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CHAPTER 5
INTERNAL CONTROL
INTRODUCTION
This chapter can be studied relatively independently of other chapters in the textbook. However,
the meaningful use of most of the tools, techniques, and methods explained and illustrated in
other chapters in the text depends on the accuracy of the information provided by the accounting
system. Accuracy, in turn, is dependent on the completeness and effectiveness of the
establishment’s internal control system. In particular, the students’ attention should be drawn to
the last part of the chapter where some of the many ways in which theft or fraud can occur are
listed. This should alert the students to the necessity for good internal control in all areas.
TRUE OR FALSE QUESTIONS
(Correct answer indicated by T for True and F for False answers)
1. Accurate accounting information is aided by a good internal control system.
T
2. An objective of internal control is to safeguard the assets of a business.
T
3. A small, owner-operated business needs as much internal control as a large business.
F
4. The cost of an internal control system is irrelevant as long as there are some benefits.
F
5. Collusion occurs when one employee bumps into another.
F
6. An internal control system, once instituted, should not be changed.
F
7. Procedures outlining the jobs to be performed by employees should be put into
writing.
T
8. Procedures for a specific type of job, for example a storekeeper, will not vary from
one establishment to another.
F
9. In the control of the receipt of food, the receiver should make out a credit
memorandum if goods are short-shipped or returned for some reason.
T
10. Record keeping and physical control of assets should be separated so both employees
are kept busy.
F
11. Lapping is a method of fraud that can occur if the employee who looks after accounts
receivable also handles cash received in payment of those accounts.
T
12. Wherever possible, the work of one employee should check on the work of another.
T
13. In the control of food sales, if the cash remittance agrees with the cash register total
reading, no further control is necessary.
F
14. Explaining to employees the reasons why tasks have to be carried out is not necessary
for good internal control.
F
15. A card used in storeroom control to record items coming into and going out of the
storeroom is a perpetual inventory card.
T
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16. A purchase requisition is sent to a supplier from whom goods are ordered for
delivery.
F
17. Machines aid in internal control because they prevent any fraud or theft.
F
18. To reduce labor costs in a large hotel, the person handling cash receipts should also
make the related entries in the accounting records.
F
19. Cash received each day should be deposited intact daily in the bank.
T
20. Bonding employees who handle cash may reduce losses.
T
21. Petty cash is cash that does not have to be accounted for.
F
22. Wherever possible, payments for purchases should be made by check.
T
23. A voucher system is a system of control over payments for purchases of goods and
services.
T
24. In a bank reconciliation, an outstanding check should be added to the company’s
bank balance.
F
25. In a bank reconciliation, if the company’s and the bank’s balance figures do not
immediately agree, the company should put through an adjustment on its books for
the difference.
F
26. Food standard cost can be affected from one period to the next by a change in the
sales mix.
T
MULTIPLE CHOICE QUESTIONS
(Correct answer indicated by asterisk)
1. An objective of internal control is to:
(a) Eliminate collusion
(b) Prevent employees from having access to cash
(c) An employee having control of both records and assets
(d) One employee checking the work of another
(c) Employees can be rotated in their jobs to eliminate collusion
(d) Forms can be designed so they never need changing
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4. Responsibilities for specific tasks should be defined so:
(c) Employees know what the policies and procedures are
(d) Management supervision can be eliminated
5. Written procedures for each set of tasks are required:
(a) Only when job rotation is in effect
(b) For employees using electronic control equipment
6. Record keeping and the control of assets should be separated:
(a) So one employee does not have too much to do
(b) To prevent collusion
7. A purchase requisition is:
(a) The same as a purchase order
(b) Sent by a supplier to the hotel’s purchaser
8. A perpetual inventory card is used for each item in the storeroom to:
(c) Show at the end of each month, the total quantities of all items received in the storeroom.
This total is the month-end inventory
(d) Show at the end of each month, the total quantities of all items issued from the storeroom.
This total is the month-end inventory
9. Lapping is a method of fraud that can occur when:
(c) Jobs are not properly rotated
(d) Written procedures are not prepared for the person in control of receivables
(c) Prevent lapping
(d) Eliminate the need for written procedures
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(c) To prevent lapping
(d) To avoid having to establish a petty cash system
12. A bank reconciliation is:
(c) A system of ensuring that the general cashier does not practice lapping
(d) A discussion with the bank manager by a company’s general manager to solve a dispute
between them
(c) Deducted from the company’s bank balance
(d) Added to the bank statement balance
14. The main purpose of calculating a standard food cost percentage is to:
(a) Know in advance what the actual food cost will be
15. In using standard cost control, a change in the sales revenue mix may cause:
(a) Actual cost to be above standard cost even though it was previously lower
(b) Actual cost to be below standard cost even though it was previously higher
EXERCISE SOLUTIONS
E5.1 Major objective of internal control is to safeguard the assets and provide information to
evaluate the effectiveness of internal control.
