Chapter 12 Solutions Administrative Processes and Controls

Concept Check
1. c
2. d
3. b
4. b
5. b
6. b
7. a
8. d
9. b
10. a

Discussion Questions
11. (SO 1) What characteristics of administrative processes are different from the
characteristics of revenue, expenditure, or conversion processes?
The characteristics of administrative processes that are different from revenue,
expenditure, or conversion processes are the frequency of occurrence and the
extent of management authorization. Whereas revenue, expenditure, and
conversion processes typically occur on a regular, recurring basis (usually daily),
administrative processes occur on a non-regular basis, either as the need arises or
on a periodic basis. Therefore, revenue, expenditure, and conversion processes
usually involve established procedures and controls that allow these processes to
occur without intervention or specific authorization by management. Administrative
processes, on the other hand, typically require that specific authorization for each
transaction would be necessary.

12. (SO) How do other processes (revenue, expenditure, conversion) affect the general
ledger?
Revenue, expenditure and conversion processes affect the general ledger
periodically through the administrative processes of financial reporting. This is the
process of funneling all of the transactions into the general ledger accounts so they
can be included in various financial reports.

13. (SO 2) How would you describe capital?

Capital can be described as the funds used to acquire the long-term capital assets of
an organization. Capital usually comes from long-term debt or equity.

14. (SO 2) Describe the nature of the authorization of source of capital processes.
Source of capital processes are those processes that authorize the raising of capital,
the execution of raising capital, and the proper accounting of that capital. Because
of the magnitude and importance of these methods of raising capital, these financial
instruments should be used only when necessary. The transactions and resulting
processes related to loans, bonds, and stock should be executed only when

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management authorizes, and the use of the resulting capital must be properly
controlled and used.

15. (SO 2) How does the specific authorization and management oversight of source of
capital processes affect internal controls?
Since top management authorizes and controls the capital transaction processes,
there is inherent control. The fact that these transactions and processes cannot
occur without specific authorization and oversight by top management is a strong
internal control.

16. (SO 3) Describe when an organization would have a need to undertake investment
processes.
An organization would need to undertake investment processes when it finds that it
has more funds on hand than necessary to operate the business. The proper
performance of the stewardship function would suggest that management should
park (or invest) the excess funds in a place that it can earn a return.

17. (SO 3) Why is the monitoring of funds flow an important underlying part of
investment processes?
The monitoring of funds flow is an important part of the investment process because
funds should be invested only if management has no immediate plans for their use.
Therefore, future cash needs of the organization should be monitored regularly in
comparison with cash balances to determine if there are excess funds available for
investment.

18. (SO 3) How are IT systems potentially useful in monitoring funds flow?
IT systems can help management to monitor the organization’s cash needs by
forecasting future cash payments and collections. The system can continually
compare current cash balances to forecasted needs and sources and provide
feedback to top management about potential excess funds that would be available
for investing.

19. (SO 4) Explain how cash resulting from source of capital processes may be handled
differently than in revenue processes.
The cash resulting from source of capital processes is likely to be handled differently
than in revenue processes because of the large sums of money involved in source
of capital transactions. Whereas collections from revenue processes are typically
handled by the organization’s employees, these employees are not likely to handle
the large sums of cash that tend to result from stock sales or other source of capital
transactions. Instead the funds are usually transferred electronically between
brokers and banks.

20. (SO 4) What advantages would motivate management to conduct fraud related to
source of capital processes?
Management may be motivated to conduct fraud through the source of capital
processes because of the large sums of money that tend to result from these

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transactions. In addition, there is a lack of traditional controls covering this process;
there are no other employees responsible for reporting or controlling these
transactions. Internal controls are not as effective in this area because of their non-
regular occurrence and their dependence on close scrutiny by top management and
the auditors. The opportunity is greater for management to perpetrate fraud in this
process than for other more routine processes.

21. (SO 4) Why are internal controls less effective in capital and investment processes?
Internal controls are not as effective in this area because of their non-regular
occurrence and their dependence on close scrutiny by top management and the
auditors. The opportunity is greater for management to perpetrate fraud in this
process than for other more routine processes.

22. (SO 5) How is a special journal different from a general journal?

A special journal is a chronological record of specific types of transactions (such as
a sales journal, purchases journal, cash receipts journal, etc.); whereas a general
journal records irregular, non-recurring transactions that are not included in a special
journal.

23. (SO 5) How is a subsidiary ledger different from a general ledger?

A subsidiary ledger is a detailed record of routine transactions, with an account
established for each entity; whereas a general ledger is a summary of information
from special journals, with specific accounts established for each type of transaction.
A subsidiary ledger is updated whenever new transactions occur. A general ledger
is updated periodically for the summarization of the special journal details.

