As mentioned several times in this book, so-called fixed assets in practice are far from “fixed” physically. It never ceases to amaze those who have taken a physical inventory of PP&E how many items cannot be found where the property record says they should be.

With the possible exception of a 1,000-ton press having a 15-foot concrete foundation, virtually all other pieces of equipment can be moved. And often are moved. Keep in mind that even the largest items were brought into a facility from a supplier and erected or installed there. What moved coming in can still move within a company.

Office furniture and fixtures, including computers and IT assets, are easily moved. Every time there is a corporate reorganization, people, desks, files, and phone equipment, not to mention computers are transferred. These moves are sometimes within the same physical facility or building; at other times people literally move to other locations and take their “stuff” with them.

There is only one way to be absolutely sure that the property register is correct, this is by ensuring that the control totals for PP&E on the general ledger are represented by actual assets where they are recorded as being. This assurance can only be obtained from a physical inventory. Periodic inventories of raw materials, work in process (WIP), and finished goods must be taken at least once a year, and that inventory should be monitored by independent auditors. Product inventories are priced out, reconciled to the books, and the control totals adjusted based on what is owned by the company and found during the physical inventory. The same testing of the controls has not usually been performed for PP&E.

Why is the same set of procedures undertaken by most companies for inventories not performed for PP&E? Basically because it is not absolutely mandated by Generally Accepted Auditing Standards (GAAS). In the 2005 edition of Wiley Practitioner’s Guide to GAAS¹, the only reference to fixed assets is in “Section 326—Evidential Matter,” which presents a listing headed “Source List of Procedures or Evidential Matter.” Under the heading of Physical Observations of Inventory, related to “existence or occurrence” the authors recommend a “plant tour, looking at documents supporting confirmations and acquisitions,” and then a general requirement that auditors review “minutes, representations, and other information regarding management’s intention to abandon or dispose of fixed assets.”

Following that, the authors then suggest auditors review “Documents supporting acquisitions, including authorizations in minutes, construction contracts, purchase orders, invoices, work orders, and so on.” Also required, according to the authors, is “confirmation of fixed assets pledged under loan agreements, and so on.” Finally, “Confirmation of equipment maintained at outside locations” is called for.

Then, in a catch-all, it is recommended that auditors should look at “Appraisal reports, replacement cost quotations, and so on; recalculation of depreciation and amortization; analytical relationship of current year’s depreciation and amortization to fixed-asset costs; and a review of controls over construction contracts payable, vouching of repair and maintenance expense accounts and review of controls over accounts payable and cash disbursements as well a review of control over construction work in progress.”

Nowhere in this 2005 edition is there a reference to any sort of formal audit requirement explicitly to check that the assets on the property register are still there, which is the subject of this chapter. Reviewing approvals for capital expenditures and monitoring payables disbursements represent sound auditing, but our experience, and that of most other valuation specialists dealing in PP&E, is that these audit issues mentioned may be necessary, but they are not sufficient.

Many management letters from auditors to the company recommend year after year that a physical inventory be taken of PP&E. In most instances this recommendation goes to the bottom of management’s priority list, and does not get accomplished before the next year’s audit. The next year’s management letter provides the identical recommendation of taking a physical inventory. This can go on for years.

It is obvious that the auditing focus has been on proper authorizations for acquisition and disposition of fixed assets and correct calculation of expense items. Given the accuracy of modern software, reviewing the depreciation calculations themselves is going to be an exercise in futility. What is important is that the basic records themselves are accurate and nowhere does it seem that auditors must monitor a taking of a physical inventory of PP&E, the way they are required to do for inventory records of raw materials, WIP, and finished goods.

When we come to the current edition of the Wiley Practitioner’s Guide to GAAS—2010,² things are even murkier. Section 326 has been renamed “Audit Evidence” as a result of the issuance of SAS 106. Now in the index to the latest volume there is no entry for fixed assets, neither is there an entry specifically related to PP&E.

