As the Feature Story about recording sales at Nick’s Steakhouse and Pizza indicates, control of cash is important to ensure that fraud does not occur. Companies also need controls to safeguard other types of assets. For example, Nick’s undoubtedly has controls to prevent the theft of food and supplies, and controls to prevent the theft of tableware and dishes from its kitchen.

In this chapter, we explain the essential features of an internal control system and how it prevents fraud. We also describe how those controls apply to a specific asset—cash. The applications include some controls with which you may be already familiar, such as the use of a bank.

The content and organization of Chapter 7 are as follows.

The Navigator

Fraud and Internal Control

Learning Objective 1

Define fraud and internal control.

The Feature Story describes many of the internal control procedures used by Nick’s Steakhouse and Pizza (CAN). These procedures are necessary to discourage employees from fraudulent activities.

Fraud

A fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Examples of fraud reported in the financial press include the following.

• A bookkeeper in a small company diverted $750,000 of bill payments to a personal bank account over a three-year period.
• A shipping clerk with 28 years of service shipped $125,000 of merchandise to himself.
• A computer operator embezzled $21 million from a major bank over a two-year period.
• A church treasurer “borrowed” $150,000 of church funds to finance a friend’s business dealings.

Why does fraud occur? The three main factors that contribute to fraudulent activity are depicted by the fraud triangle in Illustration 7-1 (in the margin).

The most important element of the fraud triangle is opportunity. For an employee to commit fraud, the workplace environment must provide opportunities that an employee can take advantage of. Opportunities occur when the workplace lacks sufficient controls to deter and detect fraud. For example, inadequate monitoring of employee actions can create opportunities for theft and can embolden employees because they believe they will not be caught.

A second factor that contributes to fraud is financial pressure. Employees sometimes commit fraud because of personal financial problems caused by too much debt. Or, they might commit fraud because they want to lead a lifestyle that they cannot afford on their current salary.

The third factor that contributes to fraud is rationalization. In order to justify their fraud, employees rationalize their dishonest actions. For example, employees sometimes justify fraud because they believe they are underpaid while the employer is making lots of money. Employees feel justified in stealing because they believe they deserve to be paid more.

Internal Control

Internal control is a process designed to provide reasonable assurance regarding the achievement of objectives related to operations, reporting, and compliance. In more detail, it consists of all the related methods and measures adopted within an organization to safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations. Internal control systems have five primary components as listed below.¹

• A control environment. It is the responsibility of top management to make it clear that the organization values integrity and that unethical activity will not be tolerated. This component is often referred to as the “tone at the top.”
• Risk assessment. Companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks.
• Control activities. To reduce the occurrence of fraud, management must design policies and procedures to address the specific risks faced by the company.
• Information and communication. The internal control system must capture and communicate all pertinent information both down and up the organization, as well as communicate information to appropriate external parties.
• Monitoring. Internal control systems must be monitored periodically for their adequacy. Significant deficiencies need to be reported to top management and/or the board of directors.

Principles of Internal Control Activities

Learning Objective 2

Identify the principles of internal control activities.

Each of the five components of an internal control system is important. Here, we will focus on one component, the control activities. The reason? These activities are the backbone of the company’s efforts to address the risks it faces, such as fraud. The specific control activities used by a company will vary, depending on management’s assessment of the risks faced. This assessment is heavily influenced by the size and nature of the company.

The six principles of control activities are as follows.

• Establishment of responsibility
• Segregation of duties
• Documentation procedures
• Physical controls
• Independent internal verification
• Human resource controls

We explain these principles in the following sections. You should recognize that they apply to most companies and are relevant to both manual and computerized accounting systems.

ESTABLISHMENT OF RESPONSIBILITY

An essential principle of internal control is to assign responsibility to specific employees. Control is most effective when only one person is responsible for a given task.

To illustrate, assume that the cash on hand at the end of the day in a Citysuper (HKG) supermarket in Taipei, Taiwan is NT$300 short of the cash entered in the cash register. If only one person has operated the register, the shift manager can quickly determine responsibility for the shortage. If two or more individuals have worked the register, it may be impossible to determine who is responsible for the error. In the Feature Story, the principle of establishing responsibility is applied at Nick’s Steakhouse and Pizza for operating a terminal in the point-of-sale system in any given shift.

Establishing responsibility often requires limiting access only to authorized personnel, and then identifying those personnel. For example, the automated systems used by many companies have mechanisms such as identifying passcodes that keep track of who made a journal entry, who entered a sale, or who went into an inventory storeroom at a particular time. Use of identifying passcodes enables the company to establish responsibility by identifying the particular employee who carried out the activity.

SEGREGATION OF DUTIES

Segregation of duties is indispensable in an internal control system. There are two common applications of this principle:

1. Different individuals should be responsible for related activities.
2. The responsibility for recordkeeping for an asset should be separate from the physical custody of that asset.

The rationale for segregation of duties is this: The work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee. For example, the personnel that design and program computerized systems should not be assigned duties related to day-to-day use of the system. Otherwise, they could design the system to benefit them personally and conceal the fraud through day-to-day use.

SEGREGATION OF RELATED ACTIVITIES Making one individual responsible for related activities increases the potential for errors and irregularities. Instead, companies should, for example, assign related purchasing activities to different individuals. Related purchasing activities include ordering merchandise, order approval, receiving goods, authorizing payment, and paying for goods or services. Various frauds are possible when one person handles related purchasing activities:

• If a purchasing agent is allowed to order goods without obtaining supervisory approval, the likelihood of the purchasing agent receiving kickbacks from suppliers increases.
• If an employee who orders goods also handles the invoice and receipt of the goods, as well as payment authorization, he or she might authorize payment for a fictitious invoice.

These abuses are less likely to occur when companies divide the purchasing tasks.

Similarly, companies should assign related sales activities to different individuals. Related selling activities include making a sale, shipping (or delivering) the goods to the customer, billing the customer, and receiving payment. Various frauds are possible when one person handles related sales transactions:

• If a salesperson can make a sale without obtaining supervisory approval, he or she might make sales at unauthorized prices to increase sales commissions.
• A shipping clerk who also has access to accounting records could ship goods to himself.
• A billing clerk who handles billing and receipt could understate the amount billed for sales made to friends and relatives.

These abuses are less likely to occur when companies divide the sales tasks. The salespeople make the sale, the shipping department ships the goods on the basis of the sales order, and the billing department prepares the sales invoice after comparing the sales order with the report of goods shipped.

SEGREGATION OF RECORDKEEPING FROM PHYSICAL CUSTODY The accountant should have neither physical custody of the asset nor access to it. Likewise, the custodian of the asset should not maintain or have access to the accounting records. The custodian of the asset is not likely to convert the asset to personal use when one employee maintains the record of the asset, and a different employee has physical custody of the asset. The separation of accounting responsibility from the custody of assets is especially important for cash and inventories because these assets are very vulnerable to fraud.

DOCUMENTATION PROCEDURES

Documents provide evidence that transactions and events have occurred. At Nick’s Steakhouse and Pizza, the point-of-sale system provides the restaurant’s documentation for the sale and the amount of cash received. Similarly, for other businesses, a shipping document indicates that the goods have been shipped, and a sales invoice indicates that the company has billed the customer for the goods. By requiring signatures (or initials) on the documents, the company can identify the individual(s) responsible for the transaction or event. Companies should document transactions when they occur.

Companies should establish procedures for documents. First, whenever possible, companies should use prenumbered documents, and all documents should be accounted for. Prenumbering helps to prevent a transaction from being recorded more than once, or conversely, from not being recorded at all. Second, the control system should require that employees promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records.

PHYSICAL CONTROLS

Use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. Illustration 7-2 shows examples of these controls.

INDEPENDENT INTERNAL VERIFICATION

Most internal control systems provide for independent internal verification. This principle involves the review of data prepared by employees. To obtain maximum benefit from independent internal verification:

1. Companies should verify records periodically or on a surprise basis.
2. An employee who is independent of the personnel responsible for the information should make the verification.
3. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action.

Independent internal verification is especially useful in comparing recorded accountability with existing assets. The reconciliation of the amount of cash recorded by the point-of-sale system with the cash in a particular terminal at Nick’s Steakhouse and Pizza is an example of this internal control principle. Other common examples are the reconciliation of a company’s cash balance per books with the cash balance per bank, and the verification of the perpetual inventory records through a count of physical inventory. Illustration 7-3 shows the relationship between this principle and the segregation of duties principle.

Large companies often assign independent internal verification to internal auditors. Internal auditors are company employees who continuously evaluate the effectiveness of the company’s internal control systems. They review the activities of departments and individuals to determine whether prescribed internal controls are being followed. They also recommend improvements when needed. In fact, most fraud is discovered by the company through internal mechanisms such as existing internal controls and internal audits. For example, the fraud at WorldCom (USA), involving billions of dollars, was uncovered by an internal auditor.

HUMAN RESOURCE CONTROLS

Human resource control activities include the following.

1. Bond employees who handle cash. Bonding involves obtaining insurance protection against theft by employees. It contributes to the safeguarding of cash in two ways. First, the insurance company carefully screens all individuals before adding them to the policy and may reject risky applicants. Second, bonded employees know that the insurance company will vigorously prosecute all offenders.
2. Rotate employees’ duties and require employees to take vacations. These measures deter employees from attempting thefts since they will not be able to permanently conceal their improper actions. Many banks, for example, have discovered employee thefts when the employee was on vacation or assigned to a new position.
3. Conduct thorough background checks. Many believe that the most important and inexpensive measure any business can take to reduce employee theft and fraud is for the human resources department to conduct thorough background checks. Two tips: (1) Check to see whether job applicants actually graduated from the schools they list. (2) Never use the telephone numbers for previous employers provided by the applicant. Always look them up yourself.

Limitations of Internal Control

Companies generally design their systems of internal control to provide reasonable assurance of proper safeguarding of assets and reliability of the accounting records. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit.

• HELPFUL HINT
Controls may vary with the risk level of the activity. For example, management may consider cash to be high risk and maintaining inventories in the stockroom as low risk. Thus, management would have stricter controls for cash.

