CHAPTER 6

Full and Fair Reporting

THINKING BEYOND THE QUESTION How do we ensure that reports to external users fairly present business activities? Full and fair reporting should help external users understand the decisions made by managers. It is not intended to protect those users from managements bad decisions. The effects of management decisions should be reported to outsiders on a timely basis so they can make informed investment decisions. Businesses may suffer financial losses for many reasons. These losses are likely to affect the value of the companys stock and the wealth of its stockholders. Financial reporting should describe business activities in sufficient detail for stockholders, creditors, and others to evaluate the performance of a business and its managers. If that performance is good, the financial reports should indicate the performance was good. If it was bad, the financial reports should indicate it was bad. Financial reporting is not intended to protect stakeholders from a companys bad financial performance, and financial reports should not be biased to protect them or to conceal a companys true performance from them. QUESTIONS Q6-1 A variety of individuals rely on financial statements to make decisions. For example, stockholders and creditors make stock purchasing and lending decisions based upon financial information. In addition, government authorities use financial information to determine whether companies have met legal requirements and regulations. Customers and suppliers rely upon financial information to determine a companys viability. Q6-2 Investors need assurance that the shares they are evaluating are reasonably priced and represent actual business activities. They use financial statements to make these determinations. Investors should be able to assume the financial information is reliable. GAAP help ensure reliability. Q6-3 Sarbanes-Oxley is intended to restore investor confidence in the financial markets by making management more accountable for the accounting reports they certify. SOX mandates heavy fines and jail terms for

managers who certify fraudulent financial information. SOX also imposes restrictions on external auditors to help ensure they remain independent. Q6-4 The audit committee is responsible for selecting, compensating, and overseeing the corporations auditor. The auditor reports directly to the audit committee, rather than to management. Thus, the auditor is less likely to be influenced by management and more likely to remain unbiased and independent. Q6-5 Accounting standards are issued through a political process. Groups that use and prepare financial information must agree that a proposed standard improves the quality of financial reporting. Generally accepted refers to this agreement. The exposure draft allows all interested parties to express an opinion about the proposed standard. A discussion memorandum (DM) alerts interested groups to the issues being considered. Responses to the DM are used to develop an exposure draft. Q6-6 The SEC has delegated standard-setting to private organizations such as the FASB. However, the SEC occasionally uses its authority to issue standards that it considers to be important regarding areas in need of authoritative guidance. Q6-7 Elements include assets, liabilities, equity, investments by owners, distributions to owners, revenues, expenses, gains, and losses. The elements appear on the balance sheet, income statement, statement of changes in shareholders equity, and cash flow statement. Q6-8 The primary objective of financial reporting is to provide information useful to current and potential investors, creditors, and other users in making decisions. Financial reports should help decision makers assess the amounts, timing, and uncertainty of prospective cash flows. Financial reports should also provide information about resources, claims to resources, and changes in resources for business organizations. Q6-9 The term unqualified opinion in no way implies anything about the qualifications of the auditors. In fact, an unqualified opinion is good news, not bad. It means that the auditor believes that the financial statements fairly present the companys actual economic events for the period covered by the audited statements. (The term unqualified opinion means that no qualifiers are included in the opinion. That is, the financial statements, without qualification, fairly present the companys economic circumstances.) Q6-10 There are two primary reasons for notes to financial statements. First, to keep the financial statements to a reasonable sizesay, one page each a great deal of combining and aggregation of accounts must occur. One purpose of the notes, therefore, is to provide additional supporting detail