24. (SO 5) In what way are subsidiary ledgers and special journals replicated in
accounting software?
Subsidiary ledgers and special journals are replicated in accounting software as they
are summarized for the general ledger postings at the end of the period. Although
transaction recording in the special journals and subsidiary ledgers takes place at
the time the transaction occurs, their replication in the general ledger is an end-of-
period summarization process.

25. (SO 6) Within accounting software systems, what is the purpose of limiting the
number of employees authorized to post to the general ledger?
Limiting the number of employees authorized to post to the general ledger allows
management to give general authority to certain employees to post to the general
ledger. Through the assignment of limited access to the general ledger module,
management can limit the capability of general ledger posting to selected
employees. When an employee with the appropriate access level logs into the
accounting system, he can process the general ledger posting. Employees who
have not been given access to general ledger posting will be unable to post to the
general ledger. In this manner, management may be able to prevent the recording
of unauthorized general ledger transactions.

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Chapter 12 Solutions Administrative Processes and Controls
26. (SO 6) In a complex IT system, how may a customer actually “authorize” a sale?
A customer may actually authorize a sale in a complex IT environment when their
inventory systems interact. For example, When a customer’s inventory levels fall
below an establish reorder point, the IT system may authorize a transfer of products
from the supplier to the customer. This means that the sale and subsequent update
of sales and receivable accounts are triggered by the customer’s computer system.
Therefore, these systems require pre-existing and negotiated relationships between
buyer and seller companies. Both parties must have already approved these
processes and established IT systems that execute the processes.

27. (SO 6) To properly segregate duties, what are the three functions that general ledger
employees should not do?
Three important segregations should be in place in a manual general ledger system.
The three segregations are that the general ledger employees should record journal
vouchers, but they should not (1.) authorize journal vouchers, (2.) have custody of
assets, or (3.) have responsibility for recording the transactions in the subsidiary
ledgers.

28. (SO 6) In an IT accounting system, which IT controls assure the security of the
general ledger?
In an IT accounting system where the records are electronic file images, access to
the system is limited through the use of user IDs, passwords, and resource authority
tables. These general controls establish which employees have access to specific
records or files.

29. (SO 7) Describe the nature of reports for external users.

Since external users do not need detailed balance information on every existing
account in the general ledger, certain accounts may be combined or “rolled up” into
a single line item that appears on a financial statement. This summary process may
occur for all of the line items on the general purpose financial statements. The four
general purpose financial statements, the balance sheet, income statement,
statement of cash flows, and statement of retained earnings, are each derived from
general ledger account balances. These general ledger balances are rolled up in
such a manner as to provide summarized information that is useful to evaluate
business performance.

30. (SO 7) Does the general ledger provide all information necessary for internal
reports?
The general ledger does not provide all information necessary for internal reports.
Internal reports often rely on information from various parts of the organization. For
instance, manufacturing, retail, service, and charitable organizations would each use
different types of information to manage the details of their revenue and expenditure
processes. In each of these scenarios, non-financial information is often useful to
managers in order to supplement the financial information derived from the general
ledger. In addition, there may be detailed financial and non-financial information in
an organization’s accounting system that is useful for internal reporting purposes but

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Chapter 12 Solutions Administrative Processes and Controls
may not be readily apparent in the general ledger. In addition, internal reports may
contain past or future information that is not included in the current period’s general
ledger.

31. (SO 7) How would operational internal reports differ from financial internal reports?
Operational internal reports focus on non-financial details of operations, such as
machine hours, down-time, inventory and sales units, headcounts for human
resources, etc. These types of operational reports may not be prepared from data in
the general ledger. However, as transactions are recorded in the accounting
processes, financial as well as non-financial data is accumulated. Therefore, the
accounting system often records both financial and operational data that can be
used in reports. Financial reports, on the other hand, are prepared directly from
ledgers, journals, and other accounting records.

32. (SO 7) How does time horizon affect the type of information in internal reports?
In day-to-day management, managers are more likely to use unit measures and
physical counts. For time horizons of one month or longer, however, managers are
more likely to use financial measures such as those generated by information in the
general ledger.

33. (SO 8) Why are managers, rather than employees, more likely to engage in
unethical behavior in capital and investment processes?
There are three main reasons why management may be more likely to engage in
unethical behavior in the capital and investment processes:
 Employees typically do not have access to the assets or records in the
capital and investment processes. These assets and records are
controlled by management because of their non-routine nature and
because of the high amounts of related funds.
 Internal controls for these processes are dependent upon the close
scrutiny and specific authorization of top management, whereas
employees typically have no authority over these types of transactions.
However, managers are most likely to be tempted to alter or hide financial
information in an effort to improve the appearance of the organization’s
financial results for investors and creditors.
 The non-routine nature of these transactions makes it more difficult to hide
fraudulent transactions. Fraud as committed by employees would be
much easier to hide within the volumes of transactions in the routine
processes like revenues, expenditures, etc.

