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ANSWERS TO QUESTIONS - CHAPTER 6

1. Internal controls.

2. Accounting controls are composed of procedures that are


designed to safeguard assets and to assure that the
accounting records contain reliable information.

Administrative controls are concerned with performance


evaluation and the assessment of the degree of
compliance with company policies and public laws.

3. A strong internal control system should have:


• Separation of duties.
• Quality employees.
• Bonded employees.
• Periods of absence (i.e., required vacations and rotation
of employees).
• A procedures manual.
• Clear lines of authority and responsibility.
• Prenumbered documents.
• Physical control over assets.
• Periodic performance evaluation.

4. Separation of duties is the procedure whereby different


individuals each separately perform the authorization,
recording, and custody functions for a business. An
example would be to have one individual write the checks
and attach appropriate documentation and have another
individual sign the check and approve payment.

5. Quality employees should have the necessary ability to


perform the required task and be adequately trained to
perform a variety of other tasks. In addition, employees
should have high personal integrity.

6. A fidelity bond is insurance that a company can purchase


to protect against loss due to employee dishonesty.

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7. When employees are not required to take extended periods
of leave or vacation, the employee may be able to cover up
illegal or unscrupulous activities while being present in the
work environment. If jobs are rotated or someone else does
the job while the employee is absent, improprieties may be
discovered.

8. The procedures manual sets forth the proper procedures


for processing transactions. The manual should be kept
up-to-date and periodic reviews should be conducted to
ensure that the procedures outlined in the manual are
being followed.

9. Specific authorizations outline the limitations that apply to


different levels of management. These authorizations
generally apply to specific positions within the
organization. For example, sale of major assets can only
be authorized by the board of directors, price reductions
must be authorized by the sales manager, etc. General
authorizations apply across different levels of
management. For example, checks for purchases should
be written only if supported by a purchase order and
receiving documents. All paid invoices must be stamped
“PAID” to avoid duplicated payments.

10. The use of prenumbered documents (i.e., checks, receipts,


and invoices) is a control to help ensure that all
transactions are properly accounted for and recorded, and
that no transactions are unrecorded or missing.

11. Physical controls are designed to safeguard assets.


Storerooms should be kept locked with limited access.
Serial numbers on equipment should be recorded.
Unannounced physical counts should be taken to account
for the physical presence of the assets. Valuable papers
should be kept in a lockbox, with limited access.
Accounting records should be kept in a fireproof vault with
backup copies kept off premises whenever possible.
Assets should be adequately insured.

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12. Independent verification of performance provides an
objective evaluation. It also requires the employee to be
accountable under predetermined standards.
Independent verification of the internal control systems
assures that the system is functioning properly.

13. Additional controls related to computers:


1. Test of reasonableness should be built into the
programs to flag clearly erroneous transactions.
2. The company should have a competent and bonded
programmer.
3. Documentary evidence should be kept in order to
leave a paper trail.
4. Access to the system should be controlled.
5. Proper documentation should be kept on the
operations and procedures of the various programs.
6. Programs and databases should be safeguarded.
Backup files should be stored in a fireproof vault with
a copy kept off the premises if possible.

14. Cash includes currency and other items payable on


demand such as checks, money orders, bank drafts, and
savings accounts.

15. Cash is more susceptible to theft and embezzlement


because it is not easily identifiable. In most cases,
possession equates to ownership.

16. Giving customers receipts helps to prevent theft of cash


receipts. Any missing receipts or quantities of money can
be detected on a timely basis. The customer serves as a
control to assure that the amount of the sale is correct
(i.e., no overcharging or undercharging) and that cash
paid is properly recorded.

17. Control procedures over cash receipts include:


• Timely deposits.
• Limiting cash on hand.
• Timely recording of cash receipts.
• Written customer receipts.

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• Timely reconciliation of actual cash to records of cash
receipts.

18. Procedures that will help protect cash disbursements


include making all disbursements by check, using
prenumbered checks kept in a secure place, and
separation of the authorization, recording, and custody
functions for cash disbursements. Supporting
documentation and authorized signatures should also be
required for payment. Paid documents should be clearly
labeled and filed for reference.

19. A debit memo included with the bank statement reduces


the amount of cash and a credit memo increases the
amount of cash.

20. Information usually contained in the bank statement


includes:
• The balance of the account at the beginning of the
period.
• Additions to the account during the period (deposits and
other credit memos).
• Subtractions made during the period for paid checks
and other debit memos.
• A running balance of the account or the beginning and
ending balance of the account.

21. The bank's balance will be larger than the book balance if
there are outstanding checks that exceed outstanding
deposits. The bank's balance will be smaller if the
outstanding deposits exceed the outstanding checks.
Errors also will cause differences.

22. The bank reconciliation is a schedule prepared to identify


items causing differences between the bank statement
balance and the Cash account balance. Preparation of a
bank reconciliation also helps determine the true cash
balance as of the date of the bank statement.

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23. An outstanding check is a cash disbursement that has
been recorded on the payer’s books but has not been
deducted from the payer’s bank account by the bank (i.e.,
has not “cleared” the bank).

24. A deposit in transit is a deposit that has been recorded on


the depositor’s books but has not yet been recorded by
the bank.

25. A certified check is a check guaranteed by a bank to be a


check drawn on an account with sufficient funds to pay the
check.

26. The amount of a customer check that was deposited and is


later found to be NSF must be deducted from the
depositor’s account. The amount of the NSF check plus
any service charges are shown as an account receivable
(i.e., the customer owes the depositor the amount).

27. The Cash Short and Over account is an account that is


used to record minor overages or shortages when
balancing cash receipts or disbursements.

28. The petty cash fund is a small cash fund that is kept on
the premises that is used to pay small disbursements
where it is not practical to write a check. For example, a
payment of $1.24 for postage might be paid out of petty
cash.

