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CHAPTER 6 Cash and Internal Control OVERVIEW OF EXERCISES, PROBLEMS, AND CASES Exercises

Estimated Time in Minutes

Level

1. Identify and describe the various forms of cash reported on a balance sheet.

1 2 7*

10 10 15

Easy Easy Mod

2. Describe the various techniques that companies use to control cash.

3 4 7*

10 10 15

Easy Mod Mod

5 6

20 15

Mod Mod

Learning Objectives

Module 1

Module 2 3. Explain the importance of internal control to a business and the significance of the Sarbanes-Oxley Act of 2002.

4. Describe the basic internal control procedures.

5. Describe the various documents used in recording purchases and their role in controlling cash disbursements. *Exercise, problem, or case covers two or more learning objectives Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

6-1 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6-2

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

Problems and Alternates

Estimated Time in Minutes

Level

1. Identify and describe the various forms of cash reported on a balance sheet.

4*

20

Mod

2. Describe the various techniques that companies use to control cash.

1 4*

25 20

Mod Mod

3. Explain the importance of internal control to a business and the significance of the Sarbanes-Oxley Act of 2002.

5*

20

Mod

4. Describe the basic internal control procedures.

2 5*

20 20

Mod Mod

5. Describe the various documents used in recording purchases and their role in controlling cash disbursements.

3

25

Diff

Learning Objectives

Module 1

Module 2

*Exercise, problem, or case covers two or more learning objectives Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-3

Cases

Estimated Time in Minutes

Level

1. Identify and describe the various forms of cash reported on a balance sheet.

1 3 4*

20 30 20

Mod Mod Mod

2. Describe the various techniques that companies use to control cash.

4*

20

Mod

3. Explain the importance of internal control to a business and the significance of the Sarbanes-Oxley Act of 2002.

2 5*

25 30

Mod Mod

4. Describe the basic internal control procedures.

5*

30

Mod

Learning Objectives

Module 1

Module 2

5. Describe the various documents used in recording purchases and their role in controlling cash disbursements. *Exercise, problem, or case covers two or more learning objectives Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6-4

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

EXERCISES LO 1

EXERCISE 6-1 CASH EQUIVALENTS

Cash equivalents at December 31, 2017: Certificate of deposit, due March 30, 2018 ..................................

Commercial paper, original maturity date February 28, 2018 ......

Deposit into a money market fund ...............................................

90-day Treasury bills....................................................................

Cash equivalents ....................................................................

LO 1

$150,000 125,000 25,000 100,000 $400,000

EXERCISE 6-2 CASH AND CASH EQUIVALENTS AND THE STATEMENT OF CASH FLOWS

Beginning balance in cash and cash equivalents .........

Cash provided by operating activities ................

Cash used in investing activities ........................

Cash provided by financing activities.................

Net increase in cash and cash equivalents ..................

Ending balance in cash and cash equivalents..............

$ 23,500* $ 140,000 (210,000) 180,000 110,000 $133,500

*$15,000 + $8,500

LO 2

EXERCISE 6-3 ITEMS ON A BANK RECONCILIATION

1. D-Bank

4. D-Book, ADJ

7. NA

2. D-Book, ADJ

5. A-Book, ADJ

8. A-Book, ADJ

3. A-Book, ADJ

6. A-Bank

9. A-Book, ADJ

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

LO 2

6-5

EXERCISE 6-4 WORKING BACKWARD: BANK RECONCILIATION

The amounts on the bank statement and on the books prior to adjustment can be determined by working backwards: DEXTER COMPANY BANK RECONCILIATION Balance per bank statement Add: Deposit in transit ...............................................................

Deduct: Outstanding checks Adjusted balance, May 31 .................................................................

$

?

332.10 (560.55) $3,254.33

Balance per books, May 31 Add: Interest earned ..................................................................

Deduct: NSF check.........................................................................

Bank service charges Adjusted balance, May 31 .................................................................

$

?

