Audit of Non-Current Assets

Audit of Non-Current Assets



Audit of Non-Current Assets

Chapter 13 Audit of Non-Current Assets


1.         Understand the audit objectives of auditing fixed assets.
2.         Recognise internal controls applicable to the acquisition and disposal of fixed assets.
3.         Design analytical procedures used in the audit of fixed assets.
4.         Design and perform test of account balances for fixed assets.


1.       Assertions for the Audit of Fixed Assets

1.1       The assertions for auditing fixed assets are as follows:
(Jun 11, Jun 13)



1.   Existence

  • Acquisitions and disposals are properly authorized.
  • The recorded fixed assets are existence.

2.   Rights and obligations

  • The recorded fixed assets are owned by the company.
  • Disposals of fixed assets represent the transfer of the risks and benefits in them to third parties.

3.   Completeness

  • Acquisitions and disposals, excluding the revenue items, are included in fixed asset account.
  • All fixed assets owned by the company are recorded.
  • All depreciation is recorded in the accounting records and costing records.

4.   Accuracy

  • Acquisitions and disposals of fixed assets are correctly calculated in accordance with relevant accounting principles and proper capital/revenue decision.
  • Depreciation is correctly calculated using appropriate depreciation methods and useful lives.

5.   Valuation and allocation

  • The carrying amount of fixed assets reflects events affecting their valuation in accordance with relevant accounting standards.

6.   Cut-off

  • All acquisitions and disposals are recorded in the right period.
  • Depreciation is allocated in the right period.

7.   Classification

  • Capital expenditure and revenue expenditure, and finance lease and operating lease are properly classified.

8.   Presentation and disclosure

  • Cost or revalued amount of fixed assets and related accumulated depreciation have been properly summarized for disclosure in the financial statements.


2.       Inherent Risks for Fixed Assets
(Jun 11)
2.1       Inherent risks for non-current assets
(a)        Difficulties in estimating the useful lives of the fixed assets.
(b)        Revaluation of properties has been taken place with consequent subjectivity in valuation.
(c)        Fixed assets in the course of construction may have uncertainty about stage of completion.
(d)        The company has capitalized some of its own costs of construction of fixed assets.
(e)        The application of capitalization policies for repair and maintenance requires clear policies and procedures for this and also subjective judgements.
(f)        The existence of moveable, high value assets with high risk of loss.
(g)        Technological changes affecting the industry, rendering the asset obsolete.
(h)        The company owns a significant number of idle fixed assets with uncertainty as to future use.
(i)         Inadequate authorization for disposal and written off of fixed assets.

Question 1
The firm of VC & Co. in which you are employed is the external auditor of Company A which is a company that operates a training centre providing IT engineers courses & photography courses. The company leased a flat in a commercial building located in Mongkok under an operating lease. The training centre promotes their IT engineers courses by providing powerful notebooks for students to use in class. At the same time, photographic equipment is provided to students to use when attending the classes of the photography courses. Recently, fewer and fewer students enroll on the photography courses, the directors consider not to offer those courses in the coming future. The company adopts the revaluation model for all the equipment.

(a)        State and explain the assertions for the auditing of the account balances, additions and disposals of notebooks and photographic equipment.                                       (8 marks)
(b)       What is inherent risk?                                                                                        (2 marks)
(c)        What are the inherent risks for the auditing of the notebooks and photographic equipment in this audit?                                                                                     (4 marks)
(d)       What are the relevant assertions affected by these inherent risks? Explain.     (6 marks)
(HKIAAT PBE Paper III Auditing and Information System June 2011 Q2)

3.       Internal Control for Fixed Assets

3.1       The internal controls for the acquisition of non-current assets are similar to those applied in purchase cycle.

Internal Controls

Internal Control Procedures

(a)     Approval of acquisition of fixed assets

  • The final authority should lie with proper level of authorization.
  • Management should ensure that purchased items are properly treated as fixed assets and not as repair and maintenance expenses, or vice or versa.
  • Controls should exist over revaluation of fixed assets, such as selection of qualified valuer, and identification of fixed assets that have suffered impairment.

