Chapter 4
Internal Control & Cash
Ethics Check
(5-10 min.) EC 4-1
a. Integrity
b. Objectivity and independence
c. Integrity
Short Exercises
1. Motive — Fraud generally results from either critical need or greed on
3. Rationalization — The perpetrator(s) is (are) convinced, in their own
(5 min.) S 4-2
Alston should report the errors to Golden because Golden is Alston’s
(10 min.) S4-3
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.
(5-10 min.) S 4-4
5. Information system — Accurate information is essential for success
in business. Accounting information enters and exits through the
information system.
Student responses may vary for the descriptions.
(5-10 min.) S 4-6
1. Smart hiring practices. The company should be careful to hire both
2. Comparisons and compliance monitoring. No person or department
should be allowed to completely process a transaction from beginning
3. Adequate records help to assure that sufficient hard copy documents
or electronic information is kept by the entity to support the validity of
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
(continued) S 4-6
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.
(20-30 min.) S 4-8
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
(10 min.) S 4-9
NSF check
(45)
Adjusted bank balance
$4,183
Adjusted book balance
$4,183
Rampart has cash of $4,183.
(5 min.) S 4-10
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Aug.
31
Cash………………………………………..
691
(5 min.) S 4-11
It appears that the employee has stolen $765 (adjusted book balance,
$4,755 − adjusted bank balance, $3,990). The adjusted bank balance is
1. Paying by check carries three controls over cash:
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
(5-10 min.) S 4-14
Budgeted cash balance needed
(11)
Cash available for additional investments
$ 4
(5 min.) S 4-15
Exercises
(10-15 min.) E 4-16A
a. Sweitzer has access to the cash collected, and she also prepares the
cash report. With access to both items, Sweitzer can steal cash and
falsify her cash report to conceal her theft.
b. Li 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.
(10 min.) E 4-17A
Cash payments:
a. Strong internal control. There is a good separation of duties.
Supervisors request equipment, and the home office purchases the
equipment.
(10 min.) E 4-18A
(10-20 min.) E 4-19A
F.L. Hardy
627
175
(250)
Adjusted bank balance
$1,254
BOOKS:
Service charge
5
(43)
Adjusted book balance
$1,254
(10-20 min.) E 4-20A
Less: Outstanding checks
(610)
Adjusted bank balance
$1,920
BOOKS:
Balance, March 31
$1,980
(10-15 min.) E 4-21A
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Mar.
31
Cash .............................................................
320
Rent Revenue .........................................
320
EFT collection of rent.
31
Miscellaneous Expense ($8 + $10) .............
18
Cash ........................................................
18
Bank service charge and charge
for printed checks.
31
Accounts Receivable ..................................
110
(10-15 min.) E 4-22A
(10-15 min.) E 4-23A
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, Linus Manufacturing 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 4-24A
(10-15 min.) E 4-25B
a. Morrison has access to the cash collected, and she also prepares the
cash report. With access to both items, Morrison can steal cash and
falsify her cash report to conceal her theft.
b. Peterson 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.
(10 min.) E 4-26B
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
(10 min.) E 4-27B
(10-20 min.) E 4-28B
F. L. Hill
Bank Reconciliation
627
280
(360)
Adjusted bank balance
$1,154
BOOKS:
Service charge
10
(98)
Adjusted book balance
$1,154
(10-20 min.) E 4-29B
Less: Outstanding checks
(603)
Adjusted bank balance
$1,917
BOOKS:
Balance, October 31
$1,997
(10-15 min.) E 4-30B
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Oct
31
Cash .........................................................
330
Rent Revenue .....................................
330
EFT collection of rent.
31
Miscellaneous Expense ($10 + $11) .......
21
Cash ....................................................
21
Bank service charge and charge
for printed checks.
31
Accounts Receivable ..............................
