Download - Hhtfa8e Ch04 Sm
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.
Chapter 4 Internal Control & Cash 274
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
Financial Accounting 8/e Solutions Manual275
(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.
Chapter 4 Internal Control & Cash 276
(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 bogus entry in the
accounting records.
Student responses may vary.
Financial Accounting 8/e Solutions Manual277
(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
Chapter 4 Internal Control & Cash 278
(Continued) S 4-4
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, only persons with custodial
responsibilities (such as the cashier or the warehouse) should
be allowed access to assets (such as cash or inventory). Only
persons 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.
Financial Accounting 8/e Solutions Manual279
(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.
Chapter 4 Internal Control & Cash 280
(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.
Student responses may vary.
Financial Accounting 8/e Solutions Manual281
(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.
Student responses may vary.
Chapter 4 Internal Control & Cash 282
(10 min.) S 4-8
Randell Corp.Bank Reconciliation
October 31, 2010BANK BOOKS
Balance, October 31 $3,180 Balance, October 31 $2,400Add: Add:
Deposit in transit 200 Bank collection 530 3,380 Interest revenue 10
2,940Less:
Less: Service charge (20)Outstanding checks (500 ) NSF check (40 )
Adjusted bank balance $2,880 Adjusted book balance $2,880
Randell has cash of $2,880.
(5 min.) S 4-9
Aug. 31 Cash……………………………………….. 530Accounts Receivable………………... 530
Collection on account.
31 Cash……………………………………….. 10Interest Revenue……………………... 10
Interest earned on bank balance.
31 Miscellaneous Expense………………... 20Cash……………………………………. 20
Bank service charge.
31 Accounts Receivable…………………… 40Cash…………………………………….. 40
NSF check.
Financial Accounting 8/e Solutions Manual283
(5 min.) S 4-10
It appears that the employee has stolen $800 (adjusted book
balance, $4,800 − adjusted bank balance, $4,000). 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
Stevens will notice a gap in the sequence of sales receipts for
the receipt that Cassidy destroyed. This knowledge will lead
Stevens to investigate what happened to the missing receipt
and what happened to the related cash.
Chapter 4 Internal Control & Cash 284
(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
Financial Accounting 8/e Solutions Manual285
(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.
Student responses may vary.
Chapter 4 Internal Control & Cash 286
(5-10 min.) S 4-14
Crescent Artichoke GrowersCash Budget
Year 2010Millions
Cash balance, beginning $ 11Estimated cash receipts—total 104
115Estimated cash payments—total (93 )Cash available (needed) before new financing 22Budgeted cash balance needed (17 )Cash available for additional investments $ 5
(5 min.) S 4-15
Rourke should report the errors to Dunn because Dunn is
Rourke’s supervisor, and Dunn is responsible for the errors. If
Dunn fails to take action, then Rourke should report the errors
to the manager of the organization. In any event, outsiders who
are relying on Dublin Limited’s financial statements must be
made aware of the need to correct the reported net income
figure.
Financial Accounting 8/e Solutions Manual287
Exercises
Group A (5-20 min.) E 4-16A
a. Mason has access to the cash collected, and he also
prepares the cash report. With access to both items, Mason
can steal cash and falsify his cash report to conceal his theft.
b. Fleming 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.
Student responses may vary.
Chapter 4 Internal Control & Cash 288
(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 both request, purchase,
and pay for equipment with little oversight by the home
office.
Cash receipts:
a. Weak internal control. 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.
Financial Accounting 8/e Solutions Manual289
(10 min.) E 4-18A
To prevent Flynn’s embezzlement, Downtown Kalamazoo’s
board of directors could have:
a. Not permitted Flynn to write Downtown Kalamazoo
Checks. Instead, appoint a board member to write the
checks.
b. Not permitted Flynn to receive cash that came to
Downtown Kalamazoo. 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 Flynn’s work by examining Downtown
Kalamazoo’s documents such as paid checks.
d. Had an audit of Downtown Kalamazoo’s transactions and
financial statements.
Student responses may vary.
