Cash & Internal Control

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CHAPTER 6

Cash and Internal ControlOVERVIEW OF EXERCISES, PROBLEMS, AN CASES

Est!"atedT!"e !n

Learn!n# O$t%o"es E&er%!ses M!n$tes Le'el

() Identify and describe the various forms of cash reported 1 10 Easyon a balance sheet. 6* 15 Mod

*) Show that you understand various techniues that ! 10 Easycompanies use to control cash. " 10 Easy

6* 15 Mod

+) E#plain the importance of internal control to a business and thesi$nificance of the Sarbanes%ley 'ct of !00!.

) (escribe the basic internal control procedures. ) !0 Mod5 15 Mod

-) (escribe the various documents used in recordin$ purchasesand their role in controllin$ cash disbursements.

*E#ercise problem or case covers two or more learnin$ outcomes+evel , (ifficulty levels- Easy Moderate /Mod (ifficult /(iff

6.(


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Est!"atedT!"e !n

Learn!n# O$t%o"es Cases M!n$tes Le'el

() Identify and describe the various forms of cash reported 1 !0 Modon a balance sheet. " "0 Mod

*) Show that you understand various techniues thatcompanies use to control cash.

+) E#plain the importance of internal control to a business and the ! !5 Modsi$nificance of the Sarbanes%ley 'ct of !00!. )* "0 Mod

) (escribe the basic internal control procedures. )* "0 Mod

-) (escribe the various documents used in recordin$ purchasesand their role in controllin$ cash disbursements

*E#ercise problem or case covers two or more learnin$ outcomes+evel , (ifficulty levels- Easy Moderate /Mod (ifficult /(iff


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0 1 E S T I O N S

() ' cash euivalent is an investment that is readily convertible to a ;nown amount ofcash and has an ori$inal maturity to the investor of three months or less. It is

included with cash on the balance sheet because the ris; of a material loss on it issmall. 4nli;e other types of investments such as those in stoc;s and bonds of othercompanies the company holdin$ a cash euivalent ;nows e#actly how much cashwill be received when it matures.

*) ' cash euivalent is convertible to a ;nown amount of cash. herefore the purchaseof a cash euivalent is not considered a si$nificant investin$ activity to be reportedon the statement of cash flows. 3ash euivalents are included with cash on thebalance sheet and thus the company is merely tradin$ one cash item for anotherwhen it writes a chec; and uses the proceeds to invest in a cash euivalent.

+) he friend is correct in the observation that all receipts should be deposited intact for

control purposes. 7owever no company should have a policy to ma#imi


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3) his misuse of corporate assets could have been prevented by havin$ a procedurein place for se$re$ation of duties. ' sin$le employee should not be allowed to ordermerchandise receive it and initiate payment for it.

4) here are a number of limitations on the efficiency of internal control. irst a systemof internal control is not cost free. or e#ample the se$re$ation of duties mayreuire a lar$er staff than would otherwise be necessary. 'n internal audit staff maybe too costly for a small company. Second no system of internal control can preventcollusion by two or more employees. hird the lac; of support from uppermana$ement may wea;en an otherwise stron$ commitment to a system of internalcontrol. inally the element of human error can never be eliminated in anyoperation re$ardless of how bi$ or small.

(5) wo basic procedures are essential to $ood internal control over cash. irst all cashreceipts should be deposited intact in a ban; on a daily basis. hat is nodisbursements should be made from any amounts received prior to their deposit inthe ban;. Second all cash disbursements should be made by chec;. he use of

serially numbered chec;s results in a clear record of all payments.

(() here may be a benefit in terms of $ood customer relations to positionin$ a cashre$ister so that customers can read the display. 7owever it is eually important forcontrol purposes. If the customer can read the display the sales cler; is less li;ely torin$ up a sale for less than the amount received and poc;et the difference. hiscontrol feature is certainly not foolproof in preventin$ this from happenin$ but it willact as a deterrent.