To illustrate, consider shoplifting losses in retail stores. Stores could eliminate such losses by having a security guard stop and search customers as they leave the store. But store managers have concluded that the negative effects of such a procedure cannot be justified. Instead, they have attempted to control shoplifting losses by less costly procedures. They post signs saying, “We reserve the right to inspect all packages” and “All shoplifters will be prosecuted.” They use hidden cameras and store detectives to monitor customer activity, and they install sensor equipment at exits.

The human element is an important factor in every system of internal control. A good system can become ineffective as a result of employee fatigue, carelessness, or indifference. For example, a receiving clerk may not bother to count goods received and may just “fudge” the counts. Occasionally, two or more individuals may work together to get around prescribed controls. Such collusion can significantly reduce the effectiveness of a system, eliminating the protection offered by segregation of duties. No system of internal control is perfect.

The size of the business also may impose limitations on internal control. Small companies often find it difficult to segregate duties or to provide for independent internal verification.

Cash Controls

Learning Objective 3

Explain the applications of internal control principles to cash receipts.

Cash is the one asset that is readily convertible into any other type of asset. It also is easily concealed and transported, and is highly desired. Because of these characteristics, cash is the asset most susceptible to fraudulent activities. In addition, because of the large volume of cash transactions, numerous errors may occur in executing and recording them. To safeguard cash and to ensure the accuracy of the accounting records for cash, effective internal control over cash is critical.

Cash Receipts Controls

Illustration 7-4 (page 340) shows how the internal control principles explained earlier apply to cash receipts transactions. As you might expect, companies vary considerably in how they apply these principles. To illustrate internal control over cash receipts, we will examine control activities for a retail store with both over-the-counter and mail receipts.

OVER-THE-COUNTER RECEIPTS

In retail businesses, control of over-the-counter receipts centers on cash registers that are visible to customers. A cash sale is entered in a cash register (or point-of-sale terminal), with the amount clearly visible to the customer. This activity prevents the sales clerk from entering a lower amount and pocketing the difference. The customer receives an itemized cash register receipt slip and is expected to count the change received. The cash register’s tape is locked in the register until a supervisor removes it. This tape accumulates the daily transactions and totals.

At the end of the clerk’s shift, the clerk counts the cash and sends the cash and the count to the cashier. The cashier counts the cash, prepares a deposit slip, and deposits the cash at the bank. The cashier also sends a duplicate of the deposit slip to the accounting department to indicate cash received. The supervisor removes the cash register tape and sends it to the accounting department as the basis for a journal entry to record the cash received. (For point-of-sale systems, the accounting department receives information on daily transactions and totals through the computer network.) Illustration 7-5 summarizes this process.

This system for handling cash receipts uses an important internal control principle—segregation of recordkeeping from physical custody. The supervisor has access to the cash register tape but not to the cash. The clerk and the cashier have access to the cash but not to the register tape. In addition, the cash register tape provides documentation and enables independent internal verification. Use of these three principles of internal control (segregation of recordkeeping from physical custody, documentation, and independent internal verification) provides an effective system of internal control. Any attempt at fraudulent activity should be detected unless there is collusion among the employees.

In some instances, the amount deposited at the bank will not agree with the cash recorded in the accounting records based on the cash register tape. These differences often result because the clerk hands incorrect change back to the retail customer. In this case, the difference between the actual cash and the amount reported on the cash register tape is reported in a Cash Over and Short account. For example, suppose that the cash register tape indicated sales of $6,956.20 but the amount of cash was only $6,946.10. A cash shortfall of $10.10 exists. To account for this cash shortfall and related cash, the company makes the following entry.

Cash Over and Short is an income statement item. It is reported as miscellaneous expense when there is a cash shortfall, and as miscellaneous revenue when there is an overage. Clearly, the amount should be small. Any material amounts in this account should be investigated.

MAIL RECEIPTS

All mail receipts should be opened in the presence of at least two mail clerks. These receipts are generally in the form of checks. A mail clerk should endorse each check “For Deposit Only.” This restrictive endorsement reduces the likelihood that someone could divert the check to personal use. Banks will not give an individual cash when presented with a check that has this type of endorsement.

The mail clerks prepare, in triplicate, a list of the checks received each day. This list shows the name of the check issuer, the purpose of the payment, and the amount of the check. Each mail clerk signs the list to establish responsibility for the data. The original copy of the list, along with the checks, is then sent to the cashier’s department. A copy of the list is sent to the accounting department for recording in the accounting records. The clerks also keep a copy.

This process provides excellent internal control for the company. By employing at least two clerks, the chance of fraud is reduced. Each clerk knows he or she is being observed by the other clerk(s). To engage in fraud, they would have to collude. The customers who submit payments also provide control because they will contact the company with a complaint if they are not properly credited for payment. Because the cashier has access to the cash but not the records, and the accounting department has access to the records but not the cash, neither can engage in undetected fraud.

Cash Disbursements Controls

Learning Objective 4

Explain the applications of internal control principles to cash disbursements.

Companies disburse cash for a variety of reasons, such as to pay expenses and liabilities or to purchase assets. Generally, internal control over cash disbursements is more effective when companies pay by check or electronic funds transfer (EFT) rather than by cash. One exception is payments for incidental amounts that are paid out of petty cash.²

Companies generally issue checks only after following specified control procedures. Illustration 7-6 shows how principles of internal control apply to cash disbursements.

VOUCHER SYSTEM CONTROLS

Most medium and large companies use vouchers as part of their internal control over cash disbursements. A voucher system is a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper.

The system begins with the authorization to incur a cost or expense. It ends with the issuance of a check for the liability incurred. A voucher is an authorization form prepared for each expenditure. Companies require vouchers for all types of cash disbursements except those from petty cash.

The starting point in preparing a voucher is to fill in the appropriate information about the liability on the face of the voucher. The vendor’s invoice provides most of the needed information. Then, an employee in the accounts payable department records the voucher (in a journal called a voucher register) and files it according to the date on which it is to be paid. The company issues and sends a check on that date, and stamps the voucher “paid.” The paid voucher is sent to the accounting department for recording (in a journal called the check register). A voucher system involves two journal entries, one to record the liability when the voucher is issued and a second to pay the liability that relates to the voucher.

The use of a voucher system, whether done manually or electronically, improves internal control over cash disbursements. First, the authorization process inherent in a voucher system establishes responsibility. Each individual has responsibility to review the underlying documentation to ensure that it is correct. In addition, the voucher system keeps track of the documents that back up each transaction. By keeping these documents in one place, a supervisor can independently verify the authenticity of each transaction. Consider, for example, the case of Aesop University presented on page 333. Aesop did not use a voucher system for transactions under $2,500. As a consequence, there was no independent verification of the documents, which enabled the employee to submit fake invoices to hide his unauthorized purchases.

Petty Cash Fund Controls

Learning Objective 5

Describe the operation of a petty cash fund.

As you just learned, better internal control over cash disbursements is possible when companies make payments by check. However, using checks to pay small amounts is both impractical and a nuisance. For instance, a company would not want to write checks to pay for postage due, working lunches, or taxi fares. A common way of handling such payments, while maintaining satisfactory control, is to use a petty cash fund to pay relatively small amounts. The operation of a petty cash fund, often called an imprest system, involves (1) establishing the fund, (2) making payments from the fund, and (3) replenishing the fund.³

ESTABLISHING THE PETTY CASH FUND

Two essential steps in establishing a petty cash fund are (1) appointing a petty cash custodian who will be responsible for the fund, and (2) determining the size of the fund. Ordinarily, a company expects the amount in the fund to cover anticipated disbursements for a three- to four-week period.

To establish the fund, a company issues a check payable to the petty cash custodian for the stipulated amount. For example, if Zhū Ltd. decides to establish a NT$3,000 fund on March 1, the general journal entry is as follows.

The fund custodian cashes the check and places the proceeds in a locked petty cash box or drawer. Most petty cash funds are established on a fixed-amount basis. The company will make no additional entries to the Petty Cash account unless management changes the stipulated amount of the fund. For example, if Zhū Ltd. decides on July 1 to increase the size of the fund to NT$7,500, it would debit Petty Cash NT$4,500 and credit Cash NT$4,500.

MAKING PAYMENTS FROM THE PETTY CASH FUND

The petty cash custodian has the authority to make payments from the fund that conform to prescribed management policies. Usually, management limits the size of expenditures that come from petty cash. Likewise, it may not permit use of the fund for certain types of transactions (such as making short-term loans to employees).

• HELPFUL HINT
The petty cash receipt satisfies two internal control procedures:

1. establishing responsibility (signature of custodian), and
2. documentation procedures.

Each payment from the fund must be documented on a prenumbered petty cash receipt (or petty cash voucher), as shown in Illustration 7-7. The signatures of both the fund custodian and the person receiving payment are required on the receipt. If other supporting documents such as a freight bill or invoice are available, they should be attached to the petty cash receipt.

The petty cash custodian keeps the receipts in the petty cash box until the fund is replenished. The sum of the petty cash receipts and the money in the fund should equal the established total at all times. Management can (and should) make surprise counts at any time to determine whether the fund is being maintained correctly.

The company does not make an accounting entry to record a payment when it is made from petty cash. It is considered both inexpedient and unnecessary to do so. Instead, the company recognizes the accounting effects of each payment when it replenishes the fund.

REPLENISHING THE PETTY CASH FUND

When the money in the petty cash fund reaches a minimum level, the company replenishes the fund. The petty cash custodian initiates a request for reimbursement. The individual prepares a schedule (or summary) of the payments that have been made and sends the schedule, supported by petty cash receipts and other documentation, to the treasurer’s office. The treasurer’s office examines the receipts and supporting documents to verify that proper payments from the fund were made. The treasurer then approves the request and issues a check to restore the fund to its established amount. At the same time, all supporting documentation is stamped “paid” so that it cannot be submitted again for payment.

To illustrate, assume that on March 15 Zhū Ltd.’s petty cash custodian requests a check for NT$2,610. The fund contains NT$390 cash and petty cash receipts for postage NT$1,320, freight-out NT$1,140, and miscellaneous expenses NT$150. The general journal entry to record the check is as follows.

Note that the reimbursement entry does not affect the Petty Cash account. Replenishment changes the composition of the fund by replacing the petty cash receipts with cash. It does not change the balance in the fund.

