978-0078025549 Chapter 4 Solution Manual Part 1

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Question 4-1 (LO 4-1)

Occupational fraud is the use of one’s occupation for personal enrichment through the

deliberate misuse or misapplication of the employing organization’s resources. Occupational

Question 4-2 (LO 4-1)

Internal control is a company’s plan to (1) safeguard the company’s assets and (2) improve

the accuracy and reliability of accounting information. Effective internal control builds a wall to

Question 4-3 (LO 4-1)

Managers are entrusted with the resources of both the company’s lenders (liabilities) and

Question 4-4 (LO 4-1)

Managers are motivated to manipulate financial statements to maximize their compensation,

Question 4-5 (LO 4-1)

The fraud triangle represents the three elements of fraud: motive, rationalization, and

Question 4-6 (LO 4-1)

The major provisions of the Sarbanes-Oxley Act include the Public Company Accounting

Oversight Board, corporate executive accountability, limitation on nonaudit services, retention of

Answers to Review Questions (continued)

Question 4-7 (LO 4-2)

1. Control Environment – The overall ethical tone of the company with respect to internal

2. Risk Assessment – Identification and analysis of internal and external risk factors that could

Chapter 4

Cash and Internal ControlsREVIEW QUESTIONS

3. Control Activities – The policies and procedures that help ensure that management’s directives

4. Monitoring – Continuous observation of the internal control system.

5. Information and Communication – Systems designed to ensure accurate measurement of

Question 4-8 (LO 4-2)

Detective controls are designed to detect errors or fraud that have already occurred, while

preventive controls are designed to keep errors or fraud from occurring in the first place.

Preventive controls include separation of duties, physical controls, proper authorizations, and

employee management. Detective controls include reconciliations and performance reviews.

Question 4-9 (LO 4-2)

Authorizing transactions, recording transactions, and maintaining control of the related assets

Question 4-10 (LO 4-2)

Everyone in a company has an impact on the operation and effectiveness of internal controls,

but the top executives are the ones who must take final responsibility for their

establishment and success. The CEO and CFO sign a report each year assessing whether the

Question 4-11 (LO 4-2)

Internal controls cannot prevent financial misstatement in all cases, do not necessarily

Question 4-12 (LO 4-2)

Collusion occurs when two or more people act in coordination to circumvent internal

controls.

Question 4-13 (LO 4-2)

Fraud is more likely to occur when it is being committed by top-level employees who have

the ability to override internal control features. For example, managers may be required to obtain

Question 4-14 (LO 4-3)

Cash includes not only currency, coins, balances in checking accounts, and checks and

money orders received from customers, but also cash equivalents, defined as investments that

Question 4-15 (LO 4-3)

A purchase with a check is recorded as an immediate cash payment.

Question 4-16 (LO 4-4)

1. Record all cash receipts as soon as possible.

2. Open mail each day, and make a list of checks received, including the amount and

3. Designate an employee to deposit cash and checks into the company’s bank account each

4. Have another employee record cash receipts in the accounting records. Verify cash

Question 4-17 (LO 4-4)

Credit cards extend credit (or lend money) to the cardholder each time the cardholder uses

the credit card. The cardholder has a specified grace period before he or she has to pay the credit

Question 4-18 (LO 4-4)

Like credit cards, debit cards offer customers a way to purchase goods and services without a

physical exchange of cash. They differ, however, in that most debit cards (sometimes referred to

Question 4-19 (LO 4-4)

1. Make all disbursements, other than very small ones, by check, debit card, or credit card.

2. Authorize all expenditures before purchase and verify the accuracy of the purchase itself.

3. Make sure checks are serially numbered and signed only by authorized employees.

4. Periodically check amounts shown in the debit card and credit card statements against

5. Set maximum purchase limits on debit cards and credit cards. Give approval to purchase

6. Employees responsible for making cash disbursements should not also be in charge of

Answers to Review Questions (continued)

Question 4-20 (LO 4-4)

Credit card purchases are recorded as purchases on account.

