HWChap008

Chapter 08 - Cash and Internal Controls

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Chapter 8

Cash and Internal Controls

QUESTIONS 1. The seven broad principles are: Establish responsibilities; Maintain adequate records;

Insure assets and bond key employees; Separate recordkeeping from custody of assets; Divide responsibilities for related transactions; Apply technology controls; Perform regular and independent reviews.

2. Internal control procedures become especially critical when the manager of a business can no longer control the business through personal supervision and direct participation.

3. Responsibility for related transactions should be divided so that the work of one department or individual acts as a check on that of another.

4. Separation of custody from recordkeeping of an asset encourages the asset custodian to avoid misplacing, misappropriating, or wasting the asset. This arrangement makes collusion necessary if an asset is to be stolen and the theft concealed in the records.

5. If individual departments were permitted to deal directly with suppliers, the amount of merchandise purchased and the resulting liabilities would not be well controlled. Having individual departments place orders through a purchasing department helps control the amounts purchased and the resulting liabilities.

6. The limitations of internal control arise from two sources: the human element (human error or human fraud) and the cost-benefit principle.

7. Cash is most liquid; and least liquid is a building. The four assets ordered from most to least liquid are: cash, accounts receivable, inventory, and building.

8. A petty cash receipt is a document stating that a payment has been made from petty cash. The one who received payment and the one who approved payment both sign the receipt.

9. Depositing all receipts on the day of receipt (1) creates an independent record of the amount of cash received and (2) helps prevent an employee from having personal use of the money for a period of time before depositing it.

10. During the year ended February 27, 2010, cash (and equivalents) of $1,470,127 thousand is used by investing activities. Cash (and equivalents) of $843,381 thousand is used by financing activities.


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11. Apple‘s net income for 2009 was $8,235 million. Further, it reported a net decrease in cash (and equivalents) of $6,612 million. These two figures are different because (1) net income is calculated on the accrual basis, and includes the effects of several noncash transactions and (2) some transactions affect cash but not income. For instance, the purchase of property, plant, and equipment assets reduces cash, but does not affect income, except through annual depreciation over the life of the asset.

12. Nokia‘s cash (bank and cash) at December 31, 2009, equals $1,142 (all in EUR millions). It is the sixth largest current asset and makes up about 4.8% of its current assets.

Its Cash (bank and cash) decreased from $1,706 at December 31, 2008, to $1,142 at December 31, 2009 (all in EUR millions). As a percent of total current assets, its Cash balance decreased from about 7.0% to about 4.8%

13. Palm‘s cash and equivalents decreased by $24,518 thousand during the fiscal year ended May 31, 2009; specifically, from $176,918 thousand to $152,400 thousand. Its statement of cash flows identifies the three major sources and uses of its cash flows: (1) $188,512 thousand used by operating activities; (2) $38,119 thousand used in investing activities; and (3) $204,015 thousand generated by financing activities. (Although not required, students might also identify the effects of exchange rate changes on cash and cash equivalents accounting for a decrease of $1,902 thousand.)

QUICK STUDIES

Quick Study 8-1 (10 minutes) 1. The main objective of internal control procedures is to safeguard the

assets of the business. This objective is best accomplished by designing an operational system with managerial policies that protect the assets from waste, fraud and theft. The system should be designed in compliance with the seven broad principles of internal control that are described in the chapter.

2. Separation of recordkeeping for assets from the custody over assets is

intended to reduce theft and fraud. If this fundamental principle is followed, there has to be collusion between two or more employees for assets to be stolen and the theft to be concealed in the records.

3. The responsibility for a transaction should be divided between two or more individuals or departments to ensure that the work of one acts as a check on the other. Absent this, someone could create fictitious invoices and pay the money to herself or himself.


8-3

Quick Study 8-2 (10 minutes) 1. The three basic guidelines for safeguarding cash are:

(a) Separate the duties of those who handle (have custody of) cash from those that keep cash records.

(b) Require that all cash receipts be deposited daily. (c) Require that all cash disbursements be made by check.

2. (a) Voucher system of control, and (b) Petty cash system of control. Quick Study 8-3 (10 minutes) 1. The cash category includes currency and coins along with the amounts

on deposit in bank accounts, checking accounts, and savings accounts. Cash also includes items that are acceptable for deposit in these accounts including customer checks, cashier checks, certified checks, and money orders.

2. The cash equivalents category includes short-term, highly liquid

investment assets meeting two criteria: (1) readily convertible to a known cash amount and (2) sufficiently close to their due dates so that their market value is not sensitive to interest rate changes. Usually only investments purchased within 3 months of their due date satisfy these criteria. Examples of cash equivalents include U.S. Treasury bills and money market funds.

3. Liquidity refers to a company‘s ability to pay for its near-term

obligations.

Quick Study 8-4 (10 minutes) 1. (a) Petty Cash .......................................................... 75 Cash ............................................................. 75 To establish the petty cash fund. (b) Entertainment Expense ..................................... 42 Postage Expense ............................................... 6 Printing Expense................................................ 13 Cash ............................................................. 61 To reimburse the petty cash fund. 2. The Petty Cash account is credited when either (1) the dollar amount of

the fund is being reduced, or (2) the fund is being eliminated.


