Chapter 4
Internal Control & Cash
Ethics Check
(5-10 min.) EC 4-1
a. Integrity
b. Objectivity and independence
c. Integrity
d. Due care
Short Exercises
(5 min.) S 4-1
Fraud is an intentional misrepresentation of facts, made for the
purpose of persuading another party to act in such a way that causes
injury or damage to that party.
The Three Components of the Fraud Triangle
1. Motive — Fraud generally results from either critical need or greed on
the part of the perpetrator. Regardless of whether the driving force is
2. Opportunity — The opportunity to commit fraud usually arises
through weak internal controls.
3. Rationalization — The perpetrator(s) is (are) convinced, in their own
minds, that they deserve the object of the fraudulent behavior. They
(5 min.) S 4-2
Alston should report the errors to Golden because Golden is Alston’s
supervisor, and Golden is responsible for the errors. If Golden fails to
take action, then Alston should report the errors to Golden’s supervisor
(10 min.) S4-3
A computer virus enters program code without your consent and
performs destructive action to your computer files or programs.
A Trojan Horse is a malicious computer program that hides inside a
legitimate program and works like a virus to corrupt your computer files
or programs.
(5-10 min.) S 4-4
COMPONENTS OF INTERNAL CONTROL
1. Control environment — Top managers must set the “tone at the top”
to establish a control environment.
2. Risk assessment — Each company must identify its own risks, based
3. Control procedures — Specific procedures are needed for a good
system of internal control.
4. Monitoring of controls — Auditors can monitor a company’s actions
5. Information system — Accurate information is essential for success
in business. Accounting information enters and exits through the
information system.
Student responses may vary for the descriptions.
(5-10 min.) S 4-5
(5-10 min.) S 4-6
There are several major internal control procedures as discussed in the
chapter besides separation of duties:
1. Smart hiring practices. The company should be careful to hire both
competent and honest personnel. Smart hiring practices involve
2. Comparisons and compliance monitoring. No person or department
should be allowed to completely process a transaction from beginning
to end without being checked by another person or a computer program.
3. Adequate records help to assure that sufficient hard copy documents
or electronic information is kept by the entity to support the validity of
transactions that were processed. Examples include sales invoices,
purchase orders, shipping records, and customer remittance advices.
4. Limited access goes hand in hand with separation of duties to assure
that only authorized individuals are allowed access to (a) the assets of
(continued) S 4-6
the company, such as cash or inventory; and (b) the records. Generally,
only people with custodial responsibilities (such as the cashier or the
5. Proper approvals. No transaction should be processed without
management’s general or specific approval. Generally, the larger the
transaction, the higher the organizational level of approval necessary.
(20-30 min.) S 4-7
Cash is important not because of its amount as reported on the balance
sheet, but because of its effect on a business. All transactions ultimately
affect cash. Businesses purchase assets and must pay cash. They make
(20-30 min.) S 4-8
Punching a hole through supporting documents reduces the
opportunity for fraud. Without this control procedure, a dishonest
employee could resubmit documents for payment a second time. The
employee could change the payee’s address and have the check sent
(10 min.) S 4-9
Rampart Corp.
Bank Reconciliation
August 31, 2016
BANK
BOOKS
Balance, August 31
$5,483
$3,530
Add: Deposit in transit
400
691
Subtotal
5,883
20
4,241
Less:
Outstanding checks
Service charge
NSF check
(5 min.) S 4-10
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Aug.
31
Cash………………………………………..
691
Accounts Receivable…………………
691
Collection on account.
31
Cash………………………………………..
20
Interest Revenue………………………
20
Interest earned on bank balance.
Cash…………………………………….
13
Bank service charge.
31
45
Cash……………………………………..
45
NSF check.
(5 min.) S 4-11
It appears that the employee has stolen $765 (adjusted book balance,
(5 min.) S 4-12
Schwab will notice a gap in the sequence of sales receipts for the receipt
that Albert destroyed. This knowledge will lead Schwab to investigate
what happened to the missing receipt and what happened to the related
cash.
(10 min.) S 4-13
1. Paying by check carries three controls over cash:
• The check provides a record of the payment.
2. A dishonest purchasing agent could:
• Purchase goods and have them delivered to his home or other location
that he controls.
• Approve payment by the company for goods that he spent too much on,
and then split the excess with the supplier.
Companies avoid this internal control weakness by separating the
following duties related to the purchase of, and payment for, goods:
(5-10 min.) S 4-14
Kent Market (KM)
Cash Budget
Year Ended December 31, 2017
Millions
Cash balance, beginning
$ 5
Estimated cash receipts—total
103
108
Estimated cash payments—total
(93)
Cash available (needed) before new financing
15
Budgeted cash balance needed
Cash available for additional investments
$ 4
(5 min.) S 4-15
“Cash and cash equivalents” includes liquid assets such as time
deposits, certificates of deposit, and high-grade U.S. or foreign
government securities that are very close to maturity (three months or
Exercises
(10-15 min.) E 4-16A
a. Sweitzer has access to the cash collected, and she also prepares the
cash report. With access to both items, Sweitzer can steal cash and
falsify her cash report to conceal her theft.
