useful lives are

audited similar to property, plant and
equipment
Assets with indefinite useful lives (e.g.,
goodwill) must be tested for impairment
Auditors generally rely on business
valuation specialists to value goodwill for
tests of impairment
13-29

Audit of PPE in Advance

Most

work can be done in advance

Consideration of internal control can be
carried out at any convenient time
Many firms audit during interim work in
October and November
After balance sheet date, only need to
exam transaction for final two or three
months
13-30