Solution manual financial accounting 9th harrison ch04

Find more at www.downloadslide.com Chapter Internal Control & Cash Short Exercises (5 min.) S 4-1 Fraud is an intentional misrepresentation of facts, made for the purpose of persuading another party to act in such a way that causes injury or damage to that party The Three Components of the Fraud Triangle Motive — Fraud generally results from either critical need or greed on the part of the perpetrator Regardless of whether the driving force is need or greed most perpetrators are driven to attempt to acquire something that belongs to others Opportunity — The opportunity to commit fraud usually arises through weak internal controls Rationalization — The perpetrator(s) is (are) convinced, in their own minds, that they deserve the object of the fraudulent behavior They may believe no one else will ever know or even that everybody else is engaging in fraudulent behavior Chapter Internal Control & Cash 4-1 Find more at www.downloadslide.com (5-10 min.) S 4-2 COMPONENTS OF INTERNAL CONTROL Control environment — Top managers must set the “tone at the top” to establish a control environment Risk assessment — Each company must evaluate its own risks, based upon its particular line of business Control procedures — Specific procedures are needed for a good system of internal control Monitoring of controls — Auditors can monitor a company’s actions and its financial statements Information system — Accurate information is essential for success in business Student responses may vary for the descriptions (5-10 min.) S 4-3 Separation of duties is essential for safeguarding assets The person who has custody of an asset should not also account for the asset A person who performs both duties can steal the asset and hide the theft by making a false entry in the accounting records Student responses may vary 4-2 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 4-4 There are several major internal control procedures as discussed in the chapter besides separation of duties: Smart hiring practices The company should be careful to hire both competent and honest personnel Smart hiring practices involve conducting background checks on job applicants, as well as training and supervision on the job Comparisons and compliance monitoring No person or department should be allowed to completely process a transaction from beginning to end without being checked by another person or a computer program Examples of comparisons and compliance monitoring are the use of operating and cash budgets Also, in key functions, one employee (or a computer program) double checks the work of another for accuracy Adequate records help to assure that sufficient hard copy documents or electronic information is kept by the entity to support the validity of transactions that were processed Examples include sales invoices, purchase orders, shipping records, and customer remittance advices Among the benefits of adequate records is the ability to provide an audit trail later for internal or external auditors to follow in auditing the entity’s financial statements Limited access goes hand in hand with separation of duties to assure that only authorized individuals are allowed access to (a) the assets of the company, such as cash or inventory; and (b) the records Generally, Chapter Internal Control & Cash 4-3 Find more at www.downloadslide.com (continued) S 4-4 only people with custodial responsibilities (such as the cashier or the warehouse) should be allowed access to assets (such as cash or inventory) Only people with recordkeeping responsibilities (such as accountants) should have access to the company’s journals and ledgers Proper approvals No transaction should be processed without management’s general or specific approval Generally, the larger the transaction, the higher the organizational level of approval necessary Notice that the first letters of these attributes spell the acronym SCALP That’s an easy and comprehensive way to remember the control procedures involved in internal controls (10 min.) S4-5 A computer virus enters program code without your consent and performs destructive action to your computer files or programs A Trojan Horse is a malicious computer program that hides inside a legitimate program and works like a virus to corrupt your computer files or programs A phishing expedition can be a Web site that attracts visitors who may be tricked into revealing their account numbers, social security numbers, passwords, or other valuable data The creator of the Web site then uses the unsuspecting Web-site visitors’ data to steal from them and for other illicit purposes 4-4 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (20-30 min.) S 4-6 Cash is important not because of its amount as reported on the balance sheet, but because of its effect on a business All transactions ultimately affect cash Businesses purchase assets and must pay cash They make sales and collect cash All expenses ultimately require cash Also, cash is susceptible to theft because it is a medium of exchange These factors combine to give cash more importance than its account balance would suggest Student responses may vary (20-30 min.) S 4-7 Punching a hole through supporting documents reduces the opportunity for fraud Without this control procedure, a dishonest employee could resubmit documents for payment a second time The employee could change the payee’s address and have the check sent to an address the employee controls Or the employee could arrange to have the second payee split the payment with the employee Canceling the documents makes it difficult to get approval for a duplicate payment Student responses may vary Chapter Internal Control & Cash 4-5 Find more at www.downloadslide.com (10 min.) S 