ch04 sm 9e

Chapter 4

Internal Control & Cash

Short Exercises

(5 min.) S 4-1

Fraud is an intentional misrepresentation of facts, made for the

purpose of persuading another party to act in such a way that causes

injury or damage to that party.

The Three Components of the Fraud Triangle

1. Motive — Fraud generally results from either critical need or greed on

the part of the perpetrator. Regardless of whether the driving force is

need or greed most perpetrators are driven to attempt to acquire

something that belongs to others.

2. Opportunity — The opportunity to commit fraud usually arises

through weak internal controls.

3. Rationalization — The perpetrator(s) is (are) convinced, in their own

minds, that they deserve the object of the fraudulent behavior. They

may believe no one else will ever know or even that everybody else is

engaging in fraudulent behavior

Chapter 4 Internal Control & Cash 4-1

(5-10 min.) S 4-2

COMPONENTS OF INTERNAL CONTROL

1. Control environment — Top managers must set the “tone at the top”

to establish a control environment.

2. Risk assessment — Each company must evaluate its own risks, based

upon its particular line of business.

3. Control procedures — Specific procedures are needed for a good

system of internal control.

4. Monitoring of controls — Auditors can monitor a company’s actions

and its financial statements.

5. Information system — Accurate information is essential for success

in business.

Student responses may vary for the descriptions.

(5-10 min.) S 4-3

Separation of duties is essential for safeguarding assets. The person

who has custody of an asset should not also account for the asset. A

person who performs both duties can steal the asset and hide the theft

by making a false entry in the accounting records.

Student responses may vary.

Financial Accounting 9/e Solutions Manual4-2

(5-10 min.) S 4-4

There are several major internal control procedures as discussed in the

chapter besides separation of duties:

1. Smart hiring practices. The company should be careful to hire both

competent and honest personnel. Smart hiring practices involve

conducting background checks on job applicants, as well as training

and supervision on the job.

2. Comparisons and compliance monitoring. No person or department

should be allowed to completely process a transaction from beginning

to end without being checked by another person or a computer program.

Examples of comparisons and compliance monitoring are the use of

operating and cash budgets. Also, in key functions, one employee (or a

computer program) double checks the work of another for accuracy.

3. Adequate records help to assure that sufficient hard copy documents

or electronic information is kept by the entity to support the validity of

transactions that were processed. Examples include sales invoices,

purchase orders, shipping records, and customer remittance advices.

Among the benefits of adequate records is the ability to provide an audit

trail later for internal or external auditors to follow in auditing the entity’s

financial statements.

4. Limited access goes hand in hand with separation of duties to assure

that only authorized individuals are allowed access to (a) the assets of

the company, such as cash or inventory; and (b) the records. Generally,


(continued) S 4-4

only people with custodial responsibilities (such as the cashier or the

warehouse) should be allowed access to assets (such as cash or

inventory). Only people with recordkeeping responsibilities (such as

accountants) should have access to the company’s journals and

ledgers.

5. Proper approvals. No transaction should be processed without

management’s general or specific approval. Generally, the larger the

transaction, the higher the organizational level of approval necessary.

Notice that the first letters of these attributes spell the acronym SCALP.

That’s an easy and comprehensive way to remember the control

procedures involved in internal controls.

(10 min.) S4-5

A computer virus enters program code without your consent and

performs destructive action to your computer files or programs.

A Trojan Horse is a malicious computer program that hides inside a

legitimate program and works like a virus to corrupt your computer files

or programs.

A phishing expedition can be a Web site that attracts visitors who may

be tricked into revealing their account numbers, social security

numbers, passwords, or other valuable data. The creator of the Web site

then uses the unsuspecting Web-site visitors’ data to steal from them

and for other illicit purposes.


(20-30 min.) S 4-6

Cash is important not because of its amount as reported on the

balance sheet, but because of its effect on a business. All

transactions ultimately affect cash. Businesses purchase assets and

must pay cash. They make sales and collect cash. All expenses

ultimately require cash. Also, cash is susceptible to theft because it is

a medium of exchange. These factors combine to give cash more

importance than its account balance would suggest.


(20-30 min.) S 4-7

Punching a hole through supporting documents reduces the

opportunity for fraud. Without this control procedure, a dishonest

employee could resubmit documents for payment a second time. The

employee could change the payee’s address and have the check sent

to an address the employee controls. Or the employee could arrange

to have the second payee split the payment with the employee.

Canceling the documents makes it difficult to get approval for a

duplicate payment.



(10 min.) S 4-8

Rampart Corp.Bank Reconciliation

October 31, 2012BANK BOOKS

Balance, October 31 $3,675 Balance, October 31 $2,540

Add: Deposit in transit 400 Add: Bank collection 670

4,075 Interest revenue 20

3,230

Less: Less:

Outstanding checks (900) Service charge (30) NSF check (25 )

Adjusted bank balance $3,175 Adjusted book balance $3,175

Rampart has cash of $3,175.

(5 min.) S 4-9

Journal

DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Oct. 31 Cash……………………………………….. 670Accounts Receivable………………... 670

Collection on account.

31 Cash……………………………………….. 20Interest Revenue……………………... 20

Interest earned on bank balance.