65.42 (110.50) (30.00) $3,254.33

1. Balance on the bank statement: $3,254.33 + $560.55 – $332.10 = $3,482.78 2. Balance on the books: $3,254.33 + $30.00 + $110.50 – $65.42 = $3,329.41

LO 4

EXERCISE 6-5 INTERNAL CONTROL

1. Students’ answers to this question will vary. Among the possible guidelines the club should follow are: a. Prenumbered tickets b. Segregation of duties for collecting cash, counting and recording cash, and depositing cash in a bank account c. Payment by check of any expenses associated with the raffle 2. The president would like verification that all money is collected and recorded. It would be difficult, if not impossible, to be completely sure that this happens. For example, human errors in counting and handling the cash may result in not all of the cash being collected (such as errors in making change). Also, it is impossible to prevent collusion from occurring if two or more individuals work together to misdirect any of the cash.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6-6

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

LO 4

EXERCISE 6-6 SEGREGATION OF DUTIES

Many possible combinations are possible. One appropriate way to segregate the duties would be as follows: Employee Task Mary Sue John Prepare invoices X Mail invoices X Pick up mail from post office X Open mail, separate checks X* X* List checks on deposit slip in triplicate X Post payment to customer’s account X Deposit checks X Prepare monthly schedule of accounts receivable X Reconcile bank statements X Key concepts are as follows: *Two employees should be present to open mail and separate checks.

Person who reconciles the bank statements should not be the same as the person who makes the deposits or posts to customer’s account.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-7

MULT I-CONCEPT EXERCISE EXERCISE 6-7 COMPOSITION OF CASH

LO 1,2 1. Y

7. N (Short-term investments: CD)

2. Y

8. Y

3. Y

9. N (Accounts receivable: Past Due)

4. N (Office supplies)

10. Y

5. N (Receivable from employees)

11. Y

6. Y

PROBLEMS LO 2

PROBLEM 6-1 BANK RECONCILIATION

1.

CALICO CORNERS BANK RECONCILIATION MAY 31 Balance per bank statement, May 31 Add: Deposit in transit Bank error: Deposit added to wrong account Deduct: Outstanding checks: No. 123 No. 127 No. 128 No. 130 Adjusted balance, May 31

$ 8,432.11 $1,250.00 123.45 $

23.40 145.00 210.80 67.32

Balance per books, May 31 Add: Interest earned on bonds Interest earned on account

$ 465.00 54.60

Deduct:

$

Bank service charges NSF check Book error: Deposit of $101.10 recorded as $1,011.00 Adjusted balance, May 31

1,373.45

(446.52) $ 9,359.04 $ 9,965.34 519.60

50.00 166.00 909.90

(1,125.90) $ 9,359.04

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6-8

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

PROBLEM 6-1 (Concluded)

2. The fallacy in the friend’s reasoning is that only the company, not the bank, can make errors. A bank reconciliation is needed to detect errors and omissions in both the books and the bank’s records.

LO 4

PROBLEM 6-2 INTERNAL CONTROL PROCEDURES

1. List of procedures to follow: a. Ring the sale on the cash register, and give every customer a receipt. b. Accept the money, and count the proceeds before putting it into the drawer. c. Make change, and count it as it is given to the customer. d. When given bills of $5 or over, do not put them in the drawer slot until customer accepts change (this avoids customer claiming he or she gave a $10 bill, for example, when it was actually a $5 bill). e. Never leave drawer open.

2. Procedures to follow at end of day to close out: a. Count the coins and currency in the drawer. Record on daily cash and sales report. b. Remove the cash register tape. c. Reconcile the tape to the cash in the drawer, and investigate any differences. d. Remit the tape and the cash to central office.

3. The primary concern in this operation is control over cash, because all sales are cash. This concern was addressed by using a cash register, having the lead person check the cash, and depositing it intact daily.

LO 5

PROBLEM 6-3 THE DESIGN OF INTERNAL CONTROL DOCUMENTS

1. The old system of allowing each motel to buy supplies from local distributors offered very little internal control. For example, the corporate office had no control over the amount paid by each individual operation for its supplies. The new system will allow the company to buy in larger quantities, hopefully at better prices. Also, with the old system, there was no physical control over the supplies. Dishonest employees at a particular motel could steal supplies much easier than under the new system.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-9

PROBLEM 6-3 (Concluded)

2. The purchase requisition form should be in triplicate, with the original filled out by the requesting department and copies to the purchasing and accounting departments.