Chapter 4 Internal Control & Cash 290
(5-10 min.) E 4-19A
1. b 5. d
2. b 6. c
3. d 7. c
4. a
(10-20 min.) E 4-20A
J. D. HunterBank Reconciliation
June 30, 2010BANK: Balance, June 30 $ 399 Add: Deposit in transit 1,210 Less: Outstanding checks: Check No. 626 $ 85 627 285 (370 ) Adjusted bank balance $1,239
BOOKS: Balance, June 30 $1,287 Less: Correction of book error — Recorded $86 check as $68 $ 18 NSF check 20 Service charge 10 (48 ) Adjusted book balance $1,239
Financial Accounting 8/e Solutions Manual291
(10-20 min.) E 4-21A
Evan RootBank Reconciliation
April 30, 2010BANK: Balance, April 30 $ 565 Add: Deposit in transit 1,790 2,355 Less: Outstanding checks (602 ) Adjusted bank balance $1,753
BOOKS: Balance, April 30 $1,827 Add: EFT collection — rent 320
2,147 Less: Service charge $ 7 NSF checks 115 Charge for printed checks 11 Correction of book error — recorded $290 check as $29 261 (394 Adjusted book balance $1,753
Root’s actual cash balance is $1,753
Chapter 4 Internal Control & Cash 292
(10-15 min.) E 4-22A
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Apr 30 Cash……………………………………. 320Rent Revenue……………………… 320
EFT collection of rent.
30 Miscellaneous Expense ($7 + $11)... 18 Cash ………………………………. 18Bank service charge and chargefor printed checks.
30 Accounts Receivable………………... 115 Cash ………………………………. 115NSF checks returned by bank.
30 Salary Expense ($290 − $29)……….. 261 Cash ………………………………. 261Correction of book error.
Financial Accounting 8/e Solutions Manual293
(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.
Chapter 4 Internal Control & Cash 294
(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, Green Grass Golf 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.
Financial Accounting 8/e Solutions Manual295
(20-30 min.) E 4-25A
Cole Communications, Inc.Cash Budget
Year Ended December 31, 2011Millions
Cash balance, December 31, 2010 $ 86
Budgeted cash receipts:
Collections from customers 11,305
Sale of assets 118
11,509
Budgeted cash payments:
Payments for cost of
services and products $6,167
Payments of operating expenses 2,544
Investment in equipment 1,826
Payment of debt 603
Payment of dividends 347 11,487
Cash available (needed) before financing 22
Budgeted cash balance, December 31, 2011 (82 )
Cash available for additional investments, or
(New financing needed) $ (60 )
Cole Communications expects to need new financing of $60
million during 2011.
Chapter 4 Internal Control & Cash 296
(10 min.) E 4-26A
Actual Interest paideffective
=each year
=$14,000,000 × .077
=$1,078,000
interest rate Amount actually borrowed
$14,000,000 − $14,000,000(.057)
$13,202,000
= 8.17%
Financial Accounting 8/e Solutions Manual297
Exercises
Group B
(5-20 min.) E 4-27B
a. Monroe has access to the cash collected, and he also
prepares the cash report. With access to both items, Monroe
can steal cash and falsify his cash report to conceal his theft.
b. Adams 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.
Student responses may vary.
Chapter 4 Internal Control & Cash 298
(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. 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.
Financial Accounting 8/e Solutions Manual299
(10 min.) E 4-29B
To prevent Smith’s embezzlement, Downtown Scanlon’s
board of directors could have:
a. Not permitted Smith to write Downtown Scanlon checks.
Instead, appoint a board member to write the checks.
b. Not permitted Smith to receive cash that came to
Downtown Scanlon. 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 Smith’s work by examining Downtown
Scanlon’s documents such as paid checks.
d. Had an audit of Downtown Scanlon’s transactions and
financial statements.
Student responses may vary.
Chapter 4 Internal Control & Cash 300
(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
J. D. HillBank ReconciliationFebruary 28, 2010
BANK: Balance, February 28 $ 383 Add: Deposit in transit 1,215 Less: Outstanding checks: Check No. 626 $ 85 627 275 (360 ) Adjusted bank balance $1,238
BOOKS: Balance, February 28 $1,282 Less: Correction of book error — Recorded $87 check as $78 $ 9 NSF check 20 Service charge 15 (44 ) Adjusted book balance $1,238
Financial Accounting 8/e Solutions Manual301
(10-20 min.) E 4-32B
Harry SmithBank ReconciliationSeptember 30, 2010
BANK: Balance, September 30 $ 545 Add: Deposit in transit 1,790 2,335 Less: Outstanding checks (609 ) Adjusted bank balance $1,726
BOOKS: Balance, September 30 $1,823 Add: EFT collection — rent 325
2,148 Less: Service charge $ 8 NSF checks 125 Charge for printed checks 10 Correction of book error — recorded $310 check as $31 279 (422 ) Adjusted book balance $1,726
Smith’s actual cash balance is $1,726
Chapter 4 Internal Control & Cash 302
(10-15 min.) E 4-33B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
May 31 Cash……………………………………. 325Rent Revenue……………………… 325
EFT collection of rent.