(*) 'n invoice rather than a purchase order is the basis for recordin$ a purchase and acorrespondin$ liability /accounts payable. rom a le$al viewpoint the purchaseorder is merely an offer by the company to purchase and does not constitute by itself

a le$ally bindin$ contract. he receipt of an invoice from the supplier is evidence thatthis outside party has accepted the offer and a$reed to sell the merchandise under aparticular set of terms and conditions.

(+) ' receivin$ report is a document used by the receivin$ department to indicate thearrival of inventory from a supplier. In a computeri


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E X E R C I S E S

+& 1 EXERCISE 6.( CASH E01IVALENTS

3ash euivalents at (ecember "1 !00A-3ertificates of deposit due March "0 !00B C1500003ommercial paper due ebruary !B !00B 1!5000(eposit into a money mar;et fund !5000D0%day reasury bills 100000

3ash euivalents C)00000

+& ! EXERCISE 6.* ITEMS ON A BAN RECONCILIATION

() (?an; ) (?oo; 2) 2'

*) (?oo; -) '?oo; 3) '?oo;

+) '?oo; 6) '?an; 4) '?oo;

+& ! EXERCISE 6.+ PETT7 CASH F1N

*552Fan. ! 8etty 3ash und "00.00

3ash "00.00o record establishment of petty cash fund.

Assets 8 L!a/!l!t!es 9 O:ners; E+55)55

Fan. "1 8osta$e E#pense A6.00(elivery E#pense )5."0Entertainment E#pense 65.)0&ffice Supplies E#pense "6.00

3ash &ver and Short ".!03ash !!5.D0o record replenishment of petty cash fund-C"00.00 G CA).10 , C!!5.D0.

Assets 8 L!a/!l!t!es 9 O:ners; E**-)45 >***)25

>+)*5


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+& ) EXERCISE 6. INTERNAL CONTROL

() Students= answers to this uestion will vary. 'mon$ the possible $uidelines the clubshould follow-

a) 8renumbered tic;ets

/) Se$re$ation of duties for collectin$ cash countin$ and recordin$ cash anddepositin$ cash in a ban; account

%) 8ayment by chec; of any e#penses associated with the raffle

*) he president would li;e verification that all money is collected and recorded. Itwould be difficult if not impossible to be completely sure that this happens. ore#ample human errors in countin$ and handlin$ the cash may result in not all of thecash bein$ collected /such as errors in ma;in$ chan$e. 'lso it is impossible toprevent collusion from occurrin$ if two or more individuals wor; to$ether to misdirect

any of the cash.

+& ) EXERCISE 6.- SE?RE?ATION OF 1TIES

Many possible combinations are possible. &ne appropriate way to se$re$ate the dutieswould be as follows-

E"@lo=eeTas Mar= S$e ohn

8repare invoices HMail invoices H

8ic; up mail from post office H&pen mail separate chec;s H* H*+ist chec;s on deposit slip in triplicate H8ost payment to customer=s account H(eposit chec;s H8repare monthly schedule of

accounts receivable H9econcile ban; statements H

*wo employees should be present to open mail and separate chec;s.


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M1LTI.CONCEPT EXERCISE

+& 1! EXERCISE 6.6 COMPOSITION OF CASH

() 2) 2 /Short%term investments- 3(

*) 3)

+) 4) 2 /'ccounts receivable- 8ast (ue

) 2 /&ffice supplies (5)

-) 2 /9eceivables from employees (()

6)

P R O B L E M S

+& ! PROBLEM 6.( BAN RECONCILIATION

() CALICO CORNERSBAN RECONCILIATION

MA7 +(, *552

?alance per ban; statement May "1 C B)"!.11'dd- (eposit%in%transit C1!50.00

?an; error- deposit credited to

wron$ account 1!" .)5 1"A".)5(educt- &utstandin$ chec;s-

J1!" C !".)0J1!A 1)5.00J1!B !10.B0J1"0 6A ."! /))6 .5!

