Accounting Information Systems Controls and Processes, 1st Edition Solution Manual

Type:

Solution Manual

Resource:

Accounting Information Systems Controls and Processes

Edition:

1st Edition

Author(s):

Leslie Turner Andrea B. Weickgenannt

Chapter 1 Solutions

Introduction to AIS

Concept Check 1. d 2. d 3. b 4. c 5. c 6. c 7. b 8. b 9. b 10. a

Discussion Questions 11. (SO 1) How might the sales and cash collection processes at a Wal-Mart store differ from the sales and cash collection processes at McDonald’s? Walmart sells items that are pre-priced and bar coded with that price. Therefore the cash registers at Walmart use bar code scanners. However, McDonalds sells fast foods that are not bar coded. The cash registers at McDonalds use touch screen systems that require a cashier to indicate the items purchased. The cash collection processes are not different. In both cases, the employee collects the cash or credit card, and returns any change.

12. (SO 1) Can you think of any procedures in place at McDonald’s that are intended to ensure the accuracy of your order? Student responses may vary, however, following are a few examples: Often, at either the drive-through or the inside cash register, the customer can see a screen that displays the items ordered. In addition, a fast food restaurant uses pre-designed slots to hold certain types of menu items.

When a customer orders a particular sandwich, the person filling the order knows exactly which slot to pull the sandwich from. Each customer receives a printed receipt with the items listed and the customer can verify the accuracy.

13. (SO 1) How might the sales and cash collection processes at Boeing Co. (maker of commercial passenger jets) differ from the sales and cash collection processes at McDonald’s? Boeing does not sell to end-user consumers, but to companies such as airlines. Therefore Boeing does not have stores, nor inventory in stores, nor cash registers to process sales. Boeing is more likely to maintain a sales force that visits potential customers to solicit sales. Those sales may be entered by the salesperson into a laptop computer connected Boeing’s network. McDonald’s, on the other hand, sells to consumers, uses order input touch screens at each location, and maintains supplies of perishable food products.

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14. (SO 1) Are there business processes that do not in some way affect accounting records or financial statements? There may be processes that do not directly affect accounting records (such as recruiting and hiring a new employee), but all processes have a direct or indirect affect on accounting records. All processes use resources such as material or employee time. Therefore, all processes have expenses related to those processes that will affect the accounting records.

15. (SO 2) Briefly describe the five components of an accounting information system.

1. Work steps within a business process that capture accounting data as the business process occurs.

2. Manual or computer-based records that record the accounting data from the business processes.

3. Internal controls within the business process that safeguard assets and ensure accuracy and completeness of the data.

4. Work steps that process, classify, summarize, and consolidate the raw accounting data.

5. Work steps that generate both internal and external reports.

16. (SO 2) Describe how sales data is captured and recorded at a restaurant such as Applebee’s. A server at Applebee’s writes the order on a pad and carries that pad to a cash register. The server enters the order on a touch screen terminal. The order information is then displayed on a terminal in the kitchen. When the customer has finished the meal, the server prints a check and delivers the check to the table. The customer pays the server by using cash or a credit card. The server processes the payment on the touch screen register and returns the change or credit card slip to the customer.

17. (SO 2) What occurs in an accounting information system that classifies accounting transactions? For each business process that affects accounting records, the accounting information system must capture any resulting accounting data, record the data, process it through classification, summarization, and consolidation, and generate appropriate reports.

18. (SO 2) What are the differences between internal reports and external reports generated by the accounting information system? Internal reports are used by management to oversee and direct processes within the organization. External reports are the financial statements used by investors and creditors.

19. (SO 3) What types of businesses are in the supply chain of an automobile manufacturer? The types of businesses in an automaker’s supply chain are often manufacturers of parts used in cars. This would include manufacturers of tires, batteries, steel, plastic, vinyl and leather, as well as many other manufacturers making the thousands of parts in a car.

20. (SO 3) When a company evaluates a supplier of materials, what kinds of characteristics might be evaluated? The supplier’s characteristics that are likely to

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be evaluated include price and payment terms, quality, reliability of the materials, as well as whether the supplier can deliver materials when needed.

21. (SO 3) How do you think a company may be able to influence a supplier to meet its business processing requirements? A company may be able to influence a supplier by choosing only suppliers that meet expectations regarding the terms of price, quality, and delivery timing. Those suppliers that do not meet these expectations may not be used in the future. This exerts some influence over suppliers to meet requirements.

22. (SO 4) Describe any IT enablement that you have noticed at a large retail store such as Wal-Mart or Target. The most noticeable IT enablement is the use of bar coded systems on the products and how they are read by the cash registers.

23. (SO 4) How do you think the World Wide Web (WWW) has led to business process reengineering at companies such as Lands End or J.Crew? Prior to the World Wide Web, customers placed orders either on the phone or by mail. Both phone and mail orders require people to take the order and enter it into the computer system. Using online sales, the customer enters his own order and no company personnel are needed to key orders into the computer system. Therefore, there was a major change in the number of people employed to key orders.

24. (SO 4) What two kinds of efficiency improvement result from business process reengineering in conjunction with IT systems? The use of IT systems usually leads to two kinds of efficiency improvements. First, the underlying processes are reengineered (through rethinking and redesign) so as to be conducted more efficiently. Second, the IT systems improve the processing efficiency of the underlying processes.

25. (SO 5) Explain the differences between a field, record, and file. A field is one set of characters that make up a single data item. For example, last name would be a field in a customer database. A record is a collection of related fields for a single entity.

For example, last name, first name, address, phone number, and credit card number fields might make up a single customer record. A file is a collection of similar records. For example, all customer records together would be a customer file.

26. (SO 5) Explain why random access files would be preferable to sequential access files when payroll personnel are changing a pay rate for a single employee. When the desired action is to access a single record, random access is preferable. If sequential access storage is used, all records must be read in sequence until the desired record is reached. On the other hand, random access allows a single record to be accessed without the necessity of reading other records. This makes it more efficient to access a particular employee record to change the pay rate.

27. (SO 5) Why do real-time systems require direct access files? If transactions are to be processed online and in real-time, it is necessary that the computer access a

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single record immediately. Thus, direct access files are required so the records can be accessed in real-time.

28. (SO 5) Why is data contained in the data warehouse called non-volatile? Each time a new transaction is completed, parts of the operational data must be updated.

Therefore, the operational database is volatile; with constantly changing information.

However, the data warehouse does not change with each transaction. The data warehouse is only changed when periodic updates occur. The data is non-volatile because it does not change constantly.

29. (SO 5) How is an extranet different from the Internet? The extranet allows access only to selected outsiders, while the Internet is open to an unlimited number of outsiders (essentially anyone having access to the Internet). On the other hand, extranets are typically used by companies to interact with specific suppliers and customers who have been granted access to a company’s network.

30. (SO 6) Prepare a list of the types of businesses that you have been in that were using Point of Sale systems. Student responses may vary, but are likely to include grocery stores, department stores, restaurants, specialty stores, gas stations, and car washes.

31. (SO 6) What do you think would be the advantages of an e-payables system over a traditional system that uses paper purchase orders and invoices? An e-payables system should be faster and more efficient than a paper-based system. In addition, an e-payables system is likely to have fewer errors in processing than a paperbased system.

32. (SO 7) Describe why enterprise risk management is important. All organizations face risks and Enterprise Risk Management assists management in reducing and controlling risk. It also involves personnel across the entire business organization, as they implement strategies to achieve the organization’s objectives.

33. (SO 7) What is the difference between general controls and application controls?

General controls are those controls that apply overall to the IT accounting system.

They are controls that are not restricted to any particular accounting application. An example of a general control is the use of passwords to allow only authorized users to log into an IT based accounting system. Application controls are those controls that are used specifically in accounting applications to control inputs, processing, and output. Application controls are intended to insure that inputs are accurate and complete, processing is accurate and complete, and that outputs are properly distributed, controlled, and disposed.

34. (SO 7) In what way is a code of ethics beneficial to an organization? If top management institutes a code of ethics and emphasizes this code by modeling its principles and disciplining or discharging those who violate the code of ethics, it can

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help reduce unethical behavior in the organization.

35. (SO 8) What roles do accountants have in relation to the accounting information system? Accountants are users of the AIS, they assist in the design of the AIS, and they are auditors of the AIS.

Brief Exercises 36. (SO 1) For each category of business processes (revenue, expenditure, conversion, administrative), give an example of a business process. Student responses are likely to vary greatly, as they may refer to any of the subprocesses within each category.

For example, the revenue processes include sales, sales returns, and cash collections; the expenditure processes include purchasing, purchase returns, cash disbursements, payroll and fixed asset processes; the conversion processes include planning, resource management, and logistics, and; administrative processes include capital processes, investments, and general ledger processes. Accordingly, any type of business process can be cited to answer this question, but the student must match the example with the appropriate process.

37. (SO 2) Think of a company that you have worked for or with which you have done business. Which departments within the company need reports generated by the accounting information systems? Student responses are likely to vary greatly, as nearly every department within a business organization uses reports generated by the accounting information systems. For example, sales departments need customer account information to help in their efforts to sell products to customers. Purchasing departments need product information to help in their efforts to purchase products needed in the business. Each of these types of information is maintained in accounting information systems. There are numerous additional examples that could apply.

38. (SO 3) Explain a supply chain linkage and give an example. A supply chain linkage is the connection of activities in the supply chain, which includes the entities, processes, and information flows that involve the movement of materials, funds, and related information through the full logistics process, from the acquisition of raw materials to the delivery of finished products to the end user. It therefore includes the linked activities of vendors, service providers, customers, and intermediaries. In addition to the example of McDonald’s buns given in the text, another example would be a shirt sold by the Gap. The Gap’s supply chain linkage would likely include a supplier from whom the shirt was purchased, a manufacturer who assembled and sewed the shirt, a secondary supplier that likely provided the fabric from which the shirt was constructed, and a farmer who raised cotton used to make the fabric.

39. (SO 4) Explain how business process reengineering occurs. Also, explain how it differs from the typical changes in company policies. With business process

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reengineering, the underlying business processes are reengineered so as to be conducted more efficiently. In other words, a comprehensive rethinking and redesign takes place in order to enhance performance of the process. A key component of BPR is the leveraging of the capabilities of IT to improve the efficiency of the process. BPR differs from typically organizational change in that it involves “thinking outside the box” in order to offer completely new and improved methods for business processes.

40. (SO 5) For an accounts receivable system, what kind of data would be found in the master files and transaction files respectively? An accounts receivable master file would include relatively permanent data necessary to process customer transactions. This would include a record for each customer. The data in the master file would probably include customer name. address, phone numbers, credit limit, and current balance. A transaction file for accounts receivable would contain the relatively temporary data that must be processed to update the master file, such as details from individual sales and cash collections from customers.

41. (SO 5) Describe the differences in the three types of processing: a. Batch processing involves the grouping of similar transactions to be processed together; b. Online processing involves processing individual transactions, one-at-a-time; and c. Real-time processing is an online processing method that involves the immediate processing of individual transactions.

42. (SO 5) The networks discussed in this chapter were LANs, Internet, intranet, and extranet. Explain each. A LAN is a computer network that spans a relatively small area such as a building or group of buildings within a business organization. The Internet is the global computer network made up of millions upon millions of computers and subnetworks throughout the world. An intranet is an organization’s private computer network, accessible only by employees of that organization to share data and manage projects. An extranet is an expansion of an intranet that allows limited access to designated outsiders such as customers and suppliers of the organization.

43. (SO 7) Give a brief summary of each of the following: a. enterprise risk management is an ongoing strategy-setting and risk assessment process that is effected by top management but involves personnel across the entire entity. b. corporate governance is an elaborate system of checks and balances whereby a company’s leadership is held accountable for building shareholder value and creating confidence in the financial reporting process. c. IT governance is the corporate governance process that applies specifically to the proper management, control, and use of IT systems.

44. (SO 9) Describe why accountants should be concerned about ethics. Accountants should be concerned about ethics because accounting information systems are

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often the tools used to commit or cover up unethical behavior. Accountants need to be aware of the possibility of fraud within the AIS so that they can assist in developing and implementing effective internal controls to reduce the risk of such unethical acts. In addition, accountants need to be prepared to resist the temptation to commit unethical acts and to avoid being coerced into assisting with a fraudulent cover-up.

45. (SO 9) Adrienne Camm is currently pursuing her accounting degree at Ridge University. She has excelled in each of her major courses to date; however, she has always struggled with her computer classes and with assignments requiring use of computer technology. Nevertheless, Adrienne confidently claims that she will become an excellent accountant. Comment on the practical and ethical implications of her position. Adrienne is mistaken in her position for the following reasons: • Practically speaking, accountants need to be well-informed about the operation of accounting information systems, which nearly always involve computer technology. The AIS is the foundation of most accounting functions, so to resist computer technology would be unreasonable, if not impossible. Also, in order to assist in developing internal controls, accountants must understand the processes within the AIS, including the use of technology, so that effective controls can be developed and implemented to reduce risks.

• Ethically speaking, accountants need to be well-informed about the operation of the AIS so that they are poised to recognize fraud and errors that may occur.

Without an understanding of the underlying technology, accountants would be unable to effectively capture and monitor business processes. Rather than fulfilling her responsibility as an accountant to develop and implement internal controls, Adrienne’s ignorance of the AIS could actually allow for fraud to be perpetrated without being prevented or detected.

For these reasons, Adrienne’s viewpoint is quite dangerous.

Problems 46. (SO 2,4) If an accounting information system were entirely a manual system (no computers used), explain how data would be captured, recorded, classified, summarized, and reported. Discuss how the sophistication of the company’s computer system impacts the accounting output and, alternatively, how the requirements for accounting outputs impact the design of the accounting information system. In a manual accounting information system, data would be captured on source documents and recorded by hand in subledgers or special journals. Account classifications would be determined by the accountants responsible for recording the transaction. The accountants would perform mathematical computations to summarize the records and post them to a general ledger. The general ledger would be manually summarized at the end of the period so that financial statements could be prepared. The financial reports would be manually compiled based on the ending general ledger balances. Since a great deal of paper and human processing are required for a manual system, a manual system is prone to error. More sophisticated, computer-based systems tend to produce more output that is more

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accurate because they are programmed to process data consistently. They also use programming to perform mathematical computations, which promotes accuracy and time savings. Therefore, IT usage to support business processes results in increased accuracy, increased efficiency, and reduced costs.

The requirements for accounting outputs impact the design of the AIS. Work steps within a business process can be designed to capture data in a manner that is consistent with the desired content and format of the related output. This promotes efficiency and effectiveness of the overall process. When business process reengineering is used to design business processes, IT systems can be introduced to take advantage of the speed and efficiency of computers to enhance the AIS. 47. (SO 1,3) Classify each of the following processes as either a revenue process, expenditure process, conversion process, or administrative process: a. Selling common stock to raise capital - ADMINISTRATIVE b. Purchasing electronic components to manufacture DVD players EXPENDITURE c. Moving electronic components from the stockroom to the production floor to begin making DVD players - CONVERSION d. Paying employees at the end of a payroll period - EXPENDITURE e. Preparing financial statements - ADMINISTRATIVE f. Receiving cash payments from customers - REVENUE g. Buying fixed assets - EXPENDITURE h. Moving manufactured DVD players from the production floor to the warehouse CONVERSION 48. (SO 1) Business processes are composed of three common stages: an initial event, a beginning, and an end. For each of the processes a through h in Problem 47, identify the applicable initial event, beginning, and end of the process. Student responses may vary as their experiences are likely to be different. Different businesses may have different events that trigger these processes; however, the following are common examples: a. Selling common stock to raise capital: Initial Event – Contacting and communicating with investors; Beginning – Receiving consideration from investor; End – Recording transactions in the accounting records. b. Purchasing electronic components to manufacture DVD players: Initial Event – Receiving a purchase request from operations personnel; Beginning – Placing an order with a supplier; End – Recording the payment for the component parts. c. Moving electronic components from the stockroom to the production floor to begin making DVD players: Initial Event – Receiving a request from the Production department for the movement of materials; Beginning – Removing inventory from the stockroom; End – Recording the receipt of goods in the production area. d. Paying employees at the end of a payroll period: Initial Event – Receiving a time sheet or other indication of time worked; Beginning – Recording hours in the

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payroll records; End – Distributing paychecks or depositing paychecks in employee accounts. e. Preparing financial statements: Initial Event – Preparing end-of-period adjusting entries; Beginning – Summarizing adjusted account balances; End – Compiling data in financial statement format and writing related disclosure notes. f. Receiving cash payments from customers: Initial Event – Communicating with customer about a sale; Beginning – Notifying customer of amounts owed related to the sale; End – Recording the receipt of cash and deposit in a bank account. g. Buying fixed assets: Initial Event – Planning for a expenditure as part of a capital budgeting process; Beginning – Placing an order for the fixed asset; End – Receiving the asset and recording it in a subsidiary ledger. h. Moving manufactured DVD players from the production floor to the warehouse: Initial Event – Receiving notification from the Production department regarding completion of products; Beginning – Removing finished goods from the production floor; End – Recording the receipt of finished goods in the warehouse.

49. (SO 1,2,7) Each of the points listed next represents an internal control that may be implemented within a company’s accounting information system to reduce various risks. For each point, identify the appropriate business process (revenue, expenditure, conversion, administrative). In addition, refer to the description of business processes under Study Objective 1 in the chapter, and identify the appropriate subprocess. (Some subprocesses may be used more than once, and others may not be used at all.) a. Customer credit must be authorized before a business transaction takes place.

Revenue processes, sales subprocesses b. An authorized price list of goods for sale is provided. Revenue processes, sales subprocesses c. A shipping report is prepared for all shipments of goods so that customers may be billed in a timely manner. Revenue processes, sales subprocesses d. Access to personnel files and paycheck records is available only in accordance with management specifications. Expenditure processes, payroll subprocesses e. New vendors are required to be authorized before a business transaction takes place. Expenditure processes, purchasing subprocesses f. Access to cash is restricted to those employees authorized by management.

Revenue or Expenditure processes, Cash collection or cash disbursement subprocesses, respectively g. Costs of goods manufactured is properly summarized, classified, recorded, and reported. Conversion processes, resource management subprocesses h. Amounts due to vendors are reconciled by comparing company records with statements received from the vendors. Expenditure processes, cash disbursements subprocesses i. Employee wage rates and paycheck deductions must be authorized by management. Expenditure processes, payroll subprocesses j. Specific procedures such as the performance of a background check are carried out for all new employee hires. Expenditure processes, payroll subprocesses

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k. The purchasing manager is notified when stock levels are low so that items may be restocked to prevent backorders. Conversion processes, resource management subprocesses l. Two signatures are required on checks for payments in excess of $5000.

Expenditure processes, cash disbursement subprocesses m. When excess cash is on hand, the funds are invested in short-term securities.

Administrative processes, investment subprocesses n. Goods received are inspected and damaged, or unmatched, items are promptly communicated to the vendor. Revenue processes, sales subprocesses o. The monthly bank statement is reconciled to the company’s cash records by an outside accountant. Revenue or Expenditure processes, Cash collection or cash disbursement subprocesses, respectively

Web Exercises 50. (SO 3) Using an internet search engine search for the terms RFID and “supply chain”. Put both of these terms in your search and be sure that supply chain is in quotation marks. Read some of the resulting web sites you find and answer these questions: a. What is RFID? Radio-frequency identification (RFID) technology helps companies identify and manage large lots of goods, typically received and stored in cartons or on skids. The cartons or skids include tags that are encoded with identifying information about the items, their supplier, and their purchase transaction. These tags can be instantly read and recorded by the company through the use of antennae or battery-operated transmitters and radio waves. b. How is it related top the supply chain? RFID enhances supply chain management by significantly reducing the time required to record purchases and inventory tracking. The instantaneous reading of RFID tags allows the items to move swiftly through the logistics process with increased speed and accuracy of the underlying records. c. How will it improve the accuracy of data from the supply chain? Accuracy is increased by the use of tags containing company and product identifiers. These tags reduce the risk of recording items in duplicate. They also aid in inventory tracking through enhanced security of products being moved between locations.

51. (SO 7) Go to the COSO web site and find the executive summary of the article “Enterprise Risk Management – Integrated Framework.” Read the sections titled “Roles and Responsibilities” and “Use of this Report.” Describe the roles that various parties should play in enterprise risk management. Although everyone within a business entity has responsibility for its ERM processes, the chief executive officer is ultimately responsible and must assume ownership of the process. Accordingly, the CEO should bring together key managers from each functional area to plan, implement, and monitor the process. The board of directors should provide necessary oversight and maintain contact with top management, internal auditors,

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and external auditors regarding the ERM process. Other managers should support the organization’s philosophy, promote compliance with its risk appetite, and manage risks within their areas of responsibility. The chief financial officer and internal auditors typically have a support role.

External to the business organization, three groups are key to the effective use of ERM: regulators, professional organizations, and educators. Regulators are expected to refer to the COSO framework in the development of expectations as well as the conduct of their examinations for business organizations they oversee.

Professional organizations should consider the COSO framework in the development of guidelines for financial management, auditing, and related topics.

Educators are urged to incorporate the framework into university curricula, as well as to conduct research and analysis on potential enhancements to the ERM process.

52. (SO 9) Using an internet search engine search for the term (in quotations) “earnings management.” From the items you read, answer the following questions: a. Is earnings management always criminal? No, earnings management is not always illegal. Since accounting principles allow for some flexibility, accountants may use the discretion at their disposal in preparing financial statements. b. Is earnings management always unethical? No, earnings management is not always unethical, due to the materiality constraint. However, earnings management becomes unethical when it “crosses the line” and is reflective of the desires of management rather than an accurate representation of the company’s financial performance. If earnings management deceives or distracts investors, it is unethical.

53. (SO 9) Using an internet search engine search for “HealthSouth” and “fraud” or “Scrushy” (the name of the company’s CEO) and explain the fraud that occurred at HealthSouth Corporation. What was the ultimate result of the prosecution of HealthSouth officials? HealthSouth’s fraud was an elaborate earnings management scheme whereby earnings were overstated by at least $1.4 billion. False revenues were recorded with corresponding decreases in contra-revenue accounts, expenses, and/or liabilities and increases in assets. Ultimately, after a long and dramatic trial, Scrushy was aquitted of all criminal charges due to lack of evidence tying him to the fraud.

Cases 54. Gas-n-Go Mart and the accounting information system.

1. Accounting data is likely to be captured at Gas-n-Go at the gas pump if the customer uses a debit card or credit card to pay for a gas purchase at the pump.

Even if the customer chooses to pay inside, the information pertaining to the sale of gasoline is recorded at the pump. The snacks must be purchased inside the store, but can be added to the gasoline charge. The accounting effect is that the

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sale and the payment collected should increase the sales account and cash or accounts receivable, respectively.

2. The records to record the accounting data would be maintained within the computer system. Although a manual process is required to operate the gas pump and cash register, the remainder of the system is computer-based, so the system records the sale and all related data.

3. Internal controls would include the security cameras in the store and gas filling area, as well as reconciliation procedures. Like the McDonalds’ example, a manager is likely to close and reconcile the cash register and gas pump sales at the end of the day.

4. The summarization of accounting data is likely to occur at the end of the period when financial reports are prepared. These steps are probably accomplished by the computer software.

5. Financial reporting occurs at the end of the period, as data are summarized into reports used for internal and external purposes. This likely includes a combination of manual and computerized processes. There are likely to be separate classifications for the sales of gasoline versus snack items.

55. Business processes and IT enablement at fast food restaurants. Student responses may vary, but are likely to consistent with the following: a. List and describe four different activities that are manual parts of business processes at a restaurant such as Wendy’s. Manual processes are required to: • greet customers at the drive-through window or counter • enter customer orders on the cash register touch-screens • prepare the food • gather the customer’s order • collect payment from the customer • clean the dining area • refill the condiment dispensers, etc.

• reconcile the cash in the cash register to amounts included in the sales summaries b. List and describe four different activities that are IT enabled parts of business processes at a restaurant such as Wendy’s. IT enables processes are used to: • record customer orders input in the cash registers. The system accumulates sales data based on the orders transacted • prepare sales amounts based upon the pre-programmed prices of items ordered • determine the amount of change due to customers based on the amount of cash collected • prepare a sales receipt upon completion of a sales transaction • transfer order details to the food preparation stations so that the items can be prepared and assembled • prepare a daily summary for each cash register at the end of the shift 56. Business processes at department stores.

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a. Some of the supporting processes that precede a sale to a customer include acquiring, pricing and display of the merchandise, hiring and training sales personnel and cashiers, preparation of cash register drawers with adequate change, and programming the system to recognize the items when they are read by a bar code scanner. b. Some of the supporting processes that occur after a sale to a customer include handling customer returns, summarization of the sales data, reconciling the cash registers with the computerized data from the registers, preparation of a bank deposit, preparation of periodic sales reports, and reconciliation of the bank statements.

57. Business processes at Cool’s Cues Co. a. The business processes described include the expenditure process involved in purchasing materials needed to manufacture pool cues and disbursing cash to suppliers for materials purchased. The case also describes revenues processes for sales of pool cues over the internet, customer collections, and sales returns (replacements). This business would also include subprocesses for payroll expenditures to pay John and Rebecca Cool for their time worked, and fixed asset processes to handle any capital assets acquired (such the workshop, office space, furniture and computers, tools and equipment, delivery vehicle, etc.). In addition, conversion processes would involve planning of the manufacturing process, planning and managing materials and resources needed for production, and logistics (movement of the manufactured goods through the production process through delivery to a customer). b. If Cool’s Cues expanded to a regional focus, it is likely that its business would grow. John and Rebecca Cool may have difficulty managing a regional business on their own, so they would likely need to hire and train employees to join their business. As more people became involved in the business processes, they would need to determine how responsibilities would be divided and how to implement internal controls in the processes. John Cue may no longer be able to personally handle all deliveries. The company’s website may also need to be enhanced to handle the additional volume anticipated in connection with the business expansion. c. If Cool’s Cues began selling pool balls and other billiard equipment in addition to its pool cues, its business processes would change. If Cool’s acquired this type of merchandise, it would have to enhance its expenditures processes to include the types of suppliers of these billiard accessories. It would also need to consider the logistics of inventory storage. In addition, its revenue processes would need to be enhanced to differentiate sales of manufactured cues versus other billiard merchandise. Its website would need to be updated to handle the additional product lines.

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Concept Check 1. d 2. c 3. b 4. a 5. b 6. b 7. c 8. c 9. c 10. b 11. d 12. a

Discussion Questions 13. (SO 1) What is the relationship between business processes and the accounting information system? As the systematic steps are undertaken within a business processes, the corresponding data generated must be captured and recorded by the accounting information system.

14. (SO 1) Why is it sometimes necessary to change business processes when IT systems are applied to business processes? When IT systems are applied to business processes, some of the detailed transaction data may no longer be taken from paper-based source documents, and manual processing may no longer be needed to summarize and post that data. Accordingly, some of the related manual steps within the business process can be eliminated or changed.

15. (SO 2) Are manual systems and processes completely outdated? No, manual systems and business processes are not completely outdated. Manual records may still be involved in the business processes of even the largest and most sophisticated accounting information systems.

16. (SO 2) What is the purpose of source documents? Source documents capture the key data of a transaction, including date, purpose, entity, quantities, and dollar amounts.

17. (SO 2) What are some examples of turnaround documents that you have seen? An example of a turnaround document is a credit card statement, where the statement itself (as received in the mail by the credit card holder) represents the output of the accounting information system of the credit card company. When the credit card holder returns the top portion of the statement with his or her payment, it then becomes an input to the company’s cash collection process.

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18. (SO 2) Why would the training of employees be an impediment to updating legacy systems? One of the advantages of legacy systems is that they are well supported and understood by existing personnel who are already trained to use the system.

Since those legacy systems are not generally based on user-friendly interfaces and they tend to be use software written in older computer languages, there is likely to be a significant investment of time and human resources required to maintain the system. In addition, legacy systems are often difficult to modify. Employees may be reluctant to forego their investment or to commit additional time in support of an updated system that becomes more challenging to maintain.

1.

19. (SO 2) Why is it true that the accounting software in and of itself is not the entire accounting information system? The accounting software is not the entire accounting information system; rather, it is a tool that supports the organization’s unique business processes. The software must often be customized to meet the needs of the organization and to integrate well with the manner in which transactions are processed. The human resources and/or manual records and documents that are part of the business processes are also an integral part of the accounting information system.

20. (SO 2) How is integration across business processes different between legacy systems and modern, integrated systems? Integration across business processes within a legacy system is extremely challenging and costly, as those systems are usually not based on user-friendly interfaces that are difficult to modify. It is also difficult to find programmers to perform such tasks. The result is that organizations which integrate business processes between legacy systems typically must resort to enhancements to their existing software or bridging their existing software to new systems or interfaces. On the other hand, modern, integrated systems are based on a single software system that integrates many or all of the business processes within the organization, thus eliminating the coordination and updating efforts required by the older systems.

21. (SO 3) Why do you think there are different market segments for accounting software? There are different market segments for accounting software to support the different needs of organizations depending on their size and the complexities of their business processes.

22. (SO 3) How would accounting software requirements for large corporations differ from requirements for small companies? Larger companies tend to need more power and functionality from their software systems because of their size and the complexities of their business processes. This may especially be true of large, multinational corporations which need to integrate business processes located all around the globe. Small companies are not likely to need such extensive power and functionality from their systems.

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23. (SO 3) What are some of the differences between ERP systems and accounting software for small companies? ERP systems are multimodule software systems designed to manage all aspects of an enterprise. The modules (financials, sales, purchasing, inventory management, manufacturing, and human resource) are based on a relational database system that provides extensive set-up options to facilitate customization to specific business needs. Thus, the modules work together to provide a consistent user interface. These systems are also extremely powerful and flexible. Many of the software systems in the small and mid market categories are not true ERP systems with fully integrated modules; however, these systems assimilate many of the features of ERP systems.

24. (SO 3) Why would accounting software development companies be interested in expanding their software products into other market segments? Software development companies and software vendors often attempt to increase the appeal of their software products to more than one market segment when the features of their products may fit the needs of different sized organizations. In addition, there is a trend toward increasing the functionality of existing systems to offer increased flexibility and functionality to meet such diverse needs. Since business organizations make considerable investments in the software products that comprise their accounting information systems, it is not surprising that there is much competition among the companies that provide these systems.

25. (SO 4) Given the business and accounting environment today, do you think it is still important to understand the manual input of accounting data? Manual input of data is still important to understand in today’s accounting environment. Many business organizations still use some manual processes for reading source documents and keying the relevant information into the accounting information system. Even hightech point of sale systems require manual processes to input the accounting data contained on bar codes.

26. (SO 4) What are the advantages to using some form of IT systems for input, rather than manual input? Using IT systems for input has the advantages of reducing the time, cost, and errors that tend to occur with manual data input.

27. (SO 4) Why would errors be reduced if a company switched input methods from manual keying of source documents to a bar code system? With manual input, human efforts are required to write on the source documents and to manually key in the data. Errors tend to occur with such a system. On the other hand, the manual steps of writing and keying are eliminated when using a bar code system, thus reducing the likelihood of error.

28. (SO 5) In general, what types of transactions are well suited to batch processing?

Batch processing is best suited to applications having large volumes of similar transactions that can be processed at regular intervals, such as payroll.

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29. (SO 5) Why might the time lag involved in batch processing make it unsuitable for some types of transaction processing? By necessity, batch systems involve a time lag while all transactions in the batch are collected. This means that available information in files will not always be current, as it would be in real-time systems.

Therefore, when constantly up-to-date information is needed by users on a timely basis, batch processing is likely to be unsuitable for transaction processing.

30. (SO 5) How would real-time processing provide a benefit to managers overseeing business processes? Real-time processing is beneficial for business managers because it provides for system checks for input errors. Therefore, errors can be corrected immediately, thus increasing the quality of the information for which the manager is held accountable. In addition, real-time systems enhance the efficiency of information availability.

31. (SO 6) How do internal reports differ from external reports? Although internal and external reports are both forms of output from an accounting information system, they have different purposes. Internal reports provide feedback to managers to assist them in running the business processes under their control. On the other hand, external reports (such as the financial statements) are used by external parties to provide information about the business organization.

32. (SO 6) What are some examples of outputs generated for trading partners?

Invoices and account statements are examples of outputs generated for customers; whereas checks and remittance advices are examples of outputs sent to vendors.

33. (SO 6) Why might it be important to have internal documents produced as an output of the accounting information system? It is important to produce internal documents as an output of an accounting information system because internal documents provide feedback needed by managers assist them in running the business processes under their control. These internal documents can be customized to allow a manger to “drill down” into the details of the process being managed.

34. (SO 7) How does documenting a system through a pictorial representation offer benefits? A pictorial representation of an accounting information system is beneficial because it provides a concise and complete way for accountants to analyze and understand the procedures, processes, and the underlying systems that capture and record the accounting data.

35. (SO 8) How does client-server computing divide the processing load between the client and server? In client-server computing, the processing load is assigned to either the server or the client on the basis of which one can handle each task most efficiently. The server is more efficient in managing large databases, extracting data from databases, and running high-volume transaction processing software applications. The client is more efficient at manipulating subsets of data and presenting data to users in a user-friendly, graphical-interface environment.

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36. (SO 8) Why do you think the client computer may be a better computer platform for presentation of data? The client computer is better for presentation of data because it manipulates subsets of data without being bogged down by the processing load of the entire data set. In addition, the client computer maintains presentation software in a user-friendly format for reporting purposes.

Brief Exercises 37. (SO 1) Think about your most recent appointment at the dentist’s office. Describe the business process that affected you as the patient/customer. In addition, describe the administrative and accounting processes that are likely to support this business.

As a patient, you would experience the revenue processes as you receive services from the hygienist and dentist. You would also be affected by the billing and collections processes when you receive an invoice for services rendered and submit payment for those services.

The dental office would need to have specific steps in place for recording the services provided to each patient so that they can be properly billed and reported.

These steps may be very detailed, especially in instances where patient fees must be allocated between dental insurance companies and the patients themselves.

There would also need to processes in place for purchasing, as a dentist’s office is expected to make regular purchases of supplies as well as to handle the other operating costs of the business. Payroll processes would also be needed to account for the time and pay of each employee in the dentist’s office, and fixed asset processes would be needed to support the investments in and depreciation of office furniture and equipment, fixtures, and dental equipment. Finally, it is possible that the business may have administrative processes in place to handle investment, borrowing, and capital transactions. Once these transactions are recorded, the business must have processes in place to post the related data to the general ledger and summarize it in a manner that facilitates the preparation of financial statements and other accounting reports.

38. (SO 2) Describe the purpose of each of the following parts of a manual system: a. source document – captures the key data of a transaction, including the date, purpose, entity, quantities, and dollar amounts. b. turnaround document – provides a connection between different parts of the accounting system by serving as the output of one system and the input to another system in a subsequent transaction. c. general ledger – provides details for the entire set of accounts used in the organization’s accounting systems. d. general journal – captures the original transactions for non routine transactions, adjusting entries, and closing entries.

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e. special journal – captures original transactions for routine transactions such as sales, purchased, payroll, cash receipts, and cash disbursements. f. subsidiary ledger – maintains detailed information regarding routine transactions, with an account established for each entity.

39. (SO 2) Consider the accounting information system in place at an organization where you have worked. Do you think that it was a manual system, legacy system, or an integrated IT system? Describe one or two characteristics of that accounting information system that lead you to your conclusion.

Student responses are likely to vary greatly, as they may refer to any work experience. Characteristics of manual systems may include paper-based documents and records, and manual processes performed by humans.

Characteristics of legacy systems may include older technology including a mainframe computer and the use of software languages such as COBOL, RPG, Basic, and PL1. Characteristics of an integrated IT system include powerful, technologically advanced computer systems with Internet interfaces. They are typically marked by efficiencies in terms of limited paperwork and user-friendly interfaces.

40. (SO 2) Suppose that a company wants to upgrade its legacy system, but cannot afford to completely replace it. Describe two approaches that can be used.

One approach to updating a legacy system is to use screen scrapers, or frontware, which add modern, user-friendly screen interfaces to an existing system. Another approach is to bridge the legacy system to new hardware and software using enterprise application integration, or EAI. 41. (SO 3, SO 5) Consider the real world example of Hobie Cat Company presented in this chapter. a. Use Exhibits 2-2 and 2-3 to help you determine the approximate range of Hobie Cat’s annual revenues. Since Hobie Cat’s ERP system falls in the Mid market segment, the company’s revenues must be between $250,000 and $10 million. b. What are the advantages Hobie Cat likely realized as a result of having real-time data available? The advantages to real-time data processing include: • reduced errors, since the system checks for input errors and corrects any errors immediately • more timely information • constantly up-to-date data files • integrated business processes into a single database so that a single system can be achieved.

42. (SO 4) Using IT systems to input accounting data can reduce costs, time, and errors.

Give an example showing how you think IT systems can lead to these reductions

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(cost, time, and errors). Student responses may vary. The responses below apply to the savings a company would be expected to realize upon implementation of a bar code system as a method of inputting data.

Using IT systems to input data can help reduce costs, such as when bar code systems at a self-checkout line eliminate the human resource costs of using a checkout clerk.

Using IT systems to input data can help save time, such as when bar code systems at a checkout line can reduce the checkout time to a fraction of the time required to manually record the transaction. This is because it eliminates the manual processes involved in writing data on a source document and later keying the data into the software system.

Using IT systems to input data can help reduce errors, such as when bar code systems eliminate the duplicate manual processes involved in writing data on a source document and later keying the data into the software system.

43. (SO 6) Identify whether the following reports would be categorized as trading partner documents, internal documents, internal reports, or external reports: a. daily cash receipts listing – internal document b. accounts receivable aging – internal report c. wire transfer of funds to a vendor – trading partner document d. customer price list – trading partner document e. general ledger – internal report f. statement of cash flows – external report g. sales invoice – trading partner document h. production schedule – internal document i. customer address list – internal document j. payroll journal – internal report 44. (SO 6) Which type of accounting information system reports would likely be prepared most frequently by financial accountants? By managerial accountants?

Financial accounts are most likely to prepare external reports (such as financial statements and other reports provided to external users of the company’s accounting information); whereas managerial accountants are most likely to prepare internal reports (such as journals and other reports that provide feedback to managers about their areas of responsibility).

45. (SO 7) Identify which of the cardinal relationships apply, form the following: a. component part – product b. customer – product c. employee ID badge – employee d. employee – supervisor

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e. vendor – check

One to many

46. (SO 8) Differentiate distributed presentation computing and distributed applications computing. Which of these forms of client server computing is most likely to be used by the sales clerks at a regional sales office for a large retail organization?

Distributed presentation computing involves a client PC’s manipulation of a subset of data for purposes of presentation. It uses spreadsheet, graphing software, mapping software, or other presentation software for this purpose. Distributed applications computing involves the client PC’s participation in application processing, including the updating or changing of data that resides on the server. Distributed applications computing is most likely to be used by sales clerks in a regional sales office to process the sales data from the various retail locations.

Problems 47. (SO 2) Suppose that a large company is considering replacing a legacy system that is nearing obsolescence. Describe any aspects of this decision that the company should consider.

When considering whether or not to replace a legacy system, a company should conduct a cost-benefit analysis. A business organization may decide to maintain a legacy system if it determines that the replacement costs would be too high. In such cases, the organization would likely place strong emphasis on the advantages of its legacy system, including its degree of customization and the extent of historical data that it contains which would be difficult to integrate into a new system. On the other hand, if the organization decided to replace its legacy system, it is likely that its reasons included such things as difficulty in supporting the older hardware, software, and programming language of its legacy system, difficulty in integrating the legacy system with newer business applications, and lack of user-friendly interfaces and supporting documentation from the legacy system.

48. (SO 1, SO 7) Visit the campus bookstore at your university. From what you see happening at the bookstore, try to draw a process map of how the processes at that store serve students, the customers.

