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Accounting controls are composed of procedures that are designed to safeguard assets and to assure that the accounting records contain reliable information. Administrative controls are concerned with performance evaluation and the assessment of the degree of compliance with company policies and public laws. 3. A • • • • • • • • • 4. strong internal control system should have: Separation of duties. Quality employees. Bonded employees. Periods of absence (i.e., required vacations and rotation of employees). A procedures manual. Clear lines of authority and responsibility. Prenumbered documents. Physical control over assets. Periodic performance evaluation.
Separation of duties is the procedure whereby different individuals each separately perform the authorization, recording, and custody functions for a business. An example would be to have one individual write the checks and attach appropriate documentation and have another individual sign the check and approve payment. Quality employees should have the necessary ability to perform the required task and be adequately trained to perform a variety of other tasks. In addition, employees should have high personal integrity. A fidelity bond is insurance that a company can purchase to protect against loss due to employee dishonesty.
7. When employees are not required to take extended periods of leave or vacation, the employee may be able to cover up illegal or unscrupulous activities while being present in the work environment. If jobs are rotated or someone else does the job while the employee is absent, improprieties may be discovered. 8. The procedures manual sets forth the proper procedures for processing transactions. The manual should be kept up-to-date and periodic reviews should be conducted to ensure that the procedures outlined in the manual are being followed. Specific authorizations outline the limitations that apply to different levels of management. These authorizations generally apply to specific positions within the organization. For example, sale of major assets can only be authorized by the board of directors, price reductions must be authorized by the sales manager, etc. General authorizations apply across different levels of management. For example, checks for purchases should be written only if supported by a purchase order and receiving documents. All paid invoices must be stamped “PAID” to avoid duplicated payments.
10. The use of prenumbered documents (i.e., checks, receipts, and invoices) is a control to help ensure that all transactions are properly accounted for and recorded, and that no transactions are unrecorded or missing. 11. Physical controls are designed to safeguard assets. Storerooms should be kept locked with limited access. Serial numbers on equipment should be recorded. Unannounced physical counts should be taken to account for the physical presence of the assets. Valuable papers should be kept in a lockbox, with limited access. Accounting records should be kept in a fireproof vault with backup copies kept off premises whenever possible. Assets should be adequately insured.
12. Independent verification of performance provides an objective evaluation. It also requires the employee to be accountable under predetermined standards. Independent verification of the internal control systems assures that the system is functioning properly. 13. Additional controls related to computers: 1. Test of reasonableness should be built into the programs to flag clearly erroneous transactions. 2. The company should have a competent and bonded programmer. 3. Documentary evidence should be kept in order to leave a paper trail. 4. Access to the system should be controlled. 5. Proper documentation should be kept on the operations and procedures of the various programs. 6. Programs and databases should be safeguarded. Backup files should be stored in a fireproof vault with a copy kept off the premises if possible. 14. Cash includes currency and other items payable on demand such as checks, money orders, bank drafts, and savings accounts. 15. Cash is more susceptible to theft and embezzlement because it is not easily identifiable. In most cases, possession equates to ownership. 16. Giving customers receipts helps to prevent theft of cash receipts. Any missing receipts or quantities of money can be detected on a timely basis. The customer serves as a control to assure that the amount of the sale is correct (i.e., no overcharging or undercharging) and that cash paid is properly recorded. 17. Control procedures over cash receipts include: • Timely deposits. • Limiting cash on hand. • Timely recording of cash receipts. • Written customer receipts. 6-3
• Timely reconciliation of actual cash to records of cash receipts. 18. Procedures that will help protect cash disbursements include making all disbursements by check, using prenumbered checks kept in a secure place, and separation of the authorization, recording, and custody functions for cash disbursements. Supporting documentation and authorized signatures should also be required for payment. Paid documents should be clearly labeled and filed for reference. 19. A debit memo included with the bank statement reduces the amount of cash and a credit memo increases the amount of cash. 20. Information usually contained in the bank statement includes: • The balance of the account at the beginning of the period. • Additions to the account during the period (deposits and other credit memos). • Subtractions made during the period for paid checks and other debit memos. • A running balance of the account or the beginning and ending balance of the account. 21. The bank's balance will be larger than the book balance if there are outstanding checks that exceed outstanding deposits. The bank's balance will be smaller if the outstanding deposits exceed the outstanding checks. Errors also will cause differences. 22. The bank reconciliation is a schedule prepared to identify items causing differences between the bank statement balance and the Cash account balance. Preparation of a bank reconciliation also helps determine the true cash balance as of the date of the bank statement.
23. An outstanding check is a cash disbursement that has been recorded on the payer’s books but has not been deducted from the payer’s bank account by the bank (i.e., has not “cleared” the bank). 24. A deposit in transit is a deposit that has been recorded on the depositor’s books but has not yet been recorded by the bank. 25. A certified check is a check guaranteed by a bank to be a check drawn on an account with sufficient funds to pay the check. 26. The amount of a customer check that was deposited and is later found to be NSF must be deducted from the depositor’s account. The amount of the NSF check plus any service charges are shown as an account receivable (i.e., the customer owes the depositor the amount). 27. The Cash Short and Over account is an account that is used to record minor overages or shortages when balancing cash receipts or disbursements. 28. The petty cash fund is a small cash fund that is kept on the premises that is used to pay small disbursements where it is not practical to write a check. For example, a payment of $1.24 for postage might be paid out of petty cash. 29. Examples of expenditures made from a petty cash fund include postage, delivery charges, taxi fares, supper money, small purchases of office supplies, and any other small items that are frequently paid with cash. 30. Current assets are assets that will be consumed or converted into cash within a one-year period or an operating cycle, whichever is longer. Noncurrent assets are assets that a business expects to be productive or to use over a period of several years. 31. Some of the most common current assets are: 6-5
• • • • • • • • •
Cash. Marketable Securities. Accounts Receivable. Short-Term Notes Receivable. Inventory. Interest Receivable. Supplies. Prepaids. Currently maturing portion of Long-Term Notes Receivable.
