Report for Bill Bragan Regarding Bobby Bully Project, Leased Equipment, Separate Recording of Us Sales, and Hiring an Internal Auditor

To:

From:

Date:

Subject:

Further to our conversation, I have summarized the information that you have requested about the analysis of the Bobby Bully project, as well as the lease vs purchase of the new equipment. I have also included my recommendations about hiring an internal auditor, and the reporting of the US sales.

When Paul produced the analysis of profit potential of Bobby Bully he took the projected sales based on the highest probability which gives an inaccurate projection and has made the project look unprofitable. Upon further analysis I have noticed that the supervisor costs have been added as a variable cost, which should be a fixed cost as the supervisor is paid a salary regardless of the amount of units that as produced. With the adjustments that I have calculated I find that Bobby Bully would be most profitable if produced with option 2 of the projected sales.

As for the leased equipment, Paul was incorrect in stating that no debt would appear on the balance sheet. This is a capital leased as there is an option to purchase at the end of the lease term. Capital leases are recorded as an asset and a liability of the balance sheet. This will affect the debt covenant with the bank.

Internal auditors are responsible for looking after the internal control risks within a company, and make recommendations to help minimize these risks. Although an external auditor does look into these risks they are only there one a year, which could be too late. With BML rapidly expanding it is important that these risks be continuously managed.

Lastly, it is important to maintain separate records for US sale and Canadian sales. The reason for this is due to the fluctuation in the foreign exchange rate. If separate records are not kept then sale could be overstated or understated if the US dollar depreciated or appreciates in respect to the Canadian dollar. As about one third BML’s total sales comes from the US it is important to track customer preferences as well as growth opportunities within the US market.

I hope that this information is helpful to you and if you require further explanations please contact me.

Regards,

Jim Marshall, CMA

Case Analysis

Short Cycle Process

Who: Jim Marshall, Consultant

What: Report for Bill Bragan regarding Bobby Bully project, leased equipment, separate recording of US sales, and hiring an internal auditor.

When: June 3, 1987

Background / Situational Analysis

The Bobby Bully project has had a lot of effort inputted into the project; in which, Bill believes that the project will succeed. However, Paul Profit, the controller, disagrees with his idea since the quantitative analysis prepared by him indicates that the project is unprofitable.

Paul Profit believed that it would be more profitable for BML to lease a necessary piece of equipment instead of buying it, as he believed that the debt would not appear on the balance sheet. However, Bill thought that the lease is too expensive and is not clear whether the equipment should be leased or bought.

Paul suggested that the company did not require the sales made in the US to be recorded separately since these sales were no different than any other sales.

Paul rejected the external auditors recommendation of hiring an internal auditor because the external auditor already looked after systems related to internal controls.

Alternatives

Bobby Bully project

According to Paul’s quantitative analysis, the unit sales were projected simply based on the highest probability of occurrence. By doing this all options are not profitable. In order to get a more reasonable projection, the company should apply a weight-average method, which will take all probabilities of occurrence into consideration (Exhibit 1).

In Paul’s projection, the supervisors’ salaries are classified as variable costs. However, the supervisor’s salary is constant each month regardless of the quantity of products produced. Therefore, it is more appropriate to allocate the supervisor salary into fixed costs (Exhibit 2).

Leased Equipment

As BML has the option of purchasing the equipment at the end of the five year lease term and the present value of the lease payments are $289,599.91 (Exhibit 3), it should be classified as a capital lease. As a capital lease both an asset and an liability should be recorded on the balance sheet.  Therefore the debt will appear on the balance sheet.