Hhtfa8e Ch04 SM

Chapter 4
Internal Control & Cash

ShortExercises
(5 min.)
S 4-1
Fraudis an intentionalmisrepresentationof facts, madefor

the purposeof persuadinganotherpartyto act in sucha way that causesinjuryor damageto that party.
TheThreeComponentsof the FraudTriangle

1. Motive- Fraudgenerallyresultsfromeithercritical needor greedon the part of the perpetrator. Regardlessof whetherthe drivingforceis needor greedmostperpetrators are drivento attemptto acquiresomethingthat belongsto others. 2. Opportunity- The opportunityto commitfraudusuallyarises throughweakinternalcontrols.
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3. Rationalization- The perpetrator(s)is (are) convinced,in their ownminds, that they deservethe objectof the fraudulentbehavior. Theymaybelieveno one else will ever knowor eventhat everybodyelse is engagingin fraudulent behavior
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Financial Accounting 8/e Solutions Manual
(5-10 min.) S 4-2 COMPONENTSOF INTERNALCONTROL 1. Controlenvironment Topmanagersmustset the toneat the top to establisha controlenvironment. 2. Riskassessment Eachcompanymustevaluateits own risks, based uponits particularline of business. 3. Controlprocedures Specificproceduresare neededfor a good system of internalcontrol. 4. Monitoringof controls Auditorscan monitora companys andits financialstatements. 5. Informationsystem Accurateinformationis essentialfor success business. in actions
Studentresponsesmayvary for the descriptions.
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(5-10 min.) S 4-3 Separation of duties is essential for safeguarding assets. The person who has custodyof an assetshouldnot also accountfor the asset. A personwho performs both duties can steal the asset and hide the theft by making a bogusentryin the accountingrecords.
Studentresponsesmayvary.
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(5-10 min.) S 4-4 Thereare severalmajorinternalcontrolproceduresas discussedin the chapterbesidesseparationof duties:
1. Smart hiring practices. The companyshouldbe carefulto hire both competentandhonestpersonnel. Smarthiringpracticesinvolveconducting backgroundcheckson job applicants,as well as trainingandsupervisionon the job.
2. Comparisons and compliance monitoring. No personor departmentshouldbe allowedto completelyprocessa transactionfrom beginningto endwithoutbeingcheckedby anotherpersonor a computer program. Examplesof comparisonsand compliancemonitoringare the use of operatingand cashbudgets. Also, in key functions,one employee(or a computerprogram)doublechecksthe workof anotherfor accuracy.
3. Adequate records help to assurethat sufficienthardcopydocuments or electronicinformationis kept by the entity to supportthe validityof transactionsthat wereprocessed. Examplesincludesalesinvoices, purchaseorders,shippingrecords,and customerremittanceadvices. Amongthe benefitsof adequaterecordsis the ability to providean audit trail later
23 Financial Accounting 8/e Solutions Manual
(Continued) S 4-4 for internalor externalauditorsto followin auditingthe entitysfinancial statements.
4. Limited access goeshandin handwith separationof dutiesto assure that only authorizedindividualsare allowedaccessto (a) the assetsof the company,suchas cashor inventory;and (b) the records. Generally,only personswith custodialresponsibilities(suchas the cashieror the warehouse)shouldbe allowedaccessto assets(suchas cashor inventory). Onlypersonswith recordkeepingresponsibilities(suchas accountants) shouldhaveaccessto the companysjournalsand ledgers.
5. Proper approvals. No transactionshouldbe processedwithout managementsgeneralor specificapproval. Generally,the largerthe transaction,the higherthe organizationallevel of approvalnecessary. Noticethat the first lettersof theseattributesspell the acronymSCALP. Thats an easy and comprehensive way to remember the control proceduresinvolvedin internalcontrols.
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(10 min.) S4-5 A computer virus enters program code without your consent and performsdestructiveactionto yourcomputerfiles 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 Website that attractsvisitorswhomaybe 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.
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(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 expensesultimately 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.
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(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 payees 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 makesit difficult to get approvalfor a duplicatepayment.
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(10 min.) S 4-8 RandellCorp. BankReconciliation October31, 2010