32. An operating cycle is the length of time that is required to turn cash into inventory, inventory into receivables, and receivables back into cash. 33. Current liabilities include: • Accounts Payable. • Short-Term Notes Payable. • Wages and Salaries Payable. • Taxes Payable. • Interest Payable. • Currently maturing portion of Long-Term Debt. 34. A classified balance sheet is one that separates assets and liabilities into current and noncurrent items. 35. Liquidity refers to a business’s ability to generate shortterm cash flows. Solvency is the ability to repay liabilities in the long run. 36. U.S. GAAP requires that assets be listed in order of liquidity (i.e., current assets first) and that current liabilities be listed before non-current liabilities. Balance sheet presentation of assets in the U.K. is the opposite, with long-term assets listed first; liabilities are presented in the same order as in the U.S. In France, both asset and liability sections list noncurrent items first. 37. This is generally true. A high current ratio indicates the ability of a company to meet its short-term debt obligations. 6-6
However, if the current ratio is too high, the company may have excess current assets which may be invested to yield a higher return for owners. 38. A high debt-to-assets ratio is not necessarily an indication of solvency problems. Companies in relatively stable industries can use leverage to increase return to the owners. Banks are an example of businesses with high debt-to-assets ratios.
SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 6 EXERCISE 6-1A 1. Separation of Duties: Whenever possible, the functions of authorization, recording, and custody should be handled by different individuals. If these duties are separated, the likelihood of theft or fraud by employees is greatly reduced, because collusion among employees is necessary to accomplish the crime. Quality of Employees: Employees should be competent and adequately trained to perform the required task. Bonded Employees: Employers should hire employees with high personal integrity. Employees in positions of trust should be covered with a fidelity bond (insurance against loss from employee dishonesty). Periods of Absence: Employees should be required to take extended vacations and/or be rotated among duties in order to discover patterns of dishonesty or theft. Procedures Manual: A procedures manual should be established, kept up-to-date, and enforced to assure that company policies are being followed. Authority and Responsibility: A clear chain of command should be established and documented. A manual should detail this chain of command and provide guidance for specific and general authority. Prenumbered Documents: The use of prenumbered documents (checks, receipts, etc.) requires all such documents to be accounted for and reduces the likelihood of unauthorized transactions. Physical Control: All assets should be properly documented, and periodically accounted for, with access limited to authorized personnel.
9. Performance Evaluations: A periodic and independent evaluation of employees' performance alerts management to inefficiencies of employees.
EXERCISE 6-2A 1. Controls for test of reasonableness: A computer does not think independently and is neutral to the size of a number. Therefore, certain tests should be built in to catch unreasonable entries. 2. Competence of computer programmers: Since many computer operators are required to run and design complex programs, it is even more important that these employees be screened and bonded. 3. Audit around the computer: These procedures are used to test the system by inputting data where the expected outcome is known. 4. Security of the system: Measures should be taken to protect unauthorized access to computer programs and data files. 5. Documentation: Documentation of programs and procedures is necessary so that more than one person is familiar with and able to operate the system. 6. Safeguard data files: Backup copies of programs and data files should be stored off-premises in order to minimize danger from destruction or theft.
EXERCISE 6-3A • Receipts should be promptly written for all cash received and the funds deposited timely in a bank or other financial institution. • All cash disbursements should be made by check and all check numbers accounted for. • All checks should require dual signatures and proper supporting documents. • The bank account should be reconciled on a monthly basis. Cash on hand should be kept to a minimum. • Cash handling and cash record-keeping duties should be separated as well as authorization for cash disbursements.
EXERCISE 6-4A Some of the internal control features that should be included in the memo to Dick Haney: • Have as much separation of duties as possible. The manager should prepare the deposit of receipts collected by the sales personnel. Dick should periodically check these amounts. If the manager is in charge of writing the checks, then Dick should sign each check and verify the documentation. One of the sales personnel should check in inventory and the manager should check the receiving reports and verify the billing. • Be sure that assets are adequately insured. • Be sure that quality employees are hired. • Require that all employees take vacations. • Use prenumbered documents.
EXERCISE 6-5A a. The discrepancy was most likely caused by theft by Rhonda Cox, the parts department manager. It is unlikely that sloppy recordkeeping could account for this much of a difference. The manager could have been involved in several types of dishonest behavior. She could have presented phony invoices for payment to a fictitious company, or sold some of the parts and not recorded the sale. Any of these activities would cause this type of discrepancy. b. Separation of duties is one internal control procedure that could have helped prevent this type of theft. If the company was so small that it had only one employee in the parts department, the owner must be very involved in that department, checking invoices, inventory, receiving reports and other documentation.