31 Miscellaneous Expense ($8 + $10)... 18 Cash ………………………………. 18Bank service charge and chargefor printed checks.
31 Accounts Receivable………………... 125 Cash ………………………………. 125NSF checks returned by bank.
31 Salary Expense ($310 − $31)……….. 279 Cash ………………………………. 279Correction of book error.
Financial Accounting 8/e Solutions Manual303
(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.
Chapter 4 Internal Control & Cash 304
(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, Beautiful Meadows Golf 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.
Financial Accounting 8/e Solutions Manual305
(20-30 min.) E 4-36B
Fallon Communications, Inc.Cash Budget
Year Ended December 31, 2011Millions
Cash balance, December 31, 2010 $ 82
Budgeted cash receipts:
Collections from customers 11,307
Sale of assets 121
11,510
Budgeted cash payments:
Payments for cost of
services and products $6,174
Payments of operating expenses 2,545
Investment in equipment 1,831
Payment of debt 604
Payment of dividends 341 11,495
Cash available (needed) before financing 15
Budgeted cash balance, December 31, 2011 (81 )
Cash available for additional investments, or
(New financing needed) $ (66 )
Fallon expects to need new financing of $66 million during
2011.
Chapter 4 Internal Control & Cash 306
(10 min.) E 4-37B
Actual Interest paideffective
=each year
=$19,000,000 × .071
=$1,349,000
interest rate Amount actually borrowed
$19,000,000 − $19,000,000(.058)
$17,898,000
= 7.54%
Financial Accounting 8/e Solutions Manual307
Challenge Exercises
(15-25 min.) E 4-38
Owens could be: Healey 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 Owens 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 Owens.
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.
Student responses may vary.
Chapter 4 Internal Control & Cash 308
(20-30 min.) E 4-39
Req. 1
The Furniture Mart, Inc.Cash Budget
Year Ended December 31, 2010Thousands
Cash balance, December 31, 2009 $ 130
Budgeted cash receipts:
Collections from customers 21,800
Issuance of stock 647
22,577
Budgeted cash payments:
Purchases of inventory items $14,545
Payment of operating expenses 2,349
Purchase of property and equipment 1,528
Payment of long-term and short-term debt 980
Payment of dividends 317 19,719
Cash available (shortage) before financing 2,858
Budgeted cash balance, December 31, 2010 (130 )
Cash available for additional investments $ 2,728
Financial Accounting 8/e Solutions Manual309
(continued) E 4-39
Req. 2
Current ratio =Total current assets
=$7,976
= 1.87Total current liabilities $4,260
Debt ratio =Total liabilities
=$11,088
= 0.50Total assets $22,377
I would lend $100 thousand to The Furniture Mart because the
company’s ratio values are strong. Also, the cash budget
indicates strong cash flows during 2010.
Chapter 4 Internal Control & Cash 310
Quiz
Q4-40 bQ4-41 aQ4-42 dQ4-43 dQ4-44 dQ4-45 bQ4-46 bQ4-47 cQ4-48 dQ4-49 dQ4-50 dQ4-51 c ($6,000 + $83,000 − $36,000 − $26,000 − $19,000
− $15,000 = − $7,000; arrange financing for this amount.)
Financial Accounting 8/e Solutions Manual311
Problems
Group A
(15-20 min.) P 4-52A
The internal control weaknesses in Celtic Import’s system are:
1. McNicholas controls the content of the invoices. With no supervision of her work, McNicholas could have the suppliers overstate their prices and then arrange to have them split the excess with her after Celtic Import pays the invoices.
2. Sweeney has both cash handling and accounting duties.
With both responsibilities, Sweeney 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. Sullivan could:
1. Make the purchase and pay arrangements with the Irish artisans who supply Celtic Import’s products. Let McNicholas keep locating new products, but don’t let her arrange for the purchases and payment.
