Questions

➢  Why should a company establish an internal control structure?

➢  Why are mechanical devices used in an internal control structure?

➢  Identify some features that could strengthen an internal control structure.

➢  Name several control documents used in merchandise transactions.

➢  What are the four objectives sought in effective cash management?

➢  List four essential features of internal control over cash receipts.

➢  The bookkeeper of a given company was stealing cash received from customers in payment of their accounts. To conceal the theft, the bookkeeper made out false credit memos indicating returns and allowances made by or granted to customers. What feature of internal control would have prevented the thefts?

➢  List six essential features of internal control over cash disbursements.

➢  What types of items cause the balance per ledger and the balance per bank statement to disagree?

➢  “The difference between a company’s Cash account balance and the balance on its bank statement is usually a matter of timing.” Do you agree or disagree? Why?

➢  Explain how transfer bank accounts can help bring about effective cash management.

➢  Describe the operation of a petty cash fund and its advantages. Indicate how control is maintained over petty cash transactions.

➢  When are entries made to the Petty Cash account?

 

Exercises

Exercise A State whether each of the following statements about internal control is true or false:

1. Those employees responsible for safeguarding an asset should maintain the accounting records for that asset.
2. Complete, accurate, and up-to-date accounting records should be maintained.
3. Whenever possible, responsibilities should be assigned and duties subdivided in such a way that only one employee is responsible for a given function.
4. Employees should be assigned to one job and should remain in that job so that skill levels will be as high as possible.
5. The use of check protectors, cash registers, and time clocks is recommended.
6. An internal auditing function should not be implemented because it leads the employees to believe that management does not trust them.
7. One of the best protections against theft is to hire honest, competent employees.
8. A foolproof internal control structure can be devised if management puts forth the effort.

Exercise B Concerning internal control, which one of the following statements is correct? Explain.

1. Broadly speaking, an internal control structure is only necessary in large organizations.
2. The purposes of internal control are to check the accuracy of accounting data, safeguard assets against theft, promote efficiency of operations, and ensure that management’s policies are being followed.
3. Once an internal control structure has been established, it should be effective as long as the formal organization remains unchanged.
4. An example of internal control is having one employee count the day’s cash receipts and compare the total with the total of the cash register tapes.

Exercise C The bank statement for Yarley Company at the end of August showed a balance of $ 12,862. Checks outstanding totaled $ 3,937, and deposits in transit were $ 5,990. If these amounts are the only pertinent data available to you, what was the adjusted balance of cash at the end of August?

Exercise D From the following data, prepare a bank reconciliation and determine the correct available cash balance for Reed Company as of 2010 October 31.

Balance per bank statement, 2010 October 31	$13,974
Ledger account balance. 2010 October 31	8,088
Proceeds of a note collected by bank not yet entered in
ledger (includes $500 of interest)	6,000
Bank service charges not yet entered by Reed Company	18
Deposit in transit	1,680
Outstanding checks:
No. 327	654
No. 328	288
No. 329	390
No. 331	252

Exercise E The following is a bank reconciliation for Brian company as of August 31.

Balance per bank statement, August 31		$ 7,470
Add:  Deposit in transit		5,676
		$13,146
Less: Outstanding checks		6,024
Adjusted balance, August 31		$ 7,122
Balance per ledger, August 31		$ 7,248
Add:  Error correction*		54
		$ 7,302
Less: NSF check	$150
Service and collection charges	30	180
Adjusted balance, August 31		$ 7,122

Prepare the journal entry or entries needed to adjust or correct the Cash account.

Exercise F On March 1 of the current year, Shelbey Company had outstanding checks of $ 15,000. During March, the company issued an additional $ 57,000 of checks. As of March 31, the bank statement showed $ 48,000 of checks had cleared the bank during the month. What is the amount of outstanding checks on March 31?

Exercise G Matson Company’s bank statement as of August 31, shows total deposits into the company’s account of $ 15,000 and a total of 14 separate deposits. On July 31, deposits of $ 410 and $ 330 were in transit. The total cash receipts for August were $ 19,000, and the company’s records show 13 deposits made in August. What is the amount of deposits in transit at August 31?

