Controls for Fixed Assets (#15)
/In this episode, we discuss the controls associated with fixed assets. The primary controls over fixed assets really cover three main topics, which is acquiring and disposing of them, as well as in-house security. I’ll start with acquisition controls.
Acquisition Controls
The most basic acquisition control is that the initial approval for a fixed asset purchase comes through the annual budgeting process. Even though the budgeting process may be done many months before there’s any plan to actually purchase an asset, you need to plan as far ahead as possible. The reason is that a company may have only a limited pool of money available, so all possible acquisitions need to be reviewed together. That way, managers can figure out how to allocate funding.
Now, let’s say that there’s a sudden need for a fixed asset, and this need appears after the budget is finalized. Well, now there may not be enough cash available to pay for both the new asset and the other assets that were approved earlier as part of the budgeting process. In this case, the most common control is to make it really hard for the new asset to be approved. This usually means that even a small request is bumped up to a very senior-level manager for approval, and there has to be a really good reason why it’s needed right now, rather than in the following budget period.
Getting back to that budget approval process, there’s usually a fairly lengthy capital request form required. The person requesting the asset has to fill out the reason for the purchase, some sort of discounted cash flow estimate, and probably an itemization of exactly when cash flows are expected – both inbound and outbound. I prefer to have a simpler form for small asset requests, just so you don’t waste the time of the managers who have to fill out the forms.
The discounted cash flow estimate in the application form is going to use a hurdle rate that’s at least as high as the corporate cost of capital.
You can consider this to be a control, because if the project’s cash flows are discounted at the hurdle rate and it results in a negative discounted cash flow, then this should tank the request. After all, a company needs to at least earn back its cost of capital on new funds invested, or it’ll eventually go out of business.
Another control over the acquisition of an asset is to guard against any purchasing shenanigans. One ploy is that employees could buy assets and sell them to the company, then steal the assets, and sell them right back to the company again. You can spot this by always entering the serial number of each asset in the fixed asset master file, and then running a report sorted by serial number, so you can see if there are any duplicates.
Of course, this also means that you have to lock down access to the fixed asset master file, so no one can alter the serial numbers.
Another control over fixed asset acquisitions is to have a second person review all additions to the fixed asset master file. The reason is that a typo or a misclassification in that file can have some consequences that’ll impact the financial statements. For example, if an asset is entered in the wrong asset category, its depreciation period might now be too short or too long, which impacts profits. Along the same lines, if its location is entered incorrectly, then good luck finding it the next time you do an audit.
Also, it helps to compare all the additions to the fixed asset master file to the approved capital request forms. It sometimes happens that employees go completely around the capital budgeting process, so this is a good way to spot when that happens.
Here’s another control. When a new asset comes in, if you can’t find a serial number on it, or it’s written on a label that could fall off, then create an identification tag that uses some kind of durable material. It doesn’t have to be made of metal, but consider using a laminated plastic tag that’s really hard to rip off. Then enter the tag ID number in the fixed asset master file. By doing this, you make sure that every asset is clearly identified.
Asset Security
Now, once your assets are approved and bought and their locations are recorded, always make someone responsible for them. This means that you create a list of all the assets that each manager is personally responsible for, and send the list to that person once every quarter.
If you really want to lock down this control, then also list “asset responsibility” in their bonus plans. If you do that, managers will definitely keep an eye on every asset in the company.
You can even go a bit further with the manager responsibility angle. Another control is to make any department from which an asset is stolen replace it with their own funds. Since they very likely have other uses for that cash, you can bet that department managers will take asset control really seriously.
If managers are going to be held responsible for assets, then they will insist on another control, which is a formal transfer document that both parties sign when an asset is shifted over to another manager. This is a good way to make sure that asset moves are being properly tracked.
That should give you a pretty good idea of controls you can use for fixed asset acquisitions. Now let’s switch over to security controls, and there are only a couple of these. First, restrict access to any parts of the company where you have expense assets that someone could easily pick up and walk out with. These days, that usually means locking the access doors to the admin offices, because of all the expensive computers in there. You might also want to restrict access to the tool crib, since tools can walk off the premises as well. Really large machinery doesn’t require much access control, for obvious reasons – if anything, I’d be quite impressed if someone could make off with some production equipment that weighs a few tons!
Another security control is to attach a radio frequency identification tag to each asset that could be stolen, and then install detectors near all of the building exits. Then, if someone walks out with a fixed asset, the alarm goes off – just like if you steal clothes from a retail store.
There’s one more control that sort of falls into the security category, which is doing an audit of all fixed assets. This doesn’t keep assets from being stolen, but at least it will tell you after the fact if anything is missing. Some companies do these audits on a rolling basis, so that only a few people need to be involved on a part-time basis, while others make a big production out of an annual audit where everything is counted in one day. Take your pick here, though I prefer a rolling audit, since the counting process tends to be more relaxed, and that means that it’s also more thorough.
And by the way, it may make sense to review the depreciation periods and salvage values being used during the audit process, at least for newer assets. If you review this information for a new asset just once, it’s not too likely that it’ll ever change again.
One more piece of this auditing process is to also review assets to see if their value has been impaired. There are some accounting rules that say you have to write an asset’s net value down to its impaired value as soon as it’s been impaired. However, this can be a lot of work, so I suggest doing an impairment review only on the most expensive assets.
Asset Disposals
Let’s switch over to a third category of asset controls, which covers asset disposals. The control that everyone seems to miss is just reviewing assets to see which ones you no longer need. If there are any, then sell them. I’ve seen more companies that just park assets off in a corner and never try to get any cash for them, so they’re basically throwing money away.
Another fixed asset control – and a really good one -- is to require the use of a disposition form before any asset can be sold, or donated, or junked or whatever the case may be. This form needs to be signed by a manager-level person. The reason for this control is to keep employees from selling off assets without anyone knowing about it. Managers really don’t like it when an asset disappears from the premises without their approval.
And one final control. Once an asset is sold, always make sure that the cash receipt from the asset sale matches the amount of cash actually received. Employees sometimes sell company assets and then keep the proceeds. I’ve even seen a company owner do this – though I have no idea why, since he took home all the profits anyways. Maybe it was the excitement of stealing his own money.
Here is my view of fixed assets. In a lot of cases, capital spending proposals are for the wrong assets, because managers want to increase the capacity of areas of the company that are not really the bottleneck operation. So… the company spends a lot of money on fixed assets, and profits don’t go up at all. Therefore, I strongly recommend focusing a great deal of attention on the need for more assets, before even worrying about controls for acquiring and disposing of them.
One other point is that a lot of spending these days goes into technology assets, which depreciate really fast. In these cases, having a lot of disposal controls doesn’t make much sense, because the assets are essentially worthless after just a couple of years.