29. Examples of expenditures made from a petty cash fund


include postage, delivery charges, taxi fares, supper
money, small purchases of office supplies, and any other
small items that are frequently paid with cash.

30. Current assets are assets that will be consumed or


converted into cash within a one-year period or an
operating cycle, whichever is longer. Noncurrent assets
are assets that a business expects to be productive or to
use over a period of several years.

31. Some of the most common current assets are:

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• Cash.
• Marketable Securities.
• Accounts Receivable.
• Short-Term Notes Receivable.
• Inventory.
• Interest Receivable.
• Supplies.
• Prepaids.
• Currently maturing portion of Long-Term Notes
Receivable.

32. An operating cycle is the length of time that is required to


turn cash into inventory, inventory into receivables, and
receivables back into cash.

33. Current liabilities include:


• Accounts Payable.
• Short-Term Notes Payable.
• Wages and Salaries Payable.
• Taxes Payable.
• Interest Payable.
• Currently maturing portion of Long-Term Debt.

34. A classified balance sheet is one that separates assets and


liabilities into current and noncurrent items.

35. Liquidity refers to a business’s ability to generate short-


term cash flows. Solvency is the ability to repay liabilities
in the long run.
36. U.S. GAAP requires that assets be listed in order of
liquidity (i.e., current assets first) and that current
liabilities be listed before non-current liabilities. Balance
sheet presentation of assets in the U.K. is the opposite,
with long-term assets listed first; liabilities are presented
in the same order as in the U.S. In France, both asset and
liability sections list noncurrent items first.

37. This is generally true. A high current ratio indicates the


ability of a company to meet its short-term debt obligations.

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However, if the current ratio is too high, the company may
have excess current assets which may be invested to yield a
higher return for owners.

38. A high debt-to-assets ratio is not necessarily an indication


of solvency problems. Companies in relatively stable
industries can use leverage to increase return to the
owners. Banks are an example of businesses with high
debt-to-assets ratios.

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SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 6

EXERCISE 6-1A

1. Separation of Duties: Whenever possible, the functions of


authorization, recording, and custody should be handled
by different individuals. If these duties are separated,
the likelihood of theft or fraud by employees is greatly
reduced, because collusion among employees is
necessary to accomplish the crime.

2. Quality of Employees: Employees should be competent


and adequately trained to perform the required task.

3. Bonded Employees: Employers should hire employees


with high personal integrity. Employees in positions of
trust should be covered with a fidelity bond (insurance
against loss from employee dishonesty).

4. Periods of Absence: Employees should be required to


take extended vacations and/or be rotated among duties
in order to discover patterns of dishonesty or theft.

5. Procedures Manual: A procedures manual should be


established, kept up-to-date, and enforced to assure that
company policies are being followed.

6. Authority and Responsibility: A clear chain of command


should be established and documented. A manual should
detail this chain of command and provide guidance for
specific and general authority.

7. Prenumbered Documents: The use of prenumbered


documents (checks, receipts, etc.) requires all such
documents to be accounted for and reduces the
likelihood of unauthorized transactions.

8. Physical Control: All assets should be properly


documented, and periodically accounted for, with access
limited to authorized personnel.

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9. Performance Evaluations: A periodic and independent
evaluation of employees' performance alerts management
to inefficiencies of employees.

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EXERCISE 6-2A

1. Controls for test of reasonableness: A computer does not


think independently and is neutral to the size of a number.
Therefore, certain tests should be built in to catch
unreasonable entries.

2. Competence of computer programmers: Since many


computer operators are required to run and design complex
programs, it is even more important that these employees
be screened and bonded.

3. Audit around the computer: These procedures are used to


test the system by inputting data where the expected
outcome is known.

4. Security of the system: Measures should be taken to


protect unauthorized access to computer programs and
data files.

5. Documentation: Documentation of programs and


procedures is necessary so that more than one person is
familiar with and able to operate the system.

6. Safeguard data files: Backup copies of programs and data


files should be stored off-premises in order to minimize
danger from destruction or theft.

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EXERCISE 6-3A

• Receipts should be promptly written for all cash received


and the funds deposited timely in a bank or other financial
institution.
• All cash disbursements should be made by check and all
check numbers accounted for.
• All checks should require dual signatures and proper
supporting documents.
• The bank account should be reconciled on a monthly basis.
Cash on hand should be kept to a minimum.
• Cash handling and cash record-keeping duties should be
separated as well as authorization for cash disbursements.

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EXERCISE 6-4A

Some of the internal control features that should be included


in the memo to Dick Haney:
• Have as much separation of duties as possible. The
manager should prepare the deposit of receipts collected
by the sales personnel. Dick should periodically check
these amounts. If the manager is in charge of writing the
checks, then Dick should sign each check and verify the
documentation. One of the sales personnel should check in
inventory and the manager should check the receiving
reports and verify the billing.
• Be sure that assets are adequately insured.
• Be sure that quality employees are hired.
• Require that all employees take vacations.
• Use prenumbered documents.

EXERCISE 6-5A

a. The discrepancy was most likely caused by theft by Rhonda


Cox, the parts department manager. It is unlikely that
sloppy recordkeeping could account for this much of a
difference. The manager could have been involved in
several types of dishonest behavior. She could have
presented phony invoices for payment to a fictitious
company, or sold some of the parts and not recorded the
sale. Any of these activities would cause this type of
discrepancy.

b. Separation of duties is one internal control procedure that


could have helped prevent this type of theft. If the
company was so small that it had only one employee in the
parts department, the owner must be very involved in that
department, checking invoices, inventory, receiving reports
and other documentation.

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Also, the owner should have insisted that the employee
take regular vacations.

Bonding the employees would help to insure against theft


loss.

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EXERCISE 6-6A
a. & c.

