The audit of depreciation and vouching of depreciation are essential parts of financial statement auditing. In modern accounting practices, auditors also focus on amortisation audit procedures to ensure that expenses related to tangible and intangible assets are properly recorded and disclosed. This blog explains the key audit procedures for depreciation and amortisation, along with important audit vouching techniques used by auditors.
Introduction to Audit of Depreciation and Amortisation
One of the key principles of the accrual basis of accounting requires that an asset’s cost is proportionally expensed based on the period over which the asset is expected to be used. Both depreciation and amortization are methods that are used to prorate the cost of a specific type of asset over its useful life.
Depreciation represents the systematic allocation of the depreciable value of an item of PPE over its useful life while amortization represents the systematic allocation of the depreciable amount of an intangible asset over its useful life.
Depreciation and amortization generally constitute an entity’s significant part of overall expenses and have a direct impact on the profit / loss of the entity. Hence, auditors need to verify and ensure that such expenditure is appropriate, accurately calculated, and has been accounted for as per applicable provisions of the Companies Act or other statutes, to the extent applicable on the respective industry and as per generally accepted accounting principles.
The importance of vouching depreciation in audit lies in ensuring the accuracy of financial statements and preventing overstatement or understatement of profits. Auditors use different vouching methods for depreciation accounting to verify the correctness of depreciation and amortisation expenses.
Objectives of Vouching of Depreciation
The auditor needs to consider the following attributes while verifying depreciation and amortization expenses. These are important depreciation audit procedures followed during the audit of depreciation and amortisation audit process.
- Obtain an understanding of the entity’s accounting policy related to depreciation and amortization.
- Ensure the company policy for charging depreciation and amortization is as per the relevant provisions of the Companies Act/applicable accounting standards.
- Ensure the accounting policy has been applied consistently year after year. Any change in the accounting policy has been adequately disclosed.
- Verify whether the depreciation has been calculated after making an adjustment of residual value from the cost of the assets.
- Verify whether depreciation and amortization charges are valid.
- Ensure depreciation and amortization charges are accurately calculated and recorded.
- Verify whether all depreciation and amortization charges are recorded in the appropriate period.
- Ensure the parts (components) of each item of property, plant, and equipment that are to be depreciated separately have been properly identified.
- Verify whether the most appropriate depreciation method for each separately depreciable component has been used.
- Obtain an understanding of the entity’s process of charging depreciation and amortization.
Verification of Fixed Assets and Supporting Records
As part of audit vouching techniques, auditors carefully examine fixed asset records and supporting documentation. These steps help explain how auditors verify depreciation expenses in practical auditing situations.
- Obtain the fixed asset register maintained by the entity. There is always a risk that an entity could capitalize expense of revenue nature to increase its profit or charge capital expenditure directly in income and expense statement to reduce its profit.
- To address this risk, the auditor may choose to check the nature of asset from fixed asset register.
- Further, there is always a risk that fake asset has been capitalized in the books and to mitigate this risk, auditors should physically verify the fixed assets, at least the ones that are material in value.
- Obtain a list of all additions/deletions along with their proper approval from the authorized person for the same.
- Select the sample of assets from the Fixed Assets Register, on materiality considerations and verify the rates of depreciation and depreciation calculations.
- Obtain the list of all the components identified by the management.
Audit Procedures for Depreciation and Amortisation
The following are essential audit procedures for depreciation and amortisation used by auditors while conducting the audit of depreciation and amortisation audit.
- Ensure intangible assets like patents, goodwill, and copyrights have been properly amortized over the period.
- Ensure depreciation is charged on the assets from the date when it is ready to use and not from the date of actual usage.
- Ensure depreciation on the revalued amount has been properly accounted for revaluation reserve.
- Depreciation computation as per Income Tax Act, 1961:
- Ensure that additions are tallying with the additions as per the Companies Act.
- Ensure the opening WDV matches the Tax Audit Schedule for the assessment year preceding the previous year under audit.
- Perform analytical procedures to obtain audit evidence as to the overall reasonableness of depreciation and amortization expense.
- Check the arithmetical accuracy of records and perform independent calculations.
- Example: Re-compute the depreciation expense for the year.
- Ensure that the depreciation and amortization have been charged as per the useful lives of PPE and intangible assets.
- Ensure that residual values have been properly verified as that impacts the computation of depreciation.
- Ensure that the depreciation and amortization have been computed prospectively whenever there is any change in the useful lives of PPE and intangible assets.
Depreciation and Amortisation Audit Checklist
The following depreciation and amortisation audit checklist helps auditors ensure that all major compliance and accounting requirements have been properly reviewed:
- Verify accounting policy for depreciation and amortization.
- Check useful life of assets as per Schedule II to the Companies Act, 2013.
- Verify residual value calculations.
- Confirm depreciation method adopted by the entity.
- Review consistency in depreciation policy.
- Recalculate depreciation expense independently.
- Verify additions and deletions in fixed assets.
- Ensure proper amortization of intangible assets.
- Review disclosures related to depreciation and amortisation.
Required Disclosures
Ensure whether the following disclosures, as required, have been made:
- Accounting policy for depreciation and amortization.
- Useful lives of assets as per Schedule II to the Companies Act, 2013.
- Residual value of assets.
- Depreciation method.
FAQs on Audit of Depreciation and Amortisation
1. What is vouching of depreciation in audit?
It is the process of verifying whether depreciation expenses are correctly calculated and recorded as per accounting standards.
2. Why is the audit of depreciation important?
It helps ensure accurate profit calculation and proper asset valuation in financial statements.
3. What are the common audit procedures for depreciation and amortisation?
These include checking fixed asset registers, verifying depreciation rates, recalculating amounts, and reviewing disclosures.
4. How do auditors verify depreciation expenses?
Auditors examine records, review accounting policies, verify asset details, and recalculate depreciation figures.
5. What is included in a depreciation and amortisation audit checklist?
It includes checking accounting policies, useful life, residual value, depreciation methods, and disclosure compliance.