BANK Balance,October31 Add: Depositin transit BOOKS $3,180 Balance,October31 Add: 200 Bankcollection 3,380 Interestrevenue Less: Servicecharge (500) NSFcheck $2,880 Adjustedbookbalance $2,400 530 10 2,940 (20) (40) $2,880
Less: Outstandingchecks Adjustedbankbalance
Randellhas cashof $2,880. (5 min.) S 4-9 Aug. 31 Cash.. AccountsReceivable... Collectionon account. 31 Cash.. InterestRevenue... Interestearnedon bankbalance. 31 MiscellaneousExpense... Cash. Bankservicecharge. 31 AccountsReceivable
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530 530
10 10
20 20
40
Internal Control & Cash 28
Cash.. NSFcheck.
40
29
(5 min.) S 4-10 It appears that the employeehas stolen $800 (adjusted book balance, $4,800 adjusted bank balance, $4,000). The adjusted bank balance is the companys true cash balance, and the company books show more cash on hand.Therefore,the booksmustbe incorrect.
(5 min.) S 4-11 Stevenswill noticea gap in the sequenceof salesreceiptsfor the receiptthat Cassidy destroyed. This knowledge will lead Stevens to investigate what happenedto the missingreceiptandwhathappenedto the relatedcash.
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(10 min.) S 4-12 1. Payingby checkcarriesthreecontrolsover cash: The checkprovidesa recordof the payment. The checkmustbe signedby an authorizedofficial. Before signing the check, the official should study the evidence supportingthe payment.
2. A dishonestpurchasingagentcould: Purchasegoodsand have themdeliveredto his homeor other location that he controls. Approvepaymentby the companyfor goodsthat he spenttoo muchon, andthensplit the excesswith the supplier.
Companies avoid this internal control weakness by separating the followingdutiesrelatedto the purchaseof, andpaymentfor, goods: purchasinggoods receivinggoods approvingandpayingfor goods
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(5 min.) S 4-13 A cash budget starts with the beginning cash balance, adds budgeted cash receipts, and subtractsbudgetedcashpayments.The result is cashavailable 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 well neednewfinancing.
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(5-10 min.) S 4-14 CrescentArtichokeGrowers CashBudget Year2010 Cashbalance,beginning Estimatedcashreceiptstotal Estimatedcashpaymentstotal Cashavailable(needed)beforenewfinancing Budgetedcashbalanceneeded Cashavailablefor additionalinvestments Millions $ 11 104 115 (93) 22 (17) $ 5
(5 min.) S 4-15 Rourke should report the errors to Dunn because Dunn is Rourkes supervisor, and Dunn is responsible for the errors. If Dunn fails to take action, then Rourke should report the errors to the manager of the organization. In any event, outsiders who are relying on Dublin Limiteds financial statementsmust be made aware of the need to correct the reported net incomefigure.
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Exercises
GroupA (5-20 min.) E 4-16A a. Mason has access to the cash collected, and he also prepares the cash report. With access to both items, Mason can steal cash and falsify his cashreportto concealhis theft. b. Fleming prepares the purchase order and also receives the goods. She can add some items to the purchase order and have these extra items shipped to a location she controls. When the goods come in, she checks the incoming shipment, so theres no outside party to learn of her dishonesty. Studentresponsesmayvary.
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(10 min.) E 4-17A Cashpayments: a. Strong internal control. There is a good separation of duties. Supervisors requestequipment,andthe homeofficepurchasesthe equipment. b. Weak internal control. Supervisors both request, purchase, and pay for equipmentwith little oversightby the homeoffice.
Cashreceipts: a. Weakinternalcontrol. The accountantboth handlescashand accountsfor cash. b. Strong internal control. There is a good separation of duties. Different peoplehandlecashand accountfor cash.
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(10 min.) E 4-18A To prevent Flynns embezzlement, Downtown Kalamazoos board of directorscouldhave: a. Not permittedFlynnto write DowntownKalamazooChecks. Instead, appointa boardmemberto write the checks. b. Not permittedFlynnto receivecashthat cameto DowntownKalamazoo. Have cash sent to a lock box at the bank and appoint a board member to get the cashfromthe lock box. c. Supervised Flynns work by examining Downtown Kalamazoos documentssuchas paid checks. d. Had an audit of Downtown Kalamazoos transactions and financial statements.
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(5-10 min.) E 4-19A 1. 2. 3. 4. b b d a (10-20 min.) E 4-20A J. D. Hunter BankReconciliation June30, 2010 BANK: Balance,June30 Add: Depositin transit Less: Outstandingchecks: CheckNo. 626 627 Adjustedbankbalance BOOKS: Balance,June30 Less: Correctionof bookerror Recorded$86 checkas $68 NSFcheck Servicecharge Adjustedbookbalance $ 399 1,210 5. 6. 7. d c c
$ 85 285
(370) $1,239
$1,287
$ 18 20 10
(48) $1,239
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(10-20 min.) E 4-21A EvanRoot BankReconciliation April 30, 2010 BANK: Balance,April 30 Add:Depositin transit Less:Outstandingchecks Adjustedbankbalance BOOKS: Balance,April 30 Add:EFTcollection rent Less: Servicecharge NSFchecks Chargefor printedchecks Correctionof bookerror recorded$290checkas $29 Adjustedbookbalance Rootsactualcashbalanceis $1,753 $ 565 1,790 2,355 (602) $1,753
$1,827 320 2,147 $7 115 11 261 (394 $1,753
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(10-15 min.) E 4-22A
Journal
DATE ACCOUNTTITLESANDEXPLANATION DEBIT CREDIT
Apr 30 Cash. RentRevenue EFTcollectionof rent. 30 MiscellaneousExpense($7 + $11)... Cash. Bankservicechargeandcharge for printedchecks. 30 AccountsReceivable... Cash. NSFchecksreturnedby bank. 30 SalaryExpense($290 $29).. Cash. Correctionof bookerror.
320 320
18 18
115 115
261 261
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(10-15 min.) E 4-23A TO: FROM: StoreManager Student
SUBJECT: Evaluationof internalcontroland planfor improvement Thereis a weaknessin internalcontrol over cashreceipts. The cashregisters 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 cashierto steal cashand 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 draweragainstthis recordedamount.
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(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 employeeand then keep the related paycheckafter the treasurer returns the signedchecksto the payroll department. To correctthis weakness,GreenGrassGolf shouldhave someoneother 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 distributepaychecksto the workers.
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(20-30 min.) E 4-25A ColeCommunications,Inc. CashBudget YearEndedDecember31, 2011

