CASES: GET SOLUTION FROM ACCOUNTING

CASE 1

Homework: CASE DESCRIPTION:

Ronald Baker was a professional accountant for an equipment retailer (ER). The ER maintained
accounts receivable for school districts in the region, otherwise, customers received credit by
using their own credit cards.
Ron’s duties included being the company cashier, who received all the incoming mail payments
on school accounts and the credit card account and all the cash and cheques taken over the
counter. Ron prepared the bank deposits (and delivered the deposits to the bank), listing all the
cheques and currency, and also prepared a remittance work sheet (daily cash report) that
showed amounts received, discounts allowed on school accounts and amounts to credit to the
accounts receivable. Ron also reconciled the bank statement. No one else reviewed the deposits
or the bank statement except the independent auditors.
Ron opened a bank account in the name of RE Company (REC), after incorporating the company
in the Department of Corporate Affairs office. Over-the –counter cash and cheques and school
district payments were taken from RE receipts and deposited in the REC account. None of the
customers noticed the difference between the rubber stamp endorsements for the two similarly
named companies, and neither did the bank. REC kept the money a while, earning inetrest; then
Ron wrote REc cheques to RE to replace the borrowed funds, in the meantime taking new RE
receipts for deposit to REC.
Ron also stole payments made by the school districts depositing them to REC. later, Ron
deposited REC cheques in RE, giving the schools credit, but approved on an additional 2 percent
discount in the process. Thus, the schools received proper credit later, and REC paid in less by the
amount of the extra discounts.
RE bank deposits systematically showed fairly small currency deposits. Ron was nervous about
taking too many cheques, so cash was preferred. The deposit slip also listed the SEC cheques
because bank tellers always compare the deposit slip listing to the cheques submitted. The
remittance sheet showed different details: instead of showing REC cheques, it showed receipts
from school district and currency, but not many over-the-counter cheques from customers. The
transactions became complicated enough that Ron had to use the microcomputer in the office to
keep track of the school districts that needed to get credit. There was no vacation for this hard
working cashier because the discrepancies might be noticed by a substitute, and Ron needed to
give the districts credits later.
Over a six-year period, Ron built up a $180,000 average balance in the REC account, which earned
a total of $77,000 interest that should have been earned by RE. By approving the extra discounts,
Ron skimmed 2 percent of $1 million in annual sales, for a total of $120,000. Since REC would
have had net income before taxes of about $1.6 million over the six-years (about 9 percent on the
sales dollar), Ron’s embezzlement took about 12.5 percent of the income.

Required:
a. Identify the main problem in the case.
b. Identify internal controls for the company in question.
 c. Discuss the effectiveness of internal controls for Equipment Retailer.
d. Describe the audit objectives of the case.
e. Discuss the following:

a. Control procedures
b. Test of controls
c. Audit of balances

Problem:
Cash embezzlement caused overstated AR, overstated customer discounts expense, and
understated cash sales. Company failed to earn interest income on funds borrowed.

Audit Objective:
Obtain evidence to determine whether the AR recorded on the books represent claims against
real
customers in the gross amounts recorded.
Control:
- - Authorization related to cash receipts, custody of cash, recording cash transactions and bank
statement reconciliation should be separate duties designed to prevent errors, irregularities and
fraud;
- -Some supervision and detail review of one or more of these duties should be performed as a
next step to detect errors, irregularities and fraud;
- -Remittance worksheet should be prepared or discounts should be approved by the controller,
the bank reconciliation should be done by someone else;
- -Ron had all the duties. Management boasted of strong internal controls, should the auditors
trust their words? The auditor should have conducted tests for cash theft and AR lapping.

Test of Control
- On cash receipts transactions as they relate to AR credit.. Dual direction samples and procedures
are :
- - Validity direction: Select a sample customer AR, and vouch payment credits to the remittance
worksheet and bank deposits, including recalculation of discounts allowed , classification
(customer name), identification and correspondence of receipt date to recording date
- -Completeness direction: Select a sample of remittance worksheets or bank deposits, vouch
details to bank deposit slips and trace forward to complete accounting posting in customer AR.

Audit of Balance:
-There is a risk of incorrect accounting.
-Perform AR confirmation as of the year-end date.
-Confirm a sample of school district accounts using positive confirmations.
- Bank confirmations can be used. Since there is a control risk, the sample may include all the
accounts, if the number is not too high.
- Use the telephone book, chamber of commerce directory and a visit to a local Ministry of
Industry and Trade office to determine the location and identity of ER

CASE 2
Case Study - Payables
ABC Chemical started a new contract with Pure Oil Distributing to supply fuel oil for the plan
generators on a cost-plus contract. Pure delivered the oil weekly in 20,000-litre-tank truck and
pumped it into ABC’s storage tanks. ABC’s receiving employees were supposed to observe the
pumping and record the quantity on a receiving report, which was then forwarded to the
accounts payable department, where it was held pending arrival of Pure’s invoice. The quantities
received then were compared to the quantities billed by Pure before the invoice was approved
for payment and a cheque prepared for signature by the controller. Since it was a cost-plus
contract, Pure billing price was not checked against any standard price.
The receiving employees were rather easily fooled by Pure’s driver. He mixed sludge with the oil;
the receiving employees did not take samples to check for quality. He called out the storage tank
content falsely (e.g., 4,000 liter on hand when 8,000 were actually in the tank); the receiving
employees did not check the gauge themselves; and the tank truck was not weighed at entry and
exit to determine the amount delivered . During the winter months when fuel oil use was high.
Pure ran in extra trucks more than once a week but pumped nothing when the receiving
employees were not looking.
Quantities “received” and paid during the first year of the contract were (in liter):