Best Supplies
Statements Model

Assets = Liab. + S. Rev. − Exp. = Net Cash Flow


Equity Inc.
Cash +Acct. = +
Rec.
(a) + 125 = NA + NA NA − NA = NA (125) OA
(125)
(c1)125+ (125) = NA + NA NA − NA = NA 125 OA
(c2)25 + NA = NA + 25 25 − NA = 25 25 OA

b. Asset exchange.

c. See financial statements model above. The $25 fee is


miscellaneous income.

d. Asset Exchange is $125 and Asset Source is $25.

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EXERCISE 6-7A

Book Added or
Reconciling Items: Balance Subtracte
Adjusted? d?
Charge for Checks Yes −
NSF Check from Customer Yes −
ATM Fee Yes −
Outstanding Checks No NA
Interest Revenue Earned on the Yes +
Account
Deposits in Transit No NA
Service Charge Yes −
Automatic Debit for Utility Bill Yes −

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EXERCISE 6-8A

Bank Added or
Reconciling Items: Balance Subtracted?
Adjusted?
NSF Check from No NA
Customer
Interest Revenue No NA
Bank Service Charge No NA
Outstanding Checks Yes −
Deposits in Transit Yes +
Debit Memo No NA
Credit Memo No NA
ATM Fee No NA
Petty Cash Voucher No NA

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EXERCISE 6-9A
a.
Bank Reconciliation
Unadjusted Bank Balance 5/31/2004 $14,625
Add: Deposit in Transit 1,590
Less: Outstanding Check (1,873)
True Cash Balance 5/31/2004 $14,342
Unadjusted Book Balance 5/31/2004 $14,330
Add: Credit Memo for Interest Earned 20
Less: Debit Memo for Service Charge (8)
True Cash Balance 5/31/2004 $14,342

b.
Date Account Titles Debit Credit
Adj Cash 20
1
Interest Earned 20
Adj Bank Service Charge Expense 8
2
Cash 8

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EXERCISE 6-10A

Unadjusted Bank Balance, 8/31 $75,925


Plus: Deposits in Transit 2,600
Less: Outstanding Check (4,925)
True Cash Balance, 8/31 $73,600

EXERCISE 6-11A

Unadjusted Book Balance, 4/30 $5,600


Add: Interest Earned $ 15
Note Collected by Bank 500 515

Less: NSF Check 75


Service Charges 50 (125)
True Cash Balance, 4/30 $5,990

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EXERCISE 6-12A

a. Asset exchange.

b.
Belcher Transfer Company
Statements Model

Assets = Liab. + S. Rev. − Exp = Net Cash Flow


Equity . Inc.
Petty
Cash Cash
(200) 200 = NA + NA NA − NA = NA NA

c.
Belcher Transfer Company
General Journal

Ref. Account Titles Debit Credit

Jan. 1 Petty Cash 200


Cash 200

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EXERCISE 6-13A
a.
Xterra, Inc.
Statements Model
Assets = S. Rev. − Exp. = Net Statement
Equity Inc.
Petty Ret. of
No Cash + Cash = Earn. Cash
. Flows
1. (300.0 + 300.00 = NA NA − NA = NA NA
0)
2. NA + NA = NA NA − NA = NA NA
3. NA + (247.5 = (247.5 NA − 247.50 = (247.5 (247.50)
0) 0) 0) OA
4. (247.5 + 247.50 = NA NA − NA = NA NA
0)

b.
Xterra, Inc.
General Journal Entries
Event Account Titles Debit Credit
No.
1. Petty Cash 300.00
Cash 300.00
2. No Entries
3. Postage Expense 65.00
Office Supplies Expense 80.75
Printing Expense 10.50
Entertainment Expense 88.25
Cash Short and Over 3.00
Petty Cash 247.50
4. Petty Cash 247.50
Cash 247.50

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EXERCISE 6-14A

a. No effect; this is an asset exchange transaction.

b. Net charge to expense is $123.20; expenses will be


debited for $125.20, the amount of the vouchers; cash
short and over will be credited for $2.00.

c. Replenishment.

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EXERCISE 6-15A

Borg Co.
Classified Balance Sheet
As of December 31, 2003
Assets
Current Assets
Cash $15,260
Accounts Receivable 42,500
Merchandise Inventory 32,000
Prepaid Insurance 3,200
Total Current Assets $ 92,960
Property, Plant and Equipment
Office Equipment 26,500
Total Property, Plant and 26,500
Equipment
Total Assets $
119,460

Liabilities and Stockholders’ Equity


Current Liabilities
Accounts Payable $11,000
Long-Term Liabilities
Long-Term Notes Payable 23,000
Total Liabilities 34,000
Stockholders’ Equity
Common Stock $40,000
Retained Earnings 45,460
Total Stockholders’ Equity 85,460
Total Liabilities and Stockholders’
Equity
$119,460

6-23
EXERCISE 6-16A

Operating Cycle:
a.
Cash  Inventory  Accounts Receivable  Cash

b. Length of operating cycle: 90 + 35 = 125 days

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SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 6

PROBLEM 6-17A

a. Separation of duties would have helped to prevent this


type of act. The authority function, check writing
function, and check delivery function should have been
separated.

b. Again, separation of duties would help to prevent this


type of fraud. Mr. Kent should not authorize the
purchase of supplies and also verify their receipt.

c. Better control procedures could help eliminate this type


of act. Require an authorization for any discounts that
are given. Also, management should periodically observe
procedures used at the cash register. Shortages in
inventory can be reduced by having another employee
checking sales receipts with the merchandise a customer
carries from the store (like Sam’s Clubs).

