Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

Chapter 6
Internal Control and Financial Reporting for
Cash and Merchandise Sales
ANSWERS TO EXERCISES
E64
Req. 1
a.
b.
c.
d.
e.
f.

Document procedures
Segregate duties / Document procedures
Establish responsibility
Independently verify
Document procedures
Independently verify

Req. 2
Steps
1. Request that goods or
services be ordered.

Documentation
Purchase requisition

Performed By
Sales manager

2. Order goods or services.

Purchase order

Materials/crew manager

3. Receive goods or services.

NONE

4. Obtain bill for goods or

services.

Supplier invoice

Accountant

5. Write check to pay the bill.

Company check

Accountant

Receiving reports are not prepared to indicate the goods or services received.
Req. 3
Because receiving reports were not prepared, there was no way to independently verify
that amounts charged by suppliers were for goods that had been delivered to authorized
work sites. The materials/crew manager, who initiated the purchase order, could simply
instruct suppliers to deliver goods to his home. The accountant could not detect this
fraud because no documentation was available to indicate the address to which goods
had been delivered. Had the company required that receiving reports be prepared by an
employee independent of the materials/crew manager, the accountant would have been
able to determine that the company was being billed for goods not delivered to a work
site.
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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

E66
Req. 1
CADIEUX COMPANY
Bank Reconciliation
September 30, 2011
Bank Statement
Ending balance per bank
statement.........................
Additions:
Deposit in transit...........
Deductions:
Outstanding checks......
Up-to-date cash balance...

$ 230
2,500
2,730

Companys Books
Ending balance per Cash
account...........................
Additions:
EFT.............................

Deductions:
Bank service charges. . .
(50)
NSF check...................
$2,680

$2,650
150
2,800
$ 20
100

(120)

Up-to-date cash balance...

$2,680

Req. 2
(1)

(2)

(3)

dr Cash (+A)............................................................................. 150

cr Accounts Receivable (A).........................................
To record electronic payment made by customer.
dr Office Expenses (+E,SE)...................................................
cr Cash (A)..................................................................
To record bank service charges.

150

20

dr Accounts Receivable (+A)................................................... 100

cr Cash (A)..................................................................
To record customer check returned due to insufficient funds.

20

100

Req. 3
The updated cash balance after the three reconciliation entries is $2,680.
Req. 4
Balance Sheet (September 30, 2011):
Current Assets:
Cash ($2,680 + $400)....................................................................

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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

E69
Sales Revenue ($100 + $80 + $50).......................................................
Less: Sales Discount ($100 collected from Wizard Inc. x 2%). .
Net Sales................................................................................................

$230
(2)*
$228

* Wizard paid in 8 days (within the discount period), but SpyderCorp paid in 27 days
(outside the discount period).
E616
Req. 1

Req. 2

Req. 3

dr Accounts Receivable (+A) ...............................................800

cr Sales Revenue (+R,+SE)............................................

800

dr Cost of Goods Sold (+E, SE)..........................................500

cr Inventory (A)...............................................................

500

dr Cash (+A) ($800 x 98%)...................................................784

dr Sales Discounts (+xR, SE) ($800 x 2%)......................... 16
cr Accounts Receivable (A)............................................

800

dr Cash (+A).........................................................................800
cr Accounts Receivable (A)............................................

800

Req. 4
Gross profit
percentage

Gross profit
Net Sales

x 100

*$284 = $800 $500 (2% x $800)

** $784 = $800 (2% x $800)

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284*
784**

x100

= 36.2%

Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

E618
Req. 1
MYSTERY INCORPORATED
Income Statement
For the Year Ended December 31, 2010
Sales Revenue ($240,000 + $42,000)...............
Less: Sales Returns and Allowances.................
Net Sales............................................................
Cost of Goods Sold............................................
Gross Profit.........................................................
Operating Expenses:
Administrative Expense.................................... $19,000
Selling Expense................................................ 40,200
Income from Operations.....................................
Income Tax Expense........................................
Net Income.........................................................

$282,000
7,000
275,000
165,000
110,000
59,200
50,800
17,600
$ 33,200

Req. 2
Gross profit: $275,000 $165,000 = $110,000.
Gross profit percentage: $110,000 $275,000 x 100%= 40%.
Gross profit is the difference between the sales prices and the costs of purchasing or
manufacturing all goods that were sold during the period. That is, gross profit is net
sales revenue minus cost of goods sold. The gross profit percentage is the average
amount of gross profit earned on each dollar of net sales. For this company, the rate
was 40%, which means that the company earned $0.40 of gross profit from each dollar
of net sales.
Req. 3
In 2009 the company earned $0.38 of gross profit for every dollar of sales, while in 2010
it earned $0.40 of gross profit for every dollar of sales. This could be due to either an
increase in the overall sales prices of its products, or a decrease in the cost of the
companys inventory.

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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

ANSWERS TO COACHED PROBLEMS

CP64
Req. 1
PSYMON COMPANY, INC.
Income Statement
For the Year Ended December 31, 2010
Sales Revenue......................................................................
Less: Sales Discounts..................................................
Sales Returns and Allowances...........................
Net Sales
.........................................................................
Cost of Goods Sold...............................................................
Gross Profit .........................................................................
Operating Expenses:
Selling Expense............................................................. $17,000
Administrative Expense................................................. 18,000
General Expenses.........................................................
2,000
Income from Operations........................................................
Income Tax Expense.............................................................
Net Income .........................................................................

