1.0
INTRODUCTION
You may recall that
in the last note two major activities discussed in the final audit were vouching and verification.
While vouching was seen as the process
of examining documentary evidence
necessary to support the recorded transactions which purportedly took
place during the period under review,
there is also the need for the verification of the assets and liabilities (and other items) appearing in
the balance sheet at the end of the
year. You are now very conversant with the objects of verification as highlighted in the last note.
In this note and even
in the next two notes, you will be exposed to the procedures for auditing transactions with
emphasis on verification of fixed
assets, investments and liabilities bearing in mind that there are well established techniques for auditing
transactions.
2.0
OBJECTIVES
At the end of this note,
you should be able to:
· define fixed assets
· state the objectives
of verifying fixed assets
· state the procedures
for fixed assets audit
· categorise
investments
· outline the
procedures for audit of investments.
3.0
MAIN CONTENT
3.1
Fixed Assets Verification
Fixed assets are the
properties of the business that are permanent in nature. Examples include: land, buildings,
machinery, plant, equipment, furniture
and others. The significance of fixed assets of an organization should be of interest to an auditor. For
instance, in a wholesale organization,
fixed assets consist of a small part of the total assets while in a manufacturing firm; the amount of fixed
assets is always very significant in the
balance sheet reporting.
An auditor should be
familiar with the major items of fixed assets as well as review addition of fixed assets
during the year. Fixed assets are purchased
for use in the day-to-day operations of the business and their lifespan will extend over a number of years.
The cost of the assets is spread over
the estimated useful life. Expenditure made in the purchase of assets or assets improvements are charged
to capital expenditure.
Depreciation of
assets is usually based on historical cost. Depreciation has been defined by Statement of Standard
Accounting Practice (SSAP) as “the
measure of the wearing out, consumption or other loss of value of a fixed asset whether arising from use,
effluxion of time or obsolescence
through technology and market changes”. An
auditor should compute or verify the computation on fixed assets. Depreciation should be allocated to
accounting periods so as to charge a fair
proportion to each accounting period during the expected life of the assets.
In computing depreciation, the auditor should
consider the following.
(a) Cost of the asset;
(ii) Use life;
(iii)
Residual/scrap/salvage value.
The auditor should be
familiar with the various methods of computing depreciation, especially, with
the popular ones like:
(i) straight line
method and
(ii) reducing balance
method
It is the auditor’s
responsibility to exercise professional judgement in assessing management’s
method of allocation of depreciation expense to accounting periods.
Depreciation rate to be used should depend on the:
(i) nature of the
fixed assets;
(ii) expected useful
life;
(iii) residual value;
and
(iv) technological
development of new products.
3.1.2
Objectives of Validating Fixed Assets
The auditor’s objectives
in validating fixed assets are to determine:
(i) the physical
existence;
(ii) what cost is
recorded on historical basis;
(iii) that all
additions to fixed assets are genuine;
(iv) that
depreciation is properly computed;
(v) that proper
recording of residual value is maintained;
(vi) that the total
amount recorded in the balance sheet is fair.
3.1.3
Procedure for Fixed Assets Audit
The procedure can be
highlighted as follows.
(i) Review the
internal control over fixed assets;
(ii) Examine the
general ledger for major additions and retirements so that they can be observed
during the physical check;
(iii) Verify legal
ownership of assets;
(iv) Verify major
items added during the year and authorisation of invoices, work orders, etc.
(v) Verify all
retirements of each asset;
(vi) Test the amount
of depreciation for each new addition and ascertain if the computation is consistent
with that of the past years;
(vii) Analyse repairs
and maintenance accounts;
(viii) Review the organizational policies on
capitalisation;
(ix) Review minutes
of meetings of the board of directors, management, etc. for authorisation to
acquire new assets;
(x) Determine whether
the amount recorded in the balance sheet is fair.
3.2
Investments
3.2.1
Brief on Investments
Firms invest in other
companies by acquiring debt and equity securities. The investments may be for
short-term or long-term holdings, and can be in the form of securities,
certificate of deposit, commercial paper, treasury bills, etc. It is important
to distinguish the categories into which investments can be divided. They are
as follows.
(a) Variability
(i) Fixed sum
deposits
(ii) Investments by
varying value.
(b) Quotation
(i) Quoted
investments
(ii) Unquoted investments.
(c) Ownership
proportion
(i) Investment giving
minority interests (less than 20%)
(ii) Investment in
associated companies (20% – 50%)
(iii) Investments in
subsidiary companies (Not greater than 50%).
(d) Period of
ownership
(i) Short-term investments
(ii) Long-term
investments.
(e) Treatment in
balance sheet
(i) Investments which
are current assets
(ii) Investments
which are not current assets.
The auditor should
ensure that investments are recorded at their fair market value or at the fair
market value of those given up at the time of exchange, whichever is clearly
determinable. The auditor should
evaluate or check the
method of accounting for investments in the financial statements and with
related disclosure requirements.
3.2.2
Audit objectives relative to Investments
The audit objectives
relative to investments are to determine:
(i) that adequate
internal control exists over the investments;
(ii) that the
investments actually exist, and are the properties of the client;
(iii) that the investments
are properly valued, and classified on the balance sheet;
(iv) that all
revenues arising from the investments have been promptly collected and
recorded.
3.2.3
Audit Programme for Investments
Note that the
verification of investments is considered to include:
(a) analysis of
related accounts such as dividend revenue, interest earned, accrued interest,
dividends receivable, gain or loss on sale of securities;
(b) for income tax
purposes – there is need to know the dates of transactions and the tax bases.
Therefore, the audit
programme is as follows.
(i) Prepare a description of internal control for investments, and
obtain a detailed schedule of all the company’s investment;
(ii) Trace transactions for purchase and sales of securities through
the system;
(iii) Review reports by the internal auditors on their periodic inspection
of securities;
(iv) Review monthly reports by officer of client’s company on securities;
(iv) Obtain/prepare analyses of investments accounts and all
related revenue accounts;
(v) Inspect securities on hand and compare serial numbers with
those
shown on previous examination;
(vi) Obtain confirmation of securities in the custody of others;
(vii) Verify purchases and sales of securities during the year;
(viii) Verify gain or loss of security transactions and obtain
information for income tax returns;
(ix) Make independent
computation of revenue from securities by reference to dividend record books;
(x) Investigate the methods of accounting for investments in subsidiary
companies;
(xi) Determine the market value of securities at the date of
balance sheet;
(xii) Determine financial statements presentation.
3.2.4
Special Points to Note on Verification of Investments
(i) Internal control
is very important. Note particularly the separation
of duties of
authorisation, custody and recording;
(ii) Physical
inspection is very desirable; all the certificates should be
examined together.
4.0
CONCLUSION
In this note, you
have learnt that review of internal control over fixed assets and investments
relative to the audit procedure should be taken seriously as other verification
activities, more or less, derive strength
from that. Also,
physical verification (check/inspection) of fixed assets and investments is
more important than their being sighted on the balance sheet.
5.0
SUMMARY
In this note, you
have learnt the following:
· Fixed assets are the
properties of the business that are permanent in nature;
· An auditor should be
conversant with the various methods and rates of computing depreciation;
· An auditor should be
aware of the objectives of validating/verifying fixed assets and investments as
they appear on the balance sheet;
· Review of the
internal control as well as physical verification are very important in the
audit procedures for fixed assets and investments.
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