for combined items that are reported on the financial statements. The second purpose of the notes is to reveal to stakeholders the accounting methods, estimates, and assumptions that were used to generate the numbers reported. Q6-11 An audit is a detailed and systematic investigation of a companys accounting records. Auditors select a representative sample of transactions to form an opinion as to whether the companys controls and systems are functioning effectively and whether the financial statements fairly present the companys financial situation. Both the accounting system and financial statements that result from it are controlled by management. Therefore, the shareholders employ an outside auditor to check over managements representations. This adds credibility to the companys financial statements. Q6-12 Managers and other decision makers need information upon which to base decisions. Part of that information is provided by the accounting system. At the same time, a companys activities are generally too complex to be reported fully. Therefore, accounting rules have been developed that measure and report certain information and ignore others. Often estimates and approximations are necessary. As a result, the picture of a company provided by accounting information is incomplete and does not fully represent the actual company. Rules used by the accounting system (i.e., GAAP) affect how the company will be represented. Accordingly, if managers and other decision makers are going to use the information provided by the accounting system, they must understand the accounting rules so as to understand the representation that is being made. Q6-13 The two primary purposes of internal controls are (1) to safeguard the organizations assets and (2) to ensure the accuracy of its accounting information. Q6-14 Internal controls are used in a computerized accounting system to protect its data from unauthorized access, improper use, and destruction. Unauthorized access is prevented by using a system of identification and passwords. In this way, users in various areas of the organization are granted access to only those aspects of the accounting system they need to conduct their work. Access to all other sections of the system are blocked. Other common internal controls include the use of limits on data entry (e.g., dollar amounts), use of software and hardware designed to detect attempts at unauthorized entry, and use of database backup files stored off the premises. Q6-15 A strong system of internal controls begins with a management philosophy that encourages appropriate security and behavior in a company. If top management takes a lax attitude about these matters, it is unlikely that it

will develop and enforce an effective system. Accordingly, top management should develop policies and ensure that these are communicated throughout the company. It should also ensure that procedures are developed to monitor and enforce control policies. Q6-16 Human resource controls include good hiring practices that involve hiring qualified employees. Background checks help ensure employee integrity. Training is important to make sure employees have a good understanding of their job responsibilities and company policies. Segregation of duties is important to make sure employees dont have control over both assets and information about those assets that would permit them to misuse the assets. Supervision is important to make sure employees are performing their responsibilities appropriately. Q6-17 Safeguarding assets often involves controlling physical access. Merchandise and materials can be secured in warehouses and display cases. Merchandise can be tagged electronically to make shoplifting difficult. Surveillance equipment can be used to monitor important resources. Cash registers, vaults, and safety deposit boxes can be used to secure financial resources. EXERCISES E6-1 Definitions of all terms are listed in the glossary. E6-2 Development of the New York Stock Exchange (NYSE)Founded in 1792, the NYSE facilitated the growing trade in corporate stocks. In later years, the NYSE required listed companies to provide accounting information to their stockholders. The 16th AmendmentIn 1913 the 16th Amendment permitted taxation of individual and corporate income. Rules and reporting requirements are necessary to determine tax liability accurately. Stock market crash of 1929Many stockholders lost their life savings when the stock market crashed in 1929. Investors demanded increased regulation of corporate financial reporting. Many believed a cause of the collapse was insufficient information about corporate activities and inadequate government oversight of stock markets. E6-3 a. b. c. Securities Act of 1933The act required most corporations to file registration statements before selling stock to investors. Reports must include a balance sheet and income statement. Securities and Exchange Act of 1934Required corporations to provide annual financial reports to stockholders. These reports must be audited by independent accountants. 10-K reportAnnual registration statements filed by corporations with the SEC.

d. E6-4 a. b. c. d. e.

10-Q reportQuarterly statements filed by corporations with the SEC. FASB GASB IASB GAO SEC

E6-5 This is a true statement. Complying with regulations is costly because financial information must be collected, summarized, and reported. In addition, an independent external auditor (a CPA) must be engaged to audit the reports. However, if regulations and controls were not in place, investors would be less likely to invest in stocks. As a result, corporations would have difficulty raising capital. E6-6 Generally accepted accounting principles are financial reporting rules established by a political process. The standard-setting process involves a number of steps to ensure each constituent group has a voice in writing the proposed standard. Thus, the pronouncements are said to be generally accepted. E6-7 Qualitative characteristics are attributes that make accounting information useful. The primary qualitative characteristics are understandability and usefulness. Relevance and reliability are considered to be the two primary qualities that result in accounting information being useful. To be relevant, information must be timely and have predictive or feedback value. To be reliable, information should faithfully represent economic events and should be verifiable and neutral. Information about an organization is more valuable when it can be compared with information from other organizations and when it is prepared using consistent methods over time. E6-8 The conceptual framework was developed in the 1970s and 1980s. The conceptual framework is a set of objectives, principles, and definitions to guide the development of new accounting standards. E6-9 The first paragraph of an auditors report identifies the statements and fiscal periods covered by the audit. The first paragraph also describes the responsibilities of auditors and management. Management is responsible for preparing the statements. Auditors are responsible for competently using the technology available to them to confirm (or disconfirm) the assertions of management made in its financial statements and related disclosures.