110
(10-15 min.) E 4-31B
(10-15 min.) E 4-32B
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, Greentown Company 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 4-33B
Quiz
Q4-45
d
Problems
1. Kennedy controls the content of the invoices. With no supervision of
3. Luck prepares the bank reconciliation. Luck has cash handling
2. O’Malley could assign either cash handling or accounting duties to
(10-20 min.) P 4-47A
Requirement 1
Requirement 2
Requirement 3
Missing Internal
Control
Characteristic
Possible Problem
Solution
a.
Separation of
duties
Theft of diamonds
— the purchasing
agent could have
diamonds sent to a
location he controls.
Separate
purchasing,
approval, and
check-signing
duties.
b.
Assignment of
responsibility
Lost revenue, because
too many employees
are managing the office
and neglecting their
duties.
Assign a single
employee to
manage the office
when the owner is
absent.
c.
Separation of
duties
Theft of cash.
Separate
accounting and
cash-handling
duties.
(continued) P 4-48A
Req. 2 (entries based on the reconciliation)
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
June
30
Cash ...................................................................
625
Rent Revenue ..............................................
625
EFT deposit for rent revenue earned.
30
Cash ...................................................................
1,275
Note Receivable ..........................................
1,275
Note receivable collected by bank.
30
Cash ...................................................................
450
Accounts Payable .......................................
450
Correction for check #3115 recorded
incorrectly.
30
Insurance Expense ...........................................
382
(continued) P 4-48A
(30-45 min.) P 4-49A
Keller Wireless
Cash Budget
2017
Thousands
Cash balance, beginning
$ 8,100
Budgeted cash receipts:
Collections from customers ($66,000 × 1.14)
75,240
Receipt of interest
600
83,940
(15-20 min.) P 4-50B
1. Martin controls the content of the invoices. With no supervision of her
3. Moore prepares the bank reconciliation. Moore has cash handling
2. Gustafson could assign either cash handling or accounting duties to
(10-20 min.) P 4-51B
Requirement 1
Requirement 2
Requirement 3
Missing Internal
Control
Characteristic
Possible Problem
Solution
a.
Separation of duties
Theft of cash or
diamonds by the
purchasing agent.
Have a manager, not
the purchasing agent,
approve invoices for
payment and sign the
checks.
b.
Assignment of
responsibilities
Lost revenue due to
delay of architectural
drawings.
Assign one senior
architect to fulfill
management duties
while Hixson is absent.
Other senior architect
should focus on
producing architectural
drawings.
c.
Separation of duties
Theft of cash.
Keep accounting and
cash handling duties
separate.
(20-30 min.) P 4-52B
(continued) P 4-52B
Req. 2 (entries based on the reconciliation)
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
July
31
Cash ...................................................................
800
Rent Revenue ...............................................
800
EFT deposit for rent revenue.
31
Cash ...................................................................
1,275
Note Receivable ...........................................
1,275
Note receivable collected by bank.
31
Cash ...................................................................
450
Accounts Payable ........................................
450
Correction for check #3115 recorded
incorrectly.
31
Accounts Receivable ........................................
430
(continued) P 4-52B
(30-45 min.) P 4-53B
Carvel Wireless
Cash Budget
2017
Cash balance, beginning
$ 7,900
Budgeted cash receipts:
Collections from customers ($65,000 × 1.12)
72,800
Receipt of interest
300
81,000
Budgeted cash payments:
Challenge Exercises and Problem
2.
Submitting purchase invoices a
second time for duplicate
payment, perhaps altering the
2.
authenticity and comparing
invoices to receiving reports to
3.
Paying suppliers excess
3.
Comparing the business’s ratio
(20-30 min.) E 4-55
Req. 1
Dollar Depot, Inc.
Cash Budget
Year Ended December 31, 2017
Thousands
Cash balance, December 31, 2016
$ 100
Budgeted cash balance, December 31, 2017
(175)
Debt ratio
=
=
=
0.52
Total assets
$22,177
Req. 3
Dollar Depot will have cash available for additional investments and
should not need to borrow.
