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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$uisition o& capital assets &or cash or other
nonmonetary considerations'
)' Disposition o& capital assets through sale#e!change# retirement# or abandonment'
*' Depreciation o& capital assets over their use&ul
economic li&e'
4' >easing o& capital assets'
LO# 4
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Inherent Risk Assessment "
roperty 0anagement rocess
Comple! Accounting Issues
>ease accounting# sel&?constructed assets# and
interest capitali-ation are vivid e!amples o& some o&
the comple! accounting issues &aced by auditors'
LO# 5
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Inherent Risk Assessment "
roperty 0anagement rocess
Di&&icult?to?Audit +ransactions
5hen assets are purchased directly &rom a vendor#
the transaction is relatively easy to audit' @o,ever#
transactions involving donated assets#
nonmonetary e!changes# and sel&?constructed
assets are more di&&icult to audit'
LO# 5
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Inherent Risk Assessment "
roperty 0anagement rocess
0isstatements Detected in rior Audits
I& misstatements in prior audits have been
detected# the auditor should set inherent riskhigher than i& &e, or no misstatements
have been &ound in the past'
LO# 5
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Control Risk Assessment "
roperty 0anagement rocess
Occurrence and Authori-ation
Control procedures &or the occurrence and
authori-ation o& property# plant# and e$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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Control Risk Assessment "
roperty 0anagement rocess
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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Control Risk Assessment "
roperty 0anagement rocess
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$ication
3irst# the auditor must determine that the capital
asset is recorded in the proper account' Second# the
repairs and maintenance account should berevie,ed to determine i& any capital assets have
been incorrectly recorded in these accounts' 3inally#
each material lease agreement should be revie,ed
&or proper classi&ication as operating or capital lease'
LO# (
+ests o& Details o& +ransactions and
Account Balances and Disclosures
LO# (
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Existence A list o& all ma6or additions should be obtained and
each addition should be vouched to supportingdocumentation' 3or ma6or ac$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# (
+ests o& Details o& +ransactions and
Account Balances and Disclosures
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# (
+ests o& Details o& +ransactions and
Account Balances and Disclosures
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# (
+ests o& Details o& +ransactions and
Account Balances and Disclosures
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