Solution manual financial accounting 4e by wild chapter06

The four assets ordered from most to least liquid are: cash, accounts receivable, inventory, and building.. Depositing all receipts on the day of receipt 1 creates an independent record

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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 26, 2005, cash (and equivalents) of $1,166,000,000 is used by investing activities Cash (and equivalents) of $459,000,000 is used by financing activities

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11 Circuit City‘s cash at February 28, 2005, equals $879,660,000 It is the second largest current asset, after Merchandise inventory Cash comprises about 33% current assets Its Cash increased from $783,471,000 at February 29, 2004, to $879,660,000 at February

28, 2005 As a percent of total current assets, its Cash balance increased from about 27% to about 33%

12 Apple‘s cash and equivalents decreased by $427,000,000 during the fiscal year ended September 25, 2004; from $3,396,000,000 to $2,969,000,000 Its statement of cash flows identifies several causes for this change Three major sources and uses are: (1)

$934,000,000 from operating activities; (2) $(1,488,000,000) used by investing activities; and (3) $127,000,000 provided by financing activities The largest outflow is the purchase of short-term investments in the amount of $3,270,000,000

QUICK STUDIES

Quick Study 6-1 (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

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 make a higher return on these assets

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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.

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

1 (a) Petty Cash 85.00

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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a (i) Book (ii) Addition Adjusting entry required

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

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

d (i) Bank (ii) Subtraction No adjustment required

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

f (i) Book (ii) Subtraction Adjusting entry required

g (i) Bank (ii) Addition No adjustment required

Days' sales uncollected = x 365

2008 2007

Interpretation: The collection of accounts receivable seems to be

slightly improving It took the company slightly over one-half day less

to collect on its accounts receivable in 2008 than in 2007

Quick Study 6-8 A (10 minutes)

The documents in a voucher system are: Purchase requisition, Purchase order, Invoice, Receiving report, Invoice approval, and Voucher

Quick Study 6-9 B (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

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Exercise 6-2 (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

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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 sunscreen, shirts, 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 sunscreen, shirts, 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

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1

Jan 1 Petty Cash 200

Cash 200

To establish a petty cash fund 2 Jan 8 Postage Expense 74

Merchandise Inventory* 29

Delivery Expense 16

Miscellaneous Expenses 43

Cash 162

To reimburse the petty cash fund * Transportation-in costs are included in Merchandise Inventory under a perpetual system 3 Jan 8 Postage Expense 74

Merchandise Inventory 29

Delivery Expense 16

Cash 162

To reimburse the petty cash fund.* Jan 8 Petty Cash 250

Cash 250

To increase the petty cash fund.*

* The two January 8 entries can be combined into one entry

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1

Sept 9 Petty Cash 350

Cash 350

To establish a $350 petty cash fund 2 Sept 30 Merchandise Inventory* 40

Postage Expenses 123

Cash Short and Over 3

Cash 246

To reimburse the petty cash fund * Transportation-in costs are included in Merchandise Inventory under a perpetual system 3 Oct 1 Petty Cash 50

Cash 50

To increase the petty cash fund to $400

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Bank Balance Book Balance Not Shown on Add Deduct Add Deduct Adjust Reconciliation

1 NSF check from customer returned on Sept

3 Deposit made on September 5 and

4 Check written by another depositor but

charged against this company's account x

6 Checks outstanding on August 31 that

7 Check written against the company account

and cleared by the bank; erroneously not

8 Principal and interest on a note receivable to

this company is collected by the bank but not

yet recorded by the company

12 Special bank charge for collection of note in

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

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DEL GATO CLINIC Bank Reconciliation June 30, 2008 Bank statement balance $10,555 Book balance $11,589

Deposit of June 30 2,856 Error on Ck No 919 9

Outstanding checks 1,829 Bank service charge 16

Adjusted bank balance $11,582 Adjusted book balance $11,582

x 365 = 45.4 days

(b) Evaluation: The change from 33.5 to 45.4 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 2007, this has increased by about 12 days in Year 2008 The

company needs to follow up to identify the reasons for this change

$61,000

$665,000

$93,000

$747,000

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Exercise 6-11 A (10 minutes)

Exercise 6-12 B (25 minutes)

a Recording inventory at gross amounts

Oct 2 Merchandise Inventory 3,000

To record payment for merchandise less the discount *($5,400 x 02)

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PROBLEM SET A

Problem 6-1A (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 Julia should

have access to the petty cash fund since she is the custodian The company should implement a policy of not allowing petty cash transactions over the lunch hour Alternatively, Justine 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 Benedict Shales 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 its 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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Feb 23 Delivery of customer's merchandise $ 20.00

Feb 12 Express delivery of contract $ 7.95

Feb 27 Purchased postage stamps 54.00 61.95

Merchandise inventory (transportation-in)*

Feb 9 COD charges on purchases 32.50

Feb 25 COD charges on purchases 13.10 45.60

Office supplies expense

Feb 5 Purchased paper for copier 14.15

Feb 20 Purchased stationery 67.77 81.92

Office Supplies Expense 81.92

Cash Over and Short 2.11

Note: The two Feb 28 entries can be combined into one

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Note: The May 31 entries can be combined into one entry

May 31 Postage Expenses 147.36

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Part 1

BRANCH COMPANY Bank Reconciliation July 31, 2008 Bank statement balance $27,233 Book balance $27,497

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Problem 6-4A (Concluded)

b The bank's collection of the $8,000 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 $7,955; and

(ii) The final balance that results from adjusting the book balance will be understated by $7,955

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Part 1

CHAVEZ COMPANY Bank Reconciliation September 30, 2008 Bank statement balance $18,453.25 Book balance $17,404.20

Interest earned $ 12.50 Deposit of Sept 30 1,682.75

20,136.00

Proceeds of note less $15 fee 1,485.00 1,497.50

326.45

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