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Chapter 7 Internal Control and Cash

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Chapter 7 Internal Control and Cash

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

    CHAPTER 7

    Internal Control and Cash

    ASSIGNMENT CLASSIFICATION TABLE

    Brief A B

    Study Objectives Questions Exercises Exercises Problems Problems

     1. Identify the principles of 1, 2, 3, 4 1 1, 2, 3 1A, 2A, 1B, 2B,

    internal control. 3A, 4A 3B, 4B

     2. Apply internal control to 5, 6, 7, 8, 2, 3, 4 1, 2, 3 1A, 2A, 3A 1B, 2B, 3B

    cash receipts and 9, 10

    disbursements.

     3. Prepare a bank 11, 12,13, 5, 6, 7, 8, 4, 5, 6, 7, 4A, 5A, 4B, 5B,

    reconciliation. 14 9, 10 8, 9 6A, 7A 6B, 7B

     15, 16, 17 11 10 8A, 9A 8B, 9B 4. Explain the reporting of

    cash.

     5. Identify ways to manage 18, 19, 20 12, 13 11, 12 10A 10B

    and monitor cash.

     Solutions Manual 7-1 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

    ASSIGNMENT CHARACTERISTICS TABLE

    Problem Difficulty Time Number Description Level Allotted (min.)

    1A Identify internal controls for cash receipts. Simple 20-30

    2A Identify internal controls for cash receipts. Simple 20-30

    3A Identify internal controls for cash receipts and Complex 40-50

    disbursements.

    4A Prepare bank reconciliation and identify internal Moderate 40-50

    controls.

    5A Prepare bank reconciliation and adjusting entries. Moderate 30-40

    6A Prepare bank reconciliation and adjusting entries. Moderate 40-50

    7A Prepare bank reconciliation and adjusting entries. Moderate 40-50

    8A Calculate cash balance. Moderate 15-20

    9A Discuss reporting of cash. Simple 15-20

    10A Prepare cash budget. Moderate 20-30

    1B Identify internal controls for cash receipts. Simple 20-30

    2B Identify internal controls for cash disbursements. Simple 20-30

    3B Identify internal controls for cash receipts and Complex 40-50

    disbursements.

    4B Prepare bank reconciliation and identify internal Moderate 40-50

    controls.

    5B Prepare bank reconciliation and adjusting entries. Moderate 30-40

    6B Prepare bank reconciliation and adjusting entries. Moderate 40-50

    7B Prepare bank reconciliation and adjusting entries. Moderate 40-50

     8B Calculate cash balance. Moderate 15-20

    9B Discuss reporting of cash. Simple 15-20

    10B Prepare cash budget. Moderate 20-30

     Solutions Manual 7-2 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

    ANSWERS TO QUESTIONS

     1. This is a violation of the internal control principle of establishing responsibility. In this case,

    each sales clerk should have a separate cash register or cash register drawer.

     2. The two applications of segregation of duties are:

     (1) The responsibility for related activities should be assigned to different individuals.

     (2) The responsibility for establishing the accountability for an asset should be separate

    from the physical custody of that asset.

     3. Documentation procedures contribute to good internal control by providing evidence of the

    occurrence of transactions and events and, when signatures (or initials) are added, the

    documents establish responsibility for the transactions. The prompt transmittal of

    documents to accounting contributes to recording transactions in the proper period, and the

    pre-numbering of documents helps to ensure that a transaction is not recorded more than

    once or not at all.

    4. (a) The concept of reasonable assurance means that the costs of establishing control

    procedures should not exceed their expected benefit. Ordinarily, a system of internal

    control provides reasonable but not absolute assurance, since absolute assurance

    would be too costly.

     (b) The human element is an important factor in a system of internal control. A good

    system may become ineffective through employee fatigue, carelessness, and

    indifference. Moreover, internal control may become ineffective as a result of

    collusion.

    5. Cash registers are readily visible to the customer. Thus, they prevent the sales clerk from

    ringing up a lower amount and pocketing the difference. In addition, the customer receives

    an itemized receipt, and the cash register tape is locked into the register for further

    verification. Having scanners reduces the chance of error in entering the price of an item.

    6. Physical controls include safes, vaults, locked warehouses, and electronic burglary

    systems and sensors that help to safeguard assets. Physical controls also include cash

    registers and computerized accounting equipment that contribute to the accuracy and

    reliability of the accounting records.

     A physical control related to cash disbursements is making sure that blank cheques are

    stored in a secure area such as a safe. This ensures that only limited individuals (those with

    access to the safe) can access the cheques and reduces the risk of cheques being written

    for unauthorized purchases or amounts.

