Verification of non-current assets in the audit of assets

Tangible Assets

Tangible
assets are so called because you can them and touch them. They primarily
consist of such assets as;

·
Land and buildings

·
Plant and equipment

·
Furniture and fitting

·
Motor vehicles

IAS
16 property plant and equipment states that assets are;

‘held
for use in the production of supply of goods and services or for rental to
other or administrative use and are expected to be used in more than one
period’.

There
are four key aspects to consider before we look in detail at audit procedures
to verify tangible assets.

·
It is permitted to include these assets at valuation rather than
original cost. There are extensive disclosure requirement where assets are
shown at valuation-we will look at the audit aspects of valuing tangible assets
separately.

·
Auditors should carefully consider the depreciation policy-the amount to
be written off these assets (cost less residual value) should be consistency in
applying, depreciation policies and be alert where policies are changed. Rates
of depreciation, residual values and economic lives of assets should be
reviewed regularly to ensure they are still applicable.

·
Auditors should look at the question of impairment. Where the value of
assets becomes impaired, in other words, they are not worth the value at which
they are shown in the accounting records, they should be written down to a
realistic value. This a particularly true of intangible assets such as brands
or goodwill, which we look at later, but can also apply to tangible assets due
to obsolescence or change in regulations.

·
Assets which are leased causes a problem as auditors has to determine
whether assets are financial through operating or finance leases are defined as
those which ‘transfer substantially all the costs incurred under operating
leases should be expensed through the profit and loss account whilst assets
acquired under finance leases can be capitalised. It is not beyond the realms
of possibility that unscrupulous managers will try and capitalised operating
lease costs thus increasing assets values and profits incorrectly, so the
auditors should activate their professional scepticism whenever they are
confronted with leases assets. It is necessary to read the lease agreements
carefully to ensure the cost are treated correctly.

Control Objectives

The control
in relation to tangible fixed assets is:

·
To ensure that all tangible fixed assets exist, are owned by the company
and are in use

·
To ensure that tangible fixed assets are correctly recorded in the
books, adequately secured and properly maintained

·
That acquisition and disposals are properly authorised

·
That asset is properly depreciated and the depreciation is properly accounted
for.

Audit Procedure

We
will look at the audit procedure applicable to different categories of asset
and at the same time, identify which assertion these procedure will provide
evidence for.

Land and Building

·
Physically inspect a sample of land and buildings (existence)

·
Inspect all documents of title, lease agreement, invoices, etc. Relating
to the purchase or disposal of land and buildings. If title deeds or other such
document are held by a third party, for example, a lender as security for a loan,
the lender should be asked to certify possession in writing (ownership, rights
and obligations).

·
Inspect minutes of directors meeting to ensure all agreement for the
purchase or sale of assets are properly authorised and signatures on document
such as title deeds, leases, conveyances, tenancy agreement, etc. Are properly
minted and approved (occurrence, rights and obligations).

·
Check a sample of entries in the assets register or assets accounts in
the nominal ledger and trace back to source document (valuation).

·
Review depreciation policy and check sample calculations. Consider in
relation to expected useful lives of assets (valuation).

·
Review assets for any permanent impairment in value (valuation).

·
If assets are stated at valuation, if a valuation has been performed in
the year, ensure name or qualification of values and basis of valuation is
appropriate and that proper disclose is made in the accounts (valuation).

·
Ensure assets register reconciles to nominal ledge (completeness and
accuracy).

·
Ensure fixed assets properly disclosed in financial statement in
accordance with IAS 16 (completeness, valuation and allocation).

Land
and building at cost will be the norm and creates no problems. Land shown at
below cost will be unusual and the auditor will need to;

·
Examine the reason for the write down

·
Examine the directors minute authorised it

·
Appraise the adequacy of the write down

Ensure
that there is adequate disclosure of the facts in the financial statements.

Building
can be under construction and can be being constructed by the client. In this
case care has to be taken to ensure that only costs, including overheads, which
directly cost but can also, include the cost of borrowing to finance the
construction and direct overheads.

Auditors
should be aware that:

·
Capitalising expenses is a way of ‘improving’ the profits and asset
values.

·
The building should not cost more than it can be valued at-excessive
costs allocated to the construction of a building should be investigated and
the question of ‘impairment’ considered.

·
It may be that auditors will have to take specialist advice in this
area.

Intangible Assets

Intangible
assets include:

·
Development costs

·
Patents, trade marks, licences, concessions, etc.

·
Goodwill-if purchased on an acquisition.

These
can be area of some difficulty for the auditors, the principal one being in the
area of valuation. It is generally, reasonably easy to evidence the fact that
intangible assets exist and that the business owns them, it is less easy to
decide what they are worth.

Again
there are accounting rules, principally set out in IAS 38 intangible assets,
which the student should be familiar with.

There
are some key issues which relate to intangible assets generally.

Research and Development

You
need to know the different between research and development.

Research
is original investigation work often only with a view to extending knowledge.
This is not an asset and the costs of research should be written off in the
financial period.

Development
is the application of research into commercial product or service. This is
preliminary cost incurred before the product or service goes into commercial
production. This may be an asset subject to some considerations.

