Question

Provide three different audit procedures you can use to verify that accumulated depreciation is reasonable and accurate when auditing PPE. Please provide detail (e.g. simply “Recalculation” is not an acceptable answer, please provide detail on how this is performed).

Answer 1

A)

Depreciation Expenses are one of the major expenses that are appearing in the income statement. These expenses are the costs that the entity charged on fixed assets which are used for operations during the periods. This is because the Accounting Standards does not allow the entity to record the expenses that they incurred for purchasing capital assets at the time of pruchasing. But they could allocate these expenses systematically over the period that Fixed Assets are using.

At the time of audit of Financial Statements, auditors should confirm that the audit procedures that they prepare are addressing the risks of material misstatements which are caused by depreciation expenses and other related items such as fixed assets.

As per the Accounting Standard 10 "Property, plant and Equipment",

Depreciation Expenses for every period must be recognized in the Income statement unless it's included in carrying the amount of any another asset. Depreciable amount of any asset should be allocated on a methodical basis over the useful life of the asset.

Every part of Property or Plant and Equipment whose cost is substantial with respect to the overall cost of the item must be depreciated seperately.

The standard also prescribes, that the Salvage value and useful life of an asset must be reviewed at the end of each financial year end, to verify whether the expectations vary from the previous estimates, changes must be accounted for as changes in accounting estimate as per Accounting Standard 5 - Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.

The method of Depreciation implemented must reflect the pattern of future economic benefits of the asset used by an enterprise. Various depreciation methods could be used for allocating the depreciable amount of an asset on a methodical basis over the useful life of an asset. The methods include SLM (Straight Line Method), Diminishing Balance Method or Double Declining Method.

As per Auditing Requirements :

In the audit of Fixed Assets, we perform the test on depreciation to ensure the valuation assertion. Below is an example of the test of fixed assets depreciation.

• Review on client's depreciation method implemented to make sure it confirms with applicable Accounting Standards.
• Examine the useful life and Residual value of Fixed Assets to ensure whether the client's estimate is appropriate. This may involve a lot of prfessional judgement, one way to do is to compare the client's estimate with the Industry Standard.
• Perfrm recalculation on depreciation to see if our result is the same as the clients' figures. This will ensure the audit assertion of Accuracy.

It is useful to note that the depreciation method and the estimate of fixed assets' useful life that the client use will directly impact on both the Balance Sheet and the Income Statement. In this case, an understatement of depreciation will result in an overstatement of both fixed assets and net profit, and vice versa.