    7. Two mail clerks contribute to a more accurate listing of mail receipts and to the

    endorsement of all cheques ―For Deposit Only.‖ In addition, two clerks reduce the likelihood

    of mail receipts being diverted to personal use.

     Solutions Manual 7-3 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

Questions (Continued)

    8. Segregating the duties surrounding the receipt, disbursement and recording of cash

    reduces the risk that employees could divert cash for personal use and cover up the theft

    by manipulating cash payments or by hiding any discrepancies through ―creative‖

    bookkeeping.

    9. Payment by cheque contributes to effective internal control over cash disbursements as the

    cheque provides a record of all payments. As well, only authorized individuals should sign

    the cheques, which reduces the likelihood of payments being made for unauthorized

    amounts or to unauthorized vendors.

10. Wanda could potentially commit a fraud by:

    (1) Falsifying a receiving report and approving payment for a nonexistent supplier. She

    could open a bank account in the name of the nonexistent supplier and deposit the

    payments in this account allowing her to steal cash from Watch Central Ltd.

    (2) Ordering merchandise and stealing the inventory. She could cover her theft by then

    falsifying the receiving reports and approving the payment to the supplier even

    though the goods are not in the store.

    Note to instructors: These are only two examples. Students may develop other valid

    examples.

    11. A bank contributes significantly to internal control over cash because it: (1) safeguards cash

    on deposit, (2) minimizes the amount of cash that must be kept on hand, and (3) provides

    a double record of all bank transactions.

    12. The lack of agreement between the cash balances may be due to either:

    (1) Time lagsa cheque written in July does not clear the bank until August.

    (2) Errorsa cheque for $110 is recorded by the depositor at $101.

    13. (a) An NSF cheque occurs when the cheque writer’s bank balance is less than the amount

    of the cheque.

     (b) In a bank reconciliation, a customer’s NSF cheque is deducted from the balance per

    books.

    (c) An NSF cheque results in an adjusting entry in the company’s books, as a debit to

    Accounts Receivable and a credit to Cash. The debit to Accounts Receivable includes

    any additional charge that the bank may add for their services with respect to the NSF

    cheque.

14. Since the March cheque has still not cleared the bank at April 30 it must be included in the thApril 30 bank reconciliation as an outstanding cheque.

    15. Cash equivalents are considered to be ―near‖ cash. Cash equivalents are highly liquid

    investments that may be converted to a specific amount of cash with maturities of three

    months or less when purchased. Cash equivalents are often reported with cash in the

    current asset section of the balance sheet.

     Solutions Manual 7-4 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

Questions (Continued)

    16. Bank indebtedness is in effect a short-term loan from the bank and should be reported on

    the balance sheet as a current liability.

    17. Compensating balances are minimum cash balances which lenders specify that a

    borrower must maintain in the borrower’s bank account to provide support for a loan. A

    compensating balance should be reported as a noncurrent asset and disclosed in the

    notes to the financial statements.

    18. The basic principles of cash management are: (1) increase collection of receivables, (2)

    keep inventory low, (3) delay payment of liabilities, (4) plan timing of major expenditures,

    and (5) invest idle cash.

    19. The company will have to ensure that any excess cash, due to the increase in cash flows,

    is properly invested and not sitting idle in a bank account.

20. A cash budget is a tool used to help planning for the company’s cash needs. It shows

    anticipated cash flows. A cash budget contributes to effective cash management by

    enabling a company to plan ahead to cover possible shortfalls and invest idle funds.

     Solutions Manual 7-5 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

    SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 7-1

The four purposes of internal control are to:

    1. Optimize the use of resources to reduce inefficiencies and waste. An application for Plenty

    Parking is the use of automatic ticket dispensers at the entry gates and time clocks to determine

    how long vehicles have been parked.

    2. Prevent and detect errors and irregularities in the accounting process. An application for Plenty

    Parking is to segregate responsibilities. For example, a different person (a manager or Gina as

    the owner) than the person who collects and deposits the cash should prepare the bank

    reconciliation.

    3. Safeguard assets from theft, robbery, and unauthorized use. An application for Plenty Parking is

    the use of a cash register to safeguard assets.

    4. Maintain reliable control systems to enhance the accuracy and reliability of its accounting

    records. An application for Plenty Parking is the comparison of the daily cash receipts to the cash

    register tape.

All four purposes are important to the success of any business endeavour.

BRIEF EXERCISE 7-2

    Cash should be reported at $21,350 ($6,000 + $850 + $2,500 + $12,000). The other items are receivables.

    The cash refund due from CRA is a receivable until received. Postdated cheques are also receivables until they can be cashed on their valid date.