31 Miscellaneous Expense………………... 30Cash……………………………………. 30

Bank service charge.

31 Accounts Receivable…………………… 25Cash…………………………………….. 25

NSF check.


(5 min.) S 4-10

It appears that the employee has stolen $710 (adjusted book balance,

$4,400 − adjusted bank balance, $3,690). The adjusted bank balance is

the company’s true cash balance, and the company books show more

cash on hand. Therefore, the books must be incorrect.

(5 min.) S 4-11

Sims will notice a gap in the sequence of sales receipts for the receipt

that Cilla destroyed. This knowledge will lead Sims to investigate what

happened to the missing receipt and what happened to the related cash.

(10 min.) S 4-12

1. Paying by check carries three controls over cash:

The check provides a record of the payment.

The check must be signed by an authorized official.

Before signing the check, the official should study the evidence

supporting the payment.

2. A dishonest purchasing agent could:

Purchase goods and have them delivered to his home or other location

that he controls.

Approve payment by the company for goods that he spent too much on,

and then split the excess with the supplier.

Companies avoid this internal control weakness by separating the

following duties related to the purchase of, and payment for, goods:

purchasing goods

receiving goods

approving and paying for goods


(5 min.) S 4-13

A cash budget starts with the beginning cash balance, adds budgeted

cash receipts, and subtracts budgeted cash payments. The result is

cash available at the end of the period. By comparing cash available to

our budgeted cash balance, we can see whether we have cash available

for additional investments, or if we’ll need new financing.


(5-10 min.) S 4-14

Cooper Apple GrowersCash Budget

Year 2011 Millions

Cash balance, beginning $ 8

Estimated cash receipts—total 103

111

Estimated cash payments—total (86 )

Cash available (needed) before new financing 25

Budgeted cash balance needed (20 )

Cash available for additional investments $ 5

(5 min.) S 4-15 Financial Accounting 9/e Solutions Manual4-8

Rocker should report the errors to Doon because Doon is Rocker’s

supervisor, and Doon is responsible for the errors. If Doon fails to take

action, then Rocker should report the errors to the manager of the

organization. In any event, outsiders who are relying on Dill Limited’s

financial statements must be made aware of the need to correct the

reported net income figure.


Exercises

(5-20 min.) E 4-16A

a. Munson has access to the cash collected, and he also prepares the

cash report. With access to both items, Munson can steal cash and

falsify his cash report to conceal his theft.

b. Fulton prepares the purchase order and also receives the goods. She

can add some items to the purchase order and have these extra items

shipped to a location she controls. When the goods come in, she

checks the incoming shipment, so there’s no outside party to learn of

her dishonesty.


(10 min.) E 4-17A

Cash payments:

a. Strong internal control. There is a good separation of duties.

Supervisors request equipment, and the home office purchases the

equipment.

b. Weak internal control. Supervisors request, purchase, and pay for

equipment with little oversight by the home office.

Cash receipts:

a. Weak internal control. There is not a good separation of duties. The

accountant both handles cash and accounts for cash.

b. Strong internal control. There is a good separation of duties. Different

people handle cash and account for cash.


(10 min.) E 4-18A

To prevent Flack’s embezzlement, Downtown Columbia’s board of

directors could have:

a. Not permitted Flack to write checks for Downtown Columbia.

Instead, appoint a board member to write the checks.

b. Not permitted Flack to receive cash that came to Downtown

Columbia. Have cash sent to a lock box at the bank and appoint a

board member to get the cash from the lock box.

c. Supervised Flack’s work by examining Downtown Columbia’s

documents such as paid checks.

d. Had an audit of Downtown Columbia’s transactions and financial

statements.


(5-10 min.) E 4-19A

1. d 5. a

2. c 6. b

3. d 7. b

4. c


(10-20 min.) E 4-20A

D. J. HarrisBank Reconciliation

January 31, 2012

BANK:

Balance, January 31 $ 409

Add: Deposit in transit 1,225

Less: Outstanding checks:

Check No.

626 $ 90

627 270 (360 )

Adjusted bank balance $1,274

BOOKS:

Balance, January 31 $1,372

Less:

Correction of book error —

Recorded $81 check as $18 $ 63

NSF check 25

Service charge 10 (98 )

Adjusted book balance $1,274


(10-20 min.) E 4-21A

Frank WhiteBank ReconciliationNovember 30, 2012

BANK:

Balance, November 30 $ 570


2,335

Less: Outstanding checks (601 )


BOOKS:

Balance, November 30 $1,780

Add: EFT collection — rent 335

2,115

Less:

Service charge $ 8

NSF checks 120

Charge for printed checks 10


recorded $270 check as $27 243 (381 )


White’s actual cash balance is $1,734.


(10-15 min.) E 4-22A

JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Nov 30 Cash…………………………………….. 335Rent Revenue……………………… 335

EFT collection of rent.