Cashbalance,December31, 2010 Budgetedcashreceipts: Collectionsfromcustomers Saleof assets Budgetedcashpayments: Paymentsfor cost of servicesandproducts Paymentsof operatingexpenses Investmentin equipment Paymentof debt Paymentof dividends Cashavailable(needed)beforefinancing Budgetedcashbalance,December31, 2011 Cashavailablefor additionalinvestments,or (Newfinancingneeded) Millions $ 86
11,305 118 11,509
$6,167 2,544 1,826 603 347
11,487 22 (82) $ (60)
Cole Communications expects to need new financing of $60 million during 2011.
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(10 min.) E 4-26A

Actual effective interestrate Interestpaid eachyear Amountactually borrowed
$14,000,000 .077 $14,000,000 $14,000,000(.057)
$1,078,000 $13,202,000
= 8.17%
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Exercises
GroupB (5-20 min.) E 4-27B a. Monroe has access to the cash collected, and he also prepares the cash report. With access to both items, Monroe can steal cash and falsify his cashreportto concealhis theft. b. Adamspreparesthe purchaseorder and also receivesthe goods. She can add someitemsto the purchaseorder and have theseextra itemsshipped to a location she controls. When the goods come in, she checks the incomingshipment,so theresno outsidepartyto learnof her dishonesty. Studentresponsesmayvary.
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(10 min.) E 4-28B Cashpayments: a. Strong internal control. There is a good separation of duties. Supervisors requestequipment,andthe homeofficepurchasesthe equipment. b. Weak internal control. Supervisors both request, purchase, and pay for equipmentwith little oversightby the homeoffice.
Cashreceipts: a. Weakinternalcontrol. The accountantboth handlescashand accountsfor cash. b. Strong internal control. There is a good separation of duties. Different peoplehandlecashand accountfor cash.
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(10 min.) E 4-29B To preventSmithsembezzlement,DowntownScanlonsboardof directors couldhave: a. Not permittedSmithto write DowntownScanlonchecks. Instead, appointa boardmemberto write the checks. b. Not permitted Smith to receive cash that came to DowntownScanlon. Have cash sent to a lock box at the bank and appoint a board member to get the cashfromthe lock box. c. Supervised Smiths work by examining Downtown Scanlons documentssuchas paid checks. d. Had an audit of Downtown Scanlons transactions and financial statements.
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(5-10 min.) E 4-30B 1. 2. 3. 4. b b d a 5. 6. 7. d c c
(10-20 min.) E 4-31B J. D. Hill BankReconciliation February28, 2010 BANK: Balance,February28 Add: Depositin transit Less: Outstandingchecks: CheckNo. 626 627 Adjustedbankbalance BOOKS: Balance,February28 Less: Correctionof bookerror Recorded$87 checkas $78 NSFcheck Servicecharge Adjustedbookbalance
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$ 383 1,215
$ 85 275
(360) $1,238
$1,282
$9 20 15
(44) $1,238
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(10-20 min.) E 4-32B HarrySmith BankReconciliation September30, 2010 BANK: Balance,September30 Add:Depositin transit Less:Outstandingchecks Adjustedbankbalance BOOKS: Balance,September30 Add:EFTcollection rent Less: Servicecharge NSFchecks Chargefor printedchecks Correctionof bookerror recorded$310checkas $31 Adjustedbookbalance Smithsactualcashbalanceis $1,726 $ 545 1,790 2,335 (609) $1,726
$1,823 325 2,148 $8 125 10 279 (422) $1,726
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(10-15 min.) E 4-33B
Journal
May 31 Cash. RentRevenue EFTcollectionof rent. 31 MiscellaneousExpense($8 + $10)... Cash. Bankservicechargeandcharge for printedchecks. 31 AccountsReceivable... Cash. NSFchecksreturnedby bank. 31 SalaryExpense($310 $31).. Cash. Correctionof bookerror.
325 325
18 18
125 125
279 279
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(10-15 min.) E 4-34B TO: FROM: StoreManager Student
SUBJECT: Evaluationof internalcontroland planfor improvement Thereis a weaknessin internalcontrol over cashreceipts. The cashregisters 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 cashierto steal cashand 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 draweragainstthis recordedamount.
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(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 employeeand then keep the related paycheckafter the treasurer returns the signedchecksto the payroll department. To correct this weakness, Beautiful Meadows Golf should have someone other than the payroll department or the shop foremandistribute paychecks to employees. For example, the humanresources department, which has no control over the time sheets or the paychecks,could distributepaychecksto the workers.
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(20-30 min.) E 4-36B FallonCommunications,Inc. CashBudget YearEndedDecember31, 2011

Cashbalance,December31, 2010 Budgetedcashreceipts: Collectionsfromcustomers Saleof assets Budgetedcashpayments: Paymentsfor cost of servicesandproducts Paymentsof operatingexpenses Investmentin equipment Paymentof debt Paymentof dividends Cashavailable(needed)beforefinancing Budgetedcashbalance,December31, 2011 Cashavailablefor additionalinvestments,or (Newfinancingneeded) Millions $ 82
11,307 121 11,510
$6,174 2,545 1,831 604 341
11,495 15 (81) $ (66)
Fallonexpectsto neednewfinancingof $66 millionduring2011.
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(10 min.) E 4-37B

