Why PP&E records are not tested with physical inventory

There is one unique aspect of property accounting that may be the cause of inattention to verifying or validating the records. The very nature of depreciation expense, calculated periodically for financial statements, is that sooner or later the net book value of every asset will be written down to salvage value or to zero.

Assume for a minute that a particular fixed asset is missing, perhaps it was traded in for a piece of new equipment and that information was never entered into the property record. As soon as this is discovered, the company should write the asset down to zero and take a charge to earnings, to correct the inaccuracy of the records.

But what if no entry is made? Then each year a depreciation charge will be taken to expense for the missing asset. After a certain number of years, the book value will automatically have been written down to zero. While this has little impact for a single, low value asset, it can seriously affect profit statements when a larger number of more costly items are involved. In the past, management as well as some auditors, were guilty of looking at one year’s expense total and comparing it to the previous year’s. Under the scenario where an asset should be written off, but isn’t, the reported operating expenses year to year will be comparable (assuming the company is using straight-line depreciation).

This thought process, analyzing the Internal Control of Fixed Assets by comparing one year’s depreciation expense to the next, provides a false sense of assurance. As long as the PCAOB is not reviewing audit firm work on PP&E and audit firms are not reviewing PP&E reconciliations of their clients, then the simplistic analysis that the two years depreciation totals are the same obviates challenge.