30 Miscellaneous Expense ($8 + $10).... 18 Cash…………………………………. 18Bank service charge and chargefor printed checks.

30 Accounts Receivable……………….... 120 Cash…………………………………. 120NSF checks returned by bank.

30 Salary Expense ($270 − $27)………… 243 Cash…………………………………. 243Correction of book error.

(10-15 min.) E 4-23A

TO: Store Manager

FROM: Student

SUBJECT: Evaluation of internal control and plan for improvement

There is a weakness in internal control over cash receipts. The cash

registers do not keep a record of sales. With no record, there is no way

to determine how much cash should be in the cash drawer. This

omission makes it easy for the cashier to steal cash and not get caught.

To improve internal control, the company should use cash registers that

record each sale. The manager can prove the amount of cash in the cash

drawer against this recorded amount.


(10-15 min.) E 4-24A

The main internal control weakness is that the payroll department both

prepares and distributes the paychecks. With both duties, a dishonest

person in the payroll department can create a time sheet for a fictitious

employee and then keep the related paycheck after the treasurer returns

the signed checks to the payroll department.

To correct this weakness, Flat Flyers should have someone other than

the payroll department or the shop foreman distribute paychecks to

employees. For example, the human resources department, which has

no control over the time sheets or the paychecks, could distribute

paychecks to the workers.


(20-30 min.) E 4-25A

Gale Communications, Inc.Cash Budget

Year Ended December 31, 2012

Millions

Cash balance, December 31, 2011 $ 85

Budgeted cash receipts:

Collections from customers 11,335

Sale of assets 157

11,577

Budgeted cash payments:

Payments for cost of

services and products $6,169

Payments of operating expenses 2,553

Investment in equipment 1,822

Payment of debt 578

Payment of dividends 358 11,480

Cash available (needed) before financing 97

Budgeted cash balance, December 31, 2012 (78 )

Cash available for additional investments, or

(new financing needed) $ 19

Gale Communications expects to have cash available for additional

investments of $19 million during 2012.


(10 min.) E 4-26A

Actual Interest paideffective

=each year

=$15,000,000 × .072

=$1,080,000

interest rate Amount actually borrowed

$15,000,000 − $15,000,000(.053)

$14,205,000

= 7.60%

(5-20 min.) E 4-27B

a. Mott has access to the cash collected, and he also prepares the cash

report. With access to both items, Mott can steal cash and falsify his

cash report to conceal his theft.

b. Austin prepares the purchase order and also receives the goods. She

can add some items to the purchase order and have these extra items

shipped to a location she controls. When the goods come in, she

checks the incoming shipment, so there’s no outside party to learn of

her dishonesty.



(10 min.) E 4-28B

Cash payments:

a. Strong internal control. There is a good separation of duties.

Supervisors request equipment, and the home office purchases the

equipment.

b. Weak internal control. Supervisors both request, purchase, and pay

for equipment with little oversight by the home office.

Cash receipts:

a. Weak internal control. There is not good separation of duties. The

accountant both handles cash and accounts for cash.

b. Strong internal control. There is a good separation of duties. Different

people handle cash and account for cash.

(10 min.) E 4-29B

To prevent Smart’s embezzlement, Downtown Huntsville’s board of

directors could have:

a. Not permitted Smart to write checks for Downtown Huntsville.

Instead, appoint a board member to write the checks.

b. Not permitted Smart to receive cash that came to Downtown

Huntsville. Have cash sent to a lock box at the bank and appoint a

board member to get the cash from the lock box.

c. Supervised Smart’s work by examining Downtown Huntsville’s

documents such as paid checks.

d. Had an audit of Downtown Huntsville’s transactions and financial

statements.



(5-10 min.) E 4-30B

1. b 5. d

2. b 6. c

3. d 7. c

4. a

(10-20 min.) E 4-31B

D. J. HardyBank Reconciliation

August 31, 2012

BANK:

Balance, August 31 $ 405


Less: Outstanding checks:

Check No.

626 $ 75

627 265 (340 )


BOOKS:

Balance, August 31 $1,352

Less:


Recorded $85 check as $58 $ 27

NSF check 30




(10-20 min.) E 4-32B

Evan NealBank Reconciliation

January 31, 2012

BANK:

Balance, January 31 $ 575


2,350

Less: Outstanding checks (606 )


BOOKS:

Balance, January 31 $1,801

Add: EFT collection — rent 330

2,131

Less:

Service charge $ 9

NSF checks 115

Charge for printed checks 11


recorded $280 check as $28 252 (387 )


Neal’s actual cash balance is $1,744.


(10-15 min.) E 4-33B


Jan 31 Cash…………………………………….. 330Rent Revenue……………………… 330

EFT collection of rent.

31 Miscellaneous Expense ($9 + $11).... 20 Cash…………………………………. 20Bank service charge and chargefor printed checks.

31 Accounts Receivable……………….... 115 Cash…………………………………. 115NSF checks returned by bank.

31 Salary Expense ($280 − $28)……….. 252 Cash………………………………… 252Correction of book error.

(10-15 min.) E 4-34B

TO: Store Manager

FROM: Student

SUBJECT: Evaluation of internal control and plan for improvement

There is a weakness in internal control over cash receipts. The cash

registers do not keep a record of sales. With no record, there is no way

to determine how much cash should be in the cash drawer. This

omission makes it easy for the cashier to steal cash and not get caught.

To improve internal control, the company should use cash registers that

record each sale. The manager can prove the amount of cash in the cash

drawer against this recorded amount.