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PROBLEM 6-18A
a.
Long Builders, Inc.
Bank Reconciliation
October 31, 2001
Unadjusted Bank Balance, October 31, $8,000
2001
Add: Deposit in Transit 2,000
Less: Outstanding Checks (1,200)
True Cash Balance, October 31, 2001 $8,800

Unadjusted Book Balance, October 31, $8,580


2001
Add: Error in recording check for 270
equipment
Less: Debit Memo for new checks (50)
True Cash Balance, October 31, 2001 $8,800

b.
General Journal
Ref. Account Title Debit Credit
1. Cash 270
Equipment 270
2. Office Supplies Expense 50
Cash 50

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PROBLEM 6-19A

Barkley Flying Service


Bank Reconciliation
April 30, 2007
Unadjusted Bank Balance, April 30, $10,000
2007
Add: Deposits in Transit $1,000
Bank Error 800 1,800
Less: Outstanding Checks 220
#2012
#2052 380
#2055 1,700 (2,300)
True Cash Balance, April 30, 2007 $ 9,500
Unadjusted Book Balance, April 30, $
2007 9,058*
Add: Note Collected by Bank $ 450
Error in recording payment for 297 747
repairs
Less: Collection Fee 15
Bank Service Charge 40
NSF Checks 250 (305)
True Cash Balance, April 30, 2007 $ 9,500

*Unadjusted cash balance per books is computed as follows:


x + $747 − $305 = $9,500;
x = $9,058

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PROBLEM 6-20A

General Journal
Event Account Titles Debit Credit
No.
a. No Entry
b. Cash 8,000
Accounts Receivable 8,000
c. No Entry
d. No Entry
e. Accounts Receivable 375
Cash 375
f. Cash 75
Interest Revenue 75
g. Cash 495
Supplies 495
h. Bank Service Charge Expense 40
Cash 40
i. Theft Loss 1,000
Cash 1,000
j. No Entry

6-28
PROBLEM 6-21A
a.
Oceanside Hotel
Bank Reconciliation
October 31, 2005
Unadjusted Bank Balance, October 31, $14,000
2005
Add: Deposit in Transit 3,550
Less: Outstanding Checks #2353 $1,500
2356 745 (2,245)
True Cash Balance, October 31, 2005 $15,305
Unadjusted Book Balance, October 31, $13,000
2005
Add: Credit Memo for Collection of
Notes 2,325
Receivable
Less: Debit Memo for Printed Checks (20)
True Cash Balance, October 31, 2005 $15,305

b.
Account Title Debit Credit

Cash 2,325
Notes Receivable 2,325

Office Supplies Expense 20


Cash 20

6-29
PROBLEM 6-22A
Asset = Liabiliti + Stockholders’
s es Equity
Event Type Commo + Retaine
Number of n Stock d
Event Earning
s

1. AU − = NA + NA + −
2. AU − = NA + NA + −
3. AE +− = NA + NA + NA

4. AS + = NA + NA + +
5. AE +− = NA + NA + NA

6-30
PROBLEM 6-23A
a.
Pete’s Sandwich Shop
Bank Reconciliation
May 31, 2006
Unadjusted Bank Balance, May 31, $22,000
2006
Add: Deposit in Transit 4,250
Less: Outstanding Checks (5,000)
True Cash Balance, May 31, 2006 $21,250

Unadjusted Book Balance, May 31, $25,000


2006
Add: Credit Memo for Collection of
Notes 1,815
Receivable
Less: Debit Memo for Service Charge $ 30
Debit Memo for Loan Payment 1,000 (1,030)
Subtotal 25,785
Stolen Cash (4,535)
True Cash Balance, May 31, 2006 $21,250

b. Correcting the amount of outstanding checks from $465 to


$5,000 reveals a true cash balance of $21,250. Given an
adjusted book balance of $25,785, there must be $4,535 of
cash missing, (i.e., $25,785 − $21,250). The discrepancy
was hidden by understating the amount of outstanding
checks thereby raising the bank balance to equal the
incorrect book balance.

c. Separation of duties and/or oversight by the owner could


help to prevent this type of act. In small businesses with
few employees, it may not be possible to have all the
accounting functions separate. In this case, it is necessary
for the owner to take an active role in the accounting of the
business.

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PROBLEM 6-24A
a.
General Journal
Event Account Titles Debit Credit
1. Petty Cash 100
Cash 100
2. No Entry
3a. Postage Expense 32
Delivery Expense 20
Meals Expense 42
Cash Short and Over 2
Petty Cash 92
3b. Petty Cash 92
Cash 92

b. The cash over will be reported on the income statement as


miscellaneous income.

c.
Event Type of Event
Number
1. AE
2. No Effect
3. AU
AE

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PROBLEM 6-24A (cont.)
d.
Effect of Transactions on Financial Statements
Assets = Liab + S. Rev. − Exp. = Net Cash Flow
. Equity Inc.
No. Cash + Petty =
Cash
1. (100) + 100 = NA + NA NA − NA = NA NA
2. NA + NA = NA + NA NA − NA = NA NA
3a. NA + (92) = NA + (92) 2 − 94 = (92) (92) OA
3b. (92) + 92 = NA + NA NA − NA = NA NA

PROBLEM 6-25A
Nixon Enterprises
Classified Balance Sheet
December 31, 2005
Assets
Current Assets
Cash $ 3,600
Accounts Receivable 4,000
Interest Receivable 240
Supplies 500
Inventory 9,000
Prepaid Rent 9,600
Total Current Assets $ 26,940
Long-Term Assets
Notes Receivable 6,000

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Office Equipment $58,000
Less: Accumulated (4,800) 53,200
Depreciation
Land 50,000
Total Long-Term Assets 109,200
Total Assets $136,140
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts Payable $ 1,000
Interest Payable 740
Salaries Payable 1,800
Unearned Revenue 9,600
Total Current Liabilities $ 13,140
Long-Term Liabilities
Notes Payable 40,000
Total Liabilities 53,140
Stockholders’ Equity
Common Stock 41,000
Retained Earnings 42,000
Total Stockholders’ Equity 83,000
Total Liab. & Stockholders’ $136,140
Equity

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PROBLEM 6-25A (cont.)