Exercise H Holder Company deposits all cash receipts intact each day and makes all payments by check. On October 31, after all posting was completed, its Cash account had a debit balance of $ 4,325. The bank statement for the month ended on October 31 showed a balance of $ 3,988. Other data are:

Outstanding checks total $ 425.

October 31 cash receipts of $ 838 were placed in the bank’s night depository and do not appear on the bank statement.

Bank service charges for October are $ 14.

Check No. 772 for store supplies on hand was entered at $ 405, but paid by the bank at its actual amount of $ 315.

Prepare a bank reconciliation for Holder Company as of October 31. Also prepare any necessary journal entry or entries.

Exercise I On August 31, Brighton Company’s petty cash fund contained coins and currency of $ 260, an IOU from an employee of $ 30, and vouchers showing expenditures of $ 120 for postage, $ 52 for taxi fare, and $ 138 to entertain a customer. The Petty Cash account shows a balance of $ 600. The fund is replenished on August 31 because financial statements are to be prepared. What journal entry is required on August 31?

Exercise J Use the data in the previous exercise. What entry would have been required if the amount of coin and currency had been $ 247.20? Which of the accounts debited would not appear in the income statement?

Exercise K Rock Company has a $ 450 petty cash fund. The following transactions occurred in December:

Dec. 2 The petty cash fund was increased to $ 1,350.

8 Petty Cash Voucher No. 318 for $ 14.20 delivery expense was prepared and paid. The fund was not replenished at this time.

20 The company decided that the fund was too large and reduced it to $ 1,120.

Prepare any necessary journal entries for these transactions.

Problems

The following 2010 June 30, bank reconciliation pertains to Tiffany Company:

		Cash	Bank
		Amount	Statement
Balance , June 30		$29,143.36	$28,644.31
Add: Deposit not credited by bank			942.60
Total			$29,586.91
Less: Outstanding checks:
No. 724	$18.45
No. 886	15.00
No. 896	143.55
No. 897	187.65
No. 898	78.90		443.55
Adjusted cash balance, June 30		$29,143.36	$29,143.36

Tiffany’s July bank statement follows:

Balance, July 1		$28,644.31
Deposits during July		5,441.94	$34,086.25
Canceled checks returned:
No. 724	$ 18.45
No. 896	143.55
No. 897	187.65
No. 898	78.90
No. 899	18.86
No. 900	1,349.55
No. 902	946.92
No. 904	44.01	$2,787.89
NSF Check of Starr Company		139.98	2,927.87
Bank statement balance, July 31			$31,158.38

The cash receipts deposited in July, including receipts of July 31, amounted to $ 5,178.30. Tiffany wrote these checks in July:

No. 899	$ 18.86
No. 900	1,349.55
No. 901	27.75
No. 902	946.92
No. 903	59.70
No. 904	44.01
No. 905	1,093.50
No. 906	15.00

The cash balance per the ledger on 2010 July 31, was $ 30,766.37.

Prepare a bank reconciliation as of 2010 July 31, and any necessary journal entry or entries to correct the accounts.

Problem B The following information pertains to Hughes Company as of 2010 May 31:

• Balance per bank statement as of 2010 May 31, was $ 59,410.
• Balance per Hughes Company’s Cash account at 2010 May 31, was $ 60,904.
• A late deposit on May 31 did not appear on the bank statement, $ 4,275.
• Outstanding checks as of May 31 totaled $ 7,614.
• During May, the bank credited Hughes Company with the proceeds, $ 6,795, of a note which it had collected for the company. Interest revenue was $ 45 of the total.
• Bank service and collection charges for May amounted to $ 18.
• Comparison of the canceled checks with the check register revealed that one check in the amount as $ 1,458 had been recorded in the books as $ 1,539. The check had been issued in payment of an account payable.
• A review of the deposit slips with the bank statement showed that a deposit for $ 2,250 of a company with a similar account number had been credited to the Hughes Company account in error.
• A $ 270 check received from a customer, R. Petty, was returned with the bank statement marked NSF.
• During May, the bank paid a $ 13,500 note of Hughes Company plus interest of $ 135 and charged it to the company’s account per instructions received. Hughes Company had not recorded the payment of this note.
• An examination of the cash receipts and the deposit tickets revealed that the bookkeeper erroneously recorded a check from a customer, C. Parker, of $ 1,458 as $ 1,944.
• The bank statement showed a credit to the company’s account for interest earned on the account balance in May of $ 450.