Also, the owner should have insisted that the employee take regular vacations. Bonding the employees would help to insure against theft loss.
EXERCISE 6-6A a. & c.
Best Supplies Statements Model Assets Cash +Acct. Rec. (a) + 125 (125) (c1)125+ (125) (c2)25 + NA = Liab. + = = = = NA NA NA + + + + NA NA 25 NA NA 25 − NA = NA − NA = NA − NA = 25 (125) OA 125 OA 25 OA S. Equity Rev. − Exp. = Net Inc. Cash Flow
b. c. d.
Asset exchange. See financial statements model above. miscellaneous income. The $25 fee is
Asset Exchange is $125 and Asset Source is $25.
EXERCISE 6-7A Reconciling Items: Charge for Checks NSF Check from Customer ATM Fee Outstanding Checks Interest Revenue Earned on the Account Deposits in Transit Service Charge Automatic Debit for Utility Bill Book Balance Adjusted? Yes Yes Yes No Yes No Yes Yes Added or Subtracte d? − − − NA + NA − −
EXERCISE 6-8A Reconciling Items: NSF Check from Customer Interest Revenue Bank Service Charge Outstanding Checks Deposits in Transit Debit Memo Credit Memo ATM Fee Petty Cash Voucher Bank Balance Adjusted? No No No Yes Yes No No No No Added or Subtracted? NA NA NA − + NA NA NA NA
EXERCISE 6-9A a. Bank Reconciliation Unadjusted Bank Balance 5/31/2004 Add: Deposit in Transit Less: Outstanding Check True Cash Balance 5/31/2004 Unadjusted Book Balance 5/31/2004 Add: Credit Memo for Interest Earned Less: Debit Memo for Service Charge True Cash Balance 5/31/2004 $14,625 1,590 (1,873) $14,342 $14,330 20 (8) $14,342
b. Date Adj 1 Adj 2 Cash
Interest Earned Bank Service Charge Expense Cash 8
EXERCISE 6-10A Unadjusted Bank Balance, 8/31 Plus: Deposits in Transit Less: Outstanding Check True Cash Balance, 8/31 $75,925 2,600 (4,925) $73,600
EXERCISE 6-11A Unadjusted Book Balance, 4/30 Add: Interest Earned Note Collected by Bank Less: NSF Check Service Charges True Cash Balance, 4/30 $5,600 $ 15 500 75 50 515 (125) $5,990
EXERCISE 6-12A a. b.
Belcher Transfer Company Statements Model Assets Cash (200) = Liab. + S. Equity NA Rev. − Exp = Net . Inc. NA
Petty Cash 200 =
Belcher Transfer Company General Journal Ref. Jan. 1 Account Titles Petty Cash Cash Debit 200 200 Credit
EXERCISE 6-13A a. Xterra, Inc. Statements Model
Assets No Cash . 1. (300.0 + 300.00 0) 2. NA + NA 3. NA + (247.5 0) 4. (247.5 + 247.50 0) Petty + Cash = S. Equity Ret. = Earn. = NA Rev. − Exp. = Net Inc. Statement of Cash Flows NA NA (247.50) OA NA
NA NA NA NA
= NA = (247.5 0) = NA
NA = NA − − 247.50 = (247.5 0) NA = NA −
b. Xterra, Inc. General Journal Entries Event No. 1. 2. 3. Account Titles Petty Cash Cash No Entries Postage Expense Office Supplies Expense Printing Expense Entertainment Expense Cash Short and Over Petty Cash Petty Cash Cash 65.00 80.75 10.50 88.25 3.00 247.50 247.50 247.50 Debit 300.00 300.00 Credit
EXERCISE 6-14A a. b. No effect; this is an asset exchange transaction. Net charge to expense is $123.20; expenses will be debited for $125.20, the amount of the vouchers; cash short and over will be credited for $2.00. Replenishment.
EXERCISE 6-15A Borg Co. Classified Balance Sheet As of December 31, 2003 Assets Current Assets Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Total Current Assets Property, Plant and Equipment Office Equipment Total Property, Plant and Equipment Total Assets Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable Long-Term Liabilities Long-Term Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities Equity and Stockholders’ $119,460 $40,000 45,460 85,460 $11,000 23,000 34,000 $15,260 42,500 32,000 3,200 $ 92,960 26,500 26,500 $ 119,460
EXERCISE 6-16A Operating Cycle: a. Cash Inventory Accounts Receivable Cash b. Length of operating cycle: 90 + 35 = 125 days
SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 6 PROBLEM 6-17A a. Separation of duties would have helped to prevent this type of act. The authority function, check writing function, and check delivery function should have been separated. Again, separation of duties would help to prevent this type of fraud. Mr. Kent should not authorize the purchase of supplies and also verify their receipt. Better control procedures could help eliminate this type of act. Require an authorization for any discounts that are given. Also, management should periodically observe procedures used at the cash register. Shortages in inventory can be reduced by having another employee checking sales receipts with the merchandise a customer carries from the store (like Sam’s Clubs).