E5.3 A purchase order is used by a business operation for purchases of goods or services from
E5.4 Petty cash accountability uses a simple linear statement based on having cash payment
receipts or vouchers for all disbursements. If cash on hand and cash payment receipts do
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E5.5 The purpose of the bank reconciliation is to bring the reported bank statement balance
into equality with the check register (checkbook). The bank will report transactions they
E5.6 Standards are developed in dollar values and percentages for costs such as cost of sales,
labor, and other items of cost. Standards are developed for sales revenue items such as
E5.7 A standard food cost percentage is compared to the actual food cost percentage to
E5.8 Standard cost is $18,282 and total standard sales revenue is $48,487. Determine the
E5.9 Assuming total actual cost is $18,480 and total actual sales revenue is $48,487.
E5.10 The person receiving the $51.40 check removes the $51.40 in cash and does not record
the payment made on the Arnold account. The amount of cash lapped daily is:
Customer
Date Payment
Cash
Name
Received in August
Removed
Arnold
2
$ 51.40
Sayers
4
10.71
Carter
7
38.99
Tuney
12
9.80
Lossie
14
30.30
Martie
17
21.55
Buddy
22
10.08
Smithe
27
12.39
Brown
30
17.68
Totals
$202.90
An effective control measure is to not allow any one person to handle cash receipts or
the recording of such receipts in the accounting records.
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Problem Solutions
P5.1 Calculate the October and November reimbursement checks to the petty cash fund.
October: Reimbursement check is $80.96 in exchange for the October receipts is
valid and was reimbursed. (Cash in the fund was $19.04 + $80.96 = $100).
November: The list of petty cash disbursements listed total $78.09; however, no receipt
P5.2 Bank Statement Reconciliation
Tavara’s Tavern June 30, 0006
Bank Statement Balance $4,810.00 Check Register Balance $5,112.00
P5.3 Bank Statement Reconciliation
October 31, 0007
Bank Statement Balance $3,506.00 Check Register Balance $4,740.00
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P5.4 Bank Statement Reconciliation
August 31, 0007
Bank Statement Balance $2,760.00 Check Register Balance $4,112.00
P5.5 The present responsibilities of the retiring bookkeeper violate the internal control
principle of separating the control of assets from record keeping. The new person hired
may be allowed to remove the machine tapes from the front office or the restaurant
P5.6 In the delivery receiving area, losses could occur from:
An individual passing by could simply pick up some or all of the goods left on the
receiving dock by a delivery driver.
A delivery driver making a delivery could easily pick up goods left on the dock by
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Coordinating the day and time that deliveries will be accepted and insisting that the
receiver/storekeeper be available to receive the goods before the driver unloads the
goods.
In the dining area, major losses may occur if servers are tempted to destroy scratch pad
records that do not have sequential numbers. Such potential losses in a manual system
can be generally overcome by:
Purchasing and using order-pads that have pre-printed sequential page numbers.
Having servers sign a form for each pad of blank order pads. Requiring each
employee to account for each page (by number) at the end of each shift.
If sales checks are collected only at one point-of-sale register, the sales checks must
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P5.7 Set a columnar schedule for each year, record the credit sales revenue, cost of sales, and
operating income. In addition, for each year, calculate bad debits as a percentage of
charge or credit sales revenue. Comment on the results.
Credit Sales
Cost of
Gross
Operating
Operating
Year
Revenue
–
Sales
=
Margin
–
Expenses
=
Income
1
$160,000
–
$ 64,000
=
$ 96,000
–
$ 80,000
=
$16,000
2
180,000
–
72,000
=
108,000
–
90,000
=
18,000
3
240,000
–
96,000
=
144,000
–
120,000
=
24,000
4
300,000
–
120,000
=
180,000
–
150,000
=
30,000
5
360,000
–
144,000
=
216,000
–
180,000
=
36,000
(Credit SR ─ CS = GM ─ Expenses = Income before bad debts)
Income before
Bad
Operating
Bad Debts
Year
Bad Debts
–
Debts
=
Income
Percentage
1
$16,000
–
$ 960
=
$15,040
0.6%
2
18,000
–
900
=
17,100
0.5%
3
24,000
–
3,840
=
20,160
1.6%
4
30,000
–
4,500
=
25,500
1.5%
5
36,000
–
5,400
=
30,600
1.5%
P5.8 It appears the new bookkeeper has been lapping payments on accounts. To resolve this
problem, the bookkeeper should not be allowed to handle any cash or incoming mail.
