Auditing Property, Plant, and Equipment

Property, plant, and equipment (PP&E) represents long-lived tangible assets used in operations. Because these assets are typically carried on the balance sheet for many years, the audit approach emphasizes testing additions and dispositions during the current year rather than re-auditing the entire balance each period.

Vouching Additions

When new fixed assets are acquired, the auditor vouches recorded additions to supporting documentation to verify existence, valuation, and proper authorization.

Procedures for Vouching Additions

1. Select significant additions from the fixed asset detail/rollforward schedule
2. Examine supporting documents including:
   • Approved capital expenditure authorization (capital budget or board approval)
   • Vendor invoices
   • Purchase contracts
   • Canceled checks or electronic payment records
3. Physically inspect significant new assets to confirm existence
4. Verify proper capitalization – Ensure that only costs meeting the capitalization threshold are recorded as assets (not expensed)
5. Verify proper classification – Ensure assets are recorded in the correct asset category with the appropriate useful life and depreciation method

tip

The auditor should be alert for items that should have been expensed but were improperly capitalized, as this overstates assets and understates expenses. Conversely, items that should have been capitalized but were expensed will understate assets.

Example: Vouching Additions at Illini Security

Illini Security purchased new surveillance equipment for $450,000 during the year. The auditor:

• Examines the board-approved capital expenditure authorization for the purchase
• Vouches the $450,000 to the vendor invoice and payment confirmation
• Physically inspects the equipment at the company's main facility
• Confirms the equipment is classified as "Security Equipment" with a 7-year useful life

Reviewing Retirements and Disposals

When assets are retired, sold, or scrapped, the auditor must verify that they are properly removed from the accounting records and that any gain or loss on disposal is correctly calculated.

Procedures for Reviewing Retirements

1. Review the schedule of asset retirements for the year
2. Examine authorization for the disposal (board approval, management authorization)
3. Verify removal from the books – Confirm the original cost and accumulated depreciation are removed
4. Recalculate gain or loss – Independently compute: Proceeds − Net Book Value = Gain (or Loss)
5. Inquire about assets no longer in use – Ask management whether any assets have been scrapped, abandoned, or idled without being removed from the records

warning

Failure to remove retired assets from the books overstates total assets and understates depreciation expense (because the retired asset continues to be depreciated, or the accumulated depreciation balance is inflated).

Example: Disposal at Kingfisher Industries

Kingfisher Industries sold a piece of manufacturing equipment for $30,000. The auditor reviews the asset register and finds the equipment had an original cost of $120,000 and accumulated depreciation of $100,000 (net book value of $20,000). The auditor recalculates: $30,000 − $20,000 = $10,000 gain on disposal and verifies this amount is properly recorded in the income statement.

Reviewing Repair and Maintenance Expense

One of the most important PP&E procedures is reviewing repair and maintenance expense accounts for items that should have been capitalized instead of expensed.

Procedure

1. Scan the repair and maintenance expense account for large or unusual charges
2. Investigate significant items – Obtain invoices and descriptions to determine whether the expenditure extends the useful life, increases capacity, or improves efficiency (which would require capitalization)
3. Apply the client's capitalization policy – Ensure consistency with prior periods

Example: Classification Review at Gies Co.

While reviewing Gies Co.'s repair and maintenance expense, the auditor identifies a $75,000 charge for "building improvements – HVAC system replacement." Because this expenditure replaces a major component and extends the building's useful life, the auditor determines it should be capitalized as a building improvement rather than expensed as maintenance. The auditor proposes a reclassification entry.

Fixed Asset Cutoff Testing

The auditor performs cutoff testing to ensure that asset purchases and dispositions are recorded in the correct accounting period.

Purchase Cutoff

• Examine invoices and receiving documents for assets acquired near year-end
• Verify that assets received before year-end are recorded as additions in the current period
• Verify that assets received after year-end are excluded from the current period

Disposition Cutoff

• Review dates of asset sales, retirements, and transfers near year-end
• Ensure assets disposed of before year-end are removed in the current period
• Ensure assets disposed of after year-end remain on the books at year-end

note

Cutoff errors for PP&E affect both the balance sheet (asset balances) and the income statement (depreciation expense and gain/loss on disposal).

Recalculating Depreciation

The auditor independently recalculates depreciation expense to test accuracy and verify that management is applying the correct method, useful life, and salvage value.

Procedure

1. Obtain the depreciation schedule from management
2. Verify inputs – Confirm cost, useful life, salvage value, and depreciation method for selected assets
3. Recalculate depreciation expense for a sample of assets and compare to the client's recorded amounts
4. Test for consistency – Ensure methods and estimates are applied consistently from year to year
5. Consider impairment – Evaluate whether any indicators of impairment exist that would require a write-down

Example: Depreciation at MAS Inc.

MAS Inc. uses straight-line depreciation for all equipment. The auditor selects a sample of 15 assets, verifies the cost and useful life per the asset register, and independently calculates depreciation. For a $200,000 piece of recording equipment with a 10-year life and $20,000 salvage value, the auditor calculates annual depreciation as ($200,000 − $20,000) / 10 = $18,000 and confirms this matches the client's recorded amount.

Recalculating Gain/Loss on Disposals

For each material disposal, the auditor recalculates:

Component	Calculation
Net Book Value	Original Cost − Accumulated Depreciation (through date of disposal)
Gain or Loss	Proceeds from Sale − Net Book Value

tip

Ensure depreciation is recorded up to the date of disposal, not just through the prior year-end. Failure to record current-year depreciation before removing the asset will result in an incorrect gain or loss.

Disclosure Review

The auditor reviews PP&E disclosures for completeness and accuracy:

Disclosure Item	Description
Depreciation methods and useful lives	Method used for each major asset class
Gross carrying amount and accumulated depreciation	By major class of asset
Depreciation expense	Total for the period
Pledged assets	Assets used as collateral for loans
Impairments	Write-downs recognized during the period
Capital commitments	Contractual commitments for future asset purchases
Asset retirement obligations	Legal obligations to dismantle or remediate

Example: Disclosures at BIF Partners

BIF Partners' financial statements disclose PP&E by category: land ($1.5M), buildings ($8.2M), equipment ($4.7M), and vehicles ($600K). The notes describe straight-line depreciation over 30 years for buildings and 5–10 years for equipment. The auditor verifies that $3.2M of buildings are pledged as collateral under the company's mortgage and confirms this is properly disclosed.

Summary

Procedure	Primary Assertion Tested
Vouch additions to invoices and contracts	Existence, Valuation, Rights
Review retirements and disposals	Completeness, Valuation
Review repair/maintenance for misclassification	Classification, Valuation
Cutoff testing (purchases and dispositions)	Cutoff
Recalculate depreciation	Valuation, Accuracy
Recalculate gain/loss on disposals	Valuation, Accuracy
Disclosure review	Presentation and Disclosure