The missing element in PP&E controls

With inventory (raw material, work in process and finished goods), for the past 70 years companies have been required to perform a physical count and valuation at least once a year. Further, auditors are required to monitor closely the inventory taking and pricing. In the case of perpetual inventory systems, periodic sample testing is required, again with external auditor input. After the reconciliation of receivables and inventory, adjusting entries must be made to bring the accounting records into agreement with the underlying fixed asset management.

It is equally necessary that the same kind of reconciliation of reported balances to actual physical assets is in place because for many companies, PP&E may represent 35% or more of total assets. Without a periodic reconciliation, the property record system will lose accuracy as items are scrapped or enhanced. If a reconciliation is performed and adjusting entries made, however, the resultant asset category totals have been verified. Management can then sign with confidence the Section 404 certification – its assertion that there is a system of Internal Controls and that the system is working properly.

Very few companies systematically reconcile the assets shown on their property records with actual physical assets being utilized by the organization. Progressive and responsible companies undertake regular physical audits, reconciling what is there with what is supposed to be there (per the property record system).

It is a high risk strategy for company management to sign a Section 404 certification if such an inventory of Fixed Assets has not been taken. Yet many companies are implying each year their Internal Control systems are working without such checks. How is this possible?