Section 326 does require the auditor to challenge management assertions about the existence of assets shown on the balance sheet. Also the valuation of those assets (should there be an impairment charge?) should be challenged, according to the Guide. Nowhere is there an explicit requirement that periodic inventories of fixed assets be taken, compared to the property record and differences reconciled. Yet it is hard to understand how management, as well as independent accountants, can assert the property register is correct without verification from an inventory.

Certainly, our experience with client asset listings suggests that there can be upward of 15% discrepancies. For almost any company, an error of ± 15% of PP&E would have to be deemed “material.” We predict that as more experience is gained with Sarbanes-Oxley (SOX), and as other systems are improved it is only a matter of time that proper attention will be given to inventory and reconciliation of fixed assets.

Asking the question provides its own answer. Some easy means of identifying specific items is necessary. Most companies tag assets as they are acquired. This tag number is physically attached to the asset itself. The tag number then becomes the primary identifier in the property record. So, if you want to find out about a particular machine tool, entering the tag number (sometimes called the asset number) into the master property file will bring up the complete record. A moment’s thought will confirm that this is essentially the only approach that will work when trying to find a specific asset in a file that may have thousands of items.

The tag should be physically placed on the asset at the time it is received. Some one individual, or department, has to be tasked with this responsibility. It is totally unrealistic to expect someone in the accounting department to run down to the receiving dock every time you receive an item classified as having to be capitalized. Exhibit 6.1 is an example of such a tag, which has detachable labels that can be placed on the appropriate paperwork, showing that the tag was attached, and that the tag number is for that specific asset. Further, since the tags come in prenumbered, this can provide a numerical control for purposes of further internal control.

The tags are usually ordered from a source that specializes in this specific function, and below we discuss the alternatives available. The tags will be received preprinted, each with a unique number. After the tag is affixed to the physical asset, a document must be prepared that sends the information to the property accountant; alternatively with appropriate software the information could be transmitted automatically. Since most items will have a purchase order (P.O.), it should be sufficient for the receiving department to reference the tag number, a brief description of the asset, its manufacturer’s serial number, and the P.O. The property accountant can then go to the P.O. file, or the capital expenditure (capex) control file, and obtain all of the information needed to add to the master record.

Consider when an item previously capitalized, one already in the master file, is disposed of; all that is necessary is to reference the asset or tag number which should trigger accounting entries. The accounting requirements, to record any cash received and reverse out the asset and accumulated depreciation, should immediately follow the physical disposition. Important as it is, this notification is even more important on a trade-in. There will have been no cash receipts to trigger an entry.

A P.O. will probably reference the existence of a trade-in, or the trade-in may be in the capex approval file; in any event failing to record trade-ins is the primary cause of many errors in internal control. The reverse is also sometimes true. A vendor will offer to accept a trade-in as a means of lowering the purchase price, the company accepts that offer, but the vendor has zero use for the old asset and neglects to collect it and take it off the premises. Then what happens is that accounting records will reflect this assumption that the trade-in physically has taken place, when in reality the old asset is still there. The company may well have written the old asset off the books, and stopped calculating depreciation expense. But, of course, the asset is still there and available for use.

Again, this practice, of a vendor not removing a trade-in, is one of the many causes for discrepancies between the file and the floor. There is no easy or good solution for this other than monitoring by internal auditing that corporate fixed-asset policies are being followed. This is not to suggest that a company should force a vendor to take the asset. It does mean that a potential uncertainty should be resolved one way or the other.

There is, theoretically, a third which would be a simple numerical label without a barcode. Actually, a barcode tag is nothing but a “numerical” label, where the number on the tag is represented by a barcode font, and usually by a human readable font as well. There is really no difference between the tags, it is just a matter of making data entry faster and more accurate by using a barcode, and a barcode reader for data entry, rather than a human typing on a keyboard. Inasmuch as the cost of maintaining good internal control over fixed assets is substantial, considering periodic physical inventories and subsequent reconciliation, while going for the absolute lowest cost approach makes little sense. Rather, the choice between barcode and RFID should be made on a Total Cost of Ownership basis.

