Chapter_08

Chapter 8Cash and Internal ControlsQUICK STUDIESQuick Study 8-1 (10 minutes)1. The main objective of internal control procedures is to safeguard theassets 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.1. Separation of recordkeeping for assets from the custody over assets isintended 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.2. The responsibility for a transaction should be divided between two ormore individuals or departments to ensure that the work of one acts asa check on the other. Absent this, someone could create fictitiousinvoices and pay the money to herself or himself., 20094851. The cash category includes currency and coins along with the amountson 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 liquidinvestment 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-termobligations.Quick Study 8-3 (10 minutes)1. A liquid asset refers to an asset that can be readily converted intoanother 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 higherreturn 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.©McG4861. The three basic guidelines for safeguarding cash are:(a) Separate the duties of those who handle (have custody of) cash fromthose 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 8-5 (10 minutes) 1. (a) Petty Cash.......................................................... 75.00 Cash.............................................................75.00To establish the petty cash fund.(b) Entertainment Expense ($26.50 + $32.17)....... 58.67 Postage Expense............................................... 5.15 Printing Expense................................................ 3.00 Cash.............................................................66.82To reimburse the petty cash fund.2. The Petty Cash account is credited when either (1) the dollar amount ofthe fund is being reduced, or (2) the fund is being eliminated.Quick Study 8-6 (15 minutes)(1) (2)a. (i ) Bank (ii ) Addition No adjustment requiredb. (i ) Book (ii ) Addition Adjusting entry requiredc. (i ) Book (ii ) Subtraction Adjusting entry requiredd. (i ) Book (ii ) Subtraction Adjusting entry requirede. (i ) Bank (ii ) Subtraction No adjustment requiredf. (i ) Book (ii ) Addition Adjusting entry requiredg. (i ) Book (ii ) SubtractionAdjusting entry required, 2009 487MADISON COMPANYBank ReconciliationJuly 31, 2009balance..............................$2,025 Bank statement balance........ $1,800 BookAdd AddDeposit of July 31.................. 210 Interest earned. (5)Bank error................................. 90______ 2,100 2,030 Deduct DeductOutstanding checks............. 100 Bank service charge.. (30)Adjusted bank balance........... $2,000Adjusted book balance...........$2,000EXERCISESExercise 8-1 (10 minutes)EvaluationThe 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’schecks.(2) Since a loss was incurred, the company apparently had not bonded itsemployee. 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.E xercise 8-2 (15 minutes)(a) Internal Control Problems(1) A major internal control problem is that the recordkeeper (who hascontrol over the accounting records) has physical control over the cash©McG488receipts. 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 acustomer 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 wasnever 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 maysteal 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.©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 84891. A cash register (with a locked record) should be used at the salesstand—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 orshe 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.©McG4901.Jan. 1 Petty Cash (350)Cash (350)To establish a petty cash fund.2.Jan. 8 Postage Expense (67)Inventory* (35)MerchandiseExpense (52)DeliveryExpenses (56)MiscellaneousCash (210)To reimburse the petty cash fund.*Transportation-in costs are included in MerchandiseInventory under a perpetual system.3.Jan. 8 Postage Expense (67)Inventory (35)MerchandiseExpense (52)DeliveryExpenses (56)MiscellaneousCash (210)To reimburse the petty cash fund.*Jan. 8 Petty Cash (200)Cash (200)To increase the petty cash fund.** The two January 8 entries can be combined into one entry.©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 84911.Sept. 9 Petty Cash (250)Cash (250)To establish a $250 petty cash fund.2.Sept. 30 Merchandise Inventory* (47)Expenses (62)PostageExpenses (103)MiscellaneousCash Short and Over (4)Cash (216)To reimburse the petty cash fund.*Transportation-in costs are included in MerchandiseInventory under a perpetual system.3.Oct. 1 Petty Cash (50)Cash (50)To increase the petty cash fund to $300.©McG492Bank Balance Book Balance Not Shown onAdd Deduct Add Deduct Adjust Reconciliation 1. NSF check from customer returned on Sept.x Cr.25 but not recorded by this company.2. Interest earned on the account. x Dr.3. Deposit made on September 5 andx processed by bank on September 6.4. Check written by another depositor butxcharged against this company's account.5. Bank service charge. x Cr.6. Checks outstanding on August 31 thatx cleared the bank in September.7. Check written against the company accountx Cr.and cleared by the bank; erroneously notrecorded by the company recordkeeper.8. Principal and interest on a note receivable tox Dr.this company is collected by the bank but notyet recorded by the company.9. Checks written and mailed to payees onx October 2.10. Checks written by the company and mailedxto payees on September 30.11. Deposit made on September 30 after thexbank closed.12. Special bank charge for collection of note inx Cr.No. 8 on company's behalf.