Refer to the separate Microsoft Excel file “Chapter 2 Solutions Pictorial Representations.xls 49. (SO 3) Look at Exhibit 2-3 and pick one accounting software product from the midmarket segment and one software product from the tier 1 ERP segment. Using those brand names of software, search the Internet for information about those products. Based on your investigation, what are the differences between the two software products you chose? (Hint: To begin your search, you might try examining

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the following web sites. www.accounting-software 411.com , www.findaccountingsoftware.com, and www.2020software.com) Student responses are likely to vary greatly, depending upon the software brands selected. However, the modules within the midmarket products may not be fully integrated or may be less complex than the tier 1 ERP systems.

50. (SO 4) Using an Internet search engine, search for the term “RFID.” From the results you find, describe how RFID will be used as an input method.

RFID stands for radio-frequency identification. RFID technology helps companies identify and manage large lots of goods, typically received and stored in cartons or on skids. The cartons or skids include tags that are encoded with identifying information about the items, their supplier, and their purchase transaction. RFID is used as an input method whereby the tags can be instantly read and recorded by using antennae or battery-operated transmitters and radio waves.

51. (SO 8) Using an Internet search engine, search for the terms “client-server” and “scalable.” From the results you find, explain why client-server systems are scalable.

Scalable systems have the ability to handle growth or increased capabilities. Thus, client-server systems are deemed to be scalable because of the manner in which tasks are divided. Since client PCs normally accomplish local processing tasks, additional client PCs could be added to the network to handle new or growing subsets of data from the server.

Cases 52. Pictorial representations of a drive-through window at a fast food chain.

Student responses are likely to vary, but may be similar to those shown in the Microsoft Excel file “Chapter 2 Solutions Pictorial Representations.xls 53. Pictorial representations of a college’s parking services processes.

Student responses are likely to vary, but may be similar to those shown in the Microsoft Excel file “Chapter 2 Solutions Pictorial Representations.xls

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Concept Check 1. b 2. c 3. a 4. d 5. d 6. b 7. b 8. a 9. a 10. d 11. c 12. b 13. c 14. d

Discussion Questions 15. (SO 1) Management is held accountable to various parties, both internal and external to the business organization. To whom does management have a stewardship obligation and to whom does it have reporting responsibilities?

Management has a stewardship obligation to the shareholders, investors, and creditors of the company, i.e., any parties who have provided funds or invested in the company. Management has a reporting responsibility to business organizations and governmental units with whom the company interacts.

16. (SO 2,4) If an employee made a mistake that resulted in a loss of company funds and misstated financial reports, would the employee be guilty of fraud? Discuss. No, a mistake, or unintentional error, does not constitute fraud. In this situation, there is no theft or concealment, so fraud does not exist.

17. (SO 2,3) Do you think it is possible that a business manager may perpetrate fraud and still have the company’s best interest in mind? Discuss. Student responses may vary. Those agreeing that it is possible may refer to the fraud triangle and note that the incentive may be job-related (such as opportunities to produce enhanced financial statements, which may increase the company’s stock price, increase compensation, avoid firings, enhance promotions, and delay bankruptcy) and the rationalization may involve plans to make restitution. On the other hand, some students may reject the notion that management fraud could be in a company’s best interest, as it puts the company at great risk. Hen frauds are discovered, they are often devastating as a result of the financial restatements and loss of trust.

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18. (SO 7) Distinguish between internal and external sources of computer fraud.

Employees are the source of internal computer fraud. When employees misuse the computer system to commit fraud (through manipulation of inputs, programs, or outputs), this is known as internal computer fraud. On the other hand, external sources of computer fraud are people outside the company or employees of the company who conduct computer network break-ins. When an unauthorized party gains access to the computer system to conduct hacking or spoofing, this is known as external computer fraud.

19. (SO 7) Identify and explain the three types of internal source computer fraud. The three types of internal source computer fraud are input manipulation, program manipulation, and output manipulation. Input manipulation involves altering data that is input into the computer. Program manipulation involves altering a computer program through the use of a salami technique, Trojan horse program, trap door alteration, etc. Output manipulation involves altering reports or other documents generated from the computer system.

20. (SO 7) Describe three popular program manipulation techniques. The salami technique accomplishes a fraud by altering small “slices” of computer information.

These slices of fraud are difficult to detect because they are so small, but they may accumulate to a considerable amount if they are carried out consistently across many accounts. This is often accomplished by rounding or applying minor adjustments. The perpetrator typically steals the amounts represented by these slices or uses them to his or her benefit.

A Trojan horse program is a small, unauthorized program within a larger, legitimate program, used to manipulate the computer system to conduct a fraud. For example, a customer account may be automatically written off upon the processing of a new batch of transactions.

A trap door alteration involves misuse of a valid programming tool, a trap door, to commit fraud. Trap doors are unique hidden entrances to computer programs that are written into the software applications to provide a manner of testing the systems.

Although they should be removed prior to implementation, they may remain to provide a tool for misusing the system to perpetrating fraud.

21. (SO 7) Distinguish between Internet spoofing and e-mail spoofing. Internet spoofing involves a person working through the Internet to access a computer network while pretending to be a trusted source. The packet of data containing the Internet protocol (IP) address contains malicious data such as viruses or programs that capture passwords and log-in names. E-mail spoofing bombards employee e-mail accounts with junk mail intended to scam the recipients.

22. (SO 10) What are the objectives of a system of internal control? The objectives of an internal control system are as follows:

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To safeguard assets from fraud or errors To maintain accuracy and integrity of accounting data To promote operational efficiency To ensure compliance with management directives

23. (SO 10) Name and distinguish among the three types of internal controls. The three types of internal controls are preventative controls, detective controls, and corrective controls. Preventative controls are designed to avoid fraud and errors by stopping any undesired acts before they occur. Detective controls help employees uncover or discover problems that may exist. Corrective controls involve steps undertaken to correct existing problems.

24. (SO 10) Identify the COSO report’s five interrelated components of internal controls.

According to the COSO report, there are five interrelated components of internal control: the control environment, risk assessment, control activities, information and communication, and monitoring.

25. (SO 10) Name the COSO report’s five internal controls activities. According to the COSO report, there are five internal control activities: authorization of transactions, segregation of duties, adequate records and documents, security of records and documents, and independent checks and reconciliations.

26. (SO 10) Distinguish between general and specific authorization. General authorization is a set of guidelines that allows transactions to be completed as long as they fall within established parameters. Specific authorization means that explicit authorization is needed for that single transaction to be completed.

27. (SO 10) Due to cost/benefit considerations, many business organizations are unable to achieve complete segregation of duties. What else could they do to minimize risks? Close supervision may serve as a compensating control to lessen the risk of negative effects when other controls, especially segregation of duties, are lacking.

28. (SO 10) Why is a policies and procedures manual considered an element of internal control? Formally written and thorough documentation on policies and procedures should provide clarity and promote compliance within a business organization, thus providing an important element of internal control. The policies and procedures should include both manual and automated processes and control measures, and should be communicated to all responsible parties within the company.

29. (SO 10) Why does a company need to be concerned with controlling access to its records? Securing and protecting company records is important to ensure that they are not misused or stolen. Unauthorized access or use of records and documents allows the easy manipulation of those records and documents, which can result in fraud or a concealment of fraud.

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30. (SO 10) Many companies have mandatory vacation and periodic job rotation policies. Discuss how these practices can be useful in strengthening internal controls. Mandatory vacations and periodic job rotation policies provide for independent monitoring of the internal control systems. Internal control responsibilities can be rotated so that someone is monitoring the procedures performed by someone else, which enhances their effectiveness.

31. (SO 10) Name the objectives of an effective accounting system. An effective accounting system must accomplish the following four objectives: • • • •

Identify all relevant financial transactions of the organization.

Capture the important data of these transactions.

Record and process the data through appropriate classification, summarization, and aggregation.

Report the summarized and aggregated information to managers.

32. (SO 10) What does it mean when information flows “down, across, and up the organization”? A business organization must implement procedures to assure that its information and reports are communicated to the appropriate management level.

This communication is described by COSO as “flowing down, across, and up that organization”. Such a communication flow assists management in properly assessing operations and making changes to operations as necessary.

33. (SO 10) Provide examples of continuous monitoring and periodic monitoring. Any ongoing review activity may be an example of continuous monitoring, such as a supervisor’s examination of financial reports and a computer system’s review modules. An example of periodic monitoring is am annual audit performed by a CPA firm or a cyclical review performed by internal auditors.

34. (SO 10) What are the factors that limit the effectiveness of internal controls? It is not possible for an internal control system to provide absolute assurance because of the following factors that limit the effectiveness of internal controls: • • •

Flawed judgments Human error Circumventing or ignoring established controls

In addition, excessive costs may prevent the implementation of some controls.

35. (SO 11) Identify and describe the five categories of the AICPA Trust Services Principles. The AICPA Trust Services Principles are divided into the following five categories of risks and controls: •

Security. Security is concerned with the risk of unauthorized physical and logical access, such as breaking into the company’s facilities or computer network.

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Availability. Availability is concerned with the risk of system interruptions or failures due to hardware of software problems such as a virus.

Processing integrity. Processing integrity is concerned with the risk of inaccurate, incomplete, or improperly authorized information due to error or fraud.

Online privacy. Online privacy is concerned with the risk of inappropriate access or use of a customer’s personal information.

Confidentiality. Confidentiality is concerned with the risk of inappropriate access or use of company information.

36. (SO 11) Distinguish between the Trust Services Principles of privacy and confidentiality. Both privacy and confidentiality are concerned with the risk of in appropriate access or use of information. However, privacy is focused on protecting the privacy of a customer’s personal information; whereas confidentiality is focused private information about the company itself and its business partners.

37. (SO 10) Identify the four domains of high-level internal control. As set forth in Appendix B, COBIT establishes four domains of high level control objectives. These include planning and organization, acquisition and implementation, delivery and support, and monitoring.

Brief Exercises 38. (SO 2,3) What possible motivation might a business manager have for perpetrating fraud? Management might be motivated to perpetrate fraud in order to improve the financial statements, which may have the result of increasing the company’s stock price and increasing incentive-based compensation. Altered financial information might also have the effect of delaying cash flow problems and/or bankruptcy, as well as improving the potential for business transactions such as mergers, borrowing, stock offerings, etc.

39. (SO 5) Discuss whether any of the following can be examples of customer fraud: •

• •

An employee billed a customer twice for the same transaction. This is not an example of customer fraud; rather, the customer is being defrauded in this scenario. On the other hand, this is an example of employee fraud (assuming that the double-billing was intentional and the resulting cash receipts are stolen by employees.

A customer remitted payment in the wrong amount. This may be an example of customer fraud, assuming that the payment was made as a deceptive tactic to avoid the full amount of the customer’s liability.

A customer received merchandise in error, but failed to return it or notify the sender. Although this scenario involves a customer’s improperly receipt of goods, it would not be considered customer fraud because it was the result of an error. Regardless of whether the error was committed by the company or the customer, deception is a required element of fraud.

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40. (SO 7) Explain the relationship between computer hacking and industrial espionage.

Give a few additional examples of how hacking could cause damage in a business.

Computer hacking is the term commonly used for computer network break-ins.

Hacking may be undertaken for various purposes, including theft of proprietary information, credit card theft, destruction or alteration of data, or merely thrillseeking. Industrial espionage is the term used for theft of proprietary company information. Although computer hacking provides one method of conducting industrial espionage, a computer is not always required to steal company information. Fraudsters trying to conduct industrial espionage may also resort to digging through the trash in order to gain information about a target company.

41. (SO 9) What are some ways in which a business could promote its code of ethics?

The best way for a company to promote its code of ethics is for its top managers to live by it on a day-to-day basis. If the code is well documented and adhered to by management, others in the organization are likely to recognize its importance.

Furthermore, if disciplines and/or discharges are applied to those who violate the code, this will also serve as a strong message regarding the importance of the ethics code.

42. (SO 10) Describe why the control environment is regarded as the foundation of a business’ system of internal control. The control environment is regarded as the foundation of a system of internal controls because it sets the tone of an organization and influences the control consciousness of its employees. Thus, the tone at the top flows through the whole business organization and affects behavior at every level. It also provides the discipline and structure of all other components of internal control. COSO identifies the tone set by management as the most important factor related to providing accurate and complete financial reports.

43. (SO 10) Think of a job you have held, and consider whether the control environment was risky or conservative. Describe which you chose and why. Student responses will vary. Characteristics of a risky control environment include absence of a code or ethics or lack of enforcement of a code of ethics, aggressive management philosophy and operating style, overlapping duties and vague lines of authority, lack of employee training, and an inactive board of directors. On the other hand, a conservative control environment is characterized by a rigidly enforced code of ethics, a conservative management philosophy and operating style, clearly established job descriptions and lines of authority, a focus on employee training and organizational development, and an accountable and attentive board of directors.

44. (SO 10) Identify the steps involved in risk assessment. Do you think it would be effective for an organization to hire external consultants to develop its risk assessment plan? The steps involved in risk assessment include: • • •

Identification of the sources of risk, both internal and external.

Determination of the impact of such risks in terms of finances and reputation.

Estimation of the likelihood of such risks occurring.

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Development of an action plan to reduce the impact and probability of these risks.

Execution of the action plan on an ongoing basis.

It would not likely be effective for an organization to hire consultants to develop its risk assessment plan because company-specific experience and expertise are needed in order to do this work effectively. For instance, members of management who are actively involved in day-to-day operations and reporting will likely have the best ability to identify risks, determine the impact of those risks, and estimate the likelihood of occurrence of such risks. Although a consultant may be useful in assisting with the development and implementation of the action plan, the first three steps of the risk assessment process would likely depend upon the working knowledge of members of the company’s management.

45. (SO 10,11) Discuss the accuracy of the following statements regarding internal control: •

•

The more computerized applications within a company’s accounting system, the lower the risk will be that fraud or errors will occur. It is not necessarily true that extensive computerized application will lower a company’s risk of fraud. This is because computerized systems also increase vulnerabilities such as unauthorized access, business interruptions, and inaccuracies. The technological complexities that accompany sophisticated computer applications call attention to the need for extensive internal controls to reduce the risk of fraud and errors.

The more involved top management is in the day-to-day operations of the business, the lower the risk will be that fraud or errors will occur. It is certainly true that the tone at the top (the tone set by top management) is the most important factor of internal control. Accordingly, it can be implied that involved managers would promote strong internal controls. However, although this is often true, it will be true only when top management acts with integrity, exemplifying and enforcing its code of ethics, maintaining a conservative approach to operations and financial reporting, and cultivating clear communications and responsibilities.

Problems 46. (SO 10) Identify whether each of the following accounting positions or duties involves authorization, recording, or custody: • • • • • •

cashier - Custody payroll processor - Recording credit clerk - Authorization mailroom clerk - Custody data entry clerk - Recording deliver paychecks - Custody Page 2-7

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deliver the bank deposit - Custody prepare the bank reconciliation - Recording check signer - Authorization inventory warehouse supervisor - Custody staff accountant - Recording

47. (SO 10) Identify whether each of the following activities represents preventative controls, detective controls, or corrective controls: • • • • • • • • • • • •

job rotation - Detective preparation of a bank reconciliation - Corrective segregation of duties - Preventative recalculating totals on computer reports - Detective use of passwords - Preventative preparing batch totals for check processing - Detective establishing a code of ethics - Preventative use of a security guard - Preventative verifying source documents before recording transactions - Preventative matching supporting documents before paying an invoice - Preventative independent review of accounting reports - Detective performing comparisons of financial statement items - Detective

48. (SO 10) Shown is a list of selected sources of internal control guidelines, given in order of issuance, followed by a list of primary purposes. Match each guideline with its primary purpose.

I. Foreign Corrupt Practices Act – b. Prevented bribery and established internal control guidelines.

II. COSO – d. Established internal control concepts based on comprehensive study.

III. SAS 99 – a. Required auditors to focus on risks and controls and to conduct audits with skepticism.

IV. Sarbanes-Oxley Act – c. Curbed fraud by requiring additional internal control reporting within annual reports.

V. Trust Services Principles – e. Established essential criteria for evaluating reliability of business systems. a. Required auditors to focus on risks and controls and to conduct audits with skepticism. b. Prevented bribery and established internal control guidelines. c. Curbed fraud by requiring additional internal control reporting within annual reports. d. Established internal control concepts based on comprehensive study. e. Established essential criteria for evaluating reliability of business systems.

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49. (SO 1, 3, 10) Using a search engine on the Internet, find articles or descriptions of the collapse of Enron. The collapse began in November 2001, and many articles appeared over the next two to three years. Required: a. Briefly describe the fraud that occurred. Student responses are likely to vary, but should focus on the accounting frauds which attempted to hide the company’s debt and losses. For instance, Enron created special purpose entities (related partnerships) for the purpose of off-balance sheet financing. Other deceptive transactions are known to have taken place for the sole purpose of creating false financial results, such as transactions involving the sale and buy-back of barges near year-end and prepaid commodities deals that were never delivered. b. Discuss what you see as weaknesses in the control environment. It is likely that students will focus on the tone at the top, and conclude that management did not set a good example of the company’s code of ethics.

They may also provide evidence of aggressive management practices.

50. (SO 3) Using a search engine on the Internet, search for articles on fraud that occurred in 2000 to 2002 in the following companies: Adelphia Enron Global Crossing WorldCom Xerox Try to locate articles or information about stock prices, how the fraud was conducted. You might wish to look at the following websites: www.hoovers.com and www.forbes.com Required: a. Find information to help you complete the following table: Students are not likely to find all of this information, but what they do find may help them better understand the massive size and scope of these frauds. Some of the stock prices or loss to investors can be found by web searches. For example, the Xerox stock prices can be found by searching on Xerox, fraud and “stock price”.

Position of Brief Those Description of Conducting Company Name Fraud Fraud Off balance sheet financing, inflated CEO, CFO, VP earnings, of Operations improper use of (Rigas family Adelphia company funds members) Off balance CEO (Ken Enron sheet financing Lay), CFO

Stock Price when fraud was uncovered

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Stock Price one year Shares Loss to later outstanding Investors

~$750 mil. $90

$0.70

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through special (Andrew purpose Fastow), entities, inflated Pres./CEO (Jeff earnings Skilling) Inflated revenue through network capacity swaps, misFounder (Gary management Winnick), CEO, and excessive CFO, and Pres.

Global Crossing spending Of Finance Off-balance sheet credit, inflated earnings through improper capitalization of CFO & operating Controller WorldCom expenses (possibly CEO) Accelerated revenue recognition on Senior Xerox leased assets executives

$60

$0.20

$11.24

$4.30

b. Discuss the common characteristics that you see in each of these examples. Most of these frauds involved misstated financial statements involving inflated earnings and off-balance sheet financing. Most of these frauds were perpetrated by members of top management, including top ranking financial executives.

Cases 51. Fraud at Springfield’s city hall. Required: a. Which internal control activity was violated in order for Mr. Sims to perpetrate this fraud? A case could be made for any or all of the internal control activities were violated in this scenario. With regard to authorization, it can be said that Mr. Sims abused his authority by circumventing the established controls in order to carry out these transactions on his own. His interference in the mailroom procedures made it impossible for any segregation of duties to occur. There was apparently inadequate security and documentation for the assets and transactions with which he was involved, and there was no one willing to come forward to review or reconcile these transactions. b. Do you consider this case to be an example of management fraud or employee fraud? Although it involves misappropriation of assets, which is Page 2-10

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typically an employee fraud, this was conducted by the chief financial officer. Accordingly, it would be considered a management fraud. It is not likely that Mr. Sims would have been able to carry out his fraud if it had not been for his high-ranking position, which apparently prevented anyone from stopping him. c. Was the city’s procedural manual adequate for prescribing internal controls to prevent this type of fraud? Why or why not? Although the case states that written guidelines were in place regarding the mailroom and bank deposit policies, requirements for logging checks received and performing an independent verification of receipts, these guidelines were obviously not followed when Mr. Sims stepped in. Rather than being a problem with the documented policies, this case seems to present a situation marked by circumvention of controls. d. Why do you think no one reported the unusual mailroom practices of Mr. Sims? To whom would such a violation be reported? Since Mr. Sims was the highest ranking financial officer in the organization, employees who suspected misconduct likely believed that there was no one with authority over Mr. Sims to whom the problem could be reported. If management is involved in fraud, it should be brought to the attention of the board of directors. In the case of a municipality, the problem could be reported to the chief administrator, mayor, or the city’s advisory council. e. Do you think a business in Springfield could be guilty of customer fraud if it agreed to deliver its payments to Mr. Sims personally rather than send them to the city’s mailing address? A business that agreed to deliver its payments to Mr. Sims personally would not likely be guilty of fraud.

Customer fraud requires the intent to deceive, so unless the business had knowledge or was otherwise involved in Mr. Sims’ fraud scheme, it would not be guilty of customer fraud. f. The comments made by the neighbor CFO express which type of limitation of internal control systems discussed in this chapter? The limitation of small staff size typically means that the business organization does not have sufficient resources to accomplish segregation of duties.

Accordingly, controls can be easily circumvented. The comment regarding the tight operating budget reflects upon the cost/benefit limitations of internal controls.

52. Coupon accounting abuse. Required: a. Discuss whether the situation described can happen to a company with a good control environment. This situation would not be likely to happen to a company with a good control environment. In a conservative control environment, management would not place so much emphasis on profitability, would not likely tie compensation to profitability and then give employees responsibility for preparing their own profitability reports, and would have likely provided for other controls (such as supervision and review of Larry’s figures).

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b. Describe any steps a company could take to prevent such abuse. If the firm was going to compensate brand managers based on profitability of their brands, then those managers should not have responsibility for preparing their own profitability reports. Rather, an independent accounting function should be in place to account for Larry’s brands. In addition, independent reconciliations should be performed with specific emphasis on risky financial items such as coupon drops. c. List those parties who might be harmed by this situation. The following parties are likely to be harmed as a result of Larry’s fraud: • investors and creditors who are relying upon the fair presentation of the firm’s financial statements as a basis for important business decisions • shareholders to whom the firms owes a stewardship obligation, especially as they are deceived with respect to the firm’s current financial status • fellow employees in the firm who will begin the next year with an inflated expense for the coupon drop (and whose compensation will be tied to financial performance) • fellow employees in the firm who share in Larry’s bonus pool and who would have received a larger bonus had Larry’s figures been accurate d. Do you consider this example to be management fraud or employee fraud? Describe how it fits the definition of your choice. This case describes management fraud, as it involves misstatement of financial records, which is typically perpetrated by managers who are attempting to realize benefits (such as increased compensation).

53. Ethical dilemma involving a CEO. Required: a. Discuss whether Mr. Brocamp’s violation of corporate ethics policy affects or reflects the control environment of the company. Yes, Mr. Brocamp’s actions affect the control environment of Mega Motor Company. As its CEO, Mr. Brocamp has primary responsibility for setting the tone at the top and living by the code of ethics. If others in the organization are aware of this violation, it sends the message that the code of ethics is not important. This is likely to lead to other problems, including fraud. b. Since the violation is personal in nature, should Mr. Brocamp have been forced to resign? Since the code of ethics specifically prohibits personal relationships between managers and members of their management chain, then Mr. Brocamp should be held accountable for his actions. Even though it could be argued that the relationship did not affect his ability to perform his job effectively, the company must have thought otherwise when it established its code of ethics. c. Should Bozeman State have hired him to teach business strategy courses? Student responses are likely to vary and may provide the basis for an interesting class discussion. Some students may agree that

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someone who violated a company ethics policy should not be teaching students about the proper management of organizations. Others may agree that faculty members are not questioned about their personal lives and that Mr. Brocamp’s wealth of experience is beneficial to students.

54. Ethical dilemma involving mail order fraud. Required: a. Discuss which type of fraud is involved in this case, from the perspective of the mail order company. This case presents an example of customer fraud, as Janie deceived the mail order company. Accordingly, she obtained property and lied about it in order to avoid the corresponding liability. b. Which of the AICPA Trust Services Principles most closely related to this situation? Processing integrity is the Trust Services Principle that most closely relates to this situation. Since Janie provided false information and the company had no way to substantiate it, inaccurate information was processed and became part of the financial records of the company. c. Describe a preventative control that could be performed by the carrier to avoid the possible recurrence of this type of fraud. If the carrier had documented the address where the package was dropped off or obtained a signature from Janie’s neighbor at the time of delivery, the deception would have been prevented. This would have provided documentation of the delivery, which could have been investigated.

55. Ethical dilemma involving charitable fundraiser. Required: a. Do you think Evan’s actions were justified? What would you have advised him to do in this situation? No, Evans actions were not justified because he did not use the donated funds for their intended purpose. Since Evan represented to the donors that the monies were to be used for a charitable purpose, he had an ethical obligation to fulfill that commitment. Even though he invested more time than he planned, he knew that his efforts were not to be compensated. This is a variation of an employee fraud. As a representative of a charitable cause, he carried out a cash receipts theft for his personal gain. b. What internal control activities could the fraternity have implemented in order to prevent Evan’s actions? The fraternity should have required its treasurer to handle the cash receipts related to this fundraising campaign.

This would separate the custody of the cash receipts from the recordkeeping that Evan was conducting. c. Can you think of a detective control that could uncover the omission of the $200 check? A review of all receipts – or in this case, acknowledgement letters – could be performed and reconciled to the record of cash contributions. Unless Evan concealed the letter written to the donor of the $200 that he stole, such a reconciliation procedure would uncover the difference.

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Concept Check 1. d 2. b 3. c 4. a 5. a 6. a 7. b 8. d 9. c 10. d 11. a 12. b 13. b

Discussion Questions 14. (SO 1) What is the difference between general controls and application controls?

General controls are internal controls that apply overall to the IT accounting systems; they are not restricted to any particular accounting application. Application controls apply within accounting applications to control inputs, processing, and outputs. They are intended to ensure that inputs and processing are accurate and complete and that outputs are properly distributed, controlled, and disposed.

15. (SO 1) Is it necessary to have both general controls and application controls to have a strong system of internal controls? Yes, it is necessary to have both types of controls in a strong system of internal controls. Since they cover different aspects of the IT accounting systems and serve different purposes, both are important and necessary. An IT system would not have good internal control if it lacked either general or application controls.

16. (SO 2) What kinds of risks or problems can occur if an organization does not authenticate users of its IT systems? If an organization does not authenticate users of its IT systems, a security breach may occur in which an unauthorized user may be able to gain access to the computer system. If hackers or other unauthorized users gain access to information to which they are not entitled, the organization may suffer losses due to exposure of confidential information. Unauthorized users may gain access to the system for the purpose of browsing, altering, or stealing company data. They could also record unauthorized transactions, shut down systems, alter programs, sabotage systems, or repudiate existing transactions.

17. (SO 2) Explain the general controls that can be used to authenticate users. In order to authenticate users, organizations must limit system log-ins exclusively to Page 2-1

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authorized users. This can be accomplished by requiring login procedures, including user IDs and passwords. Stronger systems use biometric identification or security tokens to authenticate users. In addition, once a user is logged in, the system should have established access levels and authority tables for each user. These determine which parts of the IT system each user can access. The IT system should also maintain a computer log to monitor log-ins and follow up on unusual patterns.

18. (SO 2) What is two-factor authentication with regard to smart cards or security tokens? Two-factor authentication limits system log-ins to authorized users by requiring them to have possession of a security device such as a smart card or token, and also have knowledge of a user ID and/or password. Both are needed to gain access to the system.

19. (SO 2) Why should an organization be concerned about repudiation of sales transactions by the customer? Repudiation is the attempt to claim that the customer was not part of a sales transaction that has taken place. Organizations may suffer losses if customers repudiate sales transactions. If companies do not have adequate controls to prevent repudiation, they may not be able to collect amounts due from customers. However, organizations may reduce the risk of such losses if they require log-in of customers and if they maintain computer logs to establish undeniably which users take particular actions. This can provide proof of online transactions.

20. (SO 2) A firewall should inspect incoming and outgoing data to limit the passage of unauthorized data flow. Is it possible for a firewall to restrict too much data flow?

Yes, it is possible for a firewall to restrict legitimate data flow as well as unauthorized data flow. This may occur if the firewall establishes limits on data flow that are too restrictive. In order to prevent blocking legitimate network traffic, the firewall must examine data flow and attempt to determine which data is authorized or unauthorized. The packets of information that pass through the firewall must have a proper ID to allow it to pass through the firewall.

21. (SO 2) How does encryption assist in limiting unauthorized access to data?

Encryption is the process of converting data into secret codes referred to as cipher text. Encrypted data can only be decoded by those who possess the encryption key or password. It therefore renders the data useless to any unauthorized user who does not possess the encryption key. Encryption alone does not prevent access to data, but it does prevent an unauthorized user from reading or using the data.

22. (SO 2) What kinds of risk exist in wireless networks that can be limited by WEP, WPA, and proper use of SSID? WEP, WPA, and SSIDs can limit the risk of unauthorized access to wireless networks, which transmit network data as high frequency radio signals through the air. Since anyone within range of these radio signals can receive the data, protecting data is extremely important within a wireless network. This can be accomplished through encryption via wired equivalency privacy (WEP), through encryption and user authentication via wireless protected access

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(WPA), and through password protection of the network sending and receiving nodes via service set identifiers (SSIDs).

23. (SO 2) Describe some recent news stories you have seen or heard regarding computer viruses. Student responses will vary greatly depending upon the date this is discussed, but should describe situations of computer malfunctions caused by network break-ins where damaging actions were upon an organization’s programs and data.

As of April 2008, a report by Symantec (www.symantec.com) included the following statistics: The U.S. accounted for 31% of all malicious activity and was the origin of attack in 24% of cases. Symantec observed an average of 61,940 infected computers per day. The US accounted for 56% of all denial of service attacks. In the second half of 2007, Symantec reported that 499,811 new malicious code threats were reported.

24. (SO 2) What is the difference between business continuity planning and disaster recovery planning? How are these two concepts related? Business continuity planning is a proactive program for considering risks to the continuation of business and developing plans and procedures to reduce those risks so that continuation of the IT system is always possible. On the other hand, disaster recovery planning is a reactive program for restoring business operations, including IT operations, to normal after a catastrophe occurs. These two concepts are related in that they are both focused on maintaining IT operations at all times in order to minimize business disruptions.

25. (SO 2) How can a redundant array of independent disks (RAID) help protect the data of an organization? RAID accomplishes redundant data storage by setting up two or more disks as exact mirror images. This provides an automatic backup of all data. If one disk drive fails, the other (maintained on another disk drive) can serve in its place.

26. (SO 2) What kinds of duties should be segregated in IT systems? In an IT system, the duties to be segregated are those of systems analysts who analyze and design the systems, programmers who write the software, operators who process data, and database administrators who maintain and control the database. No single person should develop computer programs and also have access to data.

27. (SO 2) Why do you think the uppermost managers should serve on the IT governance committee? An IT governance committee should be comprised of top management in order to ensure that appropriate priority is assigned to the function of governing the overall development and operation of the organization’s IT systems.

Since the committee’s functions include aligning the IT systems to business strategy and to budget funds and personnel for the effective use of IT systems, it is important that high-ranking company officials be aware of these priorities and involved in their

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development. Only top management has the power to undertake these responsibilities.

28. (SO 3,4) Why should accountants be concerned about risks inherent in a complex software system such as the operating system? Accountants need to be concerned about the risks inherent in the organization’s software systems because all other software runs on top of the operating system. These systems may have exposure areas that contain entry points for potential unauthorized access to software and/or data. These entry points must be controlled by the proper combination of general controls and application controls.

29. (SO 4) Why is it true that increasing the number of LANs or wireless networks within an organization increases risks? Increasing the number of LANs or wireless networks within an organization increases exposure areas, or entry points through which a user can gain access to the network. Each LAN or wireless access point is another potential entry point for an unauthorized user. The more entry points, the more security risk the organization faces.

30. (SO 4) What kinds of risks are inherent when an organization stores its data in a database and database management system? Since a database management system involves multiple use groups accessing and sharing a database, there are multiple risks of unauthorized access. Anyone who gains access to the database may be able to retrieve data that they should not have. This multiples the number of people who potentially have access to the data. In addition, availability, processing integrity, and business continuity risks are also important due to the fact that so many different users rely on the system. Proper internal controls can help to reduce these inherent risks.

31. (SO 4) How do telecommuting workers pose IT system risk? The network equipment and cabling that enables telecommuting can be an entry point for hackers or other break-ins, and the teleworker’s computer is another potential access point that is not under the company’s direct control. Therefore, it is difficult for the company to monitor whether telecommuters’ computers is properly protected from viruses and other threats. These entry points pose security, confidentiality, availability, and processing integrity risks.

32. (SO 4) What kinds of risks are inherent when an organization begins conducting business over the Internet? The Internet connection required to conduct web-based business can expose the company network to unauthorized use. The sheer volume of users of the World Wide Web dramatically increases the potential number of unauthorized users who may attempt to access an organization’s network of computers. An unauthorized user can compromise security and confidentiality, and affect availability and processing integrity by altering data or software or by inserting virus or worm programs. In addition, the existence of e-commerce in an organization poses online privacy risks.

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33. (SO 4) Why is it true that the use of EDI means that trading partners may need to grant access to each other’s files? EDI involves transferring electronic business documents between companies. Because EDI involves the use of a network or the Internet, risks of unauthorized access are prevalent. In order to authenticate trading partner users to accomplish the transfer of business documents, other company data files may be at risk of unauthorized use.

34. (SO 5) Why is it critical that source documents be easy to use and complete?

Source documents should be easy to use and complete in order minimize the potential for errors, incomplete data, or unauthorized transactions are entered from those source documents into the company’s IT systems. Since source documents represent the method of collecting data in a transaction, they need to be easy to use in order to reduce the risk of incorrect or missing data in the accounting system.

35. (SO 5) Explain some examples of input validation checks that you have noticed when filling out forms on websites you have visited. Student responses are likely to vary, but may include field checks, validity checks, limit checks, range checks, reasonableness checks, completeness checks, or sign checks. Although sequence checks and self-checking digits are additional input validation checks, they are not likely to be cited because they are applicable to transactions processed in batches, which is not likely to apply to students’ web transactions.

36. (SO 5) How can control totals serve as input, processing, and output controls?

Control totals can be used as input controls when they are applied as record counts, batch totals, or hash totals to verify the accuracy and completeness of data that is being entered into the IT system. These same control totals can be used as processing controls when they are reconciled during stages of processing to verify the accuracy and completeness of processing. Finally, to ensure accuracy and completeness, the output from an IT system can be reconciled to control totals, thus serving as an output control. Therefore, totals at any stage can be compared against the initial control total to help ensure the accuracy of input, processing, or output.

37. (SO 5) What dangers exist related to computer output such as reports? Output reports contain data that should not fall into the wrong hands, as the information contained in reports is often confidential or proprietary and could help someone commit fraud. Therefore, the risk of unauthorized access must be controlled through strict policies and procedures regarding report distribution, retention, and disposal.

Brief Exercises 38. (SO 2,5) Categorize each of the following as either a general control or an application control: a. validity check – application control (input) b. encryption – general control c. security token – general control

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d. batch total – application control (input, processing, and output) e. output distribution – application control (output) f. vulnerability assessment – general control g. firewall – general control h. antivirus software – general control 39. (SO 5) Each of the given situations is independent of the other. For each, list the programmed input validation check that would prevent or detect the error. a. The zip code field was left blank on an input screen requesting a mailing address. – Completeness check b. A state abbreviation of “NX” was entered in the state field. – Validity check c. A number was accidentally entered in the last name field. – Field check d. For a weekly payroll, the hours entry in the “hours worked field was 400. – Limit check or range check e. A pay rate of $50.00 per hour was entered for a new employee. The job code indicates an entry-level receptionist. – Reasonableness check 40. (SO 3) For each AICPA Trust Services Principles category shown, list a potential risk and a corresponding control that would lessen the risk. An example is provided.

In a similar manner, list a risk and control in each of the following categories: a. Security. Risk: an unauthorized user could record an invalid transaction.

Control: security token to limit unauthorized users. b. Availability. Risk: An unauthorized user may shut down a program.

Control: intrusion detection to find instances of unauthorized users. c. Processing Integrity. Risk: environmental problems such as temperature can cause glitches in the system. Control: temperature and humidity controls. d. Confidentiality. Risk: an unauthorized user could browse data. Control: encryption.

41. (SO 4) For each of the following parts of an IT system of a company, write a onesentence description of how unauthorized users could use this as an “entry point”: a. A local area network (LAN). Each workstation or the network wiring on the LAN are access points where someone could tap into the system. b. A wireless network. The wireless signals broadcast into the air could be intercepted to gain access to the system. c. A telecommuting worker. The telecommuter’s computer may be infected with a virus that allows a perpetrator to see the login ID and password. d. A company website to sell products. A hacker may try to break through the web server firewall to gain access to company data.

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42. (SO 5) Application controls include input, processing, and output controls. One type of input control is source document controls. Briefly explain the importance of each of the following source document controls: a. Form design. A well-designed form will reduce the chance of erroneous or incomplete data. It could also increase the speed at which the form is completed. b. Form authorization and control. Forms should have a signature line to indicate that the underlying transaction was approved by the correct person. Blank documents should be properly controlled to limit access to them. c. Retention of source documents. Source documents should be maintained as part of the audit trail. They also serve as a way to look up data when queries are raised.

43. (SO 5) Explain how control totals such as record counts, batch totals, and hash totals serve as input controls, processing controls, and output controls. Control totals serve as expected results after input, processing, or output has occurred. At each stage, the current totals can be compared against the initial control total to help ensure the accuracy of input, processing, or output.

44. (SO 6) Briefly explain a situation at your home, university, or job in which you think somebody used computers unethically. Be sure to include an explanation of why you think it was unethical. Student responses will vary significantly. Some possibilities include copyrighted music or video downloading from an unauthorized source, viewing pornography on computers at work, shopping or other browsing while at work, using a work computer to store personal files or process personal work, using company e-mail systems for personal e-mail (some companies may not consider this as problematic as other potential unethical acts).

Problems 45. (SO 2) Explain why an organization should establish and enforce policies for its IT systems in the following areas regarding the use of passwords for log-in: a. Length of password. Passwords should be at least eight characters in length. This would make it difficult for a hacker to guess the password in order to gain unauthorized access to the system. b. The use of numbers or symbols in passwords. Passwords should contain a mix of alphanumeric digits as well as other symbols. There may also be a mix of case sensitive letters. This would make it difficult for a hacker to guess the password.

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c. Using common words or names as passwords. Names, initials, and other common names should be avoided as passwords, as they tend to be easy to guess. d. Rotation of passwords. Passwords should be changed periodically, approximately every 90 days. This will limit the access of a hacker who has gained unauthorized access. e. Writing passwords on paper or sticky notes. Passwords should be committed to the user’s memory and should not be written down. If they are documented, this increases the likelihood that an unauthorized user may find the password and use it to gain access to the system.

46. (SO 2) The use of smart cards or tokens is called two-factor authentication. Answer the following questions, assuming that the company you work for uses smart cards or tokens for two-factor authentication.

Required: a. What do you think the advantages and disadvantages would be for you as a user? As a user, the advantages of two-factor authentication would be the security of the information in the system that I am using. I would know that it would be difficult for an unauthorized user to alter a system that uses two-factor authentication, so I have more confidence in the data within such a system. In addition, it is relatively easy to remember a password and to transport a smart card or security token. On the other hand, I might consider the use of two-factor authentication to be a disadvantage because it places more responsibility on me, the user. For instance, in order to access the system, I have to remember my password and maintain control of a security device. It might be considered an inconvenience to a user to maintain a smart card or security token and remember to keep it accessible at all times that I may need to access the system. It might also be susceptible to loss, similar to a set of keys. b. What do you think the advantages and disadvantages would be for the company? From the company’s perspective, the advantage of two-factor authentication is the strength of the extra level of security. The company has additional protection against unauthorized access, which makes it difficult for a hacker to access the system. The disadvantage is the cost of the additional authentication tools that comprise the dual layer of security.