'd@usted balance May "1 C D"5D .0)

?alance per boo;s May "1 C DD65.")'dd- Interest earned on bonds C )65.00

Interest earned on account 5) .60 51D.60

(educt- ?an; service char$es C 50.002S chec; 166.00?oo; error- (eposit of C101.10

recorded as C1011.00 D0D .D0 /11!5 .D0'd@usted balance May "1 C D"5D .0)


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+& 5 PROBLEM 6.+ THE ESI?N OF INTERNAL CONTROL OC1MENTS

() he old system of allowin$ each motel to buy supplies from local distributors offeredvery little internal control. or e#ample the corporate office had no control over the

amount paid by each individual operation for its supplies. he new system will allowthe company to buy in lar$er uantities hopefully at better prices. 'lso with the oldsystem there was no physical control over the supplies. (ishonest employees at aparticular motel could steal supplies much more easily than under the new system.

*) he purchase reuisition form should be in triplicate with the ori$inal filled out by thereuestin$ department and copies to the purchasin$ and accountin$ departments.he form should show

a) reuestin$ department

/) date reuested

%) preferred vendord) date needed

e) complete description of items reuested

) uantity of each item reuested

#) blan; for si$nature of person reuestin$

h) blan; for si$nature of supervisor for approval

!) seuential numberin$ of the forms

he receivin$ report should be in duplicate with the ori$inal filled out by the

receivin$ department with a copy to the accountin$ department. It should showa) purchase order number

/) vendor

%) carrierKshipper

d) credit terms

e) dates reuested ordered and received

) shippin$ instructions

#) items ordered and uantity of each ordered

h) uantities received of each item!) blan; for si$nature of person receivin$

D) blan; for approvals


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M1LTI.CONCEPT PROBLEMS

+& 1! PROBLEM 6. CASH AN LI01I ASSETS ON THE BALANCE SHEET

In order of liuidity on the balance sheet-

() 8etty cash fund

*) Money mar;et fund

+) Investment in stoc;

) 'ccounts receivable

-) 3ertificates of deposit /si# months

6) 8repaid rent

he first two items would be included in cash on the balance sheet. 'll other items arenot as liuid as cash and reuire either collection or sale to $enerate cash. Each of

these items would normally be classified as current assets. 8repaid rent is consideredcurrent because the benefits will normally e#pire within one year. 7oweverprepayments do not $enerate any cash for the business. It should be noted that the 3(does not ualify as a cash euivalent because it has a maturity lon$er than threemonths.

+& ") PROBLEM 6.- INTERNAL CONTROL

() Morris Mart suffers from a lac; of se$re$ation of duties. Mary handles all tas;s

associated with collection of customer accounts.*) Mary should not handle all aspects of accounts receivable billin$ and collection.

wo different employees should mail invoices and record the amounts billed. woemployees should be present when the mail is opened. 'nother employee should beresponsible for recordin$ collections from customers. inally all employees shouldbe reuired to ta;e vacations and there should be rotation of @ob duties amon$employees.

+) Someone should e#plain to Mary that she personally is not the problem but that a$ood system of internal control reuires certain chan$es to be made. his could bee#plained to her not in the conte#t of fraud but rather in the conte#t of the necessity

to verify and chec; the wor; performed by all employees.