The second paragraph of the auditors report summarizes the audit process. The purpose is to educate the reader about the nature of an audit. The third paragraph of the auditors report states the auditors opinion. The purpose is to inform the reader whether the statements are prepared according to GAAP. Auditors reports must be signed by the public accounting firm that performed the audit, thus indicating its responsibility. E6-10 Managements discussion and analysis (MD&A) is intended to explain important events and changes in performance among the years presented in the financial statements. These explanations are intended to enhance the readers understanding of the events and financial outcomes shown in the annual report. E6-11 a. Its a little difficult to believe that such a giant company has only nine different asset accounts. For example, they probably have dozens of different types of equipment or factories alone. Apparently, many individual accounts have been grouped together for reporting purposes. A judgment has been made by management that a greater level of detail would not be particularly helpful to the external users. For example, external users may not care to know about each specific type of equipment or about specific information related to each of the separate factories. It is very unlikely that this high level of aggregation would be helpful to the manager of any General Mills division. First, a manager would need specific information about his or her division or area of responsibility. Summarized information is not very useful to division managers. Second, because division managers must make very specific decisions about a wide range of issues, they would need much more detailed information about specific assets and liabilities under their control. A total of nine asset accounts, for example, is unlikely to provide the division manager with detailed enough information. Asset information would have to be broken down more for it to have any use to the manager.

b.

c.

E6-12

Quick is a going concern because it has an indefinite life. This life is sufficiently long that it can engage in long-term transactions, such as issuing long-term debt and purchasing long-term assets. It expects to continue in business to use these assets and repay the debt. It measures its performance periodically to provide information to decision makers. These periodic measurements are necessary because decision makers cannot wait until all transactions of the company are completed before making their decisions. The periodic measurements include estimates because all transactions of the company have not been completed at the end of a fiscal period.

E6-13 Bill, I think you misunderstand some of the basic issues regarding audits and auditors reports. First, an auditor does not prepare the companys financial statements. The audit expresses only an opinion regarding them. The companys accounting staff prepares the financial statements and then asks an independent, outside auditor to express an opinion on them. Second, an audit does not involve an examination of every single event or transaction engaged in by the firm. As stated in the auditors report, An audit includes examining, on a test basis, evidence . . . . This means that auditors use sampling techniques to select representative transactions. By examining representative transactions, the auditors develop an opinion regarding the financial statements taken as a whole. The cost of auditing all transactions would be prohibitive. Third, the auditors do not express an opinion as to whether the company is healthy or not. A company could be having a very hard time financially and still receive an unqualified opinion. The auditors opinion relates to whether the financial statements present fairly the facts and situation of the firm, not whether the firm is healthy. Judging whether or not the company is healthy, or whether it is a good investment or not, is not the auditors job. The auditors job is to confirm or disconfirm that the financial statements have presented information fairly in accordance with GAAP. E6-14 Accountants work in business organizations to prepare the financial information contained in companies annual reports. They manage the information systems used to record and report this information. They help other managers interpret information reported by the accounting system and make sure the information is reliable and conforms with GAAP and legal requirements. E6-15 Division revenues Division expenses Division profit Division ROA Pencils $200,000 140,000 $ 60,000 0.10 Pens $300,000 160,000 $140,000 0.14 Markers $100,000 60,000 $ 40,000 0.20

The Pens division has the highest sales and profit. Markers had the highest ROA. Analytical activities are common duties of accountants. Accountants who work for business organizations conduct analyses to determine which divisions are the most profitable. They also help develop plans to improve divisional or organizational profitability. E6-16 Internal auditors work for businesses and are responsible for developing and monitoring internal control systems and for auditing a companys divisions for compliance with accounting rules, company policies, and

legal requirements. They also may evaluate the performance of the divisions in an effort to improve efficiency and effectiveness. E6-17 Computer system controls are designed to protect a companys information resources from unauthorized access, improper use, and destruction. Controls include the following: Appropriate identification and passwordsto prevent unauthorized persons from gaining access to the system Check data errorsto ensure reasonable and appropriate data are entered into the system Automatic numberingto permit tracking of sales orders, invoices, and purchase orders Backup systems and datato prevent loss of data Disaster recovery planto permit rapid system recovery following a major disaster Human resources controls include the following: Hiring qualified employees and conducting background checks Implement good training programs to ensure employees maintain necessary skills Segregation of dutiesemployees should not have access to a resource and also account for the resource. Good supervision Physical controls include the following: Securely storing merchandise and materials in warehouses and display cases Electronically tagging merchandise Surveillance equipment Cash registers, vaults, and safety deposit boxes to secure financial resources

