Solution manual accounting 21e by warreni ch 05

Thus, one employee should not be responsible for handling cash receiptsoperations and maintaining the accounts receivable records accounting.. The individual accounts receivable ledger a

CHAPTER 5 ACCOUNTING SYSTEMS AND INTERNAL CONTROLS

CLASS DISCUSSION QUESTIONS

229

Thus, one employee should not be responsible for handling cash receipts

(operations) and

maintaining the accounts receivable records (accounting).

4 No Combining

the responsibility for related operations,

combining the functions of purchasing, receiving, and storing of supplies, increases the possibility of errors and fraud.

5 The control

procedure requiring that responsibility for a sequence

of related operations be divided among different

persons is violated in this situation This weakness in the internal control may permit

irregularities.

For example,

the ticket seller, while acting as ticket taker, could admit friends without

a ticket.

6 The

responsibility for maintaining the accounting records should

be separated

responsibility for operations

so that the accounting records can serve as an independent

operations.

7 The individual

accounts receivable ledger accounts provide

business managers information on the status of individual customer accounts,

necessary for managing collections.

Managers need

to know which customers owe money, how much they owe, and how long the amount owed has been outstanding.

8 The major advantages of the use of special journals are substantial savings in record-keeping expenses and a reduction of

record-keeping errors.

of two things may happen: (1)

an overdue notice will

be received from

Hoffman Co., and/or (2) a letter will be received from Hoffer Co.,

informing the buyer of the

overpayme

nt (It is also

possible that the error will be discovered

at the time

of making payment if the original invoice is inspected

at the time the check is being written.)

b The

schedule of accounts payable would not agree with the balance

accounts

230

13 a Cash

payments journal

b Purchases

journal

c Cash

payments journal

d Purchases

journal

e Cash

payments journal

14 An electronic

form is a software

window that provides the inputs for a particular transaction For example, a check form provides the inputs (payee, amount, date) for a cash payment transaction An electronic invoice provides the inputs

(customer, amount sold, item sold) for recording revenues earned on account.

15 The use of

controlling accounts to verify the accuracy of subsidiary accounts is used in a manual system.

computerized system, it is

assumed that the computer will accurately

individual transactions in the subsidiary accounts in determining the aggregate balance Thus, there is no

controlling accounts for controlling the accuracy of the individual postings.

16 For automated

systems that use electronic forms the special journals are not used to record original transactions.

Rather,

elec-tronic forms capture the original transaction detail from an invoice, for example, and automatically

transaction details to the appropriate ledger accounts.

17 E-commerce

can be used by

a business to conduct

transactions directly with customers Thus, an order can be received directly from the customer’s Internet input and cash can

be received from the credit card Many times, the cash

is received prior

to actually shipping the product,

resulting in a faster

revenue/collecti

on cycle Reducing paperwork throughout the cycle also improves the efficiency of the process For example, all of the accounting transactions can be fed automatically from the initial Web-based inputs.

231

c Disagree Stealing is a serious issue An employee who can justify taking a box of tea bags can probably justify “borrowing” cash from the cash register.

Ex 5–2

a The sales clerks could steal money by writing phony refunds and pocketing the cash supposedly refunded to these fictitious customers.

b 1 Elegance by Elaine suffers from inadequate separation of

responsibilities for related operations since the clerks issue refunds and restock all merchandise In addition, there is a lack of proofs and security measures since the supervisors authorize returns two hours after they are issued.

2 A store credit for any merchandise returned without a receipt would reduce the possibility of theft of cash In this case, a clerk could only issue a phony store credit rather than taking money from the cash register A store credit is not as tempting as cash In addition, sales clerks could only use a few store credits to purchase merchandise for themselves without management getting suspicious.

An advantage of issuing a store credit for returns without a receipt is that the possibility of stealing cash is reduced The store will also lose less revenue if customers must choose other store merchandise instead

of getting a cash refund The overall level of returns/exchanges may be reduced, since customers will not return an acceptable gift simply because they need cash more than the gift The policy will also reduce the “cash drain” during the weeks immediately following the holidays, allowing Elegance by Elaine to keep more of its money earning interest

or to use that cash to purchase spring merchandise or pay creditors.