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Quick Study 8-5 (15 minutes) (1) (2)

a. (i) Bank (ii) Subtraction No adjustment required

b. (i) Book (ii) Subtraction Adjusting entry required

c. (i) Book (ii) Subtraction Adjusting entry required

d. (i) Bank (ii) Addition No adjustment required

e. (i) Book (ii) Addition Adjusting entry required

f. (i) Book (ii) Addition Adjusting entry required

g. (i) Book (ii) Subtraction Adjusting entry required

Quick Study 8-6 (25 minutes)

CRUZ COMPANY Bank Reconciliation

June 30, 2011

Bank statement balance .......... $10,332 Book balance .......................................................................................................................... $11,352

Add: Add:

Deposit of June 30 .................. 2,724 Recording error on check................................................................................................ 9

Interest earned ..................................................................................................................... 5 13,056 11,366 Deduct: Deduct:

Outstanding checks ............... 1,713 Bank service charge .......................................................................................................... 23

Adjusted bank balance ............ $11,343 Adjusted book balance ....................................................................................................... $11,343

Quick Study 8-7 (15 minutes) Days' sales uncollected = x 365 2011 2010 x 365 x 365 10.7 days 11.2 days Interpretation: The collection of accounts receivable seems to be

slightly improving. It took the company approximately one-half day less to collect on its accounts receivable in 2011 than in 2010.

Accounts receivable

Net sales

$75,692

$2,591,933 $70,484

$2,296,673


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Quick Study 8-8A (10 minutes) The documents in a voucher system are:

Purchase requisition, Purchase order, Invoice, Receiving report, Invoice approval, and Voucher.

Quick Study 8-9B (15 minutes) (a) A Discounts Lost account is employed with the Net Method of

recording purchases of inventory. (b) The advantage of this method is that the Discounts Lost account

highlights for management (on the income statement) the costs incurred by the business that have resulted from the failure to take cash discounts. Management can then determine the reason and possibly correct the handling of future cash payments to ensure that all favorable purchase discounts are taken.

Quick Study 8-10 (10 minutes) a. The purposes and principles of internal control systems are

fundamentally the same for accounting systems reporting under IFRS and U.S. GAAP. Although cultural and other differences exist, and must be recognized when establishing internal controls, the basic goals and principles do not change.

b. Internal controls for cash are fundamentally the same worldwide.

Accordingly, there is global demand for tools such as cash monitoring, verification of documents, and petty cash procedures under both IFRS and U.S. GAAP.


8-6

Quick Study 8-11 (15 minutes) a. A bank reconciliation is a formal review process that requires the person to

precisely identify all transactions and events, and their amounts, that cause the cash balance on the bank statement to differ from the cash balance per the company‘s records. An online review of the bank statement does not require precise identification of those sources and their amounts.

b. A bank reconciliation has the potential to uncover several kinds of frauds

or errors that an online review is unlikely to reveal. Those include the following:

A company makes a deposit to its account but that deposit is incorrectly added to another company‘s account. A bank reconciliation would immediately identify this bank error. However, an online review would not identify this error as nothing would ―jump out‖ as unusual; the only potential way of uncovering this would be if the person doing the review remembered each and every deposit throughout the period of the bank statement (not likely).

The bank incorrectly pays a common vendor‘s bill from the company‘s cash account, when that vendor should have been paid from some other company‘s account. Common vendors include utilities (light, heat, water), government agencies, and usual suppliers of ordinary items (toiletries, paper, postage). An online review would not identify such a payment as unusual or out-of-the-ordinary. A bank reconciliation would identify this payment as an unauthorized one.

The bank incorrectly pays a larger amount to a payee than what is written on the company‘s check to that payee. An online review would not identify this bank overpayment as the payment to the payee would be expected in the regular course of business; the only hope is that the person doing the online review remembers all amounts written to all payees or that the amount is especially huge so that it is obvious. A bank reconciliation would readily identify this bank error.

A company check writer incorrectly records a check to a regular vendor for services provided at an amount larger than the bill received. A bank reconciliation would identify this error as the check amount in the bank statement would differ from the amount recorded by the bookkeeper. An online review would not identify this error as nothing unusual would ―jump out‖; the only potential way of uncovering this error would be if the person doing the review remembered the exact amounts of all bills from all vendors during the period of the bank statement (not likely).

Numerous other examples can be listed…


8-7

EXERCISES Exercise 8-1 (15 minutes)

1. A cash register (with a locked record) should be used at the sales stand—it should also be anchored to the stand. If a cash register cannot be used, the total sales value of the towels, coolers, and sunglasses given to the employee each day should be calculated. The employee should sign a receipt for the merchandise and the amount of cash that he or she has been given. At the end of each day, the employee should be required to return cash plus remaining towels, coolers, and sunglasses equal to the amount taken to the stand—possibly consider one or two return trips if the amounts are large.

2. The employee should sign a receipt for the total amount of cash he or she is given each weekend. Each time the employee makes a purchase, he or she should obtain a signed sales receipt for the payment. The sales receipt should list the items purchased and the prices paid. When the employee returns to the store, the total value of the signed sales receipts plus any remaining cash should equal the amount of cash originally given to the employee. Also, the merchandise brought back by the employee should be the same as the items listed on the signed sales receipts.

Exercise 8-2 (10 minutes) Evaluation The company‘s internal control system failed to require separation of asset custody from asset recordkeeping. Principles Ignored (1) The recordkeeper should not have been allowed to sign the company‘s

checks. (2) Since a loss was incurred, the company apparently had not bonded its

employee. If it had, the bonding company would have insured the loss. If regular, independent reviews of the accounting records had been done, the payments of salary checks to a nonemployee may have been discovered earlier.


8-8

Exercise 8-3 (15 minutes) (a) Internal Control Problems

(1) A major internal control problem is that the recordkeeper (who has control over the accounting records) has physical control over the cash receipts. Nothing in the system prevents the recordkeeper from taking cash from the mail and using it personally.

(2) The recordkeeper might also delay recording a cash receipt from a customer until more cash comes in at a later date from a second customer. Then, the new cash receipt would be deposited and recorded as a payment made by the first customer. No entry would be made in the second customer‘s account until cash was received from a third customer, and so on. (This type of fraud is called "lapping.")

(3) The recordkeeper also could pocket cash and claim that a payment was never received and apparently lost in the mail.