E6-18 Independent CPAs audit business financial reports to ensure that they fairly present a companys business activities. The audit is an important tool in maintaining strong capital markets. If managers fail in their responsibilities to report fairly to external users, independent audits are a major line of defense to prevent misleading information from reaching investors. Consequently, auditors are held to a high standard of professional responsibility and integrity. Audit failure is a major source of concern for the SEC and society in general. CPAs and the audit firms in which they work are required to maintain current professional knowledge and are reviewed on a regular basis to make sure their practices are consistent with current standards. E6-19 a. The purpose of internal control is to protect the organizations resources and to ensure the reliability of its accounting records. Every internal control, therefore, is designed to prevent

misappropriation of the companys assets or the misstatement of its accounts. b. Example: If the same person both handles the cash and accounts for cash, that individual could cover up the theft of cash by charging it off to some expense. The person might increase the Office Supplies Expense account balance by $100 and put the cash in his or her pocket. Example: Without preprinted and prenumbered sales invoices, a dishonest employee could make a sale to a customer, give a receipt, pocket the cash, and not report the sale. With prenumbered sales invoices, the missing invoice (copy) would be noticed immediately because one numbered invoice (copy) would be missing from the sequence. E6-20 Internal control problems include the following: Ima has control of both assets (cash) and accounting for the assets (sales slips) and there is no mechanism to prevent her from falsifying information or from stealing cash. In addition, there is no control over who has responsibility for cash in the cash register. Ima, coworkers, and supervisors all have access to the cash and sales slips. Supervision and verification procedures are not in place. Solving the problems requires that Ima have less discretion over the sales slips. If possible, the cash register should automatically record the amount of a sale and produce a prenumbered sales slip. Ima should be required to provide the sales slip to the customer. The customer can compare the sales slip with the purchase. The threat of a complaint is an incentive for sales clerks to record the correct amount. The sales data recorded by the cash register can be compared to the cash turned in by Ima to her supervisor. Coworkers should have their own cash drawers. Only Ima should have access to her own cash drawer so that she can be held responsible for any discrepancies. When cash and sales slips are turned in to a supervisor, they should be counted and compared by both Ima and the supervisor so that Ima can be held accountable for any discrepancies. PROBLEMS P6-1 A. B. C. Managers use financial information to evaluate performance of a division, product line, or geographical area. Stockholders rely on financial information to help them make decisions about which stocks to purchase or to sell. Creditors depend on financial information to determine the creditworthiness of a potential borrower.

D. E.

Governmental authorities need financial information to assess taxes. (continued) Employees use financial information to determine the financial condition of an employer or a potential employer. Labor unions use financial information when negotiating contracts for their members.

P6-2 Accounting regulation is vital to the capital markets because investors must have confidence in published financial information. If investors are unsure about the quality of published financial information, they cannot use the information to assess accurately the value of a stock. This uncertainty increases risk and can drive down the value of a stock on Wall Street. P6-3 The common theme is that all services are directly related to producing a companys financial statements. Management is responsible for producing the financial statements and an independent public accounting firm is responsible for expressing an opinion on the financial statements. Regulators were concerned that a public accounting firm may lose its independence and objectivity if it has designed the system, recorded transactions within the system, and provided internal auditing procedures. In addition, regulators fear auditors may lose their independence and objectivity if an audit client is a source of significant nonaudit fees. If disclosure disagreements arise, the auditor may be tempted to go along with the client, for fear of losing revenues unrelated to the audit. P6-4 The CEO and CFO are certifying that the financial condition and results of operations are presented fairly. They use the term in all material respects. This means the financial statements are free from mistakes and errors that would significantly influence a decision maker. SOX requires this statement to make it clear that the companys officers 1. 2. believe the statements are presented fairly, and take personal responsibility for them.

