Kevin Carter, CPA, a member of the IMA, the FEI, and the AICPA (see Chapter 1), is the newly hired controller of Oilers, Inc., a closely held manufacturer of replacement parts for oil well drilling equipment. Oilers distributes its products through its home office and 14 branches located near oil fields in several southwestern states. Shortly after being employed, Carter learned that the reciprocal ledger accounts at Oilers’s home office and 14 branches were out of balance by substantial amounts and that no member of the home office accounting department could remember when—if ever—the reciprocal ledger accounts had been in balance. In response to Carter’s astonished inquiries, the home office chief accountant stated that:
1. Oilers, Inc., had never been audited by independent CPAs, and it had no internal audit staff.
2. Management of Oilers, in reviewing financial statements of the 14 branches, concentrated on branch income statements and was unconcerned about the out-of-balance status of the branches’ Home Office ledger accounts.
3. To facilitate elimination of the reciprocal ledger account balances in the working paper for combined financial statements of the home office and 14 branches of Oilers, the chief accountant debited Miscellaneous Expense or credited Miscellaneous Revenue for the aggregate amount of the unlocated differences. These “plug” amounts were reported in the federal and state income tax returns filed by Oilers.
Instructions What is your advice to Kevin Carter? Should he permit the practice described above to continue?
If not, should he request management of Oilers to contract for an independent audit?
Alternatively, should he authorize the accountant at each of the 14 branches to adjust the branch’s Home Office ledger account balance to agree with the home office’s reciprocal Investment in Branch account balance, with the unlocated difference debited to Miscellaneous Expense or credited to Miscellaneous Revenue, as appropriate? Should some other course of action be taken? Explain