Question

Using your firm’s sampling technique, you have selected representative sample of Property, Plant and Equipment (PPE) items from the asset register. You have decided to use this sample to test whether the depreciation rate assigned to PPE is appropriate and in line with the present condition and expected use over the remaining life of each sample item. The relevant details of the sample selection and results of your test are summarised below:

Profit before tax	$1,875,000
PPE account balance	$11,345,000
Sample size	35
Dollar value of sample taken	$1,145,000
Error in the sample (depreciation rates for some Items were too low and/or remaining useful Life to equipment was overstated)	$48,500

Required:

1. What conclusion would you draw about ‘valuation and allocation’ of PPE from the above information? Justify your conclusion.

b. Assuming that management refuses to amend the error, discuss the impact of the above information on your audit opinion.                                                                                                 

Answer 1

Answer:

(a)

Overall error = [$48,500 / $1,145,000] X $11,345,000

                       = $480,552.40

Due to less depreciation rates and/or high remaining useful life, depreciation expense is understated and which caused an overstatement of profit before tax account balance and PPE account balance.

.

(b)

Adverse opinion will be issued by the auditor, if the management refuses to amend the error.

Explanation:

(a)

Valuation and allocation tested by the auditors in relation to PPE is important as the assets should be recorded at the appropriate carrying value or fair value as it is described according to the standards such as IAS 16 Property, Plant and Equipment. Since, there is an error of $48,500 in a sample of $1,145,000 out of the total $11,345,000 property, plant, and equipment.

Overall error = [$48,500 / $1,145,000] X $11,345,000

                       = $480,552.40

The depreciation rates for some items are too low and/or remaining useful life was overstated which caused understatement in depreciation expense and overstatement in the profit before tax.

Thus, PPE account balance is overstated by around $480,552.40 and profit before tax account balance is also overstated by $480,552.40.

(b)

Adverse opinion is provided if the auditor is not satisfied with the financial statements or if there is a high level of material misstatements. Since, there is a huge error in the valuation and allocation of PPE, financial statements will be considered containing misstatements.

If the management refuses to amend the error, then the financial statements will considered misstated and will lead an auditor to issue an adverse opinion.