232

Ex 5–2 Concluded

A disadvantage of issuing a store credit for returns without a receipt is that pre-holiday sales might drop as gift-givers realize that the return policy has tightened After the holidays, customers wishing to return items for cash refunds may be frustrated when they learn the store policy has changed The ill will may reduce future sales It may take longer to explain the new policy and fill out the paperwork for a store credit, lengthening lines at the return counter after the holidays Sales clerks will need to be trained to apply the new policy and write up a store credit Sales clerks also will need to be trained to handle the redemption

of the store credit on future merchandise purchases.

3 The potential for abuse in the cash refund system could be eliminated if clerks were required to get a supervisor’s authorization for a refund before giving the customer the cash The supervisor should only authorize the refund after seeing both the customer and the merchandise that is being returned.

An alternative would be to use security measures that would detect a sales clerk attempting to ring up a refund and remove cash when a customer is not present at the sales desk These security measures could include cameras or additional security personnel discreetly monitoring the sales desk.

Ex 5–3

As an internal auditor, you would probably disagree with the change in policy First Charter has some normal business risk associated with default on bank loans One way to help minimize this is to carefully evaluate loan applications Large loans present greater risk in the event of default than do smaller loans Thus, it is reasonable to have more than one person involved in making the decision to grant a large loan In addition, loans should be granted on their merits, not on the basis of favoritism or mere association with the bank president Allowing the bank president to have sole authority to grant large loans can lead to the president granting loans to friends and business associates, without the required due diligence This can result in a bank becoming exposed to very poor credit risks Indeed, this scenario is one of the causes of savings and loan and bank failures of the past.

233

Ex 5–4

The Barings Bank fraud shows how small lapses in internal control can have huge consequences In this case, the “rogue trader” was able to accumulate and hide huge losses When the losses became so large that they could no longer be hidden, it was too late This fraud could have been avoided with a number of internal controls First, and most obvious, the execution and recording of trades should have been separate duties The trader makes the trades but should never have access to accounting for them In this way, the actual performance of the trader could not be disguised by “fixing the books.” Second, the trader should be under managerial oversight For example, trades that exceed a certain amount of exposure should require management approval In this way, a trader would be forced to slow down or stop once trades reached a certain limit This would avoid the trader’s tendency to try to “make up” losses with even larger bets Third, there should be no possibility for unauthorized accounts All accounts should require formal approval and be set up by individuals other than the trader Once the account is set up, the accounting should also be separated from the trader In this way, the trader would not be able to set up a “private” account that goes undetected.

Ex 5–5

This is an example of a fraud with significant collusion Frauds that are perpetrated with multiple parties in different positions of control make detecting fraud more difficult In this case, the fraud began with an employee responsible for authorizing claim payments This is a sensitive position because his decisions would initiate payments However, claims would need to be authorized and verified before payment would be made Knowing this, the employee made sure each claim had a phony “victim.” Thus, there was a verifiable story behind each claim Only by tracking physical evidence of the accident could it be discovered that the claim was fictitious However, the very nature of the process was to resolve small claims quickly without excessive control Lastly, corrupt lawyers were brought into the fraud to act as attorneys for the claimants This gave the claims even more credibility In actuality, the lawyers had done legitimate business with the trucking company, so all appeared normal This fraud was discovered when the fraudulent employee’s bank noticed irregularities in his bank account and notified authorities As the saying goes, “Follow the money!”

As a side note, the corrupt claims administrator fell into this behavior due to gambling problems.

234

Ex 5–6

Event Sound should not have relied on the unusual nature of the vendors and delivery frequency to uncover this fraud The purchase and payment cycle is one

of the most critical business cycles to control, because the potential for abuse is

so great Purchases should be initiated by a requisition document This document should be countersigned by a superior so that two people agree as to what is being purchased The requisition should initiate a purchase order to a vendor for goods or services The vendor responds to the purchase order by delivering the goods The goods should be formally received using a receiving document An accounts payable clerk matches the requisition, purchase order, and invoice before any payment is made Such “triple matching” prevents unauthorized requests and payments In this case, the requests were unauthorized, suggesting that the employee had sole authority to make a request Second, this employee had access to the invoices This access allowed the employee to change critical characteristics of the invoice to hide the true nature

of the goods being received The invoice should have been delivered directly to the accounts payable clerk to avoid corrupting the document There apparently was no receiving document (common for smaller companies); thus, only the invoice provided proof of what was received and to be paid If there had been a receiving report, the invoice could not have been doctored and gone undetected, because it would not have matched the receiving report.