PROBLEM 6-18A a. Long Builders, Inc. Bank Reconciliation October 31, 2001 Unadjusted Bank Balance, October 2001 Add: Deposit in Transit Less: Outstanding Checks True Cash Balance, October 31, 2001 Unadjusted Book Balance, October 2001 Add: Error in recording check equipment Less: Debit Memo for new checks True Cash Balance, October 31, 2001 31, $8,000 2,000 (1,200) $8,800 31, for $8,580 270 (50) $8,800
b. General Journal Ref. 1. 2. Account Title Cash Equipment Office Supplies Expense Cash Debit 270 270 50 50 Credit
PROBLEM 6-19A Barkley Flying Service Bank Reconciliation April 30, 2007 Unadjusted Bank Balance, April 30, 2007 Add: Deposits in Transit $1,000 Bank Error 800 Less: Outstanding Checks #2012 #2052 #2055 True Cash Balance, April 30, 2007 Unadjusted Book Balance, April 30, 2007 Add: Note Collected by Bank Error in recording payment for repairs Less: Collection Fee Bank Service Charge NSF Checks True Cash Balance, April 30, 2007 220 380 1,700 (2,300) $ 9,500 $ 9,058* $ 450 297 15 40 250 747 $10,000 1,800
(305) $ 9,500
*Unadjusted cash balance per books is computed as follows: x + $747 − $305 = $9,500; x = $9,058
PROBLEM 6-20A General Journal Event No. a. b. c. d. e. f. g. h. i. j. Account Titles No Entry Cash Accounts Receivable No Entry No Entry Accounts Receivable Cash Cash Interest Revenue Cash Supplies Bank Service Charge Expense Cash Theft Loss Cash No Entry 375 375 75 75 495 495 40 40 1,000 1,000 8,000 8,000 Debit Credit
PROBLEM 6-21A a. Oceanside Hotel Bank Reconciliation October 31, 2005 Unadjusted Bank Balance, October 31, 2005 Add: Deposit in Transit Less: Outstanding Checks #2353 2356 True Cash Balance, October 31, 2005 Unadjusted Book Balance, October 31, 2005 Add: Credit Memo for Collection of Notes Receivable Less: Debit Memo for Printed Checks True Cash Balance, October 31, 2005 $14,000 3,550 $1,500 745 (2,245) $15,305 $13,000 2,325 (20) $15,305
b. Account Title Cash Notes Receivable Office Supplies Expense Cash Debit 2,325 2,325 20 20 Credit
PROBLEM 6-22A Asset = Liabiliti + s es Event Number Type of Event AU AU AE AS AE − − +− + +− = = = = = NA NA NA NA NA + + + + + Stockholders’ Equity Commo + Retaine n Stock d Earning s NA NA NA NA NA + + + + + − − NA + NA
1. 2. 3. 4. 5.
PROBLEM 6-23A a. Pete’s Sandwich Shop Bank Reconciliation May 31, 2006 Unadjusted Bank Balance, 2006 Add: Deposit in Transit Less: Outstanding Checks May 31, $22,000 4,250 (5,000) $21,250 $25,000 1,815 $ 30 1,000 (1,030) 25,785 (4,535) $21,250
True Cash Balance, May 31, 2006 Unadjusted Book Balance, May 31, 2006 Add: Credit Memo for Collection of Notes Receivable Less: Debit Memo for Service Charge Debit Memo for Loan Payment Subtotal Stolen Cash True Cash Balance, May 31, 2006
b. Correcting the amount of outstanding checks from $465 to $5,000 reveals a true cash balance of $21,250. Given an adjusted book balance of $25,785, there must be $4,535 of cash missing, (i.e., $25,785 − $21,250). The discrepancy was hidden by understating the amount of outstanding checks thereby raising the bank balance to equal the incorrect book balance. c. Separation of duties and/or oversight by the owner could help to prevent this type of act. In small businesses with few employees, it may not be possible to have all the accounting functions separate. In this case, it is necessary for the owner to take an active role in the accounting of the business.
PROBLEM 6-24A a. General Journal Event 1. 2. 3a. Account Titles Petty Cash Cash No Entry Postage Expense Delivery Expense Meals Expense Cash Short and Over Petty Cash Petty Cash Cash 32 20 42 2 92 92 92 Debit 100 100 Credit
b. The cash over will be reported on the income statement as miscellaneous income. c. Event Number 1. 2. 3. Type of Event AE No Effect AU AE
PROBLEM 6-24A (cont.) d. Effect of Transactions on Financial Statements Assets No.
1. 2. 3a. 3b.
(100) NA NA (92) + + + +
100 NA (92) 92
= Liab + S. . Equity =
= NA = NA = NA = NA + + + + NA NA (92) NA
Rev. − Exp. = Net Inc.
NA NA 2 NA
− − − −
NA NA 94 NA
= = = =
NA NA (92) NA
NA NA (92) OA NA
PROBLEM 6-25A Nixon Enterprises Classified Balance Sheet December 31, 2005 Assets Current Assets Cash Accounts Receivable Interest Receivable Supplies Inventory Prepaid Rent Total Current Assets Long-Term Assets Notes Receivable 6-33 $ 3,600 4,000 240 500 9,000 9,600 $ 26,940 6,000
Office Equipment $58,000 Less: Accumulated (4,800) Depreciation Land Total Long-Term Assets Total Assets
53,200 50,000 109,200 $136,140
Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable $ 1,000 Interest Payable 740 Salaries Payable 1,800 Unearned Revenue 9,600 Total Current Liabilities Long-Term Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liab. & Stockholders’ Equity 41,000 42,000
$ 13,140 40,000 53,140
PROBLEM 6-25A (cont.) Nixon Enterprises Income Statement For the Year Ended December 31, 2005 Sales Revenue Cost of Goods Sold Gross Margin Operating Expenses Operating Expenses $ 19,000 Salaries Expense 118,000 Total Operating Expenses Operating Income Non-Operating Items: Interest Revenue Gain on Sale of Equipment Interest Expense Net Income 420 6,400 (12,200) (5,380) $ 23,620 $340,000 (174,000) 166,000
SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 6 EXERCISE 6-1B a. The two categories of internal controls are accounting controls and administrative controls. Accounting controls: Procedures designed to safeguard the assets and ensure that the accounting records contain reliable information. Administrative controls: Procedures that concern the evaluation of performance and the assessment of the degree of compliance with company policies and public law. b. The purpose of internal controls is to prescribe policies and procedures to be used to provide reasonable assurance that the objectives of an enterprise will be accomplished. They are designed to safeguard the assets of a business.