P6-5 SOX demands more accountability of corporate executives. Those who falsely certify the financial statements are subject to a fine of up to $5 million and as many as 20 years in prison. It appears that SOX may have influenced Mr. Smiths decision not to sign HealthSouth Corporations fraudulent annual report. P6-6 1. The main theme of the certifications is that the annual report does not contain any untrue statements of a material nature and fairly presents the financial condition and operations of the company. Mr. Ballmer ensures the reader that Microsoft has sufficient internal

controls and procedures in place to give him confidence in the accuracy of the financial information. 2. SOX requires these certifications as a result of several high-profile frauds and bankruptcies that had a negative effect on investor confidence. Thus, the intent of SOX is to increase the accountability of executives and to mandate better control systems that instill confidence in investors. Accounting issues are identified and evaluated for consideration. A discussion memorandum is issued and responses are solicited. Public hearings are held. An exposure draft is issued and responses are solicited. Additional public hearings are held as needed. A standard is issued. Existing standards are reviewed and modified as needed.

P6-7 1. 2. 3. 4. 5. 6. 7.

Primary documents Discussion memorandumidentifies accounting issues and alternative approaches to resolving issues. Exposure draftdescribes a proposed accounting standard. Statement of financial accounting standardan official pronouncement establishing acceptable accounting procedures or financial report content. P6-8 Students responses will vary because the FASBs website is dynamic. However, students should find items as follows: Status reports on existing projects Exposure drafts FAS summaries EITF (Emerging Issues Task Force reports) Action Alert that contains board actions and upcoming projects P6-9 Students responses will vary because the IASBs website is dynamic. However, students should find items as follows: Principal news items Projects in progress IASB Project Summaries Exposure drafts Invitations to comment Official International Accounting Standards Yes, the IASB issues exposure drafts and invitations to comment. The process seems to be similar to that used by the FASB. The IASB is attempting to gain international consensus in support of new exposure drafts that ultimately will become pronouncements.

P6-10 Conceptual framework components and purpose 1. Objectives of financial reporting provide an overall purpose for financial reports. 2. Qualitative characteristics of accounting information identify attributes that make accounting information useful. 3. Elements of financial statements provide definitions of the primary classes of items contained in financial statements. 4. Recognition and measurement in financial statements identify information that should be contained in financial statements. P6-11

Useful

Relevance

Reliability

Timely

Predictive or feedback value

Representational faithfulness Neutral

Verifiable

Comparability

Consistency

Qualitative characteristics are attributes that make accounting information useful. Understandability and usefulness for decision making are the most important characteristics. Relevance and reliability are considered to be the two primary qualities that result in accounting information being useful. To be relevant, information should be timely and have predictive or feedback value. To be reliable, information should faithfully represent economic events and should be verifiable and neutral. Information about an organization is more valuable when it can be compared with information from other organizations and when it is prepared using consistent methods over time. P6-12 Jenny is facing pressure from a client who is attempting to persuade her to compromise her professional judgment. If she yields to pressure, the

banks financial statements will overstate earnings. As a result, many different users (customers, investors, borrowers, etc.) may make decisions based on financial statements that are significantly misstated. Jenny must not agree to Larrys recommendation even if the firm loses the audit as a result of her decision. P6-13 A. The report was issued on October 1, 2008. The report was not issued in a timely manner. It was released nine months after the year-end. As a result the information in the financial statements may not be relevant. The balance sheet included management's estimates of the increased value of certain fixed assets during 2007. The estimate of fixed asset value is not verifiable. Only the historical cost, supported by a sales invoice, is verifiable. Procedures used to calculate revenues and expenses were different for 2007 than for 2006 and earlier years. Information about an organization is more valuable when it can be compared with information from other organizations and when it is prepared using consistent methods over time. Short's financial statements were audited by an accounting firm owned by the president's brother. As the statements were audited by the presidents brother, the statements do not appear to be neutral. There is an apparent conflict of interest. Thus the financial statements are not reliable. Some of the company's major liabilities were not included in the annual report. The report does not faithfully represent the financial condition of the company. Thus the report is not reliable. Responsibility: Users of financial information must understand that management is responsible for preparing the statements, while auditors are responsible for competently using the technology available to them to confirm (or disconfirm) the assertions of management made in its financial statements and related disclosures. Generally accepted auditing standards: These standards include procedures used in conducting an audit to help auditors form an opinion about the fairness of the audited statements. Failure to comply with these standards is a major violation of a CPAs responsibilities. Material misstatement and material respects: Materiality is a criterion for establishing the importance of a potential misstatement in audited financial statements. These statements contain estimates and allocations that depend on judgment. The auditor attests that the financial statements are free from material misstatements.

