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Case Study IDT is a small company located in San Jose, CA and you have been appointed as the new auditor to the company. The company was established three years ago. They have one manufacturing plant in Fremont, CA that mainly produces the metal shells for smartphones and tablets. The company turned a profit of approximately $6 million dollars last year, with outstanding debt of $250 million and issued equity of $50 million. The company obtains the design specifications from the smartphone and tablet companies and then manufactures the ordered metal shells at their facility in Fremont, CA. Their prior year financial statements reflected they had $245,657,995 of original cost and $15,655,487 in accumulated depreciation. 1. Describe the main risk areas relating to fixed assets the auditor should focus on and why you believe that is a risk area. 2. Provide a list of the main audit steps to audit the Fixed Assets of IDT Manufacturing. 3. Provide 3 examples of how management can possibly mislead the auditor during the audit of fixed assets with the intention of inflating net income (i.e. what are areas in the accounting for fixed assets where management might cook the books and try and mislead the auditor)? This assignment will form part of your overall grade. Answer; Facts Given Profit $6M Debt $250M Equity $50M Cost of goods $245.7M Accumulated depreciation $15.7M 1- Main Risk Area's In Fixed Assets Amortization or depreciation which does not reflect the economic use of the asset. High chance that IDT has fixed assets that its useful life had expired and it is still setting in their books. (High) Unrecorded asset disposals and incorrect computation of gains/losses on asset disposal. Obsolescence or impairment assets and failure to recognize impairments in value. Restructuring charges related to changes in nature of the business. Incorrect recording of assets, hidden by complex ownership structures designed to keep assets off their books. Incorrect valuation of assets acquired as part of a group purchase. Improper recording of capital leases as operating leases and capitalization of costs that should be expensed. 2- Steps to Audit Fixed Assets; Completeness - Trace from fixed assets to the property, plant and equipment subsidiary ledger- to determine that the assets are recorded. Classification - Obtain or prepare an analysis of the repair and maintenance expense account- to consider if any items should be classified as capital expenditures. Review lease agreements- for determining whether assets should be capitalized. Accuracy - Review rental revenue and property tax expense- by obtaining a map of rented and leased property; this procedure will help determine the accuracy of the rental revenue and tax expense accounts by exposing the entire client's real property, thereby enabling a thorough evaluation Rights & Obligations - Verify the client's ownership of the assets- by examining titles to the fixed assets Valuation & Allocation - Reconcile the property, plant and equipment subsidiary ledger with the general ledger- to determine that the accounting for property, plant and equipment transactions was consistent. Recalculate the accounting for retirements of fixed assets. Review depreciation methods- for consistency with prior periods. Review useful lives- for appropriateness and consistency with prior period. Recalculate depreciation computations Existence - Vouch from the property, plant and equipment subsidiary ledger to the fixed assets- to determine that the assets actually exist. Vouch acquisitions to purchase orders or contracts approved by appropriate personnel. Presentation & disclosure Assertions - Review loan agreements- to verify any loans collateralized by property or equipment for proper disclosure 3- Examples; Overstate fixed assets; management may intentionally understate the depreciation expense each year, such as by using an unrealistic service life. The smaller expense translates into a larger net income, which increases equity. The accumulated depreciation contra asset account that appears on the balance sheet also is understated so that the net plant and equipment added on the asset side of the balance sheet is overstated. Thus, the balance sheet still balances