The quoted statement is not accurate.

In their work on cash, auditors are primarily

concerned with the risk of an overstatement of the cash balance. The listing of a

non-existent or fictitious check on the outstanding list would have the effect of

understating the client’s cash position, because too large an amount for

outstanding checks would be deducted from the balance per bank, resulting in

understatement of the adjusted balance.

The other element of the quoted statement relating to the auditors’ concern over

the possible omission of a deposit in transit is also in error. To omit a deposit in

transit would cause an understatement of the year-end cash balance.

If the quoted statement were revised into acceptable form, it would read along the

following lines: “When auditors are verifying a client’s bank reconciliation, they

are particularly concerned with the possibility that an outstanding check may be

omitted or that a non-existent deposit in transit may be included.

7-2. There is no assurance that the lapping activities of the cashier will be discovered

during the annual audit. Since no shortage exists as of the balance sheet date, the

only procedure which might disclose the irregularities would be a comparison of

the individual checks listed on duplicate deposit tickets with the credits to

customers’ accounts. Since a test of this nature would probably not be made for

more than a small sample of control listings it is likely that the “borrowing” and

subsequent restoration of borrowed funds might go undetected.

7-3. (a) “Lapping” is a defalcation in which a cash shortage is concealed by delaying

the crediting of cash receipts to the proper accounts receivable. The first step

in the fraud is to withhold from a bank deposit cash remitted by a customer.

A few days later, because the customer must receive credit for his remittance,

the first customer’s account is credited with an amount from a remittance

made by a second customer. The process requires the continuous shifting of

shortages from account to account and the crediting of subsequent receipts to

the wrong account receivable.

(b) The following audit procedure1. The primary purpose of the statement of cash flows is to
provide cash-basis information

about the company’s operating, investing, and financing activities.

2. The statement of cash flows provides information to help investors and creditors assess

the cash and noncash investing and financing transactions during the period.

3. Companies classify some cash flows relating to investing or financing activities as

operating activities.

4. The first step in the preparation of the statement of cash flows is to determine the net cash

flow from operating activities.

5. The net increase (decrease) in cash reported on the statement of cash flows should

reconcile the beginning and ending cash balances reported in the comparative balance

sheets.

6. Under the accrual basis of accounting, net income is usually the same as net cash flow

from operating activities.

7. A company can convert net income to net cash flow from operating activities through

either the direct method or the indirect method.

8. The direct method, also called the reconciliation method, reports cash receipts and cash

disbursements from operating activities.

9. The indirect method adjusts net income for items that affected reported net income but did

not affect cash.

10. The FASB encourages the use of the indirect method over the direct method.

11. When accounts receivable decrease during a period, cash-basis revenues are higher than

revenues reported on an accrual basis.

12. When prepaid expenses decrease during a period, expenses on the accrual-basis are

lower than they are on a cash-basis.

13. Income from an investment in common stock using the equity method is added to net

income in computing net cash provided from operating activities.

14. Cash receipts from customers are computed by adding a decrease in accounts receivable
to revenue from sales.

15. Cash payments for operating expenses are computed by subtracting an increase in

prepaid expenses and a decrease in accrued expenses payable from operating expenses.

16. A company should add back bond premium amortization to net income to arrive at net

cash flow from operating activities.s would be used to uncover lapping:

(1) Compare the detail of mailroom control listings (if prepared) to entries in

the cash receipts journal, postings to the accounts receivable subsidiary

ledger, and the detail of authenticated duplicate deposit slips. This depositing incoming cash
receipts.

(2) If control listings are not prepared, compare the remittance advices

received with customers’ checks to the cash journal entries, postings to

accounts receivable, and deposit slips. If the client stamps remittance

advices with the date received, particular attention should be given to

comparing this date with the date of the related journal entry and posting.

(3) Confirm accounts receivable and give close attention to exceptions made

by customers about payment dates. The confirmation procedure is better

applied as a surprise at an interim date so that a person engaged in

lapping will not have been able to bring the “lapped” accounts up to date.