Months Quantities (litres)

JAN 124000
FEB 112000
MAR 92000
APR 76000
MAY 72000
JUNE 56000
JULY 60000
AUGUST 56000
SEP 84000
OCT 92000
NOV 132000
DEC 144000

The ABC receiving reports all agreed with the quantities billed by Pure. Each invoice had a
receiving report attached in the ABC accounts payable files. Even though Pure had many trucks,
the same driver always came to the ABC plant, as evidenced by his signature on the receiving
report (along with the ABC company receiving employees’ initials). Pure charged $45 per liter
making the charges for the 1,100,000 liter a total of $495,000 for the year. Last year, ABC paid a
total of $360,000 for 900,000 liters, but nobody made a complete comparison with last year’s
quantity and cost.
During the first year, Pure shorted on ABC on quantity by 160,000 liters (loss = 160,000 X $.45 =
$72,000) and charged 5 cents per gallon more than the competitors (loss = 940,000 liters X $0.05
= $47,000) for a total overcharge of $119,000, not to mention the inferior sludge mix occasionally
delivered.
Aware of the current year’s higher expense and the evidence of a lower market price, the
auditors obtained the fuel delivery records from the prior year. They are shown in the table
below. The numbers in parentheses are the additional liters delivered in the current year.
MONTH
JAN 112,000 (12,000)
FEB 96,000 (16,000)
MAR 80,000 (12,000)
APRIL 68,000 (8,000)
MAY 52,000 (20,000)
JUNE 44,000 (12,000)
JULY 40,000 (20,000)
AUG 36,000 (20,000)
SEP 60,000 (24,000)
OCT 80,000 (12,000)
NOV 112,000 (20,000)
DEC 120,000 (24,000)

Required:
Work in group of four or five. Read the case and compile your answer on the following lines:
1. State the problem very briefly.
2. Describe the audit objective in this case.
3. Discuss the relevant controls at ABC Chemical.
4. What tests of control are required and why? Do you believe the controls are effective?
5. Discuss the tests of balances and analytical procedures.

Solution:
Problem:
Fuel oil supplies inventory and fuel expense inflated because of short shipments.

Audit objective
To obtain evidence that all fuel oil billed and paid was actually received in the quality expected, at
a fair price
Controls Relevant to the process
 Receiving employees should be given the tools and techniques they need to do a good
job.
 Scales at the plant entrance could weigh the trucks in and out, delivering the amount of
fuel delivered. (Weight per litre is a well-known measure).
 Sampling for simple chemical analysis would give evidence of the quality of the oil.
 Receiving employees should be instructed on the importance of their job to encourage
consciousness.
 They should have been instructed to read the storage tank gauges themselves instead of
relying on Pure’s driver.
 These tools and instructions must be locked.
 Use of scales at entry exit to weigh the trucks to determine the amount of fuel delivered.
 Train the receiving employees as how to do their job.
 The receiving employees be instructed and supervised to read the storage gauges
themselves.

Test of Controls
 The information from the “understanding the control structure” phase would have to be
detailed if it is to alert the auditors to the poor receiving practices
 Procedures will include making inquiries with the receiving employees to learn about
their practices and work habits.
 The control procedure supposedly in place was the receiving report on the oil delivery.
 A control test procedure would be to take sample of Pure’s bills, compare quantities
billed with quantities received while verify price billed against the contract.
 Because of the deception by Pure’s driver, this would not have shown anything unusual,
unless the auditor became suspicious of the fact that same driver made all the deliveries.
 Obtain and review receiving report on the oil delivered.
 Review the procedure to take a sample of oil and compare quantities billed and received
 Compare the price billed to contract.
 Make enquiries with the receiving employees to learn about their practices and work
habits.

Test of details of balance

 The balances in question are the fuel oil supply inventory and fuel expense.
 The inventory is easily audited by reading the tank storage gauge for the quantity.
  The price can be found in Pure’s invoices, however, a lower of cost or market test
requires knowledge of market prices for the oil.
 Since the company has no documentation of competing prices, the auditor will need to
research with other oil distributors to get the prices.
 Presumably, the auditor would learn that the price is approximately $0.40/per litre.
 The expense balance can be audited like a cost of goods sold amount.
 With knowledge of the beginning of fuel inventory, the quantity purchased and quantity
in the ending inventory, the fuel expense can be calculated.
 This expense quantity can be priced at Pure’s price per litre.

Substantive Analytical Procedures

 Analytical procedures applied to the expense can reveal the larger quantities and the
unusual deliveries, leading to suspicion of Pure and the driver.
 Aware of the current year’s higher expense and evidence of a lower market price, the
auditors can obtain the fuel oil delivery records from the prior year. The numbers are
shown in the table above
 Analytical Procedures applied to expense should reveal the larger quantities used and
the unusual pattern of deliveries, leading to suspicions of Pure and the driver.