Cash and Internal Control - Financial accounting t- 123docz.net

Q U E S T I O N S

1. A cash equivalent is an investment that is readily convertible to a known amount of cash and has an original maturity to the investor of three months or less. It is included with cash on the balance sheet because the risk of a material loss on it is small. Unlike other types of investments, such as those in stocks and bonds of other companies, the company holding a cash equivalent knows exactly how much cash will be received when it matures.

2. A cash equivalent is convertible to a known amount of cash. Therefore, the purchase of a cash equivalent is not considered a significant investing activity to be reported on the statement of cash flows. Cash equivalents are included with cash on the balance sheet, and thus the company is merely trading one cash item for another when it writes a check and uses the proceeds to invest in a cash equivalent.

3. The friend is correct in the observation that all receipts should be deposited intact for control purposes. However, no company should have a policy to maximize the balance in checking accounts. Other than a nominal interest rate paid, cash is a non-earning asset, and a minimal amount should be maintained in checking accounts to pay bills as they are due. Excess cash can be much more productive if it is invested in other assets, such as debt and equity securities, inventories, and plant and equipment.

4. When the balance per the bank statement and the balance per the books are recon- ciled to the correct balance, a service charge is deducted from the balance on the books. However, if it is added to the balance per the bank, it is because the company is reconciling the balance on the bank statement to the balance on the books. The bank has deducted the charge from the balance it shows. Because the company has not yet deducted this amount, a reconciliation of the bank balance to the book balance requires that the charge be added back.

5. The Sarbanes-Oxley Act was passed in the wake of a number of high-profile cases involving questionable accounting practices. Congress decided that action by the fed- eral government was needed to protect the interests of various parties that rely on corporate financial statements in making decisions.

6. A board of directors normally is composed of a combination of key officers of the cor- poration, such as the president, and outsiders. The outsiders usually have been or are presently key officers themselves of other corporations or have significant business experience.

7. This misuse of corporate assets could have been prevented by having a procedure in place for segregation of duties. A single employee should not be allowed to order merchandise, receive it, and approve payment for it.

CHAPTER 6 • CASH AND INTERNAL CONTROL 6-3

8. There are a number of limitations on the efficiency of internal control. First, a system of internal control is not cost free. For example, the segregation of duties may require a larger staff than would otherwise be necessary. An internal audit staff may be too costly for a small company. Second, no system of internal control can prevent collu- sion by two or more employees. Third, the lack of support from upper management may weaken an otherwise strong commitment to a system of internal control. Finally, the element of human error can never be eliminated in any operation, regardless of how big or small.

9. Two basic procedures are essential to good internal control over cash. First, all cash receipts should be deposited intact in a bank on a daily basis. That is, no disbursements should be made from any amounts received prior to their deposit in the bank.

Second, all cash disbursements should be made by check. The use of serially num- bered checks results in a clear record of all payments.

10. There may be a benefit in terms of good customer relations to positioning a cash reg- ister so that customers can read the display. However, it is equally important for control purposes. If the customer can read the display, the sales clerk is less likely to ring up a sale for less than the amount received and pocket the difference. This control feature is certainly not foolproof in preventing this from happening, but it will act as a deterrent.

11. An invoice rather than a purchase order is the basis for recording a purchase and a corresponding liability (accounts payable). From a legal viewpoint, the purchase order is merely an offer by the company to purchase and does not constitute by itself a legally binding contract. The receipt of an invoice from the supplier is evidence that this outside party has accepted the offer and agreed to sell the merchandise under a particular set of terms and conditions.

12. A receiving report is a document used by the receiving department to indicate the arrival of inventory from a supplier. In a computerized system, the same software pro- gram that generates the purchase order also generates a receiving report, showing the various items ordered, the terms of payment, the shipper, and other important information. On a blind receiving report, the columns for the quantities of each item are intentionally left blank. Rather than being allowed to just check off that the number ordered were all received, the clerk must count the number actually received.