(10-15 min.) E 4-35B

The main internal control weakness is that the payroll department both

prepares and distributes the paychecks. With both duties, a dishonest

person in the payroll department can create a time sheet for a fictitious

employee and then keep the related paycheck after the treasurer returns

the signed checks to the payroll department.

To correct this weakness, Fast Pass should have someone other than

the payroll department or the shop foreman distribute paychecks to

employees. For example, the human resources department, which has

no control over the time sheets or the paychecks, could distribute

paychecks to the workers.


(20-30 min.) E 4-36B

Donn Communications, Inc.Cash Budget


Millions




Sale of assets 151

11,562


Payments for cost of

services and products $6,185

Payments of operating expenses 2,557

Investment in equipment 1,823

Payment of debt 611


Cash available (needed) before financing 70



(New financing needed) $ (9 )

Donn expects to need new financing of $9 million during 2012.


(10 min.) E 4-37B

Actual Interest paideffective

=each year

=$17,000,000 × .07

=$1,190,000

interest rate Amount actually borrowed

$17,000,000 − $17,000,000(.051)

$16,133,000

= 7.38%


Quiz

Q4-38 b

Q4-39 d

Q4-40 d

Q4-41 c

Q4-42 a

Q4-43 d

Q4-44 b

Q4-45 d

Q4-46 d

Q4-47 c

Q4-48 d

Q4-49 a [$14,000 + $81,000 − $44,000 − $34,000 − $25,000 −

$13,000 = ( $21,000); arrange financing for this

amount.]


Problems

(15-20 min.) P 4-50A

The internal control weaknesses in Irish Import’s system are:

1. Fitzpatrick controls the content of the invoices. With no supervision

of her work, Fitzpatrick could have the suppliers overstate their prices

and then arrange to have them split the excess with her after Irish

Import pays the invoices.

2. Riley has both cash handling and accounting duties. With both

responsibilities, Riley could steal incoming cash and cover her theft

by manipulating the accounting records.

As with all small businesses, the key to effective internal control is

more owner involvement. O’Shea could:

1. Make the purchase and pay arrangements with the Irish artisans who

supply Irish Import’s products. Let Fitzpatrick keep locating new

products, but don’t let her arrange for the purchases and payment.

2. O’Shea could assign either cash handling or accounting duties to

Riley and then hire someone else to do the other (accounting or cash-

handling) duties. Also O’Shea needs to perform the bank

reconciliation to keep her eye on cash receipts and cash payments.


(10-20 min.) P 4-51A

Requirement 1 Requirement 2 Requirement 3Missing Internal

Control Characteristic Possible Problem Solution

a. Separation of duties

Theft of diamonds — the purchasing agent could have diamonds sent to a location he controls.

Separate purchasing, approval, and check-signing duties.

b. Assignment of responsibility

Lost revenue, because too many employees are managing the office and neglecting their duties.

Assign a single employee to manage the office when the owner is absent.

c. Separation of duties

Theft of cash. Separate accounting and cash-handling duties.


(20-30 min.) P 4-52AReq. 1

Durkin AutomotiveBank Reconciliation

April 30, 2012

BANK:

Balance, April 30, 2012 $ 9,060

Add: Deposits in transit ($892 + $2,048) 2,940

12,000

Less: Outstanding checks —

Check No.

3119 $ 425

3120 987

3121 177

3122 2,304 (3,893 )

Adjusted bank balance, April 30, 2012 $ 8,107

BOOKS:

Balance, April 30, 2012 $ 6,519

Add: EFT collection of rent $ 625

Bank collection of note receivable 1,375

Book error — $1,380 check

recorded as $1,830 450 2,450

8,969

Less: EFT payment of insurance $ 397

Unauthorized signature check 455


Adjusted book balance, April 30, 2012 $ 8,107


(continued) P 4-52A

Req. 2

A bank account helps control cash by providing a place for safekeeping.

The bank also provides a detailed list of the company’s cash

transactions that managers can compare to the company’s own cash

records and thereby correct any book errors quickly.

The bank reconciliation helps control cash by ensuring that the

company accounts for its cash transactions correctly and that the bank

and book records of cash are correct. Also, the bank reconciliation

establishes the balance of cash to report on the balance sheet.


(20-30 min.) P 4-53A

Req. 1

Donald Engineering AssociatesBank Reconciliation

November 30, 2011

BANK:

Balance, November 30 $8,457.95

Add: Deposit of November 30 in transit 381 .75

8,839.70

Less: Outstanding checks ($404.80 +

$74.82 + $34.89 + $173.25 +

$238.00 + $47.75 + $105.78) $1,079.29

Correction of bank error, which

credited our account for the

deposit of another company 415 .00 (1,494 .29 )

Adjusted bank balance, November 30 $7,345 .41

BOOKS:

Balance, November 30 $7,684.83

Add: Interest revenue earned on bank

balance $ 16.38

Bank collection of account receivable 903 .10 919.48

8,604.31

Less: EFT (utilities $750, insurance $240) $ 990.00

Service charge 7.50

Returned check due to unauthorized

Signature 193.75

NSF check 67 .65 (1,258 .90 )

Adjusted book balance, November 30 $7,345 .41


(continued) P 4-53A

Req. 2 (entries based on the reconciliation)


Nov 30 Cash………………………………………………… 16.38

Interest Revenue………………………………. 16.38


30 Cash………………………………………………… 903.10

Accounts Receivable…………………………. 903.10

Account receivable collected by bank.

