financial accounting tools for business decision making solutions 7e chapter 07

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CHAPTER INTERNAL CONTROL AND CASH LEARNING OBJECTIVES Explain the primary components of an internal control system, including its control activities and limitations Apply the key control activities to cash receipts and payments Prepare a bank reconciliation Explain the reporting and management of cash SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT Questions 1 C C 11 C 16 2,3 C 21 K C C 12 C 17 C 22 C C 13 C 18 C 23 C K 1 C C 14 C 19 C 24 C C 10 C 15 2,3 C 20 C 25 C 13 AP Brief Exercises 1 C 1,2 K AN 10 AP K C AN 11 AP 1,2 K AN AP 12 C Exercises 1 C 1,2 C AP 10 AN C AP AP 11 E 1,2 C AP AP Problems: Set A and B 1,2 C 1,2 AN AP 10 C 1,2 AN AP 1,2 AN AP AP 11 C AN Accounting Cycle Review 3,4 AP 1 C C E C 1,2 S 1,2 C Cases Solutions Manual -1 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legend: The following abbreviations will appear throughout the solutions manual file LO Learning objective BT Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Difficulty: Time: AACSB CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006 Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech Diversity Diversity Reflective Thinking Reflec Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation Solutions Manual -2 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ANSWERS TO QUESTIONS The five primary components of a good internal control system include the control environment, risk assessment, control activities, information and communication, and monitoring A control environment encourages integrity and a high standard of ethical behaviour Risk assessment involves identification and management of key business risks Control activities are policies and procedures to help mitigate the business risks Information and communication ensures that the internal control system captures and communicates the appropriate information to internal and external users Monitoring the internal control system for its adequacy is a recurring process LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Management is responsible for establishing a company’s control environment Since management is responsible for the preparation and delivery of accurate and fair financial statements, it follows that management should also be responsible for the internal control system that generates the financial information communicated to the users of that information LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting When designing and explaining to all employees the system of internal control of the company, management must be clear as to their expectations concerning what actions all employees must take and the consequences of not following management’s policies and procedures Those individuals in top management must set the correct tone by strictly adhering to the company policies and procedures and providing a consistent example and message to all employees This conformance will demonstrate commitment on the part of management to the importance of the internal control system and environment for all concerned and the pledge to administer consequences to anyone not following their lead LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -3 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition The five control activities that apply to most companies are assignment of responsibility, segregation of duties, documentation, physical controls, and review and reconciliation LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Documentation procedures contribute to good internal control by providing evidence of the occurrence of transactions and events and, when signatures (or initials) are added, the documents establish responsibility for the transactions The prompt transmittal of documents to the accounting department contributes to recording transactions in the proper period, and the pre-numbering of documents helps to ensure that a transaction is recorded only once LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Independent review and reconciliation by internal auditors is necessary because employees can forget to, or intentionally fail to, follow internal controls, or they might become careless if there is no one to observe and evaluate their performance Segregating the physical custody of assets from accounting record keeping is not enough to ensure that nothing has been stolen or recorded incorrectly A performance review still needs to be done to ensure these controls were working effectively LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit External auditors are required to be independent of the organization they audit This independence provides the reassurance needed by external users and owners of the organization about the financial condition and performance of the business depicted in the financial statements Independence provides the proper environment to arrive at appropriate accounting and disclosure conclusions, particularly when judgement is involved Internal auditors are not independent of the organization as they are employees of the organization Their role is to assist management in their responsibility to provide a proper internal control system and environment LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit Solutions Manual -4 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition A company’s system of