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Guidance note on audit of fixed assets

Posted @ July 15, 2012, 9:39 am under (Fixed Assets Verification & Audits)



     The   following   is the text of the Guidance Note on  "Audit  of
Fixed  Assets"  issued  by the Auditing  Practices  Committee  of  the
Council   of  the Institute of Chartered Accountants  of  India.  This
Guidance  Note should be read in conjunction with the "Preface to  the
Statements  on Standard Auditing Practices" issued by the Institute.

1.   Para 2.1 of the "Preface to the Statements on  Standard  Auditing
Practices" issued by the Institute of Chartered Accountants of   India
states   that the "main function of the APC is to review the  existing
auditing  practices  in India and to develop  Statements  on  Standard
Auditing  Practices (SAPs) so that these may be issued by the  Council
of  the Institute." Para 2.4 of the Preface states that the "APC  will
issue   Guidance  Notes on the issues arising from the SAPs   wherever

2.   Chapter   3  of the existing "Statement  on  Auditing  Practices"
related  to  "Fixed  Assets"  provides guidance  in  respect  of  both
accounting   and  auditing  aspects  of fixed assets.  The  accounting
aspects  of  fixed assets  form the subject matter  of  an  Accounting
Standard  on "Accounting for Fixed Assets" which is being prepared  by
the  Accounting   Standards  Board  of  the  Institute  of   Chartered
Accountants  of   India.   This  Guidance Note  on  Audit   of   Fixed
Assets  therefore supersedes  auditing  aspects of the said Chapter  3
of  the  existing Statement.

3.   This  Guidance Note, however, does not supersede the  Institute's
publications  which  provide guidance on audit of  fixed  assets  with
special  reference  to  certain  statutes,  e.g.,  the  Statement   on
Manufacturing and Other Companies (Auditor's Report) Order, 1975.

4.   In the event of a possible or perceived contradiction between the
Guidance  Note  and a Statement on Standard Auditing  Practices  (SAP)
issued  by  the  Institute, the practices laid down in  the  SAP  will


5.   Fixed   assets  are assets held for the  purpose   of   providing
or  producing   goods or services and are not meant for  sale  in  the
normal course  of business. Therefore, an asset can be classified as a
fixed  asset  or  otherwise  depending upon the use to which   it   is
put   or intended to be put. For example, assets which are  classified
as  fixed assets in one type of business may be considered as  current
assets   in  another.  Similarly, the same  asset  may  be  classified
differently in an enterprise at different points of time.

6.   Fixed   assets normally constitute a significant portion  of  the
total  assets, particularly  in a manufacturing enterprise.  Audit  of
fixed assets therefore assumes considerable importance.

7.   The following features of fixed assets have  an  impact  on   the
related audit procedures;

     (i)  By  their  very nature, fixed assets are turned  over   much
          slower  than  current  assets. Normally,  fixed  assets  are
          carried over from year to year.

    (ii)  The average unit of fixed assets is normally of a relatively
          larger rupee value.

   (iii)  Since fixed assets are high value items, their   acquisition
          is  more   effectively  controlled.   The   control   aspect
          assumes   special significance where fixed assets are  self-

    (iv)  In  an inflationary situation, normally the book  values  of
          fixed  assets are considerably lower than their  replacement

Internal Controls

8.   An   auditor  should  review  the  system  of  internal  controls
relating to fixed assets particularly the following:

     (i)  Control  over expenditure incurred on fixed assets  acquired
          or   self-constructed  - an effective method  of  exercising
          this  control   is  capital  budgeting,  which,  apart  from
          ensuring proper authorisation  of the  expenditure incurred,
          also shows in general how effectively  such expenditure   is
          being   controlled  through   periodical   comparisons    of
          actuals with budgeted figures.

    (ii)  Accountability   and utilisation controls  -  accountability
          over  each  fixed asset (or each class of fixed  assets)  is
          established,   among   other    things,   by    maintaining,
          appropriate  records.  This  facilitates control aspects  of
          custodianship   of  such  assets,  for   example,   physical
          verification   by   the  management  or   establishment   of
          procedures  relating  to  disposal of fixed assets.  On  the
          other   hand    utilisation   controls  ensure    that   the
          individual  fixed  assets  have  been  properly   used   for
          meeting the objectives of the enterprise.

