Solution manual financial accounting 8th by harrison CH04

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Chapter 4
Internal Control & Cash
Short Exercises
(5 min.)

S 4-1

Fraud is an intentional misrepresentation of facts, made for
the purpose of persuading another party to act in such a way
that causes injury or damage to that party.

The Three Components of the Fraud Triangle
1. Motive - Fraud generally results from either critical
need or greed on the part of the perpetrator. Regardless of
whether the driving force is need or greed most perpetrators
are driven to attempt to acquire something that belongs to
others.
2. Opportunity - The opportunity to commit fraud usually arises
through weak internal controls.

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3. Rationalization - The perpetrator(s) is (are) convinced, in
their own minds, that they deserve the object of the fraudulent

behavior. They may believe no one else will ever know or even
that everybody else is engaging in fraudulent behavior

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(5-10 min.)

S 4-2

COMPONENTS OF INTERNAL CONTROL
1. Control environment — Top managers must set the “tone at
the top” to establish a control environment.
2. Risk assessment — Each company must evaluate its own
risks, based upon its particular line of business.
3. Control procedures — Specific procedures are needed for a
good system of internal control.
4. Monitoring of controls — Auditors can monitor a company’s
actions and its financial statements.
5. Information system — Accurate information is essential for
success in business.

Student responses may vary for the descriptions.

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(5-10 min.)

S 4-3

Separation of duties is essential for safeguarding assets. The
person who has custody of an asset should not also account
for the asset. A person who performs both duties can steal the
asset and hide the theft by making a bogus entry in the
accounting records.

Student responses may vary.

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(5-10 min.)

S 4-4

There are several major internal control procedures as
discussed in the chapter besides separation of duties:

1. Smart hiring practices. The company should be careful to
hire both competent and honest personnel. Smart hiring
practices involve conducting background checks on job
applicants, as well as training and supervision on the job.

2. Comparisons and compliance monitoring. No person or
department should be allowed to completely process a
transaction from beginning to end without being checked by
another person or a computer program. Examples of
comparisons and compliance monitoring are the use of
operating and cash budgets. Also, in key functions, one
employee (or a computer program) double checks the work of
another for accuracy.

3. Adequate records help to assure that sufficient hard copy
documents or electronic information is kept by the entity to
support the validity of transactions that were processed.
Examples include sales invoices, purchase orders, shipping
records, and customer remittance advices. Among the benefits
of adequate records is the ability to provide an audit trail later
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(Continued)

S 4-4

for internal or external auditors to follow in auditing the entity’s
financial statements.

4. Limited access goes hand in hand with separation of duties
to assure that only authorized individuals are allowed access to
(a) the assets of the company, such as cash or inventory; and
(b) the records. Generally, only persons with custodial
responsibilities (such as the cashier or the warehouse) should
be allowed access to assets (such as cash or inventory). Only
persons with recordkeeping responsibilities (such as
accountants) should have access to the company’s journals
and ledgers.

5. Proper approvals. No transaction should be processed
without management’s general or specific approval. Generally,
the larger the transaction, the higher the organizational level of
approval necessary.
Notice that the first letters of these attributes spell the acronym
SCALP. That’s an easy and comprehensive way to remember
the control procedures involved in internal controls.

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(10 min.)

S4-5

A computer virus enters program code without your consent
and performs destructive action to your computer files or
programs.
A Trojan Horse is a malicious computer program that hides
inside a legitimate program and works like a virus to corrupt
your computer files or programs.
A phishing expedition can be a Web site that attracts visitors
who may be tricked into revealing their account numbers,
social security numbers, passwords, or other valuable data.
The creator of the Web site then uses the unsuspecting Website visitors’ data to steal from them and for other illicit
purposes.

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(20-30 min.)

S 4-6

Cash is important not because of its amount as reported on
the balance sheet, but because of its effect on a business. All
transactions ultimately affect cash. Businesses purchase
assets and must pay cash. They make sales and collect cash.
All

expenses

ultimately

require

cash.

Also,

cash

is

susceptible to theft because it is a medium of exchange.
These factors combine to give cash more importance than its
account balance would suggest.

Student responses may vary.

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(20-30 min.)

S 4-7

Punching a hole through supporting documents reduces the
opportunity for fraud. Without this control procedure, a
dishonest employee could resubmit documents for payment
a second time. The employee could change the payee’s
address and have the check sent to an address the employee
controls. Or the employee could arrange to have the second
payee split the payment with the employee. Canceling the
documents makes it difficult to get approval for a duplicate
payment.