·
Is the project technically feasible-i.e. will it be completed and result
in a commercial product or service? This may require the auditors consulting an
expert to determine the answer.

·
Is the ultimate product going to be used or sold?-consult minutes of
meeting and discussion papers.

·
Can the product be sold- i.e. does the business have the capacity to
deliver the product to the market place? Again meeting minutes and discussion
papers will provide evidence of the company’s thinking on this.

·
Will the product or service provide an income stream-is there a market
for the product, what sort of volumes will be sold and at what price? If it is
to be used internally in the organisation what sort of transfer price will be
available? Market research reports will give guidance on this.

·
Are resources available to complete the project, how much longer will it
take and how much more will it cost?-budgets, plans and forecasts will evidence
this as well as evidence of cost charged to date.

Whilst
there is evidence to be gained from several sources, as suggested above, at the
end of the day the auditors are left with having to make a judgement based on
the available evidence. An important part of coming to that judgement is the
discussion with management. Management needs to demonstrate why it has the
confidence in the project and its ultimate benefits, and why therefore the
expenditure can properly be capitalised. If necessary they should put in
writing. The auditors may need specialised help in some cases, but the ultimate
decision lies with them.

Development
cost should be amortised (depreciated) over their expected useful lives which
is either the length of time the resulting product or service is in production
and being sold or, if is an inordinately long period, the value should be
reviewed annually for impairment.

Trademarks, Patents, etc

These
should be capitalised and written off their expected useful lives. The auditors
should consider the value each year-it may be that because of technical change
or changes in rules and regulations, the value of a patent or trade mark
becomes impaired, in which case it must be written down as the income stream
from it will reduce or cease.

The
auditors should check that any renewal fees have been paid, and written off, so
the patents and trade marks are still current and the auditors should also
inspect the agreements to make sure they are still current in the name of the
company.

If
the company uses a patent agent it may be possible to obtain a third party
confirmation from them as to the ownership and currency of the patent.

Goodwill

This
is purchased goodwill, i.e. goodwill arising on the acquisition of a business
or part of a business. It represents the difference between the price paid and
the value of the underlying assets.

This
can be capitalised and written off over its useful life-which may, in some circumstances,
be quite short.

Auditors
must look at the value of goodwill and assuming they can satisfy themselves
over the value it was capitalised at, their main consideration is the expected
useful life.

The
question is this-if company A takes over company B for an amount in excess of
the value of the assets of company B it creates goodwill which the auditors can
evidence through the takeover agreement. However, suppose, in the course of its
business, company A assimilates company B to such an extent that company B name
disappears and all its products and services are marketed under the name of
company A-how then can the balance sheet of company A continue to carry goodwill
as an assets in its balance sheet if the business to which it originally
referred has effectively ceased to exist?

The
short answer, in reality is that it cannot justify upholding such goodwill so
that it should be written off through the profit and loss account, in much the
same way as if the value of the goodwill had become tainted in some way.

It
is a matter of judgement. Remember through that it is for management to decide
on the value it intends to include in the balance sheet-the auditor has to form
a judgement based on as much evidence as can be found, as to whether that value
is true and fair.

Investment

Investments
are assets held to generate income or to create a profit from them. These can
comprise, amongst other things:

·
Loans

·
Money market deposits

·
Share in other companies either quoted or unquoted

·
Properties

·
Gilts (UK government stock).

Note that for investments in shares, for this purpose we exclude
investments in subsidiary companies (holding of more than 50 percent of the
voting shares) or associated companies (holding more than 20 percent, i.e.
having a significant influence).

There
is, as might be expected, an accounting standard IAS 39 with which the student
should be familiar.

Again
the basic audit principles apply regarding evidencing existence and ownership.

·
Physical inspection of loan notes, share certificates, title deeds

·
Third party verification from banks, brokers or agents

·
Income streams from dividends, rents, etc.

·
Transaction evidence-bought and sold notes

·
Minutes of director’s meetings.

One
important point is that IAS 510 ‘Audit Evidence-Additional Consideration for
specific items’ states that where investment are described as ‘long term’ by
the company the auditors must consider whether the company has the capability
of holding the investments for the long term.

This
is done by discussing the matter with management and obtaining written
representations.

The
reason for this is obvious-if the company cannot hold the investment for the
long term, because, it is running out of money and will have to sell them to
raise cash, and then they are incorrectly disclosed in the accounts.

Valuation
can be more difficult. IAS 39 originally requires investment to be stated at
cost and them for their value to be re-measured at each balance sheet date to a
‘fair value’ except for:

·
Loans, held to maturity investments and other receivable which should be
measured at amortised cost.

·
Equity investment whose fair value cannot be measured-this is most
likely to apply to investments in unquoted companies.

For
quoted investment this is relatively straightforward as a share price can be obtained
at the period end from published sources, but the valuation of unquote
investments is more problematic and may require some discussion with the
directors. Properties held as investment properties can be valued by a
competent valuer.

At
each balance sheet date the question of impairment arises and the value must be
assessed individually.

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