Nixon Enterprises
Income Statement
For the Year Ended December 31, 2005
Sales Revenue $340,000
Cost of Goods Sold (174,000)
Gross Margin 166,000
Operating Expenses
Operating Expenses $ 19,000
Salaries Expense 118,000
Total Operating (137,000)
Expenses
Operating Income 29,000
Non-Operating Items:
Interest Revenue 420
Gain on Sale of 6,400
Equipment
Interest Expense (12,200) (5,380)
Net Income $ 23,620

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SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 6

EXERCISE 6-1B

a. The two categories of internal controls are accounting


controls and administrative controls.

Accounting controls: Procedures designed to safeguard


the assets and ensure that the accounting records
contain reliable information.

Administrative controls: Procedures that concern the


evaluation of performance and the assessment of the
degree of compliance with company policies and public
law.

b. The purpose of internal controls is to prescribe policies


and procedures to be used to provide reasonable
assurance that the objectives of an enterprise will be
accomplished. They are designed to safeguard the
assets of a business.

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EXERCISE 6-2B

a. The use of computers does not reduce the need for internal
controls; it increases the controls that are needed.
Computers do not think independently so there must be
tests for reasonableness. Since significant technical
expertise is required to design and run computer programs,
competent computer programmers are necessary. Controls
must be in place to assure the competence of these
computer programmers and operators. Computers also
present different security issues. Procedures must be in
place to safeguard computers and computer information.
Also, since computer data can be easily lost or damaged,
controls must be in place to assure backup data is kept
secure.

b. Audit around the computer: This expression describes


procedures where the auditor provides input that is
expected to result in a designated output. The system is
tested by comparing the actual output with the expected
output.

6-37
EXERCISE 6-3B

a. Cash requires additional control procedures because of its


appeal. Usually possession of cash is presumed ownership.
It usually cannot be traced and one dollar cannot be
distinguished from another. Relatively small amounts of
high-denomination currency can represent significant
amounts of value. Consequently, extra controls are
necessary to safeguard cash.

b. Cash includes currency and other items that are payable on


demand such as checks, money orders, bank drafts, and
certain savings accounts. Some companies combine
marketable securities with cash for balance sheet
presentation.

6-38
EXERCISE 6-4B

Separation of duties would have eliminated this problem.


Gates should not have had the authority to evaluate returns
(authorization) and to dispose of the defective merchandise
(custody). If these two duties had been performed by
separate individuals, it would have been difficult to commit
this type of crime.

EXERCISE 6-5B

By checking Mr. Major's references, educational background,


etc., and bonding its physicians, ECMC could have avoided
this loss.

6-39
EXERCISE 6-6B
a. & c.

Clark Stationery
Statements Model

Assets = Liab. + S. Rev. − Exp. = Net Cash Flow


Equity Inc.
Cash +Acct. = +
Rec.
(a) + 300 = NA + NA NA − NA = NA (300) OA
(300)
(c1)300+ (300) = NA + NA NA − NA = NA 300 OA
(c2)20 + NA = NA + 20 20 − NA = 20 20 OA

b. Asset exchange.

c. See financial statements model above. The $20 fee is


miscellaneous income.

d. Asset Exchange is $300 and Asset Source is $20.

6-40
EXERCISE 6-7B

Book Added or
Reconciling Items: Balance Subtracte
Adjusted? d?
Interest Revenue Yes +
Deposits in Transit No NA
Debit Memo Yes −
Service Charge Yes −
Charge for Checks Yes −
NSF Check from Customer Yes −
Note Receivable Collected by Yes +
Bank
Outstanding Checks No NA
Credit Memo Yes +

6-41
EXERCISE 6-8B

Bank Added or
Reconciling Items: Balance Subtracted?
Adjusted?
Deposits in Transit Yes +
Debit Memo No NA
Credit Memo No NA
Certified Checks No NA
Petty Cash Voucher No NA
NSF Check from No NA
Customer
Interest Revenue No NA
Bank Service Charge No NA
Outstanding Checks Yes −

6-42
EXERCISE 6-9B
a.
Bank Reconciliation
Unadjusted Bank Balance 6/30/2006 $13,879.8
5
Add: Deposits in Transit 1,476.30
Less: Outstanding Check (1,843.74)
True Cash Balance 6/30/2006 $13,512.4
1
Unadjusted Book Balance 6/30/2006 $13,483.7
5
Add: Credit Memo for Interest Earned 35.00
Less: Debit Memo for Service Charge (6.34)
True Cash Balance 6/30/2006 $13,512.4
1

b.
Date Account Titles Debit Credit
Adj Cash 35.0
1 0
Interest Revenue 35.00
Adj Bank Service Charge Expense 6.34
2
Cash 6.34

6-43
EXERCISE 6-10B

Unadjusted Bank Balance, 6/30 $68,714.35


Plus: Deposits in Transit 1,464.95
Less: Outstanding Check (4,745.66)
True Cash Balance, 6/30 $65,433.64

EXERCISE 6-11B

Unadjusted Book Balance, 5/31 $6,450


Add: Interest Earned $ 18
Note Collected by Bank 450 468

Less: NSF Check 38


Service Charges 30 (68)
True Cash Balance, 5/31 $6,850

6-44
EXERCISE 6-12B

a. Asset exchange.

b.

Cole Company
Statements Model

Assets = Liab. + S. Rev. − Exp = Net Cash Flow


Equity . Inc.
Petty
Cash Cash
(300) 300 = NA + NA NA − NA = NA NA

c.
Cole Company
General Journal

Ref. Account Titles Debit Credit

Jan. 1 Petty Cash 300


Cash 300

6-45
EXERCISE 6-13B
a.
Family Vision Center
Statements Model
Assets =
S. Rev. − Exp. = Net Statement
Equity Inc.
Petty Ret. Of
No Cash + Cash = Earn. Cash
. Flows
1. (100.0 + 100.00 = NA NA − NA = NA NA
0)
2. NA + NA = NA NA − NA = NA NA
3. NA + (83.25 = (83.25 1.18 − 84.4 = (83.25 (83.25)OA
) ) 3 )
4. (83.25) + 83.25 = NA NA − NA = NA NA

b.
Family Vision Center
General Journal Entries
Event Account Titles Debit Credit
No.
1. Petty Cash 100.00
Cash 100.00
2. No Entries
3. Postage Expense 34.68
Office Supplies Expense 18.43
Printing Expense 7.40
Transportation Expense 23.92
Cash Short and Over 1.18
Petty Cash 83.25
4. Petty Cash 83.25
Cash 83.25

6-46
6-47
EXERCISE 6-14B

a. No effect; this is an asset exchange transaction.

b. $191.16 ($184.93 vouchers; $6.23 cash short & over)

c. Replenishment.