Actual effective interestrate Interestpaid eachyear Amountactually borrowed
$19,000,000 .071 $19,000,000 $19,000,000(.058)
$1,349,000 $17,898,000
= 7.54%
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ChallengeExercises
(15-25 min.) E 4-38
Owenscouldbe: Healeycouldinvestigateby:
1. Writingbusinesschecksto herself. 1. Performingthe bankreconciliation andexaminingall checkswrittenby the business. 2. Submittingpurchaseinvoicesa 2. secondtimefor duplicatepayment, perhapsalteringthe mailingaddress on the duplicateinvoiceandsending the checkto a post officebox that Owenscontrols. Examiningpurchaseinvoicesfor authenticityandcomparinginvoices to receivingreportsto determinethat the businessreceivedall goodsit paidfor. Anyinvoicewith a hole indicatesit waspaid earlier. Callingthe suppliersdirectlyto inquireaboutany questionable invoices. 3. Payingsuppliersexcessamounts andarrangingfor suppliersto kick backpart of the excessto Owens. 3. Comparingthe businesssratio of cost of goodssold to retail selling priceto the cost-to-retail ratio in the past. A kickbackschemewouldshow up in highercost figuresanda lower profit percentage. 4. Examiningall cashrecordsand comparingthe recordsto actual quantitiesof suppliesandotheritems neededby the business.
4. Makingsmall cashpaymentsto herself.
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(20-30 min.) E 4-39 Req. 1 The FurnitureMart, Inc. CashBudget YearEndedDecember31, 2010
Cashbalance,December31, 2009 Budgetedcashreceipts: Collectionsfromcustomers Issuanceof stock Budgetedcashpayments: Purchasesof inventoryitems Paymentof operatingexpenses Purchaseof propertyand equipment Paymentof long-termand short-termdebt Paymentof dividends Cashavailable(shortage)beforefinancing Budgetedcashbalance,December31, 2010 Cashavailablefor additionalinvestments Thousands $ 130
21,800 647 22,577 $14,545 2,349 1,528 980 317
19,719 2,858 (130) $ 2,728
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(continued) E 4-39 Req. 2 Currentratio = Total currentassets Total currentliabilities = $7,976 = 1.87 $4,260
Debtratio
Total liabilities Total assets
$11,088 $22,377
= 0.50
I would lend $100 thousand to The Furniture Mart because the companys ratio values are strong. Also, the cash budget indicates strong cash flows during2010.
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Quiz
Q4-40 Q4-41 Q4-42 Q4-43 Q4-44 Q4-45 Q4-46 Q4-47 Q4-48 Q4-49 Q4-50 Q4-51 b a d d d b b c d d d c
($6,000+ $83,000 $36,000 $26,000 $19,000 $15,000 = $7,000;arrangefinancingfor this amount.)
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Problems
GroupA (15-20 min.) P 4-52A The internalcontrolweaknessesin Celtic Importssystemare: 1. McNicholas controls the content of the invoices. With no supervision of her work, McNicholas could have the suppliers overstate their prices and then arrange to have them split the excess with her after Celtic Import paysthe invoices. 2. Sweeney has both cash handling and accounting duties. With both responsibilities, Sweeney could steal incoming cash and cover her theft by manipulatingthe accountingrecords.
As with all small businesses, the key to effective internal control is more ownerinvolvement. Sullivancould: 1. Make the purchase and pay arrangements with the Irish artisans who supply Celtic Imports products. Let McNicholas keep locating new products,but dont let her arrangefor the purchasesandpayment. 2. Sullivan could assign either cash handling or accounting duties to Sweeneyand then hire someoneelse to do the other (accountingor cashhandling)duties. Also Sullivanneedsto performthe bank reconciliationto keepher eye on cashreceiptsand cashpayments.
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(10-20 min.) P 4-53A Requirement 1 Missing Internal Control Characteristic a. Separationof duties Requirement 2 Requirement 3
Possible Problem Theft of diamonds the purchasingagent couldhavediamonds sent to a locationhe controls. Lost revenue because too manyemployeesare managingthe officeand neglectingtheir duties. Theft of cash.
Solution Separate purchasing, approval,andchecksigningduties.
b. Assignmentof responsibility
Assigna single employeeto manage the officewhenthe owneris absent. Separateaccounting andcashhandling duties.
c. Separationof duties
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(20-30 min.) P 4-54A Req. 1 DunlapAutomotive BankReconciliation July 31, 2010 BANK: Balance,June30, 2010 Add:Depositsin transit ($924+ $2,008) Less:Outstandingchecks CheckNo. 3119 3120 3121 3122 Adjustedbankbalance,July 31, 2010 BOOKS: Balance,June30, 2010 Add:EFTcollectionof rent Bankcollectionof note receivable Bookerror $1,360check recordedas $1,630 Less:EFTpaymentof insurance Unauthorizedsignaturecheck Servicecharge Adjustedbookbalance,July 31, 2010 $10,379 2,932 13,311
$ 440 965 205 2,260
(3,870 ) $ 9,441
$ 7,937 $ 750 1,250 270 $ 334 407 25 2,270 10,207
(766) $ 9,441
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(continued) P 4-54A Req. 2 A bank accounthelps control cash by providinga place for safekeeping.The bank also provides a detailed list of the companys cash transactions that managers can compare to the companys own cash records and thereby correctany bookerrorsquickly.
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 balanceof cashto reporton the balancesheet.
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(20-30 min.) P 4-55A Req. 1 DicksonEngineeringAssociates BankReconciliation August31, 2010

