Chapter 08 - Cash and Internal Controls
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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Chapter 08 - Cash and Internal Controls
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.
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Chapter 08 - Cash and Internal Controls
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 ..........................................................
Cash .............................................................
75
75
To establish the petty cash fund.
(b) Entertainment Expense .....................................
Postage Expense ...............................................
Printing Expense................................................
Cash .............................................................
42
6
13
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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Chapter 08 - Cash and Internal Controls
Quick Study 8-5 (15 minutes)
(1)
a. (i) Bank (ii) Subtraction
b. (i) Book (ii) Subtraction
c. (i) Book (ii) Subtraction
d. (i) Bank (ii) Addition
e. (i) Book (ii) Addition
f. (i) Book (ii) Addition
g. (i) Book (ii) Subtraction
(2)
No adjustment required
Adjusting entry required
Adjusting entry required
No adjustment required
Adjusting entry required
Adjusting entry required
Adjusting entry required
Quick Study 8-6 (25 minutes)
CRUZ COMPANY
Bank Reconciliation
June 30, 2011
Bank statement balance .......... $10,332
Add:
Deposit of June 30 ..................
2,724
Book balance.................................................................................
$11,352
Add:
Recording error on check.......................................................
9
Interest earned............................................................................
5
11,366
Deduct:
Bank service charge.................................................................
23
Adjusted book balance ..............................................................
$11,343
13,056
Deduct:
Outstanding checks...............
1,713
Adjusted bank balance ............ $11,343
Quick Study 8-7 (15 minutes)
Days' sales uncollected =
Accounts receivable
x 365
Net sales
2011
2010
$75,692
$2,591,933 x 365
$70,484
$2,296,673 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.
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Chapter 08 - Cash and Internal Controls
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.
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Chapter 08 - Cash and Internal Controls
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…
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Chapter 08 - Cash and Internal Controls
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.
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Chapter 08 - Cash and Internal Controls
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.
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Chapter 08 - Cash and Internal Controls
Exercise 8-5 (20 minutes)
1.
Sept. 9 Petty Cash ...............................................................
Cash ...................................................................
400
400
To establish a petty cash fund.
2.
Sept. 30 Merchandise Inventory* .........................................
Postage Expenses ..................................................
Miscellaneous Expenses .......................................
Cash Short and Over ..............................................
Cash ...................................................................
32
113
87
2
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 .........................................................................
Petty Cash .........................................................
100
100
To decrease the petty cash fund.
Exercise 8-6 (20 minutes)
1.
Jan. 1 Petty Cash ...............................................................
Cash ...................................................................
200
200
To establish a petty cash fund.
2.
Jan. 8 Postage Expense ....................................................
Merchandise Inventory* .........................................
Delivery Expense ....................................................
Miscellaneous Expense .........................................
Cash ...................................................................
To reimburse the petty cash fund.
* Transportation-in costs are included in Merchandise Inventory
under a perpetual system.
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64
19
36
53
172
Chapter 08 - Cash and Internal Controls
Exercise 8-6 (Concluded)
3.
Jan. 8 Postage Expense ...................................................
Merchandise Inventory ..........................................
Delivery Expense ...................................................
Miscellaneous Expense .........................................
Cash ..................................................................
64
19
36
53
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.
3. Check written by another depositor but charged
against this company's account.
x
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
8. Deposit made on September 30 after the bank
closed.
9. Checks outstanding on August 31 that cleared the
bank in September.
x
x
10. NSF check from customer returned on Sept. 25 but
not recorded by this company.
11. Checks written by the company and mailed to
payees on September 30.
12. Deposit made on September 5 and processed by
bank on September 6.
8-10
Dr.
x
Cr.
x
x
Chapter 08 - Cash and Internal Controls
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.
Exercise 8-9 (25 minutes)
FREDERICK CLINIC
Bank Reconciliation
June 30, 2011
Bank statement balance ........
Add
Deposit of June 30 ................
Deduct
Outstanding checks.............
Adjusted bank balance ..........
$14,275
Book balance.................................................................................
$15,141
Add
Error on Ck. No. 919..................................................................
9
15,150
Deduct
Bank service charge.................................................................
125
Adjusted book balance ..............................................................
$15,025
3,250
17,525
2,500
$15,025
Exercise 8-10 (10 minutes)
June 30 Cash ....................................................................
Utilities Expense ..........................................
9
9
To correct a journal entry error.
30 Miscellaneous Expenses ..................................
Cash ..............................................................
To record bank service charge.
8-11
125
125
Chapter 08 - Cash and Internal Controls
Exercise 8-11 (25 minutes)
CHUNG COMPANY
Bank Reconciliation
May 31, 2011
Bank statement balance ........
Add
Deposit of May 31..................
