Internal Control and Cash

Correcting internal control weaknesses

Each of the following situations has an internal control weakness.

a. Upside-Down Applications develops custom programs to customers’ specifications.

Recently, development of a new program stopped while the programmers

redesigned Upside-Down’s accounting system. Upside-Down’s accountants could

have performed this task.

b. Norma Rottler has been your trusted employee for 24 years. She performs all cashhandling

and accounting duties. Norma just purchased a new luxury car and a new

home in an expensive suburb. As owner of the company, you wonder how she

can afford these luxuries because you pay her only $30,000 a year and she has no

source of outside income.

c. Izzie Hardwoods, a private company, falsified sales and inventory figures in order

to get an important loan. The loan went through, but Izzie later went bankrupt and

could not repay the bank.

d. The office supply company where Pet Grooming Goods purchases sales receipts

recently notified Pet Grooming Goods that its documents were not prenumbered.

Howard Mustro, the owner, replied that he never uses receipt numbers.

e. Discount stores such as Cusco make most of their sales in cash, with the remainder

in credit card sales. To reduce expenses, one store manager ceases purchasing

fidelity bonds on the cashiers.

f. Cornelius’s Corndogs keeps all cash receipts in an empty box for a week because

the owner likes to go to the bank on Tuesdays when Joann is working.

Requirements

1. Identify the missing internal control characteristics in each situation.

2. Identify the possible problem caused by each control weakness.

3. Propose a solution to each internal control problem.

Accounting for petty cash transactions

On June 1, Fab Salad Dressings creates a petty cash fund with an imprest balance of

\(300. During June, Al Franklin, the fund custodian, signs the following petty cash tickets:

Petty Cash

Ticket Number Item Amount

101 Office supplies \) 30

102 Cab fare for executive 20

103 Delivery of package across town 50

104 Business dinner 40

105 Merchandise inventory 90

On June 30, before replenishment, the fund contains these tickets plus cash of \(90.

The accounts affected by petty cash payments are Office Supplies, Travel Expense,

Delivery Expense, Entertainment Expense, and Merchandise Inventory.

Requirements

1. Explain the characteristics and the internal control features of an imprest fund.

2. On June 30, how much cash should the petty cash fund hold before it is replenished?

3. Journalize all required entries to create the fund and replenish it. Include explanations.

4. Make the July 1 entry to increase the fund balance to \)375. Include an explanation and briefly describe what the custodian does.

Accounting for petty cash transactions

Suppose that on June 1, Rockin’ Gyrations, a disc jockey service, creates a petty cash

fund with an imprest balance of \(300. During June, Michael Martell, fund custodian,

signs the following petty cash tickets:

Petty Cash

Ticket Number Item Amount

1 Postage for package received \) 30

2 Office party 25

3 Two boxes of stationery 20

4 Printer cartridges 15

5 Business dinner 65

On June 30, prior to replenishment, the fund contains these tickets plus cash of \(140.

The accounts affected by petty cash payments are Office Supplies, Entertainment

Expense, and Postage Expense.

Requirements

1. On June 30, how much cash should this petty cash fund hold before it is replenished?

2. Journalize all required entries to (a) create the fund and (b) replenish it. Include explanations.

3. Make the entry on July 1 to increase the fund balance to \)325. Include an explanation

Preparing a bank reconciliation and journal entries

The December cash records of Davidson Insurance follow:

Davidson’s Cash account shows a balance of \(17,450 at December 31. On December

31, Davidson Insurance received the following bank statement:

Additional data for the bank reconciliation follow:

a. The EFT credit was a receipt of rent. The EFT debit was an insurance payment.

b. The NSF check was received from a customer.

c. The \)1,400 bank collection was for a note receivable.

d. The correct amount of check no. 1419, for rent expense, is \(1,930. Davidson’s

controller mistakenly recorded the check for \)1,390.

Requirements

1. Prepare the bank reconciliation of Davidson Insurance at December 31, 2018.

2. Journalize any required entries from the bank reconciliation.

Preparing a bank reconciliation and journal entries

The August 31 bank statement of Well Healthcare has just arrived from United Bank.