30 Utilities Expense………………………………….. 750.00

Cash……………………………………………... 750.00

Monthly utilities.

30 Insurance Expense………………………………. 240.00

Cash……………………………………………... 240.00

Monthly insurance.

30 Miscellaneous Expense…………………………. 7.50

Cash……………………………………………... 7.50


30 Accounts Receivable ($193.75 + $67.65)……... 261.40

Cash……………………………………………... 261.40

NSF and US customer checks returned by bank.


(10-15 min.) P 4-54A

TO: President, Healthy Hair Care

FROM: Concerned Employee

It is unwise to have the employee who opens the mail also grant

allowances to customers. Suppose a customer pays an invoice in full.

The mailroom employee can steal the customer check and grant an

allowance to cover the theft. To correct this internal control weakness,

deny the mailroom employee access to all accounting records. Also,

appoint a separate employee to grant allowances to customers.

Notes:

1. Student responses may vary.

2. The mailroom employee obviously has access to the accounting

records—to know that a customer has paid less than the full

amount.

3. It may be necessary to explain to students that the mailroom

employee must forge the company endorsement on customer

checks stolen. This person must also open— and control—a bank

account in the company’s name. This may be quite easy.


(30-45 min.) P 4-55A

Bosworth WirelessCash Budget

2013

Thousands

Cash balance, beginning $ 1,400


Collections from customers ($61,000 × 1.15) 70,150

Receipt of interest 400

71,950


Purchases of inventory ($46,000 × 1.24) $57,040

Operating expenses 13,200

Purchases of equipment 4,500

Purchases of investments 800

Payment of dividends 500

Payment of long-term debt 200 (76,240 )

Cash available (needed) before financing (4,290)

Budgeted cash balance, ending (3,550 )


(new financing needed) $ (7,840 )


(15-20 min.) P 4-56B

The internal control weaknesses in European Import’s system are:

1. Woods controls the content of the invoices. With no supervision of

her work, Woods could have the suppliers overstate their prices and

then arrange to have them split the excess with her after European

Import pays the invoices.

2. Davis has both cash handling and accounting duties. With both

responsibilities, Davis could steal incoming cash and cover her theft

by manipulating the accounting records.

As with all small businesses, the key to effective internal controls is

more owner involvement. Stiles could:

1. Make the purchase and pay arrangements with the Spanish artisans

who supply European Import’s products. Let Woods keep locating

new products, but don’t let her arrange for the purchases and

payment.

2. Stiles could assign either cash handling or accounting duties to Davis

and then hire someone else to do the other (accounting or cash-

handling) duties. Also Stiles needs to perform the bank reconciliation

to keep her eye on cash receipts and cash payments.


(10-20 min.) P 4-57B

Requirement 1 Requirement 2 Requirement 3Missing Internal

Control Characteristic Possible Problem Solution

a. Separation of duties Theft of cash or diamonds by the purchasing agent.

Have a manager, not the purchasing agent, approve invoices for payment and sign the checks.

b. Assignment of responsibilities

Lost revenue due to delay of architectural drawings.

Assign one senior architect to fulfill management duties while Williams is absent. Other senior architect should focus on producing architectural drawings.

c. Separation of duties Theft of cash. Keep accounting and cash handling duties separate.


(20-30 min.) P 4-58B

Req. 1

Duffy AutomotiveBank Reconciliation

October 31, 2012

BANK:

Balance, October 31, 2012 $ 9,600

Add: Deposits in transit 2,904

12,504

Less: Outstanding checks

Check No.

3119 $ 488

3120 972

3121 165

3122 2,318 (3,943 )

Adjusted bank balance, October 31, 2012 $ 8,561

BOOKS:

Balance, October 31, 2012 $ 6,675

Add: EFT collection of rent $ 750

Bank collection of note receivable 1,350

Book error — $1,390 check recorded 540 2,640

as $1,930 9,315

Less: Unauthorized signature check $ 417

EFT payment of insurance 312


Adjusted book balance, October 31, 2012 $ 8,561


(continued) P 4-58B

Req. 2

A bank account helps control cash by providing a place for safekeeping.

The bank also provides a detailed list of the company’s cash

transactions that Duffy Automotive managers can compare to the

company’s own cash records and thus correct any book errors quickly.

The bank reconciliation helps control cash by ensuring that the

company accounts for its cash transactions correctly and that the bank

and book records of cash are correct. Also, the bank reconciliation

establishes the balance of cash to report on the balance sheet.