(b)     Safeguard of fixed assets

  • To record fixed assets in detail in fixed assets register.
    • To be a good control, documents should be kept and accessed by persons independent of those using and having custody of the fixed assets.
    • The register should be compared periodically with physical assets and vice versa.
    • Assets should have unique numbers affixed to them, the register containing the same number.
    • The register should contain all the details necessary to control the individual assets.
  • Fixed assets should be reconciled at least annually to cost / valuation, accumulated depreciation and depreciation charge in the financial statements.
  • Significant differences between the register and physical assets or between the register and general ledger entries would suggest high control risk and differences should be investigated by the company.
  • Physical control over high value, especially movable assets, are particularly important, including stamping with the company name, restricting access and securing machines to desks.
  • If a fixed assets register is not kept or the register is found to be subject to error, control risk will be increased and the auditor may have to extend substantive tests for details.

(c)     Disposal of fixed assets

  • Disposals should be authorized by individuals with appropriate authority after careful assessment of the continuing value of the assets, taking into account company policy, which may have rendered asset surplus to requirements.
  • Disposals requests should be written with reasons, and approved evidenced by signature.

(d)     Maintenance, insurance and other charges associated with fixed assets

  • Repairs and insurance to be approved on the basis of expert recommendation and also instructions on accounting treatments.

(e)     Authorization of depreciation charges and periodic review of accumulated depreciation

  • A system of approval of useful lives and depreciation method that complies with accounting standards.
  • A written justification of significant profits or losses on disposal of fixed assets as this may indicate failure to identify useful economic lives in the past.
  • Identify events or circumstances that might cause a sudden reduction in the estimate of recoverable amount.


4.       Tests of Details of Balances – Fixed Assets

4.1       Steps for designing tests of details of balances

4.1.1    The steps are as follows:
(a)        Assess client’s business risk, tolerable misstatements and inherent risks for fixed asset accounts.
(b)        Assess control risks for fixed asset accounts.
(c)        Design and perform test of controls and substantive tests of transactions for the purchase and payment cycle.
(d)        Design and perform analytical procedures for the purchase and payment cycle.
(e)        Design tests of details of account balances to satisfy balance-related audit objectives.

4.2       Analytical procedures

4.2.1    The nature of analytical procedures depends on the nature of client’s operations.

Analytical Procedures

Specific Purpose

(a)     Compare prior year’s balances and depreciation expense with current year’s balance, taking into considerations of any changes in conditions or asset composition

To identify any possible misstatement of depreciation expense, accumulated depreciation and net book value.

(b)     Compute the ratio of depreciation expense to the related PPE and compare to prior years’ ratios, taking into account of the company’s depreciation policy

To identify if there is changes in the rate of depreciation or error in the calculation of depreciation.

(c)     Compute the ratio of repairs and maintenance expense to the related PPE accounts and compare to prior years’ ratios.

To identify if expensing amounts that should be capitalized.

(d)     Relate the amount of insurance expense to the related PPE and compare to prior years’ amounts, taking into account of inflation adjustment.

To identify if the PPE have been under-insured that may lead to possible of substantial loss in events of accidence.

(e)     Review capital budgets and compare the amounts spent with amounts budgeted.

To identify any possible fraud or deviation from company’s policy and internal controls.
To identify capital commitments for disclosure purpose.

4.3       Verification of carrying value of fixed assets

4.3.1    The following substantive procedures, for example, may be applied:


Substantive Procedures

(a)     Current year acquisition

  • Depends on the control risks and materiality of the acquisition, the auditor should verify significant current year acquisition by examining suppliers’ invoices and related documents.

(b)     Current year disposal

  • Review whether newly acquired assets replace existing assets.
  • Analyze gains on the disposal of assets and miscellaneous income for receipts from the disposal of assets.
  • Review of plant modifications and changes in product line, and insurance coverage for deletions of fixed assets.
  • Inquire management and production personnel about the possibility of the disposal of assets.

(c)     Asset balance

  • Observe the client’s physical inspection on fixed assets.

(d)     Depreciation

  • Inquire management for depreciation policies and check whether client’s depreciation calculation follows the depreciation policy consistently.



Substantive procedures for the gain or loss on disposal of fixed assets
                                                                                                              (Dec 12, Dec 13)


(a)       Obtain the disposal of fixed asset schedule from the client.
(b)       Check casting and agree the net amount to the trial balance.
(c)       Check the sales proceeds to sales agreement.
(d)       Check whether the depreciation of the fixed asset is accounted for up to the date of disposal.
(e)       Check the cost and the accumulated depreciation of the assets disposed to the previous year’s financial statements and this year’s addition/disposal before moving out.
(f)        Recalculate the amount of gain or loss on the disposal of the fixed asset.
(g)       Check against the bank statements for the sale proceeds.