©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 84931. 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 itreceives the purchase requisition from the department making the request or when it receives reliable evidence that an obligation has been incurred.E xercise 8-8 (25 minutes)AUSTIN CLINICBank ReconciliationJune 30, 2009balance..............................$15,671 Bank statement balance........ $15,382 BookAdd AddDeposit of June 30................. 2,933 Error on Ck. No. 919 (9)18,31515,680Deduct DeductOutstanding checks............. 2,700 Bank service charge.. (65)Adjusted bank balance........... $15,615Adjusted book balance...........$15,615Exercise 8-9 (10 minutes)June 30 Cash (9)Utilities Expense (9)To correct a journal entry error.30 Miscellaneous Expenses (65)Cash (65)To record bank service charge.©McGraw-Hill Companies, 2009Fundamental Accounting Principles, 19th Edition 494PROBLEM SET AProblem 8-1A (20 minutes)1. Violates separation of duties. The company should implement a policywhereby 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 Jenn shouldhave 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, Kirsten could also serve as a petty cash custodian with her own petty cash fund.3. Violates the proper application of technological controls. While thedaily 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. Sanjay Shales needs toimplement 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. Wedo 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., 2009495Part 1Feb. 2 Petty Cash (300)Cash (300)To establish the $300 petty cash fund.Part 2Beard GalleryPetty Cash Payments Report (for February)Delivery expenseFeb. 23 D elivery of customer's merchandise...........$ 23.00 Mileage expenseFeb. 14 R eimbursement for mileage..........................66.00 Postage expenseFeb. 12 Express delivery of contract.........................$ 7.85Feb. 27 Postage expense............................................ 55.0062.85 Merchandise inventory (transportation-in)*Feb. 9 COD charges on purchases..........................32.50Feb. 25 COD charges on purchases.......................... 10.3042.80 Office supplies expenseFeb. 5 Purchased paper for copier..........................14.55Feb. 20 Purchased stationery..................................... 67.67 82.22 Total $276.87 * Transportation-in costs are included in Merchandise Inventory under a perpetual system.Part 3Feb. 28 Delivery Expense..............................................23.00 Mileage Expense...............................................66.00Postage Expense..............................................62.85Merchandise Inventory.....................................42.80Office Supplies Expense..................................82.22Cash Over and Short........................................ 2.31Cash............................................................. 279.18To reimburse the petty cash fund.Feb. 28 Petty Cash.........................................................100.00 Cash............................................................. 100.00To increase the petty cash fund to $400.Note: The two Feb. 28 entries can be combined into one.©McG496Part 1HAMILTON COMPANYBank ReconciliationJuly 31, 2009Bank statement balance............ $28,575Bookbalance..................................$25,862 Add AddDeposit of July 31..................... 7,15235,727 Proceeds of note lesscollection charge.....................5,97031,832Deduct Deduct Checks No. 3031...... $1,670 NSF check.......................$ 8053065...... 611 Service charge. (9)3069......2,438 4,719 Error (Check 3056)........ 10 824 Adjusted b ank balance............. $31,008Adjusted book balance...............$31,008Part 2July 31 Cash.........................................................................5,970Collection Expense (30)Notes Receivable..............................................6,000To record note collection less fees.July 31 Accounts Receivable—E. Shaw (805)Cash (805)To charge account for NSF check plus fees.July 31 Miscellaneous Expenses (9)Cash (9)To record bank service fee.July 31 Rent Expense (10)Cash (10)To correct an entry error., 2009497Part 3a. If the company's Cash account balance of $25,862 is listed on thebank reconciliation as $25,682 then:(i) The final balance that results from adjusting the bank statementbalance 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 $180 ($25,862 - $25,682), and thebank reconciliation will not balance.b. The bank's collection of the $6,000 note less the $30 collection feeshould 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 statementbalance will be overstated by $5,970; and(ii) The final balance that results from adjusting the book balance will be understated by $5,970.©McG498。