Question

2. Discuss the following related to property management process:

a. Inherent risk assessment

b. Control risk assessment

c. Analytical procedures

Answer 1

a. Inherent Risk Assessment:

There are three inherent risk factors that must be considered by the auditor

Complex Acounting Issues:

Lease accounting, self-constructed assets and interest capitalization are vivid examples of some of the complex accounting issues faced by auditors

Difficult to audit transactions:

When assets are purchased directly from a vendor, the transaction is relatively easy to audit. However, transactions involving donated assets, non-monetary exchanges, and self-constructed assets are more difficult to audit.

Misstaements detected in prior periods:

If misstatements in prior audits have been detected, the auditor should set inherent risk higher than if few or no misstatements have been found in the past.

B. Control Risk Assessment:

Control procedures for the occurrence and authorization of property, plant and equipment are normally part of the purchasing process. However, large capital asset transactions may be subject to additional controls. Companies should have an authorization table for approving capital asset transactions.

Completeness:

The detailed property, plant and equipment subsidiary ledger usually includes the following information for each capital asset:

1.Description, location, and ID number.

2.Date of acquisition and installed cost.

3.Depreciation methods for book and tax purposes, salvage value and estimated useful life.

C.Anaytical Procedures:

The following substantive analytical procedures can be used:

1.Compare prior-year balances in PP&E and depreciation expense with current-year balances.

2.Compute the ratio of depreciation expense to the related PP&E accounts and compare to prior years’ ratios.

3.Compute the ratio of repairs and maintenance expense to the related PP&E accounts and compare to prior years’ ratios.

4.Compute the ratio of insurance expense to related PP&E accounts and compare to prior years’ ratio.

5.Review capital budgets and compare the amounts spent with amounts budgeted.

Tests of Details of Transactions and Account Balances and Disclosures:

Completeness & Accuracy:

The auditor begins the process by obtaining a lead schedule and detailed schedules of additions and dispositions of assets. These schedules are footed and agreed to the general ledger. The auditor can trace a sample of assets to the property, plant, and equipment subsidiary ledger.

Cut-Off:

Cut-off is normally part of the accounts payable and accrued expenses work. Vendor’s invoices from a few days before and after year end are examined to determine if the assets is recorded in the proper accounting period.

Classification:

First, the auditor must determine that the capital asset is recorded in the proper account. Second, the repairs and maintenance account should be reviewed to determine if any capital assets have been incorrectly recorded in these accounts. Finally, each material lease agreement should be reviewed for proper classification as operating or capital lease

Existence:

A list of all major additions should be obtained and each addition should be vouched to supporting documentation. For major acquisitions, the auditor may physically examine the capital asset. This is often done during the inventory observation. Major dispositions should be vouched to supporting documentation and examined for proper authorization.

Rights & Obligations:

In most cases, rights or ownership can be determined by examining vendor’s invoices and other supporting documents. In some cases the auditor may wish to confirm property deeds or title documentation

Valuation & Allocation:

Capital assets are valued at acquisition cost plus any costs necessary to make the asset operational. The auditor tests the recorded cost of major new additions to PP&E

The auditor may recompute, either manually or with the aid of a computer, the proper depreciation expense for the period.