Exercises
E7-12 Understanding the Sarbanes-Oxley Act and identifying internal control strengths
and weaknesses
Learning Objective 1
The following situations suggest a strength or a weakness in internal control.
a. Top managers delegate all internal control procedures to the accounting department.
b. Accounting department staff (or the bookkeeper) orders merchandise and approves invoices
for payment.
c. Cash received over the counter is controlled by the sales clerk, who rings up the sale and
places the cash in the register. The sales clerk matches the total recorded by the register to
each day’s cash sales.
d. The employee who signs checks need not examine the payment packet because he is
confident the amounts are correct.
Requirements
1. Define internal control.
2. The system of internal control must be tested by external auditors. What law or rule requires
this testing?
3. Identify each item in the list above as either a strength or a weakness in internal control, and
give your reason for each answer.
SOLUTION
Requirement 1
E7-13 Identifying internal controls
Learning Objective 1
Consider each situation separately. Identify the missing internal control procedure from these
characteristics:
• Assignment of responsibilities
• Separation of duties
• Audits
• Electronic devices
• Other controls (specify)
a. While reviewing the records of Quality Pharmacy, you find that the same employee orders
merchandise and approves invoices for payment.
b. Business is slow at Amazing Amusement Park on Tuesday, Wednesday, and Thursday nights.
To reduce expenses, the business decides not to use a ticket taker on those nights. The ticket
seller (cashier) is told to keep the tickets as a record of the number sold.
c. The same trusted employee has served as cashier for 12 years.
d. When business is brisk, Fast Mart deposits cash in the bank several times during the day. The
manager at one store wants to reduce the time employees spend delivering cash to the bank,
so he starts a new policy. Cash will build up over weekends, and the total will be deposited
on Monday.
e. Grocery stores such as Convenience Market and Natural Foods purchase most merchandise
from a few suppliers. At another grocery store, the manager decides to reduce paperwork. He
eliminates the requirement that the receiving department prepare a receiving report listing the
goods actually received from the supplier.
SOLUTION
E7-14 Evaluating internal control over cash receipts
Learning Objective 2
Dogtopia sells pet supplies and food and handles all sales with a cash register. The cash register
displays the amount of the sale. It also shows the cash received and any change returned to the
customer. The register also produces a customer receipt but keeps no internal record of the
transactions. At the end of the day, the clerk counts the cash in the register and gives it to the
cashier for deposit in the company bank account.
Requirements
1. Identify the internal control weakness over cash receipts.
2. What could you do to correct the weakness?
SOLUTION
Requirement 1
E7-15 Evaluating internal control over cash payments
Learning Objective 3
Gary’s Great Cars purchases high-performance auto parts from a Nebraska vendor. Dave Simon,
the accountant for Gary’s, verifies receipt of merchandise and then prepares, signs, and mails the
check to the vendor.
Requirements
1. Identify the internal control weakness over cash payments.
2. What could the business do to correct the weakness?
SOLUTION
Requirement 1
E7-16 Understanding internal control, components, procedures, and laws
Learning Objectives 1, 2, 3
Match the following terms with their definitions.
1. Internal control
2. Control procedures
3. Firewalls
4. Encryption
5. Environment
6. Information system
7. Separation of duties
8. Collusion
9. Documents
10. Audits
11. Operational efficiency
12. Risk assessment
13. Sarbanes-Oxley Act
a. Two or more people working together to overcome
internal controls.
b. Part of internal control that ensures resources are not
wasted.
c. Requires companies to review internal control and take
responsibility for the accuracy and completeness of
their financial reports.
d. Should be prenumbered to prevent theft and
inefficiency.
e. Limits access to a local network.
f. Example: The person who opens the bank statement
should not also be the person who is reconciling cash.
g. Identification of uncertainties that may arise due to a
company’s products, services, or operations.
h. Examination of a company’s financial statements and
accounting system by a trained accounting professional.
i. Without a sufficient one of these, information cannot
properly be gathered and summarized.
j. The organizational plan and all the related measures
that safeguard assets, encourage employees to follow
company policies, promote operational efficiency, and
ensure accurate and reliable accounting data.
k. Component of internal control that helps ensure
business goals are achieved.
l. Rearranges data by a mathematical process.
m. To establish an effective one, a company’s CEO and top
managers must behave honorably to set a good example
for employees.