Bank error ................................
Deduct
Outstanding checks.............
Adjusted bank balance ..........
$13,800
Book balance.................................................................................
$15,500
2,200
400
16,400
Deduct
Bank service charge.................................................................
100
NSF check....................................................................................
600
Adjusted book balance ..............................................................
$14,800
1,600
______
$14,800
Exercise 8-12 (15 minutes)
(a) Days' sales uncollected on December 31, 2010:
$51,000
$565,000
x 365 = 32.9 days
Days' sales uncollected on December 31, 2011:
$83,000
$647,000
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.
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Chapter 08 - Cash and Internal Controls
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* ........................................
Cash ........................................................................
88
4,312
To record payment for merchandise less the
discount. *($4,400 x .02)
31 Accounts Payable ........................................................ 3,600
Cash ........................................................................
To record payment for merchandise less the returns
($4,000 - $400).
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3,600
Chapter 08 - Cash and Internal Controls
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 .............................................................
Accounts Payable ..................................................
72
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].
26 Accounts Payable ........................................................ 4,312
Cash ........................................................................
4,312
To record payment for merchandise.
31 Accounts Payable ........................................................ 3,600
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).
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Chapter 08 - Cash and Internal Controls
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.
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Chapter 08 - Cash and Internal Controls
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 .....................................................
Miscellaneous Expenses ............................................
Postage Expenses .......................................................
Advertising Expense ...................................................
Cash Over and Short .............................................
Cash ........................................................................
78.00
63.68
43.50
57.15
3.48
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 .......................................................
Mileage Expense ..........................................................
Delivery Expense .........................................................
Cash Over and Short ...................................................
Cash ........................................................................
48.36
38.50
39.75
30.00
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.
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Chapter 08 - Cash and Internal Controls
Problem 8-3A (30 minutes)
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
Total
87.89
$275.44
* Transportation-in costs are included in Merchandise Inventory under a perpetual system.
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 ........................................................................
To increase the petty cash fund.
Instructor note: The two entries on Feb. 28 can be combined into one.
8-17
100.00
Chapter 08 - Cash and Internal Controls
Problem 8-4A (30 minutes)
Part 1
CLARK COMPANY
Bank Reconciliation
July 31, 2011
Bank statement balance ............
Add:
Deposit of July 31.....................
$28,020
10,152
Book balance...................................................................................
$26,193
Add:
Proceeds of note less
38,172
collection charge......................................................................
8,955
35,148
Deduct:
Deduct:
Checks No. 3031...... $1,380
3065......
336
3069...... 2,148
Adjusted bank balance ..............
NSF check ...................... $ 805
Service charge ............... 15
Error (Check 3056)........ 20
840
Adjusted book balance ................................................................
$34,308
3,864
$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 .................................
Cash ........................................................................
805
805
To charge account for NSF check plus fees.
July 31 Miscellaneous Expenses ............................................
Cash ........................................................................
15
15
To record bank service fee.
July 31 Rent Expense ...............................................................
Cash ........................................................................
To correct an entry error.
8-18
20
20
Chapter 08 - Cash and Internal Controls
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.
8-19
Chapter 08 - Cash and Internal Controls
Problem 8-5A (50 minutes)
Part 1
ELS COMPANY
Bank Reconciliation
September 30, 2011
Bank statement balance...............
Add:
$18,363.25
Deposit of Sept. 30.......................
1,582.75
Book balance.............................................................................
$17,537.20
Add:
Interest earned...... $ 22.50
Proceeds of note
19,946.00
less $15 fee .........1,385.00
1,407.50
18,944.70
Deduct:
Checks No. 5893 .......$484.25
5906 ......... 859.30
5908 ....... 276.00
Adjusted bank balance.................
Deduct:
NSF check.................. 588.25
Error (Check 5904) .. 30.00
1,619.55
$18,326.45
618.25
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 ........................................................................
To correct an entry error.
8-20
30.00
Chapter 08 - Cash and Internal Controls
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.
8-21
Chapter 08 - Cash and Internal Controls
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.
8-22
Chapter 08 - Cash and Internal Controls
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 .............................................
Merchandise Inventory* ..............................................
Repairs Expense—Computer .....................................
Miscellaneous Expenses ............................................
Cash Over and Short ...................................................
Cash ........................................................................
16.29
17.60
36.57
14.82
2.44
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 ...................................................
Postage Expenses .......................................................
Delivery Expense .........................................................
Cash Over and Short ...................................................
Cash ........................................................................
40.00
38.19
58.00
21.46
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.
8-23
Chapter 08 - Cash and Internal Controls
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
Total
44.32
$189.47
* Transportation-in costs are included in Merchandise Inventory under a perpetual system.
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 .............................................
Cash ........................................................................