internal control can only give reasonable assurance that assets are properly safeguarded and that accounting records are reliable because the cost of a perfect system outweighs its benefits For example, if a company wanted flawless accounting records, they could double the number of accountants on staff and have the new accountants check all of the work that was done by experienced accountants but the benefit of this is outweighed by the costs Absolute assurance is too costly Furthermore, even if cost was not a factor, human error and collusion cannot be eliminated LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Collusion occurs when two or more employees agree to circumvent procedures or controls or get around control activities in an organization in order to gain an advantage or to cover up theft or fraud The internal control activity that is most affected by collusion is the segregation of employees’ duties LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 10 Electronic funds transfers normally result in better internal control since no cash or cheques are handled by employees, thereby limiting the possibility of misappropriation However, controls over EFT payments (and collections) need to be put in place LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 11 This is a violation of the assignment of responsibility control activity Each cash register should only be used by one employee and an independent verification of the cash in each register at the end of each shift should be compared to the total of the sales recorded in the cash register plus the float (coins and paper currency for making change) in the register If a discrepancy arises, the employee responsible for that register can be held responsible LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -5 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 12 Financial Accounting, Seventh Canadian Edition Cash registers are visible to the customer Thus, they prevent the sales clerk from ringing up a lower amount for the price and pocketing the difference In addition, the customer receives an itemized receipt, and the cash register tape is locked into the register for further verification Having scanners reduces the chance of error in entering the price of an item LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 13 This statement is true if the alternative to a cheque payment is a cash payment It is not always practical to make all payments by cheque, but payment by cheque contributes to effective internal control over cash disbursements as it provides a record of all payments Also, having only authorized individuals sign the cheques reduces the likelihood of payments being made for unauthorized amounts or to unauthorized vendors LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 14 The receptionist has an opportunity to commit fraud In the case of an appointment where the customer pays cash, the cash can be pocketed by the receptionist The receptionist can then cancel the appointment, leaving no trace in the accounting records of the revenue generated by the service This is a clear case of lack of segregation of duties LO BT: C Difficulty: C Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 15 An employee who has no other responsibilities that relate to cash should prepare the bank reconciliation If a person had responsibility for handling cash and also prepared the bank reconciliation, they could use the bank reconciliation to hide fraud by falsifying the bank balance or misstating reconciling items LO 2,3 BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 16 A bank contributes significantly to internal control over cash because it: (1) safeguards cash on deposit, (2) minimizes the amount of cash that must be kept on hand, and (3) provides another record of all bank transactions LO 2,3 BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -6 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 17 Financial Accounting, Seventh Canadian Edition The lack of agreement between the cash balances may be due to either: (1) Timing differences—caused by recording a transaction on the company’s books in one month and the bank recording it another month (example – outstanding cheque) or the bank recording a transaction first which the company will record after completing the bank reconciliation (example – a bank service charge, or an NSF cheque) (2) Errors—made by either the company or the bank For example, a cheque for $110 is recorded by the depositor at $101 LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 18 (a) (b) (c) An NSF cheque is a cheque issued by a customer that was recorded by the company when it was received and then deposited in the bank only to discover later that the customer did not have the funds to cover the cheque payment An NSF cheque makes the bank balance lower than the book balance and requires the book balance to be updated Consequently, it is deducted from the balance per books An NSF cheque results in an entry in the company’s books, as a debit to Accounts Receivable and a credit to Cash (assuming the cheque deposited was a collection on account) The debit to Accounts Receivable includes any additional charge that the bank may add for their services with respect to the NSF cheque or the company may add for late payment LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 19 Since the March cheque has still not cleared the bank at April 