13. A purchase invoice is compared with a purchase order to ensure that the goods were in fact ordered. The comparison of a receiving report with an invoice ensures that all goods that a company is being billed for were in fact received.

B R I E F E X E R C I S E S

LO 1 BRIEF EXERCISE 6-1 COMPOSITION OF CASH Y, Y, N, N, N, Y, Y

LO 2 BRIEF EXERCISE 6-2 BANK RECONCILIATION BK, BK, BS, BK, BK, BS

LO 3 BRIEF EXERCISE 6-3 SARBANES-OXLEY ACT

1. Management is responsible for establishing and maintaining an adequate internal control structure.

2. The independent auditor provides an opinion as to whether management has maintained effective internal control over financial reporting.

3. The independent auditors’ report should be directed to the board of directors and the stockholders.

4. The audit committee provides direct contact between stockholders and the independent accounting firm.

LO 4 BRIEF EXERCISE 6-4 INTERNAL CONTROL PROCEDURES

Important internal control procedures include:

1. Proper authorizations 2. Segregation of duties 3. Independent verification

4. Safeguarding of assets and records 5. Independent review and appraisal 6. Design and use of business documents

LO 5 BRIEF EXERCISE 6-5 BUSINESS DOCUMENTS 2, 5, 6, 1, 3, 4

CHAPTER 6 • CASH AND INTERNAL CONTROL 6-5

Receivables and Investments

7-2 USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

Q U E S T I O N S

1. The allowance method of accounting for bad debts tries to match one of the costs associated with granting credit, i.e., uncollectible accounts, with the revenue of the period. Under the matching principle, an estimate of bad debts is made on the basis of either the sales of the period or the accounts receivable at the end of the period.

The allowance method properly matches the revenue for the period against an expense for the same period.

2. When bad debts expense is estimated by using the percentage of accounts receivable approach, the balance already in the allowance account must be considered. For example, if the estimate of the accounts receivable that will prove to be uncollectible is

$20,000 and the allowance account has a balance of $3,000 before adjustment, only

$17,000 has to be added to it. Under the percentage of net credit sales approach, however, the emphasis is on the increase in Bad Debts Expense. The balance in the allowance account before adjustment is ignored.

3. An aging schedule is a refinement of the percentage of accounts receivable approach to estimating bad debts. The accountant categorizes the various receivables by the length of time they are outstanding. The estimate of the percent uncollectible increases as the age of the accounts goes up.

4. A note receivable arises from a written promise by someone to pay a specific amount of money in the future with interest. An account receivable arises from granting a customer an open line of credit and does not normally include interest.

5. When a note receivable is discounted with recourse, it means that if the customer fails to pay the bank the total amount due on the maturity date, the company that sold the note to the bank is liable to the bank for the full amount. Therefore, during the time a discounted note is outstanding, the seller of the note is contingently liable.

Accounting standards do not require the seller to recognize the contingency as a liability, but a note is required to alert the statement reader of the uncertainty.

6. The first CD should be classified as a cash equivalent because it has an original maturity of three months or less. The second CD is classified as a short-term investment. It is a current asset because it will be converted into cash within the next year, even though its original maturity of more than three months disqualifies it from classification as a cash equivalent.

7. Shares of common stock could be classified as either current assets or noncurrent assets. The intent of the company determines the proper classification. If Stanzel purchases the Canby Company shares with the intent of selling them in the near term, they should be classified as current assets. Otherwise, the shares should be classified as noncurrent assets.

8. Any fees or commissions paid to purchase stock in another company should be added to the cost of the investment.

B R I E F E X E R C I S E S

LO 1 BRIEF EXERCISE 7-1 ACCOUNTING FOR BAD DEBTS

The effect of the adjustment at the end of the year can be identified and analyzed as follows:

Identify ACTIVITY: Operating

and ACCOUNTS: Allowance for Doubtful Accounts Increase Analyze Bad Debts Expense Increase

STATEMENT[S]: Balance Sheet and Income Statement

Balance Sheet Income Statement

ASSETS = LIABILITIES +

STOCKHOLDERS’

EQUITY REVENUES – EXPENSES =

NET INCOME Allowance for

Doubtful Accounts*

(10,000)

(10,000) Bad Debts

Expense 10,000**

(10,000)

*The Allowance for Doubtful Accounts account has increased. It is shown as a decrease in the equation above because it is a contra account and causes total assets to decrease.