Note to Instructors: This exercise is based on an actual fraud.

Ex 5–7

a The most difficult frauds to detect are those that involve the senior management of a company that is in a conspiracy to commit the fraud The senior managers have the power to access many parts of the accounting system, while the normal separation of duties is subverted by involving many people in the fraud In addition, the authorization control is subverted because most of the authorization power resides in the senior management.

b Overall, this type of fraud can be stopped if there is strong oversight of senior management, such as an audit committee of the board of directors Individual

“whistle blowers” in the company can make their concerns known to the independent or internal auditors who, in turn, can inform the audit committee The audit committee should be independent of management and have the power to monitor the actions of management.

Ex 5–8

1 General ledger accounts: (e)

2 Subsidiary ledger accounts: (a), (b), (c), (d)

235

DELTA CONSULTING CO.

Schedule of Accounts Receivable

November 30, 2006 Envirolab $1,445 Environmental Safety Co 2,625 Greenberg Co 1,050 Smith and Smith 1,600 Total accounts receivable $6,720

Ex 5–10

a Cash receipts journal

b Cash receipts journal

c General journal (not a revenue transaction)

d General journal

e Cash receipts journal

f Cash receipts journal

g Cash receipts journal

h Revenue journal

i Cash receipts journal

j General journal

236

Nov 3 Provided service on account; posted from revenue journal.

9 Granted allowance or corrected error related to sale of November 3; posted from general journal.

13 Received cash for balance due; posted from cash receipts journal.

Ex 5–13

Gold Coast Production Co.

Schedule of Accounts Receivable

April 30, 2006 Central States Broadcasting Co $2,450 Korvette Co 975 Trask Co 3,440 Star Media 0 Total accounts receivable $6,865

Accounts Receivable (Controlling) Balance, April 1, 2006 $ 4,670 Total debits (from revenue journal) 16,165 Total credits (from cash receipts journal) (13,970) Balance, April 30, 2006 $ 6,865

237

Ex 5–14

1 General ledger account: (c), (e), (h), (j), (k), (l)

2 Subsidiary ledger account: (a), (b), (d), (f), (g), (i)

3 No posting required: (m)

Ex 5–16

1 General ledger account: (b), (c), (d), (f), (g), (i), (k), (l)

2 Subsidiary ledger account: (a), (e), (h)

3 No posting required: (j)

238

Ex 5–17

Feb 6 Purchased services, supplies, equipment, or other commodities on

account; posted from purchases journal.

10 Received allowance or corrected error related to purchase of February 6; posted from general journal.

16 Paid balance owed; posted from cash payments journal.

Ex 5–18

Lasting Spring Landscaping Schedule of Accounts Payable

June 30, 2007 Augusta Sod Co $ 7,340 Gibraltar Insurance Co 1,100 Mayfield Lumber Co 3,140 Owens Fertilizer 0 Total accounts payable $11,580

Accounts Payable (Controlling) Balance, June 1, 2007 $ 1,620 Total credits (from purchases journal) 16,400 Total debits (from cash payments journal) (6,440) Balance, June 30, 2007 $11,580

239

S PAYABLE CR.

CLEANIN G SUPPLIES DR.

T REF.

AMOUN T

200

7

Other Accounts

2007

2 8 58 Equipment 18 450 450 2

6 31 61 Salary Expense 51 2,900 2,900 6

7 31 Total 3,350 345 3,695 7

Ex 5–20

a Two errors were made in balancing the accounts in the subsidiary ledger: (1) The Martinez Mining Co transaction of October 25 should have resulted

in a balance of $3,250 instead of $2,250.

(2) The Donnelly Minerals Inc transaction of October 7 should have resulted

in a balance of $13,200 instead of $13,300, and the account balance at October 31 should have been $7,400 instead of $7,500.

b.