30, it must be included in the April 30th bank reconciliation as an outstanding cheque LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -7 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 20 Financial Accounting, Seventh Canadian Edition When performing a bank reconciliation, outstanding cheques are subtracted from the bank balance to “move” that balance closer to the one recorded on the company’s books Since the bank balance is lower than the book balance by the amount of this fraud, Sam will understate the amount of outstanding cheques on the reconciliation For example, if there was no fraud, let’s assume that the bank balance would be $5,000 and that the outstanding cheques were $3,000 so the book balance should be $2,000 After the fraud, the book balance is still $2,000 but the bank balance is now $3,300 instead of $5,000 When Sam prepares the reconciliation he has to make sure that the $3,300 will reconcile to $2,000 so he will list the outstanding cheques as only $1,300, thereby understating them by the amount of cash he has stolen The real outstanding cheques of $3,000 less the stolen amount of $1,700, equals $1,300 LO BT: C Difficulty: C Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 21 Cash includes cash on hand and cash in bank accounts Cash equivalents include short-term, highly liquid held-for-trading investments less any bank overdrafts Together, these two amounts combine and are reported as cash and cash equivalents in the current assets section of the statement of financial position LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting 22 Restricted cash is not available for general use, as it is restricted for a special purpose When the restricted purpose is of a long-term nature, the restricted cash is reported as a non-current asset If it is expected to be used within one year of the statement of financial position date, it would be classified as a current asset and disclosed in the financial statements Compensating balances are minimum cash balances which lenders specify that a borrower must maintain in the borrower’s bank account to provide support for a loan A compensating balance should be reported as a non-current asset and the details of the loan conditions should be disclosed in the notes to the financial statements LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -8 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 23 Financial Accounting, Seventh Canadian Edition The line of credit facility of $16 million does not represent a liability until Brandon Corporation borrows (or draws) money under the line of credit In the notes to the financial statements, the terms of the line of credit and its available limit of $16 million should be reported to demonstrate how the business is well positioned to deal with future cash flow demands or to take advantage of investment opportunities LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 24 The basic principles of cash management are: (1) increase the speed of collection on receivables, (2) keep inventory levels low, (3) delay payment of liabilities, (4) plan the timing of major expenditures, (5) invest idle cash, and (6) prepare a cash budget The first three principles are ways to increase cash on hand The last three principles focus on making sure management understands when cash balances will be high so that investment income can be earned from idle cash and when cash balances will be low so that bank loans or other financing can be obtained LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 25 Having too much cash on hand may hinder a business’ performance if the cash cannot be used effectively and therefore not give a proper return to the shareholders Effective uses of cash can include upgrading existing property, plant, and equipment, expanding the business, paying down debt, repurchasing shares, or paying dividends LO BT: C Difficulty: C Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -9 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 Control Activity Example Assignment of Responsibility One person operates the cash register at the exit of the parking garage Segregation of duties Tickets are provided to those entering the garage by an automated machine This ticket is given to the attendant on exiting the parking garage In this way, the attendant does not authorize the parking and collect the cash Documentation The time on the ticket is entered into a machine to determine the amount owed, which is keyed into the cash register before the gate will open In this way the total time in the parking garage is recorded Physical controls Cash is kept in a cash register Review and reconciliation If a customer is overcharged, they will complain Review to make sure parking gate is not being raised prior to payment being received Reconcile the number of parking tickets issued to the amount of cash received LO BT: C Difficulty: M Time: 15 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual -10 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR7-1 (CONTINUED) Jan (c) and (e) (continued) Bank Loan Payable 20,000 Dec 31, 2017 Jan 31 Bal Common Shares Dec 31, 2017 Retained Earnings Dec 31, 2017 Sales Jan 13 Jan 26 Jan 31 Jan 31 Bal Jan 13 Jan 26 Jan 31 Jan 31 Bal Cost of Goods Sold 122,000 68,000 35,000 225,000 Jan 18 Jan 31 Jan 31 Bal Salaries Expense 36,000 36,000 72,000 2,000,000 1,980,000 250,000 589,000 216,000 126,000 50,000 392,000 Jan 31 Depreciation