**$500,000  2% = $10,000

LO 2 BRIEF EXERCISE 7-2 ACCOUNTS RECEIVABLE TURNOVER

Accounts Receivable Turnover = Net Credit Sales/Average Accounts Receivable Accounts Receivable Turnover = $240,000/[($40,000 + $20,000)/2]

Accounts Receivable Turnover = $240,000/$30,000 = 8 times

LO 3 BRIEF EXERCISE 7-3 ACCOUNTING FOR NOTES RECEIVABLE

The effect of the adjustment at the end of the year can be identified and analyzed as follows:

Identify ACTIVITY: Operating

and ACCOUNTS: Interest Receivable Increase Analyze Interest Revenue Increase

STATEMENT[S]: Balance Sheet and Income Statement

Balance Sheet Income Statement

ASSETS = LIABILITIES +

STOCKHOLDERS’

EQUITY REVENUES – EXPENSES =

NET INCOME Interest

Receiv- able 500

500 Interest Rev-

enue 500*

500

*$50,000  6%  60/360 = $500

7-4 USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

LO 4 BRIEF EXERCISE 7-4 ACCOUNTING FOR CREDIT CARD SALES

The effect of the collection can be identified and analyzed as follows:

Identify ACTIVITY: Operating

and ACCOUNTS: Cash Increase Collection Fee Expense Increase Analyze Sales Revenue Increase (decrease in Accounts

Receivable if sale was already recorded) STATEMENT[S]: Balance Sheet and Income Statement

Balance Sheet Income Statement

ASSETS = LIABILITIES +

STOCKHOLDERS’

EQUITY REVENUES – EXPENSES =

NET INCOME

Cash 9,600 9,600 Sales Rev-

enue 10,000

Collection Fee Expense 400*

9,600

*4%  $10,000 = $400

LO 5 BRIEF EXERCISE 7-5 ACCOUNTING FOR SALE OF STOCK

The effect of the sale of the stock on March 5 can be identified and analyzed as follows:

Identify ACTIVITY: Investing

and ACCOUNTS: Cash Increase Investment in Stock Decrease Analyze Gain on Sale of Stock Increase

STATEMENT[S]: Balance Sheet and Income Statement

Balance Sheet Income Statement

ASSETS = LIABILITIES +

STOCKHOLDERS’

EQUITY REVENUES – EXPENSES =

NET INCOME Cash 12,300

Investment in Stock (10,100)

2,200 Gain on Sale of Stock

2,200

LO 6 BRIEF EXERCISE 7-6 ACCOUNTS RECEIVABLE ON THE STATEMENT OF CASH FLOWS

The increase of $40,000 – $25,000, or $15,000, in accounts receivable should be deducted from net income under the indirect method of preparing the statement of cash flows. Sales increase net income. An increase in accounts receivable is an indication that sales exceeded cash collections; therefore, to arrive at cash from operations, a deduction is needed.

REAL WORLD PRACTICE 7.1

CHAPTER 8

Operating Assets: Property, Plant, and Equipment, and Intangibles

Q U E S T I O N S

1. Operating assets include property, plant, and equipment, and intangibles. They are generally presented in two categories on the balance sheet: (1) Property, Plant, and Equipment and (2) Intangible Assets. Examples of assets considered operating assets are buildings, equipment, land, land improvements, patents, copyrights, and goodwill. Operating assets are important to the long-term future of the company because they are the assets used to produce a product or service sold to customers.

The operating assets allow a company to produce a product efficiently and remain competitive with other firms.