1. Prepare a bank reconciliation as of 2010 May 31.
2. Prepare the journal entry or entries necessary to adjust the accounts as of 2010 May 31.

Problem C The following transactions pertain to the petty cash fund of Carrington Company:

Nov. 2 A $ 450 check is drawn, cashed, and the cash placed in the care of the assistant office manager to be used as a petty cash fund.

Dec. 17 The fund is replenished. An analysis of the fund shows:

Coins and currency	$147.40
Petty cash vouchers for:
Delivery expenses	173.48
Transportation-In	111.12
Postage stamps purchased	15.00

31 The end of the accounting period falls on this date. The fund was not replenished. The fund’s contents on this date consist of:

Coins and currency	$ 352.05
Petty cash vouchers for:
Delivery expenses	31.65
Postage stamps purchased	36.30
Employee’s IOU	30.00

Present journal entries to record these transactions. Use the Cash Short and Over account for any shortage or overage in the fund.

Problem D The following transactions relate to the petty cash fund of Jarvis Wrecking Company

Apr. 1 The petty cash fund is set up with a $ 350 cash balance.

19 Because the money in the fund is down to $ 70.20, the fund is replenished.

Petty cash vouchers as follows:
Flowers for hospitalized employee (miscellaneous expense)	$84.38
Postage stampls	135.00
Office supplies	46.71

30 The cash in the fund is $ 193.07. The fund is replenished to include petty cash payments in this period’s financial statements. The petty cash vouchers are for the following:

Transportation-in	$64.12
Office supplies	92.81

May 1 The petty cash fund balance is increased to $ 400.

Prepare the journal entries to record these transactions.

Alternate problems

Alternate problem A The following data pertains to England Company:

Balance per the bank statement dated 2010 June 30, is $ 30,000.

Balance of the Cash in Bank account on the company books as of 2010 June 30, is $ 8,795.

Outstanding checks as of 2010 June 30, total $ 14,300.

Bank deposit of June 30 for $ 2,735 was not included in the deposits per the bank statement.

The bank had collected proceeds of a note, $ 22,612 (of which $ 112 was interest), that it credited to the England Company account. The bank charged the company a collection fee of $ 15 on the note.

The bank erroneously charged the England Company account for a $ 10,500 debit memo of another company that has a similar name.

Bank service charges for June, exclusive of the collection fee, amounted to $ 95.

Among the canceled checks was one for $ 700 given in payment of an account. The bookkeeper had recorded the check at $ 920 in the company records.

A check of Crosby, a customer, for $ 2,447, deposited on June 20, was returned by the bank marked NSF. No entry has been made to reflect the returned check on the company records.

A check for $ 1,435 of Malcolm, a customer, which had been deposited in the bank, was erroneously recorded by the bookkeeper as $ 1,570. The check had been received as a payment on the customer’s account receivable.

Prepare a bank reconciliation as of 2010 June 30, and any necessary journal entry or entries to correct the accounts.

Alternate problem B The bank statement of Irish Company’s checking account with the 2nd National Bank shows:

Balance, 2010 June 30		$166,118
Deposits		245,700
		411,818
Less: Checks deducted	$243,001
Service charges	67	243,068
Balance, 2010 July 31		$168,750

The following additional data are available:

Balance per ledger account as of July 31 was $ 128,209.

A credit memo included with the bank statement indicated the collection of a note by the bank for Irish Company. Proceeds were $ 13,500, of which $ 375 was interest.

An NSF check in the amount of $ 6,210 was returned by the bank and included in the total of checks deducted on the bank statement.

Deposits in transit as of July 31 totaled $ 33,750.

Checks outstanding as of July 31 were $ 55,350.

The bank added the $ 29,025 deposit of another company to Irish’s account in error.

The bank deducted one of Irish’s checks as $ 20,250 instead of the correct amount of $ 2,025.

Deposit of July 21 was recorded by the company as $ 4,299.75 and by the bank at the actual amount of $ 4,542.75. The receipts for the day were from collections on account.

