Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-1
General Comments for Chapter 4
Internal Controls, Accounting
for Cash, and Ethics
This chapter explains internal controls, which are the policies and procedures used to
provide reasonable assurance that the objectives of an enterprise will be accomplished. While the
mechanics of internal control systems vary from company to company, the chapter presents cash
as an important business asset and special procedures that should be employed to control the re-
ceipts and payments of cash.
One of the most common control policies is to use checking accounts for all payments
except petty cash disbursements. Students learn that a bank reconciliation should be prepared
each month to explain differences between the bank statement and a company’s internal account-
ing records. A common reconciliation format determines the true cash balance based on both
bank and book records. Items that typically appear on a bank reconciliation include the follow-
ing: the bank balance, deposits in transit, outstanding checks, the book balance, interest revenue
collected by the bank, receivables collected by the bank, bank service charges, and non-sufficient
funds (NSF) checks. Agreement of the two true cash balances (Bank versus Book) provides evi-
dence that accounting for cash transactions has been accurate.
The chapter also discusses the importance of ethics in the accounting profession. The
American Institute of Public Accountants requires all of its members to comply with the Code of
Professional Conduct. Situations where opportunity, pressure, and rationalization exist can lead
employees to conduct unethical acts, which, in cases like Enron, have destroyed the organization.
Finally, the chapter discussed the auditor’s role in financial reporting, including the materiality
concept and the types of audit opinions that may be issued.
Consider beginning the chapter with a discussion of internal controls and a question
about a practice familiar to your students. For example, ask why a movie theater uses one person
to sell tickets and another to collect them as patrons enter the theater. Couldn’t the theater save
money by using one employee to both sell and collect the tickets? Such a question leads into
discussing separation of duties. Similarly, you may ask why a department store requires two
clerks to sign a receipt for returned merchandise, or why some convenience stores post a sign by
the cash register offering each customer a cash reward if the cashier fails to give the customer a
receipt. After a brief introduction most students can grasp the internal control concepts by
reading the chapter material. As a lead-in to preparing a bank reconciliation, you may wish to
explain why companies need good internal controls for cash and provide examples of appropriate
controls. This will then lead to the fraud triangle, why the control of cash is so important, and the
accountant’s role in society requires trust, credibility, and ethics.
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-2
Detailed Outline of a Lesson Plan for Chapter 4
I. Begin the discussion of internal controls with a brief introduction about the nature
and purpose of internal controls. Students should be able to learn the details about
internal control concepts through their reading assignment. Mention that a business needs
good internal controls to protect its cash.
II. Use Demonstration Problem 4-1 to show students how to prepare a bank
reconciliation. Many students have checking accounts and, therefore, some familiarity
with reconciling items. You can stimulate interest by having students help create the
form for the bank reconciliation. Write captions for the unadjusted bank and book
balances on the chalkboard. Point out that neither of these amounts represents the true
amount of cash the company owns. Then ask what could cause differences between the
unadjusted bank balance and the true cash balance. Use student input to develop a form
for determining the true balance from the starting point of the unadjusted bank balance.
Use the same approach to develop a form for computing the true balance when starting
with the unadjusted book balance. Use these forms to work out the solution to
Demonstration Problem 4-3. Alternatively, use the forms provided in this manual.
III. Use Demonstration Problem 4-2 to reinforce bank reconciliation procedures. This
problem requires determining the amount of the unadjusted book balance in the cash
account. It provides sufficient information for students to determine the true cash balance
starting from the unadjusted bank balance. Students must realize that the true cash
balance is the same whether it is determined from the perspective of the unadjusted bank
or the unadjusted book balance. Once students understand this point, they can determine
the unadjusted book balance by working backwards from the true cash balance.
