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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,
Chapter 4 Internal Control & Cash 4-3
(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.
Financial Accounting 9/e Solutions Manual4-4
(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.
(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 4-5
(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.
Financial Accounting 9/e Solutions Manual4-6
(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
Chapter 4 Internal Control & Cash 4-7
(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.
(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.
Chapter 4 Internal Control & Cash 4-9
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.
Student responses may vary.
(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.
Financial Accounting 9/e Solutions Manual4-10
(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.
Student responses may vary.
(5-10 min.) E 4-19A
1. d 5. a
2. c 6. b
3. d 7. b
4. c
Chapter 4 Internal Control & Cash 4-11
(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
Financial Accounting 9/e Solutions Manual4-12
(10-20 min.) E 4-21A
Frank WhiteBank ReconciliationNovember 30, 2012
BANK:
Balance, November 30 $ 570
Add: Deposit in transit 1,765
2,335
Less: Outstanding checks (601 )
Adjusted bank balance $1,734
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
Correction of book error —
recorded $270 check as $27 243 (381 )
Adjusted book balance $1,734
White’s actual cash balance is $1,734.
Chapter 4 Internal Control & Cash 4-13
(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.
Financial Accounting 9/e Solutions Manual4-14
(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.
Chapter 4 Internal Control & Cash 4-15
(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.
Financial Accounting 9/e Solutions Manual4-16
(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.
Student responses may vary.
Chapter 4 Internal Control & Cash 4-17
(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.
Student responses may vary.
Financial Accounting 9/e Solutions Manual4-18
(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
Add: Deposit in transit 1,220
Less: Outstanding checks:
Check No.
626 $ 75
627 265 (340 )
Adjusted bank balance $1,285
BOOKS:
Balance, August 31 $1,352
Less:
Correction of book error —
Recorded $85 check as $58 $ 27
NSF check 30
Service charge 10 (67 )
Adjusted book balance $1,285
Chapter 4 Internal Control & Cash 4-19
(10-20 min.) E 4-32B
Evan NealBank Reconciliation
January 31, 2012
BANK:
Balance, January 31 $ 575
Add: Deposit in transit 1,775
2,350
Less: Outstanding checks (606 )
Adjusted bank balance $1,744
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
Correction of book error —
recorded $280 check as $28 252 (387 )
Adjusted book balance $1,744
Neal’s actual cash balance is $1,744.
Financial Accounting 9/e Solutions Manual4-20
(10-15 min.) E 4-33B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
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.
Chapter 4 Internal Control & Cash 4-21
(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.
Financial Accounting 9/e Solutions Manual4-22
(20-30 min.) E 4-36B
Donn Communications, Inc.Cash Budget
Year Ended December 31, 2012
Millions
Cash balance, December 31, 2011 $ 88
Budgeted cash receipts:
Collections from customers 11,323
Sale of assets 151
11,562
Budgeted cash payments:
Payments for cost of
services and products $6,185
Payments of operating expenses 2,557
Investment in equipment 1,823
Payment of debt 611
Payment of dividends 316 11,492
Cash available (needed) before financing 70
Budgeted cash balance, December 31, 2012 (79 )
Cash available for additional investments, or
(New financing needed) $ (9 )
Donn expects to need new financing of $9 million during 2012.
Chapter 4 Internal Control & Cash 4-23
(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%
Financial Accounting 9/e Solutions Manual4-24
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.]
Chapter 4 Internal Control & Cash 4-25
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.
Financial Accounting 9/e Solutions Manual4-26
(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.
Chapter 4 Internal Control & Cash 4-27
(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
Service charge 10 (862 )
Adjusted book balance, April 30, 2012 $ 8,107
Financial Accounting 9/e Solutions Manual4-28
(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.
Chapter 4 Internal Control & Cash 4-29
(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
Financial Accounting 9/e Solutions Manual4-30
(continued) P 4-53A
Req. 2 (entries based on the reconciliation)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Nov 30 Cash………………………………………………… 16.38
Interest Revenue………………………………. 16.38
Interest earned on bank balance.