2. Sullivan could assign either cash handling or accounting duties to Sweeney and then hire someone else to do the other (accounting or cash-handling) duties. Also Sullivan needs to perform the bank reconciliation to keep her eye on cash receipts and cash payments.
Chapter 4 Internal Control & Cash 312
(10-20 min.) P 4-53A
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.
Financial Accounting 8/e Solutions Manual313
(20-30 min.) P 4-54A
Req. 1
Dunlap AutomotiveBank Reconciliation
July 31, 2010BANK: Balance, June 30, 2010 $10,379 Add: Deposits in transit ($924 + $2,008) 2,932
13,311 Less: Outstanding checks — Check No. 3119 $ 440 3120 965 3121 205 3122 2,260 (3,870 )Adjusted bank balance, July 31, 2010 $ 9,441
BOOKS: Balance, June 30, 2010 $ 7,937 Add: EFT collection of rent $ 750
Bank collection of note receivable 1,250Book error — $1,360 check recorded as $1,630 270 2,270
10,207 Less: EFT payment of insurance $ 334 Unauthorized signature check 407 Service charge 25 (766 ) Adjusted book balance, July 31, 2010 $ 9,441
Chapter 4 Internal Control & Cash 314
(continued) P 4-54A
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.
Financial Accounting 8/e Solutions Manual315
(20-30 min.) P 4-55A
Req. 1
Dickson Engineering AssociatesBank Reconciliation
August 31, 2010BANK: Balance, August 31 $8,879.24
Add: Deposit of August 31 in transit 383 .54
9,262.78
Less: Outstanding checks ($401.00 +
$74.82 + $33.25 + $165.55 +
$236.00 + $47.75 + $107.85) $1,066.22
Correction of bank error, which
credited our account for the
deposit of another company 398 .00 (1,464 .22 )
Adjusted bank balance, August 31 $7,798 .56
BOOKS:
Balance, August 31 $8,152.71
Add: Interest revenue earned on bank
balance $ 15.85
Bank collection of account receivable 899 .15 915.00
9,067.71
Less: EFT (utilities $730, insurance $280) $1,010.00
Service charge 5.50
Returned check due to unauthorized
signature 185.50
NSF check 68 .15 (1,269.15 )
Adjusted book balance, August 31 $7,798 .56
Chapter 4 Internal Control & Cash 316
(continued) P 4-55A
Req. 2 (entries based on the reconciliation)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
May 31 Cash………………………………………………… 15.85
Interest Revenue………………………………. 15.85
Interest earned on bank balance.
31 Cash………………………………………………… 899.15
Accounts Receivable…………………………. 899.15
Account receivable collected by bank.
31 Utilities Expense………………………………….. 730.00
Cash……………………………………………... 730.00
Monthly utilities.
31 Insurance Expense………………………………. 280.00
Cash……………………………………………... 280.00
Monthly insurance.
31 Miscellaneous Expense…………………………. 5.50
Cash……………………………………………... 5.50
Bank service charge.
31 Accounts Receivable ($185.50 + $68.15)…… 253.65
Cash……………………………………………... 253.65
NSF customer checks returned by bank.
Financial Accounting 8/e Solutions Manual317
(10-15 min.) P 4-56A
TO: President, Sun Skin 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.
Chapter 4 Internal Control & Cash 318
(30-45 min.) P 4-57A
Req. 1
Jasper WirelessCash Budget
2011Thousands
Cash balance, beginning $ 1,500
Budgeted cash receipts: Collections from customers ($64,000 × 1.10) 70,400 Receipt of interest 300
72,200Budgeted cash payments: Purchases of inventory ($49,000 × 1.20) $58,800 Operating expenses 13,500 Purchases of equipment 4,800
Payment of dividends 300 Purchases of investments 400 Payment of long-term debt 400 (78,200 )Cash available (needed) before financing $ (6,000)Budgeted cash balance, ending (3,800 )Cash available for additional investments, or
(New financing needed) $ (9,800 )
Financial Accounting 8/e Solutions Manual319
(continued) P 4-57A
Req. 2
Jasper Wireless appears to be growing. The company expects
a 10% increase in collections from customers and a 20%
increase in the purchases of inventory. It is also continuing to
invest in new equipment, with no sales of long-term assets.
Chapter 4 Internal Control & Cash 320
Problems
Group B (15-20 min.) P 4-58B
The internal control weaknesses in International Import’s system are:
1. Walsh controls the content of the invoices. With no supervision of her work, Walsh could have the suppliers overstate their prices and then arrange to have them split the excess with her after International Import pays the invoices.