Expense 31,667 Jan 31 Interest Expense 4,950 Jan 31 Supplies Expense 3,200 Jan 31 Bank Charges Expense 38 Jan 31 Income Tax Expense 16,000 Solutions Manual -61 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR7-1 (CONTINUED) (d) 2018 Jan 31 31 31 31 31 Depreciation Expense Accumulated DepreciationEquipment ($2,280,000 ữ ì 1/12 = $31,667) 31,667 Interest Expense Interest Payable [($2,000,000 - $20,000) x 3% x 1/12)] = $4,950 4,950 Supplies Expense Supplies ($3,000 + $1,500 – $1,300 = $3,200) 3,200 Salaries Expense Salaries Payable 36,000 Income Tax Expense Income Tax Payable 16,000 31,667 4,950 3,200 36,000 16,000 Solutions Manual -62 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR7-1 (CONTINUED) (f) MATCHETT FABRICATIONS LTD Adjusted Trial Balance January 31, 2018 o Cash Accounts receivable Supplies Inventory Equipment Accumulated depreciation—equipment Accounts payable Interest payable Salaries payable Unearned revenue Income tax payable Bank loan payable Common shares Retained earnings Sales Cost of goods sold Salaries expense Depreciation expense Interest expense Supplies expense Bank charges expense Income tax expense Debit $ 174,162 1,025,800 1,300 405,000 2,280,000 Credit 411,667 464,500 4,950 36,000 95,000 16,000 1,980,000 250,000 589,000 392,000 225,000 72,000 31,667 4,950 3,200 38 16,000 $4,239,117 000000000 $4,239,117 Solutions Manual -63 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR7-1 (CONTINUED) (g) (1) MATCHETT FABRICATIONS LTD Income Statement Month Ended January 31, 2018 Sales Cost of goods sold Gross profit Operating expenses Salaries expense Depreciation expense Supplies expense Bank charges expense Total operating expenses Income from operations Other revenues and expenses Interest expense Total other revenues and expenses Income before income tax Income tax expense Net income $392,000 225,000 167,000 $72,000 31,667 3,200 38 106,905 60,095 (4,950) (4,950) 55,145 16,000 $ 39,145 (g) (2) MATCHETT FABRICATIONS LTD Statement of Changes in Equity Month Ended January 31, 2018 Balance, January Net income Balance, January 31 Common Shares $250,000 0000 000 $250,000 Retained Earnings $589,000 39,145 $628,145 Total Equity $839,000 39,145 $878,145 Solutions Manual -64 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR7-1 (CONTINUED) (g) (3) MATCHETT FABRICATIONS LTD Statement of Financial Position January 31, 2018 Assets Current assets Cash Accounts receivable Supplies Inventory Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Total assets $ 174,162 1,025,800 1,300 405,000 1,606,262 $2,280,000 411,667 1,868,333 $3,474,595 Liabilities and Shareholders’ Equity Current liabilities Accounts payable Interest payable Salaries payable Unearned revenue Income tax payable Bank loan payable – current portion * Total current liabilities Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity $464,500 4,950 36,000 95,000 16,000 240,000 $ 856,450 1,740,000** 2,596,450 $ 250,000 628,145 878,145 $3,474,595 * $20,000 principal payment per month x 12 months = $240,000 ** Balance $1,980,000 less current portion of $240,000 = $1,740,000 LO 3,4 BT: AP Difficulty: M Time: 90 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual -65 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-1 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE The second paragraph of the Management’s Responsibility for Financial Statements clearly states that management is responsible for establishing and maintaining an appropriate system of internal controls In addition, a statement is made in this paragraph that the role of internal auditors of the company is to perform a review and evaluation of internal controls to provide management with the reasonable assurance that assets are safeguarded, transactions are authorized and recorded and that the financial records are reliable In the Independent Auditor’s Report, the auditor considers the internal controls relevant to the company’s preparation and fair presentation of the financial statements Following this study of internal controls, the auditor designs audit procedures that are appropriate under the circumstances in order to express an opinion on the financial statements (b) Management has the primary responsibility for the system of internal control as indicated in the answer to (a) above The auditor points out in the second paragraph of the Independent Auditor’s Report that management is responsible for internal control that will enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error The auditor is not responsible for the design or effectiveness of internal controls and does not express an opinion as to their effectiveness Nonetheless, the auditor does consider the internal controls in the design of their audit, as noted in (a) above (c) Management has the primary responsibility for the preparation and presentation of the financial statements This responsibility is mentioned in both reports The very first sentence of the Management’s Responsibility for Financial Statements states this responsibility and then the auditor repeats the statement in the second paragraph of the auditor’s report LO BT: C Difficulty: M Time: 15 AACSB: Communication CPA: cpa-t001, cpa-t004 CM: Reporting and Audit Solutions Manual -66 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-2 Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE (a) North West’s cash reported at January 31, 2016 is $37,243,000 (b) Sobeys