Subtopic 5 (page 280)
Identifying inherent risk associated with Property and Equipment
Inherent Risk associated with property and equipment is that clients may overstate the balance
of this account by including Fictitious assets to appear that they have enough assets to
generate an income and by capitalizing cost which is really an expense such as minor repairs
and maintenance cost. Next is, Understatement of Depreciation Expense due to inappropriate
use of depreciation method and estimated useful life of asset to manipulate the depreciation
expense to increase the company's profit. Then Incorrect recording of assets due to complex
accounting issues. The fourth inherent risk in presentation is related to asset impairment,
sometimes management is not interested in identifying and writing down the assets because it
may reflect as incompetency of management in allocating the capital effectively and determining
asset impairment requires a good information system, a system process, effective controls and
professional judgment. Next is Obsolescence of assets, when it is realized, they must create an
allowance in the balance sheet and that allowance will affect the cost of goods sold. It has an
effect on two financial statements. Last is Incomplete recording of asset disposal, as it affects
the income statement whether it is income or loss.
The auditor will become aware of these risks through:
Knowledge of the client’s business, including industry trends and technological advances
(Power point)
Explanation: Auditors should gain a comprehensive understanding of changes in the industry and
advancement of technology to effectively evaluate management’s process for initiating,
processing, and recording transactions and then design appropriate auditing procedure
Next is to review of various documents, including:
o Business plan form major acquisition and way the company conducts its business
o Major contracts regarding capital investment and joint ventures with other companies
o The minutes of board director’s meetings
o Company filing SEC describing company action, risk and strategies (Power point)
Explanation: Documentation review can discover gaps and weaknesses that could lead to missing or improperly
implemented security controls. Auditor typically verify that the organization’s documentation is compliant with
standards and regulations and look for policies that are deficient or outdated. Common documentation weaknesses
include procedures or protocols that are no longer used, and failure to include a new operating system and its
protocols.
INHERENT RISK ASSOCIATED WITH Natural Resources is Difficult to Identify cost associated with discovery. If
the cost of natural resources is difficult to identify possible na magkaroon ng incorrect recording sa amount na
associated with cost of natural resources and pag nagkaroon ng error, it could affect also the amount of depletion.
Next inherent risk is Difficult to estimate commercially available resources to be used in determining a depletion
rate. Depletion is a non-cash expense that lowers the cost value of asset (depletion same goes with depreciation
however depreciation used in tangible asset) it could overstate and understate the amount value of asset if
depletion rate is incorrect and sa income statement pwedeng magresult ng error in recording expenses in
appropriate time period. Lastly is difficulty of estimating reclamation cost when the client restores the property.
INHERENT RISK ASSOCIATED WITH Intangible Assets are Determination of cost are is not as
straightforward as for tangible asset and Incorrect capitalization of development cost. Development
costs are capitalized only after technical feasibility of the asset for sale or use have been established.
Intangible assets are initially measure at cost however it set out the specific requirements in relation to
capitalization, for example: Company generally incur research and development cost in the process of
finding and creating new products or services but there are certain criteria to be met and that is only
development cost can be capitalize and not research cost. The project must be technically feasible, and
the company must be able to complete the project and sell the new product.
The possible risk is they may have capitalized research cost or may not able to complete and sell the
project so what could be the impact of it? intangible asset may be overstated and this would have the
effect of increasing profit. If the costs had been expensed, profit would be much lower.