(20-30 min.) P 4-59B

Req. 1

Durkin Engineering AssociatesBank Reconciliation

April 30, 2011

BANK:

Balance, April 30 $8,501.15

Add:

Deposit of April 30 in transit 382 .25

8,883.40

Less: Outstanding checks ($405.15 +

$73.87 + $35.47 + $167.88 +

$238.00 + $48.10 + $103.54) $1,072.01

Correction of bank error —

credited our account for the

deposit of another company 398 .00 (1,470 .01)

Adjusted bank balance, April 30 $7,413 .39

BOOKS:

Balance, April 30 $7,795.12

Add: Bank collection on account $ 932.87

Interest revenue on bank balance 16 .55 949 .42

8,744.54

Less: Service charge $ 5.50

EFT Payment of utility bill 780.00

EFT Payment of insurance bill 290.00

NSF check 68.15

Returned item due to

unauthorized signature 187 .50 (1,331 .15 )

Adjusted book balance, April 30 $7,413 .39


(continued) P 4-59B

Req. 2 (entries based on the reconciliation)


Apr 30 Cash…………………………………………... 932.87

Accounts Receivable………..…………. 932.87

Accounts receivable collected by bank.

30 Cash…………………………………………... 16.55

Interest Revenue………………………... 16.55


30 Utilities Expense …………………………… 780.00

Insurance Expense.…………………...…… 290.00

Cash …………….………………………… 1,070.00

EFT payments

30 Miscellaneous Expense……………………. 5.50

Cash………………………………………... 5.50


30 Accounts Receivable ($68.15 + $187.50)… 255.65

Cash………………………………………….. 255.65

NSF and US customer checks returnedby bank.


(10-15 min.) P 4-60B

TO: President, Radiant Hair Care

FROM: Concerned Employee

It is unwise to have the employee who opens the mail also grant

allowances to customers. Suppose a customer pays an invoice in full.

The mailroom employee can steal the customer check and grant an

allowance to cover the theft. To correct this internal control weakness,

deny the mailroom employee access to all accounting records. Also,

appoint a separate employee to grant allowances to customers.

Notes:

1. Student responses may vary.

2. The mailroom employee obviously has access to the accounting

records — to know that a customer has paid less than the full

amount.

3. It may be necessary to explain to students that the mailroom

employee must forge the company endorsement on customer

checks stolen. This person must also open — and control — a

bank account in the company’s name. This may be quite easy.


(30-45 min.) P 4-61B

Madison WirelessCash Budget

2013

Cash balance, beginning $ 1,300


Collections from customers ($66,000 × 1.12) 73,920

Receipt of interest 100

75,320


Purchases of inventory ($50,000 × 1.25) $62,500

Operating expenses 13,400

Purchase of property and equipment 4,800

Purchases of investments 400

Payment of dividends 200

Payments of long-term debt 600 81,900

Cash available (needed) before financing (6,580)

Budgeted cash balance, ending (3,650 )


(New financing needed) $ (10,230 )


Challenge Exercises and Problem

(15-25 min.) E 4-62

Oster could be: Hall could investigate by:

1. Writing business checks to herself.

1. Performing the bank reconciliation and examining all checks written by the business.

2. Submitting purchase invoices a second time for duplicate payment, perhaps altering the mailing address on the duplicate invoice and sending the check to a post office box that Oster controls.

2. Examining purchase invoices for authenticity and comparing invoices to receiving reports to determine that the business received all goods it paid for.

Any invoice with a hole indicates it was paid earlier.

Calling the suppliers directly to inquire about any questionable invoices.

3. Paying suppliers excess amounts and arranging for suppliers to kick back part of the excess to Oster.

3. Comparing the business’s ratio of cost of goods sold to retail selling price to the cost-to-retail ratio in the past. A kickback scheme would show up in higher cost figures and a lower profit percentage.

4. Making small cash payments to herself.

4. Examining all cash records and comparing the records to actual quantities of supplies and other items needed by the business.



(20-30 min.) E 4-63Req. 1

The Grand Design, Inc.Cash Budget


Thousands




Issuance of stock 632

21,177


Purchases of inventory items $14,245

Payment of operating expenses 2,849

Purchase of property and equipment 1,588

Payment of long-term and short-term debt 990


Cash available (shortage) before financing 1,198


Cash available for additional investments $ 1,063

Req. 2

Current ratio =Total current assets

=$7,576

= 1.74Total current liabilities $4,360

Debt ratio =Total liabilities

=$11,588

= 0.51Total assets $22,677

I would lend $95 thousand to The Grand Design because the company’s

ratio values are strong. Also, the cash budget indicates strong cash

flows during 2013.

P 4-64


The Pembrook CompanyBank Reconciliation

December 31

BANK:

Balance, December 31 (corrected for erroneous

November outstanding checks) $ 3,668

Add:

Actual amount of December 30 deposit 650

4,318

Less: Outstanding checks

No. 1560 $185

No. 1901 842

No. 1902 168 (1,195 )

Adjusted bank balance, December 31 $ 3,123

BOOKS:

Balance, December 31 $ 9,455

Add: Checks #1880, #1882, and 1883 recorded in both November and December

EFT receipt from customer

$1,155

52

Interest revenue 6 1,213

10,668

Less: NSF check $ 135

EFT Payment of utility bill 755

Book error 3,000

Unexplained difference 3,655 (7,545 )

Adjusted book balance, December 31 $ 3,123


(continued) P 4-64

Check No. 1880, 1882, and 1883 were outstanding in November so

should not also be deducted from Cash in December. The unexplained

difference of $3,655 consists of $1,155 erroneous November outstanding

checks and the $2,500 difference between deposit in transit listed on the

original reconciliation and the amount of the deposit listed on the books.