EXERCISE 6-2B a. The use of computers does not reduce the need for internal controls; it increases the controls that are needed. Computers do not think independently so there must be tests for reasonableness. Since significant technical expertise is required to design and run computer programs, competent computer programmers are necessary. Controls must be in place to assure the competence of these computer programmers and operators. Computers also present different security issues. Procedures must be in place to safeguard computers and computer information. Also, since computer data can be easily lost or damaged, controls must be in place to assure backup data is kept secure.
b. Audit around the computer: This expression describes procedures where the auditor provides input that is expected to result in a designated output. The system is tested by comparing the actual output with the expected output.
EXERCISE 6-3B a. Cash requires additional control procedures because of its appeal. Usually possession of cash is presumed ownership. It usually cannot be traced and one dollar cannot be distinguished from another. Relatively small amounts of high-denomination currency can represent significant amounts of value. Consequently, extra controls are necessary to safeguard cash.
b. Cash includes currency and other items that are payable on demand such as checks, money orders, bank drafts, and certain savings accounts. Some companies combine marketable securities with cash for balance sheet presentation.
EXERCISE 6-4B Separation of duties would have eliminated this problem. Gates should not have had the authority to evaluate returns (authorization) and to dispose of the defective merchandise (custody). If these two duties had been performed by separate individuals, it would have been difficult to commit this type of crime.
EXERCISE 6-5B By checking Mr. Major's references, educational background, etc., and bonding its physicians, ECMC could have avoided this loss.
EXERCISE 6-6B a. & c.
Clark Stationery Statements Model Assets Cash +Acct. Rec. (a) + 300 (300) (c1)300+ (300) (c2)20 + NA = Liab. + = = NA = NA = NA + + + + NA NA 20 NA NA 20 − NA − NA − NA = NA = NA = 20 (300) OA 300 OA 20 OA S. Equity Rev. − Exp. = Net Inc. Cash Flow
b. c. d.
Asset exchange. See financial statements model above. miscellaneous income. The $20 fee is
Asset Exchange is $300 and Asset Source is $20.
EXERCISE 6-7B Reconciling Items: Interest Revenue Deposits in Transit Debit Memo Service Charge Charge for Checks NSF Check from Customer Note Receivable Collected by Bank Outstanding Checks Credit Memo Book Balance Adjusted? Yes No Yes Yes Yes Yes Yes No Yes Added or Subtracte d? + NA − − − − + NA +
EXERCISE 6-8B Reconciling Items: Deposits in Transit Debit Memo Credit Memo Certified Checks Petty Cash Voucher NSF Check from Customer Interest Revenue Bank Service Charge Outstanding Checks Bank Balance Adjusted? Yes No No No No No No No Yes Added or Subtracted? + NA NA NA NA NA NA NA −
EXERCISE 6-9B a. Bank Reconciliation Unadjusted Bank Balance 6/30/2006 Add: Deposits in Transit Less: Outstanding Check True Cash Balance 6/30/2006 Unadjusted Book Balance 6/30/2006 Add: Credit Memo for Interest Earned Less: Debit Memo for Service Charge True Cash Balance 6/30/2006 $13,879.8 5 1,476.30 (1,843.74) $13,512.4 1 $13,483.7 5 35.00 (6.34) $13,512.4 1
b. Date Adj 1 Adj 2 Cash
Debit 35.0 0
Interest Revenue Bank Service Charge Expense Cash 6.34
EXERCISE 6-10B Unadjusted Bank Balance, 6/30 Plus: Deposits in Transit Less: Outstanding Check True Cash Balance, 6/30 $68,714.35 1,464.95 (4,745.66) $65,433.64
EXERCISE 6-11B Unadjusted Book Balance, 5/31 Add: Interest Earned Note Collected by Bank Less: NSF Check Service Charges True Cash Balance, 5/31 $6,450 $ 18 450 38 30 468 (68) $6,850
EXERCISE 6-12B a. b.