The deposits amount shown on the bank statement includes $ 675 of interest earned by Irish on its checking account with the bank.

1. Prepare a bank reconciliation as of 2010 July 31, for Irish Company.
2. Prepare any journal entry or entries needed at 2010 July 31.

Alternate problem C Transactions involving the petty cash fund of Sonar Company are as follows:

Mar. 1 Established a petty cash fund of $ 750, which will be under the control of the assistant office manager.

31 Fund was replenished on this date. Prior to replenishment, the fund consisted of the following:

Coins and currency	$ 491.50
Petty cash voucher indicating disbursements for:
Postage stamps	$82.00
Suppliers money for office employees working overtime	36.00
Office supplies	32.70
Window washing service	60.00
Flowers for wedding employee	15.00
Flower for hospitalized employee	15.00
Employee’s IOU	15.00

Present journal entries for these transactions. Use the Cash Short and Over account for any shortage or overage in the fund.

Alternate problem D Sun Company has decided to use a petty cash fund. Transactions involving this fund follow:

June 4 Set up a petty cash fund of $ 225.

22 When the fund had a cash amount of $ 31.35, the custodian of the fund was reimbursed for expenditures made, including:

Transportation-in	$ 82.50
Postage	27.00
Office supplies	81.75

30 The fund was reimbursed to include petty cash items in the financial statement prepared for the fiscal year ending on this date. The fund had the following cash and vouchers before reimbursement:

Coins and currency	$174.00
Petty cash vouchers for:
Employee’s IOU	15.00
Postage	27.00
Office supplies	11.10

July 1 The petty cash fund balance is increased to $ 300.

Prepare journal entries for all of these transactions.

Beyond the numbers—Critical thinking

Business decision case A During a national emergency, a managerial accountant was called back to active duty with the US Army. An acquaintance of the accountant forged papers and assumed the identity of the accountant. He obtained a position in a small company as the only accountant. Eventually he took over from the manager the functions of approving bills for payment, preparing and signing checks, and almost all other financial duties. On one weekend, he traveled to some neighboring cities and mailed invoices made out to the company for which he worked. On Monday morning, he returned to work and began receiving, approving, and paying the invoices he had prepared. The following weekend he returned to the neighboring cities and cashed and deposited the checks in bank accounts under his own name. After continuing this practice for several months, he withdrew all of the funds and never was heard from again.

Prepare a written list of the steps you would have taken to prevent this theft. Remember that this small company had limited financial resources.

Business decision case B John Billings was set up in business by his father, who purchased the business of an elderly acquaintance wishing to retire. One of the few changes in personnel made by Billings was to install a college classmate as the office manager-bookkeeper-cashier-sales manager. During the course of the year, Billings borrowed money from the bank with his father as cosigner. Although his business seemed profitable, there was a shortage of cash. The company’s investments in inventories and receivables grew substantially. Finally, after a year had elapsed, Billings’s father employed you, a certified public accountant, to audit the records of his business. You reported that the office manager-bookkeeper-cashier-sales manager had been misappropriating funds and had been using a variety of schemes to cover his actions. More specifically, he had:

• Pocketed cash receipts from sales and understated the cash register readings at the end of the day or altered the copies of the sales tickets retained.
• Stolen checks mailed to the company in payment of accounts receivable, credited the proper accounts, and then debited fictitious receivables to keep the records in balance.
• Issued checks to fictitious suppliers and deposited them in accounts bearing these names with himself as signer of checks drawn on these accounts; the books were kept in balance by debiting the Purchases account.
• Stolen petty cash funds by drawing false vouchers purporting to cover a variety of expenses incurred.
• Prepared false sales returns vouchers indicating the return of cash sales to cover further thefts of cash receipts.

For each item in the preceding list, describe in writing at least one feature of good internal control that would have prevented the losses due to dishonesty.

Business decision case C The outstanding checks of Brothers Company at 2010 November 30, were:

No. 229	$ 1,000
No. 263	$ 1,089
No. 3678	$ 679
No. 3679	$809
No. 3680	$ 1,400

During December, Brothers issued checks numbered 3681-3720; and all of these checks cleared the bank except 3719 and 3720 for $ 963 and $ 726, respectively. Checks 3678, 3679, and 3680 also cleared the bank.