The form should show the following: a. requesting department b. date requested c. preferred vendor d. date needed e. complete description of items requested f. quantity of each item requested g. blank for signature of person requesting h. blank for signature of supervisor for approval i. sequential numbering of the forms The receiving report should be in duplicate, with the original filled out by the receiving department with a copy to the accounting department. It should show the following: a. purchase order number b. vendor c. carrier/shipper d. credit terms e. dates requested, ordered, and received f. shipping instructions g. items ordered and quantity of each ordered h. quantities received of each item i. blank for signature of person receiving j. blank for approvals

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6-10

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

MULT I-CONCEPT PROBL EMS

LO 1,2

PROBLEM 6-4 CASH AND LIQUID ASSETS ON THE BALANCE SHEET

In order of liquidity on the balance sheet: 1. Petty Cash Fund 2. Money Market Fund 3. Investment in Stock 4. Accounts Receivable 5. Certificates of Deposit (six months) 6. Prepaid Rent The first two items would be included in cash and cash equivalents on the balance sheet. All other items are not as liquid and require either collection or sale to generate cash. Prepaid rent is considered current because the benefits will normally expire within one year. However, prepayments do not generate any cash for the business. It should be noted that the CD does not qualify as a cash equivalent because it has a maturity longer than three months.

LO 3,4

PROBLEM 6-5 INTERNAL CONTROL

1. Morris Mart suffers from a lack of segregation of duties. Mary handles all tasks associated with collection of customer accounts.

2. Mary should not handle all aspects of accounts receivable, billing, and collection.

Two different employees should mail invoices and record the amounts billed. Two employees should be present when the mail is opened. Another employee should be responsible for recording collections from customers. Finally, all employees should be required to take vacations, and there should be rotation of job duties among employees.

3. Someone should explain to Mary that she personally is not the problem but that a good system of internal control requires certain changes to be made. This could be explained to her not in the context of fraud but rather in the context of the necessity to verify and check the work performed by all employees.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-11

ALT ERNAT E PRO BLEMS

LO 2

PROBLEM 6-1A BANK RECONCILIATION

1. Amounts can be found by preparing a bank reconciliation: KAREN’S CATERING BANK RECONCILIATION MARCH 31 Balance per bank statement, March 31 Add: Deposit in transit Deduct: Outstanding checks: No. 112 No. 117 No. 120 No. 122 Bank error: Check written for $990; $909 charged against account Adjusted balance, March 31 Balance per books, March 31 Add: Customer check collected Interest earned on account Customer check not recorded Deduct:

Collection fee Bank service charges Adjusted balance, March 31

$6,506.10 423.00 $ 42.92 307.00 10.58 75.67

$ 436.17

81.00

45.00 4.30 1,250.00

(517.17) $6,411.93 $ ?

$

$

4.50 22.00

1,299.30 (26.50) $6,411.93*

*Adjusted balance per the books must be the same amount as the adjusted balance per the bank.

Conclusion: The balance on the books before any adjustments is the ? in the bank reconciliation and can be found by working backwards: $6,411.93 + $26.50 – $1,299.30 = $5,139.13. The corrected balance to be reported on the balance sheet is the adjusted balance of $6,411.93.

2. Karen’s has an ethical responsibility to tell the bank and the payee about the error of $81.00 in (g). Even though reporting the error will result in a decrease in Karen’s bank balance, the error should be called to the attention of the payee and the shortage remitted immediately.

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6-12 LO 4

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

PROBLEM 6-2A INTERNAL CONTROL PROCEDURES

1. The bank and regulatory agency are concerned with these documents because without proper documentation the legal agreement could be invalid. For example, without a valid title, the bank has no recourse if the customer defaults on the loan. A valid insurance policy is necessary in case the motorist should have an accident.

The regulatory agency is empowered by the government to protect the interests of the public.

2. Internal control procedures to ensure that the documents are obtained and safeguarded are as follows: a. The accuracy and completeness of all information on the note, insurance policy, and title should be verified and reviewed. b. The note and insurance policy should be reviewed periodically for expiration dates. c. Each of the documents should be kept in locked compartments with limited access.

LO 5

PROBLEM 6-3A THE DESIGN OF INTERNAL CONTROL DOCUMENTS

1. Procedures to ensure that all royalties are paid to the actors are as follows: a. All payments must be made by check. b. All payments are subject to approval by a supervisor. c. All payments should be cross-referenced to the actual sales of movies.

