Physical reconciliation of company property records

Independent audit firms have driven the SOX implementation in most organizations. For many companies, compliance with SOX began with their auditors or consultants initially suggesting what had to be done. Outside consultants were probably brought in to help establish and test the controls. Then the company’s independent auditors tested the controls that were put in place so the audit firm could affirm management’s assertions as stated in Section 404. The missing link was that the audit firm overlooked the physical inventory and reconciliation function for fixed assets. In effect, they told management that as long as they had a functioning fixed asset software system, had controls on the acquisition and capitalization of assets and properly calculated depreciation, they were OK.

Further, the Public Company Accounting Oversight Board (PCAOB), while stating that controls over PP&E were necessary, actually did not put emphasis on fixed assets in their reviews of auditor work papers. However, it has been reported that the PCAOB is planning to start a crackdown on what is effectively malpractice.

In the past, where the PCAOB did not follow this up, then the independent auditors, with limited time budgets, did not check that the assets shown on their clients’ property records were actually there. This lack of emphasis on the physical reconciliation of company property records is about to change as the PCAOB puts PP&E higher on its priority list. The PCAOB inspectors will find that some independent audit firms have done little work on asset reconciliation and, if firms are written up for this ‘deficiency’, they will very quickly start scrutinizing their clients’ practices in physical reconciliation of PP&E. When gaps are identified they will have to be plugged, inevitably delaying publication of the final accounts and adding considerable internal and external cost to the audit process.