SECTION C Case Study (Total 20 marks)
Assessing Control Risks
(A) Kumud Pty Ltd is a major manufacturer of industrial machinery. Detailed below is a
description of its purchasing and payments system.
(i) When the stores department requires items to be purchased, they issue a three-part prenumbered
purchase requisition that needs to be approved by the store’s manager. Copy 1
is sent to the purchasing department, Copy 2 is sent to the accounts payable department
and Copy 3 is filed in the stores department.
(ii) On receipt of an approved purchase requisition, the purchasing department issues a fivepart
pre-numbered purchase order. Copy 1 is sent to the supplier, Copies 2 and 3 are
forwarded to the receiving department, Copy 4 is forwarded to the accounts payable
department and Copy 5 is filed in the purchasing department.
(iii) When goods are received, the receiving department logs in the shipment by stamping
“order received” on its two copies of the purchase order, which then forms its receiving
record. One copy of the receiving record is filed in the receiving department and the other
is forwarded to the accounts payable department.
(iv) The accounts payable department checks that there is a purchase requisition, purchase
order and receiving record for each supplier invoice and then approves it for payment.
(v) The accounts payable department prepares a pre-numbered disbursement voucher and
forwards it along with the supplier’s invoice, purchase requisition, purchase order and
receiving record to the financial accountant.
(vi) The financial accountant prepares a cheque for each supplier, signs the cheque and
records it in the cash disbursements journal. The cheque is immediately mailed to the
supplier. Supporting documentation is returned to accounts payable for filing.
(vii) At the end of the month, the assistant accountant undertakes a sequence check of all
accountable forms. The financial accountant receives the monthly bank statement,
prepares a bank reconciliation and investigates any reconciling items.
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Required:
(a) Identify any five (5) internal control weaknesses in Kumud’s internal control concerning
the purchases and payments functions. Explain why each one is a weakness.

(b) Explain the process the auditor can use in assessing control risks. ( 3 marks)
(c) What will be your assessment of internal controls relating to Kumud’s purchases and
payments system?

(B) You are the audit senior on the audit of Action Games Ltd (AGL), a large retailer of
computer games. Although each sale is of relatively low value, the company has a very high
sales volume. You have just completed your review of AGL's internal controls over sales for
your audit for the year ended 30 June 2015. Based on your review, you have concluded that
AGL's internal control over sales is excellent. As a result, you have suggested an audit strategy
for sales of extensive testing of the controls and, if they prove to be effective, relying solely on
those controls to gain reasonable assurance that the sales information is fairly stated. However,
your audit manager has asked you whether you have considered the inherent limitations of
internal control in designing your audit strategy.
Required:
(a) Explain the audit manager’s concern.
(b) What would be a more appropriate audit strategy? Justify your answer.

C4) Skinny Dippers, Inc. produces nonfat frozen yogurt. The product is sold in ten-gallon containers, which have the following price and variable costs.

Budgeted fixed overhead in 20x1, the company’s first year of operations, was $340,000. Actual production was 170,000 ten-gallon containers, of which 160,000 were sold. Skinny Dippers, Inc. incurred the following selling and administrative expenses.

Required:

1. 1. Compute the product cost per container of frozen yogurt under (a) variable costing and (b) absorption costing.

2. 2-a. Prepare operating income statements for 20x1 using absorption costing.

3. 2-b. Prepare operating income statements for 20x1 using variable costing.

4. 3. Reconcile the operating income reported under the two methods by listing the two key places where the income statements differ.

5. 4. Reconcile the operating income reported under the two methods using the shortcut method.

Tilson Corporation has projected sales and production in units for the second quarter of the coming year as follows:

Cash-related production costs are budgeted at $6 per unit produced. Of these production costs, 50% are paid in the month in which they are incurred and the balance in the following month. Selling and administrative expenses will amount to $60,000 per month. The accounts payable balance on March 31 totals $190,000, which will be paid in April.