4-8 Rampart Corp Bank Reconciliation October 31, 2012 BANK Balance, October 31 Add: Deposit in transit BOOKS $3,675 Balance, October 31 $2,540 400 Add: Bank collection 4,075 670 Interest revenue 20 3,230 Less: Less: Outstanding checks Adjusted bank balance (900) $3,175 Service charge (30) NSF check (25) Adjusted book balance $3,175 Rampart has cash of $3,175 (5 min.) S 4-9 Journal DATE Oct 4-6 ACCOUNT TITLES AND EXPLANATION DEBIT 31 Cash……………………………………… Accounts Receivable……………… Collection on account 670 31 Cash……………………………………… Interest Revenue…………………… Interest earned on bank balance 20 31 Miscellaneous Expense……………… Cash…………………………………… Bank service charge 30 31 Accounts Receivable…………………… Cash…………………………………… NSF check 25 Financial Accounting 9/e Solutions Manual CREDIT 670 20 30 25 Find more at www.downloadslide.com (5 min.) S 4-10 It appears that the employee has stolen $710 (adjusted book balance, $4,400 − adjusted bank balance, $3,690) The adjusted bank balance is the company’s true cash balance, and the company books show more cash on hand Therefore, the books must be incorrect (5 min.) S 4-11 Sims will notice a gap in the sequence of sales receipts for the receipt that Cilla destroyed This knowledge will lead Sims to investigate what happened to the missing receipt and what happened to the related cash (10 min.) S 4-12 Paying by check carries three controls over cash:  The check provides a record of the payment  The check must be signed by an authorized official  Before signing the check, the official should study the evidence supporting the payment A dishonest purchasing agent could:  Purchase goods and have them delivered to his home or other location that he controls  Approve payment by the company for goods that he spent too much on, and then split the excess with the supplier Companies avoid this internal control weakness by separating the following duties related to the purchase of, and payment for, goods:  purchasing goods  receiving goods  approving and paying for goods Chapter Internal Control & Cash 4-7 Find more at www.downloadslide.com (5 min.) S 4-13 A cash budget starts with the beginning cash balance, adds budgeted cash receipts, and subtracts budgeted cash payments The result is cash available at the end of the period By comparing cash available to our budgeted cash balance, we can see whether we have cash available for additional investments, or if we’ll need new financing Student responses may vary (5-10 min.) S 4-14 Cooper Apple Growers Cash Budget Year 2011 Millions Cash balance, beginning $ Estimated cash receipts—total 103 111 Estimated cash payments—total (86) Cash available (needed) before new financing 25 Budgeted cash balance needed Cash available for additional investments 4-8 Financial Accounting 9/e Solutions Manual (20) $ Find more at www.downloadslide.com (5 min.) S 4-15 Rocker should report the errors to Doon because Doon is Rocker’s supervisor, and Doon is responsible for the errors If Doon fails to take action, then Rocker should report the errors to the manager of the organization In any event, outsiders who are relying on Dill Limited’s financial statements must be made aware of the need to correct the reported net income figure Chapter Internal Control & Cash 4-9 Find more at www.downloadslide.com Exercises (5-20 min.) E 4-16A a Munson has access to the cash collected, and he also prepares the cash report With access to both items, Munson can steal cash and falsify his cash report to conceal his theft b Fulton prepares the purchase order and also receives the goods She can add some items to the purchase order and have these extra items shipped to a location she controls When the goods come in, she checks the incoming shipment, so there’s no outside party to learn of her dishonesty Student responses may vary (10 min.) E 4-17A Cash payments: a Strong internal control There is a good separation of duties Supervisors request equipment, and the home office purchases the equipment b Weak internal control Supervisors request, purchase, and pay for equipment with little oversight by the home office Cash receipts: a Weak internal control There is not a good separation of duties The accountant both handles cash and accounts for cash b Strong internal control There is a good separation of duties Different people handle cash and account for cash 4-10 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) P 4-64 Check No 1880, 1882, and 1883 were outstanding in November so should not also be deducted from Cash in December The unexplained difference of $3,655 consists of $1,155 erroneous November outstanding checks and the $2,500 difference between deposit in transit listed on the original reconciliation and the amount of the deposit listed on the books It is possible that the $3,000 difference between the December 23 deposit on the books and the December 24 receipt on the bank statement was intentional and used to cover up the missing cash Chapter Internal Control & Cash 4-45 Find more at www.downloadslide.com Decision Cases (20-30 min.) Decision Case Environmental Concerns, Inc Bank Reconciliation September 30 BANK: Balance, September 30 $ 8,224 Add: Deposit of September 30 in transit 3,794 12,018 Less: Outstanding checks ($116 + $150 + $853 + $990 + $206 + $145) (2,460) Adjusted bank balance, September 30 $ 9,558 BOOKS: Balance, September 30 $10,402 Add: Bank collection 200 10,602 Less: Service charge NSF check Adjusted book balance, September 30 Adjusted balances not agree $ 36 (44) $10,558 Based on the above reconciliation, it appears the bookkeeper has stolen $1,000, the difference between the adjusted bank and book amounts ($9,558 − $10,558) He understated the total of outstanding checks by $1,000 to cover his theft 4-46 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Decision