The “do-it-yourself” tags, especially in that price range, are generally inkjet on paper or thermal resin on paper solutions. They are not the thermal resin on polyester, security polyester, laminated polyester, security reflective vinyl, Lexan Laminated polyester, or metal tags that most asset tag companies offer. In terms of durability (both indoor and outdoor, and in extreme environments), and chemical resistance, there is no comparison. Do-it-yourself solutions are only appropriate for very light duty applications, where the tag itself will not even be handled by anyone once it is applied.

A quick refresher: Barcodes are what we see on consumer-goods packages. They are the funny lines on the box that goes through a scanner at a supermarket checkout counter. The printer has coded the label with an item number, and the scanner is hooked up to a computer that looks up the product number and prints out the unit price. Alternatively, at the meat counter a local printer picks up the description, the weight per pound, the number of pounds, and calculates a total price which is then printed out and subsequently read by the scanner at the checkout counter.

For fixed assets the barcode label would have on the tag the consecutive serial number previously assigned to the asset. This asset number is associated, on the master property asset register, with all the relevant information maintained on that asset in the master file, not on the asset tag.

In taking a physical inventory, the auditor or analyst would point the barcode reader at the barcode label previously affixed to the asset. The reader sends out a beam, often a laser, which hits the barcode and the asset number is transmitted back to the reader.

The reader can either store the asset number, to be downloaded later, or there can be a wireless Bluetooth connection to the computer holding the master file. This transmission would then check-off that the asset had been located. Also, if during the process of locating the barcodes on assets, an asset was found without a label, this information too would have to be captured, perhaps manually. At the end of the physical inventory, the computer would be set to print out a listing of all the assets that had not been located, at which point the reconciliation process would begin.

Barcode labels themselves can be made almost any size and of any material. Considering that many assets are maintained for 30 or more years, and particularly in a factory environment where there is dirt and grease, one should buy the absolute best labels available on the market, labels that are easily seen and read. The adhesive should also be very high quality, because a “lost” barcode label is going to cause significant problems during the reconciliation phase.

Ideally, labels would be affixed to capitalized items as soon as they are received from the vendor; this function should be part of the formal procedures for the receiving department. The purchase order itself should indicate whether an item is to be capitalized and tagged. This way the staff in receiving will know to affix the appropriate tag. Exhibit 6.1 is an illustration of such an asset tag from Mavericklabel.Com. Their web site provides all the information you would need to order the appropriate labels. While costs vary depending on quantity, size, and type of material, you can obtain very good asset tags for between $0.15 and $0.50 each.

The asset tag shown in the exhibit has one significant innovation, a feature that will be very helpful in internal control. Called the Asset Tracker^® by Mavericklabel.Com there are detachable labels with the asset number. So, when the receiving department physically affixes the tag to an incoming capitalizable asset, the detachable label can be affixed to the receiving report, invoice, or purchase order, thus alerting the property accountant that the asset has been tagged, and what the new asset number is.

Many people think that one of the major reasons for having an asset tag is to prevent theft; think of a personal computer, for example. Candidly, no label is going to stop a determined thief, and there is no such thing as a label or tag that cannot be removed. What the asset tag can do is reduce fraud. It is conceivable that a disgruntled employee could buy an inexpensive laptop and transfer the asset number from the company-supplied MacBook Air. He could walk off with the high-priced computer as he quit, and he would leave behind a computer with an appropriate company asset tag on it; it is just that the tag would not match up the actual computer with the original record assuming someone actually checked it. To counter this potential fraud, some asset tags can be ordered that pop up with the word “VOID” if one attempts to remove the tag from the asset, or which tear into little pieces if one tries to remove it. Either one makes the tag effectively impossible to transfer from one asset to another.

For noncapitalized assets, such as computers, such “VOID” labels might be a very good investment.

The principal disadvantage of barcode tags is that they can get dirty and hard to read, as well as hard to locate. This is particularly true in a manufacturing environment, but also in a process facility (brewery or refinery) where just what has been tagged in prior years may not be clear from a visual examination. Barcode labels, to be read, must be in direct line of sight.

The one thing you want to avoid if possible is to try and take a physical inventory from a printout of the property record showing the assumed location to be on the floor or in the department you are inventorying. Far better to see the tag visually, record it with the reader, have the computer match up what you found, and print out an exception listing.

