UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

AUDIT OF PROPERTY, PLANT AND EQUIPMENT

NATURE & SOURCES OF PROPERTY, PLANT AND EQUIPMENT INTERNAL CONTROLS OVER PROPERTY, PLANT AND EQUIPMENT

Most businesses use property, plant and equipment in the process of generating revenues. The The principal purpose of internal controls relating to plant and equipment is to obtain maximum
term “property, plant and equipment” generally refers to noncurrent tangible assets, including efficiency from the pesos invested in plant assets.
those held under capital leases, used by a business to create and distribute its goods and services.
The term “fixed assets” is also used to describe the property, plant and equipment accounts. The amounts invested in plant and equipment represents a large portion of the total assets of
Related accounts that are audited in the same manner as property, plant and equipment are many industrial concerns. The expenses of maintenance, rearrangement, and depreciation of
leasehold improvements and construction in progress. these assets are a major factor in the income statement. The sheer size of the amounts involved
makes strong internal controls essential to the production of reliable financial statements. Errors
Expenditures to maintain or improve property, plant and equipment are normal following their in measurement of income will be material if assets are scrapped without their cost being removed
acquisition. A major audit consideration is whether such expenditures should be accounted for as from the accounts or if the distinction between capital and revenue expenditures is not
expense of the current period or reflected on the balance sheet as either an addition to the cost maintained consistently. The losses that inevitably arise from uncontrolled methods of acquiring,
of the asset or a reduction of the related accumulated depreciation. As a general rule, expenditure maintaining, and retiring plant and equipment are often greater than the losses from fraud in cash
should be capitalized if it benefits future periods by extending the useful or productive life of the handling.
asset. The distinction between the two categories of expenditures frequently is not clear-cut.
Enterprises usually have stated policies defining which expenditures are to be capitalized, and the Other important controls applicable to property, plant and equipment are as follows:
auditor must exercise judgment in determining whether the policies are appropriate and are being 1. A subsidiary ledger consisting of a separate record for each unit of property. An adequate
complied with. property, plant and equipment ledger facilitates the auditor’s work in analyzing additions
and retirements, in verifying the depreciation provision and maintenance expenses, and
AUDIT OBJECTIVES IN THE EXAMINATION OF PROPERTY, PLANT AND EQUIPMENT in comparing authorizations with actual expenditures
2. A system of authorizations requiring advance executive approval of all plant and
The objectives of auditing property, plant and equipment and related accounts are to obtain equipment acquisitions, whether by purchase, lease, or construction
reasonable assurance that 3. An authoritative written statement of company policy distinguishing between capital and
1. Property, plant and equipment recorded in the accounts exist and are owned or leased revenue expenditures. A minimum peso amount ordinarily will be established for
under capital leases by the company capitalization; any expenditures of lesser amount automatically are classified as charges
2. All additions to and disposals of property, plant and equipment have been properly against current revenue
authorized and accurately recorded 4. A policy requiring all purchases of property, plant and equipment to be handled through
3. No material items were charged to expense that should have been capitalized the purchasing department and subjected to standard routines for receiving, inspection,
4. The cost or other basis of initially recording property, plant and equipment is appropriate and payment.
5. Appropriate methods of depreciation have been properly applied, on a basis consistent 5. Periodic physical inventories, designed to verify the existence, location, and condition of
with the previous year, to all items of property, plant and equipment that should be all property listed in the accounts and to disclose the existence of any unrecorded units.
depreciated 6. A system of retirement procedures, including serially numbered retirement work orders,
6. The carrying value of property, plant and equipment is appropriate in periods subsequent stating reasons for retirement and bearing appropriate approvals
to acquisition, considering such factors as utilization, geographic location, laws and
regulations, and technological changes
7. Property, plant and equipment pledged as collateral are identified and disclosed, along
with other necessary disclosures

Auditing Problems 1
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

AUDIT WORKING PAPERS FOR PROPERTY, PLANT AND EQUIPMENT OBJECTIVES IN AUDITING DEPRECIATION

1. Summary analysis for Property, Plant and Equipment Depreciation relates most directly to the valuation or allocation audit objective. To meet this
2. Summary analysis for Accumulated Depreciation objective, the auditors in examining depreciation methods and amounts determine
3. Analyses of the Year’s Additions and Retirements a. That the methods in use are acceptable,
4. Analyses of Repairs and Maintenance Expense b. That the methods are being followed consistently, and
5. Tests of Depreciation c. That the calculations required by the chosen methods are accurate