47. (SO 4) Many IT professionals feel that wireless networks pose the highest risks in a company’s network system.

Required: a. Why do you think this is true? Wireless networks pose the highest risks in a company’s network computer system because the network signals are transported through the air (rather than over cables). Therefore, anyone who can receive radio signals could potential intercept the company’s

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information and gain access to its network. This exposure is considered greater than in traditional WANs and LANs. b. Which general controls can help reduce these risks? A company can avoid its exposure to unauthorized wireless network traffic by implementing proper controls, such as wired equivalency privacy (WEP) ore wireless protected access (WPA), station set identifiers (SSIDs), and encrypted data.

48. (SO 5) Control totals include batch totals, hash totals, and record counts. Which of these totals would be useful in preventing or detecting IT system input and processing errors or fraud described as follows? a. A payroll clerk accidentally entered the same time card twice. Any of the three control totals could be used: A batch total could detect that too many hours were entered; A hash total could detect that an employee number summation was overstated; A record count could detect that too many time cards were entered. b. The accounts payable department overlooked an invoice and did not enter it into the system because it was stuck to another invoice. Any of the three control totals could be used: A batch total could detect the missing amount; A hash total could detect that the vendor number summation was misstated; A record count could detect that too few invoices were entered. c. A systems analyst was conducting payroll fraud by electronically adding to his “hours worked” field during the payroll computer run. A batch total could detect this fraud by revealing that the hours worked on the inputs did not agree with the hours worked on the output reports. d. To create a fictitious employee, a payroll clerk removed a time card for a recently terminated employee and inserted a new time card with the same hours worked. A record count could detect this fraud only if there was a control in place to compare the number of records processed with the number of active employees and the number of active employees had been updated to reflect a reduction for the recently terminated employee.

49. (SO 5) Explain how each of the following input validation checks can prevent or detect errors: a. A field check examines a field to determine whether the appropriate type of data was entered. This will detect mistakes in input, such as erroneous input of numeric information in an alpha field. b. A validity check examines a field to ensure that the data entry in the field is valid compared with a preexisting list of acceptable values. This will detect mistakes in input, such as nonsense entries caused by the input personnel striking the wrong key. c. A limit check verifies field inputs by making sure that they do not exceed a pre-established limit. This prevents gross overstatements of the data beyond the acceptable limit.

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d. A range check verifies field inputs by making sure that they fall within a pre-established range limit. This prevents gross overstatements and understatements of the data beyond the acceptable limits. e. A reasonableness check compares the value in a field with similar, related fields to determine whether the value seems reasonable. This can detect possible errors by identifying “outliers”. f. A completeness check assesses the critical fields in an input screen to make sure that an entry has been input in those fields. This detects possible omissions of critical information. g. A sign check examines a field to determine that it has the appropriate positive or negative sign. This can prevent misstatements caused by misinterpretation of information. h. A sequence check ensures that a batch of transactions is sorted and processed in sequential order. This ensures that a batch will be in the same order as the master file. This may prevent errors in the master file by ensuring that the sequence is appropriate to facilitate an accurate update of the master file. i. A self-checking digit is an extra digit added to a coded identification number, determined by a mathematical algorithm. This detects potential errors in input data.

50. (SO 2) The IT governance committee should comprise top level managers.

Describe why you think that is important. What problems are likely to arise with regard to IT systems if the top level managers are not involved in IT governance committees? It is important for an IT governance committee to be comprised of members of top management so it can appropriately align IT investments with the company’s overall business strategies. If top level managers were not involved in this committee, it is likely that IT changes could be approved which do not enhance the company’s overall goals and strategies. In addition, it is possible that IT changes could be discussed and developed without receiving proper approval or funding.

51. (SO 2) Using a search engine, look up the term “penetration testing.” Describe the software tools you find that are intended to achieve penetration testing. Describe the types of systems that penetration testing is conducted upon. Software tools that perform penetration tests must be able to replicate a successful unauthorized access attempt or recreate an attack on a company’s security, but it must be able to do so without altering of damaging the systems upon which these tests are conducted. This will reveal weaknesses in the system so that the company can implement controls to strengthen the security of its system. Penetration testing is typically conducted upon network systems.

52. (SO 2) Visit the AICPA website at www.aicpa.org. Search for the terms “WebTrust” and “SysTrust.” Describe these services and the role of Trust Services Principles in these services. WebTrust services are professional services that build trust and confidence among customers and businesses which operate on the Internet.

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SysTrust services build trust and confidence between business partners who use and rely upon each other’s computer systems. These services are built upon the Trust Services Principles of Security, Privacy, Availability, Confidentiality, and Processing Integrity to help companies create trustworthy systems. Both of these services are represented by seal on the company’s Web site.

53. (SO 2) Using a search site, look up the terms “disaster recovery,” along with “9/11.”

The easiest way to search for both items together is to type into the search box the following: “disaster recovery” “9/11.” Find at least two examples of companies that have changed their disaster recovery planning since the terrorist attacks on the World Trade Center on September 11, 2001. Describe how these companies changed their disaster recovery plans after the terrorist attacks. Students’ answers may vary greatly, as there are numerous examples of companies who operated in or near the World Trade Center or were otherwise affected by the events of September 11, 2001 and who have revised their business disaster recovery plans as a result. A few examples are the financial services companies of Lehman Brothers, Merrill Lynch, and American Express. An article at www.cio.com includes interviews with the IT executives at these companies as they look back to the events of 9/11. In particular, Lehman Brothers has worked hard to increase its redundant storage and real-time back-ups. It also updated its phone systems so that all direct lines to customers would not terminate at the same place, as they did at the World Financial Center. In addition, it has developed a new business continuity plan, with variations that are now tied to the Homeland Security Advisory System’s color-coded warning levels. At Merrill Lynch, disaster recovery efforts focused on diversification of vendors to relieve the concentration from Lower Manhattan. In addition, it outfitted its buildings used for recovery with wireless LANs; this allows for increased flexibility through the broadcast of signals to multiple access points. For American Express, disaster recovery planning and business continuity planning have changed to a geography-based approach, recognizing that disasters are likely to affect large geographic areas. The events of 9/11 proved that Amex’s previous building-based program was not effective.

54. (SO 5) Go to any website that sells goods. Examples would be BestBuy, Staples, and J.Crew. Pretend that you wish to place an order on the site you choose and complete the order screens for your pretend order. Do not finalize the order; otherwise, you will have to pay for the goods. As you complete the order screens, attempt to enter incorrect data for fields or blanks that you complete. Describe the programmed input validation checks that you find that prevent or detect the incorrect data input. Student’s responses are likely to vary significantly, as different Web sites have different input validation checks. However, most Web sites have a warning message that will appear if invalid information is entered. (For instance, the message “The billing city, state, zip code, and country entered do not match up.

Please revise your selections below” was encountered on jcrew.com when bogus city and zip code information was entered.) The warning message will typically prevent the user from proceeding to the next step in the transaction until the error is corrected.

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Cases 55. Authentication and hacking controls at an environmental consulting company.

Required: a. From the list of general controls shown in Exhibit 4-5, list each authentication and hacking control that you think the EnviroCons Company should have in place. Any of the Authentication controls could be used, including user IDs, passwords, security tokens or smart cards, biometric devices, login procedures, access levels, computer logs, and authority tables. In addition, any of the hacking controls could be used, including a firewall, security policies, security breach resolution, secure socket layers, a virtual private network, wired equivalency privacy, service set identifiers, antivirus software, vulnerability assessments, penetration testing, and intrusion detection. Encryption is also likely to be necessary in order to protect the confidential data of the companies throughout the US that EnviroCons serves. b. Explain how each control that you list can prevent IT related risks for EnviroCons. Login procedures, including passwords, security tokens or smart cards, and biometric devices, are needed to limit access to the system to authorized users. Login procedures should always include passwords, and may be strengthened to include two-factor authentication by requiring a security token or smart card in addition to the password. In addition, the company’s system policies should be documented and administered consistently, including authority tables and establishment of appropriate access levels and securities breach resolutions, and the maintenance of computer logs. This will provide for limiting access to authorized employees, monitoring and resolving problems, and recording access times so as to establish accountability. Regarding hacking controls, firewalls are needed to block unauthorized external network traffic. Encryption will convert the data into cipher text, or secret codes that will be deemed useless to any hacker who intercepts it. SSL can be built into the Web server to encrypt data transferred on the Web site. A VPN is needed for authentication and encryption of Internet traffic, which is important for the EnviroCons consultants working offsite who need to access the company’s database. For the wireless network, WEP would also be useful for encrypting the data and unique SSIDs would require passwords between the network’s sending and receiving nodes. Antivirus software is needed to scan the system for viruses or worms and delete them before they infect the data or system. Finally, vulnerability assessments, penetration testing, and intrusion detection testing could each be used to locate weaknesses in the company’s systems so that they can be controlled to prevent unauthorized access. c. Are there any general controls that you think would not be cost-beneficial?

Biometric devices, such as fingerprint or retina scans or voice recognition software is probably not cost beneficial in the case of EnviroCons, as

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other forms of two-factor authentication could be used just as effectively at a lower cost.

56. Consideration of Internet EDI in a plastics manufacturing company. Required: a. Describe the extra IT system risks that Plaskor should consider as it evaluates whether to buy or develop an Internet EDI system. As Plaskor converts to an Internet EDI system, it will become susceptible to a wide range of risks concerning the security, availability, processing integrity, and confidentiality of its system. As new business partners may be granted access to Plaskor’s systems, the potential exists for those users to browse, alter, destroy, or steal data or programs, make unauthorized transactions, or otherwise sabotage the systems in order to make them inoperable or unavailable. These risks are increased if the company does not implement controls to detect and prevent them. b. Describe the IT internal controls that should be incorporated into an Internet EDI system. In a well-controlled Internet EDI system, the external users should be required to log with a user ID and password. Security tokens, smart cards, or biometric devices may also be used. Authority tables should limit the access level of the user and computer logs should monitor the activity of the user. A firewall should be installed to limit access to recognized external users, and data should be encrypted to ensure that its privacy is protected. The standard form of encryption used to protect Internet exchange of data is SSL. 57. Fraud at PT&T. Required: List and describe internal controls from this chapter that may helped prevent or detect Jerry Schneider’s fraud. Keep in mind that this case occurred before there was an Internet and large company computer networks.

PT&T’s authority tables should have limited Jerry Schneider’s computer access levels to selected vendor information. He should not have been able to access the entire files and program code for the company’s inventories and ordering systems. In addition, he should not have had the authority to alter programming in order to erase evidence of his activities. If access had been properly limited, the company’s computer logs would have been able to detect the types of activities that Schneider had performed while accessing PT&T’s systems. Finally, a simple physical control should have prevented the issuance of keys to suppliers.

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Concept Check 1. b 2. c 3. d 4. d 5. a 6. c 7. d 8. d 9. c 10. c 11. b 12. d

Discussion Questions 13. (SO 1) Why is tone at the top so important to corporate governance?

Tone at the top is so important because it is the set of values and behaviors in place for corporate leaders. As the term suggests, it sets the tone, or pattern, for the entire organization. Thus a “bad” tone at the top is likely to filter down and affect all levels of the enterprise.

14. (SO 1) Why do you think companies that practice good corporate governance tend to be successful in business? Good corporate governance means that the company leadership is held accountable for building shareholder value and creating confidence in financial reporting processes. This accountability means that corporate leaders are more likely to do the right thing: that is, they operate efficiently, effectively, and ethically. Such companies tend to be more successful.

15. (SO 2) Which stakeholder group (internal or external) is more likely to be affected by corporate governance, and which has a direct affect on corporate governance? External stakeholders are most affected by corporate governance. Bad corporate governance is likely to lead to negative consequences for external stakeholders such as creditors or stockholders. Internal stakeholders have a more direct effect on the state of corporate governance. Those external to the company do not have as much influence or control.

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16. (SO 2) Explain how it is possible that a shareholder could be considered both an internal and external stakeholder. Shareholders are owners of the company and could therefore be considered internal; stakeholders. However, in many large corporations, most shareholders own such a small percentage of outstanding shares that they have little to no influence on the corporation. Thus, they could be considered external stakeholders.

17. (SO 2) Why is the Board of Directors considered an internal stakeholder group, when it is required to have members who are independent of the company? Because the board of directors has the highest level of authority with respect to company objectives and strategies, it is considered an internal stakeholder group. Therefore, it has a direct and strong influence on the governance of the enterprise.

18. (SO 2) How can internal auditors maintain independence, since they are employees of the company? Internal auditors should not have any reporting relationship or conflicting roles that impact their objectivity on the job. For example, internal auditors often report to the audit committee so that they are not reporting to a manager who would lead to a conflict of interest. If internal auditors report to the CEO or CFO, those parties are more likely to have an interest in hiding any fraudulent or unacceptable behavior.

19. (SO 3) Identify the four functions of the corporate governance process.

The four functions of the corporate governance process are: management oversight, internal controls and compliance, financial stewardship, and ethical conduct.

20. (SO 3) Describe the key connection between tone at the top and management oversight. Management oversight is the set of policies and practices in place to lead the directorship of the company. This set of policies and practices, if consistently demonstrated by management, should set a good tone at the top.

21. (SO 3) Explain the connection between fiduciary duty and financial stewardship. Fiduciary duty means that management has been entrusted the power to manage assets of the corporation, which are in turn owned by the shareholders. Financial stewardship is the obligation of the fiduciary to treat these assets with discipline, respect, and accountability.

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22. (SO 4) Why is it that many accountants claim that corporate governance was born in the 1930s? The stock market crash of 1928 is believed to have been caused by misleading accounting and reporting practices. The federal government responded by passing both the Securities Act of 1933 and the Securities Exchange Act of 1934.

These were the first regulations to attempt to require management accountability to investors, so they are thought of as the birth of corporate governance.

23. (SO 4) What is the primary difference between the Securities Act of 1933 and the Securities Exchange Act of 1934? The Securities Act of 1933 requires full financial disclosure before securities can be sold, while the Securities Exchange Act of 1934 requires ongoing disclosure for registered companies.

24. (SO 5, SO 6) Why did the SEC establish the PCAOB? The PCAOB was established to govern the work of auditors of public companies.

The PCAOB provides standards for audits, and has investigative and disciplinary authority over public accounting firms.

25. (SO 5) Why can auditors no longer be involved in helping their audit clients establish accounting information systems? Around the period of discussion on the upcoming Sarbanes-Oxley act, there was a general perception in public that this type of consulting engagement impaired the independence of auditors. There was concern that a firm that helped design an accounting system could not be independent in assessing the effectiveness and reliability of that accounting system.

To enhance independence, the Sarbanes-Oxley Act prohibited such consulting engagements.

26. (SO 5) Under what conditions are auditors permitted to perform nonaudit services for their audit clients? Non-audit services are permitted only if the auditor has obtained prior approval from the client’s audit committee.

27. (SO 5, SO 6) How has the Sarbanes-Oxley Act increased the importance of audit committees in the corporate governance process?

The SOX Act places much more responsibility on the audit committee.

On financial matters, the audit committee is to supervise the board of directors, which in turn supervises corporate management. The audit

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committee must be independent and it is responsible for hiring, firing, and overseeing the external auditors. The external auditors report to the audit committee on all audit related matters. Some companies may have followed these practices prior to 2002, but SOX now requires the use of these practices.

28. (SO 5) Identify the six financial matters that must be certified by a company’s top officers under the requirements of Section 302 of the Sarbanes-Oxley Act. The following matters must be certified by a company’s top officers: (1) the signing officers have reviewed the report in detail; (2) based on the signing officer’s knowledge, the report does not misstate any facts; (3) based on the signing officer’s knowledge, the financial statements and related disclosures are fairly presented; (4) the signing officers are responsible for the establishment, maintenance, and effectiveness of internal controls; (5) the signing officers have disclosed to the auditors and audit committee any instances of fraud or internal control deficiencies; (6) the signing officers indicate whether or not any significant changes in internal controls have occurred since the date of their most recent evaluation.

29. (SO 5) Explain the relationship between Section 401 of the SarbanesOxley Act and the concept of transparency. Transparency in financial reporting implies that nothing is hidden from the view of readers of financial statements. Section 401 requires new disclosure information on the financial statements for off-balance-sheet transactions. This ensures that off-balance-sheet transactions are not hidden from readers.

30. (SO 5) Explain the difference between management’s responsibility and the company’s external auditors’ responsibility regarding the company’s internal controls under Section 404 of the Sarbanes-Oxley Act. Under section 404 of the SOX Act, the CEO and CFO have the responsibility to maintain a proper system of internal control.

Management must assess the effectiveness of the internal control system based on an established framework such as COSO. The external auditor must review the internal controls and attest to the effectiveness of the internal controls.

31. (SO 5) Explain why Section 409 of the Sarbanes-Oxley Act has placed more pressure on members of IT departments within public companies. Section 409 of the SOX Act requires real-time disclosures

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of important corporate events such as bankruptcy, new contracts, acquisitions and disposals, and changes in control. This real-time reporting requires that the company’s accounting systems track such events in real-time. Therefore, IT departments must help establish and maintain IT systems capable of achieving these reporting requirements.

32. (SO 5) How is the Sarbanes-Oxley Act forcing corporations to become more ethical? The SOX Act requires all public companies to have a code of ethics in place. This does not guarantee that ethical conduct will occur, but it at least informs managers and employees that they are expected to act ethically.

33. (SO 6) Why do corporate leaders see their jobs as more risky since the Sarbanes-Oxley Act became effective? There are several “sign-offs” that corporate leaders must do. If a corporate officer signs-off without due care or fraudulently, he or she can be subject to penalties.

34. (SO 6) Which governing body holds the top position of management oversight? The corporate board of directors holds the top management oversight position .

35. (SO 6) Identify two ways that companies are making efforts to improve the financial stewardship of their managers. In order to improve the financial stewardship of their managers, some companies are offering training programs to assist managers in understanding their stewardship responsibilities and some have made adjustments to management incentive compensation packages to reduce the temptation to manage earnings.

36. (SO 7) How can IT departments assist corporate managers in fulfilling their corporate governance roles? A company’s IT infrastructure is a very important system for allowing management access to the information they need to ensure compliance with corporate governance guidelines. The IT system can also help ensure managers and employees are trained on ethics and corporate governance. The chapter mentions the example of BASF that supplies ethics training via the Internet.

37. (SO 8) How is it that management’s role as financial stewards may be considered a conflict of interest with their position as employees of the

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company? Managers often have compensation plans in which incentives are tied to company earnings. This may lead to a conflict between what is in the best interest of shareholders and the best interest of the manager or employees. Often what is in the best interest of employees or management is not in the best interest of the shareholders.

Brief Exercises 38. (SO 2) Why are shareholders sometimes considered internal stakeholders and sometimes considered external stakeholders?

Shareholders are owners of the company and could therefore be considered internal stakeholders. However, in many large corporations, most shareholders own such a small percentage of outstanding shares that they have little to no influence on the corporation. Thus, they could be considered external stakeholders.

39. (SO 3) Is it possible for financial information to be accurate but not transparent? Similarly, is it possible for financial information to be transparent but not accurate? Explain. Yes, it is possible for information to be accurate but not transparent. For example, if a company accurately reports information on the face of the financial statements but neglects to disclose appropriate explanatory information in the footnotes, then transparency is compromised. On the other hand, a company can be thorough in providing supplementary information that is needed to understand and analyze the financial statement amounts, even though there are errors in the reporting of those amounts.

40. (SO 3) Earnings management involves lying about the company’s financial results in order to provide a more favorable impression to investors. Earnings management is discussed in the section on financial stewardship. Explain how the other three functions of corporate governance can work together to help prevent earnings management within a corporation. Besides financial stewardship the other three functions of corporate governance are management oversight, internal controls and compliance, and ethical conduct. Even if there are weaknesses in financial stewardship that allow for the possibility of earnings management, these other three functions should prevent this. If effective management oversight is practiced whereby supervision and communication are key to the ongoing processes,

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manipulations of financial information should be caught by the diligent managers who oversee the financial reporting function. In addition, the system of internal controls should provide for the assignment of rights and responsibilities and compliance with accounting conventions in a manner that encourages accuracy and transparency of financial information. Furthermore, creating and maintaining a culture of honesty and accountability is inconsistent with the practice of earnings management. Accordingly, these strengths of the other components of corporate governance are expected to overcome any weakness in financial stewardship that might create an opportunity for earnings management.

41. (SO 4) Describe how the characteristics of the financial markets in the 1980s eventually led to the creation of the Sarbanes-Oxley Act of 2002. In the 1980s, there was intense pressure for companies to met or beat their earnings targets. As a result, creative accounting practices became more common. Even in the following decade, these irregularities became so severe that a series of high-profile corporate accounting scandals erupted. The losses suffered as a result of these corporate scandals were so significant that many investors demanded that new legislation be introduced in order to prevent repeat instances of these problems. The SOX Act was the result.

42. (SO 5) Although the Sarbanes-Oxley Act of 2002 applies to public companies, many private business organizations have been impacted by this legislation, especially if they are suppliers to a public company.

Explain how this external stakeholder relationship can lead to the widespread application of Section 404 of the Act. For many of the public companies which are doing business with private companies, the requirements of the SOX Act are being superimposed upon the private companies. In order for the public company to comply with the SOX Act, it must be assured that its trading partners also maintain effective controls. As a result, many private companies are complying with the SOX Act in order to protect their business relationships.

43. (SO 6, SO 7) Describe at least three ways that the Sarbanes-Oxley Act and the increased emphasis on corporate governance have put more attention on the role of those responsible for the company’s accounting information systems. IT departments are expected to help management achieve compliance with new legislation by leveraging technology so that financial processes can be relied upon to provide

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accurate information. Secondly, many corporate managers are demanding more electronic recordkeeping to provide timely information, but that requires an IT infrastructure that supports the company’s strategies and goals. Finally, since most corporate managers do not have time to collect data, they need to have information that is readily accessible.

44. (SO 8) Why do you think it is particularly challenging for companies to maintain ethical behavior during difficult financial times? During difficult financial times, it is particularly challenging for companies to maintain ethical behavior because of the conflict of interest for managers in their role as financial stewards of the business. Management may be inclined to act in a way that protects their job or their employees at the expense of the shareholders. Earnings management techniques are an easy solution to this conflict.

Problems 45. (SO 3) List the six steps for establishing internal controls and describe how this process leads to stronger overall corporate governance. The six-step process for internal controls includes the following: 1. Define the key activities and resources involved in each business activity.

2. Define the objectives of each activity.

3. Obtain input from experienced users and advisors on the effective design of controls.

4. Formally and thoroughly document the details of the controls.

5. Test the effectiveness of controls to make sure they are operating as designed.

6. Engage in continuous improvement to fix problems and upgrade controls.

These steps help to establish a thorough understanding of processes as the foundation for an effective system. It also provides for documenting, monitoring, and improving the system as needed.

This provides for accurate and transparent financial reporting.

46. (SO 5, SO 6) List the items that must be certified by corporate management in accordance with the provisions of the Sarbanes-Oxley Act. Discuss how these responsibilities have likely changed the period-to-period activities of the certifying managers. Top managers must submit a certified statement to accompany each annual and

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quarterly report to acknowledge their responsibility for the contents of the financial reports and the underlying system of internal controls. The specific points include acknowledgments that: 1. They have reviewed the report in detail.

2. The report does not misstate any facts.

3. The financial statements and related disclosures are fairly presented.

4. They are responsible for the establishment, maintenance, and effectiveness of internal controls.

5. They have disclosed any instances of fraud or internal control deficiencies.

6. They have indicated whether or not any significant changes in internal controls have occurred since the date of their most recent evaluation.

The responsibilities inherent in these certified statements have likely resulted in significant changes in the activities of the signing officers. Specifically, the certifying officers can no longer delegate responsibility for the detailed accounting functions to their subordinates. These officers must become knowledgeable about the details in order to facilitate these certifications. Moreover, since the certifications must be filed quarterly, this new attention to detailed accounting information must be a continuous responsibility.

47. (SO 6) Identify the costs and benefits of complying with the SarbanesOxley Act of 2002. Do you think the costs are justified? The costs of complying with SOX are high, and have ranged from some companies’ complete overhaul of operations to other companies’ mere revisions in reporting and documentation. In addition, most companies have also seen increases in their audit costs, as auditors also have increased responsibilities as a result of SOX. On the other hand, some companies have realized benefits from the requirements of SOX, including enhanced performance as a result of improved internal controls.

Students’ responses to the question of SOX’s justification are likely to be mixed. Some may criticize SOX for its extreme requirements and minimal benefits, as well as the resulting shift in managerial focus from large scale, strategic issues to detailed reporting requirements. They may agree that SOX was enacted hastily in response to a few bad cases of corruption that are not necessarily representative of America’s corporate control environment as a whole. However, others may appreciate the opportunity that SOX has presented for improving

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corporate controls. Some SOX proponents believe that the benefits are likely to be realized gradually as companies increase their awareness of internal controls and streamline their business processes accordingly.

48. (SO 2, SO 5) Using an Internet search engine (such as Google, Dogpile, Lycos), determine who was the whistleblower at Enron.

Summarize the circumstances. What was the relationship of this person with the company? Was this an internal or external stakeholder? The whistleblower at Enron was Sherron Watkins, an internal stakeholder who held the position of Vice President for Corporate Development. In 2001, she wrote a letter to Enron founder Ken Lay to warn him of the company’s impending financial problems if he did not come clean about potentially disastrous accounting tricks.

She also shared her concerns with a friend at Arthur Anderson, her former employer and Enron’s audit firm.

49. (SO 3, SO 8) Using an Internet search engine (such as Google, Dogpile, Lycos), search for the terms “guilty as charged” + “California Micro Devices” in order to find an article about the company, California Micro Devices. Identify the related corporate governance issues. Two top-ranking executives at California Micro Devices were convicted of accounting fraud, including securities fraud and insider trading. As top executives, they were in a position of trust. The federal prosecutors in their case indicated that it was important to send a message about the seriousness of their crimes, the importance of their roles within the company, and the need for severe punishment for the abusive accounting schemes that were carried out.

50. (SO 3, SO 8) There are five types of management earnings techniques presented in this chapter. Provide two or three specific examples of how corporate leaders could pull off these types of fraud, as well as the internal control activities that could be used to prevent them. Student responses are likely to vary but may include the following fraud schemes, each of which may be particularly effective if conducted near year-end: • Early recognition of revenues, such as when management loads the sales pipeline with customer transactions that will actually be carried out in the next accounting period rather than the current period; i.e., channel stuffing.

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Early shipment of products, such as when management authorizes premature shipment of goods to customers. This is often done for customers who place routine or recurring orders, so management assumes that it will be able to pull off this accounting stunt by sending a shipment for a transaction that has not yet been taken place. Even if the customer refuses the shipment and returns the goods, such is likely to occur in the next accounting period, so the fraudulent sale would still be recorded in the current period.

Falsification of customers, such as when bogus customers are created in the accounting records and bogus sales transactions are developed to inflate the company’s revenues. Fictitious supporting documents may be created to give the impression of a legitimate transaction with a valid customer.

Falsification of invoices or other records may occur in an attempt to force more sales transactions into the current period’s accounting records. For instance, sales invoices and related shipping documents may be backdated so that they are included in the prior period.

Allowing customers to take products without taking title to the products, such as forcing a trial period upon them.

Management may attempt this, hoping that the customers may decide to carry out the transaction. Even if the customer returns the goods, such is likely to occur in the next accounting period, so the fraudulent shipment and sales would still be recorded in the current period.

Cases 51.Do you think the tone at the top of organizations like Enron and WorldCom led to their demise? In support of your answer, identify specific actions of top managers at each of these companies. In order to answer this question, you may wish perform research on the conditions that brought these companies down. Student responses will vary, but there is likely to be consensus on the issue of poor tone at the top leading to a company’s demise. At Enron, there are multiple examples of unscrupulous actions of deception, including the creation of offshore entities under the leadership of CFO Andrew Fastow.

These special purpose entities provided management with freedom to move funds and a place to hide corporate losses. In addition, COO Jeff

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Skilling promoted mark-to-market accounting, where future profits were recorded early. At WorldCom, Bernie Ebbers started a fraud ring that spiraled out of control even after he was ousted as CEO. He persuaded WorldCom’s board of directors to loan him millions of dollars to cover his margin calls so he would not have to sell his company stock. Management also authorized the gross misclassification of expenses as capitalized costs and the recording of bogus revenue transactions.

52. Through online research, locate a code of conduct for the top management of a real world company. Discuss the importance of each component of this code in terms of ethics and its relation to the concept of corporate governance. Student responses will vary significantly, as there are numerous examples that may be found online of company’s ethics codes. Each component of a code of ethics should address one or more of the functions of corporate governance, including management oversight, internal controls and compliance, and financial stewardship. Although these functions are interrelated, integrity and ethical behavior should be pervasive. As such, ethical conduct is often regarded as the most important part of corporate governance.

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Concept Check 1. b 2. b 3. c 4. a 5. d 6. a 7. b 8. d 9. d 10. a 11. c 12. d

Discussion Questions 13. (SO 1) At the beginning of the chapter, the real world example of Allstate’s IT expenditure is mentioned. Prior to the implementation of their IT Governance Committee, "whoever spoke the loudest or whoever had the biggest checkbook," got to select IT Projects. What do you think the problems were with this kind of approach? There would be no long-term strategy in how they spent money on IT projects. Therefore, it would be less likely that the company is buying and using the type of IT systems that support what the company wished to accomplish in the long-term.

14. (SO 1) Why is it important that IT systems be aligned with the business strategy? IT systems are critical systems that support and enhance business processes and business strategy. If the IT systems do not support the business strategy, the company will find it much more difficult to achieve the long-term goals.

15. (SO 1) Why would IT Governance include measuring the performance of IT Systems? IT Governance is the proper management of IT. Without monitoring the performance of IT, there is no feedback to determine whether it is meeting the needs of the company, and meeting the objectives it was intended to achieve.

16. (SO 3) What is the difference between technical feasibility and operational feasibility? Technical feasibility examines whether technology exists to accomplish the objectives in a proposed IT

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system. Operational feasibility is an examination of whether the organization could operate the proposed IT systems, given the limitations of the personnel and resources within the company.

17. (SO 3) How does the analysis of feasibilities in the Systems Planning help to prioritize system changes? A feasibility analysis may eliminate some proposed IT systems as not feasible. Of those remaining under consideration, the feasibility analysis helps determine which proposed IT systems are most feasible. Thus, those that are more feasible would have a higher priority and those that are less feasible have a lower priority.

18. SO 4) What is the advantage of studying the current system within the Systems Analysis phase? It is easier to determine how to improve ther efficiency and effectiveness of a system if that system is well understood. A study of the current system helps determine which areas need improvement.

19. (SO 4) During the systems analysis phase, which two data collection methods help determine user requirements? Interviews and questionnaires both solicit information or opinions from users. These methods allow users to have input in determining system requirements.

20. (SO 5) What are the advantages of purchased software when compared to software developed in-house? Purchased software is usually less costly, more reliable, and has a shorter implementation time.

21. (SO 5) Why might it be important follow some or all of the SDLC phases for purchased software? Even when software is purchased, it often must be modified or customized. The SDLC phases help organize and manage those steps to modify or customize the software.

22. (SO 5) How is conceptual design different from detailed design? The detailed design is much later in the process and creates the entire set of specifications necessary to build and implement the system. The conceptual design is earlier and is much more general in nature. It establishes alternative conceptual designs.

23. (SO 5)Within the System Design phase, what is the purpose of the Evaluation and Selection? The purpose is to assess the feasibility of each alternative conceptual design and to select the alternative design that best fits the organization’s needs.

24. (SO 5) Which part of the System Design phase would include designing rows and columns of output reports? Why is it important to design reports? The detailed design part of system design includes creating the details of output reports. Output reports include the

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information that users need to accomplish their jobs and without properly designed outputs, they cannot efficiently do these jobs.

25. (SO 6) What is the purpose of software testing? The purpose is to uncover problems in the system that would lead to erroneous accounting data.

26. (SO 6) How are accountants involved in data conversion?

Accountants should do two things in data conversion. The first is to oversee the data conversion to make sure all data are completely and accurately converted. Accountants should also reconcile the converted data with the old data to insure it was accurately converted. They would compare control totals of the old and converted data to accomplish the reconciliation.

27. (SO 6) Why is a direct cutover conversion risky? It is risky because the old system is no longer in operation, and therefore, the old system cannot be used as a backup system in the event of errors or problems with the new system.

28. (SO 6) Why is parallel conversion costly? It consumes more time and money because it requires running two systems at the same time.

29. (SO 6) Why is user acceptance important? The project team is more likely to solicit and use feedback from users if they know that users must sign off on the new system. In other words, the project team cannot say their job is finished until the user sign off occurs.

30. (SO 6) Why is post-implementation review undertaken? It is undertaken to help those involved in the SDLC to learn from any mistakes they made during the process.

31. (SO 8) How does the SDLC serve as an internal control? It is an internal control in the sense that it helps ensure that IT systems meet organizational needs and that the development and implementation of new IT systems is properly controlled.

32. (SO 9) What ethical obligations do employees have as IT systems are revised? Employees should make an honest effort to participate as requested in the SDLC, learn new system processes that result, and properly use the new systems and processes.

Brief Exercises 33. (SO 1) Describe the role that the Board of Directors should play in IT governance. The board must oversee all aspects of IT in the organization. They must articulate and communicate the direction for IT, stay aware of development, investments, and costs in IT. They

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should receive and review reports on major IT projects and regular performance reports, and ensure that there are suitable resources and infrastructure available.

34. (SO 3, SO 5) Two feasibility studies occur during the SDLC; one during Systems Planning, and one during Systems Design. Describe the differences between these two feasibility studies. In the systems design phase, the feasibility study more detailed and the scope is different. At this part of the system design phase, the alternative system conceptual designs have been narrowed to one alternative.

Thus, the feasibility study focuses on the details of that one design.

The estimates of the technology needed, the operational requirements, the costs, and the implementation schedule can be more precise. In the systems planning phase, the purpose is to assess the feasibility of several alternative conceptual designs and to narrow the alternative conceptual designs.

35. (SO 4) There are four methods of data collection used in the study of the current system; observation, documentation review, interviews, and questionnaires. Compare and contrast these four methods. In observation and documentation review, the project team views strengths and weaknesses of the system from their own perspective and they are not asking for user feedback. Interviews and questionnaires are methods to ask for user input. Interviews are faceto-face and verbal in the collection of user feedback. Questionnaires can be anonymous and written. Both interviews and questionnaires can be structured or unstructured.

36. (SO 5) Describe the purpose of Business Process Reengineering during the System Design phase. During the system design phase, the changes inherent in a new IT system may require changes in the underlying business processes. BPR is as radical rethinking and redesign of a business process to take advantage of the speed and efficiency of computers. BPR allows the company to make sure they are leveraging the capabilities of IT to improve the efficiency of the business processes.

37. (SO 6) There are four methods of system conversion; parallel, direct cutover, pilot, and phase-in. Describe these four methods and how they differ. A parallel conversion is the operation of both the old system and the new system for a limited period of time. A direct

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cutover occurs when the new system begins as of a certain date and the old system is discontinued on that same date. In a pilot conversion, the new system is implemented in a subunit or subunits within the organization. The old system would continue in other parts of the organization. In a phase-in conversion, the new system is introduced in modules, rather than the entire system at once. In comparing the four methods, the direct cutover is the most risky and the parallel is least risky. The pilot and phase-in approaches may take a longer total time to achieve a conversion to the entire new system across the organization.

38. (SO 7) Operation and maintenance is the longest and costliest part of the SDLC. Describe why this would be true. When a company has completed the SDLC and implemented a new system, the intent is to operate it for a few years to capture the benefits of the new system.

Therefore maintaining and operating the system may last for several years and therefore, be the most costly part also.

39. (SO 1, SO 8) Describe how IT performance reports are important in IT Governance. Regular monitoring of the IT system is necessary to ensure that the system is meeting its objectives and performing as expected. If management never received performance reports it would be difficult to know whether they needed to improve or revise the system.

40. (SO 9) What is the underlying purpose of the restrictions on CPA firms in Section 201 of the Sarbanes Oxley Act? These restrictions are intended to increase the independence of CPA firms that provide audit services for companies. The concern was that if a company receives fees from a client for consulting work, they may be less independent of the client’s wishes and more likely to allow clients to provide misleading accounting information to the investing public.

Problems 41. (SO 1) Mega Corporation just became a public corporation when shares of stock were sold to the public three months ago. A new board of directors has been appointed to govern the corporation. Assume that you will be giving a presentation to the board on their responsibilities for IT systems. Write a report that could be delivered to

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the board.

The board of directors of a company has a set of very important responsibilities related to IT systems. As top management of the company, the board must take responsibility to ensure that the organization has processes that align IT systems to the strategies and objectives of the company. To carry out this responsibility, the board must do certain functions, or ensure there are processes to carry out the following functions: Align IT strategy with the business strategy Cascade strategy and goals down to lower levels of the organization Provide structures that facilitate implementation of strategy and goals Insist that an IT control framework be adopted and implemented Measure and review IT performance The more detailed activities needed to carry out these board responsibilities are as follows: * Articulate and communicate long-term strategy * Stay aware of latest developments in IT * Insist that IT be a regular agenda item at board meetings * Stay aware of the company’s investments, and competitors investments in IT * Ensure the senior IT official’s reporting level is appropriate to the role of IT. * Ensure the board has a clear view of the risks and returns of current or proposed IT systems * Receive and review regular reports on the progress of IT projects, and on IT performance. * Ensure adequate resources, skills, and infrastructures to meet strategic goals for IT systems If the board of directors focuses on these activities, it will help the board to ensure that IT systems do support long-term strategic objectives of the company.

42. (SO 2) Blutarch MultiMedia Stop is a regional retailer of consumer electronics with warehouses and stores located in several large cities in California. The board and top management of Blutarch are considering updating their accounting, inventory, and retail sales

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software and hardware. Their current systems are approximately 15 years old. Assume that you have been hired as a consultant to guide them through the process of upgrading their systems. Write a document that could be presented to the Board of Directors that summarizes the SDLC. Memorandum To: Board of Directors From: Jennifer Starnes, IT Consultant Re: Systems Development Life Cycle This memo is intended to provide an executive summary on the System Development Life Cycle and the importance of it for your company.

IT systems are crucial to the success and profitability of Blutarch. To enhance long-term performance, the company must choose and use the IT systems that best support the company’s goals and objectives.

To ensure you are selecting and using the most effective IT systems, you should follow a systematic and formal process to select, design, and implement IT systems. A failure to follow a systematic and formal process in selecting and implementing IT systems is likely to lead to a mismatch between Blutarch strategic objectives and the capabilities of the IT systems.

One popular way of using a systematic and formal process is to follow a System Development Life Cycle (SDLC) method. The SDLC is a set of systematic phases and steps to follow in selecting, designing, and implementing IT systems. Given limited funds and time, following an SDLC process is a planned and controlled method of ensuring a proper match between Blutarch IT needs and the IT system implemented.

The phases of the SDLC are: systems planning; systems analysis; systems design; systems implementation; and operation and maintenance. These phases occur in the sequence given as a planned and controlled approach to implementing new IT systems. The following are brief descriptions of each of these phases.

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Systems planning involves examining the long-term objectives of your company and based on these objectives, planning and prioritizing the type of IT systems that can help you achieve those objectives. For example, if your company’s objective is to minimize inventory levels in your warehouses, you are likely to need IT systems that give you realtime and accurate information about inventory levels, and you are likely to need IT systems that help you predict or forecast sales of the various inventory items.