The one negative to the use of RFID for controlling PP&E cited by suppliers is cost. RFID tags can cost an order of magnitude more per tag than a barcode label and may require some significant system integration efforts through the IT department. As a prediction, in a few years virtually all asset tagging will be with RFID, but we are not there yet.

Let us look at the subject of cost a little more closely. Some studies have suggested it can cost upward of $4 to $5 per year per item, or even more, to maintain the property record. This cost may be exaggerated because of the way the cost calculation is made. Companies are asked how many items are in the property register. Then they take the total cost of the finance department, or controller’s organization, and split it among the dozen or so functional activities in the typical company. So total costs for the department are then split among the functions such as:

Taking the fully allocated cost for the property system, and dividing by the actual number of items in the register usually will, most likely, produce a high number for the “cost per asset maintained.” BUT, these are averages, and certainly do not represent what it costs the company to add one more, or subtract one less, asset from the record-keeping system. So let us cut the average cost more than in half; that still leaves over $1.00 per item per year, just for the accounting function related to PP&E.

Remember, this cost is a yearly cost, and the typical asset has between a five- and 15-year life. That still could come out over the lifetime of an asset to a minimum of $10 per asset item just for record keeping.

Now look at the cost of an RFID tag, maybe $1.50 per item versus $.40 to attach a barcode tag. Yes, the RFID may cost four to five times as much, in percentage terms, but in absolute dollars the net incremental cost of the RFID is little more than a dollar, significantly less than 10% of the lifetime record-keeping cost.

But why incur any incremental cost? If, in practice, the barcode tag and the RFID tag produced the same results, it would not be worthwhile. The RFID tag has one great advantage, however. All other things being equal, it will significantly reduce the time required to take a physical inventory of PP&E. This is because of the way the RFID tag works.

The reader for RFID differs from the barcode reader in one significant way. The beam from the barcode reader must be directly aimed at the tag. So, if the machine with the asset tag attached has been moved and the tag is no longer in sight, then the inventory analyst must hunt for the tag, perhaps go behind the machine to spot the tag and “zap” it. In the worst case, the tag cannot be seen or located and this item now becomes an exception that has to be reconciled and a new tag assigned.

The RFID reader is different. It sends out radio waves, which are picked up on the antenna within the tag, and a response is sent, passively, by the tag to the reader. Now the sensitivity of the reader can be an issue. The reader probably has to be fairly close to the tag, within a few feet, to cause a response. But the tag does not have to be visible to the eye to obtain a hit. Thus, the inventory analyst, carrying an RFID reader, need only be close to the tag and the item will be identified.

If you think about the cost of taking a periodic physical inventory, and the work involved, which would you prefer? The barcode that must be physically seen, or the RFID tag which need only be close to the reader even if it is not visible? It is hard to generalize how much time is going to be saved in taking an inventory with RFID tags, rather than barcode tags. It is hard to imagine, however, that the RFID tag system could take more time.

When you consider the relatively high hourly rate of people taking a fixed-asset inventory, not to mention subsequent reconciliation efforts, it takes very little time reduction to fully justify the initial expenditure on the RFID system. This of course assumes that the company has adopted a relatively high minimum capitalization threshold; this minimizes the number of assets that must be located and accounted for, thus making the higher initial unit cost virtually de minimis.

There are a couple of caveats, however, before going down the RFID path. Initial capital expense for implementing a system may be substantially more. It is not just the cost of the RFID labels. Readers can run into the multi-thousands of dollars, while barcode readers can be less than $100. It gets even more expensive if you want a real-time system that monitors all floors and rooms of your facilities, so you can locate an asset without having to do an inventory. That, however, would most likely be a second-step in a program of internal control for fixed assets.

RFID installations generally require an integrator to work with the customer onsite for initial needs assessment and installation. Otherwise, the customer may be buying a whole lot of incompatible hardware.