1.00
188.47
To reimburse the petty cash fund.
31 Petty Cash ....................................................................
50.00
Cash ........................................................................
To increase the petty cash fund.
Instructor note: The two entries on Mar. 31 can be combined into one.
8-24
50.00
Chapter 08 - Cash and Internal Controls
Problem 8-4B (30 minutes)
Part 1
STYLE CO.
Bank Reconciliation
December 31, 2011
Bank statement balance ..............
Add:
Deposit of Dec. 31 .......................
Deduct:
Checks No. 1242 ..... $ 370.50
1273 ..... 1,084.20
1282 ..... 390.00
Adjusted bank balance.................
$45,091.80 Book balance .................................................................................
$31,743.70
Add:
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:
NSF check............ $ 749.50
Printing fee ...........
79.00
1,844.70
828.50
$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.
8-25
Chapter 08 - Cash and Internal Controls
Problem 8-5B (50 minutes)
Part 1
SAFE SYSTEMS
Bank Reconciliation
May 31, 2011
Bank statement balance .................
Add:
Deposit of May 31...........................
$21,808.60 Book balance .............................................................................
$15,270.20
Add:
2,526.30
24,334.90
Proceeds of note less
$100 fee...................................................................................
7,200.00
22,470.20
Deduct:
Checks No. 1780......$1,325.90
1786...... 353.10
1789...... 639.50
Adjusted bank balance....................
Deduct:
NSF check...........$431.80
Service charge...... 12.00
2,318.50 Error (Ck 1788)...... 10.00
453.80
$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 ........................................................................
To correct an entry error.
8-26
10.00
Chapter 08 - Cash and Internal Controls
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.
8-27
Chapter 08 - Cash and Internal Controls
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
Add
Book balance...................................................................................
$68,057
Add
Bank error.......................................
Deposits in Transit.......................
Deduct
Outstanding Check.....................
Adjusted bank balance ..............
500
0
68,066
128
Bank interest.................................................................................
33
______
68,090
Deduct
Safety deposit rental..... $ 50
______
$67,938
Charge for checks.......... 102
152
Adjusted book balance ................................................................
$67,938
Part 2
Mar. 25 Miscellaneous Expenses ............................................
677
Cash ........................................................................
101
50
50
To record safety deposit box rental.
26 Miscellaneous Expenses ............................................
677
Cash ........................................................................
101
102
102
To record charge for printing checks
31 Cash ..............................................................................
101
Interest Revenue ...................................................
404
To record interest earned.
8-28
33
33
Chapter 08 - Cash and Internal Controls
Reporting in Action
— BTN 8-1
1.
($ in thousands)
Balance
Feb. 27,
2010
Cash and cash
equivalents ............... $ 1,550,861
Cash and
equivalents
as % of:
Balance
Feb. 28,
2009
Cash and
equivalents
as % of:
—
$ 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) / $1,184,398]
8-29
Chapter 08 - Cash and Internal Controls
Reporting in Action (Concluded)
3. Days' Sales Uncollected ($ millions)
Days’ sales uncollected =
Accounts receivable
Net sales
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 / $10,204,409) of its total assets. Research In Motion’s
receivables are historically high because most sales are made on credit.
4. Solution depends on the annual report information obtained.
8-30
Chapter 08 - Cash and Internal Controls
Comparative Analysis
Days’ sales uncollected =
— BTN 8-2
Accounts receivable x 365
Net sales
Research In Motion ($ millions)
Current Year: $2,594/$14,953 x 365
= 63.32 days
Prior Year:
= 69.67 days
$2,112/$11,065 x 365
Research In Motion’s days’ sales uncollected has decreased by 6.35
days. The percent decrease is: (63.32 - 69.67) / 69.67 = (9.1)%.
Apple ($ millions)
Current Year: $3,361/$42,905 x 365
= 28.59 days
Prior Year:
= 23.58 days
$2,422/$37,491 x 365
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.
8-31
Chapter 08 - Cash and Internal Controls
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.
8-32
Chapter 08 - Cash and Internal Controls
Communicating in Practice
—
BTN 8-4B
Memorandum
To:
From:
Date:
Subject:
“Owner”
“Consultant”
__________
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.
8-33
Chapter 08 - Cash and Internal Controls
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.
8-34
Chapter 08 - Cash and Internal Controls
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.
8-35
Chapter 08 - Cash and Internal Controls
Entrepreneurial Decision
1.
—
BTN 8-7
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.
8-36
Chapter 08 - Cash and Internal Controls
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
—
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
1,706
—
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.
8-37
Chapter 08 - Cash and Internal Controls
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 =
Accounts receivable
Net sales
x 365
Current Year:
7,981
40,984
x 365
= 71.1days
Prior year:
9,444
50,710
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.
8-38