MINERAL ASSAY SERVICES INC

Schedule of Accounts Payable

October 31, 2006 Martinez Mining Co $ 3,250 Cutler and Powell 9,100

C D Greer and Son 13,750 Donnelly Minerals Inc 7,400 Valley Power 3,150 Total accounts payable $ 36,650

Ex 5–21

Revenue journal: (d), (i)

Cash receipts journal: (a), (e)

Purchases journal: (g), (h)

Cash payments journal: (b), (f)

General journal: (c), (j)

Ex 5–22

1 The Cash column is for debits (not credits).

2 The Other Accounts column is for credits (not debits).

3 A better order of columns would be to place the Other Accounts Cr column to the left of the Fees Earned Cr column.

A recommended and corrected cash receipts journal is as follows:

DATE

ACCOUN T CREDITE D

POST.

REF.

OTHER ACCOUNT

S CR.

FEES EARNED CR.

ACCOUNT

S REC CR.

CASH DR.

SALES TAX PAYABLE CR.

Ex 5–24

a In the electronic invoice form from QuickBooks shown above, typical fields for data input can be identified:

1 Customer name and address

2 Date and invoice number

3 Description of item sold

4 Amount of revenue

b The customer accounts receivable is debited and Fees Earned is credited A computerized accounting system does not require posting to a separate accounts receivable controlling account In this case, the total accounts receivable reported on the balance sheet is merely the sum of the balances of the individual customer account balances.

Ex 5–24 Concluded

c Controlling accounts are not posted at the end of the month in a computerized accounting system In addition, special journals are not normally used to accumulate transactions Transactions are recorded through data input into electronic forms (or for infrequent transactions, by an electronic general journal) Balances of affected accounts are automatically posted and updated from the information recorded on the form If desired, the computer can provide a printout of the monthly transaction history for a particular account, which provides the same information as a journal In addition, the controlling account is not separately posted In a manual system, separate posting to the controlling account provides additional control by reconciling the controlling account balance against the sum of the individual customer account balances However, in a computerized accounting system there are no separate postings to a controlling account because the computer is not going to make posting or mathematical errors Therefore, there is no need for the additional control provided by posting a journal total to a controlling account.

PROBLEMS Prob 5–1A

1 and 2.

Prob 5–1A Continued

Prob 5–1A Concluded

Prob 5–2A Continued

Prob 5–2A Concluded

3., 4., and 5.

Nov 30 Office Equipment 18 9,000

The subsidiary account for Ross and Son must also be posted for a $9,000 credit.

6 The subsidiary ledger is in agreement with the controlling account Both have balances of $18,410 ($8,950 + $8,320 + $1,140).

Prob 5–3A Continued

Prob 5–3A Concluded

3 and 4.

Accounts Field Office Other Accounts Dr

Prob 5–4A

1., 2., and 3.

Accounts Field Office Other Accounts Dr

2006

1 Mar 16 PMI Sales, Inc .  32,400 Field Equipment 17 32,400 1

2 17 Culver Supply Co .  12,300 12,300 2

3 20 Castle Office Supply Co  3,060 3,060 3

4 28 Castle Office Supply Co  3,600 3,600 4

5 30 PMI Sales, Inc .  34,900 18,500 Office Equipment 18 16,400 5

6 30 Culver Supply Co .  9,200 9,200 6

Prob 5–4A Continued

2006

1 Mar 16 1 Rent Expense 71 2,400 2,400 1

2 18 2 Field Supplies 14 1,400 1,400 2

4 24 3 PMI Sales, Inc .  32,400 32,400 4

5 26 4 Culver Supply Co  12,300 12,300 5

Prob 5–4A Continued

Prob 5–4A Continued

Prob 5–4A Concluded

BLACK GOLD EXPLORATION CO.

Schedule of Accounts Payable

March 31, 2006 Castle Office Supply Co $ 3,600 Culver Supply Co 9,200 PMI Sales, Inc 34,900 Total accounts payable $ 47,700*

* The total of the schedule of accounts payable is equal to the balance of the accounts payable controlling account.