2. The shipping form should be in duplicate, with the original filled out by the shipping department and a copy to the accounting department. It should include the following: a. authorizations b. dates ordered and shipped, and expected delivery date c. customer name, address d. customer contact person e. description of titles to be shipped f. quantity of each title to be shipped

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-13

ALT ERNAT E MULT I- CONCEPT PROBL EMS LO 1,2

PROBLEM 6-4A CASH AND LIQUID ASSETS ON THE BALANCE SHEET

1. Cash in the checking account and the petty cash fund are cash. The three-month certificates of deposit and the money market fund are both cash equivalents.

2. Accounts receivable and marketable securities should be classified on the balance sheet as current assets and listed in the order of their liquidity (marketable securities are more liquid than accounts receivable).

3.

Cash and Cash Equivalents Certificates of Deposit Petty Cash Fund Money Market Fund Cash in Checking Account Totals

12/31/17 $10,000 1,200 25,800 6,000 $43,000

12/31/16 $10,000 1,500 28,000 6,000 $45,500

Increase (Decrease) $ 0 (300) (2,200) 0 $ (2,500)

The company is not as liquid at the end of 2017 as it was at the end of 2016. Although the decrease in liquidity is not large, it is due to the decreases in the balances in the petty cash fund and the money market fund.

LO 3,4

PROBLEM 6-5A INTERNAL CONTROL

1. There are two major problems with the proposed personnel arrangements. First, regardless of how ethical and honest the two individuals might be, from the viewpoint of appearances alone, it is not healthy to have two relatives working this closely together in a business. The potential for collusion is very high in this situation. Also, it is not fair to either party for Barbara to do a performance review for her cousin as her objectivity may be compromised.

2. Regardless of how effective a system of internal control, it can be easily circumvented by collusion, that is, two or more employees working together to perpetrate a fraud. The potential for this to develop can be lessened by not having one relative reporting to another. Also, Barbara should not do the performance evaluation for Cheryl.

3. The above should be explained to the two individuals. They personally are not the problem. Any two or more persons in this situation would face a conflict and weaken the company’s system of internal control.

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6-14

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

DECISION CASES READING AND INTERPRETING FINANCIAL STATEMENTS LO 1

DECISION CASE 6-1 COMPARING TWO COMPANIES IN THE SAME INDUSTRY: CHIPOTLE AND PANERA BREAD

1. The balance in Cash and cash equivalents on Chipotle’s balance sheet at the end of the year was $248,005,000, a decrease of $171,460,000 from the $419,465,000 balance at the end of the prior year. The balance in Cash and cash equivalents on Panera Bread’s balance sheet at the end of the year was $241,886,000, an increase of $45,393,000 from the $196,493,000 balance at the end of the prior year.

2. The increase or decrease in Cash and cash equivalents for each company appears on the statement of cash flows. The statement of cash flows summarizes a company’s operating, investing, and financing activities for the year, and the net increase or decrease in these activities appears towards the bottom of the statement.

3. The companies define Cash and cash equivalents very similarly. In Note 2 to the statements, Panera Bread states that “The Company considers all highly liquid investments with an original maturity at the time of purchase of three months or less to be cash equivalents.” Similarly, in its Note 1, Chipotle indicates that “The Company considers all highly liquid investment instruments purchased with an initial maturity of three months or less to be cash equivalents.”

LO 3

DECISION CASE 6-2 READING AND INTERPRETING IBM’S REPORT OF MANAGEMENT

1. IBM relies on clear definitions of responsibility and delegation of authority as part of its internal control structure. Another key ingredient in its structure is an internal audit program.

2. IBM’s Audit Committee is made up entirely of members of the board of directors who are independent from the company and not part of the company’s management team. One of the key duties of the Audit Committee is to recommend to the board of directors the public accounting firm to be retained to perform the audit. In addition, the Audit Committee meets with the public accounting firm to review relevant matters. It also meets with IBM’s management and its internal auditors.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

6-15

MAKING FINANCIAL DECISIONS LO 1

DECISION CASE 6-3 LIQUIDITY

TO:

The President of FNB of Verona Heights

FROM:

Joe Smith, Loan Officer

DATE:

X/X/XX

SUBJECT: Loan proposals I have reviewed the loan proposals recently submitted by R Montague and J Capulet and have summarized my findings. Because of limited resources available for shortterm loans, my recommendation is that we make a six-month $10 million loan to J Capulet only.

