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Whitepaper Best Practices for Controlling Fixed Assets

Real Asset Management


White Paper: Best Practices for Controlling Fixed Assets

Real Asset Management

Best Practices for Controlling Fixed Assets What is Internal Control of Fixed Assets? Fixed Assets are sometimes referred to as Property, Plant and Equipment (PP&E) and the terms are used interchangeably. There are three crucial aspects of internal control in relation to fixed assets that top-level management should focus on. This white paper will discuss the three key elements to accurate fixed asset management and offer solutions and recommendations to maintaining accuracy on the asset register. The first imperative of internal control is Sarbanes-Oxley, which requires all publicly traded firms and firms that may go public or be acquired by a public company to have a system of internal controls. Emphasis to date has been on revenue recognition and valuation of financial instruments. It appears that accounting firms, the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) are starting to focus on evaluating company controls over PP&E. Second, a good system of controls over fixed assets, real estate, IT assets and machinery and equipment will help companies reduce both property taxes, and avoid unnecessary insurance expense. Finally, a good property record, with periodic inventories of assets, assists companies in optimizing the acquisition of new assets by being able to transfer unused or infrequently used assets to areas of greater ne

LIFE-CYCLE OF BEST PRACTICES A comprehensive system of internal control of fixed assets encompasses a number of steps. Here are the critical stages: Capital expenditure approval controls are assumed to be in place. In most organizations, amounts above a structured threshold must be approved at senior management or executive level officials in an organization. Set up property record (software) and barcode. Today’s fixed asset software systems have substantial capacity and features. Conversion to a professionally developed and supported system, such as Asset4000, is quick and efficient. Barcode identification is recommended to be used on most assets controlled by the fixed asset software system. Determine life and depreciation method. While many companies use the same lives for corporate book and tax book, there is no requirement that this be done. Many companies would gain from ‘uncoupling’ the two systems. Similarly, different depreciation methods can be used for corporate book and not tax. Assign responsibility for maintaining both the assets and the system. This may be the single most important recommendation in this white paper. In many organizations, responsibility for assets and internal control over those assets is dispersed. Specific responsibilities, with adequate controls, should be a priority in every company. Procedure to track changes and retirements. Perhaps the main reason that fixed asset systems fail to reflect actual physical assets is that changes (including transfers) and retirements of assets (including trade-ins) are never reported and therefore never captured. Physical inventory taken periodically and books adjusted. This is going to be the single hardest thing to do, because it is labor-intensive, and may result in accounting write-downs. By the same token, without such periodic inventories, which are aided by barcodes, it is

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White Paper: Best Practices for Controlling Fixed Assets

Real Asset Management

impossible to certify for SOX compliance that fixed asset controls are working. Fully depreciated assets are a fact of life. Many companies have assigned accounting lives that are less than the real economic utility of the assets. Consequently, many assets that have zero book value (fully depreciated) are still in use. Memo entries into a fixed asset system should be prepared both for internal control purposes and for proper insurance values. Disposals are recorded promptly and accurately. The one true generalization about fixed assets is that they seldom are ‘fixed’. Disposals should be recorded, but if they have not, the only way to determine what should be taken off the record is to take the physical inventory mentioned above.

