Accounting Auditing and Assurance Services

Questions: Your firm is the auditor of GreenBrown Ltd, a manufacturer. You have obtained a summary of the property, plant and equipment for the year ended 30 June 2015, which identifies cost and accumulated depreciation brought forward, additions and disposals in the year and depreciation charges. A review of the management letter from the previous years audit shows that there were some problems in relation to making a distinction between capital and revenue expenditure; some items were capitalised when they should have been expensed and other capital items were included in repairs and maintenance in the income statement. Another risk identified from prior years relates to depreciation calculations; there is a range of depreciation rates within categories and there has been concern that the rates applied to some assets have been too low. The depreciation policy disclosed in the financial report shows: buildings: 24% straight line plant and machinery: 510% straight line fixtures fittings and equipment: 520% straight line. Required Describe audit procedures to ensure: (a) the accuracy of the summary of property plant and equipment (b) all items of a capital expenditure are included in additions for the year and that no revenue expenditure has been capitalized (c) the depreciation rates are calculated appropriately. Answers: The firm is the auditor of the client Green Brown Limited, a manufacturer. Requiring the following instances Requirement (a) The audit procedures of the summary of the property Plant and Equipment enumerated as the steps below: The auditor should check that, The opening balance of the said asset is brought forwarded from the previous year correctly. If the management of the company are maintain the Accumulated Depreciation account, then the balance of the previous year has been correctly forwarded to this year (Tracy, 2008). Obtain a summary analysis of changes in property owned and reconcile with the particular ledger. Vouch additions to the property during the year. The major equipments which has been added recently should be physically inspected. The repair and maintenance account related to the equipment should be thoroughly be checked. If there are some idle assets, then check the status of the same. Provision for Depreciation provided by the client should also be checked. Any disposals during the year have been taken place or not. Examine the legal ownership documents on the part of the asset. In order to the additions in the asset, test checks the invoices, deeds, contracts or other supporting documents. Investigate all instances in which the actual cost of acquisitions subsequently upgraded the amounts. Determine whether the Total Cost of the plant and equipment purchased on the installment scheme is reflected in the asset accounts and that the unpaid installments are set up as liabilities. In the case of sale of any equipment, the work orders should be checked for proper authorization. The reduction in insurance coverage should also be checked. Determine the total Accumulated Depreciation recorded in the subsidiary records agree with the applicable general ledger controlling accounts. Compare any variances with the rates applied of provision for depreciation of current year with the last year. Be alert with the excessive depreciation on fully depreciated assets. Test deductions from accumulated depreciation for the assets sold. Performance of analytical procedures for depreciation. Requirement (b) The audit procedures on all items of a capital expenditure are included in additions for the year and that no revenue expenditure has been capitalized As in the case study mentioned that, from the previous years audit shows some items were capitalized when they should have been expensed and other capital items were included in Repairs and Maintenance head in the income statement. So, in the organization there regulates a wrong idea of the nature of the expenditures which is capital in nature and which is revenue in nature. Capital Expenditure: It is the amount spent for the acquisition or renovation of some of the fixed assets like, buildings, machineries, plant, heavy equipments etc. to increase the capacity or the efficiency of the assets for a long period of time. In accounting, it is to be capitalized and shown only in the balance sheet(Farazmand and Pinkowski, 2007). Revenue Expenditure: It is the recurring expenditure the company incurs for the enhancement of the fixed assets in a regular interval. That means for the repairs or the maintenance expenditures of the assets. It is not being capitalized because it will not help to increase the earning capacity of the machine but only for the maintenance purpose. It is incurred only for the short period of time and the calculation shown in the income statement as well as in the balance sheet in the year in which the expenditure has been incurred(Farazmand and Pinkowski, 2007). The key differences between those two expenditures are as follows: Capital expenditure are for the increase of the productivity of the fixed assets, where the Revenue Expenditures are only for the maintenance of the assets. Capital expenditures are amounted huge figures, Revenue Expenditures are comparatively