(b) Internal Control Recommendations

(1) If only one person is present when the mail is opened, that person may steal cash and claim it was never received. If possible, two people should be present. Otherwise, the honesty and integrity of the person chosen to open the mail is critical. One might also consider the use of a P.O. Box for cash receipts by mail as another control procedure.

(2) It is important the recordkeeper not have physical control over cash.

Exercise 8-4 (10 minutes) 1. A liquid asset refers to an asset that can be readily converted into

another type of asset or be used to satisfy an obligation. A cash equivalent is a highly liquid short-term investment that can be readily converted to a known amount of cash and is sufficiently close to its maturity date so that its market value is relatively insensitive to interest rate changes.

2. Companies usually invest idle cash in cash equivalents to earn a higher

return on these assets. 3. Effective cash management applies the following five principles:

a. Encourages collection of receivables. b. Delays payment of liabilities. c. Keeps only necessary levels of assets. d. Plans expenditures. e. Invests any excess cash.


8-9

Exercise 8-5 (20 minutes) 1.

Sept. 9 Petty Cash ............................................................... 400 Cash ................................................................... 400 To establish a petty cash fund.

2. Sept. 30 Merchandise Inventory* ......................................... 32 Postage Expenses .................................................. 113 Miscellaneous Expenses ....................................... 87 Cash Short and Over .............................................. 2 Cash ................................................................... 234 To reimburse the petty cash fund.

* Transportation-in costs are included in the Merchandise Inventory account under a perpetual system.

3. Oct. 1 Cash ......................................................................... 100 Petty Cash ......................................................... 100 To decrease the petty cash fund.

Exercise 8-6 (20 minutes) 1.

Jan. 1 Petty Cash ............................................................... 200 Cash ................................................................... 200 To establish a petty cash fund.

2.

Jan. 8 Postage Expense .................................................... 64 Merchandise Inventory* ......................................... 19 Delivery Expense .................................................... 36 Miscellaneous Expense ......................................... 53 Cash ................................................................... 172 To reimburse the petty cash fund.

* Transportation-in costs are included in Merchandise Inventory under a perpetual system.


8-10

Exercise 8-6 (Concluded) 3. Jan. 8 Postage Expense ................................................... 64 Merchandise Inventory .......................................... 19 Delivery Expense ................................................... 36 Miscellaneous Expense ......................................... 53 Cash .................................................................. 172 To reimburse the petty cash fund. Petty Cash ............................................................... 300 Cash .................................................................. 300 To increase the petty cash fund.

Exercise 8-7 (20 minutes) Bank Balance Book Balance Not Shown on Add Deduct Add Deduct Adjust Reconciliation

1. Bank service charge. x Cr.

2. Checks written and mailed to payees on October 2. x

3. Check written by another depositor but charged against this company's account.

x

4. Principal and interest on note receivable to this company is collected by the bank but not recorded by the company.

x Dr.

5. Special bank charge for collection of note in No. 4 on company's behalf.

x Cr.

6. Check written against the company account and cleared by the bank; erroneously not recorded by the company recordkeeper.

x Cr.

7. Interest earned on the account. x Dr.

8. Deposit made on September 30 after the bank closed.

x

9. Checks outstanding on August 31 that cleared the bank in September.

x

10. NSF check from customer returned on Sept. 25 but not recorded by this company.

x Cr.

11. Checks written by the company and mailed to payees on September 30.

x

12. Deposit made on September 5 and processed by bank on September 6.

x


8-11

Exercise 8-8 (10 minutes)

1. The voucher system of control establishes procedures for: (a) Verifying, approving, and recording obligations for eventual cash disbursements, and (b) Issuing checks for payment of verified, approved, and recorded obligations.

2. All expenditures should be overseen by a voucher system of control (not only the purchase of merchandise).

3. The voucher is initially prepared by the accounting department when it receives the purchase requisition from the department making the request or when it receives reliable evidence that an obligation has been incurred.


FREDERICK CLINIC Bank Reconciliation

June 30, 2011

Bank statement balance ........ $14,275 Book balance .......................................................................................................................... $15,141

Add Add

Deposit of June 30 ................ 3,250 Error on Ck. No. 919 ........................................................................................................... 9

17,525 15,150 Deduct Deduct

Outstanding checks ............. 2,500 Bank service charge .......................................................................................................... 125

Adjusted bank balance .......... $15,025 Adjusted book balance ....................................................................................................... $15,025


June 30 Cash .................................................................... 9 Utilities Expense .......................................... 9 To correct a journal entry error.

30 Miscellaneous Expenses .................................. 125

Cash .............................................................. 125 To record bank service charge.


8-12


CHUNG COMPANY Bank Reconciliation

May 31, 2011

Bank statement balance ........ $13,800 Book balance .......................................................................................................................... $15,500

Add

Deposit of May 31 .................. 2,200

Bank error ................................ 400

16,400 Deduct Deduct

Outstanding checks ............. 1,600 Bank service charge .......................................................................................................... 100

______ NSF check ............................................................................................................................. 600

Adjusted bank balance .......... $14,800 Adjusted book balance ....................................................................................................... $14,800

Exercise 8-12 (15 minutes) (a) Days' sales uncollected on December 31, 2010: x 365 = 32.9 days

Days' sales uncollected on December 31, 2011: x 365 = 46.8 days

(b) Evaluation: The change from 32.9 to 46.8 days' sales uncollected

indicates that the receivables have become less liquid. While the accounts receivable were, on average, collected in about one month at the end of 2010, this has increased by about 14 days in Year 2011. The company needs to follow up to identify the reasons for this change.

$51,000

$565,000

$83,000

$647,000


8-13

Exercise 8-13A (10 minutes) 1. B 3. A 5. C

2. D 4. F 6. E

Exercise 8-14B (25 minutes) a. Recording inventory at gross amounts

Oct. 2

Merchandise Inventory ................................................

4,000

Accounts Payable .................................................. 4,000 To record merchandise purchases.