2. The acquisition cost of an operating asset includes all the costs normally necessary to acquire the asset and prepare it for its intended use. Acquisition costs include the purchase price, freight costs, installation costs, taxes paid at the time of purchase, and repairs made to prepare the asset for use.

3. The acquisition cost of assets purchased as a group should be determined by allo- cating the purchase price on the basis of the proportion of the fair market value to the total fair market value. Market value is best established by an independent appraisal of the property. If such appraisal is not possible, the accountant must rely on the market value of other similar assets, on the value of the assets in tax records, or on other available evidence.

4. It is important to separately account for the cost of land and building because the amount allocated to a building represents a depreciable amount, while the amount allocated to land does not. Land is not a depreciable asset.

5. Generally, interest on borrowed money should be treated as an expense of the period. If a company buys an asset and borrows money to finance the purchase, the interest on the borrowed money is not considered part of the asset’s cost. Therefore, interest is treated as a period cost and should appear on the income statement as interest expense in the period incurred. There is one exception to this general guide- line. If a company constructs an asset over a period of time and borrows money to finance the construction, the interest incurred during the construction period is not treated as interest expense. Instead, the interest must be included as part of the acquisition cost of the asset.

6. The decline in usefulness of an operating asset is related to physical deterioration factors, such as wear and tear. It is also related to obsolescence and technological factors and to the repair and maintenance of the asset. A company should use a de-

preciation method that allocates the original cost of the asset to the periods benefited and that allows the company to accurately match the expense to the revenue generated by the asset. However, the company is not required to use the same method for all depreciable assets. Actually, it is not unusual for a company to use two different depreciation methods for the same asset, one for financial reporting purposes and another one for tax purposes.

7. The straight-line method is the most popular method of depreciation for several rea- sons, including its simplicity and ease of application. It is most appropriate for assets that experience a decline in usefulness related to the passage of time. It may also be used by companies that wish to report a stable income over time.

8. When the straight-line method or units-of-production method is used, the residual value should be deducted from the acquisition cost to determine the depreciable amount to be allocated over the useful life of the asset. When the double-declining- balance method is used, the residual value is not deducted. However, the asset should not be depreciated to an amount that is lower than the residual value.

9. Companies may use one method of depreciation for financial reporting and another method for tax purposes because the objectives are different. The accountant’s purpose in recording depreciation for financial reporting purposes is to allocate the original cost of the asset to the periods benefited in a manner that matches the decline in usefulness of the asset. The accountant’s purpose in recording depreciation for tax purposes is to minimize the amount of income tax that must be paid.

10. If an estimate must be changed, the change in estimate should be recorded pro- spectively over the remaining life of the asset. Past amounts recorded for depreciation are not changed or altered. The remaining depreciable amount should be recorded over the remaining life of the asset, using the revised estimate or estimates of residual value and asset life.

11. A capital expenditure is an amount that must be capitalized or added to the value of the asset. A revenue expenditure is an outlay that should be recorded as an expense in the year incurred. An item should be treated as a capital expenditure if it increases the life or productivity of the asset. Otherwise, the amount should be treated as a revenue expenditure.

12. The gain or loss on the sale of an asset should be calculated as the difference between the selling price and the book value of the asset as of the date of sale. In order to calculate the correct gain or loss on the sale of the asset, depreciation must be recorded up to the date of the sale. A gain occurs when the selling price of the asset exceeds its book value. A loss occurs when the selling price of the asset is less than its book value. The account Gain on Sale of Asset or Loss on Sale of As- set should appear on the income statement in the Other Income/Expense category.

13. Patents, copyrights, trademarks, and goodwill are examples of intangible assets.

Some companies have a separate category on the balance sheet titled Intangibles for such assets. Other companies include intangibles in a category titled Long-Term Assets or in the Other Assets category of the balance sheet.

14. Goodwill represents the difference between the acquisition price paid to acquire a business and the total of the fair market values of the identifiable net assets ac- quired. Goodwill can be recorded as an asset only when one company acquires another. It cannot be recorded on the basis of internally generated factors that some may refer to as goodwill.