IV. Time considerations and homework assignments. Allot approximately one hour of
class time to cover internal controls and bank reconciliations. Problems 4-21 and 4-22
will provide useful follow-up for Demonstration Problems 4-1 and 4-2. We also
recommend Exercise 4-15 as an introductory problem when discussing the fraud triangle,
with a follow-up homework assignment of Problem 4-24. Exercises 4-13, 4-14, and 4-17
provide good scenarios for discussing the AICPA Professional Code of Conduct and
auditor responsibilities, with follow-up homework assignments of Problem 4-25 and
ATC 4-5.
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-3
Demonstration Problems for Chapter 4
Demonstration Problem 4-1: Bank Reconciliation
The bank statement for Greenbrier Furniture Stores showed a balance of $63,289 as of
November 30. The unadjusted balance in the general ledger cash account at November 30 was
$59,345. An examination of the bank statement disclosed the following information.
1. Outstanding checks totaled $24,598.
2. The bank had issued a $157 credit memo for interest deposited into Greenbrier’s account.
3. The bank had deducted $469 for two non-sufficient funds (NSF) checks.
4. The bank statement enclosures included a debit memo for $36 the bank had deducted from
Greenbrier’s account to pay for new checks.
5. Deposits in transit were $19,060.
6. The bank had mistakenly deducted from Greenbrier’s account a $1,246 check drawn on the
Greenbay Company.
Required
a. Reconcile the balance shown on the bank statement and the unadjusted balance of the
company’s cash account to the true cash balance.
b. What is the amount of cash that should be reported on Greenbrier’s balance sheet as of
November 30?
Demonstration Problem 4-2: Bank Reconciliation
The bank statement for Broom Company showed a $200 bank balance at the end of the month.
A comparison of Broom Company’s bank statement and accounting records disclosed a $40
deposit in transit and $55 of outstanding checks at month-end. The bank statement enclosures
included a $5 NSF check and a credit memo for $10 of interest.
Required
a. Determine the unadjusted book balance in the cash account.
b. What is the book balance in Broom’s cash account after the adjusting entries have been
made?
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-4
SOLUTIONS TO
DEMONSTRATION PROBLEMS
Demonstration Problem 4-1: Solution, part a. Bank Reconciliation
Bank Reconciliation
Unadjusted Bank Balance
$63,289
Unadjusted Book Balance
$59,345
Add:
Add:
Deposits in Transit
19,060
Credit Memo for Interest
157
Bank Error, Greenbay Check
1,246
Subtract:
Subtract:
Outstanding Checks
(24,598)
NSF Checks
(469)
Charge for Checks
(36)
True Cash Balance
$58,997
True Cash Balance
$58,997
Demonstration Problem 4-1: Solution, part b.
Determine Cash Balance
Demonstration Problem 4-2: Solution, part a. Bank Reconciliation
Bank Reconciliation
$200
Unadjusted Book Balance
Y = $180
Add:
40
Credit Memo for Interest
10
Subtract:
(55)
NSF Check
(5)
X = $185
True Cash Balance
X = $185
Compute the answer as follows: First, determine the true cash balance using the bank balance,
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-5
Demonstration Problem 4-2: Solution, part b.
Determine Cash Balance
The balance in the cash account, after the adjusting entries have been posted to the ledger
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-6
WORK PAPERS FOR
DEMONSTRATION PROBLEMS
Demonstration Problem 4-1: Work Paper, part a. Bank Reconciliation
Bank Reconciliation
Unadjusted Bank Balance
Unadjusted Book Balance
Add:
Add:
Subtract:
Subtract:
True Cash Balance
$58,997
True Cash Balance
$58,997
Demonstration Problem 4-1: Work Paper, part b.
Indicate Amount of Cash to be Reported on Balance Sheet
Demonstration Problem 4-2: Work Paper, part a. Bank Reconciliation
Bank Reconciliation
$200
Unadjusted Book Balance
Y =
Add:
Subtract:
X =
True Cash Balance
X =
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-7
Demonstration Problem 4-2: Work Paper, part b.