10 Accounts Payable ........................................................ 400

Merchandise Inventory ......................................... 400 To record credit memo for returns.

17 Merchandise Inventory ................................................ 4,400

Accounts Payable .................................................. 4,400 To record merchandise purchases.

26 Accounts Payable ........................................................ 4,400

Merchandise Inventory* ........................................ 88 Cash ........................................................................ 4,312 To record payment for merchandise less the

discount. *($4,400 x .02)


Cash ........................................................................ 3,600 To record payment for merchandise less the returns

($4,000 - $400).


8-14

Exercise 8-14B (Concluded) b. Recording inventory at net amounts

Oct. 2 Merchandise Inventory ................................................ 3,920

Accounts Payable .................................................. 3,920 To record merchandise purchases less

discount [$4,000 - ($4,000 x .02) = $3,920].

10 Accounts Payable ........................................................ 392

Merchandise Inventory .......................................... 392 To record credit memo for returns

[$400 - ($400 x .02)].

*13 Discounts Lost ............................................................. 72

Accounts Payable .................................................. 72 To record the discount lost [($4,000 - $400) x.02].

17 Merchandise Inventory ................................................ 4,312

Accounts Payable .................................................. 4,312 To record merchandise purchases less

discount [$4,400 - ($4,400 x .02) = $4,312].


Cash ........................................................................ 4,312 To record payment for merchandise.


Cash ........................................................................ 3,600 To record payment for merchandise less returns

($3,920 - $392 + $72).

* This entry could alternatively be recorded on October 31 when the cash payment is made (this is likely since the invoice was filed incorrectly).


8-15

PROBLEM SET A Problem 8-1A (20 minutes) 1. Violates separation of duties. The company should implement a policy

whereby the person recording incoming cash receipts is not responsible for posting the payments to the customer accounts.

2. Violates the principle of establishing responsibility. Only Jeff should

have access to the petty cash fund since he is the custodian. The company should implement a policy of not allowing petty cash transactions over the lunch hour. Alternatively, Jose could also serve as a petty cash custodian with his own petty cash fund.

3. Violates the proper application of technological controls. While the

daily backup is a very good internal control, the tape needs to be taken off the premises every night. If the building and computer are destroyed, the data then can be restored from the tape since it is safely kept off the premises. The company should implement a policy of storing tapes off the premises nightly.

4. Violates regular and independent review. Barto Sayles needs to

implement a way to regularly and independently review his employees. Hiring of internal auditors or an outside consultant to objectively review the internal controls and the employees‘ work needs to be implemented.

5. Violates the insuring of assets and the bonding of key employees. We

do not have enough information to know if the company can afford the move to the higher deductible on the property insurance. However, we can say that dropping the insurance for bonding the employees weakens internal control. If the company does need to engage in cost cutting they should do it without compromising their internal controls. The insurance for the bonding of employees (or at least key employees and those in sensitive positions) should be reinstated.


8-16

Problem 8-2A (20 minutes)

Part 1

May 1 Petty Cash .................................................................... 250.00 Cash ........................................................................ 250.00 To establish the petty cash fund.

May 15 Janitorial Expenses ..................................................... 78.00

Miscellaneous Expenses ............................................ 63.68 Postage Expenses ....................................................... 43.50 Advertising Expense ................................................... 57.15 Cash Over and Short ............................................. 3.48 Cash ........................................................................ 238.85 To reimburse the petty cash fund.

May 16 Petty Cash .................................................................... 200.00

Cash ........................................................................ 200.00 To increase the petty cash fund.

May 31 Postage Expenses ....................................................... 48.36

Mileage Expense .......................................................... 38.50 Delivery Expense ......................................................... 39.75 Cash Over and Short ................................................... 30.00 Cash ........................................................................ 156.61 To reimburse the petty cash fund.

Cash .............................................................................. 50.00 Petty Cash .............................................................. 50.00 To decrease the petty cash fund.

Instructor note: The two entries on May 31 can be combined into one entry for that date.

Part 2 If the May 31 replenishment is not made and no entry is recorded, then several expenses would not be recognized and both net income and equity would be overstated by $156.61 ($48.36 + $38.50 + $39.75 + $30.00). Also, the petty cash asset and total assets would be overstated by $156.61.


8-17


Part 1 Feb. 2 Petty Cash .................................................................... 300

Cash ........................................................................ 300 To establish the petty cash fund.

Part 2

Shelton Gallery Petty Cash Payments Report

Delivery expense Feb. 23 Delivery of customer's merchandise ......................... $ 18.00

Mileage expense

Feb. 14 Reimbursement for mileage ........................................ 58.00

Postage expense Feb. 12 Express delivery of contract ....................................... $ 9.95 Feb. 27 Purchased postage stamps ........................................ 64.00 73.95

Merchandise inventory (transportation-in)*

Feb. 9 COD charges on purchases ........................................ 22.50 Feb. 25 COD charges on purchases ........................................ 15.10 37.60

Office supplies expense

Feb. 5 Purchased paper for copier ........................................ 10.13 Feb. 20 Purchased stationery ................................................... 77.76 87.89

Total $275.44


Part 3

Feb. 28 Delivery Expense ......................................................... 18.00 Mileage Expense .......................................................... 58.00 Postage Expense ......................................................... 73.95 Merchandise Inventory ................................................ 37.60 Office Supplies Expense ............................................. 87.89 Cash Over and Short ................................................... 3.33 Cash ........................................................................ 278.77 To reimburse the petty cash fund.

28 Petty Cash .................................................................... 100.00 Cash ........................................................................ 100.00 To increase the petty cash fund.

Instructor note: The two entries on Feb. 28 can be combined into one.


8-18


Part 1

CLARK COMPANY Bank Reconciliation

July 31, 2011

Bank statement balance ............ $28,020 Book balance .......................................................................................................................... $26,193

Add: Add:

Deposit of July 31 ..................... 10,152

38,172

Proceeds of note less

collection charge.............................................................................................................