Systems analysis is the study of the current IT system to determine its strengths and weakness, and to get user feedback about the needs in a new IT system.

Systems design is the creation of the system that meets user needs as and improves the weaknesses of the old IT system. In other words, the data collected and analyzed in the systems analysis phase will guide the design of the new IT system.

Systems implementation is the set of steps undertaken to program, test, and activate the IT system that was designed during the systems design phase.

Operation and maintenance is the regular, ongoing functioning of the IT system and the process to fix smaller errors or problems in the IT system.

Following these phases, in this order, will help you to have IT systems that best match your company’s needs.

43. (SO 4) Assume that you are the project team manager that is engaged in a Systems Analysis. The company is a large, national retailer with several stores and warehouses located throughout the United States.

The corporate headquarters are in Atlanta, Georgia, and substantially all major accounting takes place at the corporate headquarters.

Describe how you would use the various data collection techniques of observation, documentation review, interviews, and questionnaires.

Observation and documentation review are both methods that allow a project team to better understand the IT system without soliciting input from users. That is, these methods do not interrupt the work of users,

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but they only uncover strengths and weaknesses in the IT system that are evident to the project team. These two methods would be used at the corporate headquarters by the project team. It may be necessary for the project team to also visit and observe at a couple of stores and a couple of warehouses. However, it would not be necessary, or would it be cost effective, to visit all stores and all warehouses.

Interviews and questionnaires both solicit feedback from users. Due to the number of stores and warehouses, it would be more effective to send surveys to these locations for certain users to complete. At the corporate headquarters, it would be possible to use both interviews and questionnaires. Because of the time consuming nature of interviews, they would be used on the smaller set of managers who use the IT system. The questionnaires would be used to survey the larger group of users who are not managers.

44. (SO 5) Ceemco is a small, privately owned manufacturing company in Cincinnati, Ohio. Ceemco manufactures custom products as well as store display products to sell to other companies such as retailers.

Using an Internet search engine, do a search using the search terms of Ceemco and Cincinnati. Examine the kind of manufacturing the company does. Once you have completed that, examine an accounting software site such as www.2020software.com or www.accountingsoftware411.com. Complete the following: a. Describe the process Ceemco should undertake to determine which accounting software might be the best fit for the company. For a small company of this size, they are not likely to have an IT staff that could assist with an SDLC process to develop specifications for any software systems needed. The more likely approach would be to hire a consulting firm to help select and install an accounting software system. b. Although you do not know much about the company, develop a list of requirements you believe accounting software should have for Ceemco to consider the software as a viable alternative. Since they produce many different categories of products (store displays, metal fabrication, plastic parts fabrication, medical case carts, HVAC products such as radiators, retail products such as window ornaments) they are very likely to have an extensive array of raw material inventories and the need to track many different types of work-in-process. Therefore, the most critical need may be for manufacturing and inventory tracking modules. The software would also need basic accounting modules

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such as accounts receivable, accounts payable, and general ledger. It is not possible to determine whether they do their own payroll or outsource payroll. If they do payroll in-house, they would need a payroll module. They sell the window-ornament products online, so there would be a need for an e-commerce module. There is no mention of locations other than two in Cincinnati. Therefore, they may have no need of a system that handles international currencies. c. Choose an accounting software from your Web search above and describe why you believe it is a good match for Ceemco. There is no correct answers to this question, but there are some answers that would be incorrect. For example, Quickbooks would not have the power necessary for this business. Also, enterprise level systems such as SAP or Oracle would be too expensive for a company such as Ceemco. Products such as MAS 200, MAS 500, Dynamics GP, or ACCPAC would be more appropriate.

45. (SO 2) There are several approaches to applying an SDLC methodology to IT system change. Using an Internet search engine, search for these terms: SDLC, waterfall, JAD (Joint Application Development), RAD (Rapid Application Development), Build and Fix, and Spiral Model. For example, you might try entering these search terms: SDLC waterfall. Write a brief definition of these various approaches to the System Development Life Cycle.

The student answer to this will vary depending on which web sites they use and when they access web sites. A sample answer is provided.

The SDLC waterfall approach is the oldest approach to system development. In a waterfall approach, there is a sequence of steps and the output of one sequence becomes the input for the next step.

The method described in this chapter is a waterfall approach.

Joint Application Development (JAD) is intended to reduce development time and to increase customer (end user) satisfaction with the system. It is a method that involves a series of meetings with the end users or clients that will use the system. These meetings with end users are called JAD sessions.

Rapid Application Development (RAD) usually involves object-oriented programming, a method that encourages the reuse of programmed modules. RAD includes: 1) workshops or focus groups to gather requirements, 2) Protoyping, and testing off those prototypes, 3) Strict

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time limits on each development phase that delays immediate fixes and defers these improvements to the next prototype, and 4) Less formality in team communications.

The Build and Fix method is very open-ended and can be very risky.

The method does not have formal steps such as in the waterfall method. In this method, a system is simply built (code is written) and then it is fixed until the customer is happy with it.

In the Spiral approach, an initial model of the system is developed and then successively refined with input from end users. The development of each successive version of the system is undertaken using the carefully controlled steps in the SDLC waterfall approach. In addition, after each development of each successive version, a risk assessment is undertaken to determine whether it is worthwhile to move to the next development version, or to stop.

The web sites used for this solution are: http://www.computerworld.com/developmenttopics/development/story/ 0,10801,71151,00.html http://www.startvbdotnet.com/sdlc/sdlc.aspx http://eproj.net/cgi-bin/pblog/index.php?entry=entry071106-131621 http://searchsoftwarequality.techtarget.com/sDefinition/0,,sid92_gci214 246,00.html http://www.ctg.albany.edu/publications/reports/survey_of_sysdev/surve y_of_sysdev.pdf http://www.garywwright.com/sdlc.php

46. (SO 9) Trace Johnson is an accounting software consultant at Fipps and Associates Consulting. Fipps is a value-added reseller of accounting software for mid-size companies. Mid-size companies normally have revenue between 50 million to 500 million dollars. One of Johnson’s responsibilities is to solicit new client companies, and to meet with management at these new clients so as to recommend the best accounting software system for the client. Mid-market accounting software normally has several modules that the client may choose from. For example, not all clients would need an e-business module for their accounting software, while other clients may need an ebusiness module. Since part of Johnson’s compensation is a percentage of software sales and consulting revenue that he

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generates, what are the ethical conflicts he faces when soliciting new clients and recommending software and software modules?

The nature of a consultant’s business can cause ethical issues to be raised. This is true because there can be a conflict between what is best for the client and what is best for the consultant. There are at least three important ethical traps that a consultant could easily fall into. One is excessive billing of hours. A second is recommending only software products that have a high profit margin for the consultant.

The third is recommending unnecessary modules. All three of these ethical issues have a common thread. In each of these situations, the consultant is trying to maximize his own wealth and is not putting the highest priority on the client’s needs.

A consultant could bill for extra hours not really worked for that client, or could inflate hours worked. In both cases, the consultant is dishonest and unethical. These fictitious billing acts are also fraudulent and illegal. The other two ethical issues mentioned above are not as easily proven to be illegal, but they are unethical. If a consultant feels two different software systems may meet the customers needs, but chooses the one with the higher profit margin solely fort the higher profit, he is acting unethically. Also if a consultant recommends additional software modules not really needed by the client, he is acting unethically.

Cases 47. ElectroHut is a retailer of electronics such as cell phones, satellite radios, mp3 players, and high-end LCD and plasma TVs. ElectroHut is a chain with stores in strip shopping centers throughout the United States. However, each store is a small store with generally five to six employees and a manager. As smaller stores, each store sells much less volume than large electronic retailers such as Best Buy or Circuit City.

Top management has recently become concerned with what appears to be an excessive amount of inventory loss (shrinkage) at many of its stores. At this point, the management team is uncertain as to whether the excessive loss is due to weaknesses in its IT system that tracks inventory, or is simply due to customer and

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employee theft at the stores. Top management is concerned that the IT system may be a contributing factor to the loss and would like to study whether a new system should be implemented.

Through their industry contacts, they know that large retailers such as Best Buy, Circuit City, and Staples use a much more sophisticated inventory management system than ElectroHut. A systems analysis would require a cost benefit analysis and a feasibility study. Describe steps that ElectroHut should undertake to complete a cost benefit analysis and a feasibility study for a new IT system to track inventory.

A feasibility study assesses feasibility in five areas: technical, operational, economic, and schedule feasibility. To conduct the technical feasibility, ElectroHut should determine the kind of inventory management software systems that are available in the market. For example, some companies are now using Radio Frequency Identification systems (RFID). These newer technology systems are the kind of inventory systems that ElectroHut should investigate during the technical feasibility study. The company should try to determine the latest technology in tracking inventory system. That is, what does current technology allow the company to achieve in tracking inventory. They could also consider whether the could build an inventory system internally, but this is not a likely option.

To examine operational feasibility, ElectroHut should compare its current system hardware and personnel to the system hardware and personnel needed to operate the new inventory systems identified in the technical feasibility study. ElectroHut will find that some systems are more likely to be the type that the company could operate given the hardware and personnel available to them.

Of course, some new hardware could be purchased and new personnel hired, but the more of this activity is required for a particular system, the less feasible it is from an operational standpoint.

An examination of economic feasibility is a cost-benefit analysis.

To conduct economic feasibility, ElectroHut should compare cost estimates for each potential system to the monetary benefits expected for each system. Usually, the monetary benefits are cost

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savings that result from efficiencies of the new system. ElectroHut would need to estimate the costs of new systems and the cost savings of those systems. Those potential systems in which benefits are greater than costs are more feasible.

To assess schedule feasibility, ElectroHut must try to estimate the amount of time require to implement each of the potential systems.

As the length of time to implementation increases, a system becomes less feasible. A very long implementation period may mean that the system will take too long to begin recognizing benefits and it may also mean that the hardware and software could be out of date by the time it is implemented.

48. Schibi International is in the process of purchasing a new accounting software system for their company. Schibi is in a very specialized industry, with an international market. The company manufactures very specialized parts to sell to companies in the oil exploration and drilling industry. The corporate headquarters are in Fort Worth, Texas and approximately half of their operations are U.S. based. They also maintain production plants and a sales and support staff in most oil producing countries. Explain the factors that Schibi should consider when determining which software system will best suit their needs.

The items mentioned in the question are some of the important factors. For example, the accounting system must have the capability to work with various international currencies. The software must also have the capability to use a large account numbering system so as to easily identify the various locations and purposes of the various accounts. The chart of accounts will very likely have a large number of accounts that are subdivided by location and purpose. Schibi also must consider that they are I a specialized industry. Therefore the software must be ale to match to the special processes or information needs of their industry. In addition to the unique factors that Schibi should consider, it should examine the same kinds of feasibility that any company should consider. Therefore, for any accounting software under consideration, Schibi should assess technical, operational, economic, and schedule feasibility.

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49. Refer to case 48 above. Describe which parts of the design phase Schibi should undertake to ensure that the purchased software matches with the business processes that they will use.

First, Schibi should determine whether they wish to employ consulting firm to assist in the purchase and implementation of the software. If they choose to hire a consulting firm, they should interview, request bids, and select a consulting firm early in the process. The consulting firm would then assist with all steps in selecting and implementing the software. If they so desire, they could also bring a consulting firm for the later stages of the design.

Request for proposals (RFPs) must be sent to any software firm under consideration. The returned RFP (bid), will include details about the software, the support provided for the software, and the price. The project team or IT governance committee should review each RFP in detail to select the best software system. The things that should be considered while reviewing the RFPs are: The price of the software The match of the software to user needs The technical, operational, schedule and economic feasibility Technical support provided by the vendor Reputation and reliability of the vendor Usability and user friendliness of the software Testimonials from customers currently using the software If the software selected must be modified to meet any specific needs of the company, the project team should develop design specifications for those modifications. If those modifications are extensive, the entire detailed design phase to design outputs, inputs, processes, and controls should be undertaken.

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Chapter 7 Solutions Concept Check 1. b 2. b 3. d 4. c 5. b 6. a 7. c 8. b 9. d 10. a 11. a 12. c 13. c 14. d 15. c 16. a 17. c 18. a 19. a 20. c 21. d

Discussion Questions 22. (SO 1) What are assurance services? What value do assurance services provide?

Assurance services are accounting services that improve the quality of information.

Many services performed by accountants are valued because they lend credibility to financial information.

23. (SO 2) Differentiate between a compliance audit and an operational audit. A compliance audit is a form of assurance service that involves accumulating and analyzing information to determine whether a company has complied with regulations and policies established by contractual agreements, governmental agencies, company management, or other high authority. Operational audits assess operating policies and procedures for efficiency and effectiveness.

24. (SO 2) Which type of audit is most likely to be performed by government auditors?

Which type of audit is most likely to be performed by internal auditors?

Governmental auditors are most likely to perform compliance audits, and internal auditors are most likely to perform operational audits.

25. (SO 2) Identify the three areas of an auditor’s work that are significantly impacted by the presence of IT accounting systems. The IT environment plays a key role in how auditors conduct their work in the following areas: • consideration of risk • determination of audit procedures to be used to obtain knowledge of the accounting and internal control systems • design and performance of audit tests.

26. (SO 3) Describe the three causes of information risk. Information risk is caused by: • Remote information; for instance, when the source of information is removed from the decision maker, it stands a greater chance of being misstated.

• Large volumes of information or complex information.

• Variations in viewpoints or incentives of the preparer.

27. (SO 3) Explain how an audit trail might get “lost” within a computerized system.

Loss of an audit trail occurs when there is a lack of physical evidence to view in support of a transaction. This may occur when the details of accounting transactions are entered directly into the computer system, with no supporting paper documents.

If there is a system failure, database destruction, unauthorized access, or environmental damage, the information processed under such a system may be lost or altered.

28. (SO 3) Explain how the presence of IT processes can improve the quality of information that management uses for decision making. IT processes tend to provide information in a timely and efficient manner. This enhances management’s ability to make effective decisions, which is the essence of quality of information.

29. (SO 4) Distinguish among the focuses of the GAAS standards of fieldwork and standards of reporting. The standards of fieldwork provide general guidelines for performing the audit. They address the importance of planning and supervision, understanding internal controls, and evidence accumulation. The standards of reporting address the auditor’s requirements for communicating the audit results in writing, including the reference to GAAP, consistency, adequate disclosures, and the expression of an overall opinion on the fairness of the financial statements.

30. (SO 4) Which professional standard-setting organization provides guidance on the conduct of an IT audit? The Information Systems Audit and Control Association (ISACA) is responsible for issuing Information Systems Auditing Standards (ISASs), which provide guidelines for conducting an IT audit.

31. (SO 5) If management is responsible for its own financial statements, why are auditors important? Auditors are important because they are responsible for analyzing financial statements to decide whether they are fairly stated and presented in accordance with GAAP. Since the financial statements are prepared by managers of the company, the role of auditors is to reduce information risk associated with those financial statements. To accomplish this, auditors design tests to analyze information supporting the financial statements in order to determine whether management’s assertions are valid.

32. (SO 6) List the techniques used for gathering evidence. The techniques used for gathering evidence include the following: • physically examining or inspecting assets or supporting documentation • obtaining written confirmation from an independent source

• • • •

rechecking or recalculating information observing activities making inquiries of company personnel analyzing financial relationships and making comparisons to determine reasonableness 33. (SO 6) During which phase of an audit would an auditor consider risk assessment and materiality? Risk assessment and materiality are considered during the planning phase of an audit.

34. (SO 6) What is the significance of Statement on Auditing Standards No. 94? SAS 94, “The Effect of Information Technology on the Auditor’s Consideration of Internal Control in a Financial Statement Audit”, is significant because it describes the importance of understanding both the automated and manual procedures that make up a company’s internal controls. It also provides guidance to assist an auditor in determining whether an IT audit specialist may be needed for the audit.

35. (SO 7) Distinguish between auditing through the computer and auditing with the computer. When are auditors required to audit through the computer as opposed to auditing around the computer? Auditing through the computer involves directly testing internal controls within the IT system, which requires the auditors to understand the computer system logic. Auditing through the computer is necessary when the auditor wants to test computer controls as a basis for evaluating risk and reducing the amount of audit testing required, and when supporting documents are available only in electronic form. Auditing with the computer involves auditors using their own systems, software, and computer-assisted audit techniques to help conduct an audit 36. (SO 8) Explain why it is customary to complete the testing of general controls before testing application controls. Since general controls are the automated controls that affect all computer applications, the reliability of general controls must be established before application controls are tested. The effectiveness of general controls is considered the foundation for the IT control environment. If there are problems with the effectiveness of general controls, auditors will not devote attention to the testing of application controls; rather, they will reevaluate the audit approach with reduced reliance on controls.

37. (SO 8) Identify four important aspects of administrative control in an IT environment.

Four important aspects of administrative control include: • personal accountability and segregation of incompatible responsibilities • job descriptions and clear lines of authority • computer security and virus protection • IT systems documentation 38. (SO 8) Think about a place you have worked where computers were present. What are some physical and environmental controls that you have observed in the workplace? Provide at least two examples of each from your personal experience.

Student’s responses are likely to vary greatly. Examples of physical controls may include card keys and configuration tables, as well as other physical security features such as locked doors, etc. Environmental controls may include temperature and humidity controls, fire, flood, earthquake controls, or measures to ensure a consistent power supply.

39. (SO 8) Batch totals and hash totals are common input controls. Considering the fact that hash totals can be used with batch processing, differentiate between these two types of controls. Both batch totals and hash totals are mathematical sums of data that can be used to determine whether there may be missing data. However, batch totals are meaningful because they provide summations of dollar amounts or item counts for a journal entry used in the financial accounting system, whereas hash totals are not relevant to the financial accounting system (i.e., the hash totals are used only for their control purpose and have no other numerical significance).

40. (SO 8) The test data method and an integrated test facility are similar in that they are both tests of applications controls and they both rely on the use of test data. Explain the difference between these two audit techniques. The test data method tests the processing accuracy of software applications by using the company’s own computer system to process fictitious information developed by the auditors. The results of the test must be compared with predicted results. An integrated test facility also tests processing applications, but can accomplish this without disrupting the company’s operations. An integrated test facility inputs fictitious data along with the company’s actual data, and tests it using the client’s own computer system. The testing occurs simultaneously with the company’s actual transaction processing.

41. (SO 9) Explain the necessity for performing substantive testing even for audit clients with strong internal controls and sophisticated IT systems. Since substantive testing determines whether financial information is accurate, it is necessary for all financial statement audits. Control testing establishes whether the system promotes accuracy, while substantive testing verifies the monetary amounts of transactions and account balances. Even if controls are found to be effective, there still needs to be some testing to make sure that the amounts of transactions and account balances have actually been recorded fairly.

42. (SO 9) What kinds of audit tools are used to perform routine tests on electronic data files taken from databases? List the types of tests that can be performed with these tools. CPA firms use generalized audit software (GAS) or data analysis software (DAS) to perform audit tests on electronic data files taken from commonly used database systems. These tools help auditors perform routine testing in an efficient manner. The types of tests that can be performed using GAS or DAS include: • mathematical and statistical calculations • data queries • identification of missing items in a sequence • stratification and comparison of data items • selection of items of interest from the data files • summarization of testing results into a useful format for decision making 43. (SO 10) Which of the four types of audit reports is the most favorable for an audit client? Which is the least favorable? An unqualified audit report is the most favorable because it expresses reasonable assurance that the underlying financial statements are fairly stated in all material respects. On the other hand, an adverse opinion is the least favorable report because it indicates the presence of material misstatements in the underlying financial statements.

44. (SO 10) Why is it so important to obtain a letter of representations from an audit client? The letter of representations is so important because it is management’s

acknowledgement of its primary responsibility for the fair presentation of the financial statements. In this letter, management must declare that it has provided complete and accurate information to its auditors during all phases of the audit. This serves as a significant piece of audit evidence.

45. (SO 11) How can auditors evaluate internal controls when their clients use IT outsourcing? When a company uses IT outsourcing, auditors must still evaluate internal controls. This may be accomplished by relying upon a third-party report from the independent auditor of the outsourcing center, or it can audit around the computer, or it can test controls at the outsourcing center.

46. (SO 12) An auditor’s characteristic of professional skepticism is most closely associated with which ethical principle of the AICPA Code of Professional Conduct?

Professional skepticism is most closely associated with the principle of Objectivity and Independence. Professional skepticism means that auditors should have a questioning mind and a persistent approach for evaluating financial information for the possibility of misstatements. This is closely related to the notion of objectivity and independence in its requirements for being free of conflicts of interest.

Brief Exercises 47. (SO 2) Why is it necessary for a CPA to be prohibited from having financial or personal connections with a client? Provide an example of how a financial connection to a company would impair an auditor’s objectivity. Provide an example of how a personal relationship might impair an auditor’s objectivity. An auditor should not have any financial or personal connections with a client company because they could impair his/her objectivity. It would be difficult for an auditor to be free of bias if he/she were to have a financial or personal relationship with the company or one of its associates. For example, if an auditor owned stock in a client company, the auditor would stand to benefit financially if the company’s financial statements included and unqualified audit report, as this favorable opinion could lead to favorable results for the company such as paying a dividend, obtaining financing, etc. Additionally, if an auditor had a family member or other close personal relationship with someone who works for the company, the auditor’s independence may be impaired due to the knowledge that the family member or other person may be financially dependent upon the company or may have played a significant role in the preparation of the financial statements.

48. (SO 3) From an internal control perspective, discuss the advantages and disadvantages of using IT-based accounting systems. The advantages of using ITbased accounting systems are the improvements in internal control due to the reduction of human error and increase in speed. The disadvantages include the loss of audit trail visibility, increased likelihood of lost or altered data, lack of segregation of duties, and fewer opportunities for authorization and review of transactions.

49. (SO 4) Explain why standards of fieldwork for GAAS are not particularly helpful to an auditor who is trying to determine the types of testing to be used on an audit engagement. GAAS provides a general framework that is not specific enough to

provide specific guidance in the actual performance of an audit. For detailed guidance, auditors rely upon standards issued by the PCAOB, the ASB, the IAPC, and ISACA. 50. (SO 5) Tyrone and Tyson are assigned to perform the audit of Tylen Company.

During the audit, it was discovered that the amount of sales reported on Tylen’s income statement was understated because one week’s sales transactions were not recorded due to a computer glitch. Tyrone claims that this problem represents a violation of the management assertion regarding existence, because the reported account balance was not real. Tyson argues that the completeness assertion was violated, because relevant data was omitted from the records. Which auditor is correct? Explain your answer. The completeness assertion is concerned with possible omissions from the accounting records and the related understatements of financial information; in other words, it asserts that all valid transactions have been recorded. Accordingly, Tyson’s argument is correct. Tyrone’s argument is not correct because the existence assertion is concerned with the possibility of fictitious transactions and the related overstatements of financial information.

51. (SO 6, SO 8) One of the most important tasks of the planning phase is for the auditor to gain an understanding of internal controls. How does this differ from the tasks performed during the tests of controls phase? During the planning phase of an audit, auditors must gain an understanding of internal controls in order to determine whether the controls can be relied upon as a basis for reducing the extent of substantive testing to be performed. Understanding of internal controls is the basis for the fundamental decision regarding the strategy of the audit. It also impacts the auditor’s risk assessment and establishment of materiality. During the tests of controls phase, the auditor goes beyond the understanding of the internal controls and actually evaluates the effectiveness of those controls.

52. (SO 8) How is it possible that a review of computer logs can be used to test for both internal access controls and external access controls? Other than reviewing the computer logs, identify and describe two types of audit procedures performed to test internal access controls, and two types of audit procedures performed to test external access controls. Internal access controls can be evaluated by reviewing computer logs for the existence of login failures or unusual activity, and to gauge access times for reasonableness in light of the types of tasks performed. Internal access controls can also be tested by reviewing the company’s policies regarding segregation of IT duties and other IT controls, and can test those controls to determine whether access is being limited in accordance with the company’s policies. In addition, auditors may perform authenticity testing to evaluate the authority tables and determine whether only authorized employees are provided access to IT systems.

Computer logs can also be reviewed to evaluate external access controls, as the logs may identify unauthorized users and failed access attempts. External access controls may also be tested through authenticity tests, penetrations tests, and vulnerability assessments. Authenticity tests, as described above, determine whether access has been limited to those included in the company’s authority tables.

Penetration tests involve the auditor trying to gain unauthorized access to the client’s system, by attempting to penetrate its firewall. Vulnerability assessments are tests

aimed at identifying weak points in the company’s IT systems where unauthorized access may occur, such as through a firewall or due to problems in the encryption techniques.

53. (SO 8, SO 9) Explain why continuous auditing is growing in popularity. Identify and describe a computer-assisted audit technique useful for continuous auditing.

Continuous auditing has increased in popularity due to the increase in e-commerce.

Real-time financial reporting has created the need for continuous auditing, whereby auditors continuously analyze evidence and provide assurance on the related financial information as soon as it occurs or shortly thereafter. The embedded audit module is a computer-assisted audit technique that accomplishes continuous auditing. The embedded audit module approach involves placing special audit testing programs within a company’s operating system These test modules search the data and analyze transactions or account balances that meet specified conditions of interest to the auditor.

54. (SO 12) Each of the principles of the AICPA Code of Professional Conduct relates to the trustworthiness of the CPA. Distinguish between the third principle (integrity) and the fourth principle (objectivity and independence). Integrity related closely to honesty and performing duties with a high sense of due care. Objectivity and independence are more concerned with the attitude of skepticism in approaching duties. This involves being unbiased and free of any conflicts of interest.

Problems 55. (SO 4) Match the standard-setting bodies with their purpose.

I. c.

II. a.

III. d.

IV. b.

56. (SO 8) Identify whether audit tests are used to evaluate internal access controls (I), external access controls (E), or both (B).

• Authenticity tests (B) • Penetration tests (E) • Vulnerability assessments (E) • Review of access logs (B) • Review of policies concerning the issuance of passwords and security tokens (I) 57. (SO 9) Refer to the notes payable audit program excerpt presented in Exhibit 7-3. If an auditor had a copy of his client’s data file for its notes receivable, how could a general audit software or data analysis software package be used to assist with these audit tests? GAS and DAS could assist auditors in testing notes payable by performing mathematical calculations of interest amounts, stratification of amounts into current and long-term categories according to maturity dates, and performing ratio calculations as may be needed to assess compliance with restrictions.

58. (SO 11) In order to preserve auditor independence, the Sarbanes-Oxley Act of 2002 restricts the types of nonaudit services that auditors can perform for their publiccompany audit clients. The list includes nine types of services that are prohibited because they are deemed to impair an auditor’s independence. Included in the list are the following: • financial information systems design and implementation • internal audit outsourcing Describe how an auditor’s independence could be impaired if she performed IT design and implementation functions for her audit client. Likewise, how could an auditor’s involvement with internal audit outsourcing impair her independence with respect to auditing the same company? Both of these scenarios would place the auditor in a position of auditing his/her own work. Auditors could not maintain independence if they are involved in both the IT design and implementation as well as the financial statement audit. To the extent that the IT system impacts financial reporting, an auditor could not possibly be unbiased with respect to a system that he/she had designed and implemented. Likewise, auditors are not likely to be unbiased with respect to performing a financial statement audit for the same company as he/she performed internal audit work. Any evaluations performed during the internal audit engagement are likely to have a bearing on the auditor’s professional attitude while performing the financial statement audit.

59. (SO 2) Visit the AICPA website at www.aicpa.org and click on Becoming a CPA/Academic Resources. Use the Careers in Accounting tab to locate information on audit careers. The AICPA website presents information on various career paths, including public accounting (audit, taxation, financial planning, etc.), business and industry, governmental accounting, not-for-profit accounting, education, and entrepreneurship. Some specialty areas include forensic accounting, environmental accounting, and showbiz accounting.

60. (SO 4, SO 9) Visit the ISACA website at www.isaca.org and click the Students and Educators tab and then the IT Audit Basics tab to find articles covering topics concerning the audit process. Locate an article on each of the following topics and answer the related question: a. Identify and briefly describe the four categories of CAATs. The four categories include1: • data analysis software, including GAS and DAS • Network security evaluation software/utilities • OS and DBMS security evaluation software/utilities • Software and code testing tools b. List the factors that contribute to the formation of due care in an auditor include2: • peer review 1 “Using CAATs to Support IS Audit” by S. Anantha Sayana for Information Systems Control Journal, Vol.

1, 2003.

2 “Due Professional Care” by Frederick Gallegos for Information Systems Control Journal, Vol, 2, 2002.

• • • • • • • • • • •

auditor conduct communication technical competence judgment business knowledge training certification standards independence continuous reassessment high ethical standards

61. (SO 12) Refer to the example presented in this chapter describing frauds perpetrated by top managers in large companies like Enron, Xerox, and WorldCom. Perform an Internet search to determine the nature of Xerox’s management fraud scheme and to find out what happened to the company after the problems were discovered. Xerox’s fraud involved earnings management or manipulation of the financial statements in order to boost earnings. This occurred at Xerox to the tune of hundreds of millions of dollars and involved various accounting tricks to hide the company’s true financial performance so that it would meet or beat Wall Street expectations. The most significant trick was the premature recording of revenues.

Upon discovery of the fraud, the SEC filed a $10 million civil suit against Xerox, the largest fine in SEC history. In addition, Xerox had to restate its earnings from 1997 through 2001.

Cases 62. Internal Controls and CAATs for a Wholesale client. a. What tests of controls would be effective in helping Lune determine whether Lea’s vendor database was susceptible to fraud? The following tests of controls could be used: • Verify that the database is physically secure and that programs and data files are password protected to prevent unauthorized access.

Since this situation involves an internal breach of authority, access logs should be reviewed for activity at unusual times (non-business hours).

• Make sure that system programmers do not have access to database operations so that there is no opportunity to alter source code and the related operational data.

• Ascertain that database inputs are being compared with systemgenerated outputs.

• Determine whether run-to-run totals are being generated and reviewed to evaluate the possibility of lost or altered data.

• Ascertain that computer-generated reports are regularly reviewed by management.

•

Determine whether the client’s field checks, validity checks, and reasonableness checks are all working effectively. b. What computer-assisted audit technique would be effective in helping Lune determine whether Lea’s vendor database had actually been falsified? Lune could use GAS or DAS to perform audit testing on electronic data files taken from Lea’s database system. Several types of audit tests commonly performed by GAS or DAS systems could be used in this case, including data queries, stratification and comparison of data items, and selection of items of interest. In addition, the following tests can be performed to test the propriety of inputs to the system: • Financial control totals can be used to determine whether total dollar amounts or item counts are consistent with journal entry amounts.

This can detect whether additions have been made during processing.

• Validation checks can be performed to scan entries for bogus information. Depending on the type of IT system, a validity check of the vendor number field may prevent the entry of fictitious vendors.

• Field checks can be performed to identify unrecognized data.

If the bogus transactions are being entered during processing, the auditor may use program tracing to evaluate program logic for possible points of entering fraudulent information. Run-to-run totals may also be used to determine whether data have been altered during processing. In addition, output controls such as reasonableness tests could be performed to review the output against authorized inputs, and/or audit trail tests could be performed to trace transactions through the system to determine if changes occurred along the way.

63. Issues with the client representation letter. a. Would it be appropriate for Leland to reopen the audit testing phases in order to expand procedures, in light of the lack of representative evidence from management? Why or why not? No, Leland should not expand testing procedures. The purpose of the client’s representations letter is for management to acknowledge its primary responsibility for the fair presentation of the financial statements and the accuracy of evidence provided to the auditors. It is considered the most significant piece of audit evidence. Obtaining additional evidence would not compensate for a failure to secure a letter of representations; in fact, it is likely that additional testing would be meaningless unless management represents that the evidence it supplies is accurate. b. Will Leland’s firm still be able to issue an unqualified audit report if it does not receive the representations letter? Research the standard wording to be included in an unqualified audit report, as well as the typical wording included in a client representations letter. Base your answer on your findings. No, an unqualified report is no longer possible due to the failure to obtain written representations from management. This constitutes a limitation in the scope of the audit. Leland’s firm may either withdraw from the engagement or issue a disclaimer. The standard wording for a client

representations letter can be found in AU section 333. The standard wording for an unqualified audit report can be found in AU section 508.

Chapter 8 Solutions Concept Check 1. a 2. c 3. a 4. c 5. d 6. a 7. c 8. d 9. c 10. a 11. d 12. b 13. a 14. d 15. c 16. d

Discussion Questions 17. (SO 2) Why is it important to establish and monitor credit limits for customers? Allow customers to order an excess over what they are able to pay poses a large risk for companies. It is important to review a customer’s credit worthiness and based on that credit worthiness, establish a credit limit. Once the limit is established, the company should have processes or methods to insure the credit limit is not exceeded. Without a limit, or monitoring that limit, the company has the risk of not being paid for goods or services purchased by customers.

18. (SO 2) Distinguish between a pick list and a packing slip. Although the information on these two documents is essentially the same, they are used for two different purposes. Both documents contain the items and quantities for a particular customer order. However, the pick list is used in the warehouse to pull items from the warehouse shelves, while the packing slip is included in the box or boxes shipped to the customer. The packing slip tells the customer which items should be in the shipment.

19. (SO 2) How can an effective system of internal controls lead to increased sales revenue? When an effective systems of internal controls is in place, managers may be able to spend less time overseeing operations and can therefore, spend more time on revenue growth strategies and activities. For example, with a proper set of general authorization procedures for sales, a manager would not need to approve

each sale individually. This gives the manager more time to focus on activities that could lead to increased revenue.

20. (SO 2) Why should the person responsible for shipping goods to customers not also have responsibility for maintaining records of customer accounts? Custody of assets and responsibility for record keeping should always be segregated. In this case, the person shipping the goods has custody and could therefore, steal assets.

Access to customer records would alow that person to also alter records to hide the theft. The alteration to the records could include deleting the sale or writing off the sale as a bad debt.

21. (SO 3) What is the purpose of a credit memorandum? The credit memorandum documents the fact hat a customer has returned goods. The credit memorandum is also used to reduce the customer’s receivable account balance based upon the return of goods.

22. (SO 3) How are sales invoices used (in a manual system) in the preparation of credit memos? The sales invoice is matched to the receiving report that results from returned goods. This match is necessary to verify the fact that the merchandise was in fact sold to the customer, and to verify the selling price that should be refunded.

23. (SO 2) How can a security guard in a warehouse be considered an important component of a company’s accounting system? Internal controls over asses should include physical controls to prevent theft or misuse. For example, cash should be locked in a safe to prevent the theft of cash. Likewise, a security guard can help prevent theft or misuse of assets. This internal control would not prevent all theft, but would help reduce any theft.

24. (SO 3) How could fraud be perpetrated through the sales returns process? In the absence of good internal controls, there are several types of fraud that could occur in sales returns. These include: 1) customers returning goods not originally purchased from the company, 2) customers requesting a refund higher than the original sales amount, 3) requesting refunds for goods that were never returned, but submitting false documentation of a return, and 4) theft of returned goods by an employee.

25. (SO 6,7,8) Identify and distinguish between the three types of IT systems used in the sales process. The three types of IT systems described are EDI, Internet EDI, and point of sale systems. EDI and Internet EDI are used in company to company sales of goods and services. In EDI systems, the buyer and seller computer systems are connected and order data is exchanged electronically. EDI typically uses a value added network (VAN), while Internet EDI uses the internet to exchange data.

Internet EDI is usually much more cost effective than EDI because the exchange via the Internet can be cost free. A POS system is used in end consumer sales such as retail stores and restaurants. A POS system usually is a touch screen, or bar code system at the cash register that records the sale and updates the appropriate cash, sales, and inventory accounts. All three systems are IT enablement of the sales process and they each improve the efficiency and effectiveness of sales processes.

26. (SO 6) Distinguish between B2B sales and B2C sales. Other than those presented in this chapter, name a company from your personal experience that uses B2C sales. B2B sales are IT enabled sales between two businesses. B2C sales are IT enabled sales between a business and an end consumer. A student could mention

any online retailer, online bank, online broker, airline, or travel agent as examples of B2C. 27. (SO 6) List the advantages of e-commerce systems. The advantages are reduced costs, shorter sales cycles, increased accuracy and reliability of sales data, and an increase in the potential market.

28. (SO 6) Identify two of the biggest risks to companies who use e-commerce, along with controls to prevent these risks. Two of the business risks of e-commerce would be availability and security. If a company relies on online sales extensively, any failure in the hardware or software may make the online sales system unavailable and this causes lost sales. These lost sales can at times be very large losses.

Unauthorized access or hackers represent a big risk to e-commerce. Placing sales online opens the company to unauthorized access and hacking, and therefore potential loss or destruction of data.

29. (SO 6,7) What controls should a company implement to ensure consistency of sales information between the front end and back end of its systems? Reconciliations and verifications are important in the integration of front end and back end systems. As data moves from a front end system, such as an online sales system, to a back end system, such as warehouse systems, a reconciliation or verification can insure the data was transmitted between systems accurately.

30. (SO 6) Why is a redundant server system needed in an e-commerce environment?

Availability is extremely important in e-commerce systems. Any failure of the system represents lost sales because the system is not available for customer use. A large e-commerce company could lose thousands of dollars in sales from a two or three hour downtime.

31. (SO 6) Why should a company continuously monitor the capacity of its e-commerce system?

32. (SO 7) What are the three components of an EDI system? The three component parts are: 1) intercompany transfer, indicating the sale/purchase is between two companies; 2) computer to computer, indicating the computer system of the two companies are connected; and 3) a standard format for business documents to facilitate the intercompany transference of electronic documents.

33. (SO 7) What are the three standard parts of an EDI data transmission? Header and trailer data, labeling interchanges, and data segments. Header data is data about the file or transmission being sent. The header identifies the beginning and end of a particular transaction data set. Trailer data is also data about the file or transmission and identifies the end of a particular transaction data set. Labeling interchanges identify the type of transactions in the set, such as a set of sales invoices. Data segments include the actual data within the invoices, such as quantities and prices.

34. (SO 7) How could it be possible for two companies to conduct EDI if they are not directly connected with each other? Two companies could use a value added network (VAN) as a third party to serve as the provider of electronic inboxes for EDI exchanges.

35. (SO 7) List the advantages of an EDI system. The advantages are elimination of keying, keying errors, and the time needed for keying, the elimination of mailing time and postage costs, reduction of inventory levels, and competitive advantage and/or preservation of existing business.

36. (SO 6,7,8) What is the purpose of maintaining transaction logs? Why are they especially important in IT systems? Transaction logs serve as the audit trail of transactions processed by the computer. Review of these logs can insure that transactions are lost or unaccounted for. The logs also help insure a company can avoid repudiation of sales.

37. (SO 8) List some advantages of a POS system. Advantages are: ease of use by employees, the elimination of manually entered data, real-time access to prices and inventory levels, real-time credit card authorization, real-time update of affected accounting records, immediate summaries and reports of sales and cash, and integration with the general ledger accounts.

38. (SO 8) Why are backup systems one of the most important controls for POS systems? A system failure in a POS system would interrupt or halt sales. Such lost sales can be a large dollar amount and there could be future lost sales if customers become irritated by the system failures. To avoid these failures and the resulting lost sales, a company should maintain some type of backup system.

39. (SO 9) Describe a popular fraud scheme where company employees misuse the sales revenues cutoff. This is called leaving sales open. It counts sales from the first few days of the next month in the current month, and thereby inflates sales.

Brief Exercises 40. (SO 2, SO 4) Describe what is likely to occur if company personnel erroneously recorded a sales transaction for the wrong customer? What if a cash receipt was applied to the wrong customer? Identify internal controls that would detect or prevent this from occurring. If the sale is attached to the wrong customer, the wrong customer would be billed and it may cause both the wrong customer and the correct customer to have a negative opinion about the company. In addition, if the company does not maintain adequate documentation, it may be difficult to determine which customer should be billed. Therefore, the company may not be able to collect the cash they should have collected. If a cash receipt is applied to the wrong customer, then two customer balances will be erroneous. The company would continue to bill the customer who paid, while not billing the correct amount to the wrong customer.