AUDIT PROCEDURES FOR PROPERTY, PLANT AND EQUIPMENT AUDIT PROGRAM – DEPRECIATION EXPENSE AND ACCUMULATED DEPRECIATION

Presentation and Disclosure 1. Review the depreciation policies set forth in company manuals or other management
directives. Determine whether the methods in use are designed to allocate costs of plant
1. Compare Financial Statement Presentations with GAAP and equipment assets equitably over their service lives.
2. Obtain or prepare a summary analysis of accumulated depreciation for the major
Existence or Occurrence property classifications as shown by the general ledger control accounts, listing beginning
balances, provisions for depreciation during the year, retirements, and ending balances
2. Make a Physical Inspection of Major Acquisitions of Plant and Equipment a. Compare beginning balances with the audited amounts in last year’s working
3. Vouch Plant Asset Additions papers
b. Determine that the totals of accumulated depreciation recorded in the plant and
Rights and Obligations equipment subsidiary records agree with the applicable general ledger
controlling accounts
4. Verify the Client’s Ownership of the Assets 3. Verify the provisions for depreciation
5. Review Lease Agreements a. Compare rates used in the current year with those employed in prior years, and
investigate any variances
Completeness b. Test computations of depreciation provisions for a representative number of
units and trace to individual records in the property ledger
6. Vouch from Fixed Assets to the Plant and Equipment Subsidiary Ledger c. Compare credits to accumulated depreciation accounts for the year’s
7. Obtain or Prepare an Analysis of the Repair and Maintenance Expense Account depreciation provisions with debit entries in related depreciation expense
8. Review Rental Revenue and Property Tax Expense accounts
9. Perform Analytical Procedures for Property, Plant and Equipment 4. Verify deductions from accumulated depreciation for assets retired
a. Trace deductions to the working paper analyzing retirements of assets during the
Valuation year
b. Test the accuracy of accumulated depreciation to date of retirement
10. Reconcile the Plant and Equipment Subsidiary Ledger With the General Ledger 5. Perform analytical procedures for depreciation
11. Vouch Plant Asset Disposals a. Compute the ratio of depreciation expense to total cost of plant and compare
12. Review Depreciation Methods with prior years
13. Review Useful Lives b. Compare the percentage relationship between accumulated depreciation and
14. Recalculate Depreciation Computations related property accounts with that prevailing in prior years. Discuss significant
variations from the normal depreciation program with appropriate members of
management.

Auditing Problems 2
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

PRACTICE PROBLEMS: B. On June 1, 2010, Natividad Mining Corp. acquired the rights to a coal mine containing an
estimated reserve of 2,000,000 tons of coal. The company estimated that 25,000 tons of
A. Gabaldon Company’s property, plant and equipment and accumulated depreciation coal would be extracted and sold each month. Cost allocable to coal was P 7,000,000.
balances at December 31, 2009 are:
Cost Accumulated Depreciation Also on June 1, 2010, the company purchased an equipment to be used in the
Machinery and equipment P 1,380,000 P 367,500 production, costing P 190,000 which has an estimated useful life of 10 years. The
Automobiles and trucks 210,000 114,326 equipment was expected to become obsolete after all the coal deposits had been
Leasehold improvements 432,000 108,000 extracted from the mine and only P 10,000 selling price of the equipment could be
expected. Production was in full blast since June 2, 2010.
Depreciation policy:
a. Depreciation methods and useful lives: Based on the above and the result of your audit, answer the following:
 Machinery and equipment – straight line; 10 years 1. What would be the depletion expense for the year ended December 31, 2010?
 Automobiles and trucks – 150% declining balance; 5 years, all were acquired 2. What would be the depreciation expense on the new equipment for the year 2010?
after 2005
 Leasehold improvements – straight line C. On December 31, 2009, the statement of financial position of Tinio Company showed
b. Depreciation is computed to the nearest month the following property and equipment after charging depreciation:
c. Salvage values are immaterial except for automobiles and trucks which have Building P 3,000,000
estimated salvage values equal to 15% of cost Accumulated depreciation (1,000,000) P 2,000,000