8,955

35,148 Deduct: Deduct:

Checks No. 3031 ...... $1,380 NSF check ...................... $ 805

3065 ...... 336 Service charge ............... 15

3069 ...... 2,148 3,864 Error (Check 3056) ........ 20 840

Adjusted bank balance .............. $34,308 Adjusted book balance ....................................................................................................... $34,308

Part 2

July 31 Cash .............................................................................. 8,955 Collection Expense ..................................................... 45 Note Receivable ..................................................... 9,000 To record note collection less fees.

July 31 Accounts Receivable—J. Shaw ................................. 805

Cash ........................................................................ 805 To charge account for NSF check plus fees.

July 31 Miscellaneous Expenses ............................................ 15

Cash ........................................................................ 15 To record bank service fee.

July 31 Rent Expense ............................................................... 20

Cash ........................................................................ 20 To correct an entry error.


8-19

Problem 8-4A (Concluded) Part 3 a. If the company's Cash account balance of $26,193 is listed on the

bank reconciliation as $26,139 then:

(i) The final balance that results from adjusting the bank statement balance will not be affected by the error; and

(ii) The final balance that results from adjusting the book balance of cash will be understated by $54 ($26,193 - $26,139), and the bank reconciliation will not balance.

b. The bank's collection of the $9,000 note less the $45 collection fee should have been added to the book balance of cash. Instead, it was added to the bank statement balance. As a result:

(i) The final balance that results from adjusting the bank statement balance will be overstated by $8,955; and

(ii) The final balance that results from adjusting the book balance will be understated by $8,955.


8-20


Part 1

ELS COMPANY Bank Reconciliation September 30, 2011

Bank statement balance ............... $18,363.25 Book balance .......................................................................................................................... $17,537.20

Add: Add: Interest earned ...... $ 22.50

Deposit of Sept. 30....................... 1,582.75

19,946.00

Proceeds of note

less $15 fee ......... 1,385.00

1,407.50

18,944.70 Deduct: Deduct:

Checks No. 5893 ....... $484.25 NSF check .................. 588.25

5906 ......... 859.30 Error (Check 5904) .. 30.00

5908 ....... 276.00 1,619.55 618.25

Adjusted bank balance ................. $18,326.45 Adjusted book balance .......... $18,326.45

Part 2

Sept. 30 Cash .............................................................................. 22.50 Interest Earned ....................................................... 22.50 To record interest earned.

30 Cash .............................................................................. 1,385.00

Collection Expense ...................................................... 15.00 Note Receivable ..................................................... 1,400.00 To record note collection less fee.

30 Accounts Receivable— S.Nilson ................................ 588.25

Cash ........................................................................ 588.25 To charge account for NSF check plus fee.

30 Computer Equipment ................................................... 30.00

Cash ........................................................................ 30.00 To correct an entry error.


8-21

Problem 8-5A (Continued) Part 3 There are several possible reasons why some prenumbered checks are

missing from the sequence of canceled checks returned with a bank

statement. Reasons include:

(1) Some of the checks in the numbered sequence may have cleared the

bank in a previous period and were returned with the bank statement

in that previous period.

(2) Some of the checks in the numbered sequence may remain

outstanding. If so, they will be returned with the bank statement in a

later period when they clear the bank.

(3) The issuer of the checks may have voided one or more of the checks

in the numbered sequence, perhaps because of making an error in

writing the checks.

(4) Occasionally, a check will reach the bank but the bank will incorrectly

charge the check to the wrong account. When the bank detects the

error, it will return the check separately with a note of explanation to

the depositor.


8-22

PROBLEM SET B Problem 8-1B (20 minutes) 1. Violates both applying technological control and effective segregation

of duties. It is safe to assume that Latoya Tally has knowledge of

employee passwords since she implemented the system of password

protection companywide. It is a potentially insecure situation that

Latoya processes payroll and can now probably change employee pay

rates at will, or add a fictitious employee to the file. The company

should hire an outside consultant to rework the password protection

system so Latoya will not have the knowledge that she currently

possesses.

2. Violates applying technological controls. The theater‘s system needs to

be backed up at least daily, not weekly. The theater needs to change the

backup policy and make sure the backup copies are stored off premises.

3. Violates segregation of duties. The company needs to have three

employees handle these functions instead of two. One employee should

place purchase orders, one should receive merchandise, and the third

should pay vendors.

4. Violates applying technological controls. The use of the check protector

is a good internal control. However the company needs to keep the

checks and check protector in a locked environment to prevent

unauthorized use.

5. Violates segregation of duties. It is good internal control to separate

duties for cash receipts and cash disbursements. Moreover, an

employee independent of these two functions should be given the

responsibility for reconciling the bank account monthly. If no

employees are available, this is an acceptable duty for the owner as it

allows for owner oversight, which is good internal control.


8-23

Problem 8-2B (20 minutes) Part 1

Jan. 3 Petty Cash .................................................................... 150.00 Cash ........................................................................ 150.00 To establish the petty cash fund.

Jan. 14 Office Supplies Expense ............................................. 16.29

Merchandise Inventory* .............................................. 17.60 Repairs Expense—Computer ..................................... 36.57 Miscellaneous Expenses ............................................ 14.82 Cash Over and Short ................................................... 2.44 Cash ........................................................................ 87.72 To reimburse the petty cash fund.

* Transportation-in costs are included in the Merchandise Inventory account under a perpetual system.

Jan. 15 Petty Cash .................................................................... 25.00

Cash ........................................................................ 25.00 To increase the petty cash fund.

Jan. 31 Advertising Expense ................................................... 40.00

Postage Expenses ....................................................... 38.19 Delivery Expense ......................................................... 58.00 Cash Over and Short ................................................... 21.46 Cash ........................................................................ 157.65 To reimburse the petty cash fund.