Occasionally, in replenishing a petty cash fund, the company may need to recognize a cash shortage or overage. This results when the total of the cash plus receipts in the petty cash box does not equal the established amount of the petty cash fund. To illustrate, assume that Zhū’s petty cash custodian has only NT$360 in cash in the fund plus the receipts as listed. The request for reimbursement would therefore be for NT$2,640, and Zhū would make the following entry.

Conversely, if the custodian has NT$420 in cash, the reimbursement request would be for NT$2,580. The company would credit Cash Over and Short for NT$30 (overage). A company reports a debit balance in Cash Over and Short in the income statement as miscellaneous expense. It reports a credit balance in the account as miscellaneous revenue. The company closes Cash Over and Short to Income Summary at the end of the year.

• HELPFUL HINT
Cash over and short situations result from mathematical errors or from failure to keep accurate records.

Companies should replenish a petty cash fund at the end of the accounting period, regardless of the cash in the fund. Replenishment at this time is necessary in order to recognize the effects of the petty cash payments on the financial statements.

Control Features: Use of a Bank

Learning Objective 6

Indicate the control features of a bank account.

The use of a bank contributes significantly to good internal control over cash. A company safeguards its cash by using a bank as a depository and as a clearing house for checks received and written. Use of a bank minimizes the amount of currency that a company must keep on hand. Also, use of a bank facilitates the control of cash because it creates a double record of all bank transactions—one by the company and the other by the bank. The asset account Cash maintained by the company should have the same balance as the bank’s liability account for that company. A bank reconciliation compares the bank’s balance with the company’s balance and explains any differences to make them agree.

Many companies have more than one bank account. For efficiency of operations and better control, national retailers like Marks and Spencer plc (GBR) may have regional bank accounts. Large companies, with tens of thousands of employees, may have a payroll bank account, as well as one or more general bank accounts. Also, a company may maintain several bank accounts in order to have more than one source for short-term loans when needed.

Making Bank Deposits

An authorized employee, such as the head cashier, should make a company’s bank deposits. Each deposit must be documented by a deposit slip (ticket), as shown in Illustration 7-8.

Deposit slips are prepared in duplicate. The bank retains the original; the depositor keeps the duplicate, machine-stamped by the bank to establish its authenticity.

Writing Checks

A check is a written order signed by the depositor directing the bank to pay a specified sum of money to a designated recipient. There are three parties to a check: (1) the maker (or drawer) who issues the check, (2) the bank (or payer) on which the check is drawn, and (3) the payee to whom the check is payable. A check is a negotiable instrument that one party can transfer to another party by endorsement. Each check should be accompanied by an explanation of its purpose. In many companies, a remittance advice attached to the check, as shown in Illustration 7-9, explains the check’s purpose.

It is important to know the balance in the checking account at all times. To keep the balance current, the depositor should enter each deposit and check on running-balance memo forms (or online statements) provided by the bank or on the check stubs in the checkbook.

Bank Statements

If you have a personal checking account, you are probably familiar with bank statements. A bank statement shows the depositor’s bank transactions and balances.⁴ Each month, a depositor receives a statement from the bank. Illustration 7-10 presents a typical bank statement. It shows (1) checks paid and other debits (such as debit card transactions or direct withdrawals for bill payments) that reduce the balance in the depositor’s account, (2) deposits and other credits that increase the balance in the depositor’s account, and (3) the account balance after each day’s transactions.

• HELPFUL HINT
Essentially, the bank statement is a copy of the bank’s records sent to the customer (or available online) for review.

• HELPFUL HINT
The bank credits to the customer’s account every deposit it receives. The reverse occurs when the bank “pays” a check issued by a company on its checking account balance. Payment reduces the bank’s liability. Thus, the bank debits check payments to the customer’s account with the bank.

The bank statement lists in numerical sequence all “paid” checks, along with the date the check was paid and its amount. Upon paying a check, the bank stamps the check “paid”; a paid check is sometimes referred to as a canceled check. On the statement, the bank also includes memoranda explaining other debits and credits it made to the depositor’s account.

DEBIT MEMORANDUM

Some banks charge a monthly fee for their services. Often, they charge this fee only when the average monthly balance in a checking account falls below a specified amount. They identify the fee, called a bank service charge, on the bank statement by a symbol such as SC. The bank also sends with the statement a debit memorandum explaining the charge noted on the statement. Other debit memoranda may also be issued for other bank services such as the cost of printing checks, issuing traveler’s checks, and wiring funds to other locations. The symbol DM is often used for such charges.

Banks also use a debit memorandum when a deposited check from a customer “bounces” because of insufficient funds. For example, assume that J. R. Baron, a customer of Laird Company plc, sends a check for £425.60 to Laird for services performed. Unfortunately, Baron does not have sufficient funds at its bank to pay for these services. In such a case, Baron’s bank marks the check NSF (not sufficient funds) and returns it to Laird’s (the depositor’s) bank. Laird’s bank then debits Laird’s account, as shown by the symbol NSF on the bank statement in Illustration 7-10. The bank sends the NSF check and debit memorandum to Laird as notification of the charge. Laird then records an Account Receivable from J. R. Baron (the writer of the bad check) and reduces cash for the NSF check.

CREDIT MEMORANDUM

Sometimes a depositor asks the bank to collect its notes receivable. In such a case, the bank will credit the depositor’s account for the cash proceeds of the note. This is illustrated by the symbol CM on the Laird Company bank statement. The bank issues and sends with the statement a credit memorandum to explain the entry. Many banks also offer interest on checking accounts. The interest earned may be indicated on the bank statement by the symbol CM or INT.

Reconciling the Bank Account

Learning Objective 7

Prepare a bank reconciliation.

The bank and the depositor maintain independent records of the depositor’s checking account. People tend to assume that the respective balances will always agree. In fact, the two balances are seldom the same at any given time, and both balances differ from the “correct” or “true” balance. Therefore, it is necessary to make the balance per books and the balance per bank agree with the correct or true amount—a process called reconciling the bank account. The need for agreement has two causes:

1. Time lags that prevent one of the parties from recording the transaction in the same period as the other party.
2. Errors by either party in recording transactions.

Time lags occur frequently. For example, several days may elapse between the time a company mails a check to a payee and the date the bank pays the check. Similarly, when the depositor uses the bank’s night depository to make its deposits, there will be a difference of at least one day between the time the depositor records the deposit and the time the bank does so. A time lag also occurs whenever the bank mails a debit or credit memorandum to the depositor.

The incidence of errors depends on the effectiveness of the internal controls of the depositor and the bank. Bank errors are infrequent. However, either party could accidentally record a £450 check as £45 or £540. In addition, the bank might mistakenly charge a check to a wrong account by keying in an incorrect account name or number.

RECONCILIATION PROCEDURE

The bank reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash. If a company fails to follow this internal control principle of independent internal verification, cash embezzlements may go unnoticed. For example, a cashier who prepares the reconciliation can embezzle cash and conceal the embezzlement by misstating the reconciliation. Thus, the bank accounts would reconcile, and the embezzlement would not be detected.

In reconciling the bank account, it is customary to reconcile the balance per books and balance per bank to their adjusted (correct or true) cash balances. The starting point in preparing the reconciliation is to enter the balance per bank statement and the balance per books on the reconciliation schedule. The company then makes various adjustments, as shown in Illustration 7-11.

The following steps should reveal all the reconciling items that cause the difference between the two balances.

• HELPFUL HINT
Deposits in transit and outstanding checks are reconciling items because of time lags.

1. Step 1. Deposits in transit. Compare the individual deposits listed on the bank statement with deposits in transit from the preceding bank reconciliation and with the deposits per company records or duplicate deposit slips. Deposits recorded by the depositor that have not been recorded by the bank are the deposits in transit. Add these deposits to the balance per bank.
2. Step 2. Outstanding checks. Compare the paid checks shown on the bank statement with (a) checks outstanding from the previous bank reconciliation, and (b) checks issued by the company as recorded in the cash payments journal (or in the check register in your personal checkbook). Issued checks recorded by the company but that have not yet been paid by the bank are outstanding checks. Deduct outstanding checks from the balance per bank.
3. Step 3. Errors. Note any errors discovered in the foregoing steps and list them in the appropriate section of the reconciliation schedule. For example, if the company mistakenly recorded as £169 a paid check correctly written for £196, it would deduct the error of £27 from the balance per books. All errors made by the depositor are reconciling items in determining the adjusted cash balance per books. In contrast, all errors made by the bank are reconciling items in determining the adjusted cash balance per bank.
4. Step 4. Bank memoranda. Trace bank memoranda to the depositor’s records. List in the appropriate section of the reconciliation schedule any unrecorded memoranda. For example, the company would deduct from the balance per books a £5 debit memorandum for bank service charges. Similarly, it would add to the balance per books £32 of interest earned.

BANK RECONCILIATION ILLUSTRATED

The bank statement for Laird Company plc in Illustration 7-10 (page 349) shows a balance per bank of £15,907.45 on April 30, 2017. On this date the balance of cash per books is £11,589.45. Using the four reconciliation steps, Laird determines the following reconciling items.

• HELPFUL HINT
Note in the bank statement in Illustration 7-10 that checks no. 459 and 461 have been paid but check no. 460 is not listed. Thus, this check is outstanding. If a complete bank statement were shown, checks no. 453 and 457 would also not be listed. The amounts for these three checks are obtained from the company’s cash payments records.

Illustration 7-12 shows Laird’s bank reconciliation.

• HELPFUL HINT
The entries that follow are adjusting entries. In prior chapters, Cash was an account that did not require adjustment. That was a simplifying assumption for learning purposes because we had not yet explained a bank reconciliation.

• Alternative Terminology
The terms adjusted cash balance, true cash balance, and correct cash balance are used interchangeably.

ENTRIES FROM BANK RECONCILIATION

The company records each reconciling item used to determine the adjusted cash balance per books. If the company does not journalize and post these items, the Cash account will not show the correct balance. Laird Company plc would make the following entries on April 30.

