Essay Question for CMA Exam from Internal Control Topic With the breakup of the communications industry and the commencement of deregulation by the government, small regional communications providers began emerging. One of these regional providers, SelectCom, began operations in the southeast. Based on original customers’ needs, SelectCom placed transmission switching centers throughout its service area. The switching centers were primarily driven by large computers specifically designed for transmission purposes. To gain maximum efficiency, smaller, less costly computers called Programmable Front-end Computers (PFCs) were connected to the switching centers; these PFCs are transferrable from site to site, depending on traffic requirements. In addition to transferring equipment from site to site, SelectCom has been periodically upgrading some of its switching center with newer, faster, and more sophisticated computers. Presented below are SelectCom’s procedures regarding the relocation, installation, and disposal of switching equipment. The relocation, installation, and disposal of switching equipment will be reported under a project accounting system. Cost estimates should be prepared and management authorizations obtained before project codes are opened. All installations shall be accounted for by the use of specific project codes in order to separately capture the costs of (a) applications engineering and software, (b) on-site installation tasks, and (c) hardware. The disposal of switching equipment shall be accomplished through separate retirement projects with specific codes for each site, with the costs incident to the physical removal of equipment being classifiable directly to expense. The Engineering Department shall report all project completions to the Accounting Department, which shall arrange for closing the projects, adding or deleting the assets to or from the fixed asset records, and appropriately recording costs and assets in the general ledger. The fixed asset records maintained by the Accounting Department are to be used for identification of equipment and costs by location, as well as for depreciation and local property tax purposes. As generally applied in the communications industry, group asset depreciation is to be followed for switching equipment. For this purpose, the switching equipment is to be grouped as large computers, small- to medium-sized computers, and other switching equipment. Retirements are to be charged to the respective Allowance for Depreciation accounts. As SelectCom installs new equipment, the company will offer for sale the assets that are to be removed and not relocated. For this purpose, the Internal Audit Department has been asked to confirm that the correct asset costs are being removed from the fixed asset accounting records at the correct amounts. After conducting the required reviews, the Internal Audit Department compiled the following findings: In order to meet marketing forecasts and changing transmission needs, the Engineering Department moved PFCs and other equipment on the basis of verbal advices and/or informal memoranda. In addition, cost estimates were not prepared for many of the jobs performed. For each transfer of a PFC, only an installation project code was assigned to the switching center receiving the equipment. As a consequence, all removal, installation, and disposal costs have been charged to the same project code. This fact, coupled with a lack of project cost estimates, makes it very difficult to trace costs to particular switching equipment. This situation results in many accounting and financial ramifications. On advice from Engineering, accounting personnel have closed out projects and added or deleted charges to the fixed asset records and the general ledger. Ans: The practices that represent internal control deficiencies at SelectCom include the following: The Engineering Department moved equipment based on verbal advice and/or informal memorandum. Cost estimates were not prepared for many of the jobs performed. For each equipment relocation (resettlement), only a single project code was assigned, that results in all removal, installation, and disposal costs being charged to the same project. The ways that SelectCom could strengthen compliance with procedures, improve internal control practices and eliminate those deficiencies include the following: 1- All employees involved with planning and installing equipment should be trained in the project accounting procedures and be kept informed of new policies and procedures. 2- The procedures should provide that all activities and cost estimates related to equipment movements and installations should be properly authorized before project codes are assigned. 3- A full description of work to be performed should be included on the project authorization document in order to account personnel so that they may be able to review activities and costs charged to the project, especially when actual costs exceed estimated costs above accepted tolerance levels. 4- Project codes should be closed only on written, approved advice from Engineering. 5- Periodic physical inventories should be undertaken and compared to the fixed asset records. Variances should be investigated, explained, and adjusted in the records. Significant exceptions should be reported to both departmental and senior management. The accounting and financial ramifications (complications) of the current practices outlined in the Internal Audit Department’s report are reflected below. Accounting ramifications: 1- The reliability of the accounting records is questionable. Recorded amounts for assets, depreciation, property taxes, operating expenses, and net income are misstated. As retirement project codes were not assigned for relocated equipment, installation costs incurred at the prior installation sites were not deleted from the fixed asset records, nor charged to the allowance for depreciation accounts. 2- As retirement project codes were not assigned, the cost of removing equipment was charged to the installation project code and capitalized instead of being expensed. Costs are difficult to trace to switching (transferred) equipment and sites due to use of a single project code and lack of cost estimates. Financial ramifications: 1- General cost overruns (spoils) that result in cash shortages or use of cash that could be better used for other projects. 2- Property taxes are higher than necessary due to overcapitalization of costs and improper retirement accounting, resulting in excess cash outflows. 3- Assets could be misappropriated as Engineering operates on an informal basis, with Accounting giving Engineering substantial control over assets.
Posted on: Tue, 30 Jul 2013 21:24:50 +0000
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