Question

You are required to give your opinion according to your understanding to control activities related to asset controlling

Najati Company has two main production workshops: 1 and 2. Each production workshop produces a different kind of product. The company’s policy regarding the purchase of fixed assets for the workshops states that: if expenses incurred are less than IQD100 million, they must be approved by the workshop manager; if expenses exceed IQD100 million, they must be approved by the manager of the company.

This past year, at the beginning of July, Ms. Leen, the manager of workshop 1, had planned to buy a piece of equipment, the X30, an essential piece of equipment for her workshop worth IQD 112 million. However, the company’s management board was on an overseas business trip until the end of August.

After consideration, Ms.Leen called Mr. Firas, the manager of workshop 2, for a consultation. With the support and agreement of Mr. Firas, and also the supplier of the equipment, Ms. Leen created a purchase order for the X30, for IQD 95 million, and approved the requisition for delivery of the X30. The fixed assets register note of the X30 made by workshop 1 together with the invoice issued by the supplier in the amount of IQD 95 million were sent to the accounting department for payment as soon as the equipment was received.

To reconcile the remaining IQD 17 million, a week later Mr. Firas made and approved a purchase order for spare parts, in the amount of IQD 17 million. (Mr. Firas has authority for approval of purchase orders for spare parts valued up to IQD 20 million.) Simultaneously he directed his warehouse-keeper to create an inventory receipt note for these “imaginary” spare parts to be sent to the accounting department. Ms. Leen also requested the supplier issue another invoice valued at 17 million to be sent to the accounting department for payment.

The purchase of the X30 was completed and the accounting department recorded 1 fixed asset in workshop 1 which is forecast to increase its value to IQD 95 million over an estimated 5 years serviceable time (depreciation calculated by the straight-line method from July) and expected to increase inventory value (replacement parts) to IQD 17 million.

After taking the year-end inventory physical count, workshop 2 reported to have used all the spare parts by creating a sufficient number of inventory issue notes. This action falls within the company’s regulations.

Requirement

Your group has 10 minutes to respond to the following questions and agree upon your answers:

1. What weaknesses in the fixed asset controlling activities of Najati Company led to the above situation?

2. Which controlling activities need to be modified?

3. How will the above situation affect the profit of company this year and in the following years?

Answer 1

1.

The weakness in the system is the leeway provided to workshop manager to manipulate the purchase of one single unit of assets i.e., equipment X30 worth IQD 112 million into two parts. One being the equipment X30 for IQD 95 million and spare parts of IQD 17 million.

Purchase below IQD 100 million can be approved by workshop manager. So, Ms.Leen approved the purchase order for IQD 95 million.

Mr.Firas has the authority for approval of purchase of spare parts up to IQD 20 million. So, he authorises the purchase of spare parts of IQD 17 million, which is in fact equipment X30.

A single unit of equipment is recorded as i) equipment & ii) spare parts in the record.

2.

Recording of assets in asset register and entry in stock register needs to be strengthened to ensure that actual physical assets and actual physical spare parts are recorded in respective register.

Manager in charge of assets and spare parts should work independently and should not be allowed to be influenced by the workshop manager.
Workshop manager and Manager in charge of assets and spare parts should report directly to Manger of the company.
Had this been the procedure, then splitting of single unit asset into two parts; one into equipment X30 and the second one into spare parts and subsequent creation of sufficient inventory issue notes to suit the workshop manager needs could have been avoided.

3.

i) The profit of the company for the current year will be impacted due to recording of IQD 17 million as spare parts which will increase the cost of production , which means lower gross profit margin for the current year. On the other hand, recorded depreciation will be lower than actual depreciation. The net impact on profit is shown below:

Statement showing impact on profit in 1st year
Particulars		Depreciation
		Million IQD
Actual Depreciation	112/5	22.4
Manipulated Depreciation	95/5	19
Reduced Depreciation (A)		3.4
Increase cost of spare parts (B)		17
Net Impact on profit		-13.6

ii) Reduced depreciation in subsequent years will result in higher profit, which in turn will result in higher tax expenses.