B.

C.

D.

E.

P6-14

A.

B.

C.

D.

E.

A test basis: Auditors do not examine all transactions. They use statistical sampling techniques to select a representative sample for examination. (continued) Present fairly . . . in conformity with generally accepted accounting principles: The auditor attests that the statements are prepared in accordance with GAAP and that the statements (prepared by management) present fairly the companys actual economic events for the period covered by the audited statements.

P6-15 A. and B.
Type of Account Asset 1. 2. 3. 4. 5. 6. 7. 8. 9. Wages Payable Accounts Receivable Retained Earnings Buildings Supplies Used Inventory Sales (for cash) Accumulated Depreciation Loan from Bank X X X X X X X X X X X X X X (note) X X X X X X X X X X X X X X X Liability X Equity Revenue Expense Financial Statement Income Statement Balance Sheet X X X X

10. Land 11. Owners Investment 12. Supplies 13. Sales (on credit) 14. Bonds Payable 15. Unearned Revenue 16. Wages Earned by Employees 17. Utilities Consumed

Note: The accumulated depreciation account is listed with the asset accounts, but is always a negative balance account. That is, it is always subtracted from the asset being depreciated.

P6-16 Journal
Accounts 1 Cash Accounts Receivable Service Revenues Rent Expense Cash Wage Expense Wages Payable Cash Supplies Expense Cash Depreciation Expense Accumulated Depreciation Interest Expense Cash Notes Payable Cash Cash Owners Investment Debits 7,500 400 7,900 1,800 1,800 1,700 1,000 2,700 700 700 500 500 200 200 9,000 9,000 5,000 5,000 9,000 +5,000 +5,000 200 9,000 500 200 700 500 2,700 700 1,800 1,700 1,000 Credits

Effect on Accounting Equation

A +7,500 +400 +7,900 1,800 = L+ OE CC + RE

2 3

4 5

6 7 8

Explanations: To solve this problem, it is easiest to start with the income statement information. Identify the transaction that must have led to each entry on the income statement. After tracing all income statement information, inspect the balance sheet for any remaining unexplained changes. Transactions 1 Service Revenue during June totaled $7,900 but Accounts Receivable increased by $400. This means that only $7,500 of the revenue was collected. The other $400 explains the change in Accounts Receivable on the balance sheet. 2 Rent must have been paid in cash because there was no change in Accounts Payable, nor is there a Rent Payable account. 3 Wages Expense was $1,700, but in addition, the amount of Wages Payable on the balance sheet decreased by $1,000. This means that cash paid to employees had to total $2,700 during June. 4 Supplies must have been paid for in cash because there was no change in Accounts Payable, nor is there a Supplies Payable account. 5 The change in Accumulated Depreciation on the balance sheet is fully explained by the $500 Depreciation Expense. 6 The $200 of interest expense must have been paid in cash because there is no Interest Payable account. (continued)

7 There was a $9,000 decrease in Notes Payable. It was paid off in cash (because there are no other unexplained asset changes on the balance sheet). 8 There is a $5,000 increase in Owners Investment. This contribution to the company was made in cash (because there are no more unexplained changes in the balance sheet). P6-17 A. The letter was prepared by: Stephen W. Sanger, Chairman of the Board and Chief Executive Officer Stephen R. Demeritt, Vice Chairman Raymond G. Viault, Vice Chairman The overall tone of the letter is positive. The letter focuses primarily on the accomplishments of the past year and on future opportunities. Some of the accomplishments mentioned in the letter include: An increase in net sales Net earnings set a new high of over $1 billion Strong cash flow Strong results from international businesses Growth in profits from joint ventures General Mills has three business segments. 1. The Retail segment markets ready-to-eat cereals, meals, refrigerated and frozen dough products, baking products, snacks, yogurt, and organic foods to a wide variety of grocery stores, specialty stores, drug and discount chains, and mass merchandisers in the United States. 2. The Bakeries and Foodservice segment markets to retail and wholesale bakeries, and to commercial and noncommercial foodservice distributors throughout the United States and Canada. 3. The International businesses fundamentally market the same product mix as offered in the United States to Canada, Europe, Latin America, and the Asia/Pacific region. The 1. 2. 3. earnings shortfall was caused primarily by the following: Higher commodity costs The popularity of low-carbohydrate diets The Bakeries and Foodservice business did not meet targets because of low-carbohydrate trends and higher supply chain costs

B. C. D.

P6-18

A.