reported cash and cash equivalents at May 7, 2016 of $258.8 million (c) North West Cash January 31, 2016 North West Cash January 31, 2015 Increase in cash for 2016 Increase as a % ($8,114 ÷ $29,129) Sobeys May 7, 2016 Sobeys May 2, 2015 Decrease in CCE Decrease as a % ($36,800 ÷ $295,600) $37,243,000 29,129,000 8,114,000 27.9% $258,800,000 295,600,000 (36,800,000) 12.4% North West’s cash position has improved while Sobeys’ has declined LO BT: C Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual -67 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-3 Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE (a) Generally, the accounting standards a company follows should not have a significant impact on its internal controls However, since IFRS is more principles-based and relies more upon professional judgment than ASPE, companies need to have controls in place to assess decisions that have been made when making various calculations These types of controls would rely heavily upon review, reconciliation, and approval (b) Strong internal controls are essential for proper recording of transactions and the preparation of financial statements to ensure the usefulness of this information for decision-making by external users Publicly traded companies have more external users of their financial statements than private companies By reporting on the effectiveness of their internal controls over financial reporting, public companies provide their stakeholders with important information on the quality of the process used to produce the financial statements Also, because management must prepare a report, it must assess the effectiveness of controls on an ongoing basis Many people argue that this will help identify any weaknesses in the systems, as well as fraud and error, on a timely basis LO BT: C Difficulty: M Time: 15 AACSB: Communication CPA: cpa-t001 CM: Reporting Solutions Manual -68 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-4 (a) Financial Accounting, Seventh Canadian Edition PROFESSIONAL JUDGEMENT CASE Vanessa should report several internal control weaknesses for the hotel operations to her father Patrick Chen: For the room rental portion of operations: • The opportunity exists for unrecorded room rental revenues Patrons who pay cash may have access and use of the room but the revenue from the rental remains unreported and the desk clerk pockets the cash collected • Friends can gain access to rooms and related services without any charges and without any revenue to the hotel For bar revenues: • The bartender has the opportunity to bring in inventory purchased personally and resold at the bar, while keeping the cash receipts from sales • Revenue from bar sales may go unrecorded as the bartender is too busy to enter sales in the cash register For parking lot revenues: • The opportunity exists for the attendant to understate the amount of parking revenue collected, while pocketing the cash • Friends of the attendant may be allowed parking without having to pay any fees (b) It will not always be possible to establish how much money has been lost or stolen from the hotel While some errors or omissions can be measured, such as room rentals, unrecorded liquor sales will be very difficult to measure since the liquor sold may not have come from inventory purchased Solutions Manual -69 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT7-4 (CONTINUED) (c) A general recommendation concerning hiring family members applies in this case for all of the hotel’s operations Collusion between management and its employees to defraud the hotel is heightened when the employees are members of the general manager’s family In addition, the following steps can be taken to avoid the possibility of fraud in the future: For the room rental portion of operations: • A daily reconciliation should be prepared, by someone other than the desk clerk, which compares the report for the number of rooms cleaned to the number of room rented For bar revenues: • A division of duty should be established between the person having access to inventory and the person handling cash receipts • Supervision of the handling of the inventory and the handling of the cash should be done whenever possible Any change in the normal procedures, such as was the case in the handling of the tequila, should be cause for termination • A daily check should be made comparing the amount of revenues reported from bar sales to the inventory consumed For parking lot revenues: • Install the automated payment system which will remove the attendant’s opportunity to understate revenues and pocket cash LO 1,2 BT: S Difficulty: C Time: 40 AACSB: Communication CPA: cpa-t001 CM: Reporting Solutions Manual -70 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-5 Financial Accounting, Seventh Canadian Edition ETHICS CASE (a) The stakeholders are the customers affected by the policy, the shareholders of the banks who want to see higher net income, and the management of the banks who make the decisions regarding fees and cheque processing policies (b) (1) If the bank processes cheque #3158 for $1,510 first it will bounce due to non-sufficient funds as the balance in the account is only $1,500 All of the other cheques to be processed after that will also bounce so consequently all cheques will bounce and the total NSF processing fees charged by the bank will be $225 (5 × $45) (2) If the bank processes the smallest cheques