Case Benz should assign an employee with no cash-handling duties to prepare the bank reconciliation The bookkeeper should not perform this duty, because a person who handles cash and also prepares the reconciliation can steal cash and manipulate the reconciliation to cover the theft Perhaps Benz should prepare the reconciliation himself Chapter Internal Control & Cash 4-47 Find more at www.downloadslide.com (15-30 min.) Decision Case The internal control weakness in this case is a lack of separation of duties The foreman performs too many duties The foreman hires the workers The foreman controls workers’ employment documents The foreman fills out workers’ time sheets and transmits all documents to the home office The foreman passes out paychecks to workers The workers never go to the home office, so home-office personnel not even know whether all workers exist The foreman could steal from the company as follows: The foreman could enter a fictitious worker into the payroll system and fill out bogus time sheets for the fictitious employee Then the foreman could pocket the pay check written to the employee The foreman could enter more time than actually worked by an employee and arrange to split the extra pay received by the worker The foreman could pad his own hours to receive pay for time that he did not work The following actions will correct the internal control weakness: The home office could have the construction workers come to the office for processing their employee documents Then the home office would at least know that all the workers exist Have employees sign their own time sheets 4-48 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Decision Case Have a home-office employee compare signatures on the workers’ time sheets to their signatures on file and, occasionally, to their endorsements on the backs of their paychecks Occasionally — or always — have a home-office employee go to the construction site to pass out paychecks Have a home-office employee go to the construction site occasionally to “take attendance” of workers on duty that day Then match the names of workers on duty to the time sheets turned in at the end of the week Chapter Internal Control & Cash 4-49 Find more at www.downloadslide.com Ethical Issues Ethical Issue 1 Identify the ethical issue You must decide whether it is ethical for the auditor not to require the bank to record the loss What are the alternatives? Require the client to record the loss, or permit the client not to record the loss Identify the stakeholders The auditor, the bank, and the public at large can be affected The auditor’s reputation is on the line The bank’s financial statements are in question The public can be affected if the bank issues financial statements that include erroneous amounts Assess the possible outcomes If the auditors require the bank to record the loss, the auditor will keep its reputation intact But the auditor will lose the client and also lose the revenue from this large audit The accounting firm may then be unable to expand the firm as it had hoped to If the auditors okay the bank’s financial statements even after the bank did not record the loss, the auditor would keep the bank as a client, earn the audit revenue, and be able to expand the firm as planned But the bank’s financial statements would report erroneous amounts for the notes receivable People relying on the bank’s financial statements may suffer losses as a result The accounting firm’s reputation would be hurt 4-50 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Ethical Issue Make the decision The auditor should require the bank to record the loss even if that means losing the bank as a client By sticking to its belief that the bank should record the loss, the auditors’ reputation will not be harmed as it would by okaying financial statements that include errors It’s far better to lose a client than to lose your reputation Chapter Internal Control & Cash 4-51 Find more at www.downloadslide.com Ethical Issue Identify the ethical issue Galvin’s ethical issue is whether to use his knowledge of The Salvation Army’s plans and of Nadar’s situation to either party’s advantage (or disadvantage) Should Galvin help The Salvation Army buy the land at the lowest price? Should he help Nadar sell the land at the highest price? Galvin’s position presents him with a conflict of interest What are the alternatives? There are several: (a) Let other members of the Salvation Army board of directors know of Nadar’s situation in order to help The Salvation Army buy the land at a bargain price (b) Disclose Nadar’s situation to fellow board members and insist that The Salvation Army pay market price ($3.6 million) for the land (c) Advise Nadar of The Salvation Army’s plans and encourage her to hold out for a high price on the sale of the land (d) Reveal nothing to The Salvation Army’s board or to Nadar and take no part in the negotiation between the two parties (e) Take a temporary leave of absence from The Salvation Army board for unspecified “personal reasons.” Identify the stakeholders involved Galvin, The Salvation Army, Nadar, and Community Banks Assess the possible consequences Disclosing Nadar’s weakened condition to The Salvation Army board may help The Salvation Army buy the land at a low price, depending on the ethical bearing of 4-52 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Ethical Issue fellow board members This would help The Salvation Army and hurt Nadar, relative to her ability to sell the land at market value of $3.6 million Insisting that The Salvation Army offer market price for the land would seem fair to both parties, but that would betray the trust of Nadar And it may or may not sway the board to go along with a $3.6 