The owner should open all incoming mail and prepare the bank deposit, listing all
P5.9 In the present situation, collusion could exist. The bartender may not be tearing up
tickets received for drinks and giving them back for resale to the cashier at the door. To
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eliminating the tickets and the cashier, it will be easier for the bartender to steal. He or
P5.10 a. Calculation of a food cost percentage.
Item
Cost
SP
CS %
1
$ 2.20
/
$ 6.80
32.4%
2
3.25
/
8.80
37.0%
3
3.75
/
9.85
38.1%
Total
$9.20
/
$25.45
36.1%
Table Alternative:
Item
Cost
SP
Units
Total SR
Total CS
CS %
1
$2.20
x
$6.80
x
50
=
$ 340.00
$110.00
32.4%
2
3.25
x
8.80
x
50
=
440.00
162.50
37.0%
3
3.75
x
9.85
x
50
=
492.50
187.50
38.1%
Totals
$1,272.50
$460.00
36.1%
b. Total CS: (50 × $2.20) + (50 × $3.25) + (50 × $3.75) = $460.00
Total SR: (50 × $6.80) + (50 × $8.80) + (50 × $9.85) = $1,272.50
c. The standard cost percentage will increase when the sales revenue mix changes to
show greater amounts of the items with the highest food cost percentage.
Item
Cost
SP
CS %
Units
Total SR
Total CS
1
$2.20
/
$6.80
=
32.4%
25
$ 170.00
$ 55.00
2
3.25
/
8.80
=
37.0%
100
880.00
325.00
3
3.75
/
9.85
=
38.1%
25
246.25
93.75
Totals
$1,296.25
$473.75
The total dollar CM = $1,296.25 – $473.75 = $822.50
d. The total sales revenue and total cost of sales has increased, and the total dollar CM
have both increased. The individual dollar CM on Item 2 is $5.55; The individual
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P5.11 a. Calculate a standard cost percentage for a given month.
Total
Total
Item
Selling
Quantity
Standard
Standard
Item
Cost
Price
Sold
Cost
Sales Revenue
1
$2.50
$6.00
654
$ 1,635
$ 3,924
2
1.80
4.60
2,195
3,951
10,097
3
2.30
7.00
1,110
2,553
7,770
4
1.80
5.30
990
1,782
5,247
5
2.25
5.00
295
664
1,475
6
2.80
8.00
259
725
2,072
Totals
$11,310
$30,585
Standard cost percentage: $11,310 / $30,585 = 37.0%
Actual cost percentage: $11,855 / $30,880 = 38.4%
b. The difference between standard and actual cost percentages is only 0.014%, or $545
P5.12 a. Calculate total standard cost, total standard sales revenue, and cost of sales
percentages.
Total
Total
Cost of
Menu
Item
Selling
Quantity
Standard
Standard
Sales
Item
Cost
Price
Sold
Cost
Sales Revenue
Percentage
1
$1.80
$3.95
260
$ 468.00
$1,027.00
45.6%
2
2.10
4.95
411
863.10
2,034.45
42.4%
3
4.20
8.95
174
730.80
1,557.30
46.9%
4
3.05
6.95
319
972.95
2,217.05
43.9%
5
1.40
3.95
522
730.80
2,061.90
35.4%
$3,765.65
$8,897.70
42.3%
Actual cost percent: $3,804.10 / $8,873.40 = 42.9%
Standard cost percent: $3,765.65 / $8,897.70 = 42.3%
Actual cost percentage is higher than the standard percentage by 0.6%, which is
minor. Normally the actual percentage is expected to exceed the standard percentage.
The difference is $38.45 ($3,804.10 − $3,765.65). However, actual sales revenue is
lower than the standard sales revenue, which is unusual and should be checked.
b. If the sales revenue mix changed as indicated, we would expect the food cost
standard percentage to decrease. Item 4 has a 43.9% standard food cost while menu
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CASE 5 SOLUTIONS
a. No solution is offered. Each student’s report will be based on three specific areas selected by
the student for discussion, which will differ.
b. For soups, entrées, and desserts a standard cost control system can be established by using
the following steps as a minimum:
1. Establish proper purchase control procedures.
2. Ensure there is adequate control over the storeroom using perpetual inventory cards and
Charlie must set a policy, announce it to the wait staff and put a note in the menus.