The bank statement on December 31 showed a balance of $ 23,944. Service charges amounted to $ 20, and two checks were returned by the bank, one marked NSF in the amount of $ 114 and the other marked “No account” in the amount of $ 2,000.

Brian Askew recently retired as the office manager-cashier-bookkeeper for Brothers Company and was replaced by Fred Hannah. Hannah noted the absence of an internal control structure but was momentarily deterred from embezzling for lack of a scheme of concealment. Finally, he hit upon several schemes. The $ 2,000 check marked “No account” by the bank is the product of one scheme. Hannah took cash receipts and replaced them with a check drawn on a nonexistent account to make it appear that a customer had given the company a worthless check.

The other scheme was more subtle. Hannah pocketed cash receipts in an amount equal to two unlisted outstanding checks and prepared the following bank reconciliation:

Balance per bank statement, 2010 December 31		$23,944.00
Add:  Deposit in transit		2,837.80
		$26,781.80
Less: Outstanding checks
No. 3719	$ 963.00
No. 3720	726.00	1,689.00
Adjusted balance, December 2010		$25,092.80
Balance per ledger, 2010 December 31		$27,226.80
Add:  Worthless check	$2,000.00
NSF check	114.00
Service charges	20.00	2,134.00
Adjusted balance, 2010 December 31		$25,092.80

1. State the nature of the second scheme hit on by Hannah. How much in total does it appear he has stolen by use of the two schemes together?
2. Prepare a correct bank reconciliation as of 2010 December 31.
3. After your analysis in (a) and (b), describe several procedures that would have defeated Fred Hannah’s attempts to misappropriate funds and conceal these actions.

*Note: This challenging problem was not specifically illustrated in the chapter, but it can be worked by applying the principles discussed in the chapter.

Annual report analysis D In Reader’s Digest’s Annual Report, under Report of Management, the chairman and chief executive officer and the executive vice president and chief financial officer stated:

The company maintains a system of internal accounting controls designed to provide reasonable assurance, at reasonable cost, that transactions and events are recorded properly and that assets are safeguarded. The internal control system is supported by written policies and procedures and by the careful selection, training, and supervision of qualified personnel, and is monitored by an internal audit function.

What is the purpose of this statement? To which basic elements of the internal control structure does the statement refer?

Annual report analysis E Obtain an annual report for a company (your library may have some annual reports). Determine the quick ratios for the two most recent years for the company. Comment on the results.

Ethics case – Writing experience F After reading the ethics case, discuss the ethical situation at the City Club Restaurant. Describe the steps the owners could take to end John Blue’s wage supplement scheme.

Group project G With a small group of students, visit a large local company to inquire about its internal control structure. Specifically, discover how it protects its assets against theft and waste, ensures compliance with company policies and federal laws, evaluates performance of its personnel, and ensures accurate and reliable operating data and accounting reports. If an internal audit staff exists, inquire about some of its activities. Write a report to your instructor summarizing your findings and be prepared to make a short presentation to the class.

Group project H With one or two other students, locate and visit two companies that maintain petty cash funds. Interview the custodians of those funds to identify the controls that are used to manage those funds. Write a report to your instructor comparing the controls used, pointing out any differences between the control systems and any deficiencies in the systems. Be prepared to make a short presentation to the class.

Group project I “Kiting” of bank accounts has been used to conceal shortages in bank accounts. With one or two other students, research this topic in the library. Write a paper to your instructor describing how this technique works and the steps that can be taken to detect it once it occurs and to prevent it in the future.

Using the Internet—A view of the real world

Visit the following site:

http://www.vfauditmall.com/

This is the internet site for the Vanity Fair Audit Mall. Click on the visitors center, CCA Studio, Tool Box, Job Shop, Tek Shak, Risk Depot, Contact Plaza, and Arcade. After browsing the site write a one page memo as to what you learned about internal audit.

Visit the Securities and Exchange website and find the EDGAR database at:

http://www.sec.gov/edgar.shtml

EDGAR stands for the Electronic Data Gathering, Analysis, and Retrieval system. What is its purpose? What kinds of information can be found at this site? Select a company of your choice and search the EDGAR database for information on that company. Write a report to your instructor summarizing your findings.