million offer for the land Making Nadar aware of The Salvation Army’s plans may help Nadar get a higher price for the land than she would get otherwise This would betray the trust of other members of The Salvation Army’s board Remaining silent would preserve Galvin’s integrity However, if either The Salvation Army or Nadar ever learned of Galvin’s relationship with the other party, they would wonder whether Galvin used the information against them Taking a temporary leave of absence would preserve Galvin’s integrity and remove him from the conflict of interest It would also preserve Galvin’s reputation for fairness and the reputation of Community Bank for keeping depositor information confidential Make the decision The authors would take the leave of absence and hope other Salvation Army board members not probe Galvin’s “personal reasons.” This way neither The Salvation Army nor Nadar can accuse Galvin of using inside information to the advantage of the other party Chapter Internal Control & Cash 4-53 Find more at www.downloadslide.com Ethical Issue Identify the ethical issue French’s ethical issue is whether to tell IMS personnel about Snicker Foods’ possible bankruptcy What are the alternatives? (a) Keep quiet and let nature take its course, or (b) Tell IMS’s top managers of Snicker’s possible bankruptcy Identify the stakeholders involved IMS, Snicker Foods, Community Bank, and everyone connected to these organizations — owners, employees, creditors, depositors, and their communities Assess the possible consequences Telling IMS about Snicker’s possible bankruptcy may help IMS avoid wasted effort on Snicker This may enable IMS to seek more profitable ventures and aid IMS’s recovery In turn, this may help IMS pay its loan to Community Bank Make the decision French should not tell IMS of Snicker’s financial difficulties (after all, Snicker isn’t bankrupt yet) French should let nature take its course Then she will protect the bank’s (and her own) reputation for keeping client information confidential In her aiding IMS through the loan-restructuring process, French may try to help IMS find other customers that can take up the slack if the sale to Snicker doesn’t go through 4-54 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Focus on Financials: Amazon.com, Inc (20-30 min.) Req (All amounts in millions) Bank Balance, Dec 31, 2010 + Deposit in transit − Outstanding checks Adjusted bank balance Books $324 (8) $319 Balance, Dec 31, 2010 + Interest earned + Bank collections Adjusted book balance $316 $319 The adjusted balance is $319 million and it is this amount that should ultimately be included in the cash and cash equivalents in Amazon.com, Inc.’s financials Req The following items mentioned in Item 9A of Note 14 to Amazon.com, Inc.’s Consolidated Financial Statements Note Amazon.com’s are also mentioned in the chapter:  Management is responsible for establishing and maintaining internal controls “Management is responsible for establishing and maintaining adequate internal control over financial reporting” Management concluded that internal control over financial reporting was effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements…in accordance with GAAP Chapter Internal Control & Cash 4-55 Find more at www.downloadslide.com (continued) Amazon.com Amazon.com’s internal controls were independently assessed by Ernst & Young as required by Sarbanes Oxley  Item 9A mentions that no evaluation of internal controls can provide absolute assurance that no fraud exists As the text states, fraud is more difficult to uncover if several people work together 4-56 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Focus on Analysis: RadioShack, Corp (20-30 min.) Req 1 Purchases of Treasury Stock, which used $398.8 million, in the investing section Decrease in Accounts Payable, accrued expenses, income taxes payable and other, which used $85.0 million, in the operating section Depreciation and amortization, which provided $84.2 million Actually, these are expenses that not use cash, so they are added back to income to arrive at cash provided by operations Additions to PPE, which used $80.1 million, in the investing section Increase in inventories, which used $60.4 million, in the operating section Increase in Accounts & Notes Receivable, which used $39.9, in the operating section Payment of cash dividends, $26.5 million, in the financing section Req Item 9A focuses on compliance with legal requirements, specifically those requirements of the SEC, which is the fifth objective of internal control Item 9A also mentions that the controls allow information to be “recorded, processed, summarized, and reported.” These controls are addressed by the fourth objective of internal controls: ensure accurate, reliable accounting records Chapter Internal Control & Cash 4-57 Find more at www.downloadslide.com (continued) RadioShack It is important to note that while the other three objectives of internal controls are not directly referenced in Item 9A, such objectives are also the focus of the internal control system of a large public company like RadioShack 4-58 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Group Project Student responses will vary Chapter Internal Control & Cash 4-59 ... asset and hide the theft by making a false entry in the accounting records Student responses may vary 4-2 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.)... an audit of Downtown Huntsville’s transactions and financial statements Student responses may vary 4-18 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.)... service charge 30 31 Accounts Receivable…………………… Cash…………………………………… NSF check 25 Financial Accounting 9/e Solutions Manual CREDIT 670 20 30 25 Find more at www.downloadslide.com (5 min.) S 4-10