The total current asset positions of the two companies are identical. Each has $33 million in current assets. However, the composition of the current assets differs considerably between the two companies. On the surface, R Montague may appear to be stronger because it has twice the amount of cash on hand that J Capulet does. However, cash is essentially a nonearning asset, and I am skeptical as to why R Montague believes it necessary to maintain such a large sum of cash on hand, and consequently, why it believes it needs to borrow an additional $10 million.

The accounts receivable for J Capulet is significantly larger than that for R Montague.

Assuming that the estimates of bad debts are reasonably reliable, R Montague has a bigger problem with uncollectibles than does J Capulet. R Montague has an allowance that is 1/15, or 6.67% of accounts receivable, while J Capulet’s percentage is only 1/23, or 4.35%.

In summary, J Capulet is a better candidate at the present time for a loan. I recommend that we make a six-month $10 million loan to J Capulet at the current market rate of interest. Please call if you need any further details in connection with these two loan requests.

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6-16

USING FINANCIAL ACCOUNTING INFORMATION SOLUTIONS MANUAL

ETHICAL DECISION MAKING LO 1,2

DECISION CASE 6-4 USING A BANK RECONCILIATION TO DETERMINE CASH BALANCE

1. Recognize an ethical dilemma: You realize that cash will be overstated if the check is not treated as an NSF check on the bank reconciliation. Your boss has told you to remove the adjustment you have prepared to reduce Cash and increase Accounts Receivable. You have to decide whether to challenge your boss’s instructions.

2. Analyze the key elements in the situation: a. Your boss may benefit and users of the company’s financial statements may be harmed. b. Your boss may benefit if his performance is evaluated on the relative liquidity of the company and whether receivables are collected in a timely fashion. The company’s liquidity position is better if the outstanding check is not shown as an NSF. He may also be concerned that his personal relationship with the customer will be harmed if the check is returned. Users of the statements, such as bankers and suppliers, are harmed if they are not given an accurate portrayal of the company’s liquidity. c. The rights of the users of the statements to accurate financial statements may be violated. d. The interest of your boss to portray the company’s liquidity in the most favorable light is in conflict with the interests of statement users to an accurate picture of the company’s position. e. Your responsibility is to prepare the bank reconciliation and draft any entries taking into account all the information at your disposal.

3. List alternatives and evaluate the impact of each on those affected: The alternatives are to go along with your boss’s instructions or to insist that the NSF appear on the bank reconciliation and an adjustment made to reduce Cash. An NSF check is handled by reducing the Cash account and reinstating Accounts Receivable. An outstanding check is simply a check written by a company, but not yet presented to the bank for payment. Therefore, not recording the NSF check and showing it as an outstanding check means overstating the company’s liquidity. Cash will be overstated by $10,000. Your boss may benefit from an overstatement of the company’s relative liquidity, but creditors relying on the balance sheet to make decisions will not have reliable information.

4. Select the best alternative: You should explain to your boss why it is important to report the NSF check on the reconciliation and to make an adjustment to reduce Cash. If this does not resolve the issue, you should discuss the issue with the person your boss reports to in the organization.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6 • CASH AND INTERNAL CONTROL

LO 3,4

6-17

DECISION CASE 6-5 CASH RECEIPTS IN A BOOKSTORE

Memo to the store manager: Thank you for the opportunity to spend a week at one of our stores and learn more about the bookstore business. During my training, I received valuable experience that will benefit me as I begin working for the company. I am concerned, however, about one procedure related to the receipt of cash. The current system for handling cash shortages and overages is not effective from an internal control viewpoint.

A fundamental principle of internal control over cash is that all cash receipts should be deposited intact. I know that you can appreciate that the current system does not allow us to keep an accurate record of all receipts. For this reason, I recommend that we keep a daily record of all cash shortages and overages. If these amounts are material, they should be investigated immediately. Under no circumstances should we keep a separate cash fund to make up the differences. Aside from the obvious concerns over physical custody of the cash, the present system of simply keeping a cash-over-andshort envelope results in a lack of important information to us.

I am sure you share my concerns over this critical part of our business. Please call me if I can provide any further information to you.

© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.