It is possible that the $3,000 difference between the December 23

deposit on the books and the December 24 receipt on the bank

statement was intentional and used to cover up the missing cash.


Decision Cases

(20-30 min.) Decision Case 1

Environmental Concerns, Inc.Bank Reconciliation

September 30

BANK:

Balance, September 30 $ 8,224

Add: Deposit of September 30 in transit 3,794

12,018

Less: Outstanding checks ($116 + $150 +

$853 + $990 + $206 + $145) (2,460 )

Adjusted bank balance, September 30 $ 9,558

BOOKS:

Balance, September 30 $10,402

Add: Bank collection 200

10,602

Less: Service charge $ 8

NSF check 36 (44 )

Adjusted book balance, September 30 $10,558

Based on the above reconciliation, it appears the bookkeeper has stolen

$1,000, the difference between the adjusted bank and book amounts

($9,558 − $10,558). He understated the total of outstanding checks by

$1,000 to cover his theft.


Adjustedbalancesdo notagree.

(continued) Decision Case 1

Benz should assign an employee with no cash-handling duties to

prepare the bank reconciliation. The bookkeeper should not perform this

duty, because a person who handles cash and also prepares the

reconciliation can steal cash and manipulate the reconciliation to cover

the theft. Perhaps Benz should prepare the reconciliation himself.


(15-30 min.) Decision Case 2

The internal control weakness in this case is a lack of separation of

duties. The foreman performs too many duties.

1. The foreman hires the workers.

2. The foreman controls workers’ employment documents.

3. The foreman fills out workers’ time sheets and transmits all

documents to the home office.

4. The foreman passes out paychecks to workers.

5. The workers never go to the home office, so home-office personnel

do not even know whether all workers exist.

The foreman could steal from the company as follows:

1. The foreman could enter a fictitious worker into the payroll system

and fill out bogus time sheets for the fictitious employee. Then the

foreman could pocket the pay check written to the employee.

2. The foreman could enter more time than actually worked by an

employee and arrange to split the extra pay received by the worker.

3. The foreman could pad his own hours to receive pay for time

that he did not work.

The following actions will correct the internal control weakness:

1. The home office could have the construction workers come to the

office for processing their employee documents. Then the home

office would at least know that all the workers exist.

2. Have employees sign their own time sheets.


(continued) Decision Case 2

3. Have a home-office employee compare signatures on the workers’

time sheets to their signatures on file and, occasionally, to their

endorsements on the backs of their paychecks.

4. Occasionally — or always — have a home-office employee go to

the construction site to pass out paychecks.

5. Have a home-office employee go to the construction site

occasionally to “take attendance” of workers on duty that day.

Then match the names of workers on duty to the time sheets

turned in at the end of the week.


Ethical Issues

Ethical Issue 1

1. Identify the ethical issue. You must decide whether it is ethical for the

auditor not to require the bank to record the loss.

2. What are the alternatives? Require the client to record the loss, or

permit the client not to record the loss.

3. Identify the stakeholders. The auditor, the bank, and the public at

large can be affected. The auditor’s reputation is on the line. The

bank’s financial statements are in question. The public can be

affected if the bank issues financial statements that include erroneous

amounts.

Assess the possible outcomes. If the auditors require the bank to

record the loss, the auditor will keep its reputation intact. But the

auditor will lose the client and also lose the revenue from this large

audit. The accounting firm may then be unable to expand the firm as it

had hoped to do.

If the auditors okay the bank’s financial statements even after the

bank did not record the loss, the auditor would keep the bank as a

client, earn the audit revenue, and be able to expand the firm as

planned. But the bank’s financial statements would report erroneous

amounts for the notes receivable. People relying on the bank’s

financial statements may suffer losses as a result. The accounting

firm’s reputation would be hurt.


(continued) Ethical Issue 1

4. Make the decision. The auditor should require the bank to record the

loss even if that means losing the bank as a client. By sticking to its

belief that the bank should record the loss, the auditors’ reputation

will not be harmed as it would by okaying financial statements that

include errors. It’s far better to lose a client than to lose your

reputation.


Ethical Issue 2

1. Identify the ethical issue. Galvin’s ethical issue is whether to use his

knowledge of The Salvation Army’s plans and of Nadar’s situation to

either party’s advantage (or disadvantage). Should Galvin help The

Salvation Army buy the land at the lowest price? Should he help

Nadar sell the land at the highest price? Galvin’s position presents

him with a conflict of interest.

2. What are the alternatives? There are several:

(a)Let other members of the Salvation Army board of directors know

of Nadar’s situation in order to help The Salvation Army buy the

land at a bargain price.

(b) Disclose Nadar’s situation to fellow board members and insist

that The Salvation Army pay market price ($3.6 million) for the

land.

(c) Advise Nadar of The Salvation Army’s plans and encourage her

to hold out for a high price on the sale of the land.

(d) Reveal nothing to The Salvation Army’s board or to Nadar and

take no part in the negotiation between the two parties.

