UNIT I

AUDIT OF INVESTMENT PROPERTY

Outline:

1. Introduction

2. Audit Assertions, Objectives and Procedures

3. Internal Controls for Investment Property and Equipment

4. Audit Techniques

5. Working papers in the audit of Property, Plant and Equipment

6. Audit Adjustments

Objectives:

The student should be able to:

1. Explain the management assertions, audit objectives and procedures for investment property.

2. Identify the internal control procedures for investment property. .

3. Apply audit techniques, prepare working papers and adjustments

 AUDIT OF INVESTMENT PROPERTY

INTRODUCTION

The following are key areas when auditing investment property:

1. Confirmation of ownership
2. Inspection of non-current assets
3. Valuation by third parties
4. Adequacy of depreciation rates
5. Potential impairment
6. Adequacy of disclosures

Auditors are required to evaluate the appropriateness and reasonableness of an entity's

applicable financial reporting framework and the policies selected for presenting financial
statements. Auditors incorporate an entity's accounting policies into the design of their audit
strategies and audit plans. A summary of basic accounting policies and applicable auditing
standards and procedures are presented.

Summary of Basic Accounting Principles

Investment Property includes land or a building – or a part of a building – or both,

held to earn rentals or for capital appreciation or both.

Examples:
 Land held for long-term capital appreciation.
 Land held for a currently undetermined future use.
 A building owned by the entity (or a right-of-use asset relating to a building
owned by the entity) leased out under one or more operating leases.
 A building that is vacant but is held to be leased out under one or more operating
leases.
 Property that is being constructed or developed for future use as investment
property.

Not included as Investment Property:

 Property intended for sale in the ordinary course of business or in the process of
construction or development for such sale. Example, property acquired
exclusively with a view to subsequent disposal in the near future or for
development and resale.
 Owner-occupied property (PAS 16 and PFRS 16), including property held for
future use as owner-occupied, property held for future development and
subsequent use as owner-occupied property, property occupied by employees
(whether or not the employees pay rent at market rates) and owner-occupied
property awaiting disposal.
 Property that is leased to another entity under a finance lease.

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 Partial own use property:

1. If the portions can be sold or leased out separately

 Investment property – those portions of the property that is rented out or for
capital appreciation.
 Owner-occupied property – those portions that are used by the company for
administrative or production purposes

2. If the portions cannot be sold or leased out separately

 Investment property – if the owner-occupied portion is insignificant
 Owner-occupied property – if investment property portion is insignificant

Ancilliary Services – services provided by the owner to occupants of a property held

by the enterprise. Classification of property where ancilliary services is provided by
the owner:

1. Investment property – the services are a relatively insignificant component of the

arrangement as a whole. (Example: owner supplies security and maintenance
services to the lessees)

2. Owner-occupied – where the services provided are more significant (as in the case
of a hotel, where services provided to guests are significant to the arrangement as
a whole)

Initial Recognition. Investment property should be recognized as an asset when it is:

 Probable that the future economic benefits that are associated with the property will flow
to the enterprises.
 The cost of the property can be reliably measured.

Initial Measurement. Initial measurement concepts are the same with Property, Plant and
Equipment.

 At cost, including transaction costs directly attributable to the acquisition of the property
such as legal fees, property transfer taxes, etc.

 Cost of self-constructed Investment Property - total cost incurred at the date when the
construction or development is complete.

 Investment property held under a finance lease and classified as an investment

property shall be recognized at the lower of the:
a. Fair value of the interest in the property (not the underlying value of the property)
b. Present value of the minimum lease payments

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 Investment property acquired through exchange – the same rules as in PPE shall
apply. Cost shall be determined using the following, in the order of priority:
a. Fair value of asset given up plus cash payment
b. Fair value of asset received minus any cash payment
c. Book value of the asset given up plus any cash payment

Subsequent Measurement

1. Cost Model – at cost less accumulated depreciation and any accumulated impairment
losses (PAS 16).

2. Fair Value Model

Key Internal Controls for PPE, Including Investment Property

(https://smallbusiness.chron.com/key-internal-controls-plant-assets-auditing-76644.html)

Plant assets and equipment usually represent a large portion of a company's total
assets. The cost to maintain and depreciate fixed assets can also be a big line item expense
on the income statement. Since these assets are so significant to company financial
statements and internal operations, companies should implement key controls over their
acquisition, storage and record keeping. The following are key internal controls for
property and equipment:

1. Separate Ledgers

Instead of lumping all fixed assets into one account in the accounting system,
companies should maintain a separate subsidiary ledger for each fixed asset. Each asset will
have a different useful life and salvage value, and it might require a different depreciation
method. Separate ledgers reduce errors and allow users to easily identify any out-of-the
ordinary expense entries. The company should also require accounting manager approval
before accountants can adjust, add or remove any of the asset subsidiary ledgers.

