Although they're considered low risk by auditors, fixed assets need attention to ensure the organization's records are accurate and its controls provide effective oversight of this area. As with other asset classes, best practices enhance proper accounting, valuations and financial reporting.
Fixed assets represent the long-term tangible assets an organization uses to produce and deliver its products or services, and manage its operations. In many capital-intensive industries such as manufacturing, power generation and healthcare, fixed assets represent the largest item on the balance sheet. Historically, fixed assets have received little audit scrutiny and, as a result, some major financial frauds have been perpetrated through significant misstatements of fixed asset balances in the financial statements of public companies.
When asked if fixed assets are represented accurately in year-end financial statements, most organizations will answer with "yes." However, audits may yield a different answer. Although many organizations do not perform an inventory of current fixed assets and a corresponding reconciliation, these steps provide an essential internal control for the financial reporting of fixed assets.
Typical Audit Approach
Fixed assets are probably one of the simplest and most repetitive areas of accounting. Before the passage of the Sarbanes-Oxley Act (SOX), auditors viewed fixed assets as having the appropriate internal controls and, therefore, deemed them a low-risk area. Audits of fixed assets were allocated little time and usually assigned to an entry-level staff auditor.
Fixed asset audit procedures were typically limited to:
* Reviewing a roll-forward analysis for the cost and depreciation of account balances
* Vouching of current-year purchases
* Reasonableness testing of current-year depreciation expense calculations
* Performing very limited reconciliation procedures
Back then, this approach was well-understood by external auditors, their clients' accounting managers, corporate controllers and chief financial officers.
What changed? The credibility of the financial reporting of publicly owned companies was damaged significantly by corporate scandals, beginning with the collapse of a number of major corporations in late 2001 and early 2002. Investor confidence eroded severely, and Congress enacted SOX.
One of SOX's central components is the increased testing of internal controls. Another noteworthy requirement is that publicly owned companies maintain an internal audit function. This increased testing of internal controls, coupled with the required role of internal auditors, has led to increased scrutiny of fixed assets.
Controls Over Fixed Assets
Fixed-asset transactions typically represent the acquisition and disposal of assets and the allocation of related costs to reporting periods through depreciation expense. The internal controls over the acquisition of fixed assets are straightforward, easy to test and include the following:
* Issuance and approval of a purchase order
* Receipt of assets and preparation of a receiving report
* Receipt of an invoice from a vendor
* Reconciliation of the vendor invoice to the related receiving report and purchase order
* Authorization of the payment of the vendor invoice
* Issuance of a check for payment of the vendor invoice
* Posting of the entry in the equipment subledger
* Posting of the equipment subledger activity to the related general ledger control accounts
* Reconciliation of the general ledger control accounts...