6-48
EXERCISE 6-15B

Coleman Co.
Classified Balance Sheet
As of December 31, 2003

Assets
Current Assets
Cash $10,992
Accounts Receivable 12,150
Merchandise Inventory 16,000
Total Current Assets $39,142
Property, Plant and Equipment
Land 12,500
Total Property, Plant and 12,500
Equipment
Total Assets $51,642

Liabilities and Stockholders’ Equity


Current Liabilities
Accounts Payable $ 5,500
Long-Term Liabilities
Notes Payable 11,500
Total Liabilities 17,000
Stockholders’ Equity
Common Stock $12,000
Retained Earnings 22,642
Total Stockholders’ Equity 34,642
Total Liabilities and Stockholders’ $51,642
Equity

6-49
EXERCISE 6-16B

Operating Cycle:
a.
Cash  Inventory  Accounts Receivable  Cash

b. Length of operating cycle: 80 + 42 = 122 days

6-50
SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 6

PROBLEM 6-17B

a. Separation of duties would help to prevent this type of


theft. The functions of authorization, recording, and
custody should be handled by different individuals.
Reidel should not be authorizing reimbursements,
recording the transactions, and having custody of the
funds. The accounts payable clerk should check for
proper authorization on petty cash vouchers. Also, if
Reidel had been required to take an extended vacation,
the fraud may have been detected in her absence.

b. A background check would have revealed Bruton’s


falsification of his resume.

c. Physical control. Keep office supplies in a locked closet.


Assign an employee to be responsible for custody and
disbursement of the office supplies. Different individuals
should periodically take inventory and reconcile the
count to the inventory account.

6-51
PROBLEM 6-18B
a.
We Trade
Bank Reconciliation
August 31, 2006
Unadjusted Bank Balance, August 31, 2006 $17,000
Add: Deposit in Transit 2,260
Less: Outstanding Checks ( 3,000)
True Cash Balance, August 31, 2006 $16,260

Unadjusted Book Balance, August 31, 2006 $16,000


Add: Error in recording check for inventory 360
Less: Debit Memo for new checks (100)
True Cash Balance, August 31, 2006 $16,260

b.
General Journal
Ref. Account Title Debit Credit
1. Cash 360
Inventory 360
2. Office Supplies Expense 100
Cash 100

6-52
PROBLEM 6-19B

Best Auto Supply, Inc.


Bank Reconciliation
May 31, 2007
Unadjusted Bank Balance, May 31, $8,000
2007
Add: Deposits in Transit $ 975
Bank Error 650 1,625
Less: Outstanding Checks #3013 385
3054 735
3056 1,900 (3,020)
True Cash Balance, May 31, 2007 $6,605
Unadjusted Book Balance, May 31, $5,565*
2007
Add: Note Collected by Bank $ 500
Error in recording payment for 700 1,200
utilities
Less: Collection Fee 10
Bank Service Charge 25
NSF Checks 125 (160)
True Cash Balance, May 31, 2007 $6,605

*Unadjusted cash balance per Best Auto Supply’s books is


computed as:
x + $1,200 − $160 = $6,605;
x = $5,565.

6-53
PROBLEM 6-20B

General Journal
Event Account Titles Debit Credit
No.
a. No Entry
b. No Entry
c. Office Supplies 9
Cash 9
d. Cash 330
Notes Receivable 330
e. No Entry
f. Bank Service Charge Expense 22
Cash 22
g. No Entry
h. Accounts Receivable 31
Cash 31

6-54
PROBLEM 6-21B
a.
Cooters Garage
Bank Reconciliation
March 31, 2002
Unadjusted Bank Balance, March 31, $16,000.00
2002
Add: Deposit in Transit 2,000.00
Less: Outstanding Checks #1469 $1,500.00
1470 102.00 (1,602.00)
True Cash Balance, March 31, 2002 $16,398.00

Unadjusted Book Balance, March 31, $16,868.00


2002
Add: Credit Memo for Collection of
Accounts Receivable 175.00
Less: Error in Recording Check #1468 $630.00
Debit Memo for Service Charges 15.00 (645.00)
True Cash Balance, March 31, 2002 $16,398.00

b.
Account Titles Debit Credit
Cash 175.00
Accounts Receivable 175.00
Equipment 630.00
Cash 630.00
Bank Service Charge Expense 15.00
Cash 15.00

6-55
PROBLEM 6-22B

Assets = Liabiliti + Stockholders’


es Equity
Event Type Commo Retain
Numb of n + ed
er Event Stock Earnin
gs
1. AE +− = NA + NA + NA

2. AS + = NA + NA + +
3. AU − = NA + NA + −
4. AE +− = NA + NA + NA

5. AS + = NA + NA + +

6-56
PROBLEM 6-23B
a.
Account Title Debit Credit
Accounts Receivable 1,500
Cash 1,500

b. The clerk has collected cash from a customer on account.


This required a book entry debiting cash and crediting
accounts receivable. Instead of depositing the money,
the clerk kept the money. Now the cash balance per
books is higher than the cash balance per bank. The
clerk hides the discrepancy by deducting a fictitious NSF
check from the book balance.

c. Separation of Duties. Do not allow the same person to


record transactions, reconcile bank statements, record
adjusting entries and have custody of the money.