(e) Take a temporary leave of absence from The Salvation Army

board for unspecified “personal reasons.”

3. Identify the stakeholders involved. Galvin, The Salvation Army, Nadar,

and Community Banks.

Assess the possible consequences. Disclosing Nadar’s weakened

condition to The Salvation Army board may help The Salvation Army

buy the land at a low price, depending on the ethical bearing of


(continued) Ethical Issue 2

fellow board members. This would help The Salvation Army and hurt

Nadar, relative to her ability to sell the land at market value of $3.6

million. Insisting that The Salvation Army offer market price for the

land would seem fair to both parties, but that would betray the trust of

Nadar. And it may or may not sway the board to go along with a $3.6

million offer for the land.

Making Nadar aware of The Salvation Army’s plans may help Nadar

get a higher price for the land than she would get otherwise. This

would betray the trust of other members of The Salvation Army’s

board.

Remaining silent would preserve Galvin’s integrity. However, if either

The Salvation Army or Nadar ever learned of Galvin’s relationship

with the other party, they would wonder whether Galvin used the

information against them.

Taking a temporary leave of absence would preserve Galvin’s

integrity and remove him from the conflict of interest. It would also

preserve Galvin’s reputation for fairness and the reputation of

Community Bank for keeping depositor information confidential.

4. Make the decision. The authors would take the leave of absence and

hope other Salvation Army board members do not probe Galvin’s

“personal reasons.” This way neither The Salvation Army nor Nadar

can accuse Galvin of using inside information to the advantage of the

other party.


Ethical Issue 3

1. Identify the ethical issue. French’s ethical issue is whether to tell IMS

personnel about Snicker Foods’ possible bankruptcy.

2. What are the alternatives?

(a) Keep quiet and let nature take its course, or

(b) Tell IMS’s top managers of Snicker’s possible

bankruptcy.

3. Identify the stakeholders involved. IMS, Snicker Foods, Community

Bank, and everyone connected to these organizations — owners,

employees, creditors, depositors, and their communities.

Assess the possible consequences. Telling IMS about Snicker’s

possible bankruptcy may help IMS avoid wasted effort on Snicker.

This may enable IMS to seek more profitable ventures and aid IMS’s

recovery. In turn, this may help IMS pay its loan to Community Bank.

4. Make the decision. French should not tell IMS of Snicker’s financial

difficulties (after all, Snicker isn’t bankrupt yet). French should let

nature take its course. Then she will protect the bank’s (and her own)

reputation for keeping client information confidential. In her aiding

IMS through the loan-restructuring process, French may try to help

IMS find other customers that can take up the slack if the sale to

Snicker doesn’t go through.


Focus on Financials: Amazon.com, Inc.

(20-30 min.)

Req. 1

(All amounts in millions)

Bank Books

Balance, Dec. 31, 2010 $324 Balance, Dec. 31, 2010 $316+ Deposit in transit 3 + Interest earned 1− Outstanding checks (8) + Bank collections 2

Adjusted bank balance $319 Adjusted book balance $319

The adjusted balance is $319 million and it is this amount that should

ultimately be included in the cash and cash equivalents in Amazon.com,

Inc.’s financials.

Req. 2

The following items mentioned in Item 9A of Note 14 to Amazon.com,

Inc.’s Consolidated Financial Statements Note Amazon.com’s are also

mentioned in the chapter:

Management is responsible for establishing and maintaining

internal controls “Management is responsible for establishing and

maintaining adequate internal control over financial reporting”

Management concluded that internal control over financial

reporting was effective in providing reasonable assurance

regarding the reliability of financial reporting and the preparation

of financial statements…in accordance with GAAP.


(continued) Amazon.com

Amazon.com’s internal controls were independently assessed by

Ernst & Young as required by Sarbanes Oxley.

Item 9A mentions that no evaluation of internal controls can

provide absolute assurance that no fraud exists. As the text

states, fraud is more difficult to uncover if several people work

together.


Focus on Analysis: RadioShack, Corp

(20-30 min.)

Req. 1

1. Purchases of Treasury Stock, which used $398.8 million, in the

investing section.

2. Decrease in Accounts Payable, accrued expenses, income taxes

payable and other, which used $85.0 million, in the operating

section.

3. Depreciation and amortization, which provided $84.2 million.

Actually, these are expenses that do not use cash, so they are

added back to income to arrive at cash provided by operations.

4. Additions to PPE, which used $80.1 million, in the investing

section.

5. Increase in inventories, which used $60.4 million, in the

operating section.

6. Increase in Accounts & Notes Receivable, which used $39.9, in

the operating section.

7. Payment of cash dividends, $26.5 million, in the financing

section.

Req. 2

Item 9A focuses on compliance with legal requirements, specifically

those requirements of the SEC, which is the fifth objective of internal

control. Item 9A also mentions that the controls allow information to be

“recorded, processed, summarized, and reported.” These controls are

addressed by the fourth objective of internal controls: ensure accurate,

reliable accounting records.


(continued) RadioShack

It is important to note that while the other three objectives of internal

controls are not directly referenced in Item 9A, such objectives are also

the focus of the internal control system of a large public company like

RadioShack.


Group Project

Student responses will vary.


ch04 sm 9e

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