2. Purchase Authorization

To reduce the risk of fraud and bad purchasing decisions, companies should have a
procedure for asset purchase authorization. Other departments should be required to issue a
purchase requisition document to the purchasing department to request a new asset. Before
complying, the purchasing department should obtain executive approval. Managers can
maintain plant asset budget schedules to help them decide which requisitions to approve.

3. Capitalization Policy

It's not always clear what should be considered a plant asset and what should be
categorized as an expense of doing business. For small to medium asset purchases,
accountants have the option of recognizing the purchase as an expense of doing business or

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to capitalize it as an asset. A company should have a clear capitalization policy to ensure
that assets are treated consistently. For instance, a company could instruct accountants to
capitalize any asset purchases over P10,000. Purchases under P10,000 would be classified
as expenses in the period when they are bought.

4. Periodic Inventory Evaluations

Most companies perform a periodic count of inventory. However, some overlook

periodic evaluations of plant assets. Companies should perform periodic evaluations to
verify that all plant assets on the books still exist and note their location. Management
should keep an eye on the condition of plant assets. Companies should regularly check for
damage or obsolesce that could lower the asset's market value.

Audit Assertions and Objectives

Assertion Category Account Balances Audit Objectives

Existence All Investment Property and PPE on the statement of financial

position (including assets leased under finance lease) exist.

Completeness All Investment Property and PPE owned or leased under finance
lease by the entity at the reporting date are included in the statement
of financial position.

Valuation and Investment Property and PPE is carried at the appropriate amount
Allocation taking into account requirements of PAS 16 (Property, Plant and
Equipment) and PAS 36 (Impairment of Assets).

Rights and The entity owns, or has legal right to, all the Investment Property
Obligations and PPE in the statement of financial position as the reporting date.

Presentation and Investment Property, PPE and related accounts are properly
Disclosure classified, described and disclosed in the financial statements,
including notes, in accordance with PFRSs.
Liens, pledges, security interests and restrictions are identified and
properly disclosed.
Potential Misstatements

The following table shows potential misstatements that may occur in accounting for
property, plant and equipment which the auditor should take note of:

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 Table 1 Potential Misstatements of PPE and Investment Property

Description of Internal Control Weaknesses or Factors

Misstatement Examples that Increase the Risk of Misstatement
Misstatement of Fraud:
acquisitions of  Expenditures for repairs and  Undue pressure to meet earnings
property, plant, and maintenance expenses targets.
equipment. recorded as property, plant,
and equipment acquisitions
to overstate income.

Error:
 Purchases of equipment  Inadequate accounting manual;
erroneously reported in incompetent accounting personnel.
repairs and maintenance
account

Failure to record Error:

retirements of  An asset that has been  Inadequate accounting policies, e.g.,
property, plant and replaced is discarded due to failure to use retirement work orders.
equipment its lack of value, without an
accounting entry.

Improper reporting of Error:  Inadequate

unusual transactions  A “gain” recorded on an
exchange of nonmonetary
assets that lacks commercial
substance.

Auditing Procedures

Customary auditing procedures for property and equipment include the following:

 Determining that acquisition costs are recorded properly, including costs assigned to
internally constructed assets.

 Inspecting property and equipment to gather evidence for the existence assertion and
to identify any unrecorded equipment.

 Determining if any repairs of assets meet the improvement or betterment rule and
should be capitalized.

 Analyzing repairs and maintenance, supplies, small tools, and other related accounts
to determine capitalization limits have been met.

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  Reviewing management's depreciation methods and rates.

 Identifying any idle equipment, fully depreciated equipment, or property related to

discontinued operations for separate accounting and reporting.

 Reading lease agreements to identify any capitalizable leased assets and to evaluate
management's applicable accounting policies.

 Analyzing rental income and expense for the existence of other leases and subleases.

 Reviewing the calculations of gain or loss on any disposals of property and

equipment.

Asserertions, Objectives and Procedures in the Audit of PPE and Investment

Property

A. Existence: Do the assets exist?

1. Inspect additions or if initial audit, inspect all assets.

a. Vouch a sample from accounting records to underlying documentation.
b. Vouch a sample from the accounting records to the physical assets.
2. Test cutoff. Examine documents relating to acquisition and disposal to determine
proper recording period.

B. Completeness. Are all transactions reflected in this period's balance?

1. Perform analytical procedures.

2. Reconcile subsidiary and general ledger. Prepare Schedule of assets from subsidiary
ledger or client worksheets for testing. Include in work papers.
3. Analyze repairs and maintenance.
a. Evaluate debits in repairs and maintenance account to determine proper
recording.
b. Evaluate additions to determine proper recording.

C. Rights and Obligations. Does the client own the Pproperty?

1. Examine titles and lease agreements.

2. Evaluate whether leases are properly recorded as operating and/or capital leases.
3. Vouch entries in PPE and Investment Property with payment records to ascertain
ownership.
4. Vouch entries in with insurance records (payments to insurers) to ascertain ownership.
5. Vouch entries with property tax records (assessments and payments to governments)
to ascertain ownership.

