Solution manual financial accounting 8th by harrison CH04

Limited access goes hand in hand with separation of duties to assure that only authorized individuals are allowed access to a the assets of the company, such as cash or inventory; and b

Chapter 4

Internal Control & Cash

Short Exercises

(5 min.) S 4-1

the purpose of persuading another party to act in such a way that causes injury or damage to that party.

The Three Components of the Fraud Triangle

1 Motive - Fraud generally results from either critical

need or greed on the part of the perpetrator Regardless of

whether the driving force is need or greed most perpetrators are driven to attempt to acquire something that belongs to

others

their own minds, that they deserve the object of the fraudulent behavior They may believe no one else will ever know or even that everybody else is engaging in fraudulent behavior

(5-10 min.) S 4-2

COMPONENTS OF INTERNAL CONTROL

1 Control environment — Top managers must set the “tone at the top” to establish a control environment

2 Risk assessment — Each company must evaluate its own risks, based upon its particular line of business

3 Control procedures — Specific procedures are needed for a good system of internal control

4 Monitoring of controls — Auditors can monitor a company’s actions and its financial statements

5 Information system — Accurate information is essential for success in business

Student responses may vary for the descriptions

Separation of duties is essential for safeguarding assets The

person who has custody of an asset should not also account

for the asset A person who performs both duties can steal the asset and hide the theft by making a bogus entry in the accounting records

Student responses may vary

(5-10 min.) S 4-4

There are several major internal control procedures as

discussed in the chapter besides separation of duties:

1 Smart hiring practices The company should be careful to

hire both competent and honest personnel Smart hiring

practices involve conducting background checks on job

applicants, as well as training and supervision on the job

2 Comparisons and compliance monitoring No person or

department should be allowed to completely process a

transaction from beginning to end without being checked by another person or a computer program Examples of

comparisons and compliance monitoring are the use of

operating and cash budgets Also, in key functions, one

employee (or a computer program) double checks the work of another for accuracy

3 Adequate records help to assure that sufficient hard copy

documents or electronic information is kept by the entity to

for internal or external auditors to follow in auditing the entity’s financial statements

4 Limited access goes hand in hand with separation of duties

to assure that only authorized individuals are allowed access to (a) the assets of the company, such as cash or inventory; and (b) the records Generally, only persons with custodial

responsibilities (such as the cashier or the warehouse) should

be allowed access to assets (such as cash or inventory) Only persons with recordkeeping responsibilities (such as

accountants) should have access to the company’s journals and ledgers

5 Proper approvals No transaction should be processed

without management’s general or specific approval Generally, the larger the transaction, the higher the organizational level of approval necessary

Notice that the first letters of these attributes spell the acronym

SCALP That’s an easy and comprehensive way to remember the control procedures involved in internal controls

(10 min.) S4-5

A computer virus enters program code without your consent

and performs destructive action to your computer files or programs

A Trojan Horse is a malicious computer program that hides

inside a legitimate program and works like a virus to corrupt your computer files or programs

A phishing expedition can be a Web site that attracts visitors

who may be tricked into revealing their account numbers, social security numbers, passwords, or other valuable data The creator of the Web site then uses the unsuspecting Web- site visitors’ data to steal from them and for other illicit purposes

S 4-6

Cash is important not because of its amount as reported on the balance sheet, but because of its effect on a business All transactions ultimately affect cash Businesses purchase assets and must pay cash They make sales and collect cash All expenses ultimately require cash Also, cash is susceptible to theft because it is a medium of exchange These factors combine to give cash more importance than its account balance would suggest

Student responses may vary

(20-30 min.) S 4-7

Punching a hole through supporting documents reduces the opportunity for fraud Without this control procedure, a dishonest employee could resubmit documents for payment

a second time The employee could change the payee’s address and have the check sent to an address the employee controls Or the employee could arrange to have the second payee split the payment with the employee Canceling the documents makes it difficult to get approval for a duplicate payment