first, the smallest cheques will clear processing and the largest ones will bounce By processing the cheques in this way, the bank will earn a processing fee of only $90 (2 x $45) (c) Whether this is ethical is subject to debate On the one hand, it can be argued that customers have a responsibility to maintain an adequate balance in their accounts Some customers are frequently overdrawn; thus only severe penalties will persuade them to maintain an adequate balance However, it could also be argued that processing cheques from largest to smallest is “gouging” and takes unfair advantage of the customer (d) In deciding what approach to take, the bank must consider its relationship with the customer For customers who not write NSF cheques frequently, it probably does not matter which approach is taken Any customer that is frequently overdrawn may not be the type of customer that the bank is willing to deal with over the long term so it may be beneficial to other account holders to treat those who are always overdrawn as severely as possible If the “largest to smallest” policy is used by all banks, customers won’t gain an advantage by switching accounts to other banks if this policy angers them (e) Answer will vary depending on students’ opinions LO BT: E Difficulty: M Time: 30 AACSB: Ethics and Analysis CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics Solutions Manual -71 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT7-6 Financial Accounting, Seventh Canadian Edition SERIAL CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) The strengths in ABC’s system of internal control and related control activity are as follows: Strength Password access to the cash register Control Activity Physical controls Cash register calculates the pricing of the Documentation goods and prints receipt Cash is deposited daily Physical controls Owners are involved in the reconciliation Review and reconciliation of cash with totals from the cash register Review and reconciliation Inventory is counted monthly Doug or Bev authorize the purchase of Assignment of responsibility inventory The monthly payroll schedule is Review and reconciliation reconciled to actual salaries paid Invoices are prepared when the services Documentation have been performed Solutions Manual -72 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT7-6 (CONTINUED) (b) The weaknesses in ABC’s system of internal control and the control activities violated are as follows: Weaknesses Control Activity Employees share one cash register and Assignment of responsibility management currently is unable to affix responsibility for cash to a specific employee Segregation of duties Cashier is handling cash and inventory Entering transactions can be performed by incorrect cashier, due to no logging off No mention of supervision of employees entering sales and handling inventory No mention of procedures for voided transactions or pricing adjustments on sales Reconciliation of sales is not done daily and so one cannot establish who has made an error on a sale Inventory is counted monthly to determine what products to reorder, but should also be used to determine unrecorded sales No system in place to avoid duplication of purchases Documentation of authorized overtime is not obtained Invoices for services are not prenumbered Physical controls Segregation of duties Assignment of responsibility Review and reconciliation Review and reconciliation Review and reconciliation Documentation Documentation Invoices are not issued in duplicate - Documentation photocopies have to be made and if staff forget to make a photocopy, sales could go unrecorded Solutions Manual -73 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT7-6 (CONTINUED) (b) (continued) In order to address the weaknesses, improvements that ABC’s management should consider include: Program the cash register such that a new transaction cannot be entered without the operator logging off from the previous transaction Reconcile the sales to the deposit daily and establish the responsibility of errors to the particular employee causing the error Provide supervision of employees or install cameras to ensure that all sales are recorded Design procedures involving owners for voiding or altering the pricing for transactions entered Compare and reconcile the reduction of inventory to the sales recorded daily Implement the use of pre-numbered invoices that are printed in duplicate copies that cannot be altered Account for the numerical sequence of invoices Consider automating the production of invoices Install a log of purchase orders made to avoid duplication of orders LO 1,2 BT: Difficulty: C Time: 50 AACSB: Communication CPA CM: Reporting Solutions Manual -74 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legal Notice Copyright © 2017 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXVII VI F2) Solutions Manual -75 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... and Decision- Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting. .. organization about the financial condition and performance of the business depicted in the financial statements Independence provides the proper environment to arrive at appropriate accounting and disclosure... work performed on files for individual clients Invoice clients monthly as work progresses, using the accounting records established for docketing time To the extent practicable, ask clients for retainers