Chapter Review
8-9fExercises
Sarbanes-Oxley Internal Control Report
OBJ. 1
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Using Wikipedia (www.wikipedia.com), look up the entry for Sarbanes-Oxley Act. Look over the table of contents and find the section that describes Section 404.
What does Section 404 require of management’s internal control report?
Internal Controls
OBJ. 2, 3
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Jimmy Pace has recently been hired as the manager of Jittery Jon’s Coffee Shop. Jittery Jon’s Coffee Shop is a national chain of franchised coffee shops. During his first month as store manager, Jimmy encountered the following internal control situations:
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Jittery Jon’s Coffee Shop has one cash register. Prior to Jimmy’s joining the coffee shop, each employee working on a shift would take a customer order, accept payment, and then prepare the order. Jimmy made one employee on each shift responsible for taking orders and accepting the customer’s payment. Other employees prepare the orders.
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Because only one employee uses the cash register, that employee is responsible for counting the cash at the end of the shift and verifying that the cash in the drawer matches the amount of cash sales recorded by the cash register. Jimmy expects each cashier to balance the drawer to the penny every time—no exceptions.
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Jimmy caught an employee putting a case of 1,000 single-serving tea bags in her car. Not wanting to create a scene, Jimmy smiled and said, “I don’t think you’re putting those tea bags on the right shelf. Don’t they belong inside the coffee shop?” The employee returned the tea bags to the stockroom.
State whether you agree or disagree with Jimmy’s method of handling each situation and explain your answer.
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Internal Controls
OBJ. 2, 3
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Ramona’s Clothing is a retail store specializing in women’s clothing. The store has established a liberal return policy for the holiday season in order to encourage gift purchases. Any item purchased during November and December may be returned through January 31, with a receipt, for cash or exchange. If the customer does not have a receipt, cash will still be refunded for any item under $75. If the item is more than $75, a check is mailed to the customer.
Whenever an item is returned, a store clerk completes a return slip, which the customer signs. The return slip is placed in a special box. The store manager visits the return counter approximately once every two hours to authorize the return slips. Clerks are instructed to place the returned merchandise on the proper rack on the selling floor as soon as possible.
This year, returns at Ramona’s Clothing have reached an all-time high. There are a large number of returns under $75 without receipts.
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How can salesclerks employed at Ramona’s Clothing use the store’s return policy to steal money from the cash register?
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What internal control weaknesses do you see in the return policy that make cash thefts easier?
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Would issuing a store credit in place of a cash refund for all merchandise returned without a receipt reduce the possibility of theft? List some advantages and disadvantages of issuing a store credit in place of a cash refund.
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Assume that Ramona’s Clothing is committed to the current policy of issuing cash refunds without a receipt. What changes could be made in the store’s procedures regarding customer refunds to improve internal control?
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Internal Controls for Bank Lending
OBJ. 2, 3
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Pacific Bank provides loans to businesses in the community through its Commercial Lending Department. Small loans (less than $100,000) may be approved by an individual loan officer, while larger loans (greater than $100,000) must be approved by a board of loan officers. Once a loan is approved, the funds are made available to the loan applicant under agreed-upon terms. Pacific Bank has instituted a policy whereby its president has the individual authority to approve loans up to $5,000,000. The president believes that this policy will allow flexibility to approve loans to valued clients much quicker than under the previous policy.
As an internal auditor of Pacific Bank, how would you respond to this change in policy?
Internal Controls
OBJ. 2, 3
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One of the largest losses in history from unauthorized securities trading involved a securities trader for the French bank Societe Generale. The trader was able to circumvent internal controls and create more than $7 billion in trading losses in six months. The trader apparently escaped detection by using knowledge of the bank’s internal control systems learned from a previous back-office monitoring job. Much of this monitoring involved the use of software to monitor trades. In addition, traders were usually kept to tight trading limits. Apparently, these controls failed in this case.
What general weaknesses in Societe Generale’s internal controls contributed to the occurrence and size of the losses?
Internal Controls
OBJ. 2, 3
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An employee of JHT Holdings, Inc., a trucking company, was responsible for resolving roadway accident claims under $25,000. The employee created fake accident claims and wrote settlement checks of between $5,000 and $25,000 to friends or acquaintances acting as phony “victims.” One friend recruited subordinates at his place of work to cash some of the checks. Beyond this, the JHT employee also recruited lawyers, whom he paid to represent both the trucking company and the fake victims in the bogus accident settlements. When the lawyers cashed the checks, they allegedly split the money with the corrupt JHT employee. This fraud went undetected for two years.
Why would it take so long to discover such a fraud?
Internal Controls
OBJ. 2, 3
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All-Around Sound Co. discovered a fraud whereby one of its front office administrative employees used company funds to purchase goods such as computers, digital cameras, and other electronic items for her own use. The fraud was discovered when employees noticed an increase in the frequency of deliveries from vendors and the use of unusual vendors. After some investigation, it was discovered that the employee would alter the description or change the quantity on an invoice in order to explain the cost on the bill.