Without adequate documentation, it would be difficult to correct this situation. The internal controls that would help prevent these errors are maintaining adequate documentation, including source documents such as sales orders and remittance lists; the matching of key documents before recording; reconciliations and verifications of invoices to receivables; and supervision.

41. (SO 4) Debate the logic used in the following statement: “The person responsible for handling cash receipts should also prepare the bank reconciliation because he is most familiar with the deposits that have been made to the bank account.” It is true that if a person could be absolutely trusted to do both duties, it may be more efficient. However, having both duties provides opportunity and temptation for that person to steal cash and cover up the theft. In addition, a single person doing both

duties might make an error affecting both the receipts and reconciliation.

Segregating these duties may slightly decrease the efficiency of bank reconciliations, but the positive benefits of fraud prevention or detection and error detection outweigh any efficiencies.

42. (SO 7) Revenue systems are crucial in the healthcare industry, where hundreds of billions of dollars are spent annually reconciling revenues and billing data from the perspectives of providers (doctors and clinics, etc.) and payers (insurance companies). Briefly describe how EDI would be beneficial in this industry. Describe the purpose of the header data and trailer data. In an EDI system, the computer systems of the biller and payer are connected and they would greatly speed up the billing and paying process, as well as decrease the errors in the process. Without EDI, the would be keying errors, delays related to keying data and mailing bills and payments. The header and trailer data identify the transaction data set so that the two computer systems can insure the correct transaction data is matched. The header and trailer also identify the beginning and end of a transaction data set.

43. (SO 2, SO 3, SO 4) Use the process maps in this chapter to answer the following questions: a. What would a credit manager do if a sales order received caused a customer to exceed its credit limit? The sale should be disapproved (rejected). b. What happens after the shipping department verifies that the quantities and descriptions of goods prepared for shipment are consistent with the sales order? The goods are shipped, an invoice is prepared and mailed; the following records are updated: sales, general ledger; and a month end statement is prepared and mailed to the customer. c. What would an accounts receivable clerk do if a $100 credit memo is issued to a customer whose accounts receivable balance is $1,000? The clerk should first check to make sure of the balance. Then, that customer’s balance would be decreased to $900. d. When is it necessary for an accounts receivable clerk to notify a customer?

An accounts receivable clerk would not need to notify customers.

44. (SO 2) Describe how the matching of key information on supporting documents can help a company determine that its revenue transactions have not been duplicated.

For any sale, return or cash transaction, only one set of matching documents should exist. Once the documents are matched and recorded for a particular transaction, they should be filed as a completed transaction. Thus, that same transaction would not be recorded again since the source documents are filed.

45. (SO 2,3) Describe how the use of pre-numbered forms for receiving reports and credit memos can help a company determine that sales return transactions have not been omitted from the accounting records. When pre-numbered forms are used, it is much easier to insure that the entire series of transactions have been accounted for.

Conversely, a missing number in the sequence of pre-numbered documents is a clear indication that a transaction has been omitted. This may be easier to

understand if you think about what it would mean if your own personal check book record was missing a check numbered 154.

46. (SO 8) Describe how a POS system could be useful to a company’s marketing managers. How could it be useful to production managers? A POS system can provide immediate feedback about product sales and inventory levels. Therefore, a marketing manager can get immediate feedback about which products sell well, which do not, and how price changes may affect sales of individual products. A production manager could use the inventory level feedback to more appropriately plan when to produce certain products.

47. (SO 8) Briefly describe an example from your personal experience where you purchased something from a company that uses a POS system. How might your experience have been different if the POS system did not exist in the experience you described? There are many possible experiences students could describe. Each student would probably describe. Most often students see or use POS systems at fast food restaurants and retail stores. Many students will have been employees who have used POS systems and may have very good examples. In regards to the differences if the POS system did not exist, the check out experience would be slower, thereby leading to longer lines, and more errors in the process. Errors such as incorrect prices and incorrect orders.

Problems 48. (SO 6) In 1956, Gussepi DeLucca opened a pizza restaurant that he named DeLucca’s in St. Louis, Missouri. Over the years, he opened both company and franchise locations and grew the business to include over 40 restaurants that serve the three states around the St. Louis area. In 1993, DeLucca introduced a centralized phone ordering system with one phone number for customers to use.

This meant that the customer did not need to look up the phone number of a local restaurant and call that restaurant to order. Rather, customers call one number and the employees taking the order can determine the closest DeLucca’s location and process the order. This system also centralized the pricing, ordering, and inventory systems for DeLucca’s. In 2004, DeLucca’s began offering online pizza orders through its Web site. DeLucca’s advertises this Web ordering as more convenient for the customer. For example, its ads suggest that a customer can examine the entire menu on the Web site prior to ordering; something that is not possible with phone orders.

While there are many customer advantages of Web ordering, there are also many advantages to the company. From an accounting and internal control perspective, describe the advantages of DeLucca’s system, and any risks that it reduces.

Advantages: The Web ordering system provides the advantages of: cost savings through lower marketing, employee, and paperwork costs; shorter sales cycles due to reduced time to place an order, increased accuracy and reliability of the order data; and increased potential market for the company’s products. Accordingly,

DeLucca’s Web ordering system reduces the risks of misplacing an order, filling an order incorrectly, losing a sale due to a long wait time, and recording erroneous data due to errors in manual paperwork processing. Although some of these advantages and risk reductions are also realized through the company’s centralized phone ordering system, that phone system still involves manual processes to input customer orders, so there remain some costs and risks associated with employees, accuracy, and wait times.

49. (SO 8) You are the recent heir of $20,000 cash, with which you are considering opening a sushi bar in the university community. You would accept cash and credit card payments, which would be handled primarily by your servers. You also plan to offer introductory specials to attract customers during the initial months of business.

Identify some advantages and disadvantages of investing in a POS system as part of this new business venture. What internal controls should be implemented to reduce the risk of theft or error related to the handling of cash, credit card payments, and coupons?

The advantages of investing in a POS system as part of a new business venture include the following: • Ease of use and ease of training servers. This is expected to lead to fewer errors and more accurate sales and inventory data.

• Time savings related to the elimination of manual input processes. This includes increased efficiency and reduced fraud related to processing of credit card payments from customers.

• Increased accuracy due to the real-time access to inventory and price data. For instance, if the sushi bar’s daily special is sold out, that information can be immediately changed online so that servers can quickly inform customers of the change.

• Enhanced accounting features such as real-time update of cash, sales, and inventory records, immediate summaries and analyses, and the potential for integration with a general ledger system will save manual steps and provide timely information for management purposes.

Despite these many advantages, a new business venture would need to be especially careful of the extensive hardware and software costs that are necessary to support a POS system. In addition, availability risks may be significant, as any hardware and software failures could make the system unavailable and interrupt efficient business processes. Therefore, it is important that a new business venture consider these risks, analyze the costs and benefits of the system, and implement backup systems should be in place to reduce the availability risk.

In order to reduce the risk of theft or error related to the handling of cash, credit card payments, and coupons, the sushi bar should be sure that its POS system includes all relevant payment information, including options to enter the use of coupons and method of payment. In addition, summaries can be provided immediately, so servers should be required to reconcile their transactions at the end of their shifts.

50. (SO 2,4,6) Aaron Preswick is the owner of AP’s Instant Replay, a consignment shop for used sporting goods. Aaron accepts consigned goods and offers them for sale to

the general public. Aaron rents business space, including a retail store where the consigned goods are displayed and sold, with adjoining office space where an Internet site is maintained and other administrative functions are performed. The Internet site includes photos and descriptions of items available for sale worldwide.

If the goods sell, Aaron’s consignment fee is 40% of the sale price, and 60% is remitted to the consignor. Shipping costs on electronic orders are paid by the customers.

Identify internal control considerations for the following: a. the e-commerce portion of the business. Internal control considerations associated with e-commerce should address the risks of security and confidentiality, processing integrity, and availability. Regarding security and confidentiality, Aaron should ensure that customers accessing the website and conducting sales transactions are valid customers with valid payment authorization and that transactions are logged so that an audit trail is established to avoid repudiation. Regarding processing integrity, Aaron should be concerned with data input checks that verify the completeness, accuracy, and validity of the data entered on the website. In addition, he should implement back-end controls, such as reconciliations and verifications, to ensure the accuracy of information taken from this system to the company’s accounting systems. Finally, Aaron should implement controls to minimize service disruptions that could reduce sales. Accordingly, he should implement controls for redundant systems, disaster recovery, testing of software changes, and capacity planning and testing. b. the retail portion of the business, assuming that the accounting systems are mostly manual and handled by Aaron and his wife. The five internal control activities should be considered with respect to the retail business and manual accounting systems involving sales and cash collections. Even though segregation of duties will be difficult considering that only Aaron and his wife are operating the business, they can perform business processes in a manner to promote good control. For instance, they can check each other’s work in instances where they are performing incompatible duties involving combinations of custody and record keeping. They can ensure that prices are properly authorized by consignors and credit card payments are authorized at the time of the sale. Thorough documentation (such as detailed sales receipts) should be maintained and accounted for purposes of performing reconciliations and supporting the general ledger. Also, physical controls should be in place at the retail store in order to protect the company’s assets and records.

51. (SO 2,3,4) Identify an internal control procedure that would reduce each of the risks that follow in a manual system. Also describe how (or if) an IT system could reduce these risks: Student responses may vary, as more that one control may apply to risk reduction in these circumstances. However, following are some likely answers: a. Revenues may be recorded before the related shipment occurs. Shipping documentation should be matched with sales order data and presented to the billing department as the basis for recording the sale and preparing the bill.

The IT system can perform an automatic match whereby shipping data are required as a basis for recording the revenue. b. Employees responsible for shipping and accounts receivable may collude to steal goods and cover up the theft by recording fictitious sales. To prevent this type of problem, sales orders should be reviewed for proper customer and authorized by an independent member of management prior to shipment.

The IT system can include validity checks or other controls that require a valid customer in order for the transaction to be recorded. In addition, reconciliation procedures can compare manual documentation with system records to determine that valid transactions are recorded. If the collusion involves recording the fictitious sale in the account of a valid, existing customer, the process of sending sales invoices and customer statements, and the subsequent reconciliation procedures, would be important for uncovering this type of fraud. c. Credit memos may be issued at full price, when the goods were originally sold at a discount. Original sales documentation, including key information such as original sales price, must be required as a basis for preparing credit memos.

An IT system could automatically match credit memo authorizations with the original sales data so that the credit would be issued at amounts that are consistent with the original sale pricing. d. Sales invoices may contain mathematical errors. Independent checks of sales invoices should occur before the customer is billed. This includes verification of mathematical accuracy. If an automated system is in place, the IT system can perform mathematical computations at a great time savings. e. Amounts collected on accounts receivable may be applied to the wrong customer. Customer account statements should be sent on a regular basis so that customer records can be reconciled to the company’s records. This is likely to detect a misapplication of a customer collection. An IT system could enhance the process by requiring cash receipts to be entered along with a customer account number as well as an invoice number to ensure that the receipt is applied properly. f. Duplicate credit memos may be issued for a single sales return. A comparison of the receiving log with the credit memo listing would indicate if duplicate credit memos have been issued for a single sales return. An IT system could also prevent this risk by requiring that credit memos be generated only upon entering key information from the original sale and blocking the issuance of another credit memo for an item for which credit had already been issued. g. Sales invoices may not be prepared for all shipments. Shipping records should be compared with the sales invoices records. This may be done through the verification of the sequence of shipping documents to ensure that an invoice was prepared for each item shipped. An IT system may enhance this process by matching shipping document numbers with invoices, and preparing a warning report for any instances of unmatched shipping documents.

h. Shipments may contain the wrong goods. Companies should require the matching of key information on related documents prior to shipment. This includes inventory quantities and descriptions on approved sales orders and packing lists. An IT system may make this process more efficient by performing the match automatically; it can verify whether product numbers and quantities on the sales orders match those on the shipping documentation. i. All sales transactions may not be included in the general ledger. A regular reconciliation should be performed to compare the sales journal with the amounts recorded in the general ledger. An IT system may perform a periodic automatic post of the sales journal to the general ledger, thereby eliminating the potential for missing sales transactions.

52. (SO 3,4,5) The following list presents various internal control strengths (S) or risks (R) that may be found in a company’s revenues and cash collection processes. __S__ Credit is authorized by the credit manager. _N/A_ Checks paid in excess of $5,000 require the signatures of two authorized members of management. (Although this is viewed as an internal control strength, it is not applicable to the revenues processes.) __R__ A cash receipts journal is prepared by the Treasurer’s department. (This type of accounting record should be prepared by those with recordkeeping responsibilities rather than those in a position to perform reconciliations of the cash records.) __S__ Collections received by check are received by the company receptionist, who has no additional recordkeeping responsibilities. __R__ Collections received by check are immediately forwarded unopened to the accounting department. (This would place the accounting department in an incompatible role combining recordkeeping and custody of cash.) __S___ A bank reconciliation is prepared on a monthly basis by the Treasurer’s department. __S__ Security cameras are placed in the shipping dock. __S__ Receiving reports are prepared on pre-printed, numbered forms. __R__ The billing department verifies the amount of customer sales invoices by referring to the authorized price list. (This price authorization role should be performed before billing. An approved sales order, including verified prices, should be in place at the time the documents reach the billing department.)

__S__ Entries in the shipping log are reconciled with the sales journal on a monthly basis. _N/A_ Payments to vendors are made promptly upon receipt of goods or services. (Vendor payments relate to the expenditures processes rather than the revenues processes.) __R__ Cash collections are deposited in the bank account on a weekly basis. (If cash receipts occur daily, they should be deposited promptly – preferably on a daily basis.) __S__ Customer returns must be approved by a designated manager before a credit memo is prepared. __S__ Account statements are sent to customers on a monthly basis. __R__ Purchase returns are presented to the sales department for preparation of a receiving report. (Receiving reports should be prepared promptly upon receipt of returned items. This should be done in the receiving area, where the personnel have a custody function, rather than in the sales department, where the personnel initiate sales transactions.)

53. See the completed spreadsheet “Problem 8-53.xls” on the instructor website. That spreadsheet has two tabs. The first tab is a simple spreadsheet in which numbers for invoice and amount are typed into the appropriate column. This spreadsheet is probably similar to what most students would complete. If students have a higher level of spreadsheet skills, or if they are given some instructions and guidelines, they could produce a more complex spreadsheet with formulas to determine the appropriate column. The spreadsheet in the “Complex Spreadsheet” tab uses IF formulas and the AND function to place amounts in the correct aged column 54. See the completed spreadsheet “Problem 8-54.xls” on the instructor website. There is no single correct answer to this problem. However, as a student attempts to design a spreadsheet, it will cause the student to ponder several important issues.

For example, the student must consider how to handle data that appears once, such as sales order number, but would have to be repeated for each line item on the sales order. Also, some data would be in separate tables or files. Information such as bill to address, ship to address, item descriptions, and item prices are likely to be established and maintained in other tables or files 55. (SO 2,4) Following are ten internal control failures related to the revenues and cash collection processes. __d__ A customer ordered 12 boxes of your product (total of 144 items) for express shipment. Your data entry clerk inadvertently entered 12 individual items.

__q__ You enter sales and accounts receivable data in batches at the end of each week. Several problems have resulted recently as a result of recording invoices to the wrong customer account. __f__ In an effort to boost sales, you obtain some of the stock of unissued shipping reports and create a dozen fictitious shipments. You submit these documents to the billing department for invoicing. __g__ Checks are received by the mailroom and then forwarded to the accounts receivable department for recording. The accounts receivable clerk holds the checks until the proper customer account has been identified and reconciled. __p__ Several shipping reports have been misplaced en route to the billing department from the shipping department. __h__ Several sales transactions were not invoiced within the same month as the related shipment. __c__ A sales clerk entered a non-existent date in the computer system. The system rejected the data and the sales were not recorded. __a__ Upon entering sales orders in your new computer system, a sales clerk mistakenly omitted customer numbers from the entries. __o___ A computer programmer altered the electronic credit authorization function for a customer company owned by the programmer’s cousin. __n__ Customer orders were lost in the mail en route from the sales office to the accounting department (located at the company’s headquarters).

Required: Select one internal control from the following list that would be most effective in the prevention of the failure. Indicate the letter of the control next to each failure above.

Letters should not be used more than once and some letters may not be used at all. a. Pre-formatted data entry screens b. Pre-numbered documents c. Programmed edit checks d. 100% check for matching of customer orders and sales orders e. 100% check for matching of sales orders, pick list, and packing slips f. 100% check for matching of sales orders and invoices g. 100% check for matching of deposit slip and customer check. h. Prompt data entry immediately upon receipt of customer order i. Customer verification j. Independent authorization for shipments

k. Independent authorization for billing l. Reasonableness check m. Hash totals n. Data back-up procedures o. Program change controls p. Sequence verification q. Periodic confirmation of customer account balances

56. (SO 2,3,4) Brathert Company is a small company with four people working in the revenue processes. One of the four employees supervises the other three. Some tasks that must be accomplished within the revenue processes are the following: a. Accounts receivable record keeping b. Approving credit of customers c. Authorizing customer returns d. Authorizing new customers e. Billing customers f. Cash receipts journal posting g. Entering orders received h. Inventory record keeping i. Maintaining custody of cash j. Maintaining custody of inventory k. Reconciling records to the bank statement Required: For each of the four employees (supervisor, employee 1, employee 2, and employee 3), consider the duties you would assign to each employee. In assigning duties, no employee should have more than three tasks and there should be a proper separation of duties to achieve appropriate internal control. List the four people, the duties you assigned to each employee, and a description of why those assignments achieve proper separation of duties.

Supervisor: Employee 1: Employee 2: Employee 3:

b., c., and d. (all Authorization functions) a., f., and h. (receivables, collections, and inventory Recordkeeping) e., g., and k. (sales and billing Recordkeeping and cash reconciliation) i. and j. (all Custody functions)

57. (SO 6) Refer to the ethics case regarding a mail order scenario presented as number 54 in Chapter 3. What term introduced in this chapter applies to the type of mail order deceit described in that case? What could the mail order company do to avoid a loss resulting from an event, assuming that it uses an e-commerce system?

This type of mail order deceit is known as repudiation. The mail order company should have controls in place to make sure that each sale is to a valid customer with

valid payment authorization and that an audit trail is maintained to avoid repudiation.

Customer authentication through user ID and password should be used, as well as transaction logs and data trails. In this case, it may be most effective if the company uses digital signatures or digital certificates to authenticate and validate a customer.

The signature verification would also be important upon delivery.

Web Exercises 58. (SO 9) Visit the financial education website created by Equade Internet Ltd. at www.investopedia.com. Note the definition for channel stuffing. According to this site, what is the primary motivation for channel stuffing? Channel stuffing is a deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products that they are able to sell to the public. By channel studding, distributors temporarily inflate their accounts receivables. However, unable to sell the excess products, retailers will send the excess items instead of cash back to the distributor, who must adjust its accounts receivable and ultimately its net income. In other words, channel stuffing always catches up with the company, because it cannot maintain sales at the rate it is stuffing. The primary motivation for this fraudulent business practice is to raise the value of the company’s stock.

59. (SO 6) Visit the e-commerce website for Jupitermedia Corporation at www.ecommerceguide.com and perform the following: a. Use the News and Trends tab to find a news article posted during the current month concerning developments in e-commerce. Student responses may vary.

This website updates its news postings nearly every day. Some regular features include eBay Watch and eBiz Briefs. b. Use the Research tab to find statistics or trends in e-commerce. Report on your findings. Again, student responses may vary. This website updates its news postings nearly every day. Some typical features include eBay Watch and other updates on online spending. Statistics on holiday shopping online are often available.

60. (SO 9) Refer to the example presented in this chapter regarding fraudulent revenue reporting perpetrated at Sunbeam Corp. Conduct an Internet search to determine what happened to the company and to its CEO and CFO subsequent to the 1998 discovery of this financial fiasco. In 2001, The SEC filed a civil injunction action against the former officers of the corporation (including CEO Al Dunlap and CFO Russell Kersh) for fraud that resulted in billions of dollars in investor losses. In 2002, the two top officers agreed to pay a total of $700,000 to settle these charges of improper accounting in connection with the inflating of Sunbeam’s reported earnings by more than $60 million. They also paid a total of over $15 million to settle a related class action lawsuit. As part of their settlement, these two men agreed to be permanently barred from serving as officers or directors of any public company.

Sunbeam filed for bankruptcy reorganization in 2001 and in 2002 emerged as a

private company. In 2004 it was acquired and became a subsidiary of Jarden Corporation, a consumer products company. The Sunbeam name is still used.

Cases 61. Sales processes at ReSound Company. a. The sales process in the store are very similar to any retail store. When a customer buys a CD or LP record, the product is scanned by a bar code reader, the customer pays the amount b cash, check, or credit card, and then takes the products out of the store. In online sales, Resound would have to implement an IT system and a web server to process online sales.

It would be necessary for a customer to browse or search the inventory online; requiring a real-time inventory system integrated with the sales processes. The IT systems for the online system would be more complex.

The online sales would be processed through the Web site and mailed to the customer. Payment could only be made by credit card at the time of sale. b. Usually very little, if any, data is collected fro customers during in-store sales. If the customer pays by cash, he can be completely anonymous.

Even in the case of a credit card payment, customer data is only used to charge the credit card and that data is usually not kept by the company. c. In an online sale, much more customer data must e collected, used, and stored. Customer name, address, phone number, and credit card data must be collected and stored. d. In addition to the data mentioned in part c, Resound may store and analzye the CD titles purchased by individual customers. If Resound had software capable of doing so, this data could be used to recommend other titles to customers. This system would work like the Amazon.com web site. When purchasing a book at Amazon, the customer receives suggested titles of similar books.

62. Sales and collection processes at Jamison Manufacturing. a. Refer to the separate Microsoft Excel file “Chapter 8 Solutions Process Maps.xls”. b. Weakness: The invoice is prepared without comparison to the packing slip. This means the company could bill the customer for items or quantities different from items and quantities shipped. This is especially true if items are out of stock.

Improvement: A copy of the packing slip should be forwarded to accountant 1 and the invoice should be based on items and quantities shipped.

Weakness: Customer credit is not approved until after the order is shipped: Improvement: Credit approval should occur before the order is filled sand shipped.

Weakness: Inventory records are not updated as orders are filled. Improvement:

A copy of the packing slip should be used by accountant 1 or accountant 2 to update inventory records.

Weakness: There is no prelisting of checks received with the amounts. Such as list helps prevent theft or accidentally misplacing a check. Improvement. A prelisting of checks received should be prepared to be compared to the bank deposit amount.

Weakness: There is no mention of a bank reconciliation for checks received.

Improvement: Account 1 or 2 should reconcile the bank account to cash records.

Weakness: There is no comparison of the check received to the original sales invoice. Under this system, it would be possible to assume an invoice is fully paid when it was not. Improvement: The checks received should be compared to the sales invoice.

Weakness: The collections clerk has custody of the checks and also records the transactions in the accounts receivable subsidiary ledger. Improvement: Accountant 1 or 2 should record in the subsidiary ledger upon receiving a list of checks received.

Weakness: There is no mention of monthly statements mailed to customers.

Such a statement summarizes possible several invoices for each customer and can show the ages (overdue) of the amounts. Improvement: A monthly statement should be mailed to each customer.

Weakness: There is no mention of a periodic reconciliation of subsidiary ledgers and the general ledger. Improvement: A periodic reconciliation of subsi9diary and general ledgers should occur to help prevent or detect errors, omissions, and fraud. c. Refer to the separate Microsoft Excel file “Chapter 8 Solutions Process Maps.xls”.

63. Process maps and internal control considerations for Cluxton’s sales, billing, and collection processes a. Refer to the separate Microsoft Excel file “Chapter 8 Solutions Process Maps.xls”. b. Cluxton’s sales department personnel are preparing a sales order without an approval for the transaction and without checking the credit status of the customer.

Before the sales department prepares a sales order, it should determine the relevant pricing for the items ordered and check the customer’s credit. The sales journal should not be updated at the time a sales order is prepared; rather, the sales journal should be updated upon shipment of the items to the customer.

Cluxton’s warehouse personnel currently have incompatible duties related to both custody of inventory items and inventory recordkeeping. An inventory control function should be implemented for the purpose of inventory recordkeeping. Also, there is no indication that shipping documents are being prepared by Cluxton. A separate shipping function should be established for purposes of preparing a bill of lading to present to the carrier, rather than a copy of the sales order. In addition, a shipping log should be used.

Cluxton’s billing department is not preparing a billing record or maintaining records of amounts billed. It should be preparing an invoice to be sent to the customer, rather than sending a priced version of the sales order. A copy of the invoice should be retained in the billing department.

The accounts receivable department is not updating the receivables records promptly upon the occurrence of a sales transaction; instead, it is delaying this recordkeeping task until the related cash is collected. The accounts receivable subsidiary ledger should be updated promptly upon the shipment of a sales order and the invoicing of that order. Cash collections should not be handled by the accounts receivable department, as this custody function is incompatible with the recordkeeping of customer accounts. A separate company employee should handle collections received in the mail, and a cash receipts department should be responsible for preparing the cash receipts journal and bank deposit.

Cluxton’s general ledger is being updated prematurely. Rather than updating the general ledger upon receipt of a sales order from the sales department, it should be updated at the time the shipment occurs and the related billing and accounts receivable records are prepared. c. Students’ revised process maps for Cluxton’s sales and cash collection processes should be similar to those presented in Exhibits 8-2 and 8-12, respectively.

64. Internal control risks at Art’s Artist World The following memo presents internal control weaknesses or potential risks, as well as recommendations for strengthening controls: To : Art Dusing, Owner Art’s Artist World Fr: AIS Student Re: Internal Control Recommendations During the course of my accounting work, the following circumstances were noted which represent internal control weaknesses and potential business risks in the company’s revenue processes. I am proposing potential enhancements to the

company’s system of internal controls in order to reduce these risks. I would be pleased to discuss these items with you further.

•

•

•

•

•

Sales documentation is not being prepared for all sales transactions, but only for sales on account. This allows for the possibility of fraud or error in the retail store, as there is no basis for reconciling sales with cash register and credit receipts for each shift worked by a sales clerk. In addition, inventory records cannot be updated on a regular basis. If sales clerks prepare a sales receipt for each sale, then a record exists for the purposes of performing daily reconciliations of the summaries of cash collections and updating the cash, accounts receivable, and inventory records. A duplicate copy of the receipt could be given to each customer as a record of the transaction.

Walk-in sales on account are approved by a manager upon recognizing a credit customer. This presents a potential problem for a growing company to be able to recognize all of its customers, as well as in the event that the walkin customer may no longer be affiliated with the customer company. The supervisor in the accounts receivable department should verify charge slip information in order to approve the sale before it is transacted, rather than afterwards.

The accounts receivable supervisor is not effectively utilizing the list of past due accounts. This report should be actively investigated and follow-up should be performed to maximize the likelihood of cash collection. Past due customers should be contacted promptly in order to discuss the reasons for the delay in collections and maximize the likelihood of future collection. Art’s should implement credit and collections functions to investigate and pursue payment on unpaid customer accounts rather than merely writing them off.

A cashier should not perform the bank reconciliation because this presents a problem with segregation of duties. The person with custody of cash (who receives payments and prepares the cash receipts listings and bank deposits) should not also have responsibility for reconciling the bank account. This control activity should be performed by someone independent of the cash authorization and recordkeeping functions.

The staff accountant does not currently have sufficient information to allow him or her to verify the general ledger postings. For instance, before the general ledger is updated, staff accountants should be able to determine that the cash register totals reconcile to the cash deposit and credit summary information and that the cash receipts listings agrees with the bank deposits.

65. Jeyco, Ltd.’s internal control checklist.

These checklist questions are expected to achieve the internal control purposes as presented in the following list: •

Is the sales department separate from the credit office and the IT department?

Separation of duties in important in the revenues and receivables processes, so the separation of the sales office, where initial sales records are prepared, should

•

•

•

•

•

• •

•

• •

be separated from the authorization duties performed by the credit office and the systems programming and implementation duties performed by the IT department.

Are all collections from customers received in the form of checks? Checks provide a record of collections, which can enhance the recordkeeping accuracy of the related cash, receivables, and sales accounts. On the other hand, cash collections are easier for a dishonest employee to steal.

Is it appropriate to program the system for general authorization of certain sales, within given limits? Authorizations are important for ensuring that only valid, approved transactions take place. However, as a cost/benefit consideration, limits may be set regarding the minimum amount for which specific authorization is required.

Are product quantities monitored regularly? Independent checks of the physical versus recorded inventory quantities is an important control feature that can detect errors or fraud in the inventory records. This can also be an effective tool for preventing the risk of a stock shortage which could impact customer satisfaction.

Will all data entry clerks and accounting personnel have their own PCs with log-in IDs and password protection? If employees have their own PCs, then there should be no reason for computer sharing. Therefore, instances of unauthorized access should be minimized and each employee’s login information can be monitored so that each person is held accountable for changes made.

Will different system access levels for different users be incorporated? Access controls are important for limiting access to areas of the employees’ responsibility as well as monitoring and identifying work performed by each member of personnel. This will limit sensitive information from being viewed or altered by unauthorized members of personnel.

Will customer orders be received via the Internet? This will provide for prompt recording of customer orders and reduced errors that could otherwise result if customer orders had to be manually input by company personnel.

Has the company identified an off-site alternative computer processing location?

If computer processing is necessary for the effective and efficient operation of the business, then the company should have plans in place to minimize the risk of loss due to interruptions in computer service.

Does the project budget include line items for an upgraded, uninterrupted power source and firewall? These controls protect against loss of information, loss of a computer processing source, or unauthorized access to the system, which can reduce the risk of data destruction or alteration.

Will the system be thoroughly tested prior to implementation? System testing reduces the risk of errors in programming that can cause unreliable financial reporting.

Will appropriate file backup procedures be established? Back-up procedures protect a company against a risk of loss due to destruction of data files. They also provide a means for continued processing even if company hardware and software are unavailable or destroyed.

•

• •

Will business continuity plans be prepared? Continuity plans ensure that the company will be able to operate even if there is a disruption in computer processing, destruction of the company’s operating facility, records and/or data, or other unforeseen circumstances.

Will an off-site data storage exist? Off-site data storage allows for back-up versions of company information to be maintained in case they are needed or purposes of emergency business continuity.

Will intrusion detection systems be incorporated? The company should have this electronic control to monitor for the possibility of unauthorized access to the system. This will protect the data and records within the system.

66. Internal controls at Springfield Pediatrics Evaluate the information in each of the following situations as being either an internal control (1) strength, (2) weakness, or (3) not a strength or weakness.

1. Springfield Pediatrics’ office manager approves the extension of credit to patients and also authorizes write-offs of uncollectible accounts. (2) 2. Springfield Pediatrics’ office manager may extend credit based on special circumstances rather than using a formal credit search and established credit limits. (2) 3. Springfield Pediatrics extends credit rather than requiring cash or insurance in all cases. (3) 4. The computer software package cannot be modified by the employees of the practice. (1) 5. None of the employees who generate revenues or record revenues are able to write checks. (1) 6. Computer passwords are known only by the individual employees and the managing partner, who has no recordkeeping responsibilities. (1) 7. Individual pediatricians document the services they perform on pre-numbered reports that are used for both recording revenues and patient receipts. (1) 8. Insurance coverage is verified by the office manager before medical services are rendered. (1) 9. The bank reconciliation is prepared by an independent CPA firm. (1) 10. The sequence of pre-numbered service reports are accounted for on a monthly basis by an independent CPA firm. (1) 11. The second accounting clerk receives cash and checks and prepares the daily deposit. (1) 12. The second accounting clerk maintains the accounts receivable records and can add or delete receivables information on the PC. (1) 13. The second clerk receives the cash and checks and also records cash receipts.

(2) 14. Springfield Pediatrics is involved only in medical services and does not have diversified business operations. (3) (Excerpt from Adapted CPA Simulation Problem)

67. Internal control weaknesses in cash receipts and sales processes at Slodobon, Inc. a. Refer to the separate MicroSoft Excel file for Chapter 8 Solutions Process Maps. b. Internal control weaknesses: • The mail clerk should not forward the checks and remittance advices to departments having recordkeeping responsibilities.

• The mail clerk is not preparing a record of cash received in the mail.

• Cash collections are not being deposited promptly. Furthermore, the bank deposits are being prepared by accounts receivable department personnel, who also have recordkeeping responsibilities.

• The sales department, accounting department, and accounts receivable personnel should not have custody of the checks because they have recordkeeping responsibilities.

• There is no procedure for reconciling the daily cash receipts and bank deposits.

• Bank reconciliations are being prepared by accounting department personnel, where employees also are responsible for reviewing the past due status of customer accounts. These employees have custody of cash for a limited period of time, which places them in a custody role. The bank statement should not be prepared by someone who has custody of cash.

• Cash sales should not be received by sales clerks (because it violates the segregation of duties principles), but should be directly received by the cashier.

• The cashier, who has a cash custody role, should not also be responsible for the incompatible authorization task of approving customer credit.

• The inventory control catalog should not be updated by the sales department because it violates the segregation of duties principles.

Accounts Receivable Aging Report April 30, 2008

Customer Name Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Broughton Outdoors Broughton Outdoors Jeffers Sporting Goods Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Pup Scouts of Devron Pup Scouts of Devron Regal Athletic Company Regal Athletic Company The Sports Buff The Sports Buff TOTALS

Total Account Balance 1,366.48 4,975.00 4,017.15 659.59 1,946.40 6,763.10 4,067.99 10,646.20 6,653.15 975.63 299.00 1,104.13 655.31 1,843.83 9,737.91 220.04 2,678.59 862.35 8,046.40 1,774.92 69,293.17

Past Due Balan Current Balances Invoice # Amount 77341 1,366.48 75118 4,975.00

78021 77216 77089 75663

77911

1-30 days Invoice # Amount

70698

4,017.15

74555

4,067.99

74277 73586

1,104.13 655.31

75559

220.04

77115

8,046.40

10,646.20 6,653.15 975.63 299.00

9,737.91

34,653.37

18,111.02

Past Due Balances 31-60 days Invoice # Amount

67915

65287

659.59

61190

6,763.10

61119

862.35

1,946.40

67644

1,843.83

66268

2,678.59

70564

Over 60 days Invoice # Amount

1,774.92 8,243.74

8,285.04

Accounts Receivable Aging Report April 30, 2008

Customer Name Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Broughton Outdoors Broughton Outdoors Jeffers Sporting Goods Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Pup Scouts of Devron Pup Scouts of Devron Regal Athletic Company Regal Athletic Company The Sports Buff The Sports Buff TOTALS

Total Account Balance 1,366.48 4,975.00 4,017.15 659.59 1,946.40 6,763.10 4,067.99 10,646.20 6,653.15 975.63 299.00 1,104.13 655.31 1,843.83 9,737.91 220.04 2,678.59 862.35 8,046.40 1,774.92 69,293.17

Past Due Balan Current Balances Invoice # Amount 77341 1,366.48 75118 4,975.00

78021 77216 77089 75663

77911

1-30 days Invoice # Amount

70698

4,017.15

74555

4,067.99

74277 73586

1,104.13 655.31

75559

220.04

77115

8,046.40

10,646.20 6,653.15 975.63 299.00

9,737.91

34,653.37

18,111.02

Past Due Balances 31-60 days Invoice # Amount

67915

65287

659.59

61190

6,763.10

61119

862.35

1,946.40

67644

1,843.83

66268

2,678.59

70564

Over 60 days Invoice # Amount

1,774.92 8,243.74

8,285.04

05/27/08 05/27/08 05/01/08 04/14/08 02/13/08 03/22/08 02/01/08 04/06/08 05/30/08 05/16/08 05/15/08 05/01/08 04/14/08 04/06/08 03/22/08 05/05/08 04/13/08 03/24/08 02/01/08 04/15/08 03/14/08

77341 75118 70698 65287 67915 61190 74555 78021 77216 77089 75663 74277 73586 67644 77911 75559 66268 61119 77115 70564

1366.48 4975 4017.15 659.59 11018.22 1946.4 6763.1 8709.5 4067.99 10646.2 6653.15 975.63 299 1104.13 655.31 1843.83 22177.25 9737.91 220.04 9957.95 2678.59 862.35 3540.94 8046.4 1774.92 9821.32

Sales Order Number 35610 35610 35610 35610 35610

Date 5/27/2006 5/27/2006 5/27/2006 5/27/2006 5/27/2006

Customer Number 42004 42004 42004 42004 42004

Line Number 1 2 3 4 5

Item Number 1046R 1047R 1049R 2025W 2027W

Quantity 12 12 24 24 12

Note: Some Sales Order data would not need to be entered for each sales order.

Information such as bill to address and ship to address would be in a customer master record.

Information such as item descriptions and unit prices would be in a price list record or inventory master record.

SALES JOURNAL

Date Customer May 27 World of Wines

Monthly Totals

Sales Order No. 35610

DEBIT A/R - G/L 10200 Subs. A/C# Amount 42004 617.16

617.16

Post

Sales Ret. G/L 30200

Sales G/L 30100 617.16

617.16

CREDIT Other G/L Acc# Amount

-

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Concept Check 1. d 2. d 3. c.

4. b 5. b.

6. d 7. d 8. c 9. a 10. b 11. a 12. b 13. b 14. a 15. b 16. c 17. b 18. b

Discussion Questions 19. (SO 2) Name the first document that should be prepared when a production employee recognizes that the quantity of goods on hand is insufficient to meet customer demand. Purchase requisition.

20. (SO 2) How does the maintenance of a receiving log enhance internal controls? A receiving log is a sequential listing of all goods received.

It serves as an audit trail and allows the physical goods received to be matched against other documentation to ensure that all goods are received 21. (SO 2) Why should a receiving clerk be denied access to information on a purchase order? This practice is called a “blind PO” and the advantage is that it forces a physical count of goods received. A clerk cannot complete the “quantity received” field of a receiving report until the goods have been counted. If the PO contained quantities ordered, the clerk could assume that the quantity received is equal to quantity purchased and therefore, skip the physical count. However,

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conducting the physical count is a much better practice and the blind PO serves as a control to force such a count.

22. (SO 2) Under what circumstances would it be necessary to manually update accounts payable prior to the receipt of a vendor’s invoice?

When the receipt of goods occurs at the end of a period, but the invoice is not received until the next period, the liability should be recorded in the first period even though the invoice has not yet been received.

23. (SO 4) Which department is responsible for making sure that payments are made in time to take advantage of vendor discounts? It is the responsibility of accounts payable.

24. (SO 4) Why would some checks need to include two signatures?

Large checks over a specified amount may require two signatures.

Large checks entail more risk for the company and the dual signature lessens risks.

25. (SO 4) During the process of reconciling the bank account, why is it necessary to review the dates, payees, and signatures on the canceled checks? Reviewing dates, payees, and signatures on cancelled checks may help uncover unusual events. These unusual events can then be checked to make sure that they are not part of a fraud scheme.

26. (SO 4,6) What specifically does a cash disbursements clerk do when he or she “cancels” an invoice? How does this compare to the procedures used when computer-based matching exists. To cancel an invoice means to mark or stamp it with the date paid and check number. The purpose is to help prevent duplicate payment of an invoice. In an automated matching system, the system would be programmed to ensure that there were no previous payments that would make a new payment a duplicate payment.

27. (SO 4) Why should accountants periodically review the sequence of checks issued? To ensure there are no missing or unaccounted checks. This helps prevent errors and fraud.

28. (SO 2,4) What accounting records are used by accounts payable personnel to keep track of amounts owed to each vendor? An accounts payable subsidiary ledger is used to record the detail of amounts owed to each vendor.

