AUDIT OF DEPRECIATION AND AMORTISATION TAXCONCEPT

One of the key principles of 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 systematic allocation of the depreciable value of an item of PPE over its useful life while amortization represents 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 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 as per applicable provisions of Companies Act or other statutes, to the extent applicable on the respective industry and as per generally accepted accounting principles.

Auditor needs to consider the following attributes while verifying for depreciation and amortization expenses:

Obtain the understanding of 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 Companies Act/ applicable accounting standards.

The accounting policy has been applied consistently year on year. Any change in the accounting policy has been adequately disclosed.

Whether the depreciation has been calculated after making adjustment of residual value from the cost of the assets.

Whether depreciation and amortization charges are valid.

Whether depreciation and amortization charges are accurately calculated and recorded.

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.

Whether the most appropriate depreciation method for each separately depreciable component has been used.

Audit Procedure

Obtain an understanding of entity’s process of charging depreciation and amortization.

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 and 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.
Ensure Intangible assets like patents, goodwill, copy rights 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 revalued amount has been properly accounted from revaluation reserve.

Depreciation computation as per Income Tax Act, 1961- Ensure that additions are tallying with the additions as per Companies Act and the opening WDV to the Tax audit schedule for the assessment year preceding the previous year under audit.

Perform analytical procedures to obtain audit evidence as to overall reasonableness of depreciation and amortization expense- check the arithmetical accuracy of records and perform independent calculations. For ex- Re- compute the depreciation expense for the year.

Ensure that the depreciation and amortization has 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 has been computed prospectively whenever there is any change in useful lives of PPE and intangible assets.