Student responses may vary.

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(10 min.)

S 4-8

Randell Corp.
Bank Reconciliation
October 31, 2010
BANK
Balance, October 31
Add:
Deposit in transit

Less:
Outstanding checks
Adjusted bank balance

BOOKS
$3,180 Balance, October 31
Add:
200
Bank collection
3,380
Interest revenue

$2,400
530
10
2,940

Less:
Service charge
(500)
NSF check
$2,880 Adjusted book balance

(20)
(40)
$2,880

Randell has cash of $2,880.
(5 min.)
Aug. 31 Cash………………………………………..
Accounts Receivable………………...
Collection on account.

530

31 Cash………………………………………..
Interest Revenue……………………...
Interest earned on bank balance.

10

31 Miscellaneous Expense………………...
Cash…………………………………….
Bank service charge.

20

31 Accounts Receivable……………………
Cash……………………………………..
NSF check.

40

Chapter 4

S 4-9
530

10

20

Internal Control & Cash

40

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(5 min.)

S 4-10

It appears that the employee has stolen $800 (adjusted book
balance, $4,800 − adjusted bank balance, $4,000). The adjusted

bank balance is the company’s true cash balance, and the
company books show more cash on hand. Therefore, the books
must be incorrect.

(5 min.)

S 4-11

Stevens will notice a gap in the sequence of sales receipts for
the receipt that Cassidy destroyed. This knowledge will lead
Stevens to investigate what happened to the missing receipt
and what happened to the related cash.

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(10 min.)

S 4-12

1. Paying by check carries three controls over cash:
The check provides a record of the payment.
The check must be signed by an authorized official.
Before signing the check, the official should study the
evidence supporting the payment.

2. A dishonest purchasing agent could:
Purchase goods and have them delivered to his home or
other location that he controls.
Approve payment by the company for goods that he spent
too much on, and then split the excess with the supplier.

Companies avoid this internal control weakness by
separating the following duties related to the purchase of,
and payment for, goods:
purchasing goods
receiving goods
approving and paying for goods

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(5 min.)

S 4-13

A cash budget starts with the beginning cash balance, adds
budgeted

cash

receipts,

and

subtracts

budgeted

cash

payments. The result is cash available at the end of the period.
By comparing cash available to our budgeted cash balance, we
can see whether we have cash available for additional
investments, or if we’ll need new financing.

Student responses may vary.

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(5-10 min.)

S 4-14

Crescent Artichoke Growers

Cash Budget
Year 2010
Cash balance, beginning
Estimated cash receipts—total
Estimated cash payments—total
Cash available (needed) before new financing
Budgeted cash balance needed
Cash available for additional investments

Millions
$ 11
104
115
(93)
22
(17)
$ 5

(5 min.)

S 4-15

Rourke should report the errors to Dunn because Dunn is
Rourke’s supervisor, and Dunn is responsible for the errors. If
Dunn fails to take action, then Rourke should report the errors
to the manager of the organization. In any event, outsiders who
are relying on Dublin Limited’s financial statements must be
made aware of the need to correct the reported net income
figure.

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Exercises
Group A
(5-20 min.)

E 4-16A

a. Mason has access to the cash collected, and he also
prepares the cash report. With access to both items, Mason
can steal cash and falsify his cash report to conceal his theft.
b. Fleming prepares the purchase order and also receives the
goods. She can add some items to the purchase order and
have these extra items shipped to a location she controls.
When the goods come in, she checks the incoming
shipment, so there’s no outside party to learn of her
dishonesty.
Student responses may vary.

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(10 min.)

E 4-17A

Cash payments:
a. Strong internal control. There is a good separation of duties.
Supervisors request equipment, and the home office
purchases the equipment.
b. Weak internal control. Supervisors both request, purchase,
and pay for equipment with little oversight by the home
office.

Cash receipts:
a. Weak internal control. The accountant both handles cash and
accounts for cash.
b. Strong internal control. There is a good separation of duties.
Different people handle cash and account for cash.

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(10 min.)

E 4-18A

To prevent Flynn’s embezzlement, Downtown Kalamazoo’s
board of directors could have:
a. Not permitted Flynn to write Downtown Kalamazoo
Checks. Instead, appoint a board member to write the
checks.
b. Not permitted Flynn to receive cash that came to
Downtown Kalamazoo. Have cash sent to a lock box at the
bank and appoint a board member to get the cash from the
lock box.
c. Supervised

Flynn’s

work

by

examining

Downtown

Kalamazoo’s documents such as paid checks.
d. Had an audit of Downtown Kalamazoo’s transactions and
financial statements.

