The Baccus Corp manufactures medical equipment. This is a capital intensive industry and investments in fixed assets exceed $5 million a year. The minimum cost for production equipment is $75,000 . When supervisors want new production machinery, they

Question

contact the plant manager. The plant manager approves or denies the request based on discussions with the production supervisor, the repair and maintenance supervisor, and the quality control supervisor. A purchase order is prepared by the purchasing department and sent to one of the three major suppliers of production machinery for medical equipment. The equipment is delivered immediately to the production floor and put into service. At the end of the month, the production supervisor informs the general ledger clerk about the receipt of the machinery. The general ledger clerk establishes an asset record for the machine. At the end of the year, the general ledger clerk computes straight-line depreciation based on a 10-year life with a 10 percent salvage value. Depreciation expense is recorded as a direct reduction of the asset cost. The repair department performs routine maintenance on all of the production equipment. Occasionally the repair department rebuilds a machine to extend its useful life. All of the costs associated with the repair department are charged to manufacturing overhead. When a machine becomes obsolete, production employees move it to a corner of the factory floor and break it down so that parts can be used in other machines. Production employees routinely remove parts for personal use. Some smaller machines have disappeared completely from the factory floor. The general ledger clerk takes a physical inventory every three years. About 75 percent of the fixed assets can be located and identified. Other assets have serial numbers that are inaccessible, so the item cannot be matched to a fixed asset record. Some fixed asset records cannot be traced to an actual item. Several machines that have been scrapped and are being used for spare parts were matched to fixed asset records. At the last inventory, the general ledger clerk did not make any adjustments to the fixed asset records explaining that 75 percent accuracy in the fixed asset physical inventory was excellent. Describe five internal control weaknesses and explain how to correct them.

Answer 1

WEAKNESS: There is no written documentation of the approval for purchase.
IMPROVEMENT: Fixed asset acquisitions should be formal and explicitly authorized. Each transaction should be initiated by a written request from the user or department. For high-value items, the authorization process should include a formal cost-benefit analysis and the solicitation of bids from suppliers.

WEAKNESS: Fixed assets are delivered directly to the factory floor.
IMPROVEMENT: All purchases should go through the receiving department before delivery.

WEAKNESS: The production supervisor notifies the general ledger clerk about the receipt of fixed assets.
IMPROVEMENT: The receiving department should send a copy of the receiving report to the fixed asset department.

WEAKNESS: The general ledger clerk is maintaining fixed asset records.
IMPROVEMENT: The fixed asset department should maintain fixed asset records.

WEAKNESS: Depreciation is computed using a standard method, asset life, and salvage value.
IMPROVEMENT: The method of depreciation used should reflect, as closely as possible, the asset's actual decline in utility. The internal auditor should also review and verify the depreciation periodically.

WEAKNESS: Depreciation is recorded as a direct reduction of the asset cost.
IMPROVEMENT: Depreciation should be recorded in an Accumulated Depreciation account for each asset.

WEAKNESS: Costs to rebuild a machine is charged to manufacturing overhead.
IMPROVEMENT: Physical improvements that increase an asset's value or extend its useful life should be treated as new asset acquisitions (an adjustment to the asset account).

WEAKNESS: There is no authorization to scrap an obsolete machine.
IMPROVEMENT: Obtain written authorization from management before a machine is scrapped.

WEAKNESS: Employees remove equipment and equipment parts from the premises without authorization.
IMPROVEMENT: Employees should receive explicit approval from a supervisor before removing parts or equipment from the factory.

WEAKNESS: The general ledger clerk is conducting the physical inventory and maintaining the record keeping.
IMPROVEMENT: The internal auditor, not the general ledger clerk should be taking the physical inventory count. Also, the physical count should occur more frequently.

WEAKNESS: Fixed assets cannot be matched with records.
IMPROVEMENT: Apply easily accessible labels to identify fixed assets.

WEAKNESS: Fixed assets cannot be located and are not removed from the books.
IMPROVEMENT: Fixed assets that cannot be located must be removed from the fixed asset records.

WEAKNESS: Fixed assets that are scrapped remain on the books.
IMPROVEMENT: Assets that are scrapped should be removed from the fixed asset records.

WEAKNESS: The clerk regards 75% accuracy as excellent.
IMPROVEMENT: Acceptance of 75% accuracy is poor. Any variation should be investigated and records updated. This should be done by the internal auditor.