If the confirmations are always prepared at year-end, the confirmation

procedure may be anticipated by the person doing the lapping and the

shortage given a different form such as kiting of checks. (Confirmation

of accounts receivables has not been discussed in this chapter, but some

students may be familiar enough with this procedure to include it in their

answer.)

7-4. West, Inc.

The outstanding checks said by the controller to have been distributed after

December 31 should be reversed to the extent that they were actually distributed

after that date. An actual overdraft should be revealed and not eliminated by
improper journal entries. The primary purpose of the reversal is to properly cut

off the cash and show the proper cash balance. Showing the correct cash balance

eliminates “window dressing”; recorded but undistributed checks would distort

the current ratio by reducing both cash and accounts payable.

7-5. Cavite Company

Requirement (a) Adjusting Journal Entries - 12.31.05

AJE (1) Gas and oil 320

Supplies expense 260

Delivery expense 320

Repairs and maintenance 600

Advances to employees 400

Petty cash fund 1,900

(2) Advances to employees 200

Petty cash fund 200

(3) Accounts receivable - cashier 100

Petty cash fund 10

a. Cashed checks

1. Examine checks as to payee, date, endorsements and subsequent

deposit.

2. Determine if checks were cashed with prior approval of a responsible

official.

b. Vouchers not yet replenished

1. Vouch supporting documents, invoices, etc.

2. Examine vouchers as to approval by authorized officials, signature of

payee, etc.

c. NSF checks

1. Determine reason why NSF checks are still on hand.

2. Confirm directly with drawers.

d. Return of excess travel advance

1. Examine liquidation of travel advance as reported and determine

accuracy of the amount returned.

2. Vouch supporting invoices.

e. Sale of money orders

1. Examine latest report of the Pampanga Co. to establish proper

accountability.

2. Confirm directly with the Pampanga Co. all unreported money orders

sold as well as unissued as of November 10.

f. Vouchers subsequently presented

1. Examine vouchers as to date, approval, amount and nature of

expenditures.

2. Confirm directly with employees those items representing wage

advance.

g. Book balance of the Petty Cash Fund.

1. Trace to the general ledger the balance of the fund.

240,000 + $$370,000 + $226,000 = $836,000.

90. a $480,000 + $740,000 + $452,000 = $1,672,000.

91. a $37,500 – $11,250 = $26,250.

92. b $26,250 + ($750,000 × 0.70) = $551,250.

93. c $1,800,000 – $1,500,000 = $300,000.

94. b ($1,000,000 – $250,000) ÷ 250,000 sh. = $3.00.

95. d $1,000,000 ÷ 400,000 sh. = $2.50.

96. d $350,000 ÷ 100,000 sh. = $3.50.

97. c ($500,000 – $60,000) ÷ 125,000 = $3.52.

98. c ($500,000 – $60,000) ÷ 250,000 = $1.76.

99. b (₤1,000,000 – ₤100,000) ÷ 150,000 = ₤6.00.

100. d ($800,000 – X) ÷ 160,000 = $4.25.

$800,000 – X = $680,000 = $120,000.

101. a (₤3,900,000 – ₤10,000 – ₤7,500) × 0.20 = ₤776,500.

102. b ₤30,000 – (₤30,000 0.20) = ₤24,000.

103. c [(₤3,900,000 – ₤10,000 – ₤7,500) 0.20] + (₤30,000 0.20) = ₤782,500.

104. c $100,000 × 0.60 = $60,000.

105. c $300,000 × 0.60 = $180,000.

106. b ($262,000 – $37,000 + $8,000) × 0.40 = $93,200.

107. a ($377,000 + $23,000 + $6,000) × 0.30 = $121,800.

108. a ($110,000 – $60,000 – $8,000 – $11,000 + $9,000 – $1,000 – $2,000) x

0.40 = $14,800.

109. a $2,500,000 – $430,000 = $2,070,000.

110. b $2,500,000 – $430,000 + $1,000,000 – $320,000 = $2,750,000.

111. c $1,200,000 + $215,000 = $1,415,000.

112. d $1,200,000 + $215,000 + $500,000