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Example research essay topic: Internal Controls Proper Treatment - 2,517 words

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... at current levels hay must be purchased from an outside party (at $ 80. 00 /ton) to support any volume of cattle above 30 during the winter months. Recently, RCC has been faced with the opportunity to expand self-produced hay in two different manners. First, RCC can buy a parcel of land that will produce an additional 100 tons of hay per year. This would bring total winter hay production to 160 tons per year. Second, RCC can install an irrigation system on current hay producing land to maximize its hay producing potential.

With an irrigation system you can produce an extra 40 tons of hay per year. This would bring total winter hay production to 100 tons per year The choice of what combination of purchased and self-produced hay effects the direct materials in the cost flow of cows. First, if RCC decides to continue purchasing all hay and not to expand self-producing capabilities at all, the variable rate for purchased hay will be the highest of the three scenarios. No new costs will be incurred except the variable price paid for every cow past a capacity of 30. Second, if RCC decides to purchase the adjacent land and raise the total capacity to 160 tons of winter hay the opposite effect on costs will occur. Since RCC will be able to self-produce hay for 80 animals (160 total tons of hay per year / 2 tons average consumption per year per animal unit) the step to reach the variable cost will be 80 animals rather than 30 animals.

This means that of the three options, this will produce the lowest variable cost. Since the land is not depreciable the cost of its purchase would not be included in the overhead rates of the cows. However, the lease expense is a substantial cash outflow and its total expense (including interest) must be weighed in a final decision. Third, if RCC decides to install the irrigation system, winter hay production will increase to 100 total tons of hay per year. This option means that only hay for a herd in excess of fifty cows (100 tons/ 2 tons per animal) must be purchased from an outside party. The variable cost will begin when the herd reaches fifty cows instead of the current thirty-cow threshold.

Also, the costs associated with installing a well are substantially lower than purchasing the large parcel of land. This means the overhead rate will increase above its current level because the depreciation of the land must be included in overhead. From a cost perspective, the installation of the well seems like the safest of the three propositions. Direct materials costs decrease (due to a raised threshold) and overhead increases only marginally. However, if RCC wants to increase the current herd size, this does not seem like the best logical decision. The parcel of 160 acres that you purchased in 1995 for $ 240, 000 has appreciated in two years to a fair market value of $ 320, 000.

It is our recommendation that if RCC wants to expand hay producing capacities that RCC purchase the adjacent parcel of land rather than install the irrigation system. Although operating overhead will be substantially higher, land in Rcc's area seems to be appreciating rather quickly and the cost could be looked at not only as an operating expense, but a long-term investment. Regardless of what the ultimate size of your breeding herd is, the purchase of the land should be considered for investment purposes if not for hay production. If RCC chooses to install the irrigation system, appreciation is not an option. There will be maintenance costs associated with the irrigation and well; at some point in the future the system will have to be scrapped and replaced.

Other than the hay that is produced, RCC receives no return on its costs. Additional Information Necessary to Complete the Cost System In order to complete the cost system, further information is necessary. First, in order to calculate appropriate depreciation, the true useful life of the cows is necessary. Right now they are depreciated over a 5 -year useful life in accordance with tax law. If the true useful life is longer that number should be used in place of the five-year figure for the cost allocation system. Second, in order to make a completely accurate estimation of the make or buy scenarios, the well depth must be pinpointed exactly.

The current estimates of a necessary depth between 200 and 500 feet leaves an open cost margin for this project. Third, costs associated with self-produced hay must be determined. Whether these include seed costs, or routine land maintenance, the costs must be included in the various overhead rates. Fourth, the number of male calves sold and the price they were sold would be very helpful to determine future revenues.

These numbers could be compared to the cost system to determine whether or not a true profit exists. Finally, the costs related only to specific animals must be identified. Certain costs are only attributable to breeding cows (birthing costs), male calves (freight-out expense), and bulls (extra hay). These costs must be identified and separated to the three cost flow systems. Determining Audit Risk and the Related Costs Estimating the audit risk and the cost of a first time audit of RCC involves an in depth look at potential areas of risk and the costs associated with identifying these risks, hough planning and gaining an understanding of the business.

In order to assess the audit risk of the RCC the auditor needs to: &# 61623; understand the environment and industry in which RCC operates &# 61623; apply the audit assertions to the material areas of RCC &# 61623; analyze the level of detection risk, control risk, and inherent risk of RCC. Gaining an understanding of RCC and the industry in which it operates is the initial step in planning the audit. Although this is not a major cost of the audit beyond the price of the auditors time, it is necessary before the audit can begin. Reviewing trade journals and publications of the industry provide the auditor with basic knowledge of the business.

Potential problems that have future ramifications such as the environmental issues regarding grazing restrictions and leases, diseases affecting cattle herds, and market trends in cattle sales, are noted. Touring the cattle ranch allows the auditor to observe the cattle and other major assets including farm equipment and the land used for grazing. Material assets become the focus of the audit based on their monetary value either as an asset producer or a revenue producer. The breeding stock, the cattle held for sale, and the property, plant, and equipment owned by RCC makeup the largest portion of the company and are of concern due to the potential materiality of misstatements, errors, and exposure to risk. The audit objectives for the breeding cows include determining the existence, the valuation, and the proper classification of the cows on the financial statements. With the herd of currently at 50 cattle, taking an actual count to verify their physical existence is reasonable.