To prepare the bank reconciliation, you gather the following data:

a. The August 31 bank balance is \(4,540.

b. The bank statement includes two charges for NSF checks from customers. One is

for \)380 (#1), and the other is for \(180 (#2).

c. The following Well Healthcare checks are outstanding at August 31:

Check No. Amount

237 \) 80

288 190

291 570

294 600

295 30

296 70

d. Well collects from a few customers by EFT. The August bank statement lists a

\(1,200 EFT deposit for a collection on account.

e. The bank statement includes two special deposits that Well hasn’t recorded yet:

\)800 for dividend revenue, and \(120 for the interest revenue Well earned on its

bank balance during August.

f. The bank statement lists a \)50 subtraction for the bank service charge.

g. On August 31, the Well treasurer deposited \(260, but this deposit does not appear

on the bank statement.

h. The bank statement includes a \)1,050 deduction for a check drawn by Multi-State

Freight Company. Well notified the bank of this bank error.

i. Well’s Cash account shows a balance of $2,800 on August 31.

Requirements

1. Prepare the bank reconciliation for Well Healthcare at August 31, 2018.

2. Journalize any required entries from the bank reconciliation. Include an explanation for each entry.

Identifying internal control weakness in cash receipts

Pendley Productions makes all sales on credit. Cash receipts arrive by mail. Larry

Chipello, the mailroom clerk, opens envelopes and separates the checks from the

accompanying remittance advices. Chipello forwards the checks to another employee,

who makes the daily bank deposit but has no access to the accounting records.

Chipello sends the remittance advices, which show cash received, to the accounting

department for entry in the accounts. Chipello’s only other duty is to grant sales

allowances to customers. (A sales allowance decreases the customer’s account receivable.)

When Chipello receives a customer check for \(575 less a \)45 allowance, he records the

sales allowance and forwards the document to the accounting department.

Requirements

1. Identify the internal control weakness in this situation.

2. Who should record sales allowances?

3. What is the amount that should be shown in the ledger for cash receipts?

Correcting internal control weaknesses

Each of the following situations has an internal control weakness.

a. Jade Applications has decided that one way to cut costs in the upcoming year is to

fire the external auditor. The business believes that the internal auditor should be

able to efficiently monitor the company’s internal controls.

b. In an effort to minimize the amount of paperwork, Ross Homes has decided that it

will not keep copies of customer invoices related to sales revenue. Ross believes that

this effort will minimize the amount of data storage the company will have to pay for.

c. Elle Bee, a trusted employee for many years, has never taken a vacation. The owner

believes that he’s lucky that she is so committed to her job.

d. The Medicine Chest Company keeps a small petty cash fund to handle small cash

transactions. Because no one wants to volunteer to be the custodian, the business

manager has decided that all employees should have access to the petty cash. She

figures that as long as each employee fills out a petty cash ticket, then there are

proper controls in place.

e. Due to the cost of maintaining the security cameras, Wings and More has decided

that it will remove the cameras that monitor the cash register.

f. Bryan Miller, manager of Hardware Emporium, prides himself on hiring

exceptionally skilled employees who need no training to do their jobs.

Requirements

1. Identify the missing internal control characteristics in each situation.

2. Identify the possible problem caused by each control weakness.

3. Propose a solution to each internal control problem.

Accounting for petty cash transactions

On September 1, Party Salad Dressings creates a little cash fund with an imprest

balance of \(600. During September, Michael Martell, the fund custodian, signs the

following petty cash tickets:

Petty Cash

Ticket Number Item Amount

101 Office supplies \) 60

102 Cab fare for executive 25

103 Delivery of package across town 45

104 Business dinner 55

105 Merchandise inventory 75

On September 30, prior to replenishment, the fund contains these tickets plus cash

of \(355. The accounts affected by petty cash payments are Office Supplies, Travel

Expense, Delivery Expense, Entertainment Expense, and Merchandise Inventory.