4.4       Tests of details of account balance to satisfy balance-related audit objectives
(Jun 10, Dec 11, Jun 13, Dec 13, Jun 15)

Audit Objectives

Substantive procedures

1.   Existence
(Dec 09)

  • Select a sample of assets from the non-current asset register and physically inspect them.
  • Examine a sample of suppliers’ invoices and receiving reports and check to fixed asset register.
  • Examine lease and rental agreement to ensure that the lease transactions are properly accounted for.
  • For land and building, it should perform land search.

2.   Completeness

  • Select a sample of assets visible at the client premises and inspect the asset register to ensure they are included.
  • Examine the repairs and maintenance accounts in the general ledger for large and unusual items that may be capital in nature.
  • Examine lease and rental agreement.

3.   Accuracy

  • Agree lead schedule of fixed assets to details of additions and disposals and also to the general ledger.
  • Vouch additions and disposals to suppliers’ invoices or other supporting documents.

4.   Valuation

  • Reperform depreciation calculations by:
    • Selecting a sample of assets from the register and recalculating the charge for the year
    • Recasting the list of individual asset depreciation charges
    • Agreeing the total charge to the financial statement.
  • Assess depreciation policies for reasonableness by:
    • Comparing methods used with prior year
    • Comparing methods used with similar companies
    • Analyzing the recent trend of profits and losses on asset disposals
  • If any assets have been revalued during the year:
    • Agree new valuation to valuer’s report
    • Verify that all similar assets have also been revalued
    • Reperform depreciation calculation to verify that charge is based on new carrying value.
  • When physically inspecting assets, take note of their condition and usage in case of impairment. The one responsible for physical inventory taking should be independent of the custodian and record-keeping functions.
  • For a sample of assets, agree cost to purchase invoice ensuring all relevant costs have been included.
  • If any assets have been constructed by the company, obtain analysis of costs incurred and agree to supporting documentation (timesheets, materials invoices, etc.)

5.   Rights and obligations / ownership

  • For a sample of recorded assets, obtain and inspect ownership documentation:
    • Title deeds for properties
    • Registration documents for vehicles
    • Insurance documents may also help to verify ownership
    • Suppliers’ invoices
  • Where assets are leased, inspect the lease document to assess whether the lease is operating or finance.

6.   Cut-off

  • Review acquisition and disposal transactions near the end of the reporting period for proper period.

7.   Classification

  • Examine fixed assets account and repairs account to uncover misclassification between capital and revenue items.
  • Examine lease agreement to uncover misclassification between finance lease and operating lease

8.   Presentation and disclosure

  • Agreeing opening balances with prior year financial statements.
  • Compare depreciation rates in use with those disclosed.
  • For revalued assets, ensure appropriate disclosures made (e.g. name of valuer, revaluation policy).
  • Agree breakdown of assets between classes with the general ledger account totals.


5.      Audit of Investment Properties

5.1       Inherent risk for investment properties                                             (Dec 10, Dec 14)

5.1.1    The inherent risk of material misstatement of the existence of investment property should be low to medium.
5.1.2    The reasons are as follows:
(a)        There is no indication of fraud.
(b)       Investment property is not subject to misappropriation.
(c)        Physical movements are usually rare.

5.2       Internal control for investment properties

5.2.1    There should not be any difference in internal controls for the purchase and sale of investment properties process from those of PPE transactions (refer to point 3 above).

5.3       Tests of details of account balance – investment properties

5.3.1    The audit procedures to verify the balance of investment property can be referred to those discussed in point 4 above.
5.3.2    The objective of accuracy in depreciation calculation is achieved by re-computation and reference to the entity’s depreciation policy. However, no depreciation is required if the entity adopts fair value model; therefore, the auditor has to ensure that a gain or loss arising from a change in the fair value shall be recognized in profit or loss for the period in which it arises.


Substantive procedures for the additions of investment properties           (Dec 12)


(a)       Obtain the list of investment properties purchased.
(b)       Review the minutes for the approval regarding the purchase of properties.
(c)       Inspect the sales and purchase agreement.
(d)       Inspect the solicitor’s statement for fees charged regarding the purchase of properties.
(e)       Recalculate the amount of stamp duties paid and inspect the receipt of payment.
(f)        Inspect the receipt of agency fees paid.
(g)       Agree the amount of the additions to the disclosure notes in the financial statements.
(h)       Perform land search.





Question 2
HY Limited owns several (less than 10) expensive residential properties in Hong Kong and Mainland China, all are used for earning rental income. This is the major operating activity of HY Limited. The company is owned by six shareholders who engage two directors to operate the business. The director plan to acquire more and more properties in the future, therefore, a lot of resources are allocated to set up a good internal control system for the collection of rental income.