Counting the cattle however, does not guarantee Rcc's rights to these animals. Cattle purchased or produced by RCC are accompanied by certification of the ownership of the cows. Reviewing these certificates, as well as checking ear tags and brands on the cows, would further identify Rcc's rights to these animals with more reliability due to legality of the certificates and the permanence of the brands. A confirmation should be sent to the State Board of Stock Inspection Commissioners to verify that RCC owns the rights to the brand and that it is properly registered. It is likely that much of the necessary information needed to read brands and test the validity of the certification process is beyond the level of the auditor and requires the assistance of a specialist (SAS 22). The breeding cows, either purchased or constructed, held for longer than a year, are classified as fixed assets.

Valuation of these cows is based on their accumulated costs, depreciated over their useful life. Determining the amounts of costs allocated to such animals involves an understanding of the cost system and reviewing the costs accumulated and applied. The Depreciation schedule holds relevant information regarding the depreciation method and the determination of the cows useful life. Analytical tests and recalculations are effective in determining the accuracy of the depreciation methods, but Rcc's reasoning behind the depreciation choices should also be known. There are other factors influencing the valuation of the cows including the potential disease and fertility problems, which could result in unseen risk.

Again, due to the limited knowledge of the auditor in this area, the assistance of a specialist is beneficial in identifying risks that might have gone unnoticed. The audit objectives for the male calves held for disposition include valuation, for the breeding cows, but applied differently due to the differences of the assets. The existence of the calves can be determined by taking a physical count. The valuation of the calves is based on the market value, not through Determining the existence of these calves? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?

Although the farm equipment owned by RCC is not directly used in the production of the cows, it is necessary and is a major asset on the financial statements due to its large monetary value. Potential risks involving this equipment include: the overstatement of the assets value on the balance sheet, the inclusion of nonexistent or impaired assets, and the improper application of depreciation methods of the assets. The main audit objectives regarding this equipment include verifying its existence and its proper valuation. Physically viewing the equipment is the initial step in determining its existence, but is not enough. Not only must the auditor have reasonable assurance that the stated equipment physically exists, but that it is in working condition and is used in the operations of RCC.

Valuation of the equipment depends on the cost of the asset, less the accumulated depreciation. Reviewing the depreciation not only allows the auditor to verify which depreciation method RCC uses, but can also be used to gain a reasonable assurance that the depreciation is calculated properly. As a relatively small, family-owned operation, internal controls involving sales are minimal, and with few employees, the segregation of duties is limited. Although the internal risk level appears to be high, testing the audit assertions and forming an audit plan lowers the risk of not detecting errors due to the weak internal controls. Both the costs and risks of the audit are lowered if the auditor has adequate knowledge of the RCC. Gaining knowledge of the industry, applying audit assertions to the material assets of the company, and assessing the risk level based on the findings will be the major costs of the audit and require the most of the auditors time.

The costs of the audit and determining the risks are not abnormally high, beyond the added cost of the specialist, which is minimal. The benefits of the initial audit of RCC will far outweigh the costs in future years. Our firm has been tasked with analyzing Rcc's propositioned acquisition of 70 permitted cows for $ 70, 000 and the current possession of 30 leases for summer pasturage which were acquired in 1995 from the U. S. National Forest Service for $ 7, 500.

These federal permits are attractive in the long run since the monthly grazing fee is a mere $ 2 per animal unit per month, rather than the $ 10 per animal unit per month fee for private land. RCC is currently subletting the 30 leases to another rancher for $ 1. 35 per animal unit per month. The firm is tasked to research the proper treatment of the proposed acquisition of 70 permitted cows and the 30 federal permits already in possession. RCC is also seeking research regarding how much of the purchase price can be capitalized for tax purposes and over what period of time RCC can recover these costs as tax deductions. Regarding the proper treatment of the grazing rights acquired through permit by the U. S.

National Forest Service. Section 1. 167 (a) of the Income Tax Regulations provides for the amortization of intangible assets known to be of limited use for a period of length which can be estimated with reasonable accuracy. An intangible asset, the useful life which is not limited, is not subject to the allowance for depreciation (FIC, 1137). In the tax court case Shuffelbarger v. Commissioner, the court held that federal grazing permits were of indefinite duration and not assets exhausted through use or the passage of time (Shuffelbarger v. Commissioner).

The grounds for cancellation or revocation were wholly contingent and might never happen. There was reasonable certainty of renewal of the permit or continuation of the permit. In Ranching Co. v. Commissioner, petitioners were not entitled to amortization of state or federal land leases because it was not established that such leases were of a limited duration which could be estimated with reasonable accuracy.

The lessee had the preferred right to renew the lease (Ranching Co. V. Commissioner). In a similar case, Kimble v. Stuart, the leases and permits were limited to definite terms on their faces without expressing an absolute right of renewal for additional terms; but there was no basis for assuming that the State of Arizona or the Forest Service would refuse to renew the leases and permit. The court held that there could be no allowance for amortization or depreciation because there was a lack of evidence as to any correct amortization period (Kimble v.

Stuart). Congress enacted 197 effective for acquisitions after August 10, 1993. All "Section 197 Intangibles" must be amortized over 15 years. Section 197 (d) (D) of the Internal Revenue Code recognizes permits granted by a government unit, but the firm does not believe 197 provides an exception applicable to Rcc's disposition (FIC, 169). The 70 cows to be acquired would be classified as 1245 property, which includes livestock, irrespective of the use to which they are put or the purpose for which they are held. The firm believes that RCC will not be able to amortize $ 21, 000 (70 X $ 300) of the proposed acquisition of 70 permits or the $ 7, 500 expended for the 30 leases currently held.

The purchase of 70 cows would be held in the Modified Accelerated Recovery Systems (MACRS) 5 year (01. 21) asset class and be depreciated accordingly. Depending on which portion of the year the depreciable tangible personal property are acquired, you ma Bibliography:

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Research essay sample on Internal Controls Proper Treatment

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