B.

C.

Management plans to increase list prices in certain lines, capture additional supply chain productivity (reduce the costs of acquiring raw materials), control administrative costs, and reconfigure certain manufacturing activities to become more efficient. The company did not fully and accurately disclose the results of its operations. When investors learned that the reliability of the financial information was in doubt (as evidenced by an earnings restatement), the stock price fell dramatically. Without reliable information about a companys business activities, investors cannot determine which companies are most efficient and effective and are making the best use of resources. Intentionally misleading investors and other users of financial statements is an ethical issue. When the company disclosed the truth about its earnings, the stock price fell. As a result, many investors suffered financial harm.

P6-19

A.

B.

P6-20

A.

Specific cash registerEach sales clerk is responsible for one

cash register. If clerks used a variety of cash registers during a shift, errors and omissions could not be traced to one individual. Sales are entered (recorded) into the register. Cash must be present at the end of the shift in the amount that equals sales. Cash register records identification and price. Sophisticated cash registers that record the identification and price ensure the price is correct for each item sold. Copy of cash register slip is given to customer. Customers who receive cash register slips provide another form of internal control because they help verify that the sale was recorded for the correct amount. Sales clerk and supervisor count cash and reconcile to cash register and sign forms. Before responsibility for the cash changes from clerk to supervisor, both parties verify that the amount reconciles with the cash register tape. control. The ticket seller must produce cash for each ticket that he sells. The ticket taker ensures each patron has purchased a ticket. Such a system prevents the ticket taker from pocketing patrons cash and admitting them to the theater without issuing a ticket.

B.

The movie example illustrates segregation of duties as an internal

P6-21 The church has no system of internal control. The church did not conduct an adequate background check before allowing Jay to serve as treasurer. They have no segregation of duties. Jay has access to resources and information that may make it easy for him to misuse those resources. For example, he has access to both cash and the accounting system for cash. He has very little, if any, supervision. As distasteful as it may sound, one explanation for the cash shortage is Jay. Since the church has no internal controls, Jay may be taking cash from the church to use for his personal expenses. To put a different spin on the issue, internal controls also should be in place to protect innocent Jays from false accusations. P6-22 Yes, such a policy is an example of an internal control to prevent cashiers from pocketing cash from unrecorded sales. Giving customers receipts is one way of ensuring that all sales are rung into the cash register. Customers will also usually notice if the amounts are incorrect. Therefore, offering a free meal if a receipt is not given involves the customer in making sure the internal control procedure is followed. In small companies where segregation of duties is not possible, controls such as this are common. The cashier who handles the cash also enters the sale into the cash register. The restaurant is small; therefore, we assume the cashier has little supervision. The policy is designed to prevent the cashier from pocketing cash from sales that were not recorded into the cash register. If the cashier knows each customer expects a receipt (motivated by the possibility of a free meal), he or she is more likely to enter each sale into the cash register to produce a receipt. If a sale is entered, there must be cash in the drawer for the same amount of the sale. P6-23 1 b 2 c 3 a 4 d 5 b 6 c 7 b 8 d 9 b 10 d

CASES C6-1 A. B. C. General Mills auditor is KPMG LLP. The audit was completed on June 29, 2004. The auditors responsibility is to express an opinion on the financial statements. Management is responsible for the financial statements. The auditor issued an unqualified opinion. Therefore, KPMG LLP believes the financial statements present, in all material respects, General Mills financial position. An unqualified opinion is important to the company because all potential investors, lenders, or other interested parties have assurance from an independent party that financial information is reliable. Management is responsible for the accounting numbers in the annual report. Companies use a system of internal controls to help safeguard assets. General Mills maintains an audit program that evaluates the system of internal controls. The audit committee also meets regularly with management, internal auditors, and external auditors to discuss internal control issues. The auditor does not state that the amounts are correct. Rather, the independent public accountant states whether the financial statements present fairly (in all material respects and in accordance with generally accepted accounting principles) the financial position of the company. As a public company, General Mills is required by law to hire an external company to audit the financial statements. However, even in the absence of a law, General Mills would hire an external auditor to assure the investing public that the financial reports are presented fairly. To do so would improve investor confidence and increase the companys access to investors capital.

C6-2

A. B.

C.

D.