(10 min.) E 4-17A
Cash payments:
a. Strong internal control. There is a good separation of duties.
Supervisors request equipment, and the home office purchases the
equipment.
Cash receipts:
a. Weak internal control. There is not a good separation of duties. The
accountant both handles cash and accounts for cash.
(10 min.) E 4-18A
To prevent Dunbar’s embezzlement, Downtown Forest Lake’s board of
directors could have:
a. Not permitted Dunbar to write checks for Downtown Forest Lake.
Instead, appoint a board member to write the checks.
b. Not permitted Dunbar to receive cash that came to Downtown
Forest Lake. Have subscriber checks sent to a post office box
belonging to a bank and have the bank collect the checks.
Student responses may vary.
(10-20 min.) E 4-19A
F.L. Hardy
Bank Reconciliation
October 31, 2017
BANK:
Balance, October 31
$ 279
Add: Deposit in transit
1,225
Less: Outstanding checks:
Check No.
626
$ 75
627
175
(250)
Adjusted bank balance
$1,254
BOOKS:
Balance, October 31
$1,297
Less:
Correction of book error —
Recorded $86 check as $68
$ 18
NSF check
Service charge
Adjusted book balance
$1,254
(10-20 min.) E 4-20A
Rinkland USA
Bank Reconciliation
March 31, 2016
BANK:
Balance, March 31
$ 740
Add: Deposit in transit
1,790
Subtotal
2,530
Less: Outstanding checks
(610)
Adjusted bank balance
$1,920
BOOKS:
Balance, March 31
$1,980
Add: EFT collection — rent
320
Subtotal
2,300
Less:
Service charge
NSF checks
Charge for printed checks
Correction of book error —
recorded $280 check as $28
(380)
Adjusted book balance
$1,920
(10-15 min.) E 4-21A
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Mar.
31
Cash …………………………………………………….
320
Rent Revenue …………………………………..
320
EFT collection of rent.
31
Miscellaneous Expense ($8 + $10) ………….
18
Cash ………………………………………………..
18
Bank service charge and charge
for printed checks.
31
Accounts Receivable …………………………….
Cash ………………………………………………..
NSF checks returned by bank.
31
Salary Expense ($280 − $28) …………………..
Cash ………………………………………………..
Correction of book error.
(10-15 min.) E 4-22A
TO: Store Manager
FROM: Student
SUBJECT: Evaluation of internal control and plan for improvement
There is a weakness in internal control over cash receipts. The cash
registers do not keep a record of sales. With no record, there is no way
to determine how much cash should be in the cash drawer. This
omission makes it easy for the cashier to steal cash and not get caught.
(10-15 min.) E 4-23A
The main internal control weakness is that the payroll department both
prepares and distributes the paychecks. With both duties, a dishonest
person in the payroll department can create a time sheet for a fictitious
employee and then keep the related paycheck after the treasurer returns
the signed checks to the payroll department.
(20-30 min.) E 4-24A
Byer Communications, Inc.
Cash Budget
Year Ended December 31, 2017
Millions
Cash balance, December 31, 2016
$ 65
Budgeted cash receipts:
Collections from customers
11,283
Sale of assets
137
11,485
Budgeted cash payments:
Payments for cost of
services and products
$6,194
Payments of operating expenses
2,556
Investment in equipment
1,823
Payment of debt
Payment of dividends
Cash available (needed) before financing
Budgeted cash balance, December 31, 2017
Cash available for additional investments, or
(New financing needed)
$ (45)
Byer Communications expects to need new financing of $45 million
during 2017.
(10-15 min.) E 4-25B
a. Morrison has access to the cash collected, and she also prepares the
cash report. With access to both items, Morrison can steal cash and
falsify her cash report to conceal her theft.
(10 min.) E 4-26B
Cash payments:
a. Strong internal control. There is a good separation of duties.
Supervisors request equipment, and the home office purchases the
equipment.
b. Weak internal control. Supervisors both request, purchase, and pay
for equipment with little oversight by the home office.
Cash receipts:
(10 min.) E 4-27B
To prevent Valentine’s embezzlement, Downtown Wooster’s board of
directors could have:
a. Not permitted Valentine to write checks for Downtown Wooster.
Instead, appoint a board member to write the checks.
b. Not permitted Valentine to receive cash that came to Downtown
Wooster. Have customer checks sent to a lock box belonging to the
bank and allow the bank to get the checks from the lock box.