2. Durkin has both cash handling and accounting duties. With both responsibilities, Durkin could steal incoming cash and cover her theft by manipulating the accounting records.
As with all small businesses, they key to effective internal controls is more owner involvement. Spencer could:
1. Make the purchase and pay arrangements with the French artisans who supply International Import’s products. Let Walsh keep locating new products, but don’t let her arrange for the purchases and payment.
2. Spencer could assign either cash handling or accounting duties to Durkin and then hire someone else to do the other (accounting or cash-handling) duties. Also Spencer needs to perform the bank reconciliation to keep her eye on cash receipts and cash payments.
Financial Accounting 8/e Solutions Manual321
(10-20 min.) P 4-59B
Requirement 1 Requirement 2 Requirement 3Missing Internal
Control Characteristic Possible Problem Solution
a. Separation of duties
Theft of cash 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 White 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.
Chapter 4 Internal Control & Cash 322
(20-30 min.) P 4-60B
Req. 1
Donald AutomotiveBank Reconciliation
January 31, 2010BANK: Balance, January 31, 2010 $ 8,817 Add: Deposits of January 29 & 30 in transit 2,909
11,726 Less: Outstanding checks Check No. 3119 $ 493 3120 985 13121 219 3122 2,322 (4,019 )Adjusted bank balance, January 31, 2010 $ 7,707
BOOKS: Balance, January 31, 2010 $ 6,344 Add: EFT collection of rent $ 650 Bank collection of note receivable 1,350 Book error — $1,350 check recorded 180 2,180 as $1,530 8,524
Less: NSF check $ 466 EFT payment of insurance 331 Service charge 20 (817 ) Adjusted book balance, January 31, 2010 $ 7,707
Financial Accounting 8/e Solutions Manual323
(continued) P 4-60B
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 Donald 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.
Chapter 4 Internal Control & Cash 324
(20-30 min.) P 4-61B
Req. 1
Dunlap Engineering AssociatesBank Reconciliation
October 31, 2010BANK: Balance, October 31 $8,343.87 Add: Deposit of October 31 in transit $380.50 $380 .50
$8,724.37
Less: Outstanding checks ($403.15 + $78.98 + $36.39 + $155.45 + $234.00 + $47.50 + $106.79) 1,062.26 Correction of bank error — credited our account for the deposit of another company 405 .00 (1,467.26) Adjusted bank balance, October 31 $7,257 .11
BOOKS: Balance, October 31 $7,605.86 Add: Bank collection on account $915.20 Interest revenue on bank balance 15 .45 930 .65
8,536.51 Less: Service charge $ 6.25 EFT Payment of utility bill 770.00 EFT Payment of insurance bill 250.00
NSF check 67.65 Returned item due to unauthorized signature 185 .50 (1,279 .40 )Adjusted book balance, October 31 $7,257 .11
Financial Accounting 8/e Solutions Manual325
(continued) P 4-61B
Req. 2 (entries based on the reconciliation)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Jan. 31 Cash…………………………………………... 915.20 Accounts Receivable………..………… 915.20Accounts Receivable collected by bank.
31 Cash…………………………………………... 15.45 Interest Revenue………………………... 15.45Interest earned on bank balance.
31 Utility Expense …………………………..… 770.00 Prepaid Insurance …………………...…… 250.00 Cash ……………………………………… 1,020.00EFT payments
31 Miscellaneous Expense…………………… 6.25Cash……………………………………….. 6.25
Bank service charge.
31 Accounts Receivable ($67.65 + $185.50).. 253.15 Cash………………………………………… 253.15NSF customer checks returned by bank.
Chapter 4 Internal Control & Cash 326
(10-15 min.) P 4-62B
TO: President, Flawless Skin 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.