(20-30 min.) P 4-56
The Parkview Company
Bank Reconciliation
December 31
BANK:
Balance, December 31
$ 3,936
Add: Deposit in transit
Actual amount of December 30 deposit
670
Subtotal
4,606
(continued) P 4-56
Checks No. 1880, 1882, and 1883 were outstanding in November so
should not also be deducted from Cash in December. The unexplained
difference of $3,638* consists of: $1,138 erroneous November
outstanding checks and the $2,500 difference between deposit in transit
listed on the original reconciliation and the amount of the deposit in
transit listed on the books. It is possible that the $4,000 difference
between the December 23 deposit on the books and the December 24
receipt on the bank statement was intentional and used to cover up the
missing cash.
Decision Cases
(20-30 min.) Decision Case 1
NSF check
36
(44)
Adjusted book balance, September 30
$10,558
(continued) Decision Case 1
1. The bookkeeper should not handle incoming mail. The mailroom
2. The bookkeeper should not make bank deposits. The treasurer
should have the cashier deposit the checks in the bank.
(15-30 min.) Decision Case 2
(continued) Decision Case 2
3. Don’t allow Pickins to pass out paychecks. Have employees pick up
6. Have a home-office employee go to the construction site occasionally
7. Have employees deliver or mail time sheets to home office.
Ethical Issues
2. What are the alternatives? Require the client to record the loss, or
3. Identify the stakeholders. The auditor, the bank, and the public at
large can be affected. The auditor’s reputation is on the line. The
bank’s financial statements are in question. The public, including
creditors and investors, can be affected if the bank issues financial
statements that include erroneous amounts.
Assess the possible outcomes. If the auditors require the bank to
record the loss, the auditor will keep his or her reputation intact. But
(continued) Ethical Issue 1
4. Make the decision. The auditor should require the bank to record the
loss even if that means losing the bank as a client. By sticking to his
or her belief that the bank should record the loss, the auditors’
Ethical Issue 2
1. Identify the ethical issue. Galvin’s ethical issue is whether to use his
knowledge of The Salvation Army’s plans and of Nadar’s situation to
either party’s advantage (or disadvantage). Should Galvin help The
Salvation Army buy the land at the lowest price? Should he help
Nadar sell the land at the highest price? Galvin’s position presents
2. What are the alternatives? There are several:
(a) Let other members of the Salvation Army board of directors
know of Nadar’s situation in order to help The Salvation Army
buy the land at a bargain price.
(b) Disclose Nadar’s situation to fellow board members and insist
3. Identify the stakeholders involved. Galvin, The Salvation Army,
(continued) Ethical Issue 2
fellow board members. This would help The Salvation Army and hurt
Nadar, relative to her ability to sell the land at market value of $3.6
million. Insisting that The Salvation Army offer market price for the
land would seem fair to both parties, but that would betray the trust of
Nadar. And it may or may not sway the board to go along with a $3.6
million offer for the land.
4. Make the decision. The authors would take the leave of absence and
hope other Salvation Army board members do not probe Galvin’s
Ethical Issue 3
2. What are the alternatives?
3. Identify the stakeholders involved. IMS, Snicker Foods, Community
Bank, and everyone connected to these organizations — owners,
4. Make the decision. French should not tell IMS of Snicker’s financial
difficulties (after all, Snicker isn’t bankrupt yet). French should let
Focus on Financials: Apple Inc.
(20-30 min.)
Req. 1
Cash equivalents include assets that are slightly less liquid than cash,
but similar enough to be reported together. Cash equivalents must be
readily convertible to known amounts of cash and close to maturity (with
an original maturity of three months or less at the time of purchase).
Req. 2
Apple Inc. includes in its cash equivalents highly liquid instruments with
an original maturity of three months or less at the time of purchase.
7. Depreciation and amortization, which provided $72
million. Actually, these expenses do not use cash, so they are
added back to income to arrive at cash provided by operations.
Req. 2
The following items from the report are also mentioned in the chapter:
Group Project