Every company depends on fixed assets to operate effectively. Such assets can be machines, buildings, computers and vehicles. Though firms keep records of all these resources, there are still chances of mistakes that occur. Asset misclassification is one of the most frequent ones. Placing assets in the inappropriate category or reporting the assets in a wrong way influences the whole process of financial reporting. This is one of the key issues in the process of verification of fixed assets in auditing since auditors rely on the right information to verify the real valuation and situation of assets of a business.
What Is Asset Misclassification?
Asset misclassification occurs when a company classifies an asset under the wrong classification or records it as such. An example is that a business can treat a short-term asset as a fixed asset, or it can treat a repair expense as a capital asset. In some cases, the assets can be classified in the incorrect category, i.e. tools are reported as machinery. Such errors are easy to overlook but they do cause a giant headache as soon as auditors enter the verification of fixed assets in the process of auditing.
Why Does Misclassification Happen?
Misclassification is caused by several reasons. Companies can have untrained personnel that do not know how to classify the assets, or they might not have an appropriate system of managing their assets. In other instances, mistakes are brought about by hasty bookkeeping or other old accounting software. Even the manual records leave room to make errors. Regardless of the cause, misclassification also influences the presentation of assets in financial statements that has a direct effect on the verification of the fixed assets while auditing.
Impact on Financial Statements
In case of misclassification of assets, the financial statements become inaccurate instantly. As an illustration, an expense can be presented as a fixed asset to boost profits on paper, yet money has already been expended. On the same note, the misclassification of the new machinery as an expense also minimizes the value of total assets. These problems are misleading to the stakeholders, which influences business decisions and calculation of taxes. In the process of checking fixed assets during auditing, auditors are forced to take additional time trying to rectify such mistakes and this makes the whole exercise slow.
Difficulty in Depreciation Calculation
Different kinds of assets are computed differently in the calculation of depreciation. The depreciation charged will be incorrect in case an asset is classified under the wrong category. This has an impact on the value of the assets and the costs of the company. During the verification of fixed assets that the auditors perform in the process of auditing, they examine the fact that the depreciation is registered properly. This is not easy with misclassification which results in adjustments which would not have happened with correct asset categorization.
Challenges in Physical Verification
Auditors do not rely only on records—they also physically check the assets. When an asset is misclassified, it becomes difficult to trace it during physical inspection. For instance, a piece of equipment recorded under office furniture may create confusion during the audit. This lack of clarity delays the verification of fixed assets in auditing and raises questions about the reliability of the company’s asset register.
How Companies Can Avoid Misclassification
The most appropriate solution to avoid misclassification is robust internal controls. Companies must ensure that they have a correct fixed asset register, regularly review the asset categories, educate their accounting personnel, and account for the assets with the help of efficient software. There should also be a clear policy of capitalization or expenses to prevent mistakes. These procedures accelerate, smoothly and ensure the verification of fixed assets in auditing.
This content is meant for information only and should not be considered as an advice or legal opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.
Also Read: Knowing How To Handle Fixed Assets?