BANK: Balance,August31 Add:Depositof August31 in transit Less:Outstandingchecks($401.00+ $74.82+ $33.25+ $165.55+ $236.00+ $47.75+ $107.85) Correctionof bankerror, which creditedour accountfor the depositof anothercompany Adjustedbankbalance,August31 BOOKS: Balance,August31 Add:Interestrevenueearnedon bank balance Bankcollectionof accountreceivable $8,879 .24 383.54 9,262 .78
$1,066 .22
398.00
(1,464 .22) $7,798 .56
$8,152.71 $ 15.85 899.15
915.00 9,067.71
Less:EFT(utilities$730,insurance$280) Servicecharge Returnedcheckdue to unauthorized signature NSFcheck Adjustedbookbalance,August31
$1,010 .00 5.50 185.50 68.15
(1,269.15 ) $7,798 .56
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(continued) P 4-55A Req. 2 (entries based on the reconciliation)
Journal
May
31 Cash InterestRevenue. Interestearnedon bankbalance. 31 Cash AccountsReceivable. Accountreceivablecollectedby bank. 31 UtilitiesExpense.. Cash... Monthlyutilities. 31 InsuranceExpense. Cash... Monthlyinsurance. 31 MiscellaneousExpense. Cash... Bankservicecharge. 31 AccountsReceivable($185.50+ $68.15) Cash... NSFcustomerchecksreturnedby bank.
15.85 15.85
899.15 899.15
730.00 730.00
280.00 280.00
5.50 5.50
253.65 253.65
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(10-15 min.) P 4-56A TO: FROM: President,SunSkinCare ConcernedEmployee
It is unwise to have the employeewho opens the mail also grant allowances to customers. Suppose a customer pays an invoice in full. The mailroom employeecan steal the customercheck and grant an allowanceto cover the theft. To correct this internal control weakness,deny the mailroomemployee accessto all accountingrecords. Also, appoint a separate employeeto grant allowancesto customers.
Notes: 1. Studentresponsesmayvary. 2. The mailroom employee obviously has access to the accounting recordstoknowthat a customerhas paid less thanthe full amount. 3. It may be necessaryto explain to studentsthat the mailroomemployee must forge the companyendorsementon customerchecksstolen. This person must also open and controla bank account in the companysname.This maybe quite easy.
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(30-45 min.) P 4-57A Req. 1 JasperWireless CashBudget 2011

Cashbalance,beginning Budgetedcashreceipts: Collectionsfromcustomers($64,000 1.10) Receiptof interest Budgetedcashpayments: Purchasesof inventory($49,000 1.20) Operatingexpenses Purchasesof equipment Paymentof dividends Purchasesof investments Paymentof long-termdebt Cashavailable(needed)beforefinancing Budgetedcashbalance,ending Cashavailablefor additionalinvestments,or (Newfinancingneeded) Thousands $ 1,500
70,400 300 72,200 $58,800 13,500 4,800 300 400 400 (78,200 ) $ (6,000 ) (3,800 ) $ (9,800 )
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(continued) P 4-57A Req. 2 JasperWirelessappearsto be growing.The companyexpectsa 10%increase in collections from customers and a 20% increase in the purchases of inventory. It is also continuing to invest in new equipment, with no sales of long-termassets.
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Problems
GroupB (15-20 min.) P 4-58B The internalcontrolweaknessesin InternationalImportssystemare: 1. Walsh controls the content of the invoices. With no supervision of her work, Walsh could have the suppliers overstate their prices and then arrange to have them split the excess with her after International Import paysthe invoices. 2. Durkin has both cash handling and accounting duties. With both responsibilities, Durkin could steal incoming cash and cover her theft by manipulatingthe accountingrecords.
As with all small businesses,they key to effectiveinternalcontrolsis more ownerinvolvement. Spencercould: 1. Make the purchase and pay arrangements with the French artisans who supply International Imports products. Let Walsh keep locating new products,but dont let her arrangefor the purchasesandpayment. 2. Spencer could assigneither cash handlingor accountingduties to Durkin and then hire someoneelse to do the other (accountingor cashhandling) duties. Also Spencerneedsto performthe bank reconciliationto keep her eye on cashreceiptsand cashpayments.
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(10-20 min.) P 4-59B Requirement 1 Missing Internal Control Characteristic Requirement 2 Requirement 3
Possible Problem
Solution Havea manager,not the purchasingagent approveinvoicesfor paymentandsignthe checks
a. Separationof duties Theft of cashby the purchasingagent.
b. Assignmentof responsibilities
Lost revenuedue to Assignone senior delayof architectural architectto fulfill drawings. managementdutieswhile Whiteis absent. Other seniorarchitectshould focuson producing architecturaldrawings. Keepaccountingand cashhandlingduties separate.
c. Separationof duties Theft of cash.
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73
(20-30 min.) P 4-60B Req. 1

