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Chapter Seven
Challenge Exercise 1
Stefan Pagnucci is the owner of Pagnucci’s Pizza. Pagnucci’s is operated strictly on a carry-out basis.
Customers pick up their orders at a counter where a clerk exchanges the pizza for cash. While at the counter,
the customer can see other employees making the pizzas and the large ovens in which the pizzas are baked.
Instructions:
(a) Identify the six principles of internal control and give an example of each principle that you might observe
when picking up your pizza. (Note: It may not be possible to observe all the principles.)
(b) What other internal controls would you recommend for Pagnucci’s Pizza?
Challenge Exercise 1 – Solution
a)
1. Establishment of responsibility. The counter clerk is responsible for handling cash. Other employees are
responsible for making the pizzas.
3. Documentation procedures. The counter clerk uses your order invoice (ticket) in registering the sale on
the cash register. The cash register produces a tape of all sales.
5. Independent internal verification. The counter clerk, in handling the pizza, compares the size of the pizza with
the size indicated on the order.
b) 1. When ordering the ingredients for pizza and other supplies, one employee should order, a second
2. Record-keeping for assets such as inventory and cash should not be the responsibility of those who
3. Employees should use a time clock to punch in and out.
5. Bank reconciliations should be prepared monthly by an independent person.
Challenge Exercise 2
Kris Allen Company established a petty cash fund on May 1, cashing a check for $150. The company
reimbursed the fund on June 1 and July 1 with the following results.
June 1: Cash in fund $4.75. Receipts: delivery expense $31.25; postage expense $39.00; and
miscellaneous expense $62.00.
July 1: Cash in fund $3.25. Receipts: delivery expense $31.00; entertainment expense $71.00; and
miscellaneous expense $44.75.
On July 10, Kris Allen increased the fund from $150 to $200.
Instructions:
(a) Prepare journal entries for Kris Allen Company for May 1, June 1, July 1, and July 10.
(b) What internal control features are present in a petty cash fund?
Challenge Exercise 2 – Solution
a)
May 1 Petty Cash ............................................................................. 150.00
Cash.......................................................................... 150.00
(b) The activities in a petty cash system and the related principles are:
(1) Establishing the fund. * Establishment of responsibility for custody of fund.
(2) Making payments from the fund. * Documentation procedures because the custodian must
Challenge Exercise 3
The following information pertains to Two Guys Video Company.
1. Cash balance per bank, July 31, $7,363.
3. The bank erroneously charged another company’s $700 check against Two Guys’ account.
5. The bank charged Two Guys account $350 for a customer’s NSF check.
7. Two Guys recorded a cash receipt from a customer as $32. The bank correctly recorded it at $23.
8. Bank collected a $1,250 note for Two Guys in July, plus interest $36, less fee $20. The collection has
not been
Instructions:
(a) Prepare a bank reconciliation for July 31.
(b) Journalize the adjusting entries for July 31 on the books of Two Guys Video Company.
Challenge Exercise 3 – Solution
(a) TWO GUYS COMPANY
Bank Reconciliation
July 31
Cash balance per bank statement .................................................................. $7,363
Add: Deposits in transit ................................................................................. 2,200
Bank error .......................................................................................... 700
Cash balance per books ................................................................................. $8,784
Add: Collection of note receivable
Less: Bank service charge ............................................................................. 22
Challenge Exercise 3 – Solution (Continued)
(b) July 31 Cash ........................................................................................ 1,266
Miscellaneous Expense ............................................................ 20
Notes Receivable ............................................................ 1,250
Interest Revenue ............................................................. 36
Challenge Exercise 4
PorkChop Company has recorded the following items in its financial records.
Cash in bank:
Checking account $27,000
Money market fund 13,000
Payroll account 3,000
Certificate of deposit (matures in 2 months) 5,000
Certificate of deposit (matures in 12 months) 10,000 $ 58,000
Cash in plant expansion fund 120,000
Cash on hand 11,000
Highly liquid investments 30,000
Petty cash 300
Receivables from customers 99,000
Stock investments 61,000
U.S Treasury bills 20,000
The checking account is subject to a compensating balance of $5,000. The highly liquid investments had
maturities of 3 months or less when they were purchased .The stock investments will be sold in the next 6 to
12 months. The plant expansion project will begin in 3 years.
Instructions:
(a) What amount should PorkChop report as “Cash and cash equivalents” on its balance sheet?
(b) Where should the items not included in part (a) be reported on the balance sheet?
(c) What disclosures should PorkChop make in its financial statements concerning “cash and cash
equivalents”?
Challenge Exercise 4 – Solution
(a) Cash and cash equivalents should be reported at $109,300.
Cash in bank ($58,000 - $10,000) .............................................................................. $ 48,000
Cash on hand ............................................................................................................ 11,000
(b) The certificate of deposit maturing in 12 months should be reported as a current asset separate from
“cash and cash equivalents”. “Cash in plant expansion fund” should be reported as part of long-term
Challenge Exercise 4 – Solution (Continued)
(c) PorkChop should disclose in the financial statements the details about the compensating balances. These
