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Improve internal controls over fixed assets (Part 1)

internal controls over fixed assetsA good fixed asset policy will improve internal controls over fixed assets; from acquisition to disposal and disclosure. Many organizations face challenges with recording and physically safeguarding fixed assets. Organizations must also meet disclosure and other requirements when they prepare audited or other financial statements, corporate tax returns (applicable to for-profit organizations) and T3010 Registered Charity Information Returns (applicable to charitable organizations). Accounting processes and procedures must facilitate these activities.

Part one of this two-part series explores some of the common problems which may arise with a weak or non-existent fixed asset policy. Part two will provide additional strategies which you can use to improve your fixed asset policies.

Before acquiring fixed assets

Before acquiring fixed assets, particularly if they are expensive, are an integral part of operations, will have high operating costs or are otherwise significant:

  1. Ensure that the asset will meet the organization’s needs and is the most cost-effective solution. Quite often organizations purchase equipment or other assets, only to discover that the purchase does not have all the features they expected or does not meet the basic needs of the organization.
  2. If an asset needs to be compatible with existing equipment or systems, make this determination early into the investigation stage and eliminate incompatible assets from consideration.
  3. Preparing a business case is one way to analyse suitability, compatibility, cost and other criteria. A business case for an asset purchase will include the following essential steps:
    1. Identify the requirements or needs.
    2. Identify the specific users or user departments that have the need or requirement. Their input into the evaluation process will be essential.
    3. Prioritize the requirements if they are too numerous or if a single asset or purchase cannot meet all the requirements.
    4. Identify at least 2 or 3 potential solutions to evaluate. To make evaluation easier, prepare a table or grid. List each prospective solution across the top row and list the desired features or requirements down the left column. List the most important requirements together and at the beginning of the table. Put Xs or tick-marks in the grid beneath any solution that delivers the desired requirements or features.
    5. Identify all costs to acquire the asset. It may be easier to do this if a third-party vendor supplies the asset. In that situation, the supplier will likely provide the organization with an all-inclusive purchase price. More difficult is the situation where the organization must construct or assemble the asset. In that case, it will need to accurately estimate the true cost of the acquisition, by properly identifying and valuing all the inputs that will go into constructing the asset.
    6. Identify all benefits – quantitative (for example, the capability to process sales or other accounting information) and qualitative (for example improved morale).
    7. Evaluate – it is helpful to reduce costs and benefits to a dollar or numeric value to facilitate comparisons between prospective solutions.
    8. Choose. Confidently select an asset, based on hard numbers. But also know that sometimes, it boils down to more than numbers. For instance, it may be a regulatory requirement that a certain asset is acquired, even if the acquisition makes no financial sense.
  4. Obtain the required approval from the board or management.
  5. Implement or improve internal controls to handle the following common sources of fraud and error:
    Acquisition of assets

    • Failure to capitalize assets, and instead, treating the expenditure as repairs and maintenance.
    • Not recording asset purchases at all, and then misappropriating the asset.
    • Paying for and recording the asset, and subsequently removing it from the organization’s premises without authorization (stealing or borrowing).
    • Recording the acquisition in the wrong accounting period. These cut-off errors often occur when purchases are made around the year end.
    • Failure to take title to assets in the organization’s name. Verify that title has been taken in the organization’s name, and not in the name of an employee or a related party. Whomever has title to the asset can use it for all sorts of other unauthorized purposes, including using the asset as collateral for loans.
    • Failure to record the full cost of the asset. Import duties, unrecoverable sales tax, installation costs and any other costs directly associated with installing the asset and putting it into use, should be capitalized.
    • Failure to allocate cost appropriately. If a payment relates to both capital expenditure and repairs and maintenance, organizations should ensure that the appropriate amount is capitalized, and the correct amount expensed. Additionally, if the organization makes a single payment for a group of assets, it should ensure that each asset is allocated the appropriate cost. For instance, if land, buildings and equipment are purchased as part of one lump sum payment, the organization must determine the amount to capitalize for each category of assets.
    • Paying inflated amounts for assets because of kick-back schemes.
    • Misidentifying capital leases as operating leases, and vice versa.

Disposals or impairment

  • Misappropriating assets by writing them off as obsolete or sold, and then removing the assets from the premises.
  • Recording a disposal in error, when the asset is still in use within the organization.
  • Not updating the accounting records to reflect asset sales or donations of assets.
  • Selling the asset at well below market value to friends or associates.
  • Failing to identify that assets are obsolete because of their physical condition or technological changes, for example. It is possible that useful lives may be miscalculated at the time of acquisition. If the organization mistakenly believes it has a useful asset on its balance sheet when in fact it has a dud, it likely will not budget for its replacement. A critical asset which fails, will be very disruptive to the operations.

Depreciation

  • Over-depreciating assets, by calculating depreciation for assets that are already fully depreciated, creating a credit balance for net book value.
  • Mis-posting depreciation charges to another profit and loss or income statement account.
  • Calculating depreciation charges incorrectly. These errors could involve arithmetic errors or applying the wrong depreciation rate to an asset.
  • Failing to maintain records for capital cost allowances (CCA) for corporate tax purposes. CCA rates are mandated by income tax law and can be different from the internal rates used for depreciation.

Disclosure

  • Misclassifying assets in the wrong categories, for example classifying computer equipment as office furniture. This will cause disclosure errors in financial statements, as well as errors in the calculation of depreciation, if assets have different depreciation rates.
  • Misclassifying capital leases as repairs and maintenance expenses.
  • Failing to reconcile fixed assets disclosed in the financial statement notes to the general ledger. Either balance could contain errors.

Physical Asset inventories

Many organizations do not carry out fixed asset inventories. In other instances, inventories are carried out but are not properly planned, creating the following problems:

  • Failing to evaluate the physical condition of assets, and instead, focusing only on verifying the existence of the asset.
  • Failing to follow up on the results of the physical count of assets. The organization must decide beforehand, what steps it will take if assets cannot be found or if more assets are found than it has on its records. Either of these scenarios are red flags for frauds, errors and other internal control issues.

The second and final part of this series will explore additional strategies to strengthen your fixed asset policy.

Apolone Gentles, JD, CPA,CGA, FCCA, Bsc (Hons)

Apolone Gentles is a CPA,CGA and Ontario lawyer and editor with over 20 years of business experience. She has held senior leadership roles in non-profit organizations, leading finance, human resources, information technology and facilities teams. She has also held senior roles in audit and assurance services at a “Big Four” audit firm. Apolone has also lectured in Auditing, Economics and Business at post-secondary schools. Read more here
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