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
Bank service charge.
30 Accounts Receivable ($193.75 + $67.65)……... 261.40
Cash……………………………………………... 261.40
NSF and US customer checks returned by bank.
Chapter 4 Internal Control & Cash 4-31
(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.
Financial Accounting 9/e Solutions Manual4-32
(30-45 min.) P 4-55A
Bosworth WirelessCash Budget
2013
Thousands
Cash balance, beginning $ 1,400
Budgeted cash receipts:
Collections from customers ($61,000 × 1.15) 70,150
Receipt of interest 400
71,950
Budgeted cash payments:
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 )
Cash available for additional investments, or
(new financing needed) $ (7,840 )
Chapter 4 Internal Control & Cash 4-33
(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.
Financial Accounting 9/e Solutions Manual4-34
(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.
Chapter 4 Internal Control & Cash 4-35
(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
Service charge 25 (754 )
Adjusted book balance, October 31, 2012 $ 8,561
Financial Accounting 9/e Solutions Manual4-36
(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.
Chapter 4 Internal Control & Cash 4-37
(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
Financial Accounting 9/e Solutions Manual4-38
(continued) P 4-59B
Req. 2 (entries based on the reconciliation)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Apr 30 Cash…………………………………………... 932.87
Accounts Receivable………..…………. 932.87
Accounts receivable collected by bank.
30 Cash…………………………………………... 16.55
Interest Revenue………………………... 16.55
Interest earned on bank balance.
30 Utilities Expense …………………………… 780.00
Insurance Expense.…………………...…… 290.00
Cash …………….………………………… 1,070.00
EFT payments
30 Miscellaneous Expense……………………. 5.50
Cash………………………………………... 5.50
Bank service charge.
30 Accounts Receivable ($68.15 + $187.50)… 255.65
Cash………………………………………….. 255.65
NSF and US customer checks returnedby bank.
Chapter 4 Internal Control & Cash 4-39
(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.
Financial Accounting 9/e Solutions Manual4-40
(30-45 min.) P 4-61B
Madison WirelessCash Budget
2013
Cash balance, beginning $ 1,300
Budgeted cash receipts:
Collections from customers ($66,000 × 1.12) 73,920
Receipt of interest 100
75,320
Budgeted cash payments:
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 )
Cash available for additional investments, or
(New financing needed) $ (10,230 )
Chapter 4 Internal Control & Cash 4-41
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.
Student responses may vary.
Financial Accounting 9/e Solutions Manual4-42
(20-30 min.) E 4-63Req. 1
The Grand Design, Inc.Cash Budget
Year Ended December 31, 2013
Thousands
Cash balance, December 31, 2012 $ 145
Budgeted cash receipts:
Collections from customers 20,400
Issuance of stock 632
21,177
Budgeted cash payments:
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
Payment of dividends 307 19,979
Cash available (shortage) before financing 1,198
Budgeted cash balance, December 31, 2013 (135 )
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
Chapter 4 Internal Control & Cash 4-43
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
Financial Accounting 9/e Solutions Manual4-44
(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.
Chapter 4 Internal Control & Cash 4-45
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.
Financial Accounting 9/e Solutions Manual4-46
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.
Chapter 4 Internal Control & Cash 4-47
(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.
Financial Accounting 9/e Solutions Manual4-48
(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.
Chapter 4 Internal Control & Cash 4-49
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.
Financial Accounting 9/e Solutions Manual4-50
(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.
Chapter 4 Internal Control & Cash 4-51
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
Financial Accounting 9/e Solutions Manual4-52
(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.
Chapter 4 Internal Control & Cash 4-53
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.
Financial Accounting 9/e Solutions Manual4-54
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.
Chapter 4 Internal Control & Cash 4-55
(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.
Financial Accounting 9/e Solutions Manual4-56
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.
Chapter 4 Internal Control & Cash 4-57
(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.
Financial Accounting 9/e Solutions Manual4-58
Group Project
Student responses will vary.
Chapter 4 Internal Control & Cash 4-59
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