29. (SO 5) Identify some inefficiencies inherent in a manual expenditures processing system. There is a physical matching of documents by humans and this process is time consuming and error prone. Even if a software system such as Microsoft Dynamics GP is used, there are many human tasks that are time consuming and error prone. Those tasks are: keying of data for a purchase order; the manual process of

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comparing an order received to the PO; keying in the receiving report and finding the PO in the system to match it against; keying the invoice into the system and finding the PO in the system to match it against; and the human decision making process of which invoices to approve for payment. These inefficiencies cause a large expenditure in salaries and wages for the personnel who do the matching.

30. (SO 5) What are the advantages of BPR? Using BPR to design IT systems can reduce the amount of paperwork, manual processing and the costs inherent in paperwork and manual processing. The costs include wages and salaries for the time to do manual processing and to correct errors or mismatches that occur in the manual processes.

31. (SO 8) List three examples of BPR used in the expenditures processes. BPR can be used to change a manual matching and payment system into one of three IT systems. These three include computer based three-way matching, Evaluated Receipt Settlement (ERS), and EDI. 32. (SO 8) Explain how system logic errors could cause cash management problems. When there are logic errors in a system, it may cause the system to make the same error repetitively. If the logic error is in approving payments, the system may repetitively approve payments a the wrong times or in the wrong amounts. Since the error is repetitive, it could quickly cause cash flow problems by paying too much cash, too soon.

33. Explain how system availability problems could cause cash management problems. Significant amounts of downtime in the system could delay payments to vendors. In turn, vendors may delay shipments of materials to the company, which would then delay sales to customers and cash inflows.

34. (SO 8) How is an audit trail maintained in an IT system where no paper documents are generated? Backup files and computer logs of transactions can serve as part of an audit trail.

35. (SO 8) What can a company do to protect itself from business interruptions due to power outages? A company should have a disaster recovery plan and they should use uninterruptible power supplies as a backup to the normal power source.

36. (SO 7) What paper document is eliminated when ERS is used? ERS is an invoiceless match system. This means the invoice is eliminated and the vendor is paid if the purchase order matches the goods received.

37. (SO 7) Identify compensating controls needed for an effective ERS system. Some of the compensating controls needed are: Established

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procedures in receiving to ensure goods are only accepted when quantities and part numbers match exactly; there must be a much more detailed negotiation with suppliers to establish accepted practices and firm prices with suppliers; vendors must understand that substitutions and partial shipments cannot be accepted; there should be established procedures to handle exceptions that arise, but exceptions should be very rare.

38. (SO 5) What is typically the most time-consuming aspect within the expenditures process? It is the matching of documents in a three-way match system. The time involved is usually very high because of the manual steps and because of the time involved in reconciling mismatches of part numbers, quantities, and prices in many shipments.

39. (SO 8) Identify the category of risk that can be reduced by using authority tables, computer logs, passwords, and firewalls. The category of risk that these controls reduce is security and confidentiality risk, and more specifically, unauthorized access.

40. (SO 6) Explain why the availability of computer systems in the receiving department is such an important component of an automated expenditures process. In most automated vendor payment systems, there is a presumption that the receiving personnel must reject shipments that do not match the purchase order. This means that the receiving personnel must be able to look up the desired purchase order at the same time the delivery is at the receiving dock. The receiving personnel must be able to reject the shipment, of necessary, while the delivery person is still at the receiving dock. In this circumstance, the purchase order files must be online and readily accessible to receiving personnel.

41. (SO 5,8) Identify three ways that buyers and sellers may be linked electronically. EDI systems link buyers and sellers electronically, The electronic link may be in the form of private leased lines, third-party networks called value-added networks, or via the Internet.

42. (SO 8) What techniques can a company use to reveal problems concerning potential exposure to unauthorized access to its systems?

Penetration testing, vulnerability assessment, and intrusion detection systems all help expose potential unauthorized access.

43. (SO 9) How are Web browsers used in e-payables systems? In many accounting systems, the accounting software has a custom designed screen to view and enter data. In e-payable system, a web browser is used as the interface to receive and review invoices, as well as to

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make vendor payments. The web browser is perceived to be a more user friendly approach to the interface.

44. (SO 10) Explain how procurement cards provide for increased efficiencies in the accounts payable department. P-cards are used for purchases of things such as supplies, maintenance, and travel and entertainment expenses. Without p-cards, many companies find they have a large volume of these small dollar transactions that would still require the regular matching process in accounts payable. The p-card eliminates this time consuming matching process for items purchased with the p-card. This eliminates soliciting bids, keying PO and invoice data, matching documents, reconciling mismatches, and writing small dollar amount checks. Instead, the company receives one monthly bill from the credit card issuer.

Brief Exercises 45. (SO 2,4) Describe what is likely to occur if company personnel erroneously recorded a purchase transaction for the wrong vendor?

What if a cash disbursement was posted to the wrong vendor? Identify internal controls that would detect or prevent this from occurring. If a company erroneously recorded a purchase transaction to the wrong vendor, it is likely to make a payment to the wrong party. When the correct vendor does not collect its payment, it will notify the company and demand payment. This will likely result in the company making a duplicate payment for the same transaction.

If a cash disbursement was posted to the wrong vendor account, this would also likely result in the company making a duplicate payment for the same transaction. Since the first payment did not get recorded correctly, the company would not have proper record of the payment. When it reviewed its vendor accounts, it would note that it still needed to make a payment.

It would be difficult to discover an erroneous posting of a purchase transaction or cash disbursement to the wrong vendor account. (An incorrect posting of a cash disbursement is more likely to be discovered in the document matching and subsequent posting process.) The following internal controls could detect these types of problems: • When invoices arrive from the vendor companies, there should be an attempt to match the invoice to the purchase order and receiving report before the transaction is posted to the vendor account within the accounts payable subsidiary ledger. During

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this posting, the employee who posts should verify that the transaction is recorded in the proper vendor account.

• A reconciliation should be performed upon receipt of the vendor statement. This should reveal any differences in terms of purchase or payment information.

• A review of the vendor file should be performed periodically.

The vendor to which the purchase should have been recorded or the vendor to which a payment was erroneously applied may show a negative balance (paid more than recorded purchases).

The error may also be discovered when there is a reconciliation of the accounts payable subsidiary ledger to the general ledger, although this is not as likely. The reconciliation would still balance even if an amount is recorded in the wrong vendor account. It is also possible that this error would not be discovered particularly if there are always outstanding balances in vendor accounts. The best internal control to prevent these errors would be to use an automated, rather than manual system. An automated system would automatically post to the correct vendor as the purchase order is created.

46. (SO 4) Debate the logic used in the following statement: “The person responsible for approving cash disbursements should also prepare the bank reconciliation because he is most familiar with the checks that have been written on that bank account.” It may be true that this person is more familiar with the checks, but it would not represent a good internal control process. If a separate person reconciles the account, it prevents the first person from writing fraudulent checks and covering it up by altering the bank reconciliation.

47. (SO 8) Expenditure systems are crucial in the automobile manufacturing industry, where hundreds or thousands of parts must be purchased to manufacture cars. Briefly describe how EDI would be beneficial in this industry. Since there would be such a large volume of purchase orders, invoices, and receiving reports, that handling so many paper document would be inefficient. EDI would eliminate all of the manual steps in handling these paper documents, eliminate the keying of the data on these documents, and eliminate mail delays. An EDI system would be faster, more efficient, and less error prone.

Therefore, it would also reduce the cost per transaction.

48. (SO 2,4) Describe how the matching of key information on supporting documents can help a company determine that purchase transactions have been properly executed. If the company has established proper segregation of duties and matches documents, there is a likelihood they have properly insured that purchase transactions are properly

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executed. Purchasing would not complete a PO and place an order until they receive a purchase requisition. The PO would be forwarded to accounts payable. The receiving department would complete and forward a receiving report upon receiving the goods. The invoice comes from a separate party – the vendor. If these three separate documents match, it is a good assurance that it was a valid, authorized order, it was properly received, and the vendor billed correctly for goods ordered and received.

49. (SO 2,3) Describe how the use of pre-numbered forms for debit memos can help a company determine that purchase return transactions have not been omitted from the accounting records. It is much easier to account for all debit memos if they are pre-numbered.

The sequence of numbers can be checked to ensure all have been posted.

50. (SO 5,7) Describe how a ERS system could improve the efficiency of expenditure processes? An ERS is an invoiceless system that pays vendors if the goods received match the purchase order. This system completely eliminates the document matching system that usually occurs in accounts payable. This eliminates the most time consuming aspect of paying vendors. However, it does require much more strictly defined purchasing agreements with vendors. Vendors must understand that the company cannot accept price differences from those negotiated, substitution of products, undershipments, overshipments, or partial shipments.

51. (SO 10) Describe how a procurement card improves the efficiency of purchasing supplies. A procurement card is usually used to purchase supplies or pay for travel and entertainment. Using a p-card for these purchases eliminates the typically process of PO, receiving report, and invoice matching. Individual users have much more control over the purchase of their supplies and central inventories of supplies need not be maintained.

Problems 52. (SO 2,3,4) Identify an internal control procedure that would reduce the following risks in a manual system: a. The purchasing department may not be notified when goods need to be purchased. Require that an inventory control department monitor inventory records and request purchases (purchase requisition) when goods need to be reordered.

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b. Accounts payable may not be updated for items received. Require that the receiving department complete a receiving report for all goods received, and that a copy of the report is forwarded to accounts payable. c. Purchase orders may be prepared based on unauthorized requisitions. Require that the appropriate manager approve each purchase requisition by signing the requisition form. d. Receiving clerks may steal purchased goods. Require good physical security such as security cameras and good supervision of receiving employees. Using a “blind” PO at receiving may also help since constant shortages when goods are stolen is more likely to be noticed. e. Payments may be made for items not received. Require a threeway match of the purchase order, receiving report, and invoice before a payment can be approved. f. Amounts paid may be applied to the wrong vendor account.

Assuming that the payment was to the correct vendor, but posted to the wrong account, it is very difficult to uncover this error. A reconciliation of subsidiary ledge to the accounts payable account may not uncover this because the total balance would be the same.

It may be uncovered if someone notices that the records show payments to a vendor are in excess of that owed. There is no method to completely eliminate errors in posting. g. Payments may be made for items previously returned. Require a debit memorandum be completed for any goods returned, and that a copy of this be forwarded to accounts payable so that the balance owed can be changed. h. Receiving clerks may accept delivery of goods in excess of quantities ordered. First, there must be a clear policy on overshipments that receiving personnel can apply. For example, a policy may be written that overshipments under 5% can be accepted, but all others should be rejected and returned. Second, there must be a policy that all received goods are compared against a purchase order. Also, the use a “blind” PO to force receiving personnel to count goods and they might therefore more easily detect overshipments. i. Duplicate payments may be issued for a single purchase transaction. Require that payment documentation be “cancelled’ when payment is made. This stamp on the documents should help prevent duplicate payments.

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53. (SO 1, SO 10) Chris Smith’s coffee and pastry cart and a procurement card. Suggest some controls that should be in place. Identify some resources that need to be purchased for this business. The credit card used should have a dollar amount limit as well as a daily limit. The card can also be restricted to certain kinds of vendors. For example, hotels, air fare, electronics stores, and liquor stores could all be vendors that would be prohibited purchases on this credit card. The types of resources that would be purchased are paper products such as coffee filters, paper cups, napkins, and plates; plastic utensils; ground coffee beans; creamer, sugar, sweetener, and milk; pastries; and various cleaning supplies. Finally, Chris should review all charges on the credit card each month to detect any misuse of the card.

54. (SO 1,5) AZO Company and business process reengineering project (BPR). BPR involves the radical redesign of processes, along with IT enablement of processes, to improve the efficiency and lower the cost of processes. BPR in a manual expenditure system would involve methods to convert manual processes into automated processes. Any of the IT enablement methods suggested in this chapter are possible solutions. Therefore, computer based document matching, evaluated receipt settlement, e-business or EDI, e-payables, and procurement cards are all possible. Some combination of these would also be possible. For example, ABC could use an EDI system for purchases of inventory, but use a procurement card for small supplies and travel expenditures.

55. (SO 2,4) The following list presents statements regarding the expenditure processes. Each statement is separate and should be considered to be from a separate company. For each statement, determine whether it is an internal control strength or weakness, then describe why it is a strength or weakness. If it is an internal control weakness, provide a method or methods to improve the internal control. a. A purchasing agent updates the inventory subsidiary ledger when an order is placed. This is an internal control weakness.

The purchasing agent is part of the authorization of orders.

Therefore, he/she should not have record keeping duties for those purchases. If one person has both duties, unauthorized purchases can be initiated and records can be altered to cover up these unauthorized purchases. These duties should be

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segregated and someone who does not authorize and does not have custody of purchases should be assigned to the record keeping. b. An employee in accounts payable maintains the accounts payable subsidiary ledger. This is an internal control strength.

The payable should be recorded when the invoice arrives and it matches a purchase order and receiving report. c. Purchasing agents purchase items only if they have received an approved purchase requisition. This is an internal control strength. The purchasing agents cannot initiate purchases without proper approval from a separate department or person. d. The receiving dock employee counts and inspects goods and prepares a receiving document that is forwarded to accounts payable. This is an internal control strength. The counting and inspecting of goods ensures that goods are not damaged and that the proper amount was received. This count and inspection prevents companies from paying full price for damaged goods or missing goods. e. The receiving dock employee compares the packing list to the goods received and if they match, forwards the packing list to accounts payable. This is an internal control weakness. Goods should not be compared to the packing list, they should be compared to the purchase order. A comparison to the packing list will not reveal any undershipments, overshipments, or product substitutions. The improvement would be to compare the goods received to the purchase order and forward a receiving report, not the packing list, to accounts payable. f. An employee in accounts payable matches an invoice to a receiving report before approving a payment of the invoice.

This is an internal control weakness because there is one more document that should be matched. The purchase order should also be matched to the invoice and receiving report. g. A check is prepared in the accounts payable department when the invoice is received. This represents two internal control weaknesses. First, there is no document matching mentioned (po, invoice, and receiving report). Second, acoounts payable should authorize payment by check, but should not write the check. The matched documentation should be forwarded to cash disbursements and the check is written by cash disbursements.

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56. (SO 2) Hitchins, Inc. computerization.

Required: Assume that Hitchins, Inc. is preparing to computerize the manual input processes such as completing a receiving report. Use Microsoft Excel to perform the following: a. Design an appropriate format for a data entry screen that could be used at the receiving dock to enter information from the packing slip in the company’s expenditure system. See the excel file Problem 9-56.xls.

57. (SO 4) Since the accounts payable system of matching purchase orders, invoices, and receiving reports can often be complex, organizations must routinely check to ensure they are not making a duplicate payment. The text book Web site contains a spreadsheet titled “invoices.xls”. Using your knowledge of spreadsheets and the characteristics of duplicate payments, identify any payments within the spreadsheet that appear to be duplicate or problem payments.

For the following PO’s, there are duplicate payments in which the invoice amounts are exactly the same, and the same PO is referenced. PO 1514; invoices 5644 and 6871. PO 2635; invoices 7176 and 7700. PO 3477; invoices 7957 and 8340. PO 2818 was invoiced twice, but in different amounts and it could be a duplicate payment, or it could be two partial payments. We would need the amount of the purchase order to determine.

58. (SO 8) Fracho and EDI Controls.

Required: Describe the IT controls that Frimco should include when it implements an internet EDI system. For each control you suggest, describe the intended purpose of the control. Since Frimco will be sending data electronically using a computer system, there are many general and application controls that should be a part of this IT system. Frimco may not be able to afford all of the general controls mentioned below, but they should implement as many as are cost effective. General controls include: user IDs, passwords, log-in procedures, access levels, authority tables, firewalls, encryption of data, vulnerability assessment, penetration testing, intrusion detection, software testing, and computer logs, These general controls limit unauthorized access to the IT system. To help prevent

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availability risks, general controls such as business continuity planning, backup data and backup systems, firewalls, encryption of data, vulnerability assessment, intrusion detection, and penetration testing. The purchasing software and the EDI translation software should also incorporate application input controls such as field check, validity check, limit check, and reasonableness check 59. (SO 2,3,4) Wikkam Company and segregation of duties: a. Accounts payable record keeping. b. Authorization of new vendors c. Authorization of purchase returns d. Authorization of purchases e. Cash disbursements record keeping f. Check-signing authority g. Custody of inventory in the receiving area. h. Maintaining custody of cash. i. Preparation of a debit memo for a purchase return Required: For each of the three employees (supervisor, employee 1, and employee 2), consider the duties you would assign to each employee.

In assigning duties, no employee should have more than three tasks and there should be a proper separation of duties to achieve appropriate internal control. List the three people, the duties you assigned to each employee and a description of why those assignments achieve proper separation of duties. There are likely to be a few possible answers that could be effective. The critical aspect is to try to segregate authorization, custody, and record keeping for related events as much as possible. There is no “perfect” segregation since there are only three employees.

Supervisor: duties F, G, and H. The supervisor would be the most logical person to sign checks. As a supervisor, he/she can override internal controls so it is not as much a problem that there may be some incompatibility for a supervisor.

Employee 1: duties A, E, I. This places all record keeping and document preparation with employee 1. He/she has no custody or authorization.

Employee 2: duties B, C, and D. He/she can authorize vendors,

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purchases, and purchase returns, but has no custody or record keeping responsibility.

60. (SO 7) Using a search engine, search the internet for information about Evaluated Receipt Settlement, or ERS. You may have more success by searching for the terms ERS and invoices together in one search. Based on what you read about ERS on the web, what appears to be the difficulties encountered when a company chooses to implement ERS? The most frequent problem appears to be the reluctance of suppliers (vendors) to adopt the new processes. The switch to an ERS system is a complete change of the invoice and payment process and it requires that the company and its vendor have negotiated firm prices, and polices on shipments. Since this is such a radical change from the older way of doing business, vendors resist the change.

61. (SO 9) Using a search engine, search the internet for information about Electronic Invoice Presentment and Payment. You may have more success by searching for the terms EIPP and invoices together in one search. Based on what you read about EIPP on the web, what are the advantages and disadvantages of EIPP? One of the concepts about EIPP is that is should benefit both the buying company and the selling company. What do you think the benefits are to buyer, and what are the benefits to the seller? The website http://www.accountis.com/overview/supplierbenefits/ (accessed 4/29/08) indicates that the supplier benefits are: (1) Time and cost savings by reducing the labor, material and posting costs associated with traditional payment systems. This includes an 82% cost reduction per transaction and a 33% increase in invoice processing efficiency; (2) error reduction; (3) quicker settlement which leads to the supplier receiving payment more quickly; (4) Improved visibility from the 24/7 availability of archived e-documents. This improves the ability to forecast cash flow and makes audits more efficient.

The website http://www.accountis.com/overview/buyerbenefits/ indicates that the buyers benefits are: (1) No manual data entry and rekeying of data is eliminated; (2) real-time invoice access for customers. Each customer has online access to each of their invoices; (3) faster dispute resolution. Rather than requesting assistance via

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telephone, the buyer can query the invoice set using any line item (4) One, consistent view of all invoices because an EIPP uses a standard format; (5) reduced costs by reducing the number of workers in accounts payable; a 50% - 75% processing cost savings; reduction of overbilling and invoice errors.

62. (SO 9) Visit the e-commerce website for Jupitermedia Corporation at www.ecommerce-guide.com and search for EIPP under the News and Trends tab. Identify the company that introduced an EIPP product in 2002 as part of its Financial Management Solutions Package. What does this company call its EIPP application? It is called eSettlements.

See http://www.ecommerceguide.com/news/news/article.php/1145211.

63. (SO 11) You are an accounts payable clerk for a small home improvements contractor. Speculate on the type of fraud that could be in process here. What (if anything) could you do to ascertain the propriety of the transaction and still make the payment today? It is possible that the site supervisor has created a fictitious vendor name and a fictitious invoice and is seeking reimbursement for this false documentation. In an attempt to verify whether the company exists, you could examine telephone books or online listings of the address and phone number for the company. It would be important to confirm that any address is not a PO Box and it is not the same address as an existing employee. This approach is not a guarantee because it is easy to set up a “false storefront”. Ideally, the best controls are the approval of a vendor before any purchases occur with that vendor and payment through the existing accounts payable processes.

64. (SO 11) Two of the most common ways that employees commit fraud against their employers is the misstatement of reimbursable expense accounts and the misuse of office supplies for personal purposes.

Although these schemes are usually not individually significant, their magnitude can be damaging if these practices are widespread.

Develop suggestions for internal controls that could curb the occurrence of such fraudulent activities. Some useful controls would be: approval of these transactions before they occur; requiring the submission of original invoices or receipts before payment is made; and periodic audits of these expenditures.

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Cases 65. Breston Incorporated has the following processes related to purchasing.

Required: 1. Draw a document flowchart of the purchase processes of Breston.

Refer to the separate Microsoft Excel file “Chapter 9 Solutions Process Maps.xls”.

2. Identify any weaknesses in internal controls within the purchase processes and indicate the improvements you would suggest.

Weakness: No one person or department has been assigned responsibility to monitor inventory levels and determine when to order. Improvement: Assign responsibility to a department such as inventory control.

Weakness: There is no purchase requisition completed and forwarded to purchasing to initiate the purchasing process.

Improvement: Use a purchase requisition, approved by inventory control, to initiate purchases.

Weakness: No copy of the purchase order is forwarded to accounts payable for a document match. Improvement: Forward a copy of the PO to accounts payable.

Weakness: the inventory control department updates inventory records based on a PO, not the goods received. Improvement: the inventory control department should update inventory from the receiving report.

Weakness: No copy of the receiving report goes to inventory control or accounts payable. Improvement: Copies of the receiving report should be forwarded to accounts payable and inventory control.

Weakness: The packing slip is forwarded to accounts payable instead of the receiving report. Improvement: The receiving report is forwarded to accounts payable.

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Weakness: The accounts payable matches the invoice to the packing slip. Improvement: the accounts payable department should match the invoice to the purchase order and receiving report.

Weakness: the cash disbursements department forwards a copy of the check to the general ledger department. Improvement: The cash disbursements department should send a summary journal voucher of check amounts, not a copy of each check. These subtotals are posted to the general ledger, not each individual check.

66. Mershay Enterprises is a wholesaler that purchases consumer merchandise from many different suppliers.

Required: 1. List any strengths and weaknesses in the internal control procedures of Mershay enterprises.

STRENGTHS: A manager in purchasing approves the PO before it is mailed.

The PO is prepared in 4 parts and these copies are forwarded to appropriate departments for future use.

If no PO exists for a shipment, it is returned.

The receiving report is prepared with three copies and those copies are forwarded to appropriate departments (one improvement would be a copy to a separate inventory control department; see first weakness below.

Accounts payable does a three-way match of PO, receiving report, and invoice before approval of payment.

The matched documents are reviewed by a manager, The check signer (treasurer) is segregated from the preparation of the check.

WEAKNESSES: There is no separate inventory control department to maintain inventory records.

The requisition should come from inventory control, not the warehouse.

The packing slip is compared to the purchase order instead of

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counting and inspecting the order.

The quantities on the receiving report are from the packing slip instead of a separate count by receiving employees.

If a separate inventory control department existed, a copy of the receiving report should be forwarded there.

In general, there is nothing in the description about record keeping – such as who updates inventory, accounts payable, and general ledger records.

2. Draw a document flowchart of the expenditure processes. Refer to the separate Microsoft Excel file “Chapter 9 Solutions Process Maps.xls”. This would be an excellent time to reinforce to students that the process map shows processes, but not document flow. Since the document flowchart does show document flows, it is easier to see where some potential control weaknesses exist when viewing the document flowchart.

3. Describe any benefits that Mershay may receive by installing a newer, IT system to process purchases, goods received, accounts payable, and checks. Be specific as to how IT systems could benefit each of the processes described. There are many types of IT systems for purchases, so the exact benefits would be somewhat dependent on the system chosen.

However, any IT system would reduce the number of manual tasks which would improve efficiency, reduce costs, and decrease errors. Examples would be: An IT system could monitor inventory levels and automatically generate a purchase order when quantities if individual items reach a reorder point.

An IT system could store documents such as POs or receiving reports online so that there need not be actual paper handling in forwarding documents between departments.

An IT system could match the PO, receiving, report, and invoice and leave accounts payable personnel free to work on reconciliations of those that do not match correctly.

An IT system could prepare and print checks.

An IT system could update related records in realtime as goods are ordered, received, or paid.

An IT system would provide better and more timely feedback to management about inventory levels, items on order, future expected cash flow, and details about expenditures.

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67. Hamburg Metals. is a manufacturer of aluminum cans for the beverage industry.

Required: a. Draw two process maps to reflect the business processes at Hamburg. One process map should depict the purchase processes and the second process map should depict the cash disbursements processes. Refer to the separate Microsoft Excel file “Chapter 9 Solutions Process Maps.xls”. b. Draw two document flowcharts to reflect the records and reports used by these processes at Hamburg. One flowchart should depict the purchase processes and the second flowchart should depict the cash disbursements processes. Refer to the separate Microsoft Excel file “Chapter 9 Solutions Process Maps.xls”. This would be an excellent time to reinforce to students that the process map shows processes, but not document flow. Since the document flowchart does show document flows, it is easier to see where some potential control weaknesses exist when viewing the document flowchart. c. Describe any weaknesses in these processes or internal controls.

As you identify weaknesses, also describe your suggested improvement.

Weakness: Inventory is ordered when it “seems low”.

Improvement: There should be pre-established reorder levels for each inventory item.

Weakness: The inventory control department is not initiating orders by a purchase requisition.

Improvement: An inventory control department should maintain inventory records and to complete purchase requisitions when inventory items reach the reorder level.

Weakness: The purchase automatically goes to the last vendor used.

Improvement: Purchasing agents should find the best price and not automatically use the last vendor.

Weakness: No copy of the purchase order is forwarded to accounts payable.

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Improvement: A copy of the PO should be forwarded to accounts payable.

Weakness: The receiving report is prepared from the packing slp rather than a separate count and inspection.

Improvement: require receiving personnel to count and inspect goods and complete the receiving report based on this count.

Weakness: No copy of the receiving report is forwarded to accounts payable.

Improvement: A copy of the receiving report should be forwarded to accounts payable.

Weakness: No copy of the receiving report is forwarded to inventory control.

Improvement: A copy of the receiving report should be forwarded to inventory control so that inventory records can be updated.

Weakness: Accounts payable prepares a cash disbursements voucher for all invoices and does not match the PO, invoice, and receiving report before preparing the voucher.

Improvement: Match the three documents to ensure it is a valid order that was received in good condition before the voucher is approved.

Weakness: the cash disbursements department forwards a copy of the check to the general ledger department. Improvement: The cash disbursements department should send a summary journal voucher of check amounts, not a copy of each check. These subtotals are posted to the general ledger, not each individual check. d. Draw two new process maps that include your suggested improvements. One process map should depict the purchase processes and the second process map should depict the cash disbursement processes. Refer to the separate Microsoft Excel file “Chapter 9 Solutions Process Maps.xls”.

68. The United States General Accounting Office (GAO), Office of Special Investigations was charged with investigating a potential purchase

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fraud case. The man who committed the alleged fraud was a former civilian employee of the Air force, Mark J. Krenik.

Required: Describe internal controls that should be in place at the Air Force to help prevent such fraud. Internal controls that may help prevent or detect this are: A policy requiring that any special handling instructions be approved by a manager above the person requesting the payment.

A policy requiring that a vendor cannot be paid unless that vendor has been approved and established in the system through the regular vendor approval system.

A segregation of approval so that the person requesting the payment cannot also verify that work was completed or deliveries made.

A policy requiring a periodic audit of expenditures by the internal audit department.

69. The following document flowchart shows part of the purchases and cash disbursements processes for Jidd, Inc., a small manufacturer of gadgets and widgets. Some of the flowchart symbols are labeled to indicate operations, controls, and records.

Required: For each of the symbols (numbered 1. through 12.), select one response (lettered A. through T.) from the answer lists below. Each response may be selected once or not at all.

1. __C__ 2. __R__ 3. __F__ 4. __L__

5. __M__ 6. __O__ 7. __P__ 8. __H__

9. __T__ 10. __N__ 11. __I__ 12. __K__

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Concept Check 1. c 2. a 3. b 4. b 5. c 6. d 7. c 8. a 9. a 10. d 11. a 12. a 13. d 14. a 15. d 16. a 17. c 18. d

Discussion Questions 19. (SO 1) Sales and inventory purchases are routine processes that occur nearly every day in a business. How are these routine processes different from payroll or fixed asset processes? The major difference is the frequency of occurrence. As stated in the question, sales and purchases are often undertaken daily. Payroll occurs on a fixed schedule such as every week, biweekly, or at month-end. Payroll transaction volume might be large, but only at these time intervals.

Some payroll events occur only when employees are hired or fired.

Fixed asset processes occur on an “as needed” basis. The volume of fixed asset transactions is relatively small compared to sales or purchase transaction volume. Depreciation of fixed assets occurs on a fixed interval, such as at year-end.

20. (SO 1) Even though payroll and fixed asset processes may not be as routine as revenue processes, why are they just as important? They are important because payroll and fixed asset transactions are related to two very critical resources. An organization must have employees and facilities (fixed assets) to operate.

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21. (SO 2) Why do you think management should specifically approve all employees hired? It is a nonroutine process, and therefore, the volume of hiring is usually small enough to allow specific approval of each hire. Specific approval is important because hiring the right people is one of the most important keys to success in an organization.

Also, hiring unethical people, or people with criminal backgrounds can be very detrimental to the company.

22. (SO 2) Why is it important that the human resources department maintain records authorizing the various deductions from an employee’s paycheck? First, state or federal laws require that employees authorize (allow) deductions from their salary or wages.

Secondly, without adequate records, it would be difficult to ensure the correct deductions have been taken from employee wages.

23. (SO 2) Explain why an employee’s individual record is accessed frequently, but changed relatively infrequently. Typically, an employee’s basic information does not change frequently. For example, name, birth date, SSN, either never change, or rarely change. Other employee information such as address, pay rate, or deductions change infrequently. However, some of this information, such as pay rate and deductions must be accessed every time payroll checks are prepared.

24. (SO 2) Explain two things that should occur to ensure that hours worked on a time card are accurate and complete. Each employee should update their time card daily and a supervisor should check the time card and sign or initial it before it is forwarded to payroll for processing. If an employee does not update it daily, they are more likely to put inaccurate information on it simply because it will be harder to remember the specific start and end times of work. The supervisory approval serves as an independent check of the accuracy of the time card.

25. (SO 2) Explain the reasons that an organization would have a separate bank account established for payroll. A separate bank account for payroll makes it easier to account for payroll transactions and to distinguish these transactions from other cash disbursements.

26. (SO 3) What is the purpose of supervisory review of employee time cards? The supervisory approval serves as an independent check of the accuracy of the time card.

27. (SO3) Why is it important to use an independent paymaster to distribute paychecks? It is the best segregation of duties to have a separate paymaster to distribute any paper checks. A separate paymaster segregates the custody from authorization, preparation, and

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recording of paychecks. If these duties were combined, a person could commit payroll fraud such as creating a fictitious employee. A separate paymaster helps ensure only active employees receive paychecks.

28. (SO 3) Why do payroll processes result in sensitive information and what is the sensitive information? The amount of salary or wages is sensitive, as well as the types and amounts of deductions. Also, personal information such as SSN, dependents, address and phone numbers are sensitive.

29. (SO 4) Why is batch processing well-suited to payroll processes?

Because it involves transactions that can be grouped and processed at a particular time. For example, all hourly workers might be required to turn in all time cards on Friday afternoon and be paid the next Tuesday. All of these time cards can be processed as a group on Monday.

30. (SO 4) What are the advantages of automated time keeping such as bar code readers or ID badges that are swiped through a reader?

Using these automated methods eliminates human steps that are error prone. Thus, timekeeping becomes more efficient and more accurate.

31. (SO 4) What are the advantages of outsourcing payroll? Outsourcing payroll provides increased convenience, confidentiality, and protection from risk of liability for failure to submit tax withholdings and reports.

32. (SO 5) Fixed assets are purchased and retired frequently. Given this frequent change, why are clear accounting records of fixed assets necessary? Not only must the cost and resale value be accounted for properly, but depreciation can only be calculated accurately with proper records, and any gain or loss on sale is computed based on accurate records.

33. (SO 5) Why is it important to conduct an investment analysis prior to the purchase of fixed assets? Since the dollar investment can be large, and there is usually a limited capital budget, there must be an orderly process to determine the best use of capital funds.

34. (SO 5) Explain why categorizing fixed asset expenditures as expenses or capital assets is important. Miscategorization can have a dramatic impact on financial statements and therefore, can mislead users of these statements. These amounts are usually large and therefore, have a larger impact than would other transactions such as sales or inventory purchases. If a fixed asset expenditure is classified as an expense, it will understate the balances sheet assets and understate net income.

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35. (SO 5) What are some of the practical characteristics of fixed assets that complicate the calculation of depreciation? For many companies, there is a large number and type of fixed assets. These different asset types may have different service lives and different methods of depreciation. In addition, there are offer additions or retirements of fixed assets. Finally, the tax methods of depreciation for fixed assets may require two different sets of asset and depreciation records; one for financial statement purposes, and one for tax purposes.

36. (SO 6) What is different about the nature of fixed asset purchasing that makes authorization controls important? Fixed asset purchases can be very large amounts of money and in addition, choosing the right fixed assets is very important. Management should be purchasing the fixed assets that have a good return on investment. For these reasons, fixed asset authorization usually requires a higher level of management approval, and usually requires an investment analysis such as net present value.

37. (SO 6) Explain the necessity of supervision over fixed assets. Fixed assets must be located throughout the company where employees have direct access to them. Employees could not do their jobs without these fixed assets. Since fixed assets are readily accessible to many employees, supervision is necessary to ensure that the assets are used for their intended purpose, and that they are not stolen.

38. (SO 6) Why are some fixed assets susceptible to theft? In some cases, fixed assets are small or very portable. Examples would be laptop computers, hand tools, or vehicles. These would be easy to steal. Conversely, a large fixed asset such as a manufacturing robot would not be easy to steal.

39. (SO 7) Explain why a real-time update of fixed asset records might be preferable to batch processing of fixed asset changes. Often, fixed asset changes are non-routine transactions. Since the volume of these transactions could be small, and any one transaction might affect only a single asset record, real-time updates may be more appropriate.

40. (SO 7) Why is the beginning of a fiscal year the best time to implement a fixed asset software system? Because it eliminates any mid-year adjustments for depreciation that would be necessary.

41. (SO 7) What negative things might occur if fixed asset software systems lack appropriate access controls? It would be much easier for an employee to steal a fixed asset and alter the records to hide this theft.

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42. (SO 8) Why might a supervisor collude with an employee to falsify time cards? In some cases, the supervisor might agree to the fraud so as to share in the extra money that results from the fraudulent pay.

43. (SO 8) How does the misclassification of fixed asset expenditures result in misstatement of financial statements? If something should have been recorded as a fixed asset gets recorded as an expenditure, it will understate assets and understate income. The opposite is true if an expenditure is misclassified as a capital asset. Assets are overstated and income is overstated.

Brief Exercises 44. (SO 2) Describe the type of information that a human resources department should maintain for each employee. They should maintain personnel records that include employee application, contract, resume, recommendation letters, interview reports, wage authorization, and and background investigation report. The records should also include employee address, SSN, employment history, information about authorized deductions, vacation and sick time accrued, attendance and performance evaluation records, work schedule, and promotion or termination records.

45. (SO 2) The calculation of gross and net pay can be a complicated process. Explain the items that complicate payroll calculations. Each employee’s deductions are likely to be different. In addition, the payroll formulas must be applied to every employee in the company, one at a time. The process is further complicated the fact that the inputs tend to change constantly. Each payroll period will include some changes in the number of hours worked, pay rates or withholdings.

46. (SO 3) Explain how duties are segregated in payroll. Specifically, who or which departments conduct the authorization, timekeeping, recording, and custody functions? Authorizing, timekeeping, record keeping, and custody of the paychecks should all be separated.

Namely, the human resources department, which is responsible for authorizing new employee hiring and maintaining personnel files, should be separate from the payroll time reporting and record keeping functions, performed primarily by the payroll, cash disbursements, and general ledger departments. In addition, employees in each of these departments should not have check-signing authority and should not have access to the signed checks or cash account. The person who distributes paychecks to employees, often referred to as a paymaster, should not have responsibility for any of the related payroll accounting

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functions and should not have custody of cash. The paymaster should also be independent of the departmental supervision responsibilities, so that it can be determined that paychecks are being distributed to active employees. Finally, information systems operations and programming related to the payroll processing should be separate from those responsible for custody of payroll cash and record keeping for these processes.

47. (SO 3) Explain the various reconciliation procedures that should occur in payroll. The number of hours reported on time sheets should be reconciled to the payroll register, and time sheets should be reconciled with production reports. Each of these reconciliations should be performed before paychecks are signed in order to ensure the accuracy of the underlying payroll information. In addition, the payroll register should be reconciled to the general ledger on a regular basis.

Someone separate from the payroll processing functions should reconcile the bank statement for the payroll cash account on a monthly basis.

48. (SO 4) Explain the ways in which electronic transfer of funds can improve payroll processes. EFT can be used to directly deposit p[ay to employee bank accounts. This eliminates the printing and distribution of pay checks. The company can also use EFT to deposit taxes withheld and other employee withholdings. Finally, wage attachments that result from court proceedings can be transmitted via EFT. All of these EFT processes are faster and more efficient than the use of printed checks and mailing of checks.

49. (SO 5) Explain the kinds of information that must be maintained in fixed asset records during the asset continuance phase. For each fixed assets, there must be records of the asset cost, estimated life and salvage values, depreciation, maintenance records, and repair or improvement costs.

50. (SO 6) The authorization to purchase fixed assets should include investment analysis. Explain the two parts of investment analysis.

The first part is financial justification using a model such as net present value, payback period, or internal rate of return. The use of these models requires that dollar estimates be determined for costs and benefits of the fixed asset. The second part would be a written narrative of the benefits; especially any benefits that are difficult to quantify in dollars. A written narrative of the need for investment can help justify the expenditure when financial benefits do not immediately exceed costs.

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51. (SO 8) Explain the types of unethical behavior that may occur in the fixed assets area. The use of estimates for useful lives and salvage values are an area that unethical managers can use to manipulate income statement or balance sheet amounts. Showing lower depreciation amounts can increase income and asset values above what they should be. In addition, misclassification of expenses as fixed asset expenditures can be used to show higher income and asset values.

Problems 52. (SO 2) Following is a time sheet completed by an hourly wage earner at Halfrid, Inc.

Use Microsoft Excel to perform the following: a. Design an appropriate format for a data entry screen that could be used in the payroll department to enter information from this time sheet in the company’s payroll software program. See the excel file Problem 10-52.xls. b. Prepare a payroll journal. See the excel file Problem 10-52.xls..

53. (SO 2) The text book Web site has a Microsoft Excel spreadsheet titled payroll_problem.xls. This spreadsheet is used by Neltner Company to calculate its bi-weekly payroll. Using the information in that spreadsheet, calculate all details for the February 22, 2008 payroll.

Hours worked by each employee are contained in the first worksheet.

The following four worksheets contain details for each of the three employees and a total of the three employees. The last worksheet contains federal tax withholding tables to calculate federal tax to withhold. You will calculate gross pay and deductions for all three employees. See the excel file payroll_problem_solution.xls. After students have completed the spreadsheet exercise, it might be a good discussion question to ask how a payroll software program would improve the efficiency and accuracy of the payroll process.

