Chapter 7
Internal Control and Cash
Review Questions
1.What is internal control?
Internal control is the organizational plan and all the related measures adopted by an entity to
2.How does the Sarbanes-Oxley Act relate to internal controls?
The Sarbanes-Oxley Act requires public companies to issue an internal control report, which
3. What are the five components of internal control? Briefly explain each component.
The five components of internal control are: control procedures, risk assessment, information
system, monitoring of controls, and environment.
4.What is the difference between an internal auditor and external auditor?
5.What is separation of duties?
6.List internal control procedures related to e-commerce.
7.What are some limitations of internal controls?
Limitations to internal controls relate to cost and benefit. The better the controls, the more
8.How do businesses control cash receipts over the counter?
Businesses control cash receipts over the counter by using a cash register. The cash register
9.How do businesses control cash receipts by mail?
Businesses control cash receipts by mail by separating the check and the remittance advice in
10. What are the steps taken to ensure control over purchases and payments by check?
Steps taken to ensure control over purchases and payments by check are: The buyer sends a
11. What are the controls needed to secure the petty cash fund?
12. When are the only times the Petty Cash account is used in a journal entry?
13. What are two common methods used when accepting deposits for credit card and debit card
transactions?
Two common methods for deposits of proceeds from credit card sales are the net method and
14. What are some common controls used with a bank account?
15. What is a bank reconciliation?
16. List some examples of timing differences, and for each difference, determine if it would
affect the book side of the reconciliation or the bank side of the reconciliation
Examples of timing differences are:
17. Why is it necessary to record journal entries after the bank reconciliation has been prepared?
Which side of the bank reconciliation requires journal entries?
18. What does the cash ratio help determine, and how is it calculated?
Short Exercises
S7-1 Defining internal control
Learning Objective 1
Internal controls are designed to safeguard assets, encourage employees to follow company
policies, promote operational efficiency, and ensure accurate accounting records.
Requirements
1. Which objective do you think is most important?
2. Which objective do you think the internal controls must accomplish for the business to
survive? Give your reason.
SOLUTION
S7-2 Applying internal control over cash receipts
Learning Objective 2
Sandra Kristof sells furniture for McKinney Furniture Company. Kristof is having financial
problems and takes $650 that she received from a customer. She rang up the sale through the
cash register. What will alert Megan McKinney, the controller, that something is wrong?
SOLUTION
S7-3 Applying internal control over cash receipts by mail
Learning Objective 2
Review the internal controls over cash receipts by mail presented in the chapter. Exactly what is
accomplished by the final step in the process, performed by the controller?
SOLUTION
S7-4 Applying internal control over cash payments by check
Learning Objective 3
A purchasing agent for Franklin Office Supplies receives the goods that he purchases and also
approves payment for the goods.
Requirements
1. How could this purchasing agent cheat his company?
2. How could Franklin avoid this internal control weakness?
SOLUTION
Requirement 1
S7-5 Journalizing petty cash
Learning Objective 4
Prepare the journal entries for the following petty cash transactions of Everly Gaming Supplies:
Mar. 1 Established a petty cash fund with a $250 balance.
31 The petty cash fund has $24 in cash and $235 in petty cash tickets that were
issued to pay for Office Supplies ($35) and Entertainment Expense ($200).
Replenished the fund and recorded the expenditures.
Apr. 15 Increased the balance of the petty cash fund to $300.
SOLUTION
S7-6 Recording credit card and debit card sales
Learning Objective 5
Restaurants do a large volume of business by credit and debit cards. Suppose Summer, Sand, and
Castles Resort restaurant had these transactions on January 28, 2018:
National Express credit card
sales
$
10,800
ValueCard debit card sales 10,000
Requirements
1. Suppose Summer, Sand, and Castles Resort’s processor charges a 2% fee and deposits sales
net of the fee. Journalize these sales transactions for the restaurant.
2. Suppose Summer, Sand, and Castles Resort’s processor charges a 2% fee and deposits sales
using the gross method. Journalize these sales transactions for the restaurant.
SOLUTION
S7-7 Understanding bank account controls
Learning Objective 6
Answer the following questions about the controls in bank accounts:
Requirements
1. Which bank control protects against forgery?
2. Which bank control reports the activity in the customer’s account each period?
3. Which bank control confirms the amount of money put into the bank account?
SOLUTION
Requirement 1
S7-8 Identifying timing differences related to a bank reconciliation
Learning Objective 6
For each timing difference listed, identify whether the difference would be reported on the book
side of the reconciliation or the bank side of the reconciliation. In addition, identify whether the
difference would be an addition or subtraction.
a. Deposit in transit
b. Bank collection
c. Debit memorandum from bank
d. EFT cash receipt
e. Outstanding checks
f. $1,000 deposit erroneously recorded by the bank as $100
g. Service charges
h. Interest revenue
i. $2,500 cash payment for rent expense erroneously recorded by the business as $250
j. Credit memorandum from bank
SOLUTION
S7-9 Preparing a bank reconciliation
Learning Objective 6
The Cash account of Guard Dog Security Systems reported a balance of $2,540 at December 31, 2018.
There were outstanding checks totaling $400 and a December 31 deposit in transit of $100. The bank
statement, which came from Park Cities Bank, listed the December 31 balance of $3,340. Included in the
bank balance was a collection of $510 on account from Brendan Ballou, a Guard Dog customer who pays
the bank directly. The bank statement also shows a $30 service charge and $20 of interest revenue that
Guard Dog earned on its bank balance. Prepare Guard Dog’s bank reconciliation at December 31.
SOLUTION
S7-10 Recording transactions from a bank reconciliation
Learning Objective 6
Review your results from preparing Guard Dog Security Systems’s bank reconciliation in Short
Exercise S7-9. Journalize the company’s transactions that arise from the bank reconciliation.
Include an explanation with each entry.
SOLUTION
S7-11 Computing the cash ratio
Learning Objective 7
Smythe Banners reported the following figures in its financial statements:
Cash $ 26,500
Cash Equivalents 5,000
Total Current
Liabilities
30,000
Compute the cash ratio for Smythe Banners.
SOLUTION