Cole Company Statements Model Assets Cash (300) = Liab. + S. Equity Rev. − Exp = Net . Inc. NA
Petty Cash 300 =
NA + NA
NA = NA
Cole Company General Journal Ref. Jan. 1 Account Titles Petty Cash Cash Debit 300 300 Credit
EXERCISE 6-13B a. Family Vision Center Statements Model
Assets S. Equity Petty Ret. + Cash = Earn. = NA = Rev. − Exp. = Net Inc. Statement Of Cash Flows NA NA (83.25)OA NA
No Cash . 1. (100.0 + 100.00 0) 2. NA + NA 3. NA + (83.25 ) 4. (83.25) + 83.25
= NA = (83.25 ) = NA
NA − NA = NA 1.18 − 84.4 = (83.25 3 ) NA − NA = NA
b. Family Vision Center General Journal Entries Event No. 1. 2. 3. Account Titles Petty Cash Cash No Entries Postage Expense Office Supplies Expense Printing Expense Transportation Expense Cash Short and Over Petty Cash Petty Cash Cash 34.68 18.43 7.40 23.92 1.18 83.25 83.25 83.25 Debit 100.00 100.00 Credit
EXERCISE 6-14B a. b. c. No effect; this is an asset exchange transaction. $191.16 ($184.93 vouchers; $6.23 cash short & over) Replenishment.
EXERCISE 6-15B Coleman Co. Classified Balance Sheet As of December 31, 2003 Assets Current Assets Cash Accounts Receivable Merchandise Inventory Total Current Assets Property, Plant and Equipment Land Total Property, Plant and Equipment Total Assets Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable Long-Term Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities Equity and Stockholders’ $12,000 22,642 34,642 $51,642 $ 5,500 11,500 17,000 $10,992 12,150 16,000 $39,142 12,500 12,500 $51,642
EXERCISE 6-16B Operating Cycle: a. Cash Inventory Accounts Receivable Cash b. Length of operating cycle: 80 + 42 = 122 days
SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 6 PROBLEM 6-17B a. Separation of duties would help to prevent this type of theft. The functions of authorization, recording, and custody should be handled by different individuals. Reidel should not be authorizing reimbursements, recording the transactions, and having custody of the funds. The accounts payable clerk should check for proper authorization on petty cash vouchers. Also, if Reidel had been required to take an extended vacation, the fraud may have been detected in her absence. A background check would have revealed Bruton’s falsification of his resume. Physical control. Keep office supplies in a locked closet. Assign an employee to be responsible for custody and disbursement of the office supplies. Different individuals should periodically take inventory and reconcile the count to the inventory account.
PROBLEM 6-18B a. We Trade Bank Reconciliation August 31, 2006 Unadjusted Bank Balance, August 31, 2006 $17,000 Add: Deposit in Transit 2,260 Less: Outstanding Checks ( 3,000) True Cash Balance, August 31, 2006 $16,260 Unadjusted Book Balance, August 31, 2006 Add: Error in recording check for inventory Less: Debit Memo for new checks True Cash Balance, August 31, 2006 $16,000 360 (100) $16,260
b. General Journal Ref. 1. 2. Account Title Cash Inventory Office Supplies Expense Cash Debit 360 360 100 100 Credit
PROBLEM 6-19B Best Auto Supply, Inc. Bank Reconciliation May 31, 2007 Unadjusted Bank Balance, May 31, 2007 Add: Deposits in Transit Bank Error Less: Outstanding Checks #3013 3054 3056 True Cash Balance, May 31, 2007 Unadjusted Book Balance, May 31, 2007 Add: Note Collected by Bank Error in recording payment for utilities Less: Collection Fee Bank Service Charge NSF Checks True Cash Balance, May 31, 2007 $8,000 $ 975 650 385 735 1,900 1,625
(3,020) $6,605 $5,565*
$ 500 700 10 25 125
*Unadjusted cash balance per Best Auto Supply’s books is computed as: x + $1,200 − $160 = $6,605; x = $5,565.
PROBLEM 6-20B General Journal Event No. a. b. c. d. e. f. g. h. Account Titles No Entry No Entry Office Supplies Cash Cash Notes Receivable No Entry Bank Service Charge Expense Cash No Entry Accounts Receivable Cash 31 31 22 22 9 9 330 330 Debit Credit
PROBLEM 6-21B a. Cooters Garage Bank Reconciliation March 31, 2002 Unadjusted Bank Balance, March 31, $16,000.00 2002 Add: Deposit in Transit 2,000.00 Less: Outstanding Checks #1469 $1,500.00 1470 102.00 (1,602.00) True Cash Balance, March 31, 2002 $16,398.00 Unadjusted Book Balance, March 31, 2002 Add: Credit Memo for Collection of Accounts Receivable Less: Error in Recording Check #1468 Debit Memo for Service Charges True Cash Balance, March 31, 2002 $16,868.00 175.00 $630.00 15.00 (645.00) $16,398.00
b. Account Titles Cash Accounts Receivable Equipment Cash Bank Service Charge Expense Cash Debit 175.00 175.00 630.00 630.00 15.00 15.00 Credit
PROBLEM 6-22B Assets = Liabiliti + es Event Numb er 1. 2. 3. 4. 5. Type of Event AE AS AU AE AS +− + − +− + = = = = = NA NA NA NA NA + + + + + Stockholders’ Equity Commo Retain n + ed Stock Earnin gs NA NA NA NA NA + + + + + NA + − NA +
PROBLEM 6-23B a. Account Title Accounts Receivable Cash b.
The clerk has collected cash from a customer on account. This required a book entry debiting cash and crediting accounts receivable. Instead of depositing the money, the clerk kept the money. Now the cash balance per books is higher than the cash balance per bank. The clerk hides the discrepancy by deducting a fictitious NSF check from the book balance. Separation of Duties. Do not allow the same person to record transactions, reconcile bank statements, record adjusting entries and have custody of the money.