Requirements

1. Explain the characteristics and the internal control features of an imprest fund.

2. On September 30, how much cash should the petty cash fund hold before it is replenished?

3. Journalize all required entries to create the fund and replenish it. Include explanations.

4. Make the October 1 entry to increase the fund balance to \)800. Include an explanation and briefly describe what the custodian does.

Accounting for petty cash transactions

Suppose that on September 1, Cool Gyrations, a disc jockey service, create a petty

cash fund with an imprest balance of \(350. During September, Ruth Mangan, fund

custodian, signs the following petty cash tickets:

Petty Cash

Ticket Number Item Amount

1 Postage for package received \) 25

2 Office party 10

3 Two boxes of stationery 20

4 Printer cartridges 15

5 Business dinner 65

On September 30, prior to replenishment, the fund contains these tickets plus cash of

\(210. The accounts affected by petty cash payments are Office Supplies, Entertainment

Expense, and Postage Expense.

Requirements

1. On September 30, how much cash should this petty cash fund hold before it is

replenished?

2. Journalize all required entries to (a) create the fund and (b) replenish it. Include

explanations.

3. Make the entry on October 1 to increase the fund balance to \)425. Include an

Explanation

Preparing a bank reconciliation and journal entries

The May cash records of Donald Insurance follow:

Cash Receipts Cash Payments

Date Cash Debit Check No. Cash Credit

May 4 \( 4,230 1416 \) 890

9 520 1417 120

14 530 1418 630

17 1,950 1419 1,090

31 1,840 1420 1,420

1421 900

1422 670

Donald’s Cash account shows a balance of \(17,750 at May 31. On May 31, Donald

Insurance received the following bank statement:

Deposits and other Credits:

May 10

May 1

May 5

May 15

May 18

May 22

Checks and other Debits:

8

11 (check no. 1416)

19

22 (check no. 1417)

29 (check no. 1418)

31 (check no. 1419)

May

May

May

May

May

May

May 31

Ending Balance

Beginning Balance

EFT \) 450

NSF

EFT

BC

\( 18,730

1,700

890

1,100

120

520

4,230

530

1,950

\) 14,400

9,380

375

630

1,900

35 (5,050)

Bank Statement for May

SC

Explanations: BC–bank collection; EFT–electronic funds transfer;

NSF–nonsufficient funds checks; SC–service charge

Additional data for the bank reconciliation follow:

a. The EFT credit was a receipt of rent. The EFT debit was an insurance

payment.

b. The NSF check was received from a customer.

c. The \(1,700 bank collection was for a note receivable.

d. The correct amount of check 1419, for rent expense, is \)1,900. Donald’s controller

mistakenly recorded the check for $1,090.

Requirements

1. Prepare the bank reconciliation of Donald Insurance at May 31, 2018.

2. Journalize any required entries from the bank reconciliation

Preparing a bank reconciliation and journal entries

The October 31 bank statement of Wyndham’s Healthcare has just arrived from State

Bank. To prepare the bank reconciliation, you gather the following data:

a. The October 31 bank balance is \(6,290.

b. The bank statement includes two charges for NSF checks from customers. One is

for \)370 (#1), and the other is for \(180 (#2).

c. The following Wyndham’s checks are outstanding at October 31:

Check No. Amount

237 \) 120

288 140

291 570

294 570

295 30

296 110

d. Wyndham’s collects from a few customers by EFT. The October bank statement

lists a \(2,200 EFT deposit for a collection on account.

e. The bank statement includes two special deposits that Wyndham’s hasn’t recorded

yet: \)900 for dividend revenue and \(100 for the interest revenue Wyndham’s

earned on its bank balance during October.

f. The bank statement lists a \)80 subtraction for the bank service charge.

g. On October 31, the Wyndham’s treasurer deposited \(270, but this deposit does

does not appear on the bank statement.

h. The bank statement includes a \)750 deduction for a check drawn by Multi-State

Freight Company. Wyndham’s notified the bank of this bank error.

i. Wyndham’s Cash account shows a balance of $3,200 on October 31.