BRIEF EXERCISE 7-3

1. Physical controls

    2. Other controls

    3. Independent verification (internal)

    4. Segregation of duties

    5. Establishment of responsibility

    6. Other controls

     Solutions Manual 7-6 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

BRIEF EXERCISE 7-4

1. Documentation procedures

    2. Independent verification (internal)

    3. Physical controls

    4. Establishment of responsibility

    5. Segregation of duties

    6. Establishment of responsibility, segregation of duties and independent verification

BRIEF EXERCISE 7-5

(d) Bank debit memorandum for service charges

    (c) EFT payment

    (b) Outstanding cheques from the current month

    (b) Outstanding cheques from the prior month that are still outstanding (e) Outstanding cheques from the prior month that are no longer outstanding (a) Bank error in recording a company cheque made out for $200 as $290 (c) Bank credit memorandum for interest revenue

    (d) Company error in recording a deposit of $1,280 as $1,680 (d) Bank debit memorandum for an NSF cheque

    (a) Deposit in transit from the current month

    (d) Company error in recording a cheque made out for $630 as $360 (b) Bank error in recording a $2,575 deposit as $2,755

     Solutions Manual 7-7 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

BRIEF EXERCISE 7-6

     (a) (b)

    Adjustments required Adjustments to bank Other Items Item to company’s records balance

    Bank debit Cash has to be

    memorandum for reduced for the bank

    service charges charges incurred in the

    month. Bank charges

    expense is also

    recorded

    EFT payment Cash has to be

    increased and the

    customer accounts

    receivable reduced.

    Outstanding cheques The cheques have

    from the current month already been recorded

    by the company but

    have not yet cleared

    the bank.

    Outstanding cheques The cheques have

    from the prior month that already been recorded are still outstanding by the company but

    have not yet cleared

    the bank.

    Outstanding cheques No adjustment from the previous month required as that are no longer cheques have outstanding cleared the bank Bank error in recording The bank must correct

    a company cheque the error. The made out for $200 as company’s books are $290 correct.

    Bank credit Cash has to be

    memorandum for increased and interest

    interest revenue revenue recorded.

    Company error in Cash should be

    recording deposit of reduced by $400

    $1,280 as $1,680 $1,680 - $1,280) to

    correct the error made

    by the company.

    Bank debit Cash should be

    memorandum for an reduced and the

    NSF cheque customer account

    adjusted for the NSF

    cheque.

     Solutions Manual 7-8 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

BRIEF EXERCISE 7-6 (Continued)

     (a) (b)

    Adjustments required Adjustments to bank Other Items Item to company’s records balance

    Deposit in transit from The deposit has

    the current month already been recorded

    by the company but

    has not yet been

    processed by the bank.

    Company error in Cash should be

    recording cheque made decreased by $270

    out for $630 as $360 ($630 - $360) to

    correct the error made

    by the company.

    Bank error in recording The bank must correct

    a $2,575 deposit as the error. The

    $2,755 company’s books are

    correct.

(b) Outstanding cheques and the deposit in transit do not require adjustment by the company

    because they result from timing differences only. When these items reach the bank and are

    processed, the bank balance will automatically adjust itself. Bank errors must be corrected

    by the bank and therefore do not affect the company’s books.

     Solutions Manual 7-9 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

BRIEF EXERCISE 7-7

Cash balance per bank .......................................................................................... $7,920

    Add: Deposits in transit ........................................................................................ 2,152

     10,072

    Less: Outstanding cheques ................................................................................... 1,144

    Adjusted cash balance per bank ............................................................................ $8,928

Cash balance per books ......................................................................................... $9,125

    Less: Bank service charge ...................................................................... $ 35

     NSF cheque ....................................................................................... 162 197

    Adjusted cash balance per books........................................................................... $8,928

BRIEF EXERCISE 7-8

    July 31 Bank Charges Expense ..................................................... 35

     Cash....................................................................... 35

     Accounts Receivable ......................................................... 162

     Cash....................................................................... 162

BRIEF EXERCISE 7-9

January outstanding deposits:

Cash deposits per books, January $2,800

    Less: Cash deposits per bank (2,000)

    Outstanding deposits $ 800

February outstanding deposits:

Cash deposits per books, February $2,500

    Less: Cash deposits per bank (2,300)

    Add: January outstanding deposits 800

    Outstanding deposits $1,000

BRIEF EXERCISE 7-10

November $800 ($9,500 - $8,700)

    December $2,500 ($800 + $12,600 - $10,900)

     Solutions Manual 7-10 Chapter 7 Copyright ? 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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