All units are sold on account for $15 each. Cash collections from sales are budgeted at 60% in the month of sale, 25% in the month following the month of sale, and the remaining 15% in the second month following the month of sale. Accounts receivable on April 1 totaled $586,000 ($106,000 from February's sales and $480,000 from March’s sales).

Required:

a. Prepare a schedule for each month showing budgeted cash disbursements for Tilson Corporation.

b. Prepare a schedule for each month showing budgeted cash receipts for Tilson Corporation.

A company has the following accounts and account balances at the end of its first year:
   Accounts payable, $4,000
   Cash, $22,000
   Common stock, Not given
   Dividends, $4,000
   Expenses, $17,000
   Notes payable, $3,000
   Prepaid insurance, $5,000
   Revenues, $28,000
What is the balance of its common stock account at the end of the first year?

Leidenheimer Corporation manufactures small airplane propellers. Sales for year 2 totaled $1,710,000. Information regarding resources for the month follows.
     

In addition, Leidenheimer spent $63,000 on 45 engineering changes with a cost-driver rate of $1,400 and $59,200 on 8 outside contracts with a cost driver rate of $7,400.

Required:   

Management has requested that you do the following:

a. Prepare a traditional income statement.

b. Prepare an activity-based income statement.

You are a Financial Manager for Dexter Manufacturing. Your sales were $1,000,000 in 2010, and $1,000,000 again in 2011. Your accounting department came to you recently and stated that the cash balance is much lower at the end of 2011 than it was in 2010. You calculate your Accounts Receivable and Inventory Turnover for 2011 and noticed that both of these ratios have DROPPED from 2010 to 2011! Describe in a couple paragraphs what has happened to Accounts Receivable and Inventory. Does this help explain why cash is running low in your opinion? What could you suggest to your management team to help improve these 2 ratios and to help increase cash?

The executives at your firm are discussing alternative pricing and cost strategies for one of your major product lines, but the finance manager is out of town at a conference. They have asked you to join the meeting to explain how cost-volume-profit (CVP) planning and sensitivity analysis might be useful in the decision making process. What would your finance manager say about the use of these financial tools?

Discuss how Fiji Hot Bread Kitchen can link the BSC to its reward system to award bonus payments to its employees

10) Universal Leasing leases electronic equipment to a variety of businesses. The company’s primary service is providing alternate financing by acquiring equipment and leasing it to customers under long-term sales-type leases. Universal earns interest under these arrangements at a 10% annual rate.
  
The company leased an electronic typesetting machine it purchased for $30,900 to a local publisher, Desktop Inc. on December 31, 2017. The lease contract specified annual payments of $8,000 beginning January 1, 2018, the beginning of the lease, and each December 31 through 2019 (three-year lease term). The publisher had the option to purchase the machine on December 30, 2020, the end of the lease term, for $12,000 when it was expected to have a residual value of $16,000, a sufficient difference that exercise seems reasonably certain. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Show how Universal calculated the $8,000 annual lease payments for this sales-type lease.
2. Prepare an amortization schedule that describes the pattern of interest revenue for Universal Leasing over the lease term.
3. Prepare the appropriate entries for Universal Leasing from the beginning of the lease through the end of the lease term.
  

Pfizer Company produced and sold 50,000 units of product and is operating at 75% of plant capacity. Unit information about its product is as follows:

     Sales Price                                                $70

     Variable manufacturing cost                    $45

     Fixed manufacturing cost ($500,000 ÷ 50,000) 10        55

     Profit per unit                                            $15

The company received a proposal from a foreign company to buy 15,000 units of Pfizer Company's product for $50 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular sales. The president of Pfizer Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order.

Instructions

a) Prepare a schedule reflecting an incremental analysis of this special order.

b) Should Pfizer accept/reject this order? Why?

Smoky Mountain Corporation makes two types of hiking boots—the Xtreme and the Pathfinder. Data concerning these two product lines appear below:

The company has a traditional costing system in which manufacturing overhead is applied to units based on direct labor-hours. Data concerning manufacturing overhead and direct labor-hours for the upcoming year appear below:

Required:

1. Compute the product margins for the Xtreme and the Pathfinder products under the company’s traditional costing system.

