PROCEDURES FOR AUDITING TRANSACTIONS I - FIXED ASSETS AND INVESTMENTS

1.0 INTRODUCTION

You may recall that in the last unit two major activities discussed in the final audit were vouching and verification. While vouching was seen as the process of examining documentary evidence necessary to support the recorded transactions which purportedly took place during the period under review, there is also the need for the verification of the assets and liabilities (and other items) appearing in the balance sheet at the end of the year. You are now very conversant with the objects of verification as highlighted in the last unit.
In this unit and even in the next two units, you will be exposed to the procedures for auditing transactions with emphasis on verification of fixed assets, investments and liabilities bearing in mind that there are well established techniques for auditing transactions.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1. define fixed assets 
2. state the objectives of verifying fixed assets 
3. state the procedures for fixed assets audit 
4. categorise investments 
5. outline the procedures for audit of investments. 

3.0 MAIN CONTENT

3.1 Fixed Assets Verification

Fixed assets are the properties of the business that are permanent in nature. Examples include: land, buildings, machinery, plant, equipment, furniture and others. The significance of fixed assets of an organisation should be of interest to an auditor. For instance, in a wholesale organisation, fixed assets consist of a small part of the total assets while in a manufacturing firm; the amount of fixed assets is always very significant in the balance sheet reporting.

An auditor should be familiar with the major items of fixed assets as well as review addition of fixed assets during the year. Fixed assets are purchased for use in the day-to-day operations of the business and their lifespan will extend over a number of years. The cost of the assets is spread over the estimated useful life. Expenditure made in the purchase of assets or assets improvements are charged to capital expenditure. Depreciation of assets is usually based on historical cost. Depreciation has been defined by Statement of Standard Accounting Practice (SSAP) as “the measure of the wearing out, consumption or other loss of value of a fixed asset whether arising from use, effluxion of time or obsolescence through technology and market changes”.

An auditor should compute or verify the computation on fixed assets. Depreciation should be allocated to accounting periods so as to charge a fair proportion to each accounting period during the expected life of the assets. In computing depreciation, the auditor should consider the following.

1.  Cost of the asset; (ii) Use life; (iii) Residual/scrap/salvage value. 

The auditor should be familiar with the various methods of computing depreciation, especially, with the popular ones like: (i) straight line method and
(ii) reducing balance method

It is the auditor’s responsibility to exercise professional judgement in assessing management’s method of allocation of depreciation expense to accounting periods. Depreciation rate to be used should depend on the:

(i) nature of the fixed assets;
(ii) expected useful life;

(iii) residual value; and
(iv) technological development of new products.

3.1.2 Objectives of Validating Fixed Assets

The auditor’s objectives in validating fixed assets are to determine:
(i) the physical existence;
(ii) what cost is recorded on historical basis;
(iii) that all additions to fixed assets are genuine;
(iv) that depreciation is properly computed;
(v) that proper recording of residual value is maintained;
(vi) that the total amount recorded in the balance sheet is fair.

3.1.3 Procedure for Fixed Assets Audit

The procedure can be highlighted as follows.

1.  Review the internal control over fixed assets; 
2. Examine the general ledger for major additions and retirements so that they can be observed during the physical check; 
3. Verify legal ownership of assets; 
4.  Verify major items added during the year and authorisation of invoices, work orders, etc. 
5. Verify all retirements of each asset; 
6. Test the amount of depreciation for each new addition and ascertain if the computation is consistent with that of the past years; 
7.  Analyse repairs and maintenance accounts; Review the organisational policies on capitalisation; 
8.  Review minutes of meetings of the board of directors, management, etc. for authorisation to acquire new assets;
9.  Determine whether the amount recorded in the balance sheet is fair. 

SELF-ASSESSMENT EXERCISE 1

1. What are the determinants of depreciation rate of fixed assets? 
2.  State the objectives of verifying fixed assets that appear in the balance sheet. 

3.2 Investments

3.2.1 Brief on Investments
Firms invest in other companies by acquiring debt and equity securities. The investments may be for short-term or long-term holdings, and can be in the form of securities, certificate of deposit, commercial paper, treasury bills, etc. It is important to distinguish the categories into which investments can be divided. They are as follows.

1. Variability (i) Fixed sum deposits (ii) Investments by varying value. 
2.  Quotation (i) Quoted investments (ii) Unquoted investments. 
3.  Ownership proportion (i) Investment giving minority interests (less than 20%) (ii) Investment in associated companies (20% – 50%) (iii) Investments in subsidiary companies (Not greater than 50%).
4. Period of ownership (i) Short-term investments (ii) Long-term investments. 
5. Treatment in balance sheet (i) Investments which are current assets (ii) Investments which are not current assets. 

auditor should ensure that investments are recorded at their fair market value or at the fair market value of those given up at the time of exchange, whichever is clearly determinable. The auditor should evaluate or check the method of accounting for investments in the financial statements and with related disclosure requirements.

3.2.2 Audit objectives relative to Investments

The audit objectives relative to investments are to determine:

1. that adequate internal control exists over the investments; 
2.  that the investments actually exist, and are the properties of the client; 
3. that the investments are properly valued, and classified on the balance sheet;
4.  that all revenues arising from the investments have been promptly collected and recorded. 

3.2.3 Audit Programme for Investments

1. Note that the verification of investments is considered to include:  analysis of related accounts such as dividend revenue, interest earned, accrued interest, dividends receivable, gain or loss on sale of securities; 
2.  for income tax purposes – there is need to know the dates of transactions and the tax bases. 

Therefore, the audit programme is as follows.

1. Prepare a description of internal control for investments, and obtain a detailed schedule of all the company’s investment; 
2. Trace transactions for purchase and sales of securities through the system; 
3. Review reports by the internal auditors on their periodic inspection of securities; 
4. Review monthly reports by officer of client’s company on securities; 
5. Obtain/prepare analyses of investments accounts and all related revenue accounts; 
6. Inspect securities on hand and compare serial numbers with those shown on previous examination; 
7. Obtain confirmation of securities in the custody of others; 
8. Verify purchases and sales of securities during the year; 
9. Verify gain or loss of security transactions and obtain information for income tax returns; Make independent computation of revenue from securities by reference to dividend record books; 
10.  Investigate the methods of accounting for investments in subsidiary companies; 
11. Determine the market value of securities at the date of balance sheet; 
12. Determine financial statements presentation. 

3.2.4 Special Points to Note on Verification of Investments

1.   Internal control is very important. Note particularly the separation of duties of authorisation, custody and recording; 
2. Physical inspection is very desirable; all the certificates should be examined together. 

SELF-ASSESSMENT EXERCISE 2

The auditor should be concerned with the verification of investments. What does this aspect of his audit work hope to achieve?

4.0 CONCLUSION

In this unit, you have learnt that review of internal control over fixed assets and investments relative to the audit procedure should be taken seriously as other verification activities, more or less, derive strength from that. Also, physical verification (check/inspection) of fixed assets and investments is more important than their being sighted on the balance sheet.

TO SELF-ASSESSMENT EXERCISE 1

1. Determinants of depreciation rate of fixed assets are: i) nature of the fixed asset ii) expected useful life iii) residual value iv) technological