auditing the financing and investing process
TRANSCRIPT
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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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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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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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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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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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Inherent Risk Assessment
Property /anagement Process
*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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Inherent Risk Assessment
Property /anagement Process
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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Inherent Risk Assessment
Property /anagement Process
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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Inherent Risk Assessment
Property /anagement Process
/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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Control Risk Assessment
Property /anagement Process
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
Property /anagement Process
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$e%
LO# 6
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Control Risk Assessment
Property /anagement Process
@ey Segregation o$ Duties and Possible #rrors
LO# 7
LO# &
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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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*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 expenses +ork% :endorend are examined todetermine i$ the assets is recorded in the proper
accounting period%
LO# (
*ests o$ Details o$ *ransactions and
Account Balances and Disclosures
.ece!ber
%&
%,,7
/anuar y
4
%,,&
LO# (
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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 examine the capital asset% *his is
o$ten done during the inventory observation% /a6or
dispositions should be vouched to supportingdocumentation and examined $or proper
authori,ation%
LO# (
*ests o$ 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 examining vendor
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: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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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 $acilities%% Capitali,ed and other lease arrangements%
LO# (
*ests o$ Details o$ *ransactions and
Account Balances and Disclosures
LO# 1,
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#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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