6-57
PROBLEM 6-24B
a.
General Journal
Event Account Titles Debit Credit
1. Petty Cash 250
Cash 250
2. No Entry
3. Office Supplies Expense 14
Miscellaneous Expense 25
Meals Expense 75
Transportation Expense 80
Maintenance Expense 22
Cash Short and Over 2
Petty Cash 218
4. Petty Cash 218
Cash 218

b. The shortage is an insignificant amount and will increase


total (miscellaneous) expenses.

c.
Event Type of Event
Number
1. AE
2. No Effect
3. AU
4. AE

6-58
PROBLEM 6-24B (cont.)
d.
Effect of Events on the Financial Statements
No. Assets = Liab + Stk. Rev. − Exp. = Net Cash
. Equity Inc. Flows
Cash + Petty = + Ret. Ear.
Cash
1. (250) + 250 = NA + NA NA − NA = NA NA
2. NA + NA = NA + NA NA − NA = NA NA
3. NA + (218) = NA + (218) NA − 218 = (218) (218) ÒA
4. (218) + 218 = NA + NA NA − NA = NA NA

6-59
PROBLEM 6-25B

Classified Balance Sheet


Assets
Current Assets
Cash $20,000
Accounts Receivable 6,000
Interest Receivable 400
Supplies 900
Inventory 16,000
Prepaid Rent 8,000
Total Current Assets $
51,300
Long-Term Assets
Notes Receivable 10,000
Office Equipment $52,000
Less: Accumulated (10,000) 42,000
Depreciation
Land 90,000
Total Long-Term Assets 142,000
Total Assets $193,30
0

Liabilities and Stockholders’ Equity


Current Liabilities
Accounts Payable $ 1,800
Interest Payable 1,200
Salaries Payable 3,400
Unearned Revenue 16,000
Total Current Liabilities $
22,400
Long-Term Liabilities
Notes Payable 26,900
Total Liabilities 49,300
Stockholders’ Equity
Common Stock 68,000
Retained Earnings 76,000
Total Stockholders’ Equity 144,000

6-60
Total Liab. & Stockholders’
Equity
$193,30
0

6-61
PROBLEM 6-25B (cont.)

Income Statement

Sales Revenue $400,000


Cost of Goods Sold (175,000)
Gross Margin 225,000
Operating Expenses
Operating Expenses $ 34,000
Salaries Expense 154,000
Total Operating (188,000)
Expenses
Operating Income 37,000
Non-Operating Items:
Interest Revenue 800
Gain on Sale of 10,000
Equipment
Interest Expense (5,000) 5,800
Net Income $ 42,800

6-62
ATC 6-1
Financial Statement Analysis

a. The current ratio can be computed from information provided on the balance sheet:

$9,491÷$6,543=1.45 to 1.00

b. Cash and equivalents with accounts receivable in second place.

c. $9,491÷$13,435=71%

d. According to the footnote on “Long-term Debt and Interest Rate Risk Management,”
there were no significant restrictions.

6-63
ATC 6-2

a.1.
The information is analyzed as follows:

Company 1
Significant amount of accounts receivable
Very significant amount of property, plant and equipment
No inventory

This would be Southwest Airlines.

Company 2
Small amount of accounts receivable
Small amount of property, plant and equipment (as compared with the other companies)
Large amount of inventory

This would be Pier I Imports.

Company 3
Significant amount of accounts receivable
Significant amount of property, plant and equipment
Small amount of inventory

This would be Wendy’s.

6-64
ATC 6-2 (cont.)
a.2.
Classified Balance Sheets

Southwest Pier 1 Imports


Airlines Wendy’s

Assets
Current Assets
Cash $ 623,343 $ 32,280 $ 234,262
Accounts Receivable 76,530 4,128 66,755
Inventories -0- 220,013 35,633
Other Current Assets 108,543 29,057 44,904
Total Current Assets 808,416 285,478 381,554

Property, Plant and Equipment


Property, Plant and Equipment 4,811,324 355,015 1,803,410
Less, Allowance for Depr. (1,375,631) (138,179) (537,910)
Total Prop., Plant and Equip. 3,435,693 216,836 1,265,500

Other Long-term Assets 4,051 67,954 294,626

Total Assets $4,248,160 $570,268 $1,941,680

Liabilities and Stockholders’ Equity


Current Liabilities
Accounts Payable $ 160,891 $105,541 $ 107,157
Other Current Liabilities 707,622 4,845 105,457
Total Current Liabilities 868,513 110,386 212,614

Long-term Liabilities 1,370,629 136,834 544,832

Stockholders’ Equity
Common Stock 376,903 204,327 345,019
Retained Earnings 1,632,115 118,721 839,215
Total Stockholders’ Equity 2,009,018 323,048 1,184,234
Total Liab. and Stkholders’ Equity $4,248,160 $570,268 $1,941,680

6-65
ATC 6-2 (cont.)
b.
Some identifying characteristics include the following:
Southwest Airlines:
large amount of property, plant and equipment
no inventories

Pier I Imports
large amount of inventory
small amount of property, plant and equipment

Wendy’s
large amount of property, plant and equipment
small amount of inventory

6-66
ATC 6-3

1. “The Company is responsible for the information presented in this Annual Report...”

This is the management’s acknowledgment that the financial reports and the
accounting practices on which these reports are based, are primarily its responsibility.
Persons not knowledgeable about the role of the independent auditor sometimes
believe the auditor has the primary responsibility for a company’s financial reporting
practices. Although the independent auditor is responsible for conducting a proper
audit and identifying situations when a company’s reporting is not in compliance with
GAAP, the company’s management has the primary responsibility for the reports.

2. “This system is designed to provide reasonable assurance, at suitable costs...”

This is an acknowledgment that no internal control system is foolproof, and that to try
to design such a system would cost more than its value. It does not make sense to
spend $1,000 to prevent a $5 theft. Nevertheless, the management at J. C. Penney
believes its system provides reasonable assurance at a reasonable cost.