COLLECTION OF NOTE RECEIVABLE This entry involves four accounts. Assuming that the interest of £50 has not been accrued and the collection fee is charged to Miscellaneous Expense, the entry is:

BOOK ERROR The cash disbursements journal shows that check no. 443 was a payment on account to Andrea Company, a supplier. The correcting entry is:

NSF CHECK As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is:

BANK SERVICE CHARGES Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense because they are usually nominal in amount. The entry is:

Instead of making four separate entries, Laird could combine them into one compound entry.

After Laird has posted the entries, the Cash account will show the following.

The adjusted cash balance in the ledger should agree with the adjusted cash balance per books in the bank reconciliation in Illustration 7-12.

What entries does the bank make? If the company discovers any bank errors in preparing the reconciliation, it should notify the bank. The bank then can make the necessary corrections in its records. The bank does not make any entries for deposits in transit or outstanding checks. Only when these items reach the bank will the bank record these items.

Electronic Funds Transfer (EFT) System

It is not surprising that companies and banks have developed approaches to transfer funds among parties without the use of paper (deposit tickets, checks, etc.). Such procedures, called electronic funds transfers (EFT), are disbursement systems that use wire, telephone, or computers to transfer cash balances from one location to another. Use of EFT is quite common. For example, many employees receive no formal payroll checks from their employers. Instead, employers send electronic payroll data to the appropriate banks. Also, individuals now frequently make regular payments such as those for house, car, and utilities by EFT.

EFT transfers normally result in better internal control since no cash or checks are handled by company employees. This does not mean that opportunities for fraud are eliminated. In fact, the same basic principles related to internal control apply to EFT transactions. For example, without proper segregation of duties and authorizations, an employee might be able to redirect electronic payments into a personal bank account and conceal the theft with fraudulent accounting entries.

Reporting Cash

Learning Objective 8

Explain the reporting of cash.

Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository. Companies report cash in two different statements: the statement of financial position and the statement of cash flows. The statement of financial position reports the amount of cash available at a given point in time. The statement of cash flows shows the sources and uses of cash during a period of time. The statement of cash flows was introduced in Chapter 1 and will be discussed in much detail in Chapter 13. In this section, we discuss some important points regarding the presentation of cash in the statement of financial position.

When presented in a statement of financial position, cash on hand, cash in banks, and petty cash are often combined and reported simply as Cash. Because it is the most liquid asset owned by the company, cash is listed last in the current assets section of the statement of financial position.

Cash Equivalents

Many companies, such as Lenovo Group (CHN), use the designation “Cash and cash equivalents” in reporting cash. (See Illustration 7-14 for an example.) Cash equivalents are short-term, highly liquid investments that are both:

1. Readily convertible to known amounts of cash, and
2. So near their maturity that their market value is relatively insensitive to changes in interest rates.

Examples of cash equivalents are Treasury bills, commercial paper (short-term corporate notes), and money market funds. All typically are purchased with cash that is in excess of immediate needs.

While cash equivalents are now frequently reported with cash, it appears likely that the IASB will end this practice in the future. Instead, those items that are now referred to as cash equivalents will be reported as short-term investments.

Occasionally, a company will have a net negative balance in a bank account. If the negative balance is the result of the company’s normal cash-management practices and can be paid on demand, the account balance is reported as part of cash. If these conditions are not met, the company should report the negative balance among current liabilities.

Restricted Cash

A company may have restricted cash, cash that is not available for general use but rather is restricted for a special purpose. For example, landfill companies are often required to maintain a fund of restricted cash to ensure they will have adequate resources to cover closing and clean-up costs at the end of a landfill site’s useful life. McKessor Corp. (USA) recently reported restricted cash of $962 million to be paid out as the result of investor lawsuits.

Cash restricted in use should be reported separately on the statement of financial position as restricted cash. If the company expects to use the restricted cash within the next year, it reports the amount as a current asset. When this is not the case, it reports the restricted funds as a non-current asset.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW

The Navigator

1. Define fraud and internal control. A fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. The fraud triangle refers to the three factors that contribute to fraudulent activity by employees: opportunity, financial pressure, and rationalization. Internal control consists of all the related methods and measures adopted within an organization to safeguard its assets, enhance the reliability of its accounting records, increase efficiency of operations, and ensure compliance with laws and regulations.
2. Identify the principles of internal control activities. The principles of internal control are establishment of responsibility; segregation of duties; documentation procedures; physical controls; independent internal verification; and human resource controls such as bonding and requiring employees to take vacations.
3. Explain the applications of internal control principles to cash receipts. Internal controls over cash receipts include (a) designating specific personnel to handle cash; (b) assigning different individuals to receive cash, record cash, and maintain custody of cash; (c) using remittance advices for mail receipts, cash register tapes for over-the-counter receipts, and deposit slips for bank deposits; (d) using company safes and bank vaults to store cash with access limited to authorized personnel, and using cash registers in executing over-the-counter receipts; (e) making independent daily counts of register receipts and daily comparison of total receipts with total deposits; and (f) bonding personnel that handle cash and requiring them to take vacations.
4. Explain the applications of internal control principles to cash disbursements. Internal controls over cash disbursements include (a) having specific individuals such as the treasurer authorized to sign checks and approve vendors; (b) assigning different individuals to approve items for payment, make the payment, and record the payment; (c) using prenumbered checks and accounting for all checks, with each check supported by an approved invoice; (d) storing blank checks in a safe or vault with access restricted to authorized personnel, and using a check-writing machine to imprint amounts on checks; (e) comparing each check with the approved invoice before issuing the check, and making monthly reconciliations of bank and book balances; and (f) bonding personnel who handle cash, requiring employees to take vacations, and conducting background checks.
5. Describe the operation of a petty cash fund. Companies operate a petty cash fund to pay relatively small amounts of cash. They must establish the fund, make payments from the fund, and replenish the fund when the cash in the fund reaches a minimum level.
6. Indicate the control features of a bank account. A bank account contributes to good internal control by providing physical controls for the storage of cash. It minimizes the amount of currency that a company must keep on hand, and it creates a double record of a depositor’s bank transactions.
7. Prepare a bank reconciliation. It is customary to reconcile the balance per books and balance per bank to their adjusted balances. The steps in the reconciling process are to determine deposits in transit, outstanding checks, errors by the depositor or the bank, and unrecorded bank memoranda.
8. Explain the reporting of cash. Companies list cash last in the current assets section of the statement of financial position. In some cases, they report cash together with cash equivalents. Cash restricted for a special purpose is reported separately as a current asset or as a non-current asset, depending on when the cash is expected to be used.

GLOSSARY REVIEW

Bank reconciliation

The process of comparing the bank’s balance of an account with the company’s balance and explaining any differences to make them agree. (p. 347).

Bank service charge

A fee charged by a bank for the use of its services. (p. 349).

Bank statement

A monthly statement from the bank that shows the depositor’s bank transactions and balances. (p. 348).

Bonding

Obtaining insurance protection against theft by employees. (p. 337).

Cash

Resources that consist of coins, currency, checks, money orders, and money on hand or on deposit in a bank or similar depository. (p. 354).

Cash equivalents

Short-term, highly liquid investments that can be converted to a specific amount of cash. (p. 355).

Check

A written order signed by a bank depositor, directing the bank to pay a specified sum of money to a designated recipient. (p. 347).

Deposits in transit

Deposits recorded by the depositor but not yet been recorded by the bank. (p. 350).

Electronic funds transfer (EFT)

A disbursement system that uses wire, telephone, or computers to transfer funds from one location to another. (p. 353).

Fraud

A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.(p. 330).

Fraud triangle

The three factors that contribute to fraudulent activity by employees: opportunity, financial pressure, and rationalization. (p. 330).

Internal auditors

Company employees who continuously evaluate the effectiveness of the company’s internal control system. (p. 336).

Internal control

All of the related methods and activities adopted within an organization to safeguard its assets and enhance the accuracy and reliability of its accounting records. (p. 330).

NSF check

A check that is not paid by a bank because of insufficient funds in a customer’s bank account. (p. 349).

Outstanding checks

Checks issued and recorded by a company but not yet paid by the bank. (p. 350).

Petty cash fund

A cash fund used to pay relatively small amounts. (p. 343).

Restricted cash

Cash that must be used for a special purpose. (p. 355).

Voucher

An authorization form prepared for each payment in a voucher system. (p. 342).

Voucher system

A network of approvals by authorized individuals acting independently to ensure that all disbursements by check are proper. (p. 342).

PRACTICE MULTIPLE-CHOICE QUESTIONS

(LO 1)

1. Which of the following is not an element of the fraud triangle?

   1. Rationalization.

   2. Financial pressure.

   3. Segregation of duties.

   4. Opportunity.

(LO 1)

2. An organization uses internal control to enhance the accuracy and reliability of its accounting records and to:

   1. safeguard assets.

   2. prevent fraud.

   3. produce correct financial statements.

   4. deter employee dishonesty.

(LO 2)

3. The principles of internal control do not include:

   1. establishment of responsibility.

   2. documentation procedures.

   3. management responsibility.

   4. independent internal verification.

(LO 2)

4. Physical controls do not include:

   1. safes and vaults to store cash.

   2. independent bank reconciliations.

   3. locked warehouses for inventories.

   4. bank safety deposit boxes for important papers.

(LO 3)

5. Permitting only designated personnel to handle cash receipts is an application of the principle of:

   1. segregation of duties.

   2. establishment of responsibility.

   3. independent internal verification.

   4. human resource controls.

(LO 3)

6. Which of the following control activities is not relevant when a company uses a computerized (rather than manual) accounting system?

   1. Establishment of responsibility.

   2. Segregation of duties.

   3. Independent internal verification.

   4. All of these control activities are relevant to a computerized system.

(LO 4)

7. The use of prenumbered checks in disbursing cash is an application of the principle of:

   1. establishment of responsibility.

   2. segregation of duties.

   3. physical controls.

   4. documentation procedures.

(LO 5)

8. A company writes a check to replenish a €100 petty cash fund when the fund contains receipts of €94 and €4 in cash. In recording the check, the company should:

   1. debit Cash Over and Short for €2.

   2. debit Petty Cash for €94.

   3. credit Cash for €94.

   4. credit Petty Cash for €2.