   (iii)  Information   controls   -  these  controls   ensure    that
          reliable  information  is  available  for  calculating   and
          allocating     depreciation,    recording    disposals    or
          retirements, preparing tax returns, establishing the  amount
          of  insurance coverage, filing insurance claims  controlling
          repairs and maintenance charges etc.


9.   Verification  of fixed assets consists of examination of  related
records and physical verification. The auditor should normally  verify
the  records  with  reference  to  the  documentary  evidence  and  by
evaluation of internal controls. Physical verification of fixed assets
is primarily the responsibility of the management.

Verification of Records

10.  The  opening balances of the existing  fixed  assets  should   be
verified from records such as the schedule of fixed assets, ledger  or
register balances.

11.  Acquisition of new fixed assets and improvements in the  existing
ones should be verified with reference to supporting documents such as
orders, invoices, receiving reports and title deeds.

12.  Self-constructed fixed assets, improvements and capital  work-in-
progress should be verified with reference to the supporting documents
such   as   contractors'  bills, work-order  records  and  independent
confirmation of the work performed.

13.  The auditor should scrutinise expense accounts (e.g. Repairs  and
Renewals) to ascertain that new capital assets and improvements   have
not been included therein.

14.  Where fixed assets have been written-off or fully depreciated  in
the   year   of  acquisition/construction the auditor  should  examine
whether these were recorded in the fixed assets register before  being
written-off or depreciated.

15.  In respect of fixed assets retired, i.e., destroyed, scrapped  of
sold, the auditor should examine (a) whether the retirements have been
properly  authorised  and  appropriate procedures  for  invitation  of
quotations  have  been followed wherever applicable; (b)  whether  the
assets  and  depreciation accounts have been  properly adjusted;   (c)
whether the sale proceeds, if any, have been fully accounted for;  and
(d)  whether  the resulting gains or losses, if  material,  have  been
properly adjusted and disclosed in the profit and loss account.

16.  It is possible that certain assets destroyed, scrapped  or   sold
during  the  year  have  not been recorded. The  auditor  may use  the
following procedures to ascertain such omissions:

     (i)  Review work orders/physical verification reports  to   trace
          any indicated retirements.

    (ii)  Examine   major   additions  to  ascertain   whether  they
          represent additional facilities or replacement of old assets
          which may have been retired.

   (iii)  Make enquiries of key management and supervisory personnel.

    (iv)  Obtain   a  certificate  from  a  senior   official   and/or
          departmental  managers that all assets  scrapped,  destroyed
          or  sold  have  been recorded in the books.

17.   The  ownership  of  assets like land  and  buildings  should  be
verified by  examining title deeds. In case, the title deeds are  held
by   other persons,  such  as  solicitors  or  bankers,   confirmation
should   be  obtained   directly  by the auditors  through  a  request
signed  by  the client.

Physical Verification

18.  It is the responsibility of the management to carry out  physical
verification  of  fixed assets at appropriate intervals  in  order  to
ensure that they are in existence. However, the auditor should satisfy
himself that such verification was done by observing the  verification
being  conducted by the management wherever possible and by  examining
the written instructions issued to the staff by the management and the
relevant working papers.

The  auditor should also satisfy himself that the  persons  conducting
the verification, whether the employees of the enterprise or   outside
experts (if employed), had the necessary competence.

19.  The   auditor should examine whether the method  of  verification
was  reasonable  in  the circumstances relating  to  each  asset.  For
example,  in the case of certain process industries,  verification  by
direct physical check may not be possible in the case of assets  which
are  in continuous  use or which are concealed within larger units. It
would  not   be   realistic  to  expect  the  management  to   suspend
manufacturing  operations  merely  to conduct a physical  verification
of   the   fixed assets,  unless there are  compelling  reasons  which
would  justify   such  an extreme procedure. In  such  cases  indirect
evidence  of the existence of  the  assets may suffice.  For  example,
the very fact  that  an  oil refinery is producing at normal levels of
efficiency may be sufficient to indicate the existence of the  various
process units even where each such unit cannot be verified by physical
or  visual inspection. It  may not be necessary to verify assets  like
building   by   measurement   except  where  there  is   evidence   of
alteration/demolition. At the same time  in view of the possibility of
encroachment,  adverse possession, etc.,  it may  be necessary  for  a
survey  to  be  made periodically of  open  land.  Where   the   fixed
assets  can be moved and where  verification  of  all  assets   cannot
be  conducted  at  the  same  time,  they  should   be   marked   with
distinctive numbers.