D. Valuation and Allocation. Are the assets recorded in accord with GAAP?
1. Vouch additions and disposals by examining documentation relative to authorization
of purchase, recording of purchase, PPE and Investment Property schedules for assets.

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 2. Test to determine if depreciation is recorded and if a generally accepted method has
been consistently applied.

E. Presentation and Disclosure. Are the assets properly presented and are footnote
disclosures relating depreciation methods, collateralized assets, commitments of assets,
lease terms adequate?

1. Read the financial statements.

2. Examine management representation letter for information concerning properties.

Working papers in the Audit of Investment Property

 Summary analysis that emphasizes changes during the year under audit
 Analyses of additions and retirements for the current year
 Analyses of repairs and maintenance expense accounts
 Tests of depreciation
 Other working papers the auditor deems appropriate

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 PROBLEMS

Problem 1 (Source: Asuncion, D, J. O, et al, 2021)

The following data extracted during the financial statement preparation of Zeus Company.
Zeus Company’s accountant is unsure how to classify the following items in the statement of
financial position:

1. Factory which due to a decline in activity is no longer required and

is now being held for sale in accordance with PFRS 5 P500,000
2. Farming land was purchased for its investments potential. Planning
permission has not been obtained for building construction of any
kind. 800,000
3. A factory is in the process of being constructed on behalf of the
government 1,260,000
4. A building being constructed on behalf of Marky Company 1,000,000
5. A new office building used by one of its subsidiaries as its head
office which was purchased specifically in the center of Makati City
in order to exploit its capital gains potential 1,200,000
6. A property that is in the process of construction for sale 950,000
7. A property intended for sale in the ordinary course of business 450,000
8. Owner occupied properties 1,600,000
9. A buildings occupied by employees. The employees do not pay
market rent on the building they occupy 240,000
10. Buildings occupied by employees. The employees pay rent on the
building they occupy 760,000
11. A building that is leased to a third party under a finance lease 1,110,000
12. A building that is held under mixed use; half of it is owner-occupied
and the other half is to earn rentals 1,720,000
13. A property wherein significant ancillary services are provided to
occupants 960,000
14. Land and building leased to a subsidiary 2,100,000
15. A building leased to an associate under an operating lease 1,620,000
16. A new machine leased to another associated under an operating lease 530,000
17. A machine that is leased by the company under operating lease 420,000
18. A building that is being constructed for future use as administration
building 870,000

Based on the above, determine the amounts of the following to be reported in the
consolidated financial statements of Zeus Company and its subsidiaries:

1. Investment property
2. Property, Plant and Equipment
3. Inventories

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Problem 2
Pagara, Inc. a real estate firm, and its subsidiaries have provided you with a list of the
properties they own:

a. A building owned by Pagara, being leased out to Pigar, Inc., a subsidiary of Pagara,
P20,000,000.
b. A property costing P34M held by a subsidiary of Pagara in the ordinary course of its
business
c. Land held for undetermined future use costing P15,000,000

Questions:
1. In its separate financial statement, what should be the amount of investment property to
be reported by Pagara, Inc.?
2. In the consolidated financial statement of Pagara Inc and its subsidiaries, what amount
should be reported as investment property?

Problem 3:
On January 1, 2021, Rachel Company leased a building from Goldemayre Company for the
purpose of letting out to tenants. The lease is properly classified as finance lease under PFRS
16. The fair value of the building on January 1 and December 31 is P3.5 million and P4
million, respectively. The present value of the minimum lease payment computed based on
the implicit interest rate of 12% is P3.2 million

What should be the amount to be recorded by Rachel Company on January 1, 2021 as

investment property?

Problem 4:
Blatche Company completed the construction of a shopping mall at the end of 2019 for a total
cost of P200 million. The mall has an estimated economic life of 25 years. The mall was
constructed for the purpose of earning rentals by letting out space in the shopping mall to
tenants.

An independent valuation expert was used by the company to determine the fair value of the
shopping mall on an annual basis. According to this expert, the fair values of the mall at the
end of 2020 and 2021 were P240 million and P230 million, respectively.

Questions:
1. if the company opted to use the cost model to measure the shopping mall, how much
should be recognized in profit or loss in 2021 as a result of fair value change?

2. If the company opted to use the cost model to measure the shopping mall, how much
should be recognized in profit or loss in 2021 as depreciation expense?

3. If the company opted to use the cost model to measure the shopping mall, how much is
the carrying amount of the shopping mall to be reported in its statement of financial
position as of December 31, 2021?

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4. if the company opted to use the fair value model to measure the shopping mall, how much
should be recognized in profit or loss in 2021 as a result of fair value change?

5. If the company opted to use the fair value model to measure the shopping mall, how
much should be recognized in profit or loss in 2021 as depreciation expense?

6. If the company opted to use the fair value model to measure the shopping mall, how
much is the carrying amount of the shopping mall to be reported in its statement of
financial position as of December 31, 2021?

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