Indicate Book Balance of the Cash Account
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-8
Quiz Questions for Chapter 4
1. Mary Wilson is an accounting clerk for a large department store. Her husband owns an office supply
business. Mary paid her husband’s business for supplies the department store never received. Which of
the following practices would allow Mary to perpetrate this scam?
a. Keeping prenumbered checks under lock and key.
b. Allowing a single person to approve disbursements, sign checks, and reconcile the checking
account.
c. Requiring one employee to approve supporting documents and a different employee to sign
checks.
d. Marking supporting documents “paid” when checks are signed.
2. RST’s bank statement included an NSF check that one of its customers had written to pay its account
receivable. How would recording the NSF check affect RST’s accounting equation?
a. Increase assets / decrease liabilities.
b. Have no effect on total assets, liabilities, or equity.
c. Decrease assets / increase liabilities.
d. Increase liabilities / decrease equity.
3. X Company’s unadjusted cash balance at the end of October was $14,350. Other relevant information
is: deposits in transit, $2,300; a credit memo in the bank statement for interest earned, $500; a check for
$50 incorrectly recorded as $55 by the company’s accountant; a debit memo in the bank statement for
an $8 bank service charge; and outstanding checks, $2,100. The true cash balance on October 31 was
a. $14,850.
b. $14,550.
c. $14,537.
d. $14,847.
4. EFG Company’s bank statement reported an unadjusted bank account balance of $20,900 at the end of
February. Analyzing the February bank statement disclosed the following:
Credit memo for funds the bank had collected on a note receivable, $800
Deposits in transit, $1,420
Debit memo for service charge, $6.50
Outstanding checks, $750
NSF check, $310
The true cash balance at the end of February was
a. $21,260.00.
b. $22,053.50.
c. $21,570.00.
d. $22,370.00.
5. Which of the following is true?
a. Internal controls are unnecessary when key employees are bonded.
b. Experienced accounting clerks need not use prenumbered documents.
c. The practice of separating duties prevents an employee from both approving a refund and
disbursing the cash.
d. Administrative controls would limit access to physical assets but not to accounting records.
6. A company can protect itself from dishonest employees by obtaining
a. a signature card.
b. a certified check.
c. an outstanding check.
d. a fidelity bond.
7. There are three elements typically present when fraud occurs. These are
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-9
a. Opportunity, internal controls and pressure.
b. Opportunity, pressure and rationalization.
c. Pressure, rationalization and expenses.
d. Rationalization, opportunity and independence.
8. All of the following are true about the primary roles of an independent auditor (CPA) except:
a. The auditor maintains professional confidentiality of client records.
b. The auditor assumes both legal and professional responsibilities to the public as well as to the company
paying the auditor.
c. The auditor presents conclusions in audit reports that include an opinion about whether statements are
prepared in conformity with GAAP.
d. The auditor determines if financial statements are completely accurate.
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-10
Solutions to Quiz Questions
Question
Answer
1
B
2
B
3
D
4
C
5
C
6
D
7
B
8
D
Chapter 04 – Internal Controls, Accounting for Cash, and Ethics
4-11
Summary Outline of a Lesson Plan for Chapter 4
I. Begin with a brief introduction about the nature and purpose of internal controls.
Offer a few familiar internal control examples.
II. Use Demonstration Problem 4-1 to show students how to prepare a bank
reconciliation.
III. Use Demonstration Problem 4-2 to reinforce bank reconciliation procedures.
IV. Time considerations and homework assignments. Allot approximately one hour of
class time to cover internal controls and bank reconciliations. Problems 4-21 and 4-22
will provide useful follow-up for Demonstration Problems 4-1 and 4-2. We also
recommend Exercise 4-15 as an introductory problem when discussing the fraud triangle,
with a follow-up homework assignment of Problem 4-24. Exercises 4-13, 4-14, and 4-17
provide good scenarios for discussing the AICPA Professional Code of Conduct and
auditor responsibilities, with follow-up homework assignments of Problem 4-25 and
ATC 4-5.