Petty Cash .................................................................... 75.00 Cash ........................................................................ 75.00 To increase the petty cash fund. Instructor note: The two entries on Jan. 31 can be combined into one entry.

Part 2 If the January 31 reimbursement is not made and no entry is recorded, then the expenses would not be recognized and both net income and equity would be overstated by $157.65 ($40.00 + $38.19 + $58.00 + $21.46). Also, the petty cash asset and total assets would be overstated by $157.65.


8-24

Problem 8-3B (30 minutes)

Part 1

Mar. 5 Petty Cash .................................................................... 200 Cash ........................................................................ 200 To establish the petty cash fund.

Part 2

RPM Music Center Petty Cash Payments Report

Delivery expense Mar. 11 Delivery of customer's merchandise .......................... $ 8.75

Mileage expense

Mar. 30 Reimbursement for mileage ........................................ 58.80

Postage expense

Mar. 28 Purchased postage stamps ......................................... 16.00

Merchandise inventory (transportation-in)*

Mar. 6 COD charges on purchases ........................................ $14.50

Mar. 27 COD charges on purchases ........................................ 47.10 61.60

Office supplies expense

Mar. 12 Purchased file folders .................................................. 12.13

Mar. 14 Reimbursement for office supplies ............................ 9.65

Mar. 18 Purchased paper .......................................................... 22.54 44.32

Total $189.47


Part 3

Mar. 31 Delivery Expense ......................................................... 8.75 Mileage Expense .......................................................... 58.80 Postage Expense ......................................................... 16.00 Merchandise Inventory ............................................... 61.60 Office Supplies Expense ............................................. 44.32 Cash Over and Short ............................................. 1.00 Cash ........................................................................ 188.47 To reimburse the petty cash fund.

31 Petty Cash .................................................................... 50.00 Cash ........................................................................ 50.00 To increase the petty cash fund. Instructor note: The two entries on Mar. 31 can be combined into one.


8-25


Part 1

STYLE CO. Bank Reconciliation December 31, 2011

Bank statement balance .............. $45,091.80 Book balance ......................................................................................................................... $31,743.70 Add: Add: Deposit of Dec. 31 ....................... 7,666.10 Error (Ck 1267) .... $ 18.00 52,757.90 Proceeds of note

less $20 fee ........ 19,980.00

19,998.00 51,741.70 Deduct: Deduct: Checks No. 1242 ..... $ 370.50 NSF check ............ $ 749.50 1273 ..... 1,084.20 Printing fee ........... 79.00 1282 ..... 390.00 1,844.70 828.50 Adjusted bank balance ................. $50,913.20 Adjusted book balance ....................................................................................................... $50,913.20

Part 2

Dec. 31 Cash ............................................................................... 18.00 Office Supplies ....................................................... 18.00 To correct an entry error.

31 Cash ............................................................................... 19,980.00 Collection Expense ...................................................... 20.00 Note Receivable ...................................................... 20,000.00 To record note collection less fees.

31 Accounts Receivable—Titus Industries ..................... 749.50 Cash ......................................................................... 749.50 To charge account for NSF check plus fees.

31 Miscellaneous Expenses ............................................. 79.00 Cash ......................................................................... 79.00 To record check printing charge.

Part 3

In a banking context, a debit memo is notification from the bank that it has debited the depositor's account. Since the depositor's account is a liability of the bank (a credit balance account), the debit notification means the bank has reduced the depositor's account balance. Conversely, a credit memo is a notification that the depositor's account has been credited, which means the bank has increased the depositor‘s cash balance.


8-26


Part 1

SAFE SYSTEMS Bank Reconciliation

May 31, 2011

Bank statement balance ................. $21,808.60 Book balance ......................................................................................................................... $15,270.20

Add: Add:

Deposit of May 31 ........................... 2,526.30

24,334.90

Proceeds of note less

$100 fee ...............................................................................................................................

7,200.00

22,470.20 Deduct: Deduct:

Checks No. 1780 ...... $1,325.90 NSF check ........... $431.80

1786 ...... 353.10 Service charge ...... 12.00

1789 ...... 639.50 2,318.50 Error (Ck 1788) ...... 10.00 453.80

Adjusted bank balance .................... $22,016.40 Adjusted book balance ....................................................................................................... $22,016.40

Part 2

May 31 Cash .............................................................................. 7,200.00 Collection Expense ..................................................... 100.00 Note Receivable ..................................................... 7,300.00 To record note collection less fee.

31 Accounts Receivable—S. Bax .................................... 431.80

Cash ........................................................................ 431.80 To charge account for NSF check plus fee.

31 Miscellaneous Expenses ............................................ 12.00

Cash ........................................................................ 12.00 To record bank service fee.

31 Utilities Expense .......................................................... 10.00

Cash ........................................................................ 10.00 To correct an entry error.


8-27

Problem 8-5B (Concluded) Part 3 There are several possible reasons why some prenumbered checks are missing from the sequence of canceled checks returned with a bank statement. Reasons include:

(1) Some of the checks in the numbered sequence may have cleared the bank in a previous period and were returned with the bank statement in that previous period.

(2) Some of the checks in the numbered sequence may remain outstanding. If so, they will be returned with the bank statement in a later period when they clear the bank.

(3) The issuer of the checks may have voided one or more of the checks in the numbered sequence, perhaps because of making an error in writing the checks.

(4) Occasionally, a check will reach the bank but the bank will incorrectly charge the check to the wrong account. When the bank detects the error, it will return the check separately with a note of explanation to the depositor.


8-28

SERIAL PROBLEM — SP 8 Serial Problem — SP 8, Business Solutions (50 minutes)

Part 1

BUSINESS SOLUTIONS Bank Reconciliation

March 31, 2012

Bank statement balance ............ $67,566 Book balance .......................................................................................................................... $68,057

Add Add

Bank error .......................................