PROBLEM 6-24B a. General Journal Event 1. 2. 3. Account Titles Petty Cash Cash No Entry Office Supplies Expense Miscellaneous Expense Meals Expense Transportation Expense Maintenance Expense Cash Short and Over Petty Cash Petty Cash Cash 14 25 75 80 22 2 218 218 218 Debit 250 250 Credit
b. The shortage is an insignificant amount and will increase total (miscellaneous) expenses. c. Event Number 1. 2. 3. 4. Type of Event AE No Effect AU AE
PROBLEM 6-24B (cont.) d. Effect of Events on the Financial Statements No. Cash 1. 2. 3. 4. (250) NA NA (218) Assets + + + + + Petty Cash 250 NA (218) 218 = Liab + Stk. . Equity = + Ret. Ear. = = = = NA NA NA NA + + + + NA NA (218) NA Rev. − Exp. = Net Inc. Cash Flows
NA NA NA NA
− NA − NA − 218 − NA
= NA = NA = (218) = NA
NA NA (218) ÒA NA
Classified Balance Sheet Assets Current Assets Cash Accounts Receivable Interest Receivable Supplies Inventory Prepaid Rent Total Current Assets Long-Term Assets Notes Receivable Office Equipment $52,000 Less: Accumulated (10,000) Depreciation Land Total Long-Term Assets Total Assets
$20,000 6,000 400 900 16,000 8,000
10,000 42,000 90,000
142,000 $193,30 0
Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable $ 1,800 Interest Payable 1,200 Salaries Payable 3,400 Unearned Revenue 16,000 Total Current Liabilities Long-Term Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity
Total Liab. & Stockholders’ Equity $193,30 0
PROBLEM 6-25B (cont.) Income Statement Sales Revenue Cost of Goods Sold Gross Margin Operating Expenses Operating Expenses Salaries Expense Total Operating Expenses Operating Income Non-Operating Items: Interest Revenue Gain on Sale of Equipment Interest Expense Net Income 800 10,000 (5,000) 5,800 $ 42,800 $ 34,000 154,000 (188,000) 37,000 $400,000 (175,000) 225,000
ATC 6-1 Financial Statement Analysis a. The current ratio can be computed from information provided on the balance sheet: $9,491÷$6,543=1.45 to 1.00 b. c. d. Cash and equivalents with accounts receivable in second place. $9,491÷$13,435=71% According to the footnote on “Long-term Debt and Interest Rate Risk Management,” there were no significant restrictions.
ATC 6-2 a.1. The information is analyzed as follows: Company 1 Significant amount of accounts receivable Very significant amount of property, plant and equipment No inventory This would be Southwest Airlines. Company 2 Small amount of accounts receivable Small amount of property, plant and equipment (as compared with the other companies) Large amount of inventory This would be Pier I Imports. Company 3 Significant amount of accounts receivable Significant amount of property, plant and equipment Small amount of inventory This would be Wendy’s.
ATC 6-2 (cont.) a.2. Classified Balance Sheets Southwest Airlines Assets Current Assets Cash Accounts Receivable Inventories Other Current Assets Total Current Assets Property, Plant and Equipment Property, Plant and Equipment Less, Allowance for Depr. Total Prop., Plant and Equip. Other Long-term Assets Total Assets Current Liabilities Accounts Payable Other Current Liabilities Total Current Liabilities Long-term Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liab. and Stkholders’ Equity $ 623,343 76,530 -0108,543 808,416 4,811,324 (1,375,631) 3,435,693 4,051 $4,248,160 Liabilities and Stockholders’ Equity $ 160,891 707,622 868,513 1,370,629 376,903 1,632,115 2,009,018 $4,248,160 $105,541 4,845 110,386 136,834 204,327 118,721 323,048 $570,268 $ 107,157 105,457 212,614 544,832 345,019 839,215 1,184,234 $1,941,680 $ 32,280 $ 234,262 4,128 66,755 220,013 35,633 29,057 44,904 285,478 381,554 355,015 (138,179) 216,836 67,954 $570,268 1,803,410 (537,910) 1,265,500 294,626 $1,941,680 Pier 1 Imports Wendy’s
ATC 6-2 (cont.) b. Some identifying characteristics include the following: Southwest Airlines: large amount of property, plant and equipment no inventories Pier I Imports large amount of inventory small amount of property, plant and equipment Wendy’s large amount of property, plant and equipment small amount of inventory
ATC 6-3 1. “The Company is responsible for the information presented in this Annual Report...” This is the management’s acknowledgment that the financial reports and the accounting practices on which these reports are based, are primarily its responsibility. Persons not knowledgeable about the role of the independent auditor sometimes believe the auditor has the primary responsibility for a company’s financial reporting practices. Although the independent auditor is responsible for conducting a proper audit and identifying situations when a company’s reporting is not in compliance with GAAP, the company’s management has the primary responsibility for the reports. 2. “This system is designed to provide reasonable assurance, at suitable costs...” This is an acknowledgment that no internal control system is foolproof, and that to try to design such a system would cost more than its value. It does not make sense to spend $1,000 to prevent a $5 theft. Nevertheless, the management at J. C. Penney believes its system provides reasonable assurance at a reasonable cost. 3 & 4. “Emphasis is placed on the careful selection, training, and development of professional managers...” This acknowledges that a good system of internal controls requires more than “checking up” on employees. Employees, including management, are less likely to make mistakes if they have the appropriate ethics and skill when hired, and if they are properly trained to do the job they are expected to perform. For example, if employees are formally told what types of activities involving suppliers the company considers to be unethical, employees are less likely to get themselves and J. C. Penney into trouble by engaging in unacceptable activities.