(LO 6)

9. The control features of a bank account do not include:

   1. having bank auditors verify the correctness of the bank balance per books.

   2. minimizing the amount of cash that must be kept on hand.

   3. providing a double record of all bank transactions.

   4. safeguarding cash by using a bank as a depository.

(LO 7)

10. In a bank reconciliation, deposits in transit are:

    1. deducted from the book balance.

    2. added to the book balance.

    3. added to the bank balance.

    4. deducted from the bank balance.

(LO 7)

11. The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:

    1. outstanding checks.

    2. deposit in transit.

    3. a bank error.

    4. bank service charges.

(LO 8)

12. Which of the following items in a cash drawer at November 30 is not cash?

    1. Money orders.

    2. Coins and currency.

    3. An NSF check.

    4. A customer check dated November 28.

(LO 8)

13. Which of the following statements correctly describes the reporting of cash?

    1. Cash cannot be combined with cash equivalents.

    2. Restricted cash funds may be combined with cash.

    3. Cash is listed last in the current assets section.

    4. Restricted cash funds cannot be reported as a current asset.

Solutions

PRACTICE EXERCISES

Indicate whether procedure is good or weak internal control.

(LO 2, 3)

1. Listed below are five procedures followed by Shepherd SA.
   1. Total cash receipts are compared to bank deposits daily by someone who has no other cash responsibilities.
   2. Time clocks are used for recording time worked by employees.
   3. Employees are required to take vacations.
   4. Any member of the sales department can approve credit sales.
   5. Sam Hill ships goods to customers, bills customers, and receives payment from customers.

Instructions

Indicate whether each procedure is an example of good internal control or of weak internal control. If it is an example of good internal control, indicate which internal control principle is being followed. If it is an example of weak internal control, indicate which internal control principle is violated. Use the table below.

Procedure	IC Good or Weak?	Related Internal Control Principle
1.
2.
3.
4.
5.

Solution

Prepare bank reconciliation and adjusting entries.

(LO 7)

2. The information below relates to the Cash account in the ledger of Ansel A/S.

1. Balance June 1—€17,150; Cash deposited—€64,000.
2. Balance June 30—€17,704; Checks written—€63,746.

The June bank statement shows a balance of €16,422 on June 30 and the following memoranda.

Credits		Debits
Collection of €1,500 note plus interest €30	€1,530	NSF check: Anne Adams	€425
Interest earned on checking account	€35	Safety deposit box rent	€55

At June 30, deposits in transit were €4,750, and outstanding checks totaled €2,383.

Instructions

1. Prepare the bank reconciliation at June 30.
2. Prepare the adjusting entries at June 30, assuming (1) the NSF check was from a customer on account, and (2) no interest had been accrued on the note.

Solution

PRACTICE PROBLEM

Prepare bank reconciliation and journalize entries.

(LO 7)

Victoria Peak Ltd.’s bank statement for May 2017 shows the following data.

Balance 5/1	HK$126,500	Balance 5/31	HK$142,800
Debit memorandum:		Credit memorandum:
NSF check	HK$1,750	Collection of note receivable	HK$5,050

The cash balance per books at May 31 is HK$133,190. Your review of the data reveals the following.

1. The NSF check was from Copple Co., a customer.
2. The note collected by the bank was a HK$5,000, 3-month, 12% note. The bank charged a HK$100 collection fee. No interest has been accrued.
3. Outstanding checks at May 31 total HK$24,100.
4. Deposits in transit at May 31 total HK$17,520.
5. A Victoria Peak Ltd. check for HK$3,520, dated May 10, cleared the bank on May 25. The company recorded this check, which was a payment on account, for HK$3,250.

Instructions

1. Prepare a bank reconciliation at May 31.
2. Journalize the entries required by the reconciliation.

Solution

EXERCISES

Identify the principles of internal control.

(LO 2)

E7-1 Luna Ernesto is the owner of Ernesto’s Pizza. Ernesto’s is operated strictly on a carryout basis. Customers pick up their orders at a counter where a clerk exchanges the pizza for cash. While at the counter, the customer can see other employees making the pizzas and the large ovens in which the pizzas are baked.

Instructions

Identify the six principles of internal control and give an example of each principle that you might observe when picking up your pizza. (Note: It may not be possible to observe all the principles.)

Identify internal control weaknesses over cash receipts and suggest improvements.

(LO 2, 3)

E7-2 The following control procedures are used at Aldean Ltd. for over-the-counter cash receipts.

1. To minimize the risk of robbery, cash in excess of £100 is stored in an unlocked attaché case in the stockroom until it is deposited in the bank.
2. All over-the-counter receipts are registered by three clerks who use a cash register with a single cash drawer.
3. The company accountant makes the bank deposit and then records the day’s receipts.
4. At the end of each day, the total receipts are counted by the cashier on duty and reconciled to the cash register total.
5. Cashiers are experienced; they are not bonded.

Instructions

1. For each procedure, explain the weakness in internal control, and identify the control principle that is violated.

2. For each weakness, suggest a change in procedure that will result in good internal control.

Identify internal control weaknesses over cash disbursements and suggest improvements.

(LO 2, 4)

E7-3 The following control procedures are used in Monique’s Boutique Shoppe for cash disbursements.

1. The company accountant prepares the bank reconciliation and reports any discrepancies to the owner.
2. The store manager personally approves all payments before signing and issuing checks.
3. Each week, 100 company checks are left in an unmarked envelope on a shelf behind the cash register.
4. After payment, bills are filed in a paid invoice folder.
5. The company checks are unnumbered.

Instructions

1. For each procedure, explain the weakness in internal control, and identify the internal control principle that is violated.
2. For each weakness, suggest a change in the procedure that will result in good internal control.

Identify internal control weaknesses over cash disbursements and suggest improvements.

(LO 4)

E7-4 At Teresa SpA, checks are not prenumbered because both the purchasing agent and the treasurer are authorized to issue checks. Each signer has access to unissued checks kept in an unlocked file cabinet. The purchasing agent pays all bills pertaining to goods purchased for resale. Prior to payment, the purchasing agent determines that the goods have been received and verifies the mathematical accuracy of the vendor’s invoice. After payment, the invoice is filed by vendor name, and the purchasing agent records the payment in the cash disbursements journal. The treasurer pays all other bills following approval by authorized employees. After payment, the treasurer stamps all bills PAID, files them by payment date, and records the checks in the cash disbursements journal. Teresa Company maintains one checking account that is reconciled by the treasurer.

Instructions

1. List the weaknesses in internal control over cash disbursements.
2. Write a memo to the company treasurer indicating your recommendations for improvement.

Indicate whether procedure is good or weak internal control.

(LO 2. 3, 4)

E7-5 Listed below are five procedures followed by Zulma AG.

1. Several individuals operate the cash register using the same register drawer.
2. A monthly bank reconciliation is prepared by someone who has no other cash responsibilities.
3. Rosa Garcia writes checks and also records cash payment journal entries.
4. One individual orders inventory, while a different individual authorizes payments.
5. Unnumbered sales invoices from credit sales are forwarded to the accounting department every four weeks for recording.

Instructions

Indicate whether each procedure is an example of good internal control or of weak internal control. If it is an example of good internal control, indicate which internal control principle is being followed. If it is an example of weak internal control, indicate which internal control principle is violated. Use the table below.

Procedure	IC Good or Weak?	Related Internal Control Principle
1.
2.
3.
4.
5.

Indicate whether procedure is good or weak internal control.

(LO 2, 3, 4)

E7-6 Listed below are five procedures followed by Bingham Enterprises Ltd.

1. Employees are required to take vacations.
2. Any member of the sales department can approve credit sales.
3. Blake Nayak ships goods to customers, bills customers, and receives payment from customers.
4. Total cash receipts are compared to bank deposits daily by someone who has no other cash responsibilities.
5. Time clocks are used for recording time worked by employees.

Instructions

Indicate whether each procedure is an example of good internal control or of weak internal control. If it is an example of good internal control, indicate which internal control principle is being followed. If it is an example of weak internal control, indicate which internal control principle is violated. Use the table below.

Procedure	IC Good or Weak?	Related Internal Control Principle
1.
2.
3.
4.
5.

Prepare journal entries for a petty cash fund.

(LO 5)

E7-7 LaSalle SA established a petty cash fund on May 1, cashing a check for €100. The company reimbursed the fund on June 1 and July 1 with the following results.

1. June 1: Cash in fund €1.75. Receipts: delivery expense €31.25; postage expense €41.00; and miscellaneous expense €25.00.
2. July 1: Cash in fund €3.25. Receipts: delivery expense €21.00; entertainment expense €53.00; and miscellaneous expense €24.75.

On July 10, LaSalle increased the fund from €100 to €150.

Instructions

Prepare journal entries for LaSalle SA for May 1, June 1, July 1, and July 10.

Prepare journal entries for a petty cash fund.

(LO 5)

E7-8 Ankara A. Ş. uses an imprest petty cash system. The fund was established on March 1 with a balance of 100. During March, the following petty cash receipts were found in the petty cash box.

Date	Receipt No.	For	Amount
3/5	1	Stamp Inventory	39
7	2	Freight-Out	17
9	3	Miscellaneous Expense	6
11	4	Travel Expense	24
14	5	Miscellaneous Expense	7

The fund was replenished on March 15 when the fund contained 4 in cash. On March 20, the amount in the fund was increased to 150.

Instructions

Journalize the entries in March that pertain to the operation of the petty cash fund.

Prepare bank reconciliation and adjusting entries.

(LO 7)

E7-9 Basel AG is unable to reconcile the bank balance at January 31. Basel’s reconciliation is as follows.

Cash balance per bank	CHF3,660.20
Add: NSF check	590.00
Less: Bank service charge	30.00
Adjusted balance per bank	CHF4,220.20
Cash balance per books	CHF3,825.20
Less: Deposits in transit	480.00
Add: Outstanding checks	935.00
Adjusted balance per books	CHF4,280.20

Instructions

1. Prepare a correct bank reconciliation.
2. Journalize the entries required by the reconciliation.

Determine outstanding checks.

(LO 7)

E7-10 On April 30, the bank reconciliation of Yazici Company shows three outstanding checks: no. 254, €650; no. 255, €720; and no. 257, €410. The May bank statement and the May cash payments journal show the following.