Requirements

1. Prepare the bank reconciliation for Wyndham’s Healthcare at October 31, 2018.

2. Journalize any required entries from the bank reconciliation. Include an explanation for each entry.

Using Excel for a Bank Reconciliation

Download an Excel template for this problem online in MyAccountingLab or at http://www.pearsonhighered.com/Horngren.

Lori Anders of Wilderness Associates is getting ready to prepare the October bank reconciliation.

The cash balance on the books of Wilderness Associates on October 31 is \(3,546.

Lori reviews the bank statement, and notes the checking account balance at October 31 is \)2,445. The bank statement also

reveals that the bank collected a note receivable on behalf of Wilderness Associates—the principal was \(1,500 and the interest

was \)15. One customer’s check for \(29 was returned by the bank for insufficient funds. Two additional items on the bank statement

were the monthly EFT for the utilities, \)250, and the bank service fee of \(12. Lori notes that the cash deposit made on

October 31 of \)3,300 does not appear on the statement, and that three checks totaling $975 had not cleared the bank account

when the bank statement was prepared.

Requirements

1. Prepare the bank reconciliation for Wilderness Associates at October 31, 2018. Format appropriate cells with dollar signs and double

underlines. Use Excel formulas to calculate subtotals and totals.

2. Journalize the entries based on the bank reconciliation. For dollar amounts, use cell references on bank reconciliation

Preparing a bank reconciliation and journal entries

This problem continues the Canyon Canoe Company situation from Chapter 6.

Canyon Canoe Company has decided to open a new checking account at River

Nations Bank during March 2019. Canyon Canoe Company’s March Cash T-account

for the new cash account from its general ledger is as follows:

Cash—River Nations Bank Checking Account

Balance

Deposit

Deposit

Deposit

Deposit

200

4,300

750

1,675

1,500

14,165

Mar. 1

2

13

20

27

Deposit

0

10,000

2,325

2,750

4,500

31 3,490

Mar. 2

4

9

14

21

Ck#101

Ck#102

Ck#103

Ck#104

Ck#105

175

300

28

30

Ck#106

Ck#107

Balance

Canyon Canoe Company’s bank statement dated March 31, 2019, follows:

Beginning Balance, March 1, 2019

Deposits and other credits:

Mar. 2

14

21

28

29 EFT Sport Shirts(1)

(1) Sport Shirts is a customer making a payment on account.

(2) Bank Checks is a company that prints business checks (considered

a bank expense) for Canyon Canoe Company

\(10,000

2,325

2,750

4,500

500

Checks and other debits:

Mar. 2 EFT to Bank Checks(2)

Ending balance, March 31, 2019

\) 0

31 Interest Revenue 45

3 Ck#101

6 Ck#102

15 Ck#104

16 Ck#103

55

200

4,300

1,675

750

28 EFT to Rivers Energy(3) 270

29 Ck#106 175

31 Bank service charge 70

20,120

(7,495)

$ 12,625

(3) Rivers Energy is a utility provider.

Requirements

1. Prepare the bank reconciliation at March 31, 2019.

2. Journalize any transactions required from the bank reconciliation.

3. Compute the adjusted account balance for the Cash T-account, and denote the balance as End. Bal. Does the adjusted balance of the Cash T-account match the adjusted book balance on the bank reconciliation?

Preparing a bank reconciliation and journal entries

This problem continues the Crystal Clear Cleaning problem begun in Chapter 2 and

continued through Chapter 6.

In March 2019, Crystal Clear Cleaning opened a new checking account at First

Regional Bank. The bank statement dated March 31, 2019, for Crystal Clear

Cleaning follows:

Beginning Balance, March 1, 2019

Deposits and other credits:

Mar. 2

10

18

20

23 EFT Peg’s Restaurant(1)

(1) Peg’s Restaurant is a customer making a payment on account.

(3) Texas Energy is a utility provider.

(2) Check Art is a company that prints business checks (considered a

bank expense) for Crystal Clear Cleaning.

