Management usually assumes that since fixed assets are “fixed” there should be little trouble monitoring what is going on. Accountants are concerned with calculating annual depreciation charges, for their company’s books and taxes. Occasionally, the property record will be the basis of decisions on insurance coverage for the assets. Even less frequently, property tax assessments may be challenged, but this is often the responsibility of the tax department.

So while there are many uses, and many users, of a good property tax accounting system, the one thing that is usually lacking is a reconciliation of the books of account to the assets actually present physically. While every company takes a physical inventory of raw materials, work in process, and finished goods, very few actually take a look at their “fixed” assets and compare what is there with what the property record says is there.

In short, there is a gap here in Internal Control, a gap that goes on year after year. The assumption is often made, “Well our records might not be perfect, but they were good enough to get by our audit last year, nothing has changed, so we should be okay this year.” Further, auditors and managements often are more interested in year to year comparisons rather than the value of absolute amounts. So if this year’s depreciation expense can be reconciled to last year’s depreciation expense, allowing for additions and deletions, everything is assumed to be correct.

Compounding the issue is that while the subject of Internal Control has generated tremendous interest following adoption of Sarbanes-Oxley (SOX), most efforts have been devoted to areas such as revenue recognition and financial instruments. By and large independent auditors review fixed-asset accounting controls, make sure there have been no changes since the previous audit, and wish for the client to take and reconcile a physical inventory. Many management letters from auditors to audit committees and the Chief Financial Officer (CFO) have almost a boilerplate recommendation that such an audit should be undertaken.

Taking, and reconciling, an inventory of PP&E is a major project. Particularly in a period of retrenchment, when the company has to “do more with less,” the priority of a physical inventory of PP&E inevitably “slips” until the next year comes around and the process starts again. This state of affairs continues because PP&E is seen as having a lower priority than many other aspects of Internal Control. Items which command the attention of auditors become a priority of the audit committee. In turn, auditors’ priorities are set by their perception of what the Public Company Accounting Oversight Board (PCAOB) is focusing on. And, to date, PCAOB has not put emphasis on their reviews on what the audit firms did with client PP&E. As noted, revenue recognition and financial instruments at fair value seem to have a much higher PCAOB priority.

But what if the PCAOB starts to review auditor workpapers dealing with PP&E on a more intensive basis? Most auditors’ workpapers would likely come up short. Unfortunately, if the PCAOB was to start putting PP&E on a priority basis, companies would feel intensive pressure from their external auditors.

As will be discussed in this book, developing a sound system of internal control for fixed assets, and cleaning up past errors and omissions, are not trivial efforts. Realistically they really cannot be done in less than one to two years, assuming that all other financial and operating functions of the business must continue to be carried on at current rates. Put another way, extra resources will inevitably have to be devoted to fixing existing fixed-asset systems. This will cost time and money, which most management will begrudge—which of course is the reason we are where we are today.

This is the first comprehensive book to focus on Internal Controls for Fixed Assets. It is a step-by-step guide to developing and maintaining a functioning internal control system that will withstand the closest scrutiny from independent public accountants and ultimately the PCAOB.

We recommend strong internal audit involvement in diagnosing the current condition of the present fixed-asset accounting system. Internal audit should also be involved in the development of specific recommendations for the required remedial work. Performing the actual required work should probably be managed by existing accounting and operations staff often with the help of outside consultants. Depending on the speed with which the company wishes to finish the task, some temporary help may be necessary, and use of an outside consultant may be cost effective.

At the time this is written it is not clear whether the United States will or will not have adopted International Financial Reporting Standards (IFRS). Nonetheless, and in order for this to be valuable even to U.S. subsidiaries that do have to report under IFRS, throughout the book similarities and differences between IFRS and Generally Accepted Accounting Principles (GAAP) will be covered. Two major differences are that under IFRS companies are permitted, although not required, to write up certain assets and investment properties. Second, in case an impairment charge has been taken, a subsequent improvement in the value can be booked, thus reversing the prior impairment charge. Neither of these is currently permitted under GAAP.

As the Financial Accounting Standards Board (FASB) increases the use of fair value, it is possible that PP&E at some time may have to be written up in the United States to current fair value. We briefly touch on this topic, although other books cover this specific subject of fair value in much greater detail. We do cover in detail present requirements for testing for impairment, because this is a subject which potentially affects almost every company.

The primary focus of this book is PP&E, but we also cover briefly certain aspects of intangible assets, primarily those that arise in a business combination.

Because of the importance of SOX compliance, we focus on the role of internal auditing in making sure that companies come as close as possible to full compliance. If independent accountants, given a push from the PCAOB, start to focus on internal controls dealing with PP&E, it will be critical for internal audit staffs to become intimately involved. While the primary emphasis is on the accounting and management control aspects, it is clear that internal audit must be fully knowledgeable of what the current state of affairs is, and what the ultimate goal should be.

Inasmuch as this is probably one of the first books written on the subject, the author will welcome comments and suggestions from readers for subsequent editions ([email protected]). It is impossible to cover everything of importance and undoubtedly certain topics will have been inadvertently left out. All help will be graciously accepted.

Readers are not expected to sit down and read this book from cover to cover. Rather it should be considered an overall guide to the total subject. Each chapter more or less stands on its own. References to material in other chapters are given. Nonetheless, there is some overlap, and this represents a conscious decision to make the book as user friendly as possible.