(a)      Assess with reasons the inherent risk of material misstatement of the existence of HY Limited’s investment properties.                                                                         (2 marks)
(b)     Assuming that the substantive approach is adopted, list four audit procedures that should be performed in addressing the existence assertion of investment properties.
(4 marks)
(c)      The company adopts the Fair Value Model for the accounting of the investment properties. The auditor has decided to use an expert’s services regarding the fair value of the investment properties.

What matters should be agreed between the auditor and the auditor’s expert?
(6 marks)
(d)     Assuming the substantive approach is adopted, what the audit procedures to be performed for the rental income?                                                                        (6 marks)
(e)      Assuming the company maintained good internal control for the collection of rental income, is it appropriate for the auditor to adopt the substantive approach for the audit of rental income.                                                                                                  (2 marks)
(HKIAAT PBE Paper III Auditing and Information System December 2010 Q4)



6.       Audit of Intangible Assets

6.1       Inherent risk for intangible assets

6.1.1    Intangible assets that usually can be found in the financial statements of companies in HK are mainly purchased goodwill, patents, brand names, trademarks, copyrights, mastheads and research and development (R&D) expenditure.
6.1.2    The valuation of intangible assets involves the estimates of useful life and impairment losses. These kinds of estimates involve considerable judgement and may lead to disagreement between the auditor and the client. In such a situation, the auditor may assess the inherent risk as high, especially, if the amounts capitalized are material.

6.2       Assertions for the audit of intangible assets

6.2.1    There should not be any difference in assertions for the audit of fixed assets (refer to point 1 above).

6.3       Tests of details of account balance – patent and trade marks

Audit Objectives

Substantive procedures

1.   Existence and rights of ownership

  • Trace from the list of register of patents and trademarks to the ledger account to ensure that the items have been recorded with supporting documents for their acquisitions.
  • Inspect the registration document or certificate issued by the authority concerned.

2.   Valuation (realizable value)

  • Check payments to cash book and examine the correspondence with patent agent and Patent Office for the creation and registration.
  • Check calculation and reasonableness of amortization according to the life of the patent, paying attention to the unexpired term in light of current conditions.
  • Review the amortization period and method, discuss with the client for the recoverability of the carrying amount and impairment losses, if any.

3.   Presentation and disclosure

  • Check adequate disclosure of the accounting policy.
  • Scan through the list of expense accounts to establish that no patent expenses have been wrongly treated as revenue expenses.


6.4       Tests of details of account balance – R&D

Audit Objectives

Substantive procedures

1.   Existence and rights of ownership

  • Scan through the ledger account of R&D to determine whether any expenditure incurred are of the nature and components of R&D cost according to the definition of HKAS 38 “Intangible Assets” and meet the recognition criteria.
  • Obtain the list of items of development expenditure and select samples for checking to the supporting documents for the expenses incurred.

2.   Valuation (realizable value)

  • Ensure the capitalization method meets the criteria imposed by HKAS 38 for the cost to be recognized as asset.
  • Check to the supporting documents to confirm the accuracy and consistency of classification and coding.
  • Consider that the amount written-off reflects the appropriate amount of impairment loss, or failure to meet the recognition criteria and discuss with the management for the recoverability of the value capitalized.
  • Review the cash forecasts and budget for evidence of adequate resources or reasonable expectation of available resources to enable the project to be completed.
  • Review sales forecast, estimates or budgets and discuss with the management on the marketability and recoverability of the R&D project.

3.   Presentation and disclosure

  • Consider adequate disclosure in the financial statements in accordance with HKAS 38.






6.5       Tests of details of account balance – Purchased goodwill
(Jun 14)

Audit Objectives

Substantive procedures

1.   Existence and rights of ownership

  • Examine the documents supporting the purchase of the business and trace the payment to cash book if the business is bought during the year.

2.   Valuation (realizable value)

  • If the purchase is made during the year, ensure that the calculation of goodwill is correct by examining the bases of valuing all the assets acquired to ensure that they are properly valued, with regard to the reasonableness of the valuations and the qualifications and independence of the valuer(s).
  • Review and discuss with management whether there is any sign of impairment loss on the carrying amount at year-end.

3.   Presentation and disclosure

  • Ensure that the accounting policy related to goodwill is properly disclosed and complies with accounting standard.



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Audit of Non-Current Assets


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Audit of Non-Current Assets



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Audit of Non-Current Assets