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A L TE R N A T E P R O B L E M S

+& ! PROBLEM 6.(A BAN RECONCILIATION

() 'mounts can be found by preparin$ a ban; reconciliation-

AREN;S CATERIN?BAN RECONCILIATION

MARCH +(, *552

?alance per ban; statement March "1 C6506.10'dd- (eposit%in%transit )!".00(educt- &utstandin$ chec;s-

J11! C )!.D!J11A "0A.00

J1!0 10.5BJ1!! A5 .6A C )"6.1A

?an; error- chec; written forCDD0 CD0D char$ed a$ainstaccount B1 .00 /51A .1A

'd@usted balance March "1 C6)11 .D"?alance per boo;s March "1 C L

'dd- 3ustomer chec; collected C )5.00Interest earned on account )."03ustomer chec; not recorded 1!50 .00 1!DD."0

(educt- 3ollection fee C ).50

?an; service char$es !! .00 /!6 .50'd@usted balance March "1 C6)11 .D"*

*'d@usted balance per the boo;s must be the same amount as the ad@usted balanceper the ban;.

Con%l$s!onhe balance on the boo;s before any ad@ustments is the L in the ban;reconciliation and can be found by wor;in$ bac;wards- C6)11.D" C!6.50 GC1!DD."0 , C51"D.1". he corrected balance to be reported on the balance sheetis the ad@usted balance of C6)11.D".

*) Naren has an ethical responsibility to tell the ban; about the error of CB1.00 in Item#)Even thou$h reportin$ the error will result in a decrease in Naren=s ban; balance

the error should be called to the attention of the ban;.


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+& ) PROBLEM 6.*A INTRNAL CONTROL PROCE1RES

() he ban; and re$ulatory a$ency are concerned with these documents becausewithout proper documentation the le$al a$reement could be invalid. or e#ample

without a valid title the ban; has no recourse if the customer defaults on the loan. 'valid insurance policy is necessary in case the motorist should have an accident.he re$ulatory a$ency is empowered by the $overnment to protect the interests ofthe public.

*) Internal control procedures to ensure that the documents are obtained andsafe$uarded-

a) he accuracy and completeness of all information on the note insurance policyand title should be verified and reviewed.

/) he note and insurance policy should be reviewed periodically for e#pirationdates.

%) Each of the documents should be ;ept in loc;ed compartments with limitedaccess.

+& 5 PROBLEM 6.+A THE ESI?N OF INTERNAL CONTROL OC1MENTS

() 8rocedures to ensure that all royalties are paid to the actors-

a) 'll payments must be made by chec;.

/) 'll payments are sub@ect to approval by a supervisor.

%) 'll payments should be cross%referenced to the actual sales of movies.

*) he shippin$ form should be in duplicate with the ori$inal filled out by the shippin$department and a copy to the accountin$ department. It should include

a) authori


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ALTERNATE M1LTI.CONCEPT PROBLEMS

+& 1! PROBLEM 6.A CASH AN LI01I ASSETS ON THE BALANCE SHEET

() 3ash in the chec;in$ account and the petty cash fund are cash. he three%month

certificates of deposit and the money mar;et fund are both cash euivalents.

*) 'ccounts receivable and mar;etable securities should be classified on the balancesheet as current assets and listed in the order of their liuidity /mar;etable securitiesare more liuid than accounts receivable.

+) In%reaseCash and Cash E


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E C I S I O N C A S E S

REAIN? AN INTERPRETIN? FINANCIAL STATEMENTS

+& 1 ECISION CASE 6.( REAIN? LIFE TIME FITNESS;S FINANCIAL STATEMENTS

() he balance in 3ash and cash euivalents on the company=s (ecember "1 !00)balance sheet is C10!11000. he balance on (ecember "1 !00" wasC1B))6000 thus cash and cash euivalents decreased durin$ !00) byCB!"5000.

*) he decrease in cash and cash euivalents of CB!"5000 appears on thecompany=s statement of cash flows. he statement of cash flows summari


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MAIN? FINANCIAL ECISIONS

+& 1 ECISION CASE 6.+ LI01IIT7

&- he 8resident of 2? of Qerona 7ei$hts

9&M- Foe Smith +oan &fficer

('E- HKHKHH

S4?FE3- +oan proposals

I have reviewed the loan proposals recently submitted by 9. Monta$ue and F. 3apuletand would li;e to summari


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