Bank Statement
Checks Paid
Date	Check No.	Amount
5/4	254	650
5/2	257	410
5/17	258	159
5/12	259	275
5/20	261	500
5/29	263	480
5/30	264	560

Cash Payments Journal
Checks Issued
Date	Check No.	Amount
5/2	258	159
5/5	259	275
5/10	260	820
5/15	261	500
5/22	262	750
5/24	263	480
5/29	264	560

Instructions

Using Step 2 in the reconciliation procedure, list the outstanding checks at May 31.

Prepare bank reconciliation and adjusting entries.

(LO 7)

E7-11 The following information pertains to Teresina Video SA.

1. Cash balance per bank, July 31, R$7,293.
2. July bank service charge not recorded by the depositor R$28.
3. Cash balance per books, July 31, R$7,427.
4. Deposits in transit, July 31, R$1,500.
5. Bank collected R$700 note for Teresina in July, plus interest R$35, less fee R$25. The collection has not been recorded by Teresina, and no interest has been accrued.
6. Outstanding checks, July 31, R$684.

Instructions

1. Prepare a bank reconciliation at July 31.
2. Journalize the adjusting entries at July 31 on the books of Teresina Video SA.

Prepare bank reconciliation and adjusting entries.

(LO 7)

E7-12 The information below relates to the Cash account in the ledger of Marin SA.

1. Balance September 1—£17,150; Cash deposited—£64,000.
2. Balance September 30—£17,404; Checks written—£63,746.

The September bank statement shows a balance of £16,122 on September 30 and the following memoranda.

Credits		Debits
Collection of £1,500 note plus interest £30	£1,530	NSF check: Violet Jones	£725
Interest earned on checking account	£45	Safety deposit box rent	£65

At September 30, deposits in transit were £4,450, and outstanding checks totaled £2,383.

Instructions

1. Prepare the bank reconciliation at September 30.
2. Prepare the adjusting entries at September 30, assuming (1) the NSF check was from a customer on account, and (2) no interest had been accrued on the note.

Compute deposits in transit and outstanding checks for two bank reconciliations.

(LO 7)

E7-13 The cash records of Petit SA show the following four situations.

1. The June 30 bank reconciliation indicated that deposits in transit total €920. During July, the general ledger account Cash shows deposits of €15,750, but the bank statement indicates that only €15,600 in deposits were received during the month.
2. The June 30 bank reconciliation also reported outstanding checks of €880. During the month of July, Petit’s books show that €17,200 of checks were issued. The bank statement showed that €16,400 of checks cleared the bank in July.
3. In September, deposits per the bank statement totaled €26,700, deposits per books were €25,400, and deposits in transit at September 30 were €2,800.
4. In September, cash disbursements per books were €23,700, checks clearing the bank were €24,500, and outstanding checks at September 30 were €2,100.

There were no bank debit or credit memoranda. No errors were made by either the bank or Petit.

Instructions

Answer the following questions.

1. In situation (1), what were the deposits in transit at July 31?
2. In situation (2), what were the outstanding checks at July 31?
3. In situation (3), what were the deposits in transit at August 31?
4. In situation (4), what were the outstanding checks at August 31?

Show presentation of cash in financial statements.

(LO 8)

E7-14 Nayak plc has recorded the following items in its financial records.

Cash in bank	£ 41,000
Cash in plant expansion fund	100,000
Cash on hand	8,000
Highly liquid investments	34,000
Petty cash	500
Receivables from customers	89,000
Share investments	61,000

The highly liquid investments had maturities of 3 months or less when they were purchased. The share investments will be sold in the next 6 to 12 months. The plant expansion project will begin in 3 years.

Instructions

1. What amount should Nayak report as “Cash and cash equivalents” on its statement of financial position?
2. Where should the items not included in part (a) be reported on the statement of financial position?
3. What disclosures should Nayak make in its financial statements concerning “cash and cash equivalents”?

PROBLEMS: SET A

Identify internal control principles over cash disbursements.

(LO 2, 3)

P7-1A Contreras Supply SLU recently changed its system of internal control over cash disbursements. The system includes the following features.

Instead of being unnumbered and manually prepared, all checks must now be prenumbered and written by using the new check-writing machine purchased by the company. Before a check can be issued, each invoice must have the approval of Berta Rojas, the purchasing agent, and Tiare Diaz, the receiving department supervisor. Checks must be signed by either Amaika Blake, the treasurer, or Juan Perez, the assistant treasurer. Before signing a check, the signer is expected to compare the amount of the check with the amount on the invoice.

After signing a check, the signer stamps the invoice PAID and inserts, within the stamp, the date, check number, and amount of the check. The “paid” invoice is then sent to the accounting department for recording.

Blank checks are stored in a safe in the treasurer’s office. The combination to the safe is known only by the treasurer and assistant treasurer. Each month, the bank statement is reconciled with the bank balance per books by the assistant chief accountant. All employees who handle or account for cash are bonded.

Instructions

Identify the internal control principles and their application to cash disbursements of Contreras Supply SLU.

Journalize and post petty cash fund transactions.

(LO 5)

P7-2A Arial Ltd. maintains a petty cash fund for small expenditures. The following transactions occurred over a 2-month period.

July	1	Established petty cash fund by writing a check on Coulter Bank for €200.
	15	Replenished the petty cash fund by writing a check for €198.00. On this date, the fund consisted of €2.00 in cash and the following petty cash receipts: freight-out €87.00, postage expense €51.40, entertainment expense €46.60, and miscellaneous expense €11.20.
	31	Replenished the petty cash fund by writing a check for €192.00. At this date, the fund consisted of €8.00 in cash and the following petty cash receipts: freight-out €82.10, charitable contributions expense €45.00, postage expense €25.50, and miscellaneous expense €39.40.
Aug.	15	Replenished the petty cash fund by writing a check for €187.00. On this date, the fund consisted of €13.00 in cash and the following petty cash receipts: freight-out €75.60, entertainment expense €43.00, postage expense €33.00, and miscellaneous expense €37.00.
	16	Increased the amount of the petty cash fund to €300 by writing a check for €100.
	31	Replenished the petty cash fund by writing a check for €277.00. On this date, the fund consisted of €23 in cash and the following petty cash receipts: postage expense €133.00, travel expense €95.60, and freight-out €47.10.

Instructions

1. Journalize the petty cash transactions.
2. Post to the Petty Cash account.
3. What internal control features exist in a petty cash fund?

(a) July 15, Cash short €1.80

(b) Aug. 31 balance €300

Prepare a bank reconciliation and adjusting entries.

(LO 7)

P7-3A On May 31, 2017, Terrell Ltd. had a cash balance per books of £6,781.50. The bank statement from Home Town Bank on that date showed a balance of £6,824.60. A comparison of the statement with the Cash account revealed the following facts.

1. The statement included a debit memo of £60 for the printing of additional company checks.
2. Cash sales of £836.15 on May 12 were deposited in the bank. The cash receipts journal entry and the deposit slip were incorrectly made for £886.15. The bank credited Terrell Company for the correct amount.
3. Outstanding checks at May 31 totaled £276.25. Deposits in transit were £1,916.15.
4. On May 18, the company issued check No. 1181 for £685 to Barry Dietz on account. The check, which cleared the bank in May, was incorrectly journalized and posted by Terrell for £658.
5. A £3,000 note receivable was collected by the bank for Terrell on May 31 plus £80 interest. The bank charged a collection fee of £20. No interest has been accrued on the note.
6. Included with the cancelled checks was a check issued by Bridges plc to Jon Newton for £600 that was incorrectly charged to Terrell by the bank.
7. On May 31, the bank statement showed an NSF charge of £640 for a check issued by Sandy Grifton, a customer, to Terrell on account.

Instructions

(a) Adjusted cash balance per bank £9,064.50

1. Prepare the bank reconciliation at May 31, 2017.
2. Prepare the necessary adjusting entries for Terrell at May 31, 2017.

Prepare a bank reconciliation and adjusting entries from detailed data.

(LO 7)

P7-4A The bank portion of the bank reconciliation for Rintala Ltd. at November 30, 2017, was as follows.

RINTALA LTD. Bank Reconciliation November 30, 2017
Cash balance per bank		£14,367.90
Add: Deposits in transit		2,530.20
		16,898.10
Less: Outstanding checks
Check Number	Check Amount
3451	£2,260.40
3470	720.10
3471	844.50
3472	1,426.80
3474	1,050.00	6,301.80
Adjusted cash balance per bank		£10,596.30

The adjusted cash balance per bank agreed with the cash balance per books at November 30.

The December bank statement showed the following checks and deposits.

Bank Statement
Checks			Deposits
Date	Number	Amount	Date	Amount
12-1	3451	£ 2,260.40	12-1	£ 2,530.20
12-2	3471	844.50	12-4	1,211.60
12-7	3472	1,426.80	12-8	2,365.10
12-4	3475	1,640.70	12-16	2,672.70
12-8	3476	1,300.00	12-21	2,945.00
12-10	3477	2,130.00	12-26	2,567.30
12-15	3479	3,080.00	12-29	2,836.00
12-27	3480	600.00	12-30	1,025.00
12-30	3482	475.50	Total	£18,152.90
12-29	3483	1,140.00
12-31	3485	540.80
	Total	£15,438.70

The cash records per books for December showed the following.

Cash Receipts Journal
Date	Amount
12-3	£ 1,211.60
12-7	2,365.10
12-15	2,672.70
12-20	2,954.00
12-25	2,567.30
12-28	2,836.00
12-30	1,025.00
12-31	1,190.40
Total	£16,822.10

The bank statement contained two memoranda:

1. A credit of £3,645 for the collection of a £3,500 note for Rintala plus interest of £160 and less a collection fee of £15. Rintala has not accrued any interest on the note.
2. A debit of £572.80 for an NSF check written by D. Chagnon, a customer. At December 31, the check had not been redeposited in the bank.

At December 31, the cash balance per books was £12,485.20, and the cash balance per the bank statement was £20,154.30. The bank did not make any errors, but two errors were made by Rintala.