\(33,000

900

19,000

50,000

350

Checks and other debits:

Mar. 2 EFT to Check Art(2)

Ending balance, March 31, 2019

\) 0

31 Interest Revenue 50

5 Ck#235

9 Ck#237

9 Ck#236

26 Ck#239

10

2,400

1,500

2,900

2,000

28 EFT to Texas Energy(3) 130

29 Ck#240 300

31 Bank service charge 25

103,300

(9,265)

$ 94,035

Crystal Clear Cleaning’s Cash account in the general ledger shows the following

transactions for March:

Cash—First Regional Bank Checking Account

Balance

Deposit

Deposit

Deposit

Deposit

2,400

2,900

1,500

400

2,000

94,870

Mar. 2

10

18

20

31 Deposit

0

33,000

900

19,000

50,000

1,770

Mar. 2

4

5

10

21

Ck#235

Ck#236

Ck#237

Ck#238

Ck#239

300

300

23

29

Ck#240

Ck#241

Balance

Requirements

1. Prepare the bank reconciliation at March 31, 2019.

2. Journalize any required entries from the bank reconciliation. Post to the Cash T-account to verify the balance of the account matches the adjusted book balance from the bank reconciliation.

Conduct an Internet search for information on internal control and the Sarbanes-Oxley Act. Write a report of your findings. In your account, discuss some of the advantages and disadvantages of the Sarbanes-Oxley Act. Present it to your class (if required by your instructor).

Levon Helm was a kind of one-person mortgage broker. He would drive around Tennessee looking for homes that had second mortgages, and if the criteria were favorable, he would offer to buy the second mortgage for “cash on the barrelhead.” Helm bought low and sold high, making sizable profits. Being a small operation, he employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an old family friend, and he trusted her so implicitly that he never checked up on the ledgers or the bank reconciliations. At some point, Patterson started “borrowing” from the business and concealing her transactions by booking phony expenses. She intended to pay it back someday, but she got used to the extra cash and couldn’t stop. By the time the scam was discovered, she had drained the company of funds that it owed to many of its creditors. The company went bankrupt, Patterson did some jail time, and Helm lost everything

Requirements 

1. What was the key control weakness in this case? 
2. Many small businesses cannot afford to hire enough people for adequate separation of duties. What can they do to compensate for this?

This case is based on an actual situation. Centennial Construction Company, headquartered in Dallas, Texas, built a Rodeway Motel 35 miles north of Dallas. The construction foreman, whose name was Slim Chance, hired the 40 workers needed to complete the project. Slim had the construction workers fill out the necessary tax forms, and he sent their documents to the home office. Work on the motel began on April 1 and ended September 1. Each week,Slim filled out a time card of hours worked by each employee during the week. Slim faxed the time cards to the home office, which prepared the payroll checks on Friday morning. Slim drove to the home office on Friday, picked up the payroll checks, and returned to the construction site. At 5 p.m. on Friday, Slim distributed payroll checks to the workers.

Requirements

1. Describe in detail the main internal control weakness in this situation. Specify what negative result(s) could occur because of the internal control weakness.

2. Describe what you would do to correct the internal control weakness.

In 100 words or fewer, explain why there may be a difference between the bank statement ending cash balance and the ending balance in the Cash account. Give at least two examples of adjustments to the bank balance and the book balance.

Levon Helm was a kind of one-person mortgage broker. He would drive around Tennessee looking for homes that had second mortgages, and if the criteria were favorable, he would offer to buy the second mortgage for “cash on the barrelhead.” Helm bought low and sold high, making sizable profits. Being a small operation, he employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an old family friend, and he trusted her so implicitly that he never checked up on the ledgers or the bank reconciliations. At some point, Patterson started “borrowing” from the business and concealing her transactions by booking phony expenses. She intended to pay it back someday, but she got used to the extra cash and couldn’t stop. By the time the scam was discovered, she had drained the company of funds that it owed to many of its creditors. The company went bankrupt, Patterson did some jail time, and Helm lost everything

Requirements 

1. What was the key control weakness in this case? 
2. Many small businesses cannot afford to hire enough people for adequate separation of duties. What can they do to compensate for this?