DonaldAutomotive BankReconciliation January31, 2010 BANK: Balance,January31, 2010 Add:Depositsof January29 & 30 in transit Less:Outstandingchecks CheckNo. 3119 3120 13121 3122 Adjustedbankbalance,January31, 2010 BOOKS: Balance,January31, 2010 Add: EFTcollectionof rent Bankcollectionof note receivable Bookerror $1,350checkrecorded as $1,530 Less: NSFcheck EFTpaymentof insurance Servicecharge Adjustedbookbalance,January31, 2010 $ 8,817 2,909 11,726
$ 493 985 219 2,322
(4,019 ) $ 7,707
$ 6,344 $ 650 1,350 180
2,180 8,524
$ 466 331 20
(817) $ 7,707
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(continued) P 4-60B Req. 2 A bank accounthelps control cash by providinga place for safekeeping.The bank also provides a detailed list of the companys cash transactions that Donald Automotive managers can compare to the companys own cash recordsandthuscorrectany bookerrorsquickly.
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 balanceof cashto reporton the balancesheet.
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(20-30 min.) P 4-61B Req. 1 DunlapEngineeringAssociates BankReconciliation October31, 2010

BANK: Balance,October31 Add: Depositof October31 in transit $8,343 .87 $380 .50 $380 .50 $8,724 .37
Less: Outstandingchecks($403.15+ $78.98+ $36.39+ $155.45+ $234.00+ $47.50+ $106.79) Correctionof bankerror creditedour accountfor the depositof anothercompany Adjustedbankbalance,October31 BOOKS: Balance,October31 Add: Bankcollectionon account Interestrevenueon bankbalance Less: Servicecharge EFTPaymentof utility bill EFTPaymentof insurancebill NSFcheck Returneditemdue to unauthorizedsignature Adjustedbookbalance,October31
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1,062 .26
405.00
(1,467 .26) $7,257 .11
$7,605 .86 $915 .20 15.45 $ 6.25 770.00 250.00 67.65 185.50 (1,279 .40) $7,257 .11
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930.65 8,536 .51
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(continued) P 4-61B Req. 2 (entries based on the reconciliation)
Journal
Jan. 31 Cash... AccountsReceivable.. AccountsReceivablecollectedby bank. 31 Cash... InterestRevenue... Interestearnedon bankbalance. 31 Utility Expense.. PrepaidInsurance... Cash EFTpayments 31 MiscellaneousExpense Cash.. Bankservicecharge. 31 AccountsReceivable($67.65+ $185.50).. Cash NSFcustomerchecksreturnedby bank.
915.20 915.20
15.45 15.45
770.00 250.00 1,020.00
6.25 6.25
253.15 253.15
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(10-15 min.) P 4-62B TO: FROM: President,FlawlessSkinCare ConcernedEmployee
It is unwise to have the employeewho opens the mail also grant allowances to customers. Suppose a customer pays an invoice in full. The mailroom employeecan steal the customercheck and grant an allowanceto cover the theft. To correct this internal control weakness,deny the mailroomemployee accessto all accountingrecords. Also, appoint a separate employeeto grant allowancesto customers.
Notes: 1. Studentresponsesmayvary. 2. The mailroom employee obviously has access to the accounting records to knowthat a customerhas paid less thanthe full amount. 3. It may be necessaryto explain to studentsthat the mailroomemployee must forge the companyendorsementon customerchecksstolen. This person must also open and control a bank account in the companysname.This maybe quite easy.
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(30-45 min.) P 4-63B Req. 1 CarvelWireless CashBudget 2011