34. (SO 8) How do processes with large volumes of transactions make fraudulent
behavior easier?
The routine nature and large volumes of transactions in the processes for sales,
purchases, payroll, etc. make it easier for employees to hide fraudulent transactions
or unethical behavior. Fraud may be hidden in the large masses of transactions
within these processes.

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Chapter 12 Solutions Administrative Processes and Controls
35. (SO 8) Explain the importance of full disclosure in source of capital processes.
Full disclosure is extremely important in the source of capital processes so that
creditors can be fully informed of all relevant information in making credit decisions.
Accordingly, financial reports and other disclosures must be complete and accurate
in order to avoid misleading any current or potential creditors.

Brief Exercises
36. (SO 2) Describe the steps in source of capital processes and explain how top
management is involved.
When the need for capital arises, the Board of Directors is consulted for approval
and for determination of whether debt of equity capital will be pursued. If equity
capital is chosen, a stock underwriter will be contracted to sell the shares of stock
and collect the proceeds. The company will need to determine whether or not to pay
dividends. If debt capital is chosen, the company will need to decide whether it
should issue bonds or borrow the funds. If bonds are chosen, the company will
contract with a bond underwriter, who will sell the bonds and collect the proceeds, as
well as handle the periodic payment of interest. If funds are borrowed,
arrangements must be made for the bank loan by contracting with creditors. The
proceeds will be collected and periodic interest will be paid. Throughout this
process, management is involved in most of these steps. Management would
present the need for capital to the Board of Directors. Depending on the source of
capital determined by the Board, management would then be responsible for
contracting with the appropriate party (stock or bond underwriter or bank creditor).
Finally, management would be involved in the arrangements for collecting proceeds
from the source of capital processes as well as the payment of interest or dividends.

37. (SO 3) Describe the steps in investment processes and explain how top
management is involved.
When excess funds are identified, they are to be evaluated in comparison with
upcoming needs of the organization. If it is decided that the excess should be
invested, the type of investment must be determined. The company may invest in
marketable securities, in which case it would contract with a stock broker to buy
stocks or bonds (and sell these securities as necessary). Alternatively, the company
may invest in treasury stock, in which case it would contract with a stock broker to
buy the treasury shares and reissue shares as desired. Throughout this process,
management involvement occurs at many points. Management is responsible for
monitoring cash flows to determine if excess funds exist and if they are available for
investment or needed for upcoming operations. Management would also be
responsible for contracting with a stock broker for the purchase of stocks, bonds, or
treasury stock (as well as the subsequent sale of these investments, as needed).

38. (SO 4) Explain the internal control environment of source of capital and investment
processes.
For both source of capital and investment processes, the important control is the
specific authorization and oversight by top management. The very close supervision

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Chapter 12 Solutions Administrative Processes and Controls
of these transactions helps prevent risks related to the theft or misuse of the cash
that is related to capital and investment processes. In addition, the large sums of
money involved in capital and investment decisions usually dictates that the cash not
be handled by the regular company employees. Instead, the funds are likely to be
transferred electronically between brokers and banks. Because of the high risk of
management fraud in these processes and the potential for management
circumvention of controls, typical internal controls such as segregation of duties and
reconciliations are not as effective in the prevention or detection of fraud surrounding
these processes. As an added control feature, auditors are often urged to carefully
examine capital and investment transactions.

39. (SO 5) Describe the steps in a manual accounting cycle.

When a transaction occurs, it must be identified as either routine or non-routine.
Routine transactions are recorded in a special journal and subsidiary ledger; non-
routine transactions are recorded in the general journal. At the end of the day,
week, or other period, the journals and ledgers are summarized and posted to the
general ledger. General ledger totals are summarized in a trial balance, and end-of-
period adjusting entries are prepared. The adjusted general ledger is used to
prepare financial statements. Once the financial statements are completed, closing
entries are prepared, then the cycle may begin anew.

40. (SO 6) Describe why it is true that there may be two authorizations related to sales,
revenue, and conversion processes before they are posted to the general ledger.
In a properly controlled accounting system, transactions within the revenue and
conversion processes must be authorized before they are carried out. In addition,
another authorization is needed to begin the process of posting entries from the
special journals and subsidiary ledgers to the general ledger. Thus, there may be
two authorizations related to these routine processes.

41. (SO 8) For each report below, indicate whether the report is likely to be for internal
or external users (some reports may be both), and whether data would come
exclusively from the general ledger. The format would be:

Report Name Internal or External Exclusively G/L Data?