54. (SO 5) The text book Web site has a Microsoft Excel spreadsheet titled fixed_asset.xls. The spreadsheet represents a fixed asset subsidiary ledger for Brazos Corporation. On July 3, 2008, Brazos purchased for

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the office a multifunction printer/fax/copier from Brereton Office Supplies for $2,000. The machine has no salvage value and a four year life. Add a new ledger record for this machine and calculate and record the 2008 depreciation expense for all fixed assets. Brazos uses straight-line depreciation with a half-year convention. See the Excel file fixed_asset_solution.xls. After students have completed the spreadsheet exercise, it might be a good discussion question to ask how a fixed asset software program would improve the efficiency and accuracy of the fixed asset processes.

55. (SO 6) Explain the process of approval of purchases for fixed assets.

How does this process differ from that of purchasing raw materials?

When a request to purchase a fixed asset is initiated by a manager, a formal investment analysis should occur. This would include a costbenefit analysis such as net present value, and a written justification of the benefits and costs, as well as any benefits and costs that are not easily quantifiable. There should also be an established capital budget and any fixed asset purchase request should be analyzed in comparison to other requests within that budget, and a determination made of the best use of the limited capital budget funds. Since fixed asset expenditures can involve large dollar amounts, there should also be specific authorization by a manager for the purchase. The company should have an established policy that identifies the level of managerial approval needed for various levels of expenditure.

The processes mentioned above are most of the different processes for fixed asset purchases when compared to raw material purchases.

One other difference is that requests to purchase raw materials generally originate in inventory control or production scheduling, the requests for fixed asset purchases would come from various managers of operating units within the enterprise. The other processes of the purchase, such as POs, document matching, and cash disbursements are similar to those processes for raw material purchases.

56. (SO 3) Using an Internet search engine, search for the phrase “biometric time recording” (be sure to include the quotation marks).

Based on your search results, describe a biometric time recording system and its advantages. A biometric time recording system uses unique physical characteristics of human beings to identify and record time for employees. Such biometric characteristics are finger print,

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hand print, face, retina, or voice pattern. The most commonly used biometric characteristic is the finger print. In a biometric time recording system, a company installs a scanner that reads the fingerprint and records the arrival and departure times. The advantage to the employee is the ease of use. The employee does not need to record times on a time card and does not have to use or keep track of an employee ID badge. The employer sees many advantages. Time keeping is more accurate and complete, payroll accuracy is increased, employees are identified with certainty and building security is increased. In addition, it eliminates “buddy punching” where one employee “punches” the time clock for his buddy who is actually absent.

57. (SO 7) Using an Internet search engine, search for the phrase “fixed asset software” (be sure to include the quotation marks). Examine the results to find companies that sell fixed asset software. List and explain some of the features of fixed asset software that these companies use as selling points for their software.

One software vendor (http://www.realassetmgt.com/rsd/asset_accounting/fixed_asset_mana gement.htm) lists the following benefits: Easily access a complete audit trail with history/actions performed by all users.

Calculate depreciation for one book or multiple books (state, federal and corporate).

Compute and retain depreciation figures for past, current and future periods.

Create ‘Parent/Child’ asset relationships to establish key dependencies and hierarchies.

Produce a full range of standard and customized reports and forecasts.

Set user-defined data and description fields (up to 30 levels of analysis).

Conduct full and partial asset disposals, transfers, relifes, revaluations and splits.

Generate Section 179 charges and bonus depreciation for applicable assets.

Upload asset images for identification purposes.

Adapt quickly to the familiar Windows® inspired interface.

Comply with corporate governance regulations such as SarbanesOxley (SOX), GAAP, US Tax and GASB 34.

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Utilize seamless links to Project4000, RAMI’s project cost control module.

Take advantage of fixed asset tracking capabilities available with Track4000.

Directly import raw data, in a range of formats, using the Data Import Wizard.

Employ Asset4000i for remote access to your fixed asset register.

Login with a valid username and password combination prior to accessing the database.

Establish individual or group access rights for security purposes.

Quickly add new asset details in a single input screen.

A simple process for depreciation calculations whether for individual assets or groups of assets.

Several methods of depreciation including Straight Line, Double Straight Line, Reducing Balance, Variable Rate, Adjusted Declining, Digressive, MACRS, ACRS, adjustments and Residual, Multiple Units of Production (MUOP) and Non Depreciating The ability to forecast depreciation as far into the future as desired.

The ability to recalculate the current period’s depreciation to reflect updates in the asset register.

A powerful, built-in report engine that provides more than 100 standard reports and thousands of customizable reports.

A full audit history for events including disposals, transfers, asset splits, relifes and revaluations can be accessed in seconds.

The ability to physically and financially move an asset from one cost center to another without re-keying information.

The software can display asset images and associated documents such as emails, invoices, purchase orders and contracts.

58. (SO 8) Read the article at this link: http://www.fixedassetinfo.com/articles/adventures1.asp. Describe why the scenario described is unethical. Also, list controls or other steps that management could have taken to prevent or detect this scenario.

Yes, it is unethical. Even if the company had no specific policy about the use of cars by family members, the employee should have known this is unethical. There are many reasons for the use by a family member to be unethical. First, the asset is not being used for a business related purpose. Second, this forces the company to pay expenses (gasoline and maintenance) that should be personal expenses. Also, the company is not likely to have insurance coverage that would cover a driver other than the employee.

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There are very few controls that would be effective in this situation.

This is true because the asset (car) is not located on company property and therefore, proper supervision cannot be applied to ensure the asset is not misused. The best controls are setting good policies and enforcing those policies. Two important policies would be a specific policy limiting company car use to employees only, and a good code of ethics for employees. These policies alone cannot prevent such misuse, but may make employees less likely to try such misuse.

There is one new technology solution the company could consider. A GPS unit could be installed in each car and this unit could be monitored to track the location, speed, and stops of each car. Since this would be an expensive system, the company would have to determine whether it is cost effective.

59. (SO 8) Using an Internet search engine, search for the terms “Patti Dale” and theft (be sure to include the quotation marks around the name). Explain the unethical behavior that occurred. Also, explain any internal controls that you believe were missing or not followed in this case.

Patti Dale was a 20 year employee of the University of North Texas who organized a payroll fraud scheme that resulted in the theft of $255,185 from UNT. She allowed students and friends of her son to falsify payroll time sheets. She issued paychecks for work not done and received a kickback from these students. She also fraudulently hired friends of her son and paid them or work they did not do.

It appears the most important internal control missing is segregation of duties. No single person should authorize hiring and approve time cards. It appears her supervisor, the Dean, should have been approving time cards. An automated system of time keeping such as ID badge swiping or biometric record keeping systems would have reduced the falsified time records.

Ms. Dale also had submitted over $65,000 in falsified travel expenditures.

Cases

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60. Zimmer Company is a small manufacturing firm with 60 employees with seven departments.

Required: Describe any improvements you would suggest to strengthen the payroll internal controls at Zimmer.

Currently, the department managers hire employees and distribute paychecks. This gives managers the opportunity to create fictitious workers and have custody of those checks. The improvement would include two things. Final hiring approvals should be in the HR department, not the department managers. Paychecks should be distributed by independent paymasters, not the department managers.

Currently, the pay rate is written on the employee W-4 by the department manager. The HR department should determine pay rates.

Time cards are now kept in a holder near the door and workers keep them all day. This gives employees too much opportunity to misuse time cards. They can easily be stolen, altered, or use for “buddy punch” where an employee clocks in for his buddy. Time cards should be more secure or the company should use a more advanced solution such as automated time keeping through ID badges or biometric time recording.

Currently, the time cards are removed fro the holder on Friday and taken to payroll by “an employee who is not busy”. Two improvements are needed. First, the supervisor should review and approve each time card. Second, there should be a designated person charged with delivering time cards to payroll.

Rather than the manager calling the payroll department to report pay rate changes, there should be written documentation of pay rate changes using a personnel action form. Without such documentation, there is no audit trail of rate changes. In addition, a manager may suggest rate changes, but final approval should occur in the HR department.

The company should use an imprest payroll account for paychecks rather than the regular checking account.

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There is no mention of the cash disbursements department approving a check from the regular account to be deposited in the payroll account. This should occur if a separate payroll account exists.

61. Wegstram Industries has payroll processes as described in the following paragraphs.

Required: a. Prepare a process map of the payroll processes at Wegstram.

Refer to the separate Microsoft Excel file “Chapter 10 Solutions Process Maps.xls. b. Identify both internal control strengths and internal control weaknesses of the payroll processes.

STRENGTHS There is a separate HR department involved in hiring, and completing and approving documents related to hiring and terminations.

Hiring, terminations, pay rate changes are all initiated by HR on personnel action forms. This creates proper approval and an audit trail.

Two copies of each paycheck are generated. The original is forwarded to cash disbursements and the copy goes to accounts payable.

Cash disbursements, not payroll signs the checks.

The payroll department, the proper department to do so, is updating the payroll ledger.

WEAKNESSES An automated time keeping system would be more accurate and less susceptible to fraud.

There is no supervisory approval of time cards.

There is no reconciliation or independent check of employee hours worked.

There is no separate payroll checking account.

There is no mention of vouchers for payroll that are forwarded to cash disbursements so that a check can be written to the payroll account for the total of the payroll.

There is no independent paymaster to distribute checks.

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Unclaimed checks are returned to payroll, not a paymaster. c. For any internal control weaknesses, describe suggested improvements.

Purchase and use an automated time keeping system.

Have supervisors approve time cards before they are forwarded to payroll.

There should be a reconciliation to job cards or an independent verification of hours worked.

Use a separate bank account for payroll.

Accounts payable should prepare a voucher for the total payroll amount and cash disbursements would write a check to be deposited in the payroll account.

An independent paymaster should distribute checks.

Unclaimed checks should go to a department not involved in the authorization or preparation of paychecks. For example, they could be returned to internal audit.

62. Brahaman Enterprises is a mid-size manufacturing company with 120 employees and approximately 45 million in sales.

Required: a. Identify any internal control strengths and weaknesses in the fixed asset processes at Brahaman. Explain why each of those that you identify are strengths or weaknesses.

STRENGTHS There is a process to identify benefits and costs for new asset requests.

There is an independent review of costs and benefits of proposed assets by the finance department.

A discounted cash flow analysis is undertaken before purchase.

There is a pre-established capital budget.

A high level manager must approve asset purchases.

Payment is not made until the PO, receiving report, and invoice are matched.

The accounts payable department updates the accounts payable subsidiary ledger and fixed asset records.

WEAKNESSES

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A set of levels of approval, dependent on the amount of the asset, have not been established.

The VP of operations may not necessarily need to exhaust all funds. If there are not enough asset proposals with acceptable cost-benefit, then it would be better to not spend all funds.

Buyers should receive bids on assets, especially those assets with very high purchase price.

Assets are always delivered to a user department, rather than receiving. b. For each internal control weakness, describe improvement(s) in the processes to address the weakness.

Establish higher levels of managerial approval for assets with higher costs.

Establish a policy that assets must meet some minimum level of discounted cash flow return before the purchase can be approved.

Establishing a bid process for assets that exceed a certain dollar amount.

When practical, fixed assets should be delivered to receiving for count and inspection. This may not be possible for fixed assets such as those that must be installed at the user location.

63. The Rampart Company has the following processes related to fixed assets.

Required: Describe any improvements you would suggest to strengthen the fixed asset internal controls at Rampart.

There should be a more formal approval process that would include: identification of costs and benefits, a discounted cash flow analysis, a specific authorization from a high level manager.

There should be established expectations of return on investment that assets must be expected to achieve before purchase is approved.

A bid process should be established for assets of high value.

When practical, fixed assets should be delivered to the receiving department. This may not be possible for fixed assets such as those that must be installed at the user location.

Expected life and salvage values should be estimated for each asset

10-15

Chapter 10 Solutions Expenditures Processes and Controls – Payroll and Fixed Assets

instead of using the same values as the previous purchase.

64. (CMA Adapted) Bellet Co. makes automobile parts for sale to major automobile manufacturers in the United States.

Required: Identify any internal control weaknesses and suggest improvements to strengthen the internal controls over machinery and equipment at Bellet.

Weaness: The asset purchase approval process lacks many important processes.

Improvement: There should be a more formal approval process that would include: identification of costs and benefits, a discounted cash flow analysis, a specific authorization from a high level manager.

Weakness: Asset purchases are approved as long as funds exist.

Improvement: There should be established expectations of return on investment that assets must be expected to achieve before purchase is approved.

Weakness: There is no bid process, or a process to find the best price on the asset.

Improvement: A bid process should be established for assets of high value. Assets of lesser value may not need a bid process, but there should be a price comparison of two or more vendors to find the best price.

Weakness: Assets are not inspected at the receiving dock.

Improvement: When practical, fixed assets should be delivered to the receiving department and inspected for damage before delivery to the user department. This may not be possible for fixed assets such as those that must be installed at the user location.

Weakness: Depreciation methods, rates, and salvage values have not been changed for 10 years.

Improvement: Depreciation methods, rates, and salvage values should be reviewed each year.

Weakness: It appears the characteristics of each assets are not

10-16

Chapter 10 Solutions Expenditures Processes and Controls – Payroll and Fixed Assets

evaluated in setting salvage values and life.

Improvement: Expected life and salvage values should be estimated for each asset.

Weakness: The plant manager notifies property accounting of retirements, but it does not indicate that any documents are prepared, or that approval is necessary.

Improvement: There should be formal documents prepare for asset disposal or retirement, this should have proper managerial approval, and there should be an established policy on what happens to retired assets.

Weakness: There is no reconciliation of fixed assets to fixed asset records. Improvement: a yearly count of fixed assets and reconciliation to the fixed asset records should occur.

10-17

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009 October 30, 2009 November 13, 2009 November 27, 2009

Blackstone, M. Misner, C. Shafari, N. Reg. hrs.

Overtime hrs. Reg. hrs.

Overtime hrs. Reg. hrs.

80 5 80 6 80 80 0 80 8 80 80 2 80 9 80 80 10 80 0 80

December 11, 2009 December 25, 2009 Totals

320

17

320

23

320

Shafari, N. Overtime hrs.

0 0 2 12

14

Blackstone, Myra Single, 1 exemption

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Payrate: $ Overtime Payrate: $ Regular Overtime Gross Pay Gross Pay $ 1,120.00 $ 105.00 $ 1,120.00 $ $ 1,120.00 $ 42.00 $ 1,120.00 $ 210.00

Total Gross Pay 1,225.00 1,120.00 1,162.00 1,330.00

14.00 per hour 21.00 per hour Soc Sec. 6.20% 75.95 69.44 72.04 82.46

Medicare 1.45% 17.76 16.24 16.85 19.29

Health Insur. Deduction:

Fed Tax Witholding 154.10 138.35 144.65 173.95

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 4,480.00 $ $ $ -

357.00 -

4,837.00 -

299.89 -

70.14 -

611.05 -

Health Insur. Deduction: $

ST Tax 4% 49.00 44.80 46.48 53.20

50.00 per pay

Health insurance 50.00 50.00 50.00 50.00

$ $ $ $

Net Pay 878.19 801.17 831.98 951.11

193.48 -

200.00 -

$ $ $ $

3,462.44 -

Misner, Christopher Married, 2 exemptions

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 1,280.00 $ 1,280.00 $ 1,280.00 $ 1,280.00

Regular Payrate: $ Overtime Payrate: $ Overtime Gross Pay 144.00 192.00 216.00 -

Total Gross Pay 1,424.00 1,472.00 1,496.00 1,280.00

16.00 per hour 24.00 per hour Soc Sec. 6.20% 88.29 91.26 92.75 79.36

Medicare 1.45% 20.65 21.34 21.69 18.56

Health Insur. Deduction:

Fed Tax Witholding 137.90 145.10 148.70 127.75

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 5,120.00 $ $ $ -

552.00 -

5,672.00 -

351.66 -

82.24 -

559.45 -

Health Insur. Deduction: $

ST Tax 4% 56.96 58.88 59.84 51.20

80.00 per pay

Health insurance 80.00 80.00 80.00 80.00

$ $ $ $

Net Pay 1,040.20 1,075.41 1,093.02 923.13

226.88 -

320.00 -

$ $ $ $

4,131.76 -

Shafari, Nunca Married, 2 exemptions

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 800.00 $ 800.00 $ 800.00 $ 800.00

Regular Payrate: $ Overtime Payrate: $ Overtime Gross Pay 30.00 180.00

Total Gross Pay 800.00 800.00 830.00 980.00

10.00 per hour 15.00 per hour Soc Sec. 6.20% 49.60 49.60 51.46 60.76

Medicare 1.45% 11.60 11.60 12.04 14.21

Health Insur. Deduction:

Fed Tax Witholding 49.20 49.20 52.20 82.75

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 3,200.00 $ $ $ -

210.00 -

3,410.00 -

211.42 -

49.45 -

233.35 -

Health Insur. Deduction: $

ST Tax 4% 32.00 32.00 33.20 39.20

80.00 per pay

Health insurance 80.00 80.00 80.00 80.00

$ $ $ $

Net Pay 577.60 577.60 601.11 703.08

136.40 -

320.00 -

$ $ $ $

2,459.39 -

PAYROLL TOTALS FOR THREE EMPLOYEES

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 3,200.00 $ 3,200.00 $ 3,200.00 $ 3,200.00 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ -

Overtime Gross Pay 249.00 192.00 288.00 390.00 -

Total Gross Pay 3,449.00 3,392.00 3,488.00 3,590.00 -

Soc Sec. 6.20% 213.84 210.30 216.26 222.58 -

Medicare 1.45% 50.01 49.18 50.58 52.06 -

Fed Tax Witholding 341.20 332.65 345.55 384.45 -

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

$ $ $ $ $

-

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 12,800.00 $ $ $ -

-

1,119.00 -

-

13,919.00 -

-

-

-

862.98 -

201.83 -

1,403.85 -

ST Tax 4% 137.96 135.68 139.52 143.60 -

Health insurance 210.00 210.00 210.00 210.00 -

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

Net Pay 2,495.99 2,454.18 2,526.10 2,577.32 -

-

-

556.76 -

840.00 -

$ $ $ $ $

-

$ 10,053.59 $ $ $ -

FEDERAL TAX WITHOLDING TABLES BI-WEEKLY PAYROLL PERIOD SINGLE PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In The OVER of this this amount column column over PLUS » TIMES » (Taxable income less the amount in this column) 0 102 NO TAX WITHHELD 102 389 0 10% 102 389 1,289 28.7 15% 389 1,289 2,964 163.7 25% 1,289 2,964 6,262 582.45 28% 2,964 6,262 13,525 1,505.89 33% 6,262 13,525 OVER 3,902.68 35% 13,525 MARRIED PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In The OVER of this this amount column column over PLUS » TIMES » (Taxable income less the amount in this column) 0 308 NO TAX WITHHELD 308 898 0 10% 308 898 2,719 59 15% 898 2,719 5,146 332.15 25% 2,719 5,146 7,813 938.9 28% 5,146 7,813 13,731 1,685.66 33% 7,813 13,731 OVER 3,638.60 35% 13,731

MONTHLY PAYROLL PERIOD SINGLE PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In OVER of this this column column PLUS » TIMES »

0 221 843 2,793 6,423 13,567 29,304

221 NO TAX WITHHELD 843 0 10% 2,793 62.2 15% 6,423 354.7 25% 13,567 1,262.20 28% 29,304 3,262.52 33% OVER 8,455.73 35% MARRIED PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In OVER of this this column column PLUS » TIMES »

0 667 1,946 5,892 11,150 16,929 29,750

667 NO TAX WITHHELD 1,946 0 10% 5,892 127.9 15% 11,150 719.8 25% 16,929 2,034.30 28% 29,750 3,652.42 33% OVER 7,883.35 35%

LL PERIOD SONS MPUTED TAX IS...

The amount over

(Taxable income less the amount in this column) TAX WITHHELD 221 843 2,793 6,423 13,567 29,304 RSONS MPUTED TAX IS...

The amount over (Taxable income less the amount in this column) TAX WITHHELD 667 1,946 5,892 11,150 16,929 29,750

TURNER DISTRIBUTING GENERAL JOURNAL December, 199X DATE

ACCT NO. EXPLANATION

Dec. 23

POST

DEBIT

10300 Allowance for doubtful accounts 10200 Accounts receivable

X X

850.00

40600 Payroll Tax Expense 20600 F.I.C.A. Taxes Payable 20400 State Unemployment Taxes Payable 20500 Federal Unemployment Taxes Payable

X X X X

701.04

40400 Depreciation expense 10900 Accumulated depreciation

X X

29,834.80

40800 Interest expense 20900 Interest payable

X X

123.29

40900 Bad debt expense 10300 Allowance for doubtful accounts

X X

1,578.13

10400 Inventory 30400 Cost of goods sold 30600 Purchase returns and allowances 30700 Purchase discounts Purchases Freight in Inventory

X X X X X X X

61,540.00 438,374.11 13,928.00 7,517.61

40700 Federal income tax expense 20700 Federal income taxes payable

X X

5,222.02

30100 Sales 31200 Miscellaneous revenue 30200 Sales returns and allowances 30300 Sales discounts 28000 Income summary

X X X X X

678,135.38 275.00

28000 Income summary 30400 Cost of goods sold 40100 Rent expense 40200 Advertising expense 40300 Office supplies expense 40400 Depreciation expense 40500 Wages and salaries expense 40600 Payroll tax expense 40700 Federal income tax expense 40800 Interest expense 40900 Bad debt expense 41000 Other operating expense

X X X X X X X X X X X X

601,933.71

28000 Income summary 29000 Retained earnings

X X

29,591.47

CREDIT

850.00

MONTH END Dec. 31

636.91 49.47 14.66

YEAR END -ADJUSTING Dec. 31

Dec. 31

Dec. 31

Dec. 31

Dec. 31

29,834.80

123.29

1,578.13

466,381.72 10,128.00 44,850.00

5,222.02

YEAR END -CLOSING Dec. 31

Dec. 31

Dec. 31

42,191.20 4,694.00 631,525.18

438,374.11 24,000.00 7,258.00 3,909.20 29,834.80 75,235.72 7,086.44 5,222.02 123.29 1,578.13 9,312.00

29,591.47

SALES JOURNAL

Date Customer Dec. 4 ElectroWorld Dec. 5 Wendover Electronics Dec. 11 ElectroWorld Dec. 13 Wendover Electronics Dec. 18 Clean Images

Monthly Totals

Invoice or Cr. Memo Number 836 837 838 839 840

Subsid.

Acct. No. 516 518 516 518 517

DECEMBER

Subsid.

Post X X X X X

Debit Accout. Rec. Sales Returns G/L 10200 G/L 30200 15,000.00 5,600.00 7,580.00 1,820.00 11,100.00

41,100.00

-

Credit Sales G/L 31000 15,000.00 5,600.00 7,580.00 1,820.00 11,100.00

41,100.00

CASH RECEIPTS JOURNAL DECEMBER

Date Description Dec. 2 Flo's Department Store Dec. 3 Mills Company Dec. 9 ElectroWorld Dec. 10 Wendover Electronics Dec. 11 Hanson Company Dec. 13 Kompier Beauty Supplies Dec. 13 Kozy Kitchens Dec. 23 ElectroWorld Dec. 23 Wendover Electronics Dec. 26 First Security Bank

Monthly Totals

Ctrl.

Init.

PJ PJ PJ PJ PJ PJ PJ PJ PJ PJ

DEBIT Cash G/L 10100 8,200.00 275.00 14,700.00 5,488.00 5,000.00 9,679.00 3,200.00 3,400.00 1,783.60 75,000.00

126,725.60

CREDIT Sales Disc.

A/R - G/L 10200 G/L 30300 Subs. A/C# Amt.

300.00 112.00

Post

516 518

15,000.00 5,600.00

X X

521

9,679.00

X

516 518

3,400.00 1,820.00

X X

Sales G/L 30100 8,200.00

Other G/L A/C #

Amt.

Post

31200

275.00

X

21000

75,000.00

X

5,000.00 3,200.00 36.40

448.40

35,499.00

16,400.00

75,275.00

PURCHASES JOURNAL Vendor Invoice Date Vendor No. Dec. 11 Marcos Office Equipment 2179 Dec. 24 Remington Manufacturing 85854 Dec. 31 Marcos Office Equipment

Monthly Totals

Purchases G/L 30500

DECEMBER DEBIT Other G/L Acc# Amount 10800 7,599.00

Post X

17,660.00 10800

17,660.00

1,899.00

9,498.00

X

CREDIT A/P - G/L 20100 Subs. A/C# Amount Post 363 7,599.00 X 362 17,660.00 X 363 1,899.00 X

27,158.00

Purch. Ret. G/L 30600

CASH DISBURSEMENTS JOURNAL

DECEMBER

CREDIT Cash Purch. Disc.

G/L 10100 G/L 30700 25,400.00 2,000.00 175.00 7,599.00 1,708.00

Date Dec. 9 Dec. 10 Dec. 10 Dec. 11 Dec. 13 Dec. 13 Dec. 13

Check No. Description 356 Remington Manufacturing 357 Hampton Properties 358 Cinergy 359 Marcos Office Equipment 360 Eze-Load Freight 361-363 See Payroll Journal 364 Internal Revenue Serv.

Dec. Dec. Dec. Dec. Dec.

365 Internal Revenue Serv.

366 State of Kentucky 367 EzeLoad Freight 368 Remington Manufacturing 369-371 See Payroll Journal

9.25 26.22 950.00 17,306.80

353.20

Monthly Totals

57,041.87

353.20

13 13 24 30 31

A/P - G/L 20100 Subs. A/C# 362

363

1,867.60

362

A/P - G/L 20100 Amount 25,400.00

7,599.00

Post X

DEBIT Freight-in G/L 30800

A/C#

Other G/L Amount

40100 41000

2,000.00 175.00

X X

20300 20600 20500 20400

748.60 1,119.00 9.25 26.22

X X X X

Post

X 1,708.00

950.00 17,660.00

50,659.00

X

2,658.00

4,078.07

PAYROLL JOURNAL

Date Employee Dec. 13 Tim Anson Amber Hughes Porter James Dec. 31 Tim Anson Amber Hughes Porter James

Monthly totals

Regular Hours 78.00 76.00 96.00 96.00

DECEMBER

EARNINGS Regular Overtime Overtime Pay Hours Pay 2,200.00 780.00 760.00 2,400.00 1,056.00 3.48 57.42 1,008.00 4.07 64.10

8,204.00

121.52

Gross Pay G/L 40500 2,200.00 780.00 760.00 2,400.00 1,113.42 1,072.10 8,325.52

DEDUCTIONS F.I.C.A. Fed. Inc. Tax G/L 20600 G/L 20300 168.30 305.00 59.67 56.00 58.14 18.00 183.60 315.00 85.18 70.00 82.02 60.00

636.91

824.00

PAYMENT Net Pay G/L 10100 1,726.70 664.33 683.86 1,901.40 958.24 930.08 6,864.61

Ck. No. 361 362 363 369 370 371

Sub Post Ref X X X X X X

GENERAL LEDGER 10100 CASH Oct. 1 Balance Forward Oct. 31 Oct. 31 Oct. 31 Net Wages and Salary Oct. 31 Bank Service Charge Nov. 30 Nov. 30 Nov. 30 Net Wages and Salary Nov. 30 Bank Service Charge Dec. 31 Dec. 31 Dec. 31

Journal

10200 ACCOUNTS RECEIVABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 23 Bad debt write-off Dec. 31 Dec. 31

Journal

CR CD PR G CR CD PR G CR CD PR

S CR S CR GJ S CR

10300 ALLOWANCE FOR DOUBTFUL ACCOUNTS Journal Oct. 1 Balance Forward Dec. 23 Bad-debt write-off GJ Dec. 31 Adjusting entry G

10400 INVENTORY Oct. 1 Balance Forward Dec. 31 Adjusting entry Dec. 31 Adjusting entry

Journal

10600 MARKETABLE SECURITIES

Journal

G G

Debit

Credit

69,578.24 66,582.87 5,825.64 18.50 28,287.10 44,528.64 5,861.38 22.00 126,725.60 57,041.87 6,864.61

Debit

Credit

25,926.54 23,829.30 54,275.80 24,774.04 850.00 41,100.00 35,499.00

Debit

Credit

850.00 1,578.13

Debit

Credit

61,540.00 44,850.00

Debit

Credit

10800 FIXED ASSETS Jan. 1 Balance Forward Dec. 31

Journal

10900 ACCUMULATED DEPRECIATION Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

20100 ACCOUNTS PAYABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31

Journal

20300 FED. INCOME TAXES W/H Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31

Journal

Debit

CD PR CD PR CD PR

775.20

P

Debit 9,498.00

Debit

G

P CD P CD P CD

Credit

Credit 29,834.80

Debit

Credit 37,258.67

62,537.81 76,819.67 52,116.21 27,158.00 50,659.00

Credit

756.50 756.50 748.60 748.60 824.00

20400 STATE UNEMPLOYMENT TAXES PAYABLE Journal Oct. 1 Balance Forward Oct. 31 G Nov. 31 CD Nov. 30 G Dec. 31 CD Dec. 31 G

Debit

20500 FEDERAL UNEMPLOYMENT TAXES PAYABLE Journal

Debit

Credit 27.23

27.23 26.22 26.22 49.47

Credit

Oct. Oct. Nov. Nov. Dec. Dec.

1 Balance Forward 31 31 30 31 31

G CD G CD G

6.99 6.99 9.25 9.25 14.66

20600 F.I.C.A TAXES PAYABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 F.I.C.A Witheld Oct. 31 Employer's Tax Nov. 30 Nov. 30 F.I.C.A Witheld Nov. 30 Employer's Tax Dec. 31 Dec. 31 Dec. 31 Employer's Tax

Journal

Debit

Credit

CD PR G CD PR G CD PR G

975.60

20700 FEDERAL INCOME TAXES PAYABLE Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

20900 INTEREST PAYABLE Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

21000 NOTES PAYABLE Oct. 1 Balance Forward Dec. 31

Journal

26000 COMMON STOCK Oct. 1 Balance Forward

Journal

Debit

Credit

28000 INCOME SUMMARY Dec. 31 Closing entry Dec. 31 Closing entry Dec. 31 Closing entry

Journal G G G

Debit

Credit 631,525.18

572.85 572.85 1,145.70 559.50 559.50 1,119.00 636.91 636.91

Debit

G

Credit 5,222.02

Debit

G

Credit 123.29

Debit

CR

Credit 75,000.00

601,933.71 29,591.47

29000 RETAINED EARNINGS Jan. 1 Balance Forward Dec. 31 Closing entry

Journal

Debit

30100 SALES Oct. 1 Balance Forward Oct. 31 Credit Sales Oct. 31 Cash Sales Nov. 30 Credit Sales Nov. 30 Cash Sales Dec. 31 Credit Sales Dec. 31 Cash Sales Dec. 31 Closing entry

Journal

30200 SALES RETURNS & ALOWANCES Oct. 1 Balance Forward Nov. 30 Dec. 31 Closing entry

Journal

30300 SALES DISCOUNTS TAKEN Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

CR CR CR G

581.00 182.50 448.40

30400 COST OF GOODS SOLD Dec. 31 Adjusting entry Dec. 31 Closing entry

Journal G G

Debit 438,374.11

30500 PURCHASES Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

Debit

G

S CR S CR S CR G

S G

P P P G

30600 PURCHASE RETURNS & ALLOWANCES Journal Oct. 1 Balance Forward Dec. 31 Adjusting entry G

Credit 29,591.47

Debit

Credit 28,287.52 39,887.68 62,021.58 850.00 41,100.00 16,400.00

678,135.38

Debit

Credit

7,560.00 7,560.00

Credit

4,694.00

Credit 438,374.11

Credit

28,567.00 68,258.00 17,660.00 466,381.72

Debit 13,928.00

Credit

30700 PURCHASE DISCOUNTS TAKEN Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

30800 FREIGHT-IN Oct. 1 Balance Forward Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

31200 MISCELLANEOUS REVENUE Oct. 1 Balance Forward Dec. 31 Dec. 31 Closing entry

Journal

Debit

CR G

275.00

40100 RENT EXPENSE Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

40200 ADVERTISING EXPENSE Oct. 1 Balance Forward Dec. 31 Closing entry

Journal

40300 OFFICE SUPPLIES EXPENSE Oct. 1 Balance Forward Nov. 30 Dec. 31 Closing entry

Journal

Debit

P G

258.00

40400 DEPRECIATION EXPENSE

Journal

Debit

Dec. Dec.

G G

31 Adjusting entry 31 Closing entry

CD CD CD G

CD CD G

CD CD CD G

Debit

Credit 1,583.17 681.57 353.20

7,517.61

Debit

Credit

1,890.00 2,658.00 10,128.00

Credit 275.00

Credit

2,000.00 2,000.00 2,000.00 24,000.00

Debit

G

Credit 7,258.00

Credit

3,909.20

Credit

29,834.80 29,834.80

40500 WAGES AND SALARIES EXP. Oct. 1 Balance Forward Oct. 31 Nov 30 Dec. 31 Dec. 31 Closing entry

Journal

40600 PAYROLL TAX EXPENSE Oct. 1 Balance Forward Oct. 31 Nov 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

G G G G

577.40 589.50 701.04

40700 FEDERAL INCOME TAX EXPENSE

Journal

Debit

Dec.

G

31 Adjusting entry

PR PR PR G

Debit 7,502.50 6,825.70 8,325.52

75,235.72

Debit

Dec. Dec.

G G

123.29

40900 BAD DEBT EXPENSE

Journal

Debit

Dec. Dec.

G G

41000 OTHER OPERATING EXPENSE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31 Closing entry

Credit

5,222.02

Journal

31 Adjusting entry 31 Closing entry

Credit

7,086.44

40800 INTEREST EXPENSE 31 Adjusting entry 31 Closing entry

Credit

Credit

123.29

Credit

1,578.13 1,578.13

Journal

Debit

G CD G CD CD G

18.50 302.00 18.00 211.00 175.00

Credit

9,312.00

Debit Balance 34,945.25 104,523.49 37,940.62 32,114.98 32,096.48 60,383.58 15,854.94 9,993.56 9,971.56 136,697.16 79,655.29 72,790.68 72,790.68 72,790.68 72,790.68 Debit Control Balance Init.

1,580.00 PJ 27,506.54 3,677.24 PJ 57,953.04 33,179.00 PJ 32,329.00 73,429.00 37,930.00 37,930.00 37,930.00 Credit Balance 628.00 (222.00) 1,356.13 1,356.13 Debit Balance 44,850.00 106,390.00 61,540.00 61,540.00 Debit Balance 10,000.00 10,000.00 10,000.00

Debit Control Balance Init.

259,250.00 PJ 268,748.00 268,748.00 Credit Balance 29,002.50 58,837.30 58,837.30 Credit Control Balance Init.

25,975.68 PJ 63,234.35 696.54 PJ 77,516.21 25,400.00 PJ 52,558.00 1,899.00 1,899.00 1,899.00 Credit Balance 775.20 756.50 748.60 824.00 824.00 824.00 Credit Balance 27.23 26.22 49.47 49.47 49.47 49.47 Credit Balance

6.99 9.25 14.66 14.66 14.66 14.66 Credit Balance 975.60 572.85 1,145.70 559.50 1,119.00 636.91 1,273.82 1,273.82 1,273.82 Credit Balance 5,222.02 Credit Balance 123.29 Credit Balance 75,000.00 Credit Balance 75,000.00 75,000.00

Balance

-

Credit Balance 201,817.52 231,408.99 Credit Balance 489,588.60 517,876.12 557,763.80 619,785.38 620,635.38 661,735.38 678,135.38 Debit Balance 34,631.20 42,191.20 34,631.20 34,631.20 Debit Balance 3,482.10 4,063.10 4,245.60 4,694.00 Debit Balance 438,374.11 Debit Balance 351,896.72 380,463.72 448,721.72 466,381.72 Credit Balance 13,928.00 Credit

Balance 4,899.67 6,482.84 7,164.41 7,517.61 Debit Balance 5,580.00 7,470.00 10,128.00 Credit Balance 275.00 Debit Balance 18,000.00 20,000.00 22,000.00 24,000.00 Debit Balance 7,258.00 Debit Balance 3,651.20 3,909.20 Debit Balance 29,834.80 -

Debit Ctrl Balance Init 52,582.00 PJ 60,084.50 PJ 66,910.20 PJ 75,235.72 0.00 0.00 Debit Balance 5,218.50 5,795.90 6,385.40 7,086.44 Debit Balance 5,222.02 5,222.02 Debit Balance 123.29 Debit Balance 1,578.13 Debit Balance 8,587.50 8,606.00 8,908.00 8,926.00 9,137.00 9,312.00 -

FIXED ASSET SUBSIDIARY LEDGER Item Purch. From Est. Life

Sept.

Dec. Dec. Dec. Dec. Dec. Dec.

Date 30 31 31 31 31 31 31

Item Purch. From Est. Life

Apr. Dec. Dec. Dec.

Date 21 31 31 31

Item Purch. From Est. Life

Jul. Dec. Dec.

Date 5 31 31

Item Purch. From Est. Life

Dec. Dec.

Date 11 31

Item Purch. From Est. Life

Dec. Dec.

Date 31 31

Item Purch. From Est. Life

Jul. Dec.