Deposits in Transit .......................

500

0

Bank interest ........................................................................................................................

33

______

68,066 68,090 Deduct Deduct

Outstanding Check..................... 128 Safety deposit rental ..... $ 50

______ Charge for checks.......... 102 152

Adjusted bank balance .............. $67,938 Adjusted book balance ....................................................................................................... $67,938

Part 2

Mar. 25 Miscellaneous Expenses ............................................ 677 50 Cash ........................................................................ 101 50 To record safety deposit box rental.

26 Miscellaneous Expenses ............................................ 677 102

Cash ........................................................................ 101 102 To record charge for printing checks

31 Cash .............................................................................. 101 33

Interest Revenue ................................................... 404 33 To record interest earned.


8-29

Reporting in Action — BTN 8-1 1.

($ in thousands)

Balance Feb. 27,

2010

Cash and equivalents

as % of:

Balance Feb. 28,

2009

Cash and equivalents

as % of:

Cash and cash equivalents ...............

$ 1,550,861

—

$ 835,546

—

Current assets ........... 5,812,656 26.7% 4,841,586 17.3%

Current liabilities ....... 2,431,777 63.8 2,115,351 39.5

Stockholders‘ equity . 7,602,663 20.4 5,874,128 14.2

Total assets ................ 10,204,409 15.2 8,101,372 10.3

Analysis comment: Cash and cash equivalents have increased as a percent of the various bases over this period. It is probably safe to say that Research In Motion‘s liquidity position has improved.

2. Per the statement of cash flows for year ended February 27, 2010 ($ thousands):

Cash and equivalents, beginning-year .......... $ 835,546 Cash and equivalents, year-end ...................... $1,550,861

Percent change* ........................................................ 85.6% increase *[($1,550,861 - $835,546) / $835,546]

Per the statement of cash flows for year ended February 28, 2009 ($ thousands):

Cash and equivalents, beginning-year ........... $1,184,398

Cash and equivalents, year-end ...................... $ 835,546 Percent change* ....................................................... 29.5% decrease

*[($1,184,398 – $835,546) / $1,184,398]


8-30

Reporting in Action (Concluded) 3. Days' Sales Uncollected ($ millions)

Days‘ sales uncollected = x 365 Feb. 27, 2010: $2,593,742/ $14,953,224 x 365 = 63.31 days Feb. 28, 2009: $2,112,117/ $11,065,186 x 365 = 69.67 days

The number of days of uncollected sales in accounts receivable has decreased from 69.67 days to 63.31 days. This decrease of 6.36 days indicates that the company‘s assets are tied up in receivables for a shorter period of time; further, this difference is material. Research In Motion‘s accounts receivable for fiscal 2009 represent 44.6% ($2,593,742 / $5,812,656) of its current assets and 25.4% ($2,593,742 / $10,204,409) of its total assets. Research In Motion‘s receivables are historically high because most sales are made on credit.

4. Solution depends on the annual report information obtained.

Accounts receivable

Net sales


8-31

Comparative Analysis — BTN 8-2 Days‘ sales uncollected = x 365 Research In Motion ($ millions)

Current Year: $2,594/$14,953 x 365 = 63.32 days Prior Year: $2,112/$11,065 x 365 = 69.67 days

Research In Motion‘s days‘ sales uncollected has decreased by 6.35 days. The percent decrease is: (63.32 - 69.67) / 69.67 = (9.1)%.

Apple ($ millions)

Current Year: $3,361/$42,905 x 365 = 28.59 days Prior Year: $2,422/$37,491 x 365 = 23.58 days

Apple‘s days‘ sales uncollected has increased by 5.01 days. The percent increase is: (28.59 – 23.58) / 23.58 = 21.2%.

Comparative Analysis: Apple‘s increase in days‘ sales uncollected is 21.2%, which is a marked unfavorable trend compared with Research In Motion‘s decrease of 9.1%. That is, Apple has failed to successfully manage the number of days‘ sales that are uncollected relative to the prior year. However, it is important to remember that, historically, Apple‘s accounts receivable have not been a large asset for this company.

Accounts receivable

Net sales


8-32

Ethics Challenge — BTN 8-3 1. In a small business office it is very important that the owner of the

business become involved with control and oversight. In this medical office it would greatly enhance the internal control environment if Dr. Conrad reconciles the bank statements.

2. Unfortunately, due to collusion of the employees, the bank

reconciliation will not detect this fraud. The cash deposits per the books will reconcile to the cash deposits per the bank.

3. Despite the collusion, the scheme is not foolproof. For example, some

ways in which the scheme might be uncovered or prevented include the following:

A bank employee may become suspicious and call Dr. Conrad and ask if she is aware that occasionally her employees cash patient checks for cash.

An astute patient might notice that his/her statement contains a miscellaneous credit rather than a cash payment notation. If the patient is aware of accounting practices, then Dr. Conrad might be advised.

Dr. Conrad might be able to detect the fraud herself if she reviews the daily posting log generated by most computers in that she might see the batch totals for miscellaneous credits are posted at times different from all cash payment credits.

Dr. Conrad could require approval for each miscellaneous credit.

As a control, Dr. Conrad could require all checks be stamped ‗For Deposit Only‘ when they are received.

4. Dr. Conrad should review her salary schedules for employees to make

sure that she is at least offering market pay. She may want to consider bonding her employees to insure herself against material losses. Dr. Conrad should probably reconcile the bank statement herself as well as make it a practice to review the daily posting log for miscellaneous credits. Also, she should implement a policy whereby she is the only one to authorize any miscellaneous credits to patient accounts.