2. The company is considering replacing its traditional costing system with an activity-based costing system that would assign its manufacturing overhead to the following four activity cost pools (the Other cost pool includes organization-sustaining costs and idle capacity costs):

Beacons Company maintains and repairs warning lights, such as those found on radio towers and lighthouses. Beacons Company prepared the following end-of-period spreadsheet at December 31, 20Y5, the end of the fiscal year:

Required:

Blumen Textiles Corporation began April with a budget for 34,000 hours of production in the Weaving Department. The department has a full capacity of 45,000 hours under normal business conditions. The budgeted overhead at the planned volumes at the beginning of April was as follows:

The actual factory overhead was $213,800 for April. The actual fixed factory overhead was as budgeted. During April, the Weaving Department had standard hours at actual production volume of 35,000 hours. Determine the variable factory overhead controllable variance and the fixed factory overhead volume variance. Enter a favorable variance as a negative number using a minus sign and an unfavorable variance as a positive number. Round your interim computations to the nearest cent, if required.

a. Variable factory overhead controllable variance: $  Favorable

b. Fixed factory overhead volume variance: $ Unfavorable

Direct Materials and Direct Labor Variances

At the beginning of June, Bezco Toy Company budgeted 17,000 toy action figures to be manufactured in June at standard direct materials and direct labor costs as follows:

The standard materials price is $0.5 per pound. The standard direct labor rate is $10 per hour. At the end of June, the actual direct materials and direct labor costs were as follows:

There were no direct materials price or direct labor rate variances for June. In addition, assume no changes in the direct materials inventory balances in June. Bezco Toy Company actually produced 14,800 units during June.

Determine the direct materials quantity and direct labor time variances. Round your per unit computations to two decimal places, if required. Enter a favorable variance as a negative number using a minus sign and an unfavorable variance as a positive number.

J.M Smucker Company operates two divisions, the Fruit Preserves Division and the Snack Foods Division. The Fruit Preserves Division manufactures and sells jelly and jams to supermarkets. The Snack Foods Division sells its products to theme parks. The company is considering disposing of the Snack Foods Division since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31, 2017 are presented below:

                             Fruit Preserves    Snack Foods

                                Division       Division             Total

Sales revenue                   $1,500,000         $500,000        $2,000,000

Cost of goods sold                 900,000        350,000       1,250,000

Gross profit                       600,000          150,000           750,000

Selling & admin expenses           250,000          180,000           430,000

Net income                     $   350,000        $(30,000)       $   320,000

In the Snack Foods Division, 60% of the cost of goods sold are variable costs and 25% of selling and administrative expenses are variable costs. The management of the company feels it can save $60,000 of fixed cost of goods sold and $50,000 of fixed selling expenses if it discontinues operation of the Snack Foods Division.

Instructions

(a) Determine whether the company should discontinue operating the Snack Foods Division. Prepare a schedule which supports your decision.

(b) If the company had discontinued the division for 2017, determine what net income would have been.

Downstream Intercompany Equipment Transactions

On July 1, 2015, Pearl Industries sold administrative equipment with a book value of $1,200,000 to its subsidiary, Shiek Shoes, for $1,400,000. At the date of sale, the equipment had a remaining life of five years. It is being straight-line depreciated on Shiek’s books. It is now December 31, 2017, the end of the accounting year, and you are preparing the working paper to consolidate the trial balances of Pearl and Shiek. Shiek still owns the equipment.

Required

(a) Prepare the necessary consolidation eliminating entries at December 31, 2017.

(b) It is now December 31, 2018. Prepare the required eliminating entries for this intercompany equipment transaction for the December 31, 2018, consolidation working paper.

(c) Now assume that Shiek sells the equipment to an outside party for $1,000,000 on January 1, 2019.

What is the consolidated gain on the sale of equipment? $Answer

What is the gain reported by Shiek? $Answer

Prepare the required eliminating entries for the December 31, 2019, consolidation working paper.