Additional information: Equipment 1,200,000

a. Gabaldon entered into a 12-year operating lease starting January 1, 2007. The Accumulated depreciation (400,000) 800,000
leasehold improvements were completed on December 31, 2007 and the facility was
occupied on January 1, 2007 The company has adopted the revaluation model for the valuation of property and
b. On July 1, 2010, machinery and equipment were purchased at a total invoice cost of equipment. This has resulted in the recognition in prior periods of an asset revaluation
P 325,000. Installation cost of P 44,000 was incurred surplus for the building of P 150,000. On December 31, 2009, an independent valuer
c. On August 30, 2010, Gabaldon purchased new automobile for P 25,000 assessed the fair value of the building to be P 1,600,000 and the equipment to be P
d. On September 30, 2010, a truck with a cost of P 48,000 and a carrying amount of P 900,000. The building and equipment had remaining useful lives of 25 years and 4 years,
30,000 on December 31, 2009 was sold for P 23,500 respectively, as of December 31, 2009.
e. On December 20, 2010, a machine with a cost of P 17,000, a carrying amount of P
2,975 on date of disposition, was sold for P 4,000 Based on the above and the result of your audit, determine the following: (Ignore
deferred tax consequence)
Based on the above and the result of your audit, answer the following: 1. Revaluation surplus as of December 31, 2009, after recording the re valuation
1. The gain on sale of truck on September 30 is? 2. Amount to be recognized in 2009 profit or loss related to the revaluation of property
2. The gain on sale of machinery on December 20, 2010 is? and equipment
3. The adjusted balance of property, plant, and equipment as of December 31, 2010 is? 3. Total depreciation in 2010
4. The total depreciation expense for the year ended December 31, 2010 is? 4. Carrying amount of property and equipment as of December 31, 2010
5. The carrying amount of the property, plant, and equipment as of December 31, 2010 5. Revaluation surplus as of December 31, 2010
is?

Auditing Problems 3
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

D. On January 1, 2009, Cabiao Corporation purchased a tract of land (site number 101) with will occur evenly each year. The fair value of the machine is P 280,000. The cost to sell
a building for P 1,800,000. Additionally, Cabiao paid a real estate broker’s commission of the machine is P 40,000. The company’s discount rate is 10%. The impairment loss to
P 108,000, legal fees of P 18,000 and title guarantee insurance of P 54,000. The closing be recognized in 2010 profit or loss is?
statement indicated that the land value was P 1,500,000 and the building value was P
300,000. Shortly after acquisition, the building was razed at a cost of P 225,000. F. On November 15, 2010, Abar Corporation acquired Rapids, a company that operates
a scenic railway along the coast of a popular tourist area. The summarized statement
Cabiao entered into a P 9,000,000 fixed-price contract with Cabanatuan Builders, Inc. on of financial position at fair values of Rapids on July 1, 2010, reflecting the terms of
March 1, 2009 for the construction of an office building on the land site 101. The building acquisition was:
was completed and occupied on September 30, 2010. Additional construction costs were
incurred as follows:
Goodwill P 200,000
Operating license 1,200,000
Plans, specifications and blueprints P 36,000
Property-train stations and land 300,000
Architect’s fees for design and supervision 285,000
Rail track and coaches 300,000
The building is estimated to have a forty-year life from date of completion and will be Steam engines (2) 1,000,000
depreciated using the 150% declining balance method. Purchase consideration P 3,000,000

To finance the construction cost, Cabiao borrowed P 9,000,000 on March 1, 2009. The The operating license is for ten years. It has recently been renewed by the transport
loan is payable in ten annual installments of P 900,000 plus interest at the rate of 14%. authority and is stated at the cost of its renewal. The carrying amounts of the property
Cabiao used part of the loan proceeds for working capital requirements. Cabiao’s average and rail track and coaches are based on their estimated replacement cost. The
amounts of accumulated building construction expenditures were as follows: engines are valued at their net selling price.

