Reporting Capital Equipment: An
Auditor's Perspective
Overview
• Internal audit background
• Capital equipment sources and requirements • Audit perspective and definitions
• Depreciation and asset accounting
– Construction
– Capitalized interest – Asset useful life
Overview
• Auditing and what can go wrong • Asset tracking and disposal
What Is Internal Audit?
Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s
operations. It helps an organization accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness of risk
management, control, and governance processes.
Internal Audit Overview
• Not the IRS
– CPAs, CIAs and other credentials, but rarely tax-focused
– Not “out to get you”
• Different from external auditors
– Some are tax-based
– Typically evaluating controls over financial statements
• Internal audit perspective
– Operational focus
– Working for the same company – Risk mitigation/avoidance strategy
Capital Equipment Sources
Department involvement and possible origination
– Information Technology (IT) – Clinical Engineering
– Plant Services
– Design and Construction
– Materials Management/Purchasing – Accounting/Finance
What Is Needed?
• Adhere to the facility’s capital planning,
bidding, requisition, approval, procurement and disposal process
• Change order process – should follow similar capital approval process
• Conflict of interest disclosure
• Vendor/contractor evaluation and screening process
What Is Needed?
• Vendor/contractor immunization per facility requirements
• Budget deviation process
• Fully executed contracts prior to procurement/construction
• Vendor/contractor not excluded from federal or state healthcare program participation
What Is Needed?
• Contracts approved by legal department • Process to prevent duplicate payments
• Service, warranty and training requirements within contract
• Lease versus purchase
What Is Needed?
• Process to identify/tag assets when purchased • Attach numbered asset tags to fixed assets
• Asset tag numbers included in the detailed fixed asset register
• Department management periodically reviews the fixed asset inventory within their
What Is Needed?
• Fixed assets tracked in a detailed fixed asset register – including: – Asset description – Date acquired – Vendor – Cost basis – Assigned department – Depreciation method/life
Audit Perspective
• Vendor, contractor and asset selection process • ROI calculated and validated
• Capital budgeting and purchasing authorized • Acquisition costs are appropriate
• All costs to prepare the asset for use are captured
Audit Perspective
• Risks
– Capital misallocation
– Unsuccessful implementation
– Unauthorized/unapproved purchases
– Lack of competitive bidding or negotiating – Inaccurate classification/accounting of assets – Exclusion of key departments
– Exclusion of all related costs (shipping, maintenance, licensing, IT support, etc.)
Audit Perspective
• Fraud Potential
– Misappropriation of assets
– Vendor selection provides kickbacks
– Contract awarded to family friends (without
disclosure and appropriate competitive bidding) – Inflated/duplicated costs on cost-plus contracts – Overpayment for asset quality (e.g., lower quality
product delivered, but paid for higher quality product)
Know Capital Definitions
• Unique to each facility
– Small facilities may capitalize assets at lower thresholds (e.g. $2,500)
– Items may be combined to meet thresholds (e.g., computer, monitor, peripherals)
– Routine repair and maintenance of assets should be expensed during the period
– Established thresholds are used to minimize
administrative efforts on numerous small dollar items
Know Capital Definitions
• Remodeling or improvements extending the fixed asset’s life are generally capitalized
• Software components of assets can be capitalized
• Various project implementation costs related to software may be capitalized and others
expensed
• Understand how to separate components during procurement
Depreciation
• A loss in the value of property over the time the property is being used (IRS Definition) • Methodology options (limited)
– Estimated life of the asset – Term of the capital lease
– Suggested useful life via AHA publication
• Should be systematic and consistently applied • Typically straight-line method is used
Depreciation
• Land is not typically depreciated as part of the capital equipment depreciation schedule
• Assets are usually reviewed periodically for evidence of impairment (reduced life)
• Asset impairment costs are used to adjust the remaining book value of the asset
• Impairment adjustments are usually separate from routine depreciation schedules
Asset Accounting
• Assets are typically tagged, logged and tracked • Useful life (applied to depreciation schedule)
should be appropriate
• Asset life should be greater than 1 year to be capitalized
• If asset is part of a leasehold improvement, useful life should not exceed the lease
• Start of depreciable asset’s life should not occur during construction
Asset Accounting
• For Medicare cost report purposes, the
American Hospital Association’s Estimated
Useful Lives of Depreciable Hospital Assets is a guide that can be used for estimating the
Asset Accounting
• A different useful life may be approved by the Fiscal Intermediary - Factors to consider:
– Normal wear and tear
– Obsolescence due to normal economic and technological changes
– Climatic and other local conditions
Asset Accounting
• Process to transfer construction in process (CIP) to appropriate asset classification
• In-house labor may be capitalized if properly applied (i.e., cost that would have been
incurred as part of the construction) • Periodic validation of asset inventory