Cashbalance,beginning Budgetedcashreceipts: Collectionsfromcustomers($62,000 1.14) Receiptof interest Budgetedcashpayments: Purchasesof inventory($47,000 1.25) Operatingexpenses Purchaseof propertyand equipment Purchasesof investments Paymentof dividends Paymentsof long-termdebt Cashavailable(needed)beforefinancing Budgetedcashbalance,ending Cashavailablefor additionalinvestments,or (Newfinancingneeded) $ 1,900
70,680 700 73,280 $58,750 13,700 4,100 300 400 500
77,750 (4,470 ) (3,550 ) $ (8,020 )
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(continued) P 4-63B Req. 2 Carvel Wirelessappearsto be growing.The companyexpectsa 14%increase in collectionsfrom customersand a 25% increasein purchasesof inventory. It is maintaining its purchases of property and equipment, with no sales of long-termassets.
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DecisionCases
(20-30 min.) DecisionCase1 EnvironmentalConcerns,Inc. BankReconciliation September30, 2010
BANK: Balance,September30 Add:Depositof September30 in transit Less:Outstandingchecks($116+ $150+ $853+ $990+ $206+ $145) Adjustedbankbalance,September30 BOOKS: Balance,September30 Add:Bankcollection Less:Servicecharge NSFcheck Adjustedbookbalance,September30 $8 36 $ 8,224 3,794 12,018 (2,460 ) $ 9,558
$10,402 200 10,602 (44) $10,558
Adjusted balances do not agree.
Based on the above reconciliation, it appears the bookkeeper has stolen $1,000,the differencebetweenthe adjustedbankand bookamounts($9,558 $10,558). He understated the total of outstanding checks by $1,000 to cover his theft. Benzshouldassignan employeewith no cashhandlingdutiesto preparethe bankreconciliation.The bookkeeper shouldnot performthis duty, becausea personwhohandlescashand also preparesthe reconciliationcan steal cash
Chapter 4 Internal Control & Cash 82
and manipulate the reconciliation to cover the theft. Perhaps Benz should preparethe reconciliationhimself.
83
(15-30 min.) DecisionCase2 The internal control weakness in this case is a lack of separation of duties. The foremanperformstoo manyduties. 1. The foremanhiresthe workers. 2. The foremancontrolsworkersemploymentdocuments. 3. The foremanfills out workers time sheets and transmitsall documents to the homeoffice. 4. The foremanpassesout paychecksto workers. 5. The workers never go to the home office, so homeoffice personnel do not evenknowwhetherall workersexist. The foremancouldsteal fromthe companyas follows: 1. The foremancould enter a fictitiousworker into the payroll systemand fill out bogustime sheets for the fictitiousemployee.Then the foreman couldpocketthe pay checkwrittento the employee. 2. The foreman could enter more time than actually worked by an employeeand arrangeto split the extrapay receivedby the worker. 3. The foremancouldpad his ownhoursto receivepay for timethat he did not work.
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(continued) DecisionCase2 The followingactionswill correctthe internalcontrolweakness: 1. The homeofficecouldhavethe constructionworkerscometo the office for processing their employee documents. Then home office would at least knowthat all the workersexist. 2. Haveemployeessigntheir owntimesheets. 3. Have a homeoffice employeecomparesignatureson the workers time sheets to their signatures on file and, occasionally, to their endorsementson the backsof their paychecks. 4. Occasionally or always have a homeoffice employee go to the constructionsite to passout paychecks. 5. Have a homeoffice employee go to the construction site occasionally to take attendance of workers on duty that day. Then match the namesof workerson duty to the time sheets turnedin at the end of the week.
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EthicalIssue1
1. Identify the ethical issue. Youmustdecidewhetherit is ethical for the auditornot to requirethe bankto recordthe loss. 2. What are the alternatives? Requirethe clientto recordthe loss, or permitthe clientnot to recordthe loss. 3. Identify the stakeholders. The auditor, the bank, and the public at large can be affected. The auditors reputation is on the line. The banks financial statementsare in question.The public can be affectedif the bank issuesfinancialstatementsthat includeerroneousamounts. 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 accountingfirm may then be unable to expandthe firm as it had hopedto do. (continuedon next page)
Chapter 4
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(continued) EthicalIssues If the auditorsokaythe banksfinancialstatementsevenafter the bankdid 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 banks financial statements would report erroneous amounts for the notes receivable. People relying on the banks financial statements may suffer lossesas a result. The accountingfirmsreputationwouldbe hurt. 4. Make the decision. The auditor should require the bank to record the loss even if that meanslosingthe bank as a client. By stickingto its belief that the bank should record the loss, the auditors reputation will not be harmedas it wouldby okayingfinancialstatementsthat includeerrors. Its far betterto lose a clientthanto lose yourreputation.
(continuedon next page)
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(continued) EthicalIssues
EthicalIssue2
1. Identify the ethical issue. Galvins ethical issue is whether to use his knowledgeof The SalvationArmysplansand of Nadarssituationto either partys advantage (or disadvantage). Should Galvin help The Salvation Armybuy the land at the lowest price? Shouldhe help Nadar sell the land at the highest price? Galvins position presents him with a conflict of interest.
2. What are the alternatives? Thereare several: (a)Let other members of the Salvation Army board of directors know of Nadarssituationin orderto help The SalvationArmybuy the landat a bargainprice. (b) Disclose Nadars situation to fellow board members and insist that The SalvationArmypay marketprice($2.2 million)for the land. (c)Advise Nadar of The SalvationArmysplans and encourageher to hold out for a highpriceon the sale of the land. (d)Reveal nothing to The Salvation Armys board or to Nadar and take no part in the negotiationbetweenthe two parties. (e)Take a temporary leave of absence from The Salvation Army board for unspecifiedpersonalreasons.
Chapter 4 Internal Control & Cash 88
3. Identify the stakeholders involved. Galvin, The Salvation Army, Nadar,andCommunityBanks.
Assess the possible consequences.
DisclosingNadarsweakened
conditionto TheSalvationArmyboardmayhelp The Salvation Army buy the land at a low price, depending on the ethical bearingof fellowboardmembers.This wouldhelp The SalvationArmyand hurt Nadar, relativeto her ability to sell the land at marketvalueof $2.2 million. Insistingthat The SalvationArmyoffer market pricefor the landwouldseemfair to bothparties,but that wouldbetraythe trust of Nadar. And it may or may not sway the board to go along with a $2.2 millionoffer for the land.
Making Nadar aware of The Salvation Armys plans may help Nadar get a higher price for the land than she would get otherwise. This would betray the trust of othermembersof The SalvationArmysboard.
Remainingsilent would preserve Galvins integrity. However, if either The Salvation Army or Nadar ever learned of Galvins relationship with the
89
other party, they would wonder whether Galvin used the information againstthem.
Takinga temporaryleaveof absencewouldpreserveGalvinsintegrityand remove him from the conflict of interest. It would also preserve Galvins reputation for fairness and the reputation of CommunityBank for keeping depositorinformationconfidential.
4. Make the decision. The authors would take the leave of absence and hope other Salvation Army board members do not probe Galvins personal reasons. This way neither The Salvation Army nor Nadar can accuse Galvin of using inside information to the advantage of the other party.
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(continued) EthicalIssues
EthicalIssue3
1. Identify the ethical issue. Frenchsethical issueis whetherto tell IMS personnelaboutSnickerFoodspossiblebankruptcy.
2. What are the alternatives? (a)Keepquiet and let naturetake its course,or (b) Tell IMSstop managersof Snickerspossible
bankruptcy.
3. Identify the stakeholders involved. IMS, SnickerFoods,Community Bank, and everyone connected to these organizations owners, employees,creditors,depositors,andtheir communities.
Assess the possible consequences. Telling IMS about Snickers possible bankruptcy may help IMS avoid wasted effort on Snicker. This may enable IMS to seek more profitable ventures and aid IMSs recovery. In turn, this mayhelp IMSpay its loanto CommunityBank.
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4. Make the decision. French should not tell IMS of Snickers financial difficulties (after all, Snicker isnt bankrupt yet). French should let nature take its course. Then she will protect the banks (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 doesnt go through.
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Focuson Financials: Amazon.com,Inc.