Student responses may vary

Randell Corp

Bank Reconciliation October 31, 2010

Outstanding checks (500) NSF check (40) Adjusted bank balance $2,880 Adjusted book balance $2,880

Randell has cash of $2,880

(5 min.) S 4-9

Aug 31 Cash……… 530

Accounts Receivable……… 530 Collection on account

(5 min.) S 4-11

Stevens will notice a gap in the sequence of sales receipts for the receipt that Cassidy destroyed This knowledge will lead Stevens to investigate what happened to the missing receipt and what happened to the related cash

1 Paying by check carries three controls over cash:

The check provides a record of the payment

The check must be signed by an authorized official

Before signing the check, the official should study the

evidence supporting the payment

2 A dishonest purchasing agent could:

Purchase goods and have them delivered to his home or

other location that he controls

Approve payment by the company for goods that he spent

too much on, and then split the excess with the supplier

Companies avoid this internal control weakness by separating the following duties related to the purchase of, and payment for, goods:

purchasing goods

receiving goods

approving and paying for goods

(5 min.) S 4-13

A cash budget starts with the beginning cash balance, adds budgeted cash receipts, and subtracts budgeted cash payments The result is cash available at the end of the period

By comparing cash available to our budgeted cash balance, we can see whether we have cash available for additional investments, or if we’ll need new financing

Student responses may vary

Crescent Artichoke Growers

Cash Budget Year 2010

Millions

Estimated cash receipts—total 104

115 Estimated cash payments—total (93) Cash available (needed) before new financing 22 Budgeted cash balance needed (17) Cash available for additional investments $ 5

(5 min.) S 4-15

Rourke should report the errors to Dunn because Dunn is Rourke’s supervisor, and Dunn is responsible for the errors If Dunn fails to take action, then Rourke should report the errors

to the manager of the organization In any event, outsiders who are relying on Dublin Limited’s financial statements must be made aware of the need to correct the reported net income figure

b Fleming prepares the purchase order and also receives the goods She can add some items to the purchase order and have these extra items shipped to a location she controls When the goods come in, she checks the incoming shipment, so there’s no outside party to learn of her dishonesty

Student responses may vary

Cash payments:

a Strong internal control There is a good separation of duties Supervisors request equipment, and the home office purchases the equipment

b Weak internal control Supervisors both request, purchase, and pay for equipment with little oversight by the home office

b Not permitted Flynn to receive cash that came to Downtown Kalamazoo Have cash sent to a lock box at the bank and appoint a board member to get the cash from the lock box

c Supervised Flynn’s work by examining Downtown Kalamazoo’s documents such as paid checks

d Had an audit of Downtown Kalamazoo’s transactions and financial statements

Student responses may vary

(10-20 min.) E 4-21A

Evan Root Bank Reconciliation April 30, 2010 BANK:

Add: Deposit in transit 1,790

Less: Outstanding checks (602)

BOOKS:

Add: EFT collection — rent 320

2,147 Less:

Service charge $ 7

Charge for printed checks 11

Correction of book error —

recorded $290 check as $29 261 (394

Root’s actual cash balance is $1,753

To improve internal control, the company should use cash registers that record each sale The manager can prove the amount of cash in the cash drawer against this recorded amount

The main internal control weakness is that the payroll

department both prepares and distributes the paychecks With

both duties, a dishonest person in the payroll department can create a time sheet for a fictitious employee and then keep the related paycheck after the treasurer returns the signed checks

to the payroll department

To correct this weakness, Green Grass Golf should have someone other than the payroll department or the shop foreman distribute paychecks to employees For example, the human resources department, which has no control over the time sheets or the paychecks, could distribute paychecks to the workers

(20-30 min.) E 4-25A

Cole Communications, Inc

Cash Budget Year Ended December 31, 2011

Millions

Cash balance, December 31, 2010 $ 86

Budgeted cash receipts:

