Depreciation expenses are one of the significant expenses that reporting in the company’s income statement. Those expenses are the costs that the entity charged to fixed assets used for operation during the periods through depreciation by using the systematic methods accepted by certain accounting standards. In the income statement, depreciation expenses are allocated in the cost of goods sold or administrative expenses depending on the
This is because the accounting standard allows the entity not to record the expenses that they incurred for purchasing capital assets at the time of purchasing.
But they could allocate those expenses systematically over the period that they are using.
During the audit of financial statements, auditors should ensure that the audit procedures that they prepare address the risks of material misstatements caused by depreciation expenses and other related items such as fixed assets are properly addressed. Audit assertions that auditor seeking for an audit of depreciation expenses that reports by the company are accurate, concurrent as well as disclosure. It is assessed whether the depreciation expenses are accurate and really occurred in the current accounting period.
Audit procedures that auditors normally perform in an audit of depreciation expenses include recalculation of depreciation expenses, analytical review, an inspection of fixed assets addition, an inspection of fixed assets disposal, review the depreciation method, and useful life of assets. The auditor is also reviewing the classification of fixed assets.
Understanding about depreciation process
Before performing detailed testing on the depreciation expenses, auditors should consider reviewing and assessing the control over the fixed assets and depreciation. This will help auditors test the depreciation expenses more efficiently.
The key control that auditors should look into includes purchasing fixed assets, physical control, depreciation calculation, classification of fixed assets, and recording those expenses into financial statements.
The key risks that auditors should look into when auditing depreciation or fixed assets included:
- Assets are not exist: if the assets are not exist, the company still keep depreciate on the assets that exist only in the books but physically disappear. If the assets are not exist, the company might need to write of the assets rather than keep depreciate it since the company stop getting the benefit from the assets. Keeping depreciate on the assets that are not exist will lead to overstat of depreciation expenses.
- Wrong deprecaiton method: the depreciation methods that the company use to charge to assets should be consistent with the way how the assets are use or the way how the company obtain the benefit from the assets. For example, office building shuold normally using the straighline method to calculate the depreciation. If in case the company use declining or double decling balance method to depreciate the assets, then the deprepreciation expenses that the company charge to the profit and loss is not consistent with the benefit that the company geting from it.
- Understat of depreciation expenses: management of the company might use the accounting assuption to by using the method that cause depreciation expenses smaller than it should be, so that the profit could be positively affected. Understate of depreciation expenses might be cause be incorrect residual value of assets and the evaluation of usfull lift. Another thing that could cause this issue is a delay in
The following are the essential procedures that auditors should perform during their testing on depreciation expenses:
- Review Depreciation Rate: Auditors should assess the reasonableness of depreciation that the entity provided to the group or class of assets. The rate should be consistent to the capacity that fixed assets could contribute to the inflow of economic. Audits should also assess the deprecation rate against the rate provided by the tax authority as well as their understanding. Professional skepticism should also be applied during this testing by considering whether the depreciation rate could help management could get the expenses that they want. In some situationss, management may want to larges expenses or else.
- Recalculate the depreciation expenses: This is normally done by auditors to recalculate the depreciation expenses prepared by accountants in their depreciation schedule. Once auditors completed their calculations, then auditors should compare their results to client results. The difference should clearly investigate.
- Review the accumulated depreciation: The auditor should also review the accumulated depreciation that reports in the balance sheet. These amounts are mater to the net book value of fixed assets. If they are not included the expenses incurred during the period correctly, then the net book value of fixed assets will also incorrectly stated.
- Reconcile the depreciation expenses: Depreciation expenses that recording the income statements should be reconciled with the expenses calculated in the depreciation schedule. The auditor should reconcile this, and if they are not reconciled, the explanation should be obtained from management.
- Test the reasonableness: This procedure is linked to the recalculation procedure. For example, auditors perform depreciation expenses recalculation for a few months and then they project the expenses into the whole years based on their own figure. Once auditors did the whole year projection, then auditors could compare their own calculation with accountant figures. This comparison is expected to have different. But, the auditor could set the acceptable threshold.