ATC 6-3 (cont.) 5. “...delegation of authority...” This is an acknowledgment that the top levels of management cannot make all decisions. A large organization requires that upper management delegate some decision-making authority to subordinates who have been properly selected and trained, and these employees must be trusted to do what is in the best interest of the company. 6. “...division of responsibility...” This relates to proper separation of duties. The company tries not to place an employee in a position where he or she can commit a fraud and then conceal that act. For example, the person with authority to write checks should not be the person responsible for reconciling the bank statements. 7. “Communication programs are aimed at assuring that established policies and procedures are disseminated and understood...” Management has the right and responsibility for establishing the business policies that will be used at a company. However, if the employees are not properly informed of these policies, they cannot be expected to follow them. An example of how policies are communicated throughout an organization would be the use of “procedures manuals.”
ATC 6-4 a. b. Code-Breakers: Cipher-Tec1.27 to 1 1.60 to 1 ($40,000 ÷ $25,000) ($70,000 ÷ $55,000)
Other things being equal, Code-Breakers would be able to pay its bills, in the shortrun, easier than Cipher-Tec because it has more current assets in relation to current liabilities. Because Code-Breakers has less of its total assets invested in current assets ($40,000 versus $70,000) it has more assets invested in long-term operational assets. Thus, one might expect Code-Breakers to have a higher return-on-assets ratio than Cipher-Tec.
ATC 6-5 a. Current Assets Cash Merchandise inventory Accounts receivable Totals Current Liabilities Wages payable Accounts payable Totals Current ratios: Stillman Tsay b. Current Assets (see above) Building Land Total Assets Current Liabilities (see above) Notes Payable Total Liabilities Stillman $ 80,000 80,000 45,000 $205,000 $ 60,000 90,000 $150,000 Tsay $110,000 80,000 50,000 $240,000 $ 70,000 120,000 $190,000 Stillman $15,000 30,000 35,000 $80,000 Stillman $20,000 40,000 $60,000 Tsay $ 25,000 55,000 30,000 $110,000 Tsay $ 25,000 45,000 $ 70,000
$ 80,000 ÷ $60,000 = 1.33 to 1.00 $110,000 ÷ $70,000 = 1.57 to 1.00
Debt to assets ratios: Stillman $150,000 ÷ $205,000 = 73.2% Tsay: $190,000 ÷ $240,000 = 79.2%
c. Based only on the information available in the problem:
Stillman appears to have the higher short-term financial risk, because its current ratio is lower than Tsay’s. Tsay appears to have the higher long-term financial risk because its debt to assets ratio is higher than Stillman’s.
ATC 6-6 Some of the procedures that should be suggested include: • Separation of duties. • Bonded employees. • Requiring days off and regular vacations. • Evaluation of the company’s system of internal control.
ATC 6-7 a. b. Because the credit was made directly to retained earnings and not recorded as revenue, the amount would not have appeared on the company’s income statement. Putman unwittingly entered into a criminal conspiracy. Unintentional involvement is a common feature of white-collar crime. Few people start out with the willful intent to engage in criminal behavior. They tend to become trapped by circumstances and pressures that result in gradual involvement into deeper and deeper levels of crime. The depth of their involvement frequently comes as a surprise. More lying on the part of Putman is likely to result in even deeper involvement in criminal activity. It is best to divorce yourself from unethical or illegal activity at the earliest possible time. Putman is probably better off to tell the truth. She may be able to plea bargain by expressing a willingness to cooperate in the investigation against Wheeler. The lesson here is not so much what is illegal or unethical as it is how to avoid becoming unintentionally involved in illegal or unethical behavior. The avoidance of unintentional involvement is a recurring theme in the ethics cases presented in the text. In asking Putman to be dishonest by originally subtracting the error from the bank’s unadjusted trial balance, and later by asking Putman to make a dishonest entry to adjust the cash account to coincide with the bank’s balance, Mr. Wheeler has proven himself a person of shady character. Mr. Wheeler is obviously only concerned about his own self interest. He is not the kind of person one would expect to be loyal. Unethical behavior is not usually applied on a selective basis. If a person is unethical in one arena, he can be expected to act the same way in other circumstances. It is not only unethical but also illegal to take the $18,000. The failure to report a known error to the bank would be considered to be a criminal act of embezzlement.
ATC 6-8 Using the EDGAR Database NOTE: This solution was accurate as of December 15, 2001. However, the EDGAR database is subject to update at any time, so this solution will likely be “dated” at the time you assign this case to your students.
These data are from the February 3, 2001 financial statements and dollar amounts are in thousands. a. b. c. d. Pep Boys current assets were $699,666 and its current liabilities were $590,459. Thus, its current ratio was 1.19 to 1.00. Merchandise inventory was the current asset with the largest balance. At $547,735 it comprised 78% of the current assets. Total assets were $1,906,204, so current assets were 37% of total assets. On its balance sheet Pep Boys shows currently maturing long-term debt of $197 ($197 thousand).
e. If Pep Boys were a manufacturer of auto parts, its current assets would probably
represent a smaller percentage of its total assets. This would be the result of it needing more equipment.
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