The reports are:
Income statement External Yes
Aged accounts receivable Both No
Inventory stock status Internal No
Open purchase orders Internal No
Machine down-time Internal No
Cash flow statement External No
Production units produced Internal No

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Chapter 12 Solutions Administrative Processes and Controls

Problems
42. (SO 1, SO 2) Compare the source of capital processes to sales processes in terms
of:
a. The frequency of transactions
b. The volume of transactions
c. The magnitude in dollars of a single transaction
d. The manner of authorization
Compared with the sales processes, (a. and b.) source of capital processes
occur much less frequently and in smaller volumes. Whereas sales transactions
typically occur on a daily basis (and may even occur several times per day),
source of capital transactions tend to occur in small volumes and on an irregular
basis. Often, there may be only a few times within any given annual period that a
source of capital transaction occurs. In addition, (c.) the magnitude of an
individual source of capital transaction tends to be much greater than for an
individual sales transaction. Finally, (d.) whereas routine sales transactions are
usually authorized by employees having general authorization privileges, source
of capital transactions require specific authorization of management.

43. (SO 1, SO 3) Compare the investment processes to sales processes in terms of:
a. The frequency of transactions
b. The volume of transactions
c. The magnitude in dollars of a single transaction
d. The manner of authorization
Compared with the sales processes, (a. and b.) investment processes occur
much less frequently and in smaller volumes. Whereas sales transactions
typically occur on a daily basis (and may even occur several times per day),
investment transactions tend to occur in small volumes and on an irregular
basis. Often, there may be only a few times within any given annual period
that an investment transaction occurs. In addition, (c.) the magnitude of an
individual investment transaction tends to be much greater than for an
individual sales transaction. Finally, (d.) whereas routine sales transactions
are usually authorized by employees having general authorization privileges,
investment transactions require specific authorization of management.

44. Exhibit 12-9 shows a screen capture from Great Plains accounting software. The
following modules in Great Plains are shown:

Financial
Sales
Purchasing
Inventory
Payroll
Manufacturing
Fixed Assets

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Chapter 12 Solutions Administrative Processes and Controls
For each of the transactions listed, explain which module would you choose and
why.

a. Entering an invoice received from a supplier.

b. Entering the receiving of materials at the shipping dock.
c. Enter a check received in payment of an account receivable.
d. Posting a batch of sales invoices to the general ledger.
e. Enter hours worked by employees.
f. Print checks for suppliers

a. Entering an invoice received from a supplier- this would fall under the
Purchasing module. The purchasing module is appropriate because it
would record the purchase or expenditure in the purchases journal, as well
as the related payable to the supplier in an accounts payable subsidiary
ledger.
b. Entering the receipt of material at the shipping dock – this would fall under
the Inventory module. The inventory module is appropriate because it
would record the items on hand and the movement of goods available for
production.
c. Entering a check received in payment of an account receivable – this
would fall under the Sales module. The sales module is appropriate
because it would include collections of sales in the cash receipts journal
and the related customer accounts in the accounts receivable subsidiary
ledger.
d. Posting a batch of sales invoices to the general ledger – this would fall
under the Financial module. The financial module is appropriate because
it includes all accounting cycle functions, including the summarization of
special journals and their posting to the general ledger.
e. Entering hours worked by employees – this would fall under the Payroll
module. The payroll module is appropriate because it records all periodic
workforce activities in a payroll journal.
f. Printing checks for suppliers – this would fall under the Purchasing
module. The purchasing module is appropriate because it would record
the payment to the supplier in an accounts payable subsidiary ledger as
well as the related release of funds in a cash disbursements journal.

45. Ebbicott Industries internal control weaknesses.

Weakness 1: Cam prepares and posts journal vouchers. Journal vouchers
should be prepared by the personnel in the other processes of revenue,
expenditures, payroll, and conversion. Those journal vouchers should be
forwarded to Cam for posting.
Weakness 2: The journal vouchers are not prenumbered. Journal vouchers
should be prenumbered and the sequence should be accounted for. Any missing
numbers in sequence should be reconciled or explained.
Weakness 3: Journal vouchers are frequently voided or revised. While it may not
be possible to completely eliminate such errors, voided and revised journal

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Chapter 12 Solutions Administrative Processes and Controls
vouchers should occur rarely.
Weakness 4: Journal vouchers are posted biweekly. Ideally, they should be
posted more frequently, and at least weekly.
Weakness 5: The voucher log is chronological. It should be in order of the
prenumbered sequence.
Weakness 6: Cam reconciles the subsidiary accounts to the control accounts in
the general ledger. Reconciliation is a good internal control, but ideally,
someone other than cam should do this reconciliation.
Weakness 7; The general journal reconciliation occurs bimonthly. It should be
reconciled at the end of each month.

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