lower in figures. The Capital Expenditures should be capitalized, On the Other Hand, the Revenue Expenditures need not be capitalized The Capital Expenditures are shown only in the Balance Sheet of the company. But Revenue Expenditures are shown in the Balance Sheet as well as in the Income Statement as well. Capital Expenditures are related for the purchase or for the installation of the fixed assets. Revenue Expenditures are related for the repairs and maintenance of the fixed assets. The Capital Expenditures are incurred in the year in which it is purchased or put to use, bur Revenue Expenditures are incurred in regular interval almost in every year. So the auditor should always be alert about the nature of the expenditure which is capital in nature and which is revenue in nature. Following are the steps an auditor can obtain: The auditor should ask the concerned accountant of the company about the doubtful items of expenditures. Then to identify the nature of the expenditure the auditor should undergo the nature of the work and procedures, rules and regulations etc. of the organization. The auditor should check whether the demarcation of the expenditures have been made as per the Generally Accepted Accounting Principles (GAAP) of accounting or not. For an example, the painting in the new building is revenue expenditure, whereas the new building is capital expenditure. The auditor should consider the situation of making payments because same expenditure could be capital in nature and sometimes revenue in nature in different situations. Requirement (c) Depreciation: Depreciation is the systematic deduction in the cost of the fixed assets like building, machinery, plant, furniture and fixtures etc. Depreciation needs to be deducted on the value of the assets every year to match the cost of the valuation of the assets over a period of time. So that at the end of a certain period the asset can reflect the exact value at that time (King, 2002). Depreciation rates as may be different types according to the Companies Act, 1956 or as per the Income Tax Act, 1961. The method of calculation of the depreciation are, Straight Line Method, Written down Value Method, Weighted Average Method etc. as per as the companys volume of work or nature of work. Audit procedures regarding the depreciation (Honigmann, 2007) on fixed assets are as follows: The auditor must ensure that the rates of depreciation provided as per the Companies Act, 1956. The nature of the business or the capital employed should be checked. Whether the depreciation is charged is more than the rates as specified in the act, then the auditor should examine this has been done as per the technical and professional ethics Difference rates for different assets are employed or not. In case of the change in the method of accounting depreciation, the recalculation has been done on the date on which the asset came into force and any deficiency has been booked in the profit loss account. Depreciation has been charged on the assets as Pro-rata basis on the assets that has been purchased during the current year. Any revaluation work, all the assets have been charged on revalued amounts. In the given case, depreciation has been charged on the assets at the rate of a different range at straight line method on different assets. This is a violation of the act, because depreciation rates should be in the static and not in a range. The auditors duty regarding the above case is to first enquire the management for the reason why they approved the range of the depreciation. Then he should compare the rates as specified in the act and make the decision which percentage of the range is applicable on the different assets as to take effect in the accounts. Again some of the assets have been charged as low rates of depreciation. So the auditors duties regarding this is to follow the calculation of the deficiency occurred of this default and try to advice the accountant concerned to make sufficient rectification for the reconciliation to make the accounts transparent to stand the status of the organization as well. At the end of the report, the auditor should make his decision as to whether he would reflect some adverse reports on the negligence occurred above as per the act and flash the points of suggestions as to how the organization will overcome these types of mistakes to perform well in the future. References: Tracy, J. (2008). Accounting for dummies. Hoboken, NJ: Wiley Pub., Inc. Agar, C. (2005). Capital investment financing. Oxford: Elsevier Butterworth-Heinemann. Poterba, J. and Rami rez Verdugo, A. (2008). Portfolio substitution and the revenue cost of exempting state and local government interest payments from federal income tax. Cambridge, Mass.: National Bureau of Economic Research. King, A. (2002). Valuation. New York: J. Wiley. Honigmann, E. (2007). Buying and selling a small business. [United States?]: Monnet Press. Bragg, S. (2013). Accounting best practices. Hoboken, N.J.: John Wiley Sons. SLATER, J. (2012). College accounting chapters 1-12 with study guide and working papers. Upper saddle river: Prentice hall. Farazmand, A. and Pinkowski, J. (2007). Handbook of globalization, governance, and public administration. Boca Raton, FL: CRC/Taylor Francis.