Instructions

(a) Adjusted balance per books £15,458.40

1. Using the four steps in the reconciliation procedure, prepare a bank reconciliation at December 31.
2. Prepare the adjusting entries based on the reconciliation. (Hint: The correction of any errors pertaining to recording checks should be made to Accounts Payable. The correction of any errors relating to recording cash receipts should be made to Accounts Receivable.)

Prepare a bank reconciliation and adjusting entries.

(LO 7)

P7-5A Cayemberg AG maintains a checking account at the Commerce Bank. At July 31, selected data from the ledger balance and the bank statement are shown below.

	Cash in Bank
	Per Books	Per Bank
Balance, July 1	€17,600	€16,791
July receipts	81,100
July credits		82,470
July disbursements	77,150
July debits		74,756
Balance, July 31	€21,550	€24,505

Analysis of the bank data reveals that the credits consist of €81,000 of July deposits and a credit memorandum of €1,470 for the collection of a €1,400 note plus interest revenue of €70. The July debits per bank consist of checks cleared €74,700 and a debit memorandum of €65 for printing additional company checks.

You also discover the following errors involving July checks: (1) A check for €230 to a creditor on account that cleared the bank in July was journalized and posted as €320. (2) A salary check to an employee for €255 was recorded by the bank for €155.

The June 30 bank reconciliation contained only two reconciling items: deposits in transit €7,000 and outstanding checks of €6,200.

Instructions

(a) Adjusted balance per books €23,045

1. Prepare a bank reconciliation at July 31, 2017.
2. Journalize the adjusting entries to be made by Cayemberg. Assume that interest on the note has not been accrued.

Identify internal control weaknesses in cash receipts and cash disbursements.

(LO 2, 3, 4)

P7-6A Nature Hill Middle School wants to raise money for a new sound system for its auditorium. The primary fund-raising event is a dance at which the famous disc jockey Obnoxious Al will play classic and not-so-classic dance tunes. Rob Drexler, the music and theater instructor, has been given the responsibility for coordinating the fund-raising efforts. This is Rob’s first experience with fund-raising. He decides to put the eighth-grade choir in charge of the event; he will be a relatively passive observer.

Rob had 500 unnumbered tickets printed for the dance. He left the tickets in a box on his desk and told the choir students to take as many tickets as they thought they could sell for £5 each. In order to ensure that no extra tickets would be floating around, he told them to dispose of any unsold tickets. When the students received payment for the tickets, they were to bring the cash back to Rob and he would put it in a locked box in his desk drawer.

Some of the students were responsible for decorating the gymnasium for the dance. Rob gave each of them a key to the money box and told them that if they took money out to purchase materials, they should put a note in the box saying how much they took and what it was used for. After 2 weeks the money box appeared to be getting full, so Rob asked Erik Radley to count the money, prepare a deposit slip, and deposit the money in a bank account Rob had opened.

The day of the dance, Rob wrote a check from the account to pay the DJ. Obnoxious Al, however, said that he accepted only cash and did not give receipts. So Rob took £200 out of the cash box and gave it to Al. At the dance, Rob had Sobia Hamm working at the entrance to the gymnasium, collecting tickets from students, and selling tickets to those who had not prepurchased them. Rob estimated that 400 students attended the dance.

The following day, Rob closed out the bank account, which had £250 in it, and gave that amount plus the £180 in the cash box to Principal Coleman. Principal Coleman seemed surprised that, after generating roughly £2,000 in sales, the dance netted only £430 in cash. Rob did not know how to respond.

Instructions

Identify as many internal control weaknesses as you can in this scenario, and suggest how each could be addressed.

PROBLEMS: SET B

Identify internal control weaknesses over cash receipts.

(LO 2, 3)

P7-1B Orpheum Theater is located in the Vancouver Mall. A cashier’s booth is located near the entrance to the theater. Three cashiers are employed. One works from 1–5 p.m., another from 5–9 p.m. The shifts are rotated among the three cashiers. The cashiers receive cash from customers and operate a machine that ejects serially numbered tickets. The rolls of tickets are inserted and locked into the machine by the theater manager at the beginning of each cashier’s shift.

After purchasing a ticket, the customer takes the ticket to an usher stationed at the entrance of the theater lobby some 60 feet from the cashier’s booth. The usher tears the ticket in half, admits the customer, and returns the ticket stub to the customer. The other half of the ticket is dropped into a locked box by the usher.

At the end of each cashier’s shift, the theater manager removes the ticket rolls from the machine and makes a cash count. The cash count sheet is initialed by the cashier. At the end of the day, the manager deposits the receipts in total in a bank night deposit vault located in the mall. The manager also sends copies of the deposit slip and the initialed cash count sheets to the theater company treasurer for verification and to the company’s accounting department. Receipts from the first shift are stored in a safe located in the manager’s office.

Instructions

1. Identify the internal control principles and their application to the cash receipts transactions of the Orpheum Theater.
2. If the usher and cashier decide to collaborate to misappropriate cash, what actions might they take?

Journalize and post petty cash fund transactions.

(LO 5)

P7-2B De Smet SA maintains a petty cash fund for small expenditures. The following transactions occurred over a 2-month period.

July 1		Established petty cash fund by writing a check on Star Bank for €100.
	15	Replenished the petty cash fund by writing a check for €94.90. On this date, the fund consisted of €5.10 in cash and the following petty cash receipts: freight-out €51.00, postage expense €20.50, entertainment expense €23.10, and miscellaneous expense €4.10.
	31	Replenished the petty cash fund by writing a check for €92.90. At this date, the fund consisted of €7.10 in cash and the following petty cash receipts: freight-out €43.50, charitable contributions expense €20.00, postage expense €20.10, and miscellaneous expense €9.30.
Aug. 15		Replenished the petty cash fund by writing a check for €98.00. On this date, the fund consisted of €2.00 in cash and the following petty cash receipts: freight-out €40.20, entertainment expense €21.00, postage expense €14.00, and miscellaneous expense €19.80.
	16	Increased the amount of the petty cash fund to €150 by writing a check for €50.
	31	Replenished the petty cash fund by writing a check for €137.00. On this date, the fund consisted of €13 in cash and the following petty cash receipts: freight-out €74.00, entertainment expense €43.20, and postage expense €17.70.

Instructions

(a) July 15 Cash over €3.80

(b) Aug. 31 balance €150

1. Journalize the petty cash transactions.
2. Post to the Petty Cash account.
3. What internal control features exist in a petty cash fund?

Prepare a bank reconciliation and adjusting entries.

(LO 7)

P7-3B Aglife Genetics Ltd. of Lancashire spreads herbicides and applies liquid fertilizer for local farmers. On May 31, 2017, the company’s Cash account per its general ledger showed the following balance.

The bank statement from Lancashire Bank on that date showed the following balance.

Checks and Debits	Lancaster Bank Deposits and Credits	Daily Balance
XXX	XXX	5/31 12,648

A comparison of the details on the bank statement with the details in the Cash account revealed the following facts.

1. The statement included a debit memo of £35 for the printing of additional company checks.
2. Cash sales of £1,720 on May 12 were deposited in the bank. The cash receipts journal entry and the deposit slip were incorrectly made for £1,820. The bank credited Aglife Genetics for the correct amount.
3. Outstanding checks at May 31 totaled £1,425, and deposits in transit were £2,100.
4. On May 18, the company issued check no. 1181 for £1,102 to M. Datz on account. The check, which cleared the bank in May, was incorrectly journalized and posted by Aglife Genetics for £110.
5. A £4,000 note receivable was collected by the bank for Aglife Genetics on May 31 plus £100 interest. The bank charged a collection fee of £25. No interest has been accrued on the note.
6. Included with the cancelled checks was a check issued by River Lune Company to Carol Mertz for £900 that was incorrectly charged to Aglife Genetics by the bank.
7. On May 31, the bank statement showed an NSF charge of £2,012 for a check issued by Tyler Gricius, a customer, to Aglife Genetics on account.

Instructions

(a) Adj. cash bal. £14,223

1. Prepare the bank reconciliation at May 31, 2017.
2. Prepare the necessary adjusting entries for Aglife Genetics Ltd. at May 31, 2017.

Prepare a bank reconciliation and adjusting entries from detailed data.

(LO 7)

P7-4B The bank portion of the bank reconciliation for Brasilia SA at October 31, 2017, was as follows.

BRASILIA SA Bank Reconciliation October 31, 2017
Cash balance per bank	R$6,000
Add: Deposits in transit	842
	6,842

Less: Outstanding checks

Check Number	Check Amount
2451	R$700
2470	396
2471	464
2472	170
2474	578	2,308
Adjusted cash balance per bank		R$4,534

The adjusted cash balance per bank agreed with the cash balance per books at October 31.

The November bank statement showed the following checks and deposits:

Bank Statement
Checks			Deposits
Date	Number	Amount	Date	Amount
11-1	2470	R$  396	11-1	R$  842
11-2	2471	464	11-4	666
11-5	2474	578	11-8	545
11-4	2475	903	11-13	1,416
11-8	2476	1,556	11-18	810
11-10	2477	330	11-21	1,624
11-15	2479	980	11-25	1,412
11-18	2480	714	11-28	908
11-27	2481	382	11-30	652
11-30	2483	317	Total	R$8,875
11-29	2486	495
	Total	R$7,115

The cash records per books for November showed the following.

Cash Receipts Journal
Date	Amount
11-3	R$ 666
11-7	545
11-12	1,416
11-17	810
11-20	1,642
11-24	1,412
11-27	908
11-29	652
11-30	1,581
Total	R$9,632

The bank statement contained two bank memoranda:

1. A credit of R$1,375 for the collection of a R$1,300 note for Brasilia plus interest of R$91 and less a collection fee of R$16. Brasilia has not accrued any interest on the note.
2. A debit for the printing of additional company checks R$35.

At November 30, the cash balance per books was R$5,969, and the cash balance per the bank statement was R$9,100. The bank did not make any errors, but two errors were made by Brasilia.

Instructions

(a) Adjusted cash balance per bank R$7,201

1. Using the four steps in the reconciliation procedure described on pages 350–351, prepare a bank reconciliation at November 30.
2. Prepare the adjusting entries based on the reconciliation. (Hint: The correction of any errors pertaining to recording checks should be made to Accounts Payable. The correction of any errors relating to recording cash receipts should be made to Accounts Receivable.)