8-33

Communicating in Practice — BTN 8-4B

Memorandum

To: ―Owner‖ From: ―Consultant‖ Date: __________ Subject: Advice on monitoring purchase discounts [Instructor‘s Note: The response should acknowledge the owner‘s concern and recommend the net method of recording purchases. It should explain how this method results in the recording of ―Discounts Lost,‖ which will flow through to the income statement, thus providing the information desired. The memo might look something like the following.]

The net method gives management an advantage in controlling and

monitoring purchase discounts. When invoices are recorded at gross

amounts, the amount of discounts taken is deducted from the balance of

the Merchandise Inventory account.

This means that the amount of any discounts lost is not reported in any

account or on the income statement. Consequently, discounts lost are

unlikely to come to the attention of management. However, when

purchases are recorded at net amounts, a discounts lost expense is

brought to management‘s attention as an operating expense on the income

statement. Management can then seek to identify the reason for discounts

lost, such as oversight, carelessness, or unfavorable terms.

This practice gives management better control over persons responsible

for paying bills on time to take advantage of favorable discounts. This also

means it‘s less likely that favorable discounts are lost.


8-34

Taking It to the Net — BTN 8-5

[Instructor Note: These answers were taken from the 2008 Report to the Nation.]

1. The median loss caused by occupational frauds was $175,000.

2. More than one-quarter of fraud cases caused at least $1 million in losses.

3. Companies lose 7% of their annual revenues to fraud; this 7% figure translates to $994 billion in fraud losses.

4. The typical length of fraud schemes was 2 years from the time the fraud began until it was detected.

5. Companies that conducted surprise audits suffered a median loss of $70,000, whereas those without surprise audits had a median loss of $207,000.

6. The median loss suffered by companies with fewer than 100 employees was $200,000 per scheme.

7. Check tampering and fraudulent billing were the most common small business fraud schemes.

8. 35% of respondents cited inadequate internal controls as the primary contributing factor in the frauds investigated.

9. Only 7% of the perpetrators had convictions prior to committing their frauds.


8-35

Teamwork in Action — BTN 8-6

Common internal controls visible in a typical retail store include:

1. Door locks and roll-down screens for after-hours lock-up. 2. Electronic detection devices stationed at entrances or anti-theft

devices on merchandise that must be removed by cashier with special equipment.

3. Security cameras. 4. Security guards. 5. Cash registers. 6. Separate cash drawers or transaction codes to identify clerks at

registers. 7. Bar coding on merchandise. 8. Limited number of apparel items allowed in a dressing room. 9. Dressing room attendants. 10. A security safe on the premises. 11. Timeclocks.


8-36

Entrepreneurial Decision — BTN 8-7 1. Seven principles of internal control along with examples are:

a. Establish responsibilities. The clerks at the counter should be responsible for handling cash. The other employees should be responsible for preparing the orders and helping customers. There also should be employees assigned responsibilities such as maintaining inventories, cleaning premises, clerical duties, locking doors, etc.

b. Maintain adequate records. The clerks at the counter should enter all sales on the cash registers. The cash registers should include a locked record of all sales rung up for subsequent verification procedures. Other records should include those for inventories, supplies, payroll time records, and so on.

c. Insure assets and bond key employees. The owner should acquire insurance for the employees and the physical facilities. Insurance should also be acquired for potential casualties such as a customer slipping on the floor.

d. Separate recordkeeping from custody of assets. The employee who is responsible for food preparation and inventory should not be in control of the recordkeeping for the inventory. Similar separation should exist for all important assets.

e. Divide responsibility for related transactions. The employee responsible for ordering inventory should be separate from the employee controlling inventory who should also be separate from the employee who pays for inventory.

f. Apply technological controls. The owner should invest in technological controls such as cash registers, time clocks, security cameras, and other devices to reduce the risk of fraud or theft.

g. Perform regular and independent reviews. The owner should implement regular reviews of all operating and control procedures.

2. As the business grows, controls will become more important. She will have more employees and will have to delegate more responsibilities. Strong controls will be important to make sure that the business is not a victim of fraud or employee errors.


8-37

Hitting the Road — BTN 8-8 No formal solution exists for this activity. It is usually interesting for the class to exchange their discoveries via class discussion. This is particularly the case with respect to popular college service/product centers. Common controls found in college units include:

1. Door locks and roll-down screens for after-hours lock-up.

2. Electronic detection devices stationed at entrances or anti-theft devices on merchandise that must be removed by a cashier.

3. Security cameras.

4. Security guards.

5. Cash registers.

6. Bar coding on products and assets.

7. A security safe on the premises.

Global Decision — BTN 8-9 1.

(EUR millions)

Current year

balance

Cash as percent

of:

Prior year

balance

Cash as percent

of:

Cash (and equivalents) ............ 1,142 — 1,706 —

\ Current assets ....................... 23,613 4.8% 24,470 7.0%

Total assets ............................ 35,738 3.2 39,582 4.3

Current liabilities ................... 15,188 7.5 20,355 8.4

Stockholders‘ equity ............. 14,749 7.7 16,510 10.3

Analysis comment: Cash has decreased as a percent of each of these bases for this two-period comparison. This suggests that Nokia‘s liquidity (cash) position has not improved.


8-38

Global Decision (Concluded)

2. Cash, beginning-year (EUR millions) ................................................... 1,706

Cash, year-end (EUR millions) .............................................................. 1,142

Percent change* .................................................................. (33.1)% decrease *[(1,142 – 1,706) / 1,706]

3. Days' Sales Uncollected Formula (EUR millions)

Days‘ sales uncollected = x 365 Current Year: x 365 = 71.1days

Prior year: x 365 = 68.0 days

The number of days of uncollected sales in accounts receivable has increased from the prior year to the current year. Nokia is not collecting its receivables as efficiently this year compared to its prior year.

Accounts receivable

Net sales

7,981

40,984

9,444

50,710

HWChap008

Documents

cash balance

palms cash

petty cash receipt

nokias cash bank

custody of assets

equipment assets

asset custodian

internal controls questions