$182,000
8,000
7,000
167,000
98,000
69,000

37,000
32,000
9,600
$ 22,400

Req. 2
PSYMON COMPANY, INC.
Income Statement
For the Year Ended December 31, 2010
Net Sales
.........................................................................
Cost of Goods Sold...............................................................
Gross Profit .........................................................................
Selling, General, and Administrative Expenses....................
Income from Operations........................................................
Income Tax Expense.............................................................
Net Income .........................................................................

$167,000
98,000
69,000
37,000
32,000
9,600
$ 22,400

Req. 3
Gross Profit Percentage =

Gross Profit
Net Sales

x 100 =

$69,000 x 100 =
$167,000

41.3%

Gross profit is the difference between the sales prices and the costs of purchasing or
manufacturing all goods that were sold during the period. That is, gross profit is net
sales revenue minus cost of goods sold. The gross profit percentage is the average
amount of gross profit earned on each dollar of net sales. For this company, the rate
was 41.3%, which means that the company earned slightly more than $0.41 of gross
profit from each dollar of net sales.
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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

ANSWERS TO GROUP A PROBLEMS

PA63
Req. 1
Comparison of deposits listed in the Cash account with deposits listed on the bank statement
reveals a $13,000 deposit in transit on December 31.
Req. 2
Comparison of the checks cleared on the bank statement with (a) outstanding checks from
November, and (b) checks written in December reveals two outstanding checks at the end of
December ($3,500 + $150 = $3,650).
Req. 3

STEWART COMPANY
Bank Reconciliation
At December 31, 2010

Bank Statement
Ending balance per bank
statement.......................

$86,720

Additions:
Deposits in transit................

Company's Books
Ending balance per Cash
account..........................
$96,470
Additions:
Interest earned...................

Deductions:
Outstanding checks.............

3,650

Up-to-date cash balance......

$96,070

Deductions:
NSFJ. Left...........................
Bank service charges.............

300
150

Up-to-date cash balance........ $96,070

Req. 4
(1)
dr Cash (+A)..............................................................................
cr Interest Revenue (+R,+SE)........................................
Interest earned.
(2)

50
96,520

13,000
99,720

50
50

dr Office Expenses (+E, SE) .................................................

cr Cash (A)...................................................................

150

dr Accounts Receivable (+A) .................................................

cr Cash (A)...................................................................

300

150

Service charges deducted from bank balance.

(3)

300

Customer's check returned; not sufficient funds.

These entries are necessary because the bank has appropriately recorded these changes in its
accounts, but Stewart Company hasnt yet recorded them in its accounts. The Cash account
(and the other accounts in the entries) must be updated before adjusted financial statements
can be prepared.
Req. 5
Balance in Cash account..................................................................................

$96,070

Req. 6
Current Assets:
Cash ($96,070 + $300).........................................................................

$96,370

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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

ANSWERS TO SKILLS DEVELOPMENT CASES

S64
Req. 1
Unapproved refunds and voids can be used by dishonest cashiers to eliminate valid
sales that have been made and paid for by customers. By eliminating the sales
revenue, cashiers can then take the cash given by the customer without anyone
knowing it. While the register-monitoring control does not completely prevent this from
happening, it does make it possible to detect it on a timely basis. Today, most cash
registers require cashiers to enter an employee identification number, so unusual
refund or void activities can be linked to a particular employee, who can be questioned
and/or monitored more closely.
Req. 2
The control that requires two workers to perform related activities is called segregation
of duties. It addresses the control objective of preventing or detecting unauthorized
activities involving the companys assets.
Req. 3
If a periodic system were used, Famous Footwear would not be able to quantify the
amount of shrinkage occurring. In a periodic system, the only clue that shrinkage has
occurred comes after the inventory is counted and cost of goods sold is computed to be
higher than expected.
Req. 4
The parties most directly affected by inventory theft in this case are Famous Footwears
(1) managers and (2) employees, and Brown Shoes (3) investors, (4) creditors, and
(5) honest customers, who will pay higher prices.
Managers are likely to be paid, in part, based on the financial performance of each
store. If inventory is being taken without full payment for the sale, the stores gross
profit (and net income) will be lower than it should be. This will adversely affect the
managers pay.
Obviously, any dishonest employees who are detected will be harmed (fired, sued,
jailed) by having committed the theft. Beyond them, though, other store employees will
be harmed, particularly if the companys head office has to close stores whose profits
are significantly reduced as a result of inventory theft by dishonest employees.
Because Brown Shoe Company ultimately owns the profits of Famous Footwear, any
theft by employees at Famous Footwear will adversely affect the financial results of
Brown Shoe Company. Poor financial results could harm investors whose ownership
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Chapter 06 - Internal Control and Financial Reporting for Cash and Merchandise Sales

share in Browns stock will likely fall in value. Similarly, poor financial results could
cause Brown Shoe Company to violate loan covenants, which could lead to
renegotiation of the companys loans on less favorable terms, causing further reductions
in the companys income and stock price.
Browns creditors could be adversely affected if financial losses delay the companys
ability to repay its liabilities on a timely basis or, in the extreme case, prevent the
company from repaying its liabilities at all.
These possibilities describe only the relatively direct effects of losses caused by
inventory theft. Clearly, on an individual by individual basis, the friends and family of
each manager, employee, investor, and creditor also could be affected in other personal
ways. For example, if managers fail to receive bonuses or employees are laid off when
a store is closed, theyll have less money to pay for their own personal costs of living. It
could even be you who loses a part-time job through no fault of your own.

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