Date 3 31

Office Furniture Marcos Office Equipment 5 years

2001 2001 2002 2003 2004 2005 2006

Debit 7,200.00

Where Located: Office Est. salvage:

Asset Record Credit

Debit 36,800.00

Asset Record Credit

2008 2008

Asset Totals:

Asset Record Credit

Balance 215,250.00

Depreciation Record Debit Credit

Where Located: Office Est. salvage:

Balance 7,599.00

Where Located: Office Est. salvage:

Asset record Debit Credit 1,899.00

Depreciation Record Debit Credit

Asset NBV 36,800.00 33,120.00 25,760.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00

Balance 10,762.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50

Asset NBV 215,250.00 204,487.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50

Balance 759.90 759.90 759.90 759.90 759.90 759.90 759.90 759.90

Asset NBV 7,599.00 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10

Balance 189.90 189.90 189.90 189.90 189.90 189.90 189.90 189.90

Asset NBV 1,899.00 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10

Balance 1,899.00

Balance 250.00 250.00 250.00 250.00 250.00 250.00 250.00 250.00

Asset NBV 2,000.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00

59,087.30

211,660.70

-

Depreciation Record Debit Credit 189.90

Debit 2,000.00

Balance 3,680.00 11,040.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00

-

759.90

Printer/fax/copier Brereton Office Supplies 4 years

Asset NBV 7,200.00 6,480.00 5,040.00 3,600.00 2,160.00 720.00 -

Where Located: Warehouse Est. salvage: -

Asset Record Debit Credit 7,599.00

Computer Marcos Office Equipment 5 years

2007 2007

Depreciation Record Debit Credit

10,762.50 21,525.00

Minolta Copier Marcos Office Equipment 5 years

2007 2007

Balance 36,800.00

3,680.00 7,360.00 7,360.00

Debit 215,250.00

Balance 720.00 2,160.00 3,600.00 5,040.00 6,480.00 7,200.00 7,200.00 7,200.00

Where Located: Loading Dock Est. salvage: -

Inventory Handling System Woerner Manufacturing 10 years

2006 2006 2007

Depreciation Record Debit Credit 720.00 1,440.00 1,440.00 1,440.00 1,440.00 720.00

Delivery Truck Beechmont Ford 5 years

2005 2005 2006 2007

Balance 7,200.00

-

Where Located: Office Est. salvage:

Asset record Credit

Balance 2,000.00

-

Depreciation Record Debit Credit 250.00

270,748.00

Bill of Materials Bar Blender Catalog Number TXS-BAS-456 TXS-PLA-743 TXS-FEE-432 TXS-HAR-865 TXS-SWI-643 TXS-SWI-642 TXS-COL-164 TXS-GAS-235 TXS-BLA-409 TXS-MOT-521 TXS-JAR-678 TXS-COV-731

Batch Size: Description 8" Plastic blender base 8" Steel bottom plate 1/2" Rubber feet Wirining harness Red pulse rocker switches White rocker switch White 3" blender collar 3" Rubber gasket 3" Blade assembley 1/4 hp Blender motor 1 Qt blender jar Black blender cover

500 Quantity 1 1 4 2 6 1 1 1 1 1 1 1

Catalog Number Description TXS-BAS-456 8" Plastic blender base TXS-BAS-458 9" Plastic blender base TXS-BLA-409 3" Blade assembley TXS-BLA-411 4" Blade assembley TXS-COL-164 White 3" blender collar TXS-COL-164 White 3" blender collar TXS-COV-730 White blender cover TXS-COV-731 Black blender cover TXS-FEE-432 1/2" Rubber feet TXS-FEE-434 1" Rubber feet TXS-GAS-235 3" Rubber gasket TXS-GAS-239 4" Rubber gasket TXS-HAR-865 Wirining harness TXS-JAR-678 1 Qt blender jar TXS-JAR-679 1.5 Qt blender jar TXS-MOT-521 1/4 hp Blender motor TXS-MOT-522 1/2 hp Blender motor TXS-PLA-743 8" Steel bottom plate TXS-PLA-744 9" Steel bottom plate TXS-SWI-642 White rocker switch TXS-SWI-643 Red pulse rocker switches

Unit Cost 0.80 0.84 7.50 7.75 0.45 0.48 0.65 0.65 0.05 0.08 0.20 0.24 2.40 1.40 2.20 8.00 12.00 1.10 1.20 0.25 0.25

Materials Requisition Form Issued to:

Work Order Number:

Date:

Material Item # TXS-BAS-456 TXS-PLA-743 TXS-FEE-432 TXS-HAR-865 TXS-SWI-643 TXS-SWI-642 TXS-COL-164 TXS-GAS-235 TXS-BLA-409 TXS-MOT-521 TXS-JAR-678 TXS-COV-731

Authorized By: Received By: Cost Accounting:

Description 8" Plastic blender base 8" Steel bottom plate 1/2" Rubber feet Wirining harness Red pulse rocker switches White rocker switch White 3" blender collar 3" Rubber gasket 3" Blade assembley 1/4 hp Blender motor 1 Qt blender jar Black blender cover

Quantity Issued 500 500 2,000 1,000 3,000 500 500 500 500 500 500 500

n Form Work Order Number:

Unit Cost

Extended Cost 400.00 550.00 100.00 2,400.00 750.00 125.00 240.00 100.00 3,750.00 4,000.00 700.00 325.00

0.80 1.10 0.05 2.40 0.25 0.25 0.48 0.20 7.50 8.00 1.40 0.65

$

13,440.00

Accounts Receivable Aging Report April 30, 2008

Customer Name Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Broughton Outdoors Broughton Outdoors Jeffers Sporting Goods Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Pup Scouts of Devron Pup Scouts of Devron Regal Athletic Company Regal Athletic Company The Sports Buff The Sports Buff TOTALS

Total Account Balance 1,366.48 4,975.00 4,017.15 659.59 1,946.40 6,763.10 4,067.99 10,646.20 6,653.15 975.63 299.00 1,104.13 655.31 1,843.83 9,737.91 220.04 2,678.59 862.35 8,046.40 1,774.92 69,293.17

Past Due Balan Current Balances Invoice # Amount 77341 1,366.48 75118 4,975.00

78021 77216 77089 75663

77911

1-30 days Invoice # Amount

70698

4,017.15

74555

4,067.99

74277 73586

1,104.13 655.31

75559

220.04

77115

8,046.40

10,646.20 6,653.15 975.63 299.00

9,737.91

34,653.37

18,111.02

Past Due Balances 31-60 days Invoice # Amount

67915

65287

659.59

61190

6,763.10

61119

862.35

1,946.40

67644

1,843.83

66268

2,678.59

70564

Over 60 days Invoice # Amount

1,774.92 8,243.74

8,285.04

Accounts Receivable Aging Report April 30, 2008

Customer Name Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Acme Sporting Goods Central Broughton Outdoors Broughton Outdoors Jeffers Sporting Goods Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Kansas Dept. of Wildlife Pup Scouts of Devron Pup Scouts of Devron Regal Athletic Company Regal Athletic Company The Sports Buff The Sports Buff TOTALS

Total Account Balance 1,366.48 4,975.00 4,017.15 659.59 1,946.40 6,763.10 4,067.99 10,646.20 6,653.15 975.63 299.00 1,104.13 655.31 1,843.83 9,737.91 220.04 2,678.59 862.35 8,046.40 1,774.92 69,293.17

Past Due Balan Current Balances Invoice # Amount 77341 1,366.48 75118 4,975.00

78021 77216 77089 75663

77911

1-30 days Invoice # Amount

70698

4,017.15

74555

4,067.99

74277 73586

1,104.13 655.31

75559

220.04

77115

8,046.40

10,646.20 6,653.15 975.63 299.00

9,737.91

34,653.37

18,111.02

Past Due Balances 31-60 days Invoice # Amount

67915

65287

659.59

61190

6,763.10

61119

862.35

1,946.40

67644

1,843.83

66268

2,678.59

70564

Over 60 days Invoice # Amount

1,774.92 8,243.74

8,285.04

05/27/08 05/27/08 05/01/08 04/14/08 02/13/08 03/22/08 02/01/08 04/06/08 05/30/08 05/16/08 05/15/08 05/01/08 04/14/08 04/06/08 03/22/08 05/05/08 04/13/08 03/24/08 02/01/08 04/15/08 03/14/08

77341 75118 70698 65287 67915 61190 74555 78021 77216 77089 75663 74277 73586 67644 77911 75559 66268 61119 77115 70564

1366.48 4975 4017.15 659.59 11018.22 1946.4 6763.1 8709.5 4067.99 10646.2 6653.15 975.63 299 1104.13 655.31 1843.83 22177.25 9737.91 220.04 9957.95 2678.59 862.35 3540.94 8046.4 1774.92 9821.32

Sales Order Entry Screen Date:

Customer number:

Sales order number:

Line #

Item #

Quantity

1 2 3 4 5

This could be a more complex screen if the instructor wishes. This covers the bare minimum of data that would be entered.

Sales Order Number 35610 35610 35610 35610 35610

Date 5/27/2006 5/27/2006 5/27/2006 5/27/2006 5/27/2006

Customer Number 42004 42004 42004 42004 42004

Line Number 1 2 3 4 5

Item Number 1046R 1047R 1049R 2025W 2027W

Quantity 12 12 24 24 12

Note: Some Sales Order data would not need to be entered for each sales order.

Information such as bill to address and ship to address would be in a customer master record.

Information such as item descriptions and unit prices would be in a price list record or inventory master record.

SALES JOURNAL

Date Customer May 27 World of Wines

Monthly Totals

Sales Order No. 35610

DEBIT A/R - G/L 10200 Subs. A/C# Amount 42004 617.16

617.16

Post

Sales Ret. G/L 30200

Sales G/L 30100 617.16

617.16

CREDIT Other G/L Acc# Amount

-

Post

Receiving Entry Screen Date:

Order number:

Customer account:

Line #

Part #

Quantity Shipped

1 2 3 4 5

This could be a more complex screen if the instructor wishes. This covers the bare minimum of data that would be entered. Data such as order quantity, customer address, etc. would already be in the computer files and would not need to be entered.

Customer Order Number 75489 75489 75489

Date 9/30/2007 9/30/2007 9/30/2007

Customer Number 5404 5404 5404

Line Number 1 2 3

Item Number 918-0142 725-1396 725-0267

Ship Quantity 50 80 40

Note: Some receiving data would not need to be entered for each receipt of goods.

Information such as bill to address and ship to address would be in a customer master record.

Information such as item descriptions and unit type would be in a price list record or inventory master record.

ustomer master record. ist record or

Payroll Data Entry Screen Pay period

05/02/07

Approval by; KTB

Employee SSN# 222556666

DAY Monday Tuesday Wednesday Thursday Friday Saturday Sunday

IN TIME 8:02 8:00 8:11 7:57 12:01 9:00

OUT TIME 11:40 11:45 11:30 11:44 16:15 12:04

IN TIME 12:34 12:44 12:15 12:52 17:10

OUT TIME 17:02 17:01 17:00 17:16 21:05

TOTAL REGULAR HOURS HOURS 8:06 8:02 8:04 8:11 8:09 3:04 0:00 43.60 40.00

Note: This solution has proper formating to show hours and minutes for each day, and formulas at the bottom to calculate total hours, regular hours, and overtime hours.

Also, spreadsheet protection has been used to allow entry only in the boxes shaded yellow.

OVERTIME HOURS

las at the bottom to

3.60

Date 05/02/07 05/02/07

Employee /SS# 222556666 222556666

Hours: Pay Rate: Regular/ Regular/ Overtime Overtime 40.00 $ 19.750 $ 3.60 $ 29.625 $

Gross FICA Medicare Pay Withheld Withheld 790.00 $ 48.98 $ 11.46 106.65 $ 6.61 $ 1.55

federal Inc. Tax Withheld $ 158.00 $ $ 21.33 $

Net Pay 571.57 77.16

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009 October 30, 2009 November 13, 2009 November 27, 2009

Blackstone, M. Misner, C. Shafari, N. Reg. hrs.

Overtime hrs. Reg. hrs.

Overtime hrs. Reg. hrs.

80 5 80 6 80 80 0 80 8 80 80 2 80 9 80 80 10 80 0 80

December 11, 2009 December 25, 2009 Totals

320

17

320

23

320

Shafari, N. Overtime hrs.

0 0 2 12

14

Blackstone, Myra Single, 1 exemption

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Payrate: $ Overtime Payrate: $ Regular Overtime Gross Pay Gross Pay $ 1,120.00 $ 105.00 $ 1,120.00 $ $ 1,120.00 $ 42.00 $ 1,120.00 $ 210.00

Total Gross Pay 1,225.00 1,120.00 1,162.00 1,330.00

14.00 per hour 21.00 per hour Soc Sec. 6.20% 75.95 69.44 72.04 82.46

Medicare 1.45% 17.76 16.24 16.85 19.29

Health Insur. Deduction:

Fed Tax Witholding 154.10 138.35 144.65 173.95

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 4,480.00 $ $ $ -

357.00 -

4,837.00 -

299.89 -

70.14 -

611.05 -

Health Insur. Deduction: $

ST Tax 4% 49.00 44.80 46.48 53.20

50.00 per pay

Health insurance 50.00 50.00 50.00 50.00

$ $ $ $

Net Pay 878.19 801.17 831.98 951.11

193.48 -

200.00 -

$ $ $ $

3,462.44 -

Misner, Christopher Married, 2 exemptions

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 1,280.00 $ 1,280.00 $ 1,280.00 $ 1,280.00

Regular Payrate: $ Overtime Payrate: $ Overtime Gross Pay 144.00 192.00 216.00 -

Total Gross Pay 1,424.00 1,472.00 1,496.00 1,280.00

16.00 per hour 24.00 per hour Soc Sec. 6.20% 88.29 91.26 92.75 79.36

Medicare 1.45% 20.65 21.34 21.69 18.56

Health Insur. Deduction:

Fed Tax Witholding 137.90 145.10 148.70 127.75

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 5,120.00 $ $ $ -

552.00 -

5,672.00 -

351.66 -

82.24 -

559.45 -

Health Insur. Deduction: $

ST Tax 4% 56.96 58.88 59.84 51.20

80.00 per pay

Health insurance 80.00 80.00 80.00 80.00

$ $ $ $

Net Pay 1,040.20 1,075.41 1,093.02 923.13

226.88 -

320.00 -

$ $ $ $

4,131.76 -

Shafari, Nunca Married, 2 exemptions

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 800.00 $ 800.00 $ 800.00 $ 800.00

Regular Payrate: $ Overtime Payrate: $ Overtime Gross Pay 30.00 180.00

Total Gross Pay 800.00 800.00 830.00 980.00

10.00 per hour 15.00 per hour Soc Sec. 6.20% 49.60 49.60 51.46 60.76

Medicare 1.45% 11.60 11.60 12.04 14.21

Health Insur. Deduction:

Fed Tax Witholding 49.20 49.20 52.20 82.75

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 3,200.00 $ $ $ -

210.00 -

3,410.00 -

211.42 -

49.45 -

233.35 -

Health Insur. Deduction: $

ST Tax 4% 32.00 32.00 33.20 39.20

80.00 per pay

Health insurance 80.00 80.00 80.00 80.00

$ $ $ $

Net Pay 577.60 577.60 601.11 703.08

136.40 -

320.00 -

$ $ $ $

2,459.39 -

PAYROLL TOTALS FOR THREE EMPLOYEES

Payroll Date January 11, 2008 January 25, 2008 February 8, 2008 February 22, 2008 March 7, 2008 March 21, 2008 April 4, 2008 April 18, 2008 May 2, 2008 May 16, 2008 May 30, 2008 June 13, 2008 June 27, 2008 July 11, 2008 July 25, 2008 August 8, 2008 August 22, 2008 September 5, 2008 September 19, 2008 October 3, 2008 October 17, 2008 October 31, 2008 November 14, 2008 November 28, 2008 December 12, 2008 December 26, 2008 January 9, 2009 January 23, 2009 February 6, 2009 February 20, 2009 March 6, 2009 March 20, 2009 April 3, 2009 April 17, 2009 May 1, 2009 May 15, 2009 May 29, 2009 June 12, 2009 June 26, 2009 July 10, 2009 July 24, 2009 August 7, 2009 August 21, 2009 September 4, 2009 September 18, 2009 October 2, 2009 October 16, 2009

Regular Gross Pay $ 3,200.00 $ 3,200.00 $ 3,200.00 $ 3,200.00 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ -

Overtime Gross Pay 249.00 192.00 288.00 390.00 -

Total Gross Pay 3,449.00 3,392.00 3,488.00 3,590.00 -

Soc Sec. 6.20% 213.84 210.30 216.26 222.58 -

Medicare 1.45% 50.01 49.18 50.58 52.06 -

Fed Tax Witholding 341.20 332.65 345.55 384.45 -

October 30, 2009 November 13, 2009 November 27, 2009 December 11, 2009 December 25, 2009

$ $ $ $ $

-

Quarter 1 totals Quarter 2 totals Quarter 3 totals Year to date totals

$ 12,800.00 $ $ $ -

-

1,119.00 -

-

13,919.00 -

-

-

-

862.98 -

201.83 -

1,403.85 -

ST Tax 4% 137.96 135.68 139.52 143.60 -

Health insurance 210.00 210.00 210.00 210.00 -

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

Net Pay 2,495.99 2,454.18 2,526.10 2,577.32 -

-

-

556.76 -

840.00 -

$ $ $ $ $

-

$ 10,053.59 $ $ $ -

FEDERAL TAX WITHOLDING TABLES BI-WEEKLY PAYROLL PERIOD SINGLE PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In The OVER of this this amount column column over PLUS » TIMES » (Taxable income less the amount in this column) 0 102 NO TAX WITHHELD 102 389 0 10% 102 389 1,289 28.7 15% 389 1,289 2,964 163.7 25% 1,289 2,964 6,262 582.45 28% 2,964 6,262 13,525 1,505.89 33% 6,262 13,525 OVER 3,902.68 35% 13,525 MARRIED PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In The OVER of this this amount column column over PLUS » TIMES » (Taxable income less the amount in this column) 0 308 NO TAX WITHHELD 308 898 0 10% 308 898 2,719 59 15% 898 2,719 5,146 332.15 25% 2,719 5,146 7,813 938.9 28% 5,146 7,813 13,731 1,685.66 33% 7,813 13,731 OVER 3,638.60 35% 13,731

MONTHLY PAYROLL PERIOD SINGLE PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In OVER of this this column column PLUS » TIMES »

0 221 843 2,793 6,423 13,567 29,304

221 NO TAX WITHHELD 843 0 10% 2,793 62.2 15% 6,423 354.7 25% 13,567 1,262.20 28% 29,304 3,262.52 33% OVER 8,455.73 35% MARRIED PERSONS IF THE TAXABLE COMPUTED TAX IS...

INCOME IS...

OVER BUT NOT The total The % In OVER of this this column column PLUS » TIMES »

0 667 1,946 5,892 11,150 16,929 29,750

667 NO TAX WITHHELD 1,946 0 10% 5,892 127.9 15% 11,150 719.8 25% 16,929 2,034.30 28% 29,750 3,652.42 33% OVER 7,883.35 35%

LL PERIOD SONS MPUTED TAX IS...

The amount over

(Taxable income less the amount in this column) TAX WITHHELD 221 843 2,793 6,423 13,567 29,304 RSONS MPUTED TAX IS...

The amount over (Taxable income less the amount in this column) TAX WITHHELD 667 1,946 5,892 11,150 16,929 29,750

TURNER DISTRIBUTING GENERAL JOURNAL December, 199X DATE

ACCT NO. EXPLANATION

Dec. 23

POST

DEBIT

10300 Allowance for doubtful accounts 10200 Accounts receivable

X X

850.00

40600 Payroll Tax Expense 20600 F.I.C.A. Taxes Payable 20400 State Unemployment Taxes Payable 20500 Federal Unemployment Taxes Payable

X X X X

701.04

40400 Depreciation expense 10900 Accumulated depreciation

X X

29,834.80

40800 Interest expense 20900 Interest payable

X X

123.29

40900 Bad debt expense 10300 Allowance for doubtful accounts

X X

1,578.13

10400 Inventory 30400 Cost of goods sold 30600 Purchase returns and allowances 30700 Purchase discounts Purchases Freight in Inventory

X X X X X X X

61,540.00 438,374.11 13,928.00 7,517.61

40700 Federal income tax expense 20700 Federal income taxes payable

X X

5,222.02

30100 Sales 31200 Miscellaneous revenue 30200 Sales returns and allowances 30300 Sales discounts 28000 Income summary

X X X X X

678,135.38 275.00

28000 Income summary 30400 Cost of goods sold 40100 Rent expense 40200 Advertising expense 40300 Office supplies expense 40400 Depreciation expense 40500 Wages and salaries expense 40600 Payroll tax expense 40700 Federal income tax expense 40800 Interest expense 40900 Bad debt expense 41000 Other operating expense

X X X X X X X X X X X X

601,933.71

28000 Income summary 29000 Retained earnings

X X

29,591.47

CREDIT

850.00

MONTH END Dec. 31

636.91 49.47 14.66

YEAR END -ADJUSTING Dec. 31

Dec. 31

Dec. 31

Dec. 31

Dec. 31

29,834.80

123.29

1,578.13

466,381.72 10,128.00 44,850.00

5,222.02

YEAR END -CLOSING Dec. 31

Dec. 31

Dec. 31

42,191.20 4,694.00 631,525.18

438,374.11 24,000.00 7,258.00 3,909.20 29,834.80 75,235.72 7,086.44 5,222.02 123.29 1,578.13 9,312.00

29,591.47

SALES JOURNAL

Date Customer Dec. 4 ElectroWorld Dec. 5 Wendover Electronics Dec. 11 ElectroWorld Dec. 13 Wendover Electronics Dec. 18 Clean Images

Monthly Totals

Invoice or Cr. Memo Number 836 837 838 839 840

Subsid.

Acct. No. 516 518 516 518 517

DECEMBER

Subsid.

Post X X X X X

Debit Accout. Rec. Sales Returns G/L 10200 G/L 30200 15,000.00 5,600.00 7,580.00 1,820.00 11,100.00

41,100.00

-

Credit Sales G/L 31000 15,000.00 5,600.00 7,580.00 1,820.00 11,100.00

41,100.00

CASH RECEIPTS JOURNAL DECEMBER

Date Description Dec. 2 Flo's Department Store Dec. 3 Mills Company Dec. 9 ElectroWorld Dec. 10 Wendover Electronics Dec. 11 Hanson Company Dec. 13 Kompier Beauty Supplies Dec. 13 Kozy Kitchens Dec. 23 ElectroWorld Dec. 23 Wendover Electronics Dec. 26 First Security Bank

Monthly Totals

Ctrl.

Init.

PJ PJ PJ PJ PJ PJ PJ PJ PJ PJ

DEBIT Cash G/L 10100 8,200.00 275.00 14,700.00 5,488.00 5,000.00 9,679.00 3,200.00 3,400.00 1,783.60 75,000.00

126,725.60

CREDIT Sales Disc.

A/R - G/L 10200 G/L 30300 Subs. A/C# Amt.

300.00 112.00

Post

516 518

15,000.00 5,600.00

X X

521

9,679.00

X

516 518

3,400.00 1,820.00

X X

Sales G/L 30100 8,200.00

Other G/L A/C #

Amt.

Post

31200

275.00

X

21000

75,000.00

X

5,000.00 3,200.00 36.40

448.40

35,499.00

16,400.00

75,275.00

PURCHASES JOURNAL Vendor Invoice Date Vendor No. Dec. 11 Marcos Office Equipment 2179 Dec. 24 Remington Manufacturing 85854 Dec. 31 Marcos Office Equipment

Monthly Totals

Purchases G/L 30500

DECEMBER DEBIT Other G/L Acc# Amount 10800 7,599.00

Post X

17,660.00 10800

17,660.00

1,899.00

9,498.00

X

CREDIT A/P - G/L 20100 Subs. A/C# Amount Post 363 7,599.00 X 362 17,660.00 X 363 1,899.00 X

27,158.00

Purch. Ret. G/L 30600

CASH DISBURSEMENTS JOURNAL

DECEMBER

CREDIT Cash Purch. Disc.

G/L 10100 G/L 30700 25,400.00 2,000.00 175.00 7,599.00 1,708.00

Date Dec. 9 Dec. 10 Dec. 10 Dec. 11 Dec. 13 Dec. 13 Dec. 13

Check No. Description 356 Remington Manufacturing 357 Hampton Properties 358 Cinergy 359 Marcos Office Equipment 360 Eze-Load Freight 361-363 See Payroll Journal 364 Internal Revenue Serv.

Dec. Dec. Dec. Dec. Dec.

365 Internal Revenue Serv.

366 State of Kentucky 367 EzeLoad Freight 368 Remington Manufacturing 369-371 See Payroll Journal

9.25 26.22 950.00 17,306.80

353.20

Monthly Totals

57,041.87

353.20

13 13 24 30 31

A/P - G/L 20100 Subs. A/C# 362

363

1,867.60

362

A/P - G/L 20100 Amount 25,400.00

7,599.00

Post X

DEBIT Freight-in G/L 30800

A/C#

Other G/L Amount

40100 41000

2,000.00 175.00

X X

20300 20600 20500 20400

748.60 1,119.00 9.25 26.22

X X X X

Post

X 1,708.00

950.00 17,660.00

50,659.00

X

2,658.00

4,078.07

PAYROLL JOURNAL

Date Employee Dec. 13 Tim Anson Amber Hughes Porter James Dec. 31 Tim Anson Amber Hughes Porter James

Monthly totals

Regular Hours 78.00 76.00 96.00 96.00

DECEMBER

EARNINGS Regular Overtime Overtime Pay Hours Pay 2,200.00 780.00 760.00 2,400.00 1,056.00 3.48 57.42 1,008.00 4.07 64.10

8,204.00

121.52

Gross Pay G/L 40500 2,200.00 780.00 760.00 2,400.00 1,113.42 1,072.10 8,325.52

DEDUCTIONS F.I.C.A. Fed. Inc. Tax G/L 20600 G/L 20300 168.30 305.00 59.67 56.00 58.14 18.00 183.60 315.00 85.18 70.00 82.02 60.00

636.91

824.00

PAYMENT Net Pay G/L 10100 1,726.70 664.33 683.86 1,901.40 958.24 930.08 6,864.61

Ck. No. 361 362 363 369 370 371

Sub Post Ref X X X X X X

GENERAL LEDGER 10100 CASH Oct. 1 Balance Forward Oct. 31 Oct. 31 Oct. 31 Net Wages and Salary Oct. 31 Bank Service Charge Nov. 30 Nov. 30 Nov. 30 Net Wages and Salary Nov. 30 Bank Service Charge Dec. 31 Dec. 31 Dec. 31

Journal

10200 ACCOUNTS RECEIVABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 23 Bad debt write-off Dec. 31 Dec. 31

Journal

CR CD PR G CR CD PR G CR CD PR

S CR S CR GJ S CR

10300 ALLOWANCE FOR DOUBTFUL ACCOUNTS Journal Oct. 1 Balance Forward Dec. 23 Bad-debt write-off GJ Dec. 31 Adjusting entry G

10400 INVENTORY Oct. 1 Balance Forward Dec. 31 Adjusting entry Dec. 31 Adjusting entry

Journal

10600 MARKETABLE SECURITIES

Journal

G G

Debit

Credit

69,578.24 66,582.87 5,825.64 18.50 28,287.10 44,528.64 5,861.38 22.00 126,725.60 57,041.87 6,864.61

Debit

Credit

25,926.54 23,829.30 54,275.80 24,774.04 850.00 41,100.00 35,499.00

Debit

Credit

850.00 1,578.13

Debit

Credit

61,540.00 44,850.00

Debit

Credit

10800 FIXED ASSETS Jan. 1 Balance Forward Dec. 31

Journal

10900 ACCUMULATED DEPRECIATION Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

20100 ACCOUNTS PAYABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31

Journal

20300 FED. INCOME TAXES W/H Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31

Journal

Debit

CD PR CD PR CD PR

775.20

P

Debit 9,498.00

Debit

G

P CD P CD P CD

Credit

Credit 29,834.80

Debit

Credit 37,258.67

62,537.81 76,819.67 52,116.21 27,158.00 50,659.00

Credit

756.50 756.50 748.60 748.60 824.00

20400 STATE UNEMPLOYMENT TAXES PAYABLE Journal Oct. 1 Balance Forward Oct. 31 G Nov. 31 CD Nov. 30 G Dec. 31 CD Dec. 31 G

Debit

20500 FEDERAL UNEMPLOYMENT TAXES PAYABLE Journal

Debit

Credit 27.23

27.23 26.22 26.22 49.47

Credit

Oct. Oct. Nov. Nov. Dec. Dec.

1 Balance Forward 31 31 30 31 31

G CD G CD G

6.99 6.99 9.25 9.25 14.66

20600 F.I.C.A TAXES PAYABLE Oct. 1 Balance Forward Oct. 31 Oct. 31 F.I.C.A Witheld Oct. 31 Employer's Tax Nov. 30 Nov. 30 F.I.C.A Witheld Nov. 30 Employer's Tax Dec. 31 Dec. 31 Dec. 31 Employer's Tax

Journal

Debit

Credit

CD PR G CD PR G CD PR G

975.60

20700 FEDERAL INCOME TAXES PAYABLE Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

20900 INTEREST PAYABLE Oct. 1 Balance Forward Dec. 31 Adjusting entry

Journal

21000 NOTES PAYABLE Oct. 1 Balance Forward Dec. 31

Journal

26000 COMMON STOCK Oct. 1 Balance Forward

Journal

Debit

Credit

28000 INCOME SUMMARY Dec. 31 Closing entry Dec. 31 Closing entry Dec. 31 Closing entry

Journal G G G

Debit

Credit 631,525.18

572.85 572.85 1,145.70 559.50 559.50 1,119.00 636.91 636.91

Debit

G

Credit 5,222.02

Debit

G

Credit 123.29

Debit

CR

Credit 75,000.00

601,933.71 29,591.47

29000 RETAINED EARNINGS Jan. 1 Balance Forward Dec. 31 Closing entry

Journal

Debit

30100 SALES Oct. 1 Balance Forward Oct. 31 Credit Sales Oct. 31 Cash Sales Nov. 30 Credit Sales Nov. 30 Cash Sales Dec. 31 Credit Sales Dec. 31 Cash Sales Dec. 31 Closing entry

Journal

30200 SALES RETURNS & ALOWANCES Oct. 1 Balance Forward Nov. 30 Dec. 31 Closing entry

Journal

30300 SALES DISCOUNTS TAKEN Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

CR CR CR G

581.00 182.50 448.40

30400 COST OF GOODS SOLD Dec. 31 Adjusting entry Dec. 31 Closing entry

Journal G G

Debit 438,374.11

30500 PURCHASES Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

Debit

G

S CR S CR S CR G

S G

P P P G

30600 PURCHASE RETURNS & ALLOWANCES Journal Oct. 1 Balance Forward Dec. 31 Adjusting entry G

Credit 29,591.47

Debit

Credit 28,287.52 39,887.68 62,021.58 850.00 41,100.00 16,400.00

678,135.38

Debit

Credit

7,560.00 7,560.00

Credit

4,694.00

Credit 438,374.11

Credit

28,567.00 68,258.00 17,660.00 466,381.72

Debit 13,928.00

Credit

30700 PURCHASE DISCOUNTS TAKEN Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

30800 FREIGHT-IN Oct. 1 Balance Forward Nov. 30 Dec. 31 Dec. 31 Adjusting entry

Journal

31200 MISCELLANEOUS REVENUE Oct. 1 Balance Forward Dec. 31 Dec. 31 Closing entry

Journal

Debit

CR G

275.00

40100 RENT EXPENSE Oct. 1 Balance Forward Oct. 31 Nov. 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

40200 ADVERTISING EXPENSE Oct. 1 Balance Forward Dec. 31 Closing entry

Journal

40300 OFFICE SUPPLIES EXPENSE Oct. 1 Balance Forward Nov. 30 Dec. 31 Closing entry

Journal

Debit

P G

258.00

40400 DEPRECIATION EXPENSE

Journal

Debit

Dec. Dec.

G G

31 Adjusting entry 31 Closing entry

CD CD CD G

CD CD G

CD CD CD G

Debit

Credit 1,583.17 681.57 353.20

7,517.61

Debit

Credit

1,890.00 2,658.00 10,128.00

Credit 275.00

Credit

2,000.00 2,000.00 2,000.00 24,000.00

Debit

G

Credit 7,258.00

Credit

3,909.20

Credit

29,834.80 29,834.80

40500 WAGES AND SALARIES EXP. Oct. 1 Balance Forward Oct. 31 Nov 30 Dec. 31 Dec. 31 Closing entry

Journal

40600 PAYROLL TAX EXPENSE Oct. 1 Balance Forward Oct. 31 Nov 30 Dec. 31 Dec. 31 Closing entry

Journal

Debit

G G G G

577.40 589.50 701.04

40700 FEDERAL INCOME TAX EXPENSE

Journal

Debit

Dec.

G

31 Adjusting entry

PR PR PR G

Debit 7,502.50 6,825.70 8,325.52

75,235.72

Debit

Dec. Dec.

G G

123.29

40900 BAD DEBT EXPENSE

Journal

Debit

Dec. Dec.

G G

41000 OTHER OPERATING EXPENSE Oct. 1 Balance Forward Oct. 31 Oct. 31 Nov. 30 Nov. 30 Dec. 31 Dec. 31 Closing entry

Credit

5,222.02

Journal

31 Adjusting entry 31 Closing entry

Credit

7,086.44

40800 INTEREST EXPENSE 31 Adjusting entry 31 Closing entry

Credit

Credit

123.29

Credit

1,578.13 1,578.13

Journal

Debit

G CD G CD CD G

18.50 302.00 18.00 211.00 175.00

Credit

9,312.00

Debit Balance 34,945.25 104,523.49 37,940.62 32,114.98 32,096.48 60,383.58 15,854.94 9,993.56 9,971.56 136,697.16 79,655.29 72,790.68 72,790.68 72,790.68 72,790.68 Debit Control Balance Init.

1,580.00 PJ 27,506.54 3,677.24 PJ 57,953.04 33,179.00 PJ 32,329.00 73,429.00 37,930.00 37,930.00 37,930.00 Credit Balance 628.00 (222.00) 1,356.13 1,356.13 Debit Balance 44,850.00 106,390.00 61,540.00 61,540.00 Debit Balance 10,000.00 10,000.00 10,000.00

Debit Control Balance Init.

259,250.00 PJ 268,748.00 268,748.00 Credit Balance 29,002.50 58,837.30 58,837.30 Credit Control Balance Init.

25,975.68 PJ 63,234.35 696.54 PJ 77,516.21 25,400.00 PJ 52,558.00 1,899.00 1,899.00 1,899.00 Credit Balance 775.20 756.50 748.60 824.00 824.00 824.00 Credit Balance 27.23 26.22 49.47 49.47 49.47 49.47 Credit Balance

6.99 9.25 14.66 14.66 14.66 14.66 Credit Balance 975.60 572.85 1,145.70 559.50 1,119.00 636.91 1,273.82 1,273.82 1,273.82 Credit Balance 5,222.02 Credit Balance 123.29 Credit Balance 75,000.00 Credit Balance 75,000.00 75,000.00

Balance

-

Credit Balance 201,817.52 231,408.99 Credit Balance 489,588.60 517,876.12 557,763.80 619,785.38 620,635.38 661,735.38 678,135.38 Debit Balance 34,631.20 42,191.20 34,631.20 34,631.20 Debit Balance 3,482.10 4,063.10 4,245.60 4,694.00 Debit Balance 438,374.11 Debit Balance 351,896.72 380,463.72 448,721.72 466,381.72 Credit Balance 13,928.00 Credit

Balance 4,899.67 6,482.84 7,164.41 7,517.61 Debit Balance 5,580.00 7,470.00 10,128.00 Credit Balance 275.00 Debit Balance 18,000.00 20,000.00 22,000.00 24,000.00 Debit Balance 7,258.00 Debit Balance 3,651.20 3,909.20 Debit Balance 29,834.80 -

Debit Ctrl Balance Init 52,582.00 PJ 60,084.50 PJ 66,910.20 PJ 75,235.72 0.00 0.00 Debit Balance 5,218.50 5,795.90 6,385.40 7,086.44 Debit Balance 5,222.02 5,222.02 Debit Balance 123.29 Debit Balance 1,578.13 Debit Balance 8,587.50 8,606.00 8,908.00 8,926.00 9,137.00 9,312.00 -

FIXED ASSET SUBSIDIARY LEDGER Item Purch. From Est. Life

Sept.

Dec. Dec. Dec. Dec. Dec. Dec.

Date 30 31 31 31 31 31 31

Item Purch. From Est. Life

Apr. Dec. Dec. Dec.

Date 21 31 31 31

Item Purch. From Est. Life

Jul. Dec. Dec.

Date 5 31 31

Item Purch. From Est. Life

Dec. Dec.

Date 11 31

Item Purch. From Est. Life

Dec. Dec.

Date 31 31

Item Purch. From Est. Life

Jul. Dec.

Date 3 31

Office Furniture Marcos Office Equipment 5 years

2001 2001 2002 2003 2004 2005 2006

Debit 7,200.00

Where Located: Office Est. salvage:

Asset Record Credit

Debit 36,800.00

Asset Record Credit

2008 2008

Asset Totals:

Asset Record Credit

Balance 215,250.00

Depreciation Record Debit Credit

Where Located: Office Est. salvage:

Balance 7,599.00

Where Located: Office Est. salvage:

Asset record Debit Credit 1,899.00

Depreciation Record Debit Credit

Asset NBV 36,800.00 33,120.00 25,760.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00

Balance 10,762.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50 32,287.50

Asset NBV 215,250.00 204,487.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50 182,962.50

Balance 759.90 759.90 759.90 759.90 759.90 759.90 759.90 759.90

Asset NBV 7,599.00 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10 6,839.10

Balance 189.90 189.90 189.90 189.90 189.90 189.90 189.90 189.90

Asset NBV 1,899.00 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10 1,709.10

Balance 1,899.00

Balance 250.00 250.00 250.00 250.00 250.00 250.00 250.00 250.00

Asset NBV 2,000.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00 1,750.00

59,087.30

211,660.70

-

Depreciation Record Debit Credit 189.90

Debit 2,000.00

Balance 3,680.00 11,040.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00 18,400.00

-

759.90

Printer/fax/copier Brereton Office Supplies 4 years

Asset NBV 7,200.00 6,480.00 5,040.00 3,600.00 2,160.00 720.00 -

Where Located: Warehouse Est. salvage: -

Asset Record Debit Credit 7,599.00

Computer Marcos Office Equipment 5 years

2007 2007

Depreciation Record Debit Credit

10,762.50 21,525.00

Minolta Copier Marcos Office Equipment 5 years

2007 2007

Balance 36,800.00

3,680.00 7,360.00 7,360.00

Debit 215,250.00

Balance 720.00 2,160.00 3,600.00 5,040.00 6,480.00 7,200.00 7,200.00 7,200.00

Where Located: Loading Dock Est. salvage: -

Inventory Handling System Woerner Manufacturing 10 years

2006 2006 2007

Depreciation Record Debit Credit 720.00 1,440.00 1,440.00 1,440.00 1,440.00 720.00

Delivery Truck Beechmont Ford 5 years

2005 2005 2006 2007

Balance 7,200.00

-

Where Located: Office Est. salvage:

Asset record Credit

Balance 2,000.00

-

Depreciation Record Debit Credit 250.00

270,748.00

Bill of Materials Bar Blender Catalog Number TXS-BAS-456 TXS-PLA-743 TXS-FEE-432 TXS-HAR-865 TXS-SWI-643 TXS-SWI-642 TXS-COL-164 TXS-GAS-235 TXS-BLA-409 TXS-MOT-521 TXS-JAR-678 TXS-COV-731

Batch Size: Description 8" Plastic blender base 8" Steel bottom plate 1/2" Rubber feet Wirining harness Red pulse rocker switches White rocker switch White 3" blender collar 3" Rubber gasket 3" Blade assembley 1/4 hp Blender motor 1 Qt blender jar Black blender cover

500 Quantity 1 1 4 2 6 1 1 1 1 1 1 1

Catalog Number Description TXS-BAS-456 8" Plastic blender base TXS-BAS-458 9" Plastic blender base TXS-BLA-409 3" Blade assembley TXS-BLA-411 4" Blade assembley TXS-COL-164 White 3" blender collar TXS-COL-164 White 3" blender collar TXS-COV-730 White blender cover TXS-COV-731 Black blender cover TXS-FEE-432 1/2" Rubber feet TXS-FEE-434 1" Rubber feet TXS-GAS-235 3" Rubber gasket TXS-GAS-239 4" Rubber gasket TXS-HAR-865 Wirining harness TXS-JAR-678 1 Qt blender jar TXS-JAR-679 1.5 Qt blender jar TXS-MOT-521 1/4 hp Blender motor TXS-MOT-522 1/2 hp Blender motor TXS-PLA-743 8" Steel bottom plate TXS-PLA-744 9" Steel bottom plate TXS-SWI-642 White rocker switch TXS-SWI-643 Red pulse rocker switches

Unit Cost 0.80 0.84 7.50 7.75 0.45 0.48 0.65 0.65 0.05 0.08 0.20 0.24 2.40 1.40 2.20 8.00 12.00 1.10 1.20 0.25 0.25

Materials Requisition Form Issued to:

Work Order Number:

Date:

Material Item # TXS-BAS-456 TXS-PLA-743 TXS-FEE-432 TXS-HAR-865 TXS-SWI-643 TXS-SWI-642 TXS-COL-164 TXS-GAS-235 TXS-BLA-409 TXS-MOT-521 TXS-JAR-678 TXS-COV-731

Authorized By: Received By: Cost Accounting:

Description 8" Plastic blender base 8" Steel bottom plate 1/2" Rubber feet Wirining harness Red pulse rocker switches White rocker switch White 3" blender collar 3" Rubber gasket 3" Blade assembley 1/4 hp Blender motor 1 Qt blender jar Black blender cover

Quantity Issued 500 500 2,000 1,000 3,000 500 500 500 500 500 500 500

n Form Work Order Number:

Unit Cost

Extended Cost 400.00 550.00 100.00 2,400.00 750.00 125.00 240.00 100.00 3,750.00 4,000.00 700.00 325.00

0.80 1.10 0.05 2.40 0.25 0.25 0.48 0.20 7.50 8.00 1.40 0.65

$

13,440.00