11,509 Budgeted cash payments:

Payments for cost of

Payments of operating expenses 2,544

Payment of dividends 347 11,487 Cash available (needed) before financing 22 Budgeted cash balance, December 31, 2011 (82) Cash available for additional investments, or

Cole Communications expects to need new financing of $60 million during 2011

Actual Interest paid

Exercises

Group B

(5-20 min.) E 4-27B

a Monroe has access to the cash collected, and he also prepares the cash report With access to both items, Monroe can steal cash and falsify his cash report to conceal his theft

b Adams prepares the purchase order and also receives the goods She can add some items to the purchase order and have these extra items shipped to a location she controls When the goods come in, she checks the incoming shipment, so there’s no outside party to learn of her dishonesty

Student responses may vary

Cash payments:

a Strong internal control There is a good separation of duties Supervisors request equipment, and the home office purchases the equipment

b Weak internal control Supervisors both request, purchase, and pay for equipment with little oversight by the home office

c Supervised Smith’s work by examining Downtown Scanlon’s documents such as paid checks

d Had an audit of Downtown Scanlon’s transactions and financial statements

Student responses may vary

(10-20 min.) E 4-32B

Harry Smith Bank Reconciliation September 30, 2010 BANK:

Balance, September 30 $ 545

Add: Deposit in transit 1,790

Less: Outstanding checks (609)

BOOKS:

Add: EFT collection — rent 325

2,148 Less:

Service charge $ 8

Charge for printed checks 10

Correction of book error —

recorded $310 check as $31 279 (422)

Smith’s actual cash balance is $1,726

To improve internal control, the company should use cash registers that record each sale The manager can prove the amount of cash in the cash drawer against this recorded amount

The main internal control weakness is that the payroll

department both prepares and distributes the paychecks With

both duties, a dishonest person in the payroll department can create a time sheet for a fictitious employee and then keep the related paycheck after the treasurer returns the signed checks

to the payroll department

To correct this weakness, Beautiful Meadows Golf should have someone other than the payroll department or the shop foreman distribute paychecks to employees For example, the human resources department, which has no control over the time sheets or the paychecks, could distribute paychecks to the workers

(20-30 min.) E 4-36B

Fallon Communications, Inc

Cash Budget Year Ended December 31, 2011

Millions

Cash balance, December 31, 2010 $ 82

Budgeted cash receipts:

11,510 Budgeted cash payments:

Payments for cost of

Payments of operating expenses 2,545

Payment of dividends 341 11,495 Cash available (needed) before financing 15 Budgeted cash balance, December 31, 2011 (81) Cash available for additional investments, or

Fallon expects to need new financing of $66 million during

2011

Actual Interest paid

2 Submitting purchase invoices

a second time for duplicate

payment, perhaps altering the

mailing address on the

duplicate invoice and sending

the check to a post office box

that Owens controls

2 Examining purchase invoices for authenticity and comparing invoices to receiving reports to determine that the business received all goods it paid for

Any invoice with a hole indicates it was paid earlier

Calling the suppliers directly to inquire about any questionable invoices

3 Paying suppliers excess

amounts and arranging for

suppliers to kick back part of

the excess to Owens

3 Comparing the business’s ratio of cost of goods sold to retail selling price to the cost- to-retail ratio in the past A kickback scheme would show

up in higher cost figures and a lower profit percentage

Req 1

The Furniture Mart, Inc

Cash Budget Year Ended December 31, 2010

Thousands

Cash balance, December 31, 2009 $ 130

Budgeted cash receipts:

22,577 Budgeted cash payments:

Purchases of inventory items $14,545

Payment of operating expenses 2,349

Purchase of property and equipment 1,528

Payment of long-term and short-term debt 980

Payment of dividends 317 19,719 Cash available (shortage) before financing 2,858 Budgeted cash balance, December 31, 2010 (130) Cash available for additional investments $ 2,728