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 year’s 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: 2–4% straight line
• plant and machinery: 5–10% straight line
• fixtures fittings and equipment: 5–20% 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.
The firm is the auditor of the client Green Brown Limited, a manufacturer. Requiring the following instances
The audit procedures of the summary of the property Plant and Equipment enumerated as the steps below:
The auditor should check that,
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 year’s 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:
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.
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 company’s volume of work or nature of work.
Audit procedures regarding the depreciation (Honigmann, 2007) on fixed assets are as follows:
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 auditor’s 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 auditor’s 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 RamiÌÂrez 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.
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