Student responses may vary.

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1.

b

5.

d

2.

b

6.

c

3.

d

7.

c

4.

a

(5-10 min.)

E 4-19A

(10-20 min.)

E 4-20A

J. D. Hunter
Bank Reconciliation
June 30, 2010
BANK:
Balance, June 30
Add: Deposit in transit
Less: Outstanding checks:
Check No.
626
627
Adjusted bank balance

$ 399
1,210

$ 85

285

BOOKS:
Balance, June 30
Less:
Correction of book error —
Recorded $86 check as $68
NSF check
Service charge
Adjusted book balance

Chapter 4

(370)
$1,239

$1,287

$ 18
20
10

(48)
$1,239

Internal Control & Cash

291

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(10-20 min.)

E 4-21A

Evan Root
Bank Reconciliation
April 30, 2010
BANK:
Balance, April 30
Add: Deposit in transit

$ 565
1,790
2,355
(602)
$1,753

Less: Outstanding checks
Adjusted bank balance
BOOKS:
Balance, April 30
Add: EFT collection — rent
Less:
Service charge
NSF checks
Charge for printed checks
Correction of book error —
recorded $290 check as $29

Adjusted book balance
Root’s actual cash balance is $1,753

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$1,827
320
2,147
$ 7
115
11
261

(394
$1,753


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(10-15 min.)

E 4-22A

Journal
DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Apr 30 Cash…………………………………….
Rent Revenue………………………
EFT collection of rent.

320

30 Miscellaneous Expense ($7 + $11)...
Cash ……………………………….
Bank service charge and charge
for printed checks.

18

30 Accounts Receivable………………...
Cash ……………………………….
NSF checks returned by bank.

115

30 Salary Expense ($290 − $29)………..
Cash ……………………………….
Correction of book error.

261

Chapter 4

CREDIT

320

18

115

261

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(10-15 min.)
TO:

Store Manager

FROM:

Student

E 4-23A

SUBJECT: Evaluation of internal control and plan for
improvement
There is a weakness in internal control over cash receipts. The

cash registers do not keep a record of sales. With no record,
there is no way to determine how much cash should be in the
cash drawer. This omission makes it easy for the cashier to
steal cash and not get caught.

To improve internal control, the company should use cash
registers that record each sale. The manager can prove the
amount of cash in the cash drawer against this recorded
amount.

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(10-15 min.)

E 4-24A

The main internal control weakness is that the payroll
department both prepares and distributes the paychecks. With
both duties, a dishonest person in the payroll department can
create a time sheet for a fictitious employee and then keep the
related paycheck after the treasurer returns the signed checks
to the payroll department.
To correct this weakness, Green Grass Golf should have
someone other than the payroll department or the shop
foreman distribute paychecks to employees. For example, the

human resources department, which has no control over the
time sheets or the paychecks, could distribute paychecks to
the workers.

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(20-30 min.)

E 4-25A

Cole Communications, Inc.
Cash Budget
Year Ended December 31, 2011
Cash balance, December 31, 2010

Millions
$

Budgeted cash receipts:
Collections from customers
Sale of assets
Budgeted cash payments:
Payments for cost of

services and products
Payments of operating expenses
Investment in equipment
Payment of debt
Payment of dividends
Cash available (needed) before financing
Budgeted cash balance, December 31, 2011
Cash available for additional investments, or
(New financing needed)

86

11,305
118
11,509

$6,167
2,544
1,826
603
347

11,487
22
(82)
$

(60)

Cole Communications expects to need new financing of $60

million during 2011.

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(10 min.)
Actual
effective
interest rate

E 4-26A

Interest paid
each year
$14,000,000 × .077
$1,078,000
= Amount actually =
= $13,202,000
$14,000,000 −
borrowed
$14,000,000(.057)

= 8.17%

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Exercises
Group B
(5-20 min.)

E 4-27B

a. Monroe has access to the cash collected, and he also
prepares the cash report. With access to both items, Monroe
can steal cash and falsify his cash report to conceal his theft.
b. Adams prepares the purchase order and also receives the
goods. She can add some items to the purchase order and
have these extra items shipped to a location she controls.
When the goods come in, she checks the incoming
shipment, so there’s no outside party to learn of her
dishonesty.
Student responses may vary.

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