20.  The auditor should examine whether the frequency of  verification
was reasonable in the circumstances of each case. Where the assets are
few  and  can  be  easily verified,  an  annual  verification  may  be
considered  as reasonable. However, where the assets are numerous  and
difficult  to verify, a verification, say, once every three  years  by
rotation  -  so that all assets are verified at least  once  in  every
three years - may be sufficient.

21.  The auditor should test check the book records of  fixed   assets
with  the  physical verification reports. He  should  examine  whether
discrepancies  noticed  on physical verification  have  been  properly
dealt with. In this regard the auditor has to use his judgement as  to
whether having regard to the circumstances the discrepancy is material
enough to warrant an adjustment in the accounts and/or modification in
the internal control system.

Valuation and Disclosure

22.  The   auditor should satisfy himself that the fixed  assets  have
been valued  and  disclosed in the financial statements  according  to
the  generally  accepted bases of accounting which are determined   by
law,   professional   pronouncements1  (An  illustrative    list    of
professional  pronouncements on the subject is given in  Appendix  A.)
and  prevailing practices.

23.  The  auditor should test check the calculations  of  depreciation
and the total depreciation arrived at should be compared with that  of 
the  preceding   years  to  identify  reasons   for   variations.   He
should  particularly  examine  whether  the depreciation   charge   is
adequate  keeping   in   view   the   generally  accepted   bases   of
accounting  for depreciation.

24.  Revaluation  of fixed assets implies restatement  of  their  book
values  on  the basis of systematic scientific appraisal  which  would
include  ascertainment  of  working condition of each  unit  of  fixed
assets, technical estimates of future working life and the possibility
of obsolescence. Such an appraisal is usually made by independent  and
qualified  persons such as engineers, architects, etc. To  the  extent
possible, the auditor should examine these appraisals. As long as  the
appraisals  appear  reasonable  and based on  adequate  facts,  he  is
entitled to accept the revaluation made by the experts.

25.  Where   several  assets have been purchased  for  a  consolidated
price,   the   auditor  should  examine  the  method  by   which   the
consideration   has  been apportioned to the various assets.  In  case
this  has been done  on the  basis of an expert valuation,  he  should
examine  whether  the  same appears reasonable and based  on  adequate

26.  Where an enterprise owns assets jointly with  others   (otherwise
than as a partner in a firm) the auditor should examine the   relevant
documents such as title deeds, agreements etc., in order to  ascertain
the extent of the enterprise's share in such assets.

                          APPENDIX A
 List  of  publications  issued  by  the  Institute  of   Chartered
Accountants  of India which indicate the generally accepted  bases  of
accounting  of fixed assets.

A.   Accounting Standards

     1.   Disclosure of Accounting Policies (AS 1).
     2.   Prior   Period  and  Extraordinary  Items  and  Changes   in
          Accounting Policies (AS 5).

     3.   Depreciation Accounting (AS 6).
     4.   Accounting for fixed Assets (AS 10).

B.   Other Publications

     1.   Guidance   Note   on   Treatment   of   Expenditure   During
          Construction Period.
     2.   Statement on Accounting for Foreign Currency Translation.
     3.   Guidance  Note  on  Accounting  Treatment  of  Interest   on
          Deferred Payments.
     4.   Guidance Note on Accounting for Capital Based Grants.
     5.   Guidance   Note   on  Treatment  of  Reserves   Created   on
          Revaluation of Fixed Assets.
     6.   Compendium of Guidance Notes - Guidance Notes on  'Provision
          for Depreciation' and 'Mode of Valuation of Fixed Assets'.

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