What general internal control weaknesses contributed to this fraud?
Financial Statement Fraud
OBJ. 2, 3
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A former chairman, CFO, and controller of Donnkenny, Inc., an apparel company that makes sportswear for Pierre Cardin and Victoria Jones, pleaded guilty to financial statement fraud. These managers used false journal entries to record fictitious sales, hid inventory in public warehouses so that it could be recorded as “sold,” and required sales orders to be backdated so that the sale could be moved to an earlier period. The combined effect of these actions caused $25 million out of $40 million in quarterly sales to be phony.
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Why might control procedures listed in this chapter be insufficient in stopping this type of fraud?
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How could this type of fraud be stopped?
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Internal Control of Cash Receipts
OBJ. 2, 3
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The procedures used for over-the-counter receipts are as follows: At the close of each day’s business, the salesclerks count the cash in their respective cash drawers, after which they determine the amount recorded by the cash register and prepare the memo cash form, noting any discrepancies. An employee from the cashier’s office counts the cash, compares the total with the memo, and takes the cash to the cashier’s office.
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Indicate the weak link in internal control.
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How can the weakness be corrected?
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Internal Control of Cash Receipts
OBJ. 2, 3
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Sergio Flores works at the drive-through window of Big & Bad Burgers. Occasionally, when a drive-through customer orders, Sergio fills the order and pockets the customer’s money. He does not ring up the order on the cash register.
Identify the internal control weaknesses that exist at Big & Bad Burgers and discuss what can be done to prevent this theft.
Internal Control of Cash Receipts
OBJ. 2, 3
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The mailroom employees send all remittances and remittance advices to the cashier. The cashier deposits the cash in the bank and forwards the remittance advices and duplicate deposit slips to the Accounting Department.
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Indicate the weak link in internal control in the handling of cash receipts.
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How can the weakness be corrected?
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Entry for Cash Sales; Cash Short
OBJ. 2, 3
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The actual cash received from cash sales was $25,538, and the amount indicated by the cash register total was $25,670. Journalize the entry to record the cash receipts and cash sales.
Entry for Cash Sales; Cash Over
OBJ. 2, 3
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The actual cash received from cash sales was $66,670, and the amount indicated by the cash register total was $66,341. Journalize the entry to record the cash receipts and cash sales.
Internal Control of Cash Payments
OBJ. 2, 3
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Abbe Co. is a small merchandising company with a manual accounting system. An investigation revealed that in spite of a sufficient bank balance, a significant amount of available cash discounts had been lost because of failure to make timely payments. In addition, it was discovered that the invoices for several purchases had been paid twice.
Outline procedures for the payment of vendors’ invoices so that the possibilities of losing available cash discounts and of paying an invoice a second time will be minimized.
Internal Control of Cash Payments
OBJ. 2, 3
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Paragon Tech Company, a communications equipment manufacturer, recently fell victim to a fraud scheme developed by one of its employees. To understand the scheme, it is necessary to review Paragon Tech’s procedures for the purchase of services.
The purchasing agent is responsible for ordering services (such as repairs to a photocopy machine or office cleaning) after receiving a service requisition from an authorized manager. However, because no tangible goods are delivered, a receiving report is not prepared. When the Accounting Department receives an invoice billing Paragon Tech for a service call, the accounts payable clerk calls the manager who requested the service in order to verify that it was performed.
The fraud scheme involves Mae Jansma, the manager of plant and facilities. Mae arranged for her uncle’s company, Radiate Systems, to be placed on Paragon Tech’s approved vendor list. Mae did not disclose the family relationship.
On several occasions, Mae would submit a requisition for services to be provided by Radiate Systems. However, the service requested was really not needed, and it was never performed. Radiate Systems would bill Paragon Tech for the service and then split the cash payment with Mae.
Explain what changes should be made to Paragon Tech’s procedures for ordering and paying for services in order to prevent such occurrences in the future.
Bank Reconciliation
OBJ. 5
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Identify each of the following reconciling items as: (a) an addition to the cash balance according to the bank statement, (b) a deduction from the cash balance according to the bank statement, (c) an addition to the cash balance according to the company’s records, or (d) a deduction from the cash balance according to the company’s records. (None of the transactions reported by bank debit and credit memos have been recorded by the company.)
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Bank service charges, $90.
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Check of a customer returned by bank to company because of insufficient funds, $520.
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Check for $420 incorrectly recorded by the company as $240.
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Check for $1,440 incorrectly charged by bank as $140.
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Deposit in transit, $5,310.
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Outstanding checks, $10,370.
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Note collected by bank, $12,600.
