Carnegie’s Property, Plant And Equipment Account Representing An Audit Risk

One of Carnegie’s accounts which represent an audit risk is Property, Plant and Equipment. There are several reasons why this account is particularly at risk. The main reason is that its sudden increase in value across the last financial year (see preliminary 2018 financial report) and its ties to the CETO component of the intangibles account, which has recently been written down by approximately 42% of its total value (see note 4 of preliminary 2018 financial report). The change in the PPE account’s value should draw the attention of the auditor due to the fact that any drastic change in the value of an account which is significant to the operation of a company is noteworthy. PPE is Carnegie’s second largest asset account behind intangibles, and it will be crucial to the company’s revenue making ability in the future as its PPE assets will generate the electricity it desires to sell. The rapid increase in PPE on Carnegie’s balance sheet immediately suggests that existence is an assertion which the auditor should investigate. This is due to the fact that there is a clear incentive for management to overstate this amount in a time such as this when the company is in financial distress, as well as the possibility that the drastic change in this account’s amount has led to an accidental overstatement.

The fact that Carnegie’s CETO assets were written down by $35 million earlier this year, has implications for the audit risk of the PPE account due to the fact that these accounts are inherently linked. The PPE account includes power generating wave buoys which were built according to the specifications of the intellectual property which comprises the value of the intangible assets account. The fact that the value of the intellectual property of Carnegie’s CETO buoy design has been slashed may indicate that a similar write down could be required for the existing CETO buoys, however no such write down is evident in their 2018 preliminary financial statements. Also, due to the intense nature of competition in the renewable energy market, the PPE account of the company is likely to face a downward valuation pressure. This is sufficient to question the valuation of the assets which make up this account, and consequently accuracy, valuation and allocation is the second assertion which we believe an auditor should investigate for PPE.

The substantive test which our group suggests the external auditor undertakes for the purpose of investigating the assertion of existence of Carnegie’s PPE can be summarised as a vouching of invoices, followed by a physical examination of assets, and finally an inspection of legal title documents. This test is designed to ensure that the figure for PPE on the statement of financial position does in fact correspond to assets that the company both possesses and owns. It is likely that it would not be possible to perform this test for every item of PPE listed on Carnegie’s asset register, in which case testing randomly selected samples would be appropriate. Such a test would require minimal internally generated information from Carnegie and consequently the the auditor should have no doubts regarding the reliability of the results generated by this method of testing. This manner of testing is common practice and is used by many auditors tasked with auditing clients with large and variable PPE accounts. The fact that some of Carnegie’s assets exist underwater (such as their CETO buoys) may potentially complicate the inspection process, however the verification of the existence of these assets would be crucial for the audit of this client.

The main audit standard that we will be considering for the nature of PPE is ASA 500; Using the Work of an Auditor’s Expert. ASA500 requires auditors to obtain sufficient appropriate evidence to draw reasonable conclusions on clients’ financial statements. It also provides some useful methods for auditors to obtain evidence such as inspection, observation, external confirmation, recalculation, reperformance, analytical procedures and enquiry. These provides some fundamental guidance for designing the audit procedures to valid the assertion of AVA and existence. However, in order to obtain sufficient appropriate evidence in the valuation of PPE of Carnegie, the auditor may rely on expert knowledge, given the specialised renewable energies technology equipment is beyond the scope of accounting or auditing, as per ASA620. Also, given the fact that the CETO technology has not yet reached the commercialisation stage, it is difficult for auditors to confirm a readily observable market price for the equipment. Moreover, there exists high level of uncertainty on the commercialisation of the wave farm, as evidenced in the fact that Carnegie fails to reach the milestone for government’s grant. Therefore, valuation experts in the renewable energy field may need to be engaged or employed for developing a reasonable estimated value for the equipment of Carnegie.

According to the above auditing standards and the nature of the risk of material misstatement of the PPE account in Carnegie’s statement of financial position, the following substantive test of details are recommended. The audit procedures are assumed to be performed at the financial-year-end audit. First, random samples of each class of equipment and plants would be drawn from the PPE register as at the end of the financial year. According to ASA530; Audit Sampling, the sample design depends on the nature of the underlying population and the purpose of the auditing procedures. For example, assume Carnegie has only three plants in its register. Auditors might choose the whole population other than sample for testing because of the small population.

On the contrary, assume Carnegie has over a thousand sets of machines with historical cost of 100 dollars each. Due to the low unit value of the machines and the high number of units, a random sample might be drawn from the population for further substantive testing. After deciding the sample structure, the auditors could recalculate the value of the PPE by using the inputs and assumptions from the clients, then compare the results with clients’ results. This procedure can help to find arithmetical errors and ensure accuracy of the record. For some specific classes of advanced or machinery which are yet to be commercialised, the auditors would obtain reasonable estimates of the value of the equipment by using the work of valuation experts, who focus on the renewable energy industry. Before the commencement of the experts’ engagement, the auditors should make enquiries about the experts’ competence, capability and objectivity. The auditors could ask the experts to submit independence declarations and review the experts’ previous work to confirm the competence and capability. Also, the auditors should make a reasonable agreement with the experts detailing the nature and the scope of the experts’ work and the auditors and experts’ duties in the engagement. After getting the report from the experts, the auditors should assess the quality of the estimates provided. They should evaluate the reasonableness of the inputs, reasoning processes and conclusions and check their consistency with other audit evidences. For example, the auditors could cross-examine the predicted sales volume from the experts and the one developed in the audit of the intangible assets account. Also, the auditors should evaluate the source data used by the experts.

Lastly, the auditors would compare the estimated value of the PPE assets from the experts with the value recalculated under the clients’ own inputs and assumptions in the second step. If any material discrepancy is found, the auditors should investigate further. For example, the auditors should make enquiries to the management about the items involved and objectively assess the reasonableness of the management’s inputs and assumptions, then reach the conclusions and recommendation to the management.