Another aspect of RFID asset management that is often overlooked is that without individual discipline, it is much more open to the fraud problem that VOID asset tags or destructible vinyl asset tags are designed to prevent. If the inventory procedure does not include actually verifying the tag on the asset, then fraud might be possible and the perpetrator go absolutely undetected.

All one would have to do is take the RFID asset tag off the asset, and leave it somewhere near where the asset was, and where it would be when an inventory is done. If the inventory person does not actually physically verify the asset, they will see the response from the RFID asset tag, and assume everything is okay. In reality, though, instead of a valuable asset, all the company would have is a worthless RFID tag!

Particularly for IT equipment such as personal computers, cell phones, and other small portable items, companies must attempt to control these assets. If a business has a very good, functional, property control system, it should be used for all corporate assets, particularly those that might “wander off” if an employee quits.

This means that a property tag can be affixed to a computer or other mobile device, and the tag number and asset description recorded in either the main property system, or in an “off-line” system specifically set up for expensed items.

In other words, the decision whether to charge an item to expense, or to capitalize it, can and should be made irrespective of whether a property identification tag is on the asset or not. Elsewhere we recommended a relatively high minimum threshold for capitalization, perhaps $5,000 per unit. The purpose or objective is to minimize the number of assets the company must reconcile if it is to meet the requirements of good internal control. It certainly is easier to control or look after 2,000 items than 10,000 items, particularly when you should be taking a periodic physical inventory.

But having a high cut-off does not mean you throw caution to the wind and disregard valuable equipment, simply because the initial cost of the item is below the capitalization level set by corporate policy. Many companies put the responsibility for mobile equipment in the hands of Human Resources (when people quit they have to turn in their equipment) or in IT (where assets, including software, can be controlled and upgraded as necessary).

Internal control, in short, does not start and stop with capitalization policies. However, what has been capitalized, and appears as an asset on the firm’s balance sheet, does have to be reconciled periodically. Expensed items do not have to be inventoried to comply with SOX, although good practice suggests that a periodic check-up is a good idea. Having a property record for capitalized assets, however, that is not representative of total corporate assets is prima facie evidence that certain key elements of internal control are missing.

Keeping track of valuable assets, whether or not written off initially to expense, is also an important part of internal control. Neither internal auditors nor independent accountants (outside auditors) usually monitor or report on expensed items. This is probably the reason that companies use low capitalization limits, just to be sure that attention is paid to low-cost but nonetheless valuable assets. But, as discussed in Chapter 2, if the property file is too large, it becomes overwhelming to carry out a complete physical inventory.

Based on the discussion in the previous section of barcode versus RFID tags, for expensed items a barcode label is undoubtedly going to be sufficient. It should be easy to locate a barcode tag on a cell phone or personal computer, and the only issue is making sure that the label material itself, the adhesive, and the printing on the barcode label will withstand constant handling.

The second file, of items charged to expense when acquired, can be used by internal managers to help evaluate current and projected expenditures, monitor usage, retrieve assets from departed employees, and generally minimize risk. IT departments have to know what hardware is hooked up to the company network, both for control and productivity. Paying for software by the number of actual users requires accurate information, as does the understanding of projected replacement for both hardware and software.

Essentially there are different uses for these two files, even though on the surface they both deal with company-owned “assets.” Trying to put all this data in one large massive file actually works against the goal of true internal control. For this reason we strongly recommend maintaining two separate systems, although the same software can be used for both systems.

The true property record represents the assets that are on the balance sheet, assets which must be accounted for to meet the SOX requirement. The second file is a management tool that may increase productivity and reduce costs.

These two files have certain similarities, but trying to combine them in one overall system will actually be counterproductive.

There are two basic types of asset tags: barcode and RFID. Barcode tags are much less expensive initially. In taking a physical inventory of PP&E it may be difficult to locate the tag, which then involves research time to reconcile. The advantage is that the inventory analyst does have to look at the asset and make sure it is as described in the property ledger. You want to avoid having the tag on an expensive asset moved by an employee to a similar but less expensive asset.

RFID tags are substantially more expensive when you include any necessary software integration. Once the system is set up, RFID will significantly reduce the amount of time required to take the type of physical inventory we believe is required by SOX.