SOLUTION
E7-17 Accounting for petty cash
Learning Objective 4
2. Cash Short & Over $15
Jackie’s Dance Studio created a $220 imprest petty cash fund. During the month, the fund
custodian authorized and signed petty cash tickets as follows:
Petty Cash Ticket
No. Item Account Debited Amount
1 Delivery of programs to
customers
Delivery Expense $ 20
2 Mail package Postage Expense 10
3 Newsletter Printing Expense 25
4 Key to closet Miscellaneous
Expense
40
5 Copier paper Office Supplies 70
Requirements
1. Make the general journal entry to create the petty cash fund. Include an explanation.
2. Make the general journal entry to record the petty cash fund replenishment. Cash in the fund
totals $40. Include an explanation.
3. Assume that Jackie’s Dance Studio decides to decrease the petty cash fund to $120. Make the
general journal entry to record this decrease.
SOLUTION
Requirement 1, 2, 3
E7-18 Controlling petty cash
Learning Objective 4
2. March 31, Cash CR $136
Just Hangin’ Night Club maintains an imprest petty cash fund of $150, which is under the control
of Sandra Morgan. At March 31, the fund holds $14 cash and petty cash tickets for office
supplies, $128, and delivery expense, $15.
Requirements
1. Explain how an imprest petty cash system works.
2. Journalize the establishment of the petty cash fund on March 1 and the replenishing of the
fund on March 31.
3. Prepare a T-account for Petty Cash and post to the account. What is the balance of the Petty
Cash account at all times?
SOLUTION
Requirement 1
Requirement 2
E7-19 Journalizing credit card sales
Learning Objective 5
Marathon Running Shoes reports the following:
2018
Sep.
1
Recorded National Express credit card sales for of $96,000, net
of processor fee of 1%. Ignore Cost of Goods Sold.
15 Recorded ValueMax credit card sales of $80,000. Processor
charges a 1.5% fee. ValueMax charges the fee at the end of the
month, therefore Marathon uses the gross method for these
credit card sales. Ignore Cost of Goods Sold.
30 ValueMax collected the fees for the month of September.
Assume the September 15 transaction is the only ValueMax
credit card sale.
Journalize all entries required for Marathon Running Shoes.
SOLUTION
E7-20 Classifying bank reconciliation items
Learning Objective 6
The following items could appear on a bank reconciliation:
a. Outstanding checks, $670.
b. Deposits in transit, $1,500.
c. NSF check from customer, no. 548, for $175.
d. Bank collection of note receivable of $800, and interest of $80.
e. Interest earned on bank balance, $20.
f. Service charge, $10.
g. The business credited Cash for $200. The correct amount was $2,000.
h. The bank incorrectly decreased the business’s account by $350 for a check written by
another business.
Classify each item as (1) an addition to the book balance, (2) a subtraction from the book
balance, (3) an addition to the bank balance, or (4) a subtraction from the bank balance.
SOLUTION
E7-21 Preparing a bank reconciliation
Learning Objective 6
1. Adjusted Balance $1,137
Hardy Photography’s checkbook lists the following:
Date Check No. Item Check Deposit Balance
Nov. 1 $ 500
4 622 Quick Mailing $ 45 455
9 Service Revenue $ 135 590
13 623 Photo Supplies 85 505
14 624 Utilities 45 460
18 625 Cash 50 410
26 626 Office Supplies 110 300
28 627 Upstate Realty Co. 290 10
30 Service Revenue 1,235 1,245
Hardy’s November bank statement shows the following:
Requirements
1. Prepare Hardy Photography’s bank reconciliation at November 30, 2018.
2. How much cash does Hardy actually have on November 30, 2018?
3. Journalize any transactions required from the bank reconciliation.
SOLUTION
Requirement 1