Question 4-21 (LO 4-5)

A bank reconciliation matches the balance of cash in the bank account with the balance of

cash in the company’s own records by reconciling timing differences and errors. It is the

Question 4-22 (LO 4-5)

The two reasons are timing differences and errors. Timing differences arise when one party

Question 4-23 (LO 4-5)

Examples include deposits outstanding, checks outstanding, notes collected by the bank,

Question 4-24 (LO 4-5)

As a final step in the reconciliation process, the company must update the balance of cash for

Question 4-25 (LO 4-6)

The petty cash fund is cash kept on hand to pay for minor purchases.

Question 4-26 (LO 4-6)

Management establishes a petty cash fund by writing a check for cash against the company’s

checking account and giving the withdrawn cash to an employee who becomes responsible for it.

Question 4-27 (LO 4-7)

In addition to the change in total cash which can be calculated using two consecutive balance

Question 4-28 (LO 4-7)

Operating activities include cash transactions involving revenue and expense events during

Answers to Review Questions (continued)

Question 4-29 (LO 4-8)

When accrual-basis net income and free cash flows for the period move in the same direction

(that is, both increase or both decrease compared to last period), accrual-basis net income is

Question 4-30 (LO 4-8)

Between 1999 and 2004, Krispy Kreme had a negative relationship between cash flows and net

income, while Starbucks’ was positive. This should have been a sign to investors that Krispy

Kreme’s rising net income did not provide a good indication of the company’s long-term

BRIEF Exercises

Brief Exercise 4-1 (LO 4-1)

1. c.

2. a.

3. d.

4. b.

5. e.

Brief Exercise 4-2 (LO 4-2)

1. e.

2. d.

3. a.

4. c.

5. b.

Brief Exercise 4-3 (LO 4-2)

1. e.

2. a.

3. f.

4. c.

5. b.

6. d.

Brief Exercise 4-4 (LO 4-3)

1. Yes

2. No

3. Yes

4. Yes

5. No

6. Yes

Brief Exercise 4-5 (LO 4-4)

1. $ 500,000

2. 350,000

3. 582,000 (= $600,000 less 3% service fee)

Brief Exercise 4-6 (LO 4-4)

1. Debit Credit

Salaries Expense 500

Equipment 1,000

Repairs and Maintenance Expense 400

Brief Exercise 4-7 (LO 4-5)

1. d.

2. c.

3. f.

4. e.

5. a.

6. b.

Brief Exercise 4-8 (LO 4-5)

Reconciliation items Bank balance Company balance

1. Checks outstanding Subtract No entry

2. NSF checks No entry Subtract

3. Deposit recorded twice by company No entry Subtract

Brief Exercise 4-9 (LO 4-5)

Bank balance $2,000

Deposits outstanding +4,200

Brief Exercise 4-10 (LO 4-5)

Company balance $2,620

Service fees −85

NSF check −350

Brief Exercise 4-11 (LO 4-5)

Debit Credit

Cash 1,035

Notes Receivable 1,000

Service Fee Expense 85

Accounts Receivable 350

Brief Exercise 4-12 (LO 4-5)

Bank balance $7,345 Company balance $4,593

Checks outstanding −2,803 Service fees −85

Interest earned +34

Brief Exercise 4-13 (LO 4-6)

Debit Credit

Postage Expense 60

Delivery Expense 85

Supplies Expense 50

Entertainment Expense 25

Debit Credit

Petty Cash 220

Brief Exercise 4-14 (LO 4-7)

1. c.

2. a.

3. b.

Brief Exercise 4-15 (LO 4-7)

Receipts for lessons in June $4,500

Receipts for lessons in May 500

Brief Exercise 4-16 (LO 4-7)

Total investing cash flows = $13,000

Brief Exercise 4-17 (LO 4-7)

Issuance of stock $11,000

Borrowing from bank 35,000

Brief Exercise 4-18 (LO 4-8)

Operating Cash Flows + Investing Cash Flows = Free Cash Flows

Tuohy Incorporated $19,200 $(4,800) $14,400

Oher Corporation 13,500 7,400 20,900