(20-30 min.) Req. 1 (All amounts in millions)
Bank Balance,Dec. 31, 2008 + Depositin transit Outstandingchecks Adjusted bankbalance $324 3 (8) $319 Books Balance,Dec. 31, 2008 + Interestearned + Bankcollections Adjustedbookbalance $316 1 2 $319
The adjustedbalance($319million)agreeswith the amountreportedfor cash and cash equivalents on Amazon.Com, Inc.s December 31, 2008 ConsolidatedBalanceSheet.
Req. 2 Paragraph2, Item9A of Note14 to Amazon.com,Inc.s Consolidated FinancialStatementsNoteAmazon.Coms managementstatesthat: Management is responsible for establishing and maintaining adequate internal control over financial reporting. Management has assessed the effectiveness of our internal over financial reporting as of December 31, 2008Asa result, managementhas concludedthat our internal control over
93 Financial Accounting 8/e Solutions Manual
financial reporting was effective in providing assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Ernst & Young has independently assessed the effectivenessof our internal control over financial reporting and its report is includedbelow.
The statement mentions internal control, reliability of financial reporting, and the fact that the internal control system has been independently assessedby the companysexternalindependentauditors,Ernst& Young.
Chapter 4
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Focuson Analysis: FootLocker,Inc.

(20-30 min.) Req. 1 The sevenlargestitemsaffectingcaseare: 1. Sales of short-term investments, which provided $1,620 million, in the investingsection. 2. Purchases of short-term investments, which used $1,378 million, in the investingsection. 3. Depreciation and amortization, which provided $166 million. Actually, theseare expensesthat do not use cash, so they are added backto incometo arriveat cashprovidedby operations. 4. Capital expenditures, which used $148 million, in the investing section 5. Reductionin deferred incometaxes, which used $129 million, in the operatingsection. 6. Noncashimpairmentchargesandstoreclosingprogramcosts,$124 million. Again, theseare expensesthat do not use cash, so they are addedbackto net incometo arriveat cashprovidedby operations. 7. Paymentof cashdividends,$77 million,in the financingsection.
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(continued) Focuson Analysis: FootLocker,Inc. Req. 2 Objectivesof InternalControl 1. Safeguardassets 2. Encourageemployeesto followcompanypolicy 3. Ensureaccurate,reliable accountingrecords
Reportof ManagementStates: Thecompanymaintainsa systemof internalcontrolsdesignedto provide reasonableassurance,at appropriate cost, that assets are safeguarded, transactions are executed in accordance with managements authorization, and the accounting records provide a reliable basis for the preparation of financial statements.
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GroupProject
Studentresponseswill vary.
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Chapter 4

Internal Control & Cash

Fraudis an intentionalmisrepresentationof facts, madefor

TheThreeComponentsof the FraudTriangle

Financial Accounting 8/e Solutions Manual

Studentresponsesmayvary for the descriptions.

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

(5-10 min.) S 4-4 Thereare severalmajorinternalcontrolproceduresas discussedin the chapterbesidesseparationof duties:

(Continued) S 4-4 for internalor externalauditorsto followin auditingthe entitysfinancial statements.

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

(20-30 min.) S 4-6

Internal Control & Cash

(20-30 min.) S 4-7

Financial Accounting 8/e Solutions Manual

(10 min.) S 4-8 RandellCorp. BankReconciliation October31, 2010

Less: Outstandingchecks Adjustedbankbalance

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

$1,827 320 2,147 $7 115 11 261 (394 $1,753

Internal Control & Cash

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

Financial Accounting 8/e Solutions Manual

(10-15 min.) E 4-23A TO: FROM: StoreManager Student

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

(20-30 min.) E 4-25A ColeCommunications,Inc. CashBudget YearEndedDecember31, 2011

11,305 118 11,509

$6,167 2,544 1,826 603 347

11,487 22 (82) $ (60)

Internal Control & Cash

(10 min.) E 4-26A

$14,000,000 .077 $14,000,000 $14,000,000(.057)

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

(5-10 min.) E 4-30B 1. 2. 3. 4. b b d a 5. 6. 7. d c c

Internal Control & Cash

Financial Accounting 8/e Solutions Manual

$1,823 325 2,148 $8 125 10 279 (422) $1,726

Internal Control & Cash

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

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

(10-15 min.) E 4-34B TO: FROM: StoreManager Student

Financial Accounting 8/e Solutions Manual

Internal Control & Cash

(20-30 min.) E 4-36B FallonCommunications,Inc. CashBudget YearEndedDecember31, 2011

11,307 121 11,510

$6,174 2,545 1,831 604 341

11,495 15 (81) $ (66)

Fallonexpectsto neednewfinancingof $66 millionduring2011.