Prepare a bank reconciliation and adjusting entries.

(LO 7)

P7-5B Tizani SpA’s bank statement from Eastern National Bank at August 31, 2017, shows the information below.

Balance, August 1	€11,284	Bank credit memoranda:
August deposits	47,521	Collection of note
Checks cleared in August	46,175	receivable plus €105
Balance, August 31	17,146	interest	€4,505
		Interest earned	41
		Bank debit memorandum:
		Safety deposit box rent	30

A summary of the Cash account in the ledger for August shows: balance, August 1, €10,559; receipts €50,050; disbursements €47,794; and balance, August 31, €12,815. Analysis reveals that the only reconciling items on the July 31 bank reconciliation were a deposit in transit for €2,200 and outstanding checks of €2,925. The deposit in transit was the first deposit recorded by the bank in August. In addition, you determine that there were two errors involving company checks drawn in August: (1) A check for €340 to a creditor on account that cleared the bank in August was journalized and posted for €480. (2) A salary check to an employee for €275 was recorded by the bank for €295.

Instructions

(a) Adjusted balance per books €17,471

1. Prepare a bank reconciliation at August 31.
2. Journalize the adjusting entries to be made by Tizani at August 31. Assume that interest on the note has not been accrued by the company.

Prepare a comprehensive bank reconciliation with theft and internal control deficiencies.

(LO 2, 3, 4, 7)

P7-6B Stupendous Ltd. is a very profitable small business. It has not, however, given much consideration to internal control. For example, in an attempt to keep clerical and office expenses to a minimum, the company has combined the jobs of cashier and bookkeeper. As a result, Jake Burnett handles all cash receipts, keeps the accounting records, and prepares the monthly bank reconciliations.

The balance per the bank statement on October 31, 2017, was £15,313. Outstanding checks were no. 62 for £107.74, no. 183 for £127.50, no. 284 for £215.26, no. 862 for £132.10, no. 863 for £192.78, and no. 864 for £140.49. Included with the statement was a credit memorandum of £460 indicating the collection of a note receivable for Stupendous by the bank on October 25. This memorandum has not been recorded by Stupendous.

The company’s ledger showed one cash account with a balance of £18,608.81. The balance included undeposited cash on hand. Because of the lack of internal controls, Burnett took for personal use all of the undeposited receipts in excess of £3,226.18. He then prepared the following bank reconciliation in an effort to conceal his theft of cash.

Bank Reconciliation
Cash balance per books, October 31		£18,608.81
Add: Outstanding checks
No. 862	£132.10
No. 863	192.78
No. 864	140.49	390.37
		18,999.18
Less: Undeposited receipts		3,226.18
Unadjusted balance per bank, October 31		15,773.00
Less: Bank credit memorandum		460.00
Cash balance per bank statement, October 31		£15,313.00

Instructions

(a) Adjusted balance per books £17,623.31

1. Prepare a correct bank reconciliation. (Hint: Deduct the amount of the theft from the adjusted balance per books.)
2. Indicate the three ways that Burnett attempted to conceal the theft and the pound amount pertaining to each method.
3. What principles of internal control were violated in this case?

MATCHA CREATIONS

(Note: This is a continuation of the Matcha Creations problem from Chapters 1–6.)

MC7 Part 1 Mei-ling is struggling to keep up with the recording of her accounting transactions. She is spending a lot of time marketing and selling mixers and giving her cookie classes. Her friend Mike is an accounting student who runs his own accounting service. He has asked Mei-ling if she would like to have him do her accounting. Mike and Mei-ling meet and discuss her business.

Part 2 Mei-ling decides that she cannot afford to hire Mike to do her accounting. One way that she can ensure that her cash account does not have any errors and is accurate and up-to-date is to prepare a bank reconciliation at the end of each month. Mei-ling would like you to help her.

Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this problem.

BROADENING YOUR PERSPECTIVE

Financial Reporting and Analysis

Financial Reporting Problem: TSMC, Ltd. (TWN)

BYP7-1 The financial statements of TSMC are presented in Appendix A. The complete annual report, including notes to the consolidated financial statements, is available in the Investors section of the company’s website, www.tsmc.com.

Instructions

1. What data about cash and cash equivalents are shown in the consolidated statement of financial position?
2. In its notes to consolidated financial statements, how does TSMC define cash equivalents?

Comparative Analysis Problem: Nestlé SA (CHE) vs. Petra Foods Ltd. (SGP)

BYP7-2 Nestlé’s financial statements are presented in Appendix B. Financial statements of Petra Foods are presented in Appendix C.

Instructions

1. Based on the information contained in these financial statements, determine each of the following for each company (ignore overdrafts):
   1. Cash and cash equivalents balance at December 31, 2013.
   2. Cash provided by operating activities during the most recent fiscal year shown (from the statement of cash flows).
2. What conclusions concerning the management of cash can be drawn from these data?

Real-World Focus

BYP7-3 All organizations should have systems of internal control. Universities are no exception. This site discusses the basics of internal control in a university setting.

Address: www.bc.edu/offices/audit/controls

Steps: Go to the site shown above.

Instructions

The home page of this site provides links to answer the following questions.

1. In a university setting, who has responsibility for evaluating the adequacy of the system of internal control?
2. What are some red flags indicating white-collar crime?
3. What role does an internal audit play at Boston College?
4. What are two IT controls over computer operations?

Critical Thinking

Decision-Making Across the Organization

BYP7-4 The board of trustees of a local church is concerned about the internal accounting controls for the offering collections made at weekly services. The trustees ask you to serve on a three-person audit team with the internal auditor of a local college and a public accountant who has just joined the church.

At a meeting of the audit team and the board of trustees, you learn the following.

1. The church’s board of trustees has delegated responsibility for the financial management and audit of the financial records to the finance committee. This group prepares the annual budget and approves major disbursements. It is not involved in collections or recordkeeping. No audit has been made in recent years because the same trusted employee has kept church records and served as financial secretary for 15 years. The church does not carry any fidelity insurance.
2. The collection at the weekly service is taken by a team of ushers who volunteer to serve one month. The ushers take the collection plates to a basement office at the rear of the church. They hand their plates to the head usher and return to the church service. After all plates have been turned in, the head usher counts the cash received. The head usher then places the cash in the church safe along with a notation of the amount counted. The head usher volunteers to serve for 3 months.
3. The next morning, the financial secretary opens the safe and recounts the collection. The secretary withholds £150–£200 in cash, depending on the cash expenditures expected for the week, and deposits the remainder of the collections in the bank. To facilitate the deposit, church members who contribute by check are asked to make their checks payable to “Cash.”
4. Each month, the financial secretary reconciles the bank statement and submits a copy of the reconciliation to the board of trustees. The reconciliations have rarely contained any bank errors and have never shown any errors per books.

Instructions

With the class divided into groups, answer the following.

1. Indicate the weaknesses in internal accounting control over the handling of collections.
2. List the improvements in internal control procedures that you plan to make at the next meeting of the audit team for (1) the ushers, (2) the head usher, (3) the financial secretary, and (4) the finance committee.
3. What church policies should be changed to improve internal control?

Communication Activity

BYP7-5 As a new auditor for the public accounting firm of Murphy, Mooney, and Feeney, you have been assigned to review the internal controls over mail cash receipts of Sullivan Company. Your review reveals the following: Checks are promptly endorsed “For Deposit Only,” but no list of the checks is prepared by the person opening the mail. The mail is opened either by the cashier or by the employee who maintains the accounts receivable records. Mail receipts are deposited in the bank weekly by the cashier.

Instructions

Write a letter to Michael Kelly, owner of Sullivan Company, explaining the weaknesses in internal control and your recommendations for improving the system.

Ethics Case

BYP7-6 You are the assistant controller in charge of general ledger accounting at Prince Edward Bottling. Your company has a large loan from an insurance company. The loan agreement requires that the company’s cash account balance be maintained at €200,000 or more, as reported monthly.

At June 30, the cash balance is €80,000, which you report to Anne Shirley, the financial vice president. Anne excitedly instructs you to keep the cash receipts book open for one additional day for purposes of the June 30 report to the insurance company. Anne says, “If we don’t get that cash balance over €200,000, we’ll default on our loan agreement. They could close us down, put us all out of our jobs!” Anne continues, “I talked to Gilbert Distributors (one of Prince Edward’s largest customers) this morning. They said they sent us a check for €150,000 yesterday. We should receive it tomorrow. If we include just that one check in our cash balance, we’ll be in the clear. It’s in the mail!”

Instructions

1. Who will suffer negative effects if you do not comply with Anne Shirley’s instructions? Who will suffer if you do comply?
2. What are the ethical considerations in this case?
3. What alternatives do you have?

Answers to Insight and Accounting Across the Organization Questions

1. p. 331 And the Controls Are… Q: Why is sustainability information important to investors? A: Investors, customers, suppliers, and employees want more information about companies’ long-term impact on society. There is a growing awareness that sustainability issues can affect a company’s financial performance. Proper reporting on sustainability issues develops a solid reputation for transparency and provides confidence to shareholders.
2. p. 338 Internal Control and the Role of Human Resources Q: Why would unsupervised employees or employees who report to each other represent potential internal control threats? A: An unsupervised employee may have a fraudulent job (or may even be a fictitious person), e.g., a person drawing a paycheck without working. Or, if two employees supervise each other, there is no real separation of duties, and they can conspire to defraud the company.
3. p. 346 How Employees Steal Q: How can companies reduce the likelihood of occupational fraud? A: To reduce the occurrence of occupational fraud, a company should follow the procedures discussed in this chapter. These include having only designated personnel sign checks, having different personnel approve payments and make payments, ensuring that check-signers do not record disbursements, using prenumbered checks and matching each check to an approved invoice, storing blank checks securely, reconciling the bank statement, and stamping invoices paid.
4. p. 354 Madoff’s Ponzi Scheme Q: How was Madoff able to conceal such a giant fraud? A: Madoff fabricated false investment statements that were provided to investors. In addition, his auditor never verified these investment statements even though the auditor gave him an unqualified opinion each year.