• Process to account for missing or damaged assets
Asset Accounting
• Detailed construction activities maintained • Project broken down into components to
accelerate depreciation
• Example: doors, wiring, flooring, etc… • Breaking construction into smaller
components accelerates depreciation
• Rather than depreciating the building/project over 40 years, components can be depreciated quicker
Asset Accounting
• Interest may also be capitalized as part of the asset
• Asset lease capital versus operating lease • Lease term/present value within GAAP
standards
• Non-capitalized costs include
– Taxes
Asset Accounting
• Interest capitalization period begins when the following three conditions are present:
– Expenditures for the asset have been made
– Activities that are necessary to get the asset ready for its intended use are in progress
– Interest cost is being incurred
• Interest capitalization shall continue as long as those three conditions are present
Asset Accounting
• Capitalized interest references
– Capitalization Period (ASC 835-25) – Amount to capitalize (ASC 835-30)
– Projects funded with tax-exempt borrowings (ASC 835-30)
What An Auditor Audits
• Fixed asset master/log compared to assets found in service
• In service assets selected and traced back to the asset log
• Property, Plant and Equipment (PPE) ledger reconciled to the general ledger
• Testing of useful life and depreciation calculations
What An Auditor Audits
• Asset disposal process
• Asset impairment identification and recording process
• Expenditure authorization and variance between actual and budgets
• Lease classification
• CIP account valuation, timely close-out and commencement of depreciation
So You’re Being Audited
• Have or know where purchasing and capital project policies are located
• Maintain documentation related to all phases of the project (budgeting through final
payment)
• Maintain all approvals of original budgets, payments and change orders
• Keep the competitive bids and justification for deviations
So You’re Being Audited
• Link asset tag numbers to project assets • Maintain similar documentation for
emergency asset replacements
• Provide evidence of security of the asset to prevent unauthorized removal/disposal (e.g., physical/logical security)
• Post implementation review of ROI calculations and/or presentations
What Can Go Wrong?
• Asset life too long
– Period expenses are understated
– Income statement inaccuracies (i.e., overstated) – Balance sheet reflects higher asset value
– Impairment write-off at the asset end of life may be significant (increasing period expenses)
What Can Go Wrong?
• Asset life too short
– Period expenses are overstated
– Income statement inaccuracies (i.e., understated) – Balance sheet reflects lower asset value
– Inaccurate ROI calculations
– Gain resulting from sale at end of asset life could be significantly different than book value
– If sold at book value versus fair value, hospital realizes a loss of cash/trade-in value
What Can Go Wrong?
• Capital thresholds may not be met • Example – surgical instrument set
– Could cost $15,000 for set
– Could be capitalized, but typically treated as an expense
– Individual instrument value making-up the set is below capital thresholds
What Can Go Wrong?
• Operating leases incorrectly used to obtain capital equipment
• Operational dollars may be accessible versus obtaining capital approval
• Leases have received significant attention in recent years
• Capital leases differ significantly from operating leases – balance sheet
When In Doubt, Ask
• How does the hospital account for surgical instruments?
• What if a single instrument in the set exceeds the capital threshold?
• Are there exceptions to the rule (e.g., large-scale thermometer purchase)?
• How does depreciation versus minor
equipment expense impact my department? • Controls to prevent capitalization of items
Asset Tracking and Disposal
• Third-party involvement (e.g., bio medical and computer vendors)
• Reconciliation should be periodically
performed between hospital and third-party records
• Responsibility for missing or damaged equipment
Asset Tracking and Disposal
• Asset disposition form and related process • Approval of asset disposition form in
accordance with hospital authority matrix • Accounting involvement recording gain/loss • Proper segregation of duties listed above
• Revise depreciation schedules if asset is disposed prior to end of useful life
Asset Tracking and Disposal
• Remove sensitive/patient data from electronic equipment
• HIPAA-related penalties related to loss/release of protected health information (PHI)
• Removal of asset from asset management system/log
• Possible accounting treatment when
Summary
• Internal Audit can be your friend
• Know and involve all relevant departments • Understand the facility’s capital acquisition
process and accounting treatment • Work with Finance, Accounting and
Purchasing for proper classification
• Maintain accurate records/documentation
• Follow the facility’s asset tracking and disposal processes
About CHAN HEALTHCARE
• Expertise in Internal Audit, Information Technology, Data Analytics, Compliance, Revenue Cycle, Healthcare
Finance, Physician Practices, and Risk Management • Draw out knowledge and trends from the nearly 30
healthcare networks and 700+ healthcare facilities served nationwide
• Associates supported by team of subject matter experts, state-of-the-art technology, and proven methodologies and tools to provide clients with innovative solutions • ONLY professional services firm dedicated 100% to
Contact Information
Brian Mikel 615-284-4528