For the period March 1 to December 31, 2009 P 2,700,000 On December 1, 2010, the boiler of one of the steam engines exploded, completely
For the period January 1 to September 30, 2010 P 6,900,000 destroying the whole engine. Fortunately, no one was injured, but the engine was
beyond repair. Due to its age, a replacement could not be obtained. Because of the
Cabiao is using the allowed alternative treatment for borrowing cost reduced passenger capacity, the estimated value in use of the business after the
accident was assessed at P 2 million.
Based on the above and the result of your audit, determine the following:
1. Cost of land site number 101 Passenger numbers after the accident were below expectations even after allowing
2. Cost of office building for the reduced capacity. A market research report concluded that tourists were not
3. Depreciation of office building for 2010 using the railway because of the fear of a similar accident occurring to the remaining
engine. In the light of this, the value in use of the business was re-assessed on
E. On January 1, 2006, the S. Domingo Company purchased a machine for P 1,300,000
December 31, 2010 at P 1.8 million. On this date, Abar received an offer of P 900,000
which it installed in a rented factory. It is depreciating the machine over 12 years by
in respect of the transferable operating license.
the straight-line method to a residual value of P 100,000. Late in 2010, because of
increasing competition in the industry, the company believes that its asset may be
Based on the above and the result of your audit, compute the carrying amount of the
impaired and will have a remaining useful life of 5 years, over which it estimates the
following as of December 31, 2010 after recognizing the impairment loss, if any:
asset will produce total cash inflows of P 2,000,000 and will incur total cash outflows
 Goodwill
of P 1,650,000. The cash flows are independent of the company’s other activities and
 Operating license

Auditing Problems 4
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

 Property – train stations and land Nueva Ecija Inc. was granted 2,500 acres of land in a village located near the slums
 Rail track and coaches outside the city limits, by a local government authority. The condition attached to this
 Steam engines grant was that Nueva Ecija Inc. should clean up this land and lay roads by employing
laborers from the village in which the land is located. The government has fixed the
G. On January 1, 2010, San Isidro Corporation decided to dispose of an item of plant that minimum wage payable to the workers. The entire operation will take three years and
is carried in its records at a cost of P 900,000, with accumulated depreciation of P is estimated to cost P 50 million. This amount will be spent in this way: P 10 million
160,000. Depreciation on the plant since it was originally acquired has been charged each in the first and second years and P 30 million in the third year. The fair value of
at P 10,000 per month. The plant will continue to be operated until it is sold, at which this land is currently P 60 million. How much should be recognized as income from
time the operations of the plant will be outsourced. The company undertook all the government grant at the end of the first year?
necessary actions to be able to classify the asset as held for sale. It is estimated that
it could sell the plant for its fair value, P 720,000, incurring P 20,000 selling costs in Nueva Ecija, Inc. received a consolidated grant of P 60 million. Three-fourths of the
the process. The plant has been depreciated at an amount of P 10,000 per month. grant is to be utilized to purchase a college building for students from
underdeveloped or developing countries. The balance of the grant is for subsidizing
On March 31, 2010, the plant had not been sold but, due to a shortage of this type of the tuition costs of those students for four years from the date of grant. The college
plant, there had been an increase in the fair value to P 770,000. On June 30, 2010, building which costs P 50 million, will be depreciated using the straight-line method
San Isidro sold the plant for P 785,000, incurring P 25,000 selling costs. over 10 years. Assuming that the tuition subsidy will be offered evenly over the period
of 4 years, the amount that should be recognized as income at the end of year 1 is?
Based on the above and the result of your audit, answer the following:
1. The impairment loss to be recognized on January 1, 2010 (date of classification as
held for sale) is
2. The depreciation expense to be recognized in 2010 is
3. The gain to be recognized in profit or loss as a result of increase in fair value of
the plant is
4. The gain to be recognized on sale of plant on June 30, 2010

H. Nueva Ecija Inc. received a grant of P 30 million to compensate it for cost it incurred
in planting trees over a period of five years. Nueva Ecija Inc. will incur costs in this
manner: Year 1 – P 1 million; Year 2 – P 2 million; Year 3 – P 3 million; Year 4 – P 4
million; Year 5 – P 5 million. How much should be recognized as income from the
government grant at the end of year 1?

On January 1, 2009, Nueva Ecija Company received a grant of P 75 million from the
Japanese government for the construction of a laboratory and research facility with
an estimated cost of P 90 million and useful life of 25 years. The facility was completed
in early 2010. The amount to be recognized in Nueva Ecija’s 2010 profit or loss as
income from government grant is?