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OBJ. 5
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Which of the reconciling items listed in Exercise 8-16 require an entry in the company’s accounts?
Bank Reconciliation
OBJ. 5
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The following data were accumulated for use in reconciling the bank account of Nakajima Co. for July:
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Cash balance according to the company’s records at July 31, $49,910.
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Cash balance according to the bank statement at July 31, $48,250.
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Checks outstanding, $4,460.
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Deposit in transit, not recorded by bank, $6,450.
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A check for $590 issued in payment of an account was erroneously recorded in the check register as $950.
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Bank debit memo for service charges, $30.
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Prepare a bank reconciliation, using the format shown in Exhibit 12.
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If the balance sheet is prepared for Nakajima Co. on July 31, what amount should be reported for cash?
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Must a bank reconciliation always balance (reconcile)?
AnswerChecked Figure: Adjusted balance: $50,240
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Entries for Bank Reconciliation
OBJ. 5
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Using the data presented in Exercise 8-18, journalize the entry or entries that should be made by the company.
Entries for Note Collected by Bank
OBJ. 5
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Accompanying a bank statement for Santee Company is a credit memo for $15,120 representing the principal ($14,000) and interest ($1,120) on a note that had been collected by the bank. The company had been notified by the bank at the time of the collection but had made no entries. Journalize the entry that should be made by the company to bring the accounting records up to date.
Bank Reconciliation
OBJ. 5
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An accounting clerk for Chesner Co. prepared the following bank reconciliation:
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From the data in this bank reconciliation, prepare a new bank reconciliation for Chesner Co., using the format shown in Exhibit 12.
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If a balance sheet is prepared for Chesner Co. on August 31, what amount should be reported for cash?
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Bank Reconciliation
OBJ. 5
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The following June 30 bank reconciliation was prepared for Poway Co.
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Identify the errors in the bank reconciliation.
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Prepare a new bank reconciliation for Poway Co., using the format shown in the illustrative problem.
AnswerChecked Figure: Corrected adjusted balance: $19,780
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Using Bank Reconciliation to Determine Cash Receipts Stolen
OBJ. 2, 3, 5
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Alaska Impressions Co. records all cash receipts on the basis of its cash register tapes. Alaska Impressions Co. discovered during October that one of its salesclerks had stolen an undetermined amount of cash receipts while taking the daily deposits to the bank. The following data have been gathered for October:
Cash in bank according to the general ledger $11,680 Cash according to the October 31 bank statement 13,275 Outstanding checks as of October 31 3,670 Bank service charge for October 40 Note receivable, including interest collected by bank in October 2,100 No deposits were in transit on October 31.
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Determine the amount of cash receipts stolen by the salesclerk.
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What accounting controls would have prevented or detected this theft?
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Petty Cash Fund Entries
OBJ. 6
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Journalize the entries to record the following:
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Check is issued to establish a petty cash fund of $1,290.
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The amount of cash in the petty cash fund is now $303. Check is issued to replenish the fund, based on the following summary of petty cash receipts: office supplies, $427; miscellaneous selling expense, $365; miscellaneous administrative expense, $165. If the amount of the check to replenish the fund plus the balance in the fund do not equal $1,290, record the discrepancy in the cash short and over account.
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Variation in Cash Flows
OBJ. 7
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Hasbro, Inc., designs, manufactures, and markets toy products worldwide. Hasbro’s toys include Monopoly®, My Little Pony®, and Nerf brands. For a recent year, Hasbro reported the following net cash flows from operating activities (in thousands):
Explain why Hasbro reported negative net cash flows from operating activities during the second and third quarters and a large positive cash flow for the fourth quarter, with overall net positive cash flow for the year.
OBJ. 8
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El Dorado Inc. has monthly cash expenses of $168,500. On December 31, the cash balance is $1,415,400.
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Compute the ratio of cash to monthly cash expenses.
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Based on (a), what are the implications for El Dorado Inc.?
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Cash to Monthly Cash Expenses Ratio
OBJ. 8
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Capstone Turbine Corporation produces and sells turbine generators for such applications as charging electric, hybrid vehicles. Capstone Turbine reported the following financial data for a recent year (in thousands):
Cash to Monthly Cash Expenses Ratio
OBJ. 8
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Amicus Therapeutics, Inc., is a biopharmaceutical company that develops drugs for the treatment of various diseases, including Parkinson’s disease. Amicus Therapeutics reported the following financial data (in thousands) for three recent years:
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Determine the monthly cash expenses for Year 3, Year 2, and Year 1. Round to one decimal place.
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Determine the ratio of cash to monthly cash expenses for Year 3, Year 2, and Year 1 as of December 31. Round to one decimal place.
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Based on (a) and (b), comment on Amicus Therapeutics’ ratio Amicus Therapeutics’
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of cash to monthly operating expenses for Years 1, 2, and 3.
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