Financial Accounting 8/e Solutions Manual327
(30-45 min.) P 4-63B
Req. 1
Carvel WirelessCash Budget
2011
Cash balance, beginning $ 1,900
Budgeted cash receipts:
Collections from customers ($62,000 × 1.14) 70,680
Receipt of interest 700
73,280
Budgeted cash payments:
Purchases of inventory ($47,000 × 1.25) $58,750
Operating expenses 13,700
Purchase of property and equipment 4,100
Purchases of investments 300
Payment of dividends 400
Payments of long-term debt 500 77,750
Cash available (needed) before financing (4,470)
Budgeted cash balance, ending (3,550 )
Cash available for additional investments, or
(New financing needed) $ (8,020 )
Chapter 4 Internal Control & Cash 328
(continued) P 4-63B
Req. 2
Carvel Wireless appears to be growing. The company expects a
14% increase in collections from customers and a 25% increase
in purchases of inventory. It is maintaining its purchases of
property and equipment, with no sales of long-term assets.
Financial Accounting 8/e Solutions Manual329
Decision Cases
(20-30 min.) Decision Case 1
Environmental Concerns, Inc.Bank ReconciliationSeptember 30, 2010
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.
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
Chapter 4 Internal Control & Cash 330
Adjustedbalancesdo notagree.
the reconciliation to cover the theft. Perhaps Benz should prepare the reconciliation himself.
Financial Accounting 8/e Solutions Manual331
(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.
Chapter 4 Internal Control & Cash 332
(continued) Decision Case 2
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 home office would at least know that all
the workers exist.
2. Have employees sign their own time sheets.
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.
Financial Accounting 8/e Solutions Manual333
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.
(continued on next page)
Chapter 4 Internal Control & Cash 334
(continued) Ethical Issues
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.
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.
(continued on next page)
Financial Accounting 8/e Solutions Manual335
(continued) Ethical Issues
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 ($2.2
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.
Chapter 4 Internal Control & Cash 336
(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 fellow board members. This would help
The Salvation Army and hurt Nadar, relative to her ability to
sell the land at market value of $2.2 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 $2.2
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
Financial Accounting 8/e Solutions Manual337
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.
Chapter 4 Internal Control & Cash 338
(continued) Ethical Issues
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.
Financial Accounting 8/e Solutions Manual339
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.
Chapter 4 Internal Control & Cash 340
Focus on Financials: Amazon.com, Inc.
(20-30 min.)
Req. 1
(All amounts in millions)
Bank Books
Balance, Dec. 31, 2008 $324 Balance, Dec. 31, 2008 $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 ($319 million) agrees with the amount
reported for cash and cash equivalents on Amazon.Com, Inc.’s
December 31, 2008 Consolidated Balance Sheet.
Req. 2
Paragraph 2, Item 9A of Note 14 to Amazon.com, Inc.’s
Consolidated Financial Statements Note Amazon.Com’s
management states that:
Management is responsible for establishing and maintaining
adequate internal control over financial reporting….
Management has assessed the effectiveness of our internal
over financial reporting as of December 31, 2008…As a result,
management has concluded that our internal control over
Financial Accounting 8/e Solutions Manual341
financial reporting was effective in providing assurance
regarding the reliability of financial reporting and the
preparation of financial statements…in accordance with GAAP.
Ernst & Young has independently assessed the effectiveness
of our internal control over financial reporting and its report is
included below.
The statement mentions internal control, reliability of
financial reporting, and the fact that the internal control system
has been independently assessed by the company’s external
independent auditors, Ernst & Young.
Chapter 4 Internal Control & Cash 342
Focus on Analysis: Foot Locker, Inc.
(20-30 min.)
Req. 1
The seven largest items affecting case are:
1. Sales of short-term investments, which provided $1,620
million, in the investing section.
2. Purchases of short-term investments, which used
$1,378 million, in the investing section.
3. Depreciation and amortization, which provided $166
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. Capital expenditures, which used $148 million, in the
investing section
5. Reduction in deferred income taxes, which used $129
million, in the operating section.
6. Non-cash impairment charges and store closing
program costs, $124 million. Again, these are expenses
that do not use cash, so they are added back to net
income to arrive at cash provided by operations.
7. Payment of cash dividends, $77 million, in the financing
section.
Financial Accounting 8/e Solutions Manual343
(continued) Focus on Analysis: Foot Locker, Inc.
Req. 2
Objectives ofReport of Management States: Internal Control
“The company maintains a system of internal controls designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded, transactions are executed in accordance with management’s authorization, and the accounting records provide a reliable basis for the preparation of financial statements.”
1. Safeguard assets2. Encourage
employees to follow company policy
3. Ensure accurate, reliable accounting records
Chapter 4 Internal Control & Cash 344
Group Project
Student responses will vary.
Financial Accounting 8/e Solutions Manual345