Auditing Problems 5
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

AUDIT OF PROPERTY, PLANT AND EQUIPMENT POST- TEST

Your new audit client, Guimba Company, prepared the trial balance below as of December 31, Additional data are as follows:
2010. The company started its operations on January 1, 2009. Your examination resulted in the
necessity of applying the adjusting entries indicated in the additional data below. a. The 1,500,000 share capital was issued at a 10 percent premium to the owners of the land
and buildings on December 31, 2008, the date of organization. Shares with a par value of
Guimba Company 180,000 were donated back by the vendors. The following entry was made:
Trial Balance
December 31, 2010 Treasury shares 180,000
Donated shares 180,000
Debits Credits
Cash P 510,000 The shares were donated because the proceeds from its subsequent sale were to be
Accounts receivable – net 600,000 considered as an allowance on the purchase price of land and buildings in proportion to
Inventories, December 31, 2009 669,000 their values as first recorded. The treasury shares were sold in 2010 for P 75,000, which
Land 660,000 was credited to treasury shares
Buildings 990,000
Accumulated depreciation, building P 19,800 b. On December 31, 2010, a machine costing P 15,000 when the business started was
Machinery 444,000 removed. The machine had been depreciated at 10 percent during the first year. The only
Accumulated depreciation, machinery 45,000 entry made was one crediting the machinery account with its sales price of P 6,000
Sinking fund assets 75,000
Bond discount 75,000 c. Depreciation is to be provided on the straight-line basis, as follows: buildings, 2 percent
Treasury shares 105,000 of cost; machinery, 10 percent of cost. Ignore residual values.
Accounts payable 567,000
Accrued bond interest 11,250 Based on the above and the result of your audit, you are to provide the answers to the following:
First mortgage, 6% sinking fund bonds 679,500 1. The correct balance of Land account as of December 31, 2010 is?
Share capital 1,500,000 2. The adjusted carrying amount of Building as of December 31, 2010 is?
Share premium 150,000 3. The adjusted carrying amount of Machinery as of December 31, 2010 is?
Donated shares 180,000 4. The adjusted depreciation expense for 2010 is?
Retained earnings, December 31, 2009 222,450 5. How much is the gain or loss on sale of machinery on December 31, 2010?
Net sales 2,625,000
Purchases 850,500 6. When there are few property and equipment transactions during the year, the
Salaries and wages 507,000 continuing auditor usually makes
Factory operating expenses 364,500 a. Complete review of the related internal controls and assesses control risk
Administrative expenses 105,000 relative to them
Bond interest 45,000 _________ b. Preliminary review of the related internal controls and performs extensive
Total P 6,000,000 P 6,000,000 tests of current year property and equipment transactions
c. Complete review of the related internal controls and performs analytical
review tests to verify current year additions to property and equipment

Auditing Problems 6
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

d. Preliminary review of the related internal controls and performs a thorough

examination of the balances at the beginning of the year

7. Which of the following techniques would best result in sufficient evidence with regard
to an audit of the quantity of fixed assets on hand in a particular department?
a. Physical observation
b. Analytical review of purchase requests and subsequent invoices
c. Interviews with department manager
d. Examination of the account balances contained in general and subsidiary
ledgers

8. To verify the proper value of costs charged to real property records for improvements
to the property, the best source of evidence would be:
a. A letter signed by the real property manager asserting the propriety of costs
incurred
b. Original invoices supporting entries into the accounting records
c. A comparison of billed amounts to contract estimates
d. Inspection by the auditor of real property improvements

9. An auditor might use several procedures to test for the proper accounting for
retirement of plant and equipment. Which of the following tests would be the most
effective in providing evidence about the retirement of fixed assets?
a. Determination of whether fully depreciated assets still in use are included in
the asset accounts
b. Examination of the cash accounts for unusual entries
c. Analysis of debits to the accumulated depreciation account
d. Analysis of debits to the fixed asset account

10. Assets may suffer an impairment in value for a variety of reasons, but not likely as a
result of:
a. A corporate restructuring
b. Slumping demand for uncompetitive products
c. Significant increases in market share
d. Obsolescence

Auditing Problems 7