ROLES AND RESPONSIBILITIES Fixed asset management is often a group effort in an organization, as many different positions share responsibilities. From the CFO to the Internal Auditor, each position plays a role in maintaining and reporting on the asset register and assuring the record system is accurate. The CFO and Controller have primary overall responsibility for internal control and fixed asset acquisition, management and disposition. Usually, one or more individuals are given direct responsibility for maintaining the software system and input from others in the organization is imperative. This can sometime cause a breach in communication, as in many organizations, the property accountant has difficulty obtaining cooperation from higher level managers in other departments. The Property Accountant is at the heart of every successful fixed asset system and the related internal controls. This is an important job. The individual(s) have far-reaching responsibilities in virtually every aspect of the organization’s operations, including tax, insurance, IT, strategic planning and budgeting. The Tax Manager has perhaps the single biggest role in utilizing the property record to optimize the organization’s cash flow. Federal and state taxes on income are directly affected by depreciation and amortization charges. Property tax assessments are usually based on information supplied by the tax manger from the property record. The choice of lives, depreciation methods and individual asset basis for tax purposes can significantly affect cash and reported income. We do not recommend, however, that tax departments have the primary responsibility for the property record system. The Insurance Manager is often the forgotten player in the area of property records and fixed assets. Yet in many companies insurance premiums are substantial. Insurance premiums are a direct reflection of the information supplied by the insurance manager to the broker or insurance company. Errors in the system, both ghost assets and zombie assets, adversely impact the accuracy of reportable information. Most companies can reduce their property and casualty (C&P) insurance when the property record has accurate internal controls. The owner of an asset is the individual or department that has physical custody of the asset and should have overall responsibility for the asset. In many organizations, however, this sense of responsibility is missing. Thus there appears to be no incentive for asset sales, retirements or transfers to be recorded in a timely basis. What the property accountant does not know simply cannot be recorded. Therefore it is the responsibility of the asset owner to communicate properly. The Internal Auditors should treat property records, and the internal control of fixed assets, as a high priority. Most internal audit departments have very limited resources, and the audit committee and top management will usually indicate areas of concern. With other aspects of internal control pretty much taken care of, one of the largest areas still needing scrutiny deals with PP&E. Finally, the External Auditor allocations of resources are governed by a number of factors, including perceptions of SEC and PCAOB areas of interest. It would not be surprising to see these regulatory organizations start to scrutinize internal controls on fixed assets; in turn this will force independent auditors to increase their focus on this specific area in future annual audits.

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White Paper: Best Practices for Controlling Fixed Assets

Real Asset Management

INITIAL STEPS TO BE TAKEN To ensure accurate internal control, a detailed assessment of an organization’s current policies and procedures should be made, including review of current software adequacy.

Sample reconciliation should be reviewed to determine the nature of the problem. Just how accurate or inaccurate is the present system? A sample physical inventory will indicate the degree of accuracy. Set minimum capitalization level as a policy decision. This should be set high enough so that inexpensive items are not set up in the system, thus reducing costs.

Start a new system with new acquisitions from today forward. Going back and fixing everything may appear unrealistic, but at a minimum an organization should start a new control system and use it from here forward.

Get current records in line with reality. This involves making sure current accounting records reflect actual assets on hand. Three approaches are possible: 1.

Take existing printout and try and find the items.

2.

Take a physical inventory and identify corresponding items on existing property ledger.

3.

Use a professionally developed and supported asset tracking tool such as Track4000.

Review Property Tax issues. Eliminate ghost assets from records to reduce taxes. It is not always necessary to have the same value for property taxes as is used elsewhere in the system. For example, so-called ‘soft construction costs’ probably should be removed from asset values reported to local assessors. Review Insurable values. Assets should be neither over-insured nor under-insured. A good property record system can be updated to current replacement cost using indexes.

SUMMARY AND RECOMMENDATIONS Fixed asset management in relation to internal control is critical to the fiscal health of all operations. Frequent and effective fixed asset management processes could potentially save your organization hundreds of thousands of dollars a year. The PCAOB, and independent auditors, have already started the process of reviewing internal controls on fixed assets. The best property record system in the world does not represent true internal control. The only way to assure that the property record is correct, and that the record truly reflects actual conditions, is to take a physical inventory of PP&E and then reconcile the results. If you are looking to justify the implementation of a fixed asset management system, take some time to detail the deficiencies in your current processes. Then set up a working schedule, a timeline, with specific tasks assigned to individuals. This will involve all the participants discussed above, plus IT management to assure that all new software is fully compatible with existing company systems.

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White Paper: Best Practices for Controlling Fixed Assets

Real Asset Management

The best practices we recommend can be handled as follows: 99

Determine the current condition of you property record system, including both the capabilities of existing software and the underlying accuracy of the information contained in today’s system.

99

Make sure your existing software has full flexibility and capability to handle the wide variety of uses to which a good property record system can be put.

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Review capitalization policy to avoid putting small dollar items into the system.

99

Start entering new acquisitions into the updated property record system using a barcode tag on each asset.

99

To the extent resources are available start to clean up the existing file representing past acquisitions by identifying ghost assets, and reconciling what we refer to as zombie assets.

99

Review insurable values, which can be input into a new system.

99

Review property tax assessments against current financial information.

99

Optimize tax depreciation by taking maximum advantage of Federal Tax requirements.

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Best Practices for Controlling Fixed Assets Whitepaper