3 & 4. “Emphasis is placed on the careful selection, training, and development of professional
managers...”

This acknowledges that a good system of internal controls requires more than
“checking up” on employees. Employees, including management, are less likely to
make mistakes if they have the appropriate ethics and skill when hired, and if they are
properly trained to do the job they are expected to perform. For example, if employees
are formally told what types of activities involving suppliers the company considers to
be unethical, employees are less likely to get themselves and J. C. Penney into trouble
by engaging in unacceptable activities.

6-67
ATC 6-3 (cont.)

5. “...delegation of authority...”

This is an acknowledgment that the top levels of management cannot make all
decisions. A large organization requires that upper management delegate some
decision-making authority to subordinates who have been properly selected and
trained, and these employees must be trusted to do what is in the best interest of the
company.

6. “...division of responsibility...”

This relates to proper separation of duties. The company tries not to place an
employee in a position where he or she can commit a fraud and then conceal that act.
For example, the person with authority to write checks should not be the person
responsible for reconciling the bank statements.

7. “Communication programs are aimed at assuring that established policies and


procedures are disseminated and understood...”

Management has the right and responsibility for establishing the business policies that
will be used at a company. However, if the employees are not properly informed of
these policies, they cannot be expected to follow them. An example of how policies
are communicated throughout an organization would be the use of “procedures
manuals.”

6-68
ATC 6-4

a. Code-Breakers: 1.60 to 1 ($40,000 ÷ $25,000)


Cipher-Tec1.27 to 1 ($70,000 ÷ $55,000)

b. Other things being equal, Code-Breakers would be able to pay its bills, in the short-
run, easier than Cipher-Tec because it has more current assets in relation to current
liabilities.

c. Because Code-Breakers has less of its total assets invested in current assets
($40,000 versus $70,000) it has more assets invested in long-term operational assets.
Thus, one might expect Code-Breakers to have a higher return-on-assets ratio than
Cipher-Tec.

6-69
ATC 6-5

a. Current Assets Stillman Tsay


Cash $15,000 $ 25,000
Merchandise inventory 30,000 55,000
Accounts receivable 35,000 30,000
Totals $80,000 $110,000

Current Liabilities Stillman Tsay


Wages payable $20,000 $ 25,000
Accounts payable 40,000 45,000
Totals $60,000 $ 70,000

Current ratios:
Stillman $ 80,000 ÷ $60,000 = 1.33 to 1.00
Tsay $110,000 ÷ $70,000 = 1.57 to 1.00

b.
Stillman Tsay
Current Assets (see above) $ 80,000 $110,000
Building 80,000 80,000
Land 45,000 50,000
Total Assets $205,000 $240,000

Current Liabilities (see above) $ 60,000 $ 70,000


Notes Payable 90,000 120,000
Total Liabilities $150,000 $190,000

Debt to assets ratios:


Stillman $150,000 ÷ $205,000 = 73.2%
Tsay: $190,000 ÷ $240,000 = 79.2%

c. Based only on the information available in the problem:


Stillman appears to have the higher short-term financial risk, because its current ratio is
lower than Tsay’s.

Tsay appears to have the higher long-term financial risk because its debt to assets ratio is
higher than Stillman’s.

6-70
ATC 6-6

Some of the procedures that should be suggested include:


• Separation of duties.
• Bonded employees.
• Requiring days off and regular vacations.
• Evaluation of the company’s system of internal control.

6-71
ATC 6-7

a. Because the credit was made directly to retained earnings and not recorded as
revenue, the amount would not have appeared on the company’s income statement.

b. Putman unwittingly entered into a criminal conspiracy. Unintentional involvement is a


common feature of white-collar crime. Few people start out with the willful intent to
engage in criminal behavior. They tend to become trapped by circumstances and
pressures that result in gradual involvement into deeper and deeper levels of crime.
The depth of their involvement frequently comes as a surprise. More lying on the part
of Putman is likely to result in even deeper involvement in criminal activity. It is best to
divorce yourself from unethical or illegal activity at the earliest possible time. Putman
is probably better off to tell the truth. She may be able to plea bargain by expressing a
willingness to cooperate in the investigation against Wheeler. The lesson here is not
so much what is illegal or unethical as it is how to avoid becoming unintentionally
involved in illegal or unethical behavior. The avoidance of unintentional involvement is
a recurring theme in the ethics cases presented in the text.

c. In asking Putman to be dishonest by originally subtracting the error from the bank’s
unadjusted trial balance, and later by asking Putman to make a dishonest entry to
adjust the cash account to coincide with the bank’s balance, Mr. Wheeler has proven
himself a person of shady character. Mr. Wheeler is obviously only concerned about
his own self interest. He is not the kind of person one would expect to be loyal.
Unethical behavior is not usually applied on a selective basis. If a person is unethical
in one arena, he can be expected to act the same way in other circumstances.

d. It is not only unethical but also illegal to take the $18,000. The failure to report a
known error to the bank would be considered to be a criminal act of embezzlement.

6-72
ATC 6-8
Using the EDGAR Database

NOTE: This solution was accurate as of December 15, 2001. However, the EDGAR
database is subject to update at any time, so this solution will likely be “dated”
at the time you assign this case to your students.

These data are from the February 3, 2001 financial statements and dollar amounts are in
thousands.

a. Pep Boys current assets were $699,666 and its current liabilities were $590,459.
Thus, its current ratio was 1.19 to 1.00.

b. Merchandise inventory was the current asset with the largest balance. At $547,735 it
comprised 78% of the current assets.

c. Total assets were $1,906,204, so current assets were 37% of total assets.

d. On its balance sheet Pep Boys shows currently maturing long-term debt of $197 ($197
thousand).

e. If Pep Boys were a manufacturer of auto parts, its current assets would probably
represent a smaller percentage of its total assets. This would be the result of it needing
more equipment.

6-73