QUESTION

CMA303_Principles of Auditing
Major Assignment Sem 1, 2012
Your firm is the auditor of Easy Hire Pty Ltd (Easy Hire).the company hires out equipment to
industries such as construction, engineering & event management. It has 76 branches nationwide,
with its head office located in Sydney. Each branch has designated amount of stock for hire.  The
amount of stock for hire is by the marketing department at head office, according to the local
demand for products.
In the past, branch managers had to obtain authority form the financial controller at head office to
purchase equipment from suppliers. Replacement equipment is issued due to either wear & tear or
loss by the customer. In the case of a customer losing or destroying the equipment, the replacement
value of the lost item is charged to the customer.
Customers are given credit, but the credit limits are set by the credit controllers at head office.
Standard terms of payment are 30 days from the date of the monthly statement.
The company has a new managing director who, early in the financial year, decided to decentralise
decision making & give the branch managers more authority. She also introduced an incentive
scheme for branch management, based on branch profits. Branch managers can now purchase
replacement equipment & set credit limits for customers.
The managing director has set up a list of designated suppliers for equipment& has negotiated
additional credit terms and /or special settlement discounts from them. A contract of repair of
equipment has been granted to an organisation with links to the main shareholder in the company.
You have the task of planning the audit & identifying the risks of material misstatement. Your
preliminary analysis, which compared the year under review to the previous year, showed the
following.
a) Branch sales & profits have increased considerably
b) Debtors levels (days outstanding) have remained relatively constant.
c) Creditors levels (days outstanding) have increased marginally.
d) Equipment write offs (due to wear & tear) have reduced relative to sales.
e) Equipment stocks at branches have increased considerably.
f) Repair-of-equipment costs have increased as a % of sales

Required:

Describe three internal control activities regarding replacement purchases that you would expect to
see in place. Give reasons for your answers.

SOLUTION

1. Introduction

Easy Hire is a firm which hires out equipment to industries such as construction, engineering & event management. It has 76 branches nationwide, with its head office located in Sydney. Each branch has designated amount of stock for hire. The amount of stock for hire is by the marketing department at head office, according to the local demand for products. In the past the control of the firm has been firmly placed in the managers of the head office, however with a new management system in place the firm is considering g giving greater authority to branch managers to make the required purchases.

The aim of the paper is to identify the benefits of this change in business strategy of giving greater authority to the branch managers and analyse its impact on the operational efficiency of the firm. The paper studies the three methods of internal control applicable in the purchase and the replacement of the machinery.

2. Methods of Internal Control

The auditor should be clearly able to identify the issues associated with the internal control in the corporation to assess the risk in reporting of materials and  avoid any kind of misstatement that arise due to either error or fraud .Keeping these key issue in mind the audit process should be effectively designed for the organization. The auditor should be effectively able to identify the risks and implement the control procedures such that there is no financial misreporting. The internal control deficiencies identified by the auditor should be effectively communicated to the management of the firm.

SME’s have to manage their businesses effectively and efficiently, for this it is important that all the management of the firm effectively implements control mechanisms. This is also applicable in the case of Easy hire, which is considering giving greater authority to branch manager’s .Implying that the decision making can be done at the lower level of management. To avoid financial misuse of the funds it is important that a certain mechanism of internal control also be applicable to the branch managers. So that both efficiency as well as control can be maintained in the organization.

(Ratcliffe et al, 2009)

Internal control is affected by each level in the organization. The main objective of the management has to be to increase operational efficiency of the organization and as well as ensure compliance with the rules and regulations set up by the government. However there is no guarantee that the internal control activities ensure the internal control activities help in the attainment of the long term organizational goals but none the less ensure a considerable degree of operational efficiency in the business.

(Ucop.edu- accessed on 12/05/2012)

2.1 Components of Internal Control

The internal control mechanism consists of 5 relevant components; these components can be effectively applied to any business. We apply the 5 components of internal control to easy hire and understand the mechanism of internal control in the organizational.

Control Environment

The control environment sets the quality for the business. It provides a structured framework within which the organization functions. The environmental discipline affects the working of the employees in the organization. A structured control environment has been maintained for the organization Easy Hire the management has maintained a strict control over the sales and purchases of machinery and equipment within the organization.

Risk Assessment

The risk assessment process is the most important competent of the internal control mechanism. It is important for the organization to effectively evaluate the risk before undertaking any investment. A potential risk has been identified with easy hire a major shareholder of the firm has been contracted to repair the equipment of the organization, As well as special terms of credit has been have negotiated. These mechanisms pose a potential future threat where these favours can affect the profitability of the firm and interfere with the independence of working of the corporation.

Control Activities

The control activities are those which ensure the effective implementation of the organizational control mechanism strategy. In this the Easy Hire has to ensure that the control activities are effectively implemented been certain strategic changes in the business operations have been undertaken by the organization are Approval, Authorization and Verification.

1. Authorization, Approval and Verification – Authorization is the effective delegation of responsibility to a particular group of people in the organization to enable effective decision making. In the above the branch managers are being authorised to make effective decision on the purchase of materials. While delegated authority to the branch managers to enable the decision making process certain quality control measures should also be placed so that the goods that are bought are of high quality and ensure efficiency in the organization and not financial fraud. The goods bought should be checked and verified by the quality control measures in place.
2. Segregation of Duties – The segregation of duties and responsibilities enable the creation of an effective top- down communication. It enables the mangers to clearly identify their roles and responsibilities. This also helps in the creation of accountability in the organization. In the case of Easy Hire the branch managers have been given the additional responsibility to make the purchase of the machinery. The quality control measures have not been effective which have resulted in the greater stock of equipment at branches. This is a clear reflection that the branch managers have not identified the duties and the responsibility that have been entrusted upon them. The managers have failed to make sound decision, and this a result of weak control mechanisms and activities developed by the organization.
3. Monitoring – The monitoring activities include the activities of the management of the financial resources and evaluating the financial decisions .It appears in the case of Easy Hire that the monitoring activities have been considerably weak as we can see in the case of special terms of credit being negotiated with the suppliers in the organization. As well as over stocking of equipment as a result of non-monitoring of the financial decisions made by the branch managers.

(Ratcliffe et al ,2009, Ucop.edu- accessed on 12/05/2012 and yale.edu – accessed on -12/05/2012)

3. Conclusion

From the above case it can be concluded that the delegation of greater authority to branch managers as resulted in creating inefficiency in the organization. The reflection of the inefficiency can be seen in the form of rising inventories, reduction the write-off as well as increase in the number of creditors. Therefore there is a need for the firm to undertake greater quality control activities to restore greater organizational efficiency.

4. References

• Ractcliffe, Thomas, and Charles Landes. “Understanding Internal control and Internal control Services.” Journal of Media Accountancy 1.1 (2009): 1-12. Print.
• Ucop, Education. “Understanding Internal Controls.” Ucop education 1.1 (2012): 1-21. Print.
• Yale , University. “Internal Control Framework.” Yale University Guides 1.1 (2000): 1-5. Print.

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