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CHAPTER 4 ACCOUNTING NOTES FOR STUDENTS, Lecture notes of Accounting

Abertay UniversityAccounting

CHAPTER 4 ACCOUNTING NOTES FOR STUDENTS

Typology: Lecture notes

2019/2020

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Financial Accounting, 9e (Harrison/Horngren/Thomas)
Chapter 4 Internal Control & Cash
4.1 Learning Objective 4-1
1) One of the main elements of the fraud triangle is rationalization.
Answer: TRUE
Diff: 2
LO: 4-1
AASCB: Ethical Understanding and Reasoning Abilities
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Risk Analysis
2) Perpetrators of fraud usually commit fraud for their own short-term economic gain.
Answer: TRUE
Diff: 2
LO: 4-1
AASCB: Ethical Understanding and Reasoning Abilities
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Risk Analysis
3) Fraud is a major problem.
Answer: TRUE
Diff: 1
LO: 4-1
AASCB: Ethical Understanding and Reasoning Abilities
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Risk Analysis
4) One of the most common types of fraud that impacts the financial statements is the
misappropriation of assets.
Answer: TRUE
Diff: 2
LO: 4-1
AASCB: Ethical Understanding and Reasoning Abilities
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Risk Analysis
5) Fraudulent financial reporting is committed by company managers.
Answer: TRUE
Diff: 2
LO: 4-1
AASCB: Ethical Understanding and Reasoning Abilities
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Risk Analysis
1
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
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Financial Accounting, 9e (Harrison/Horngren/Thomas)

Chapter 4 Internal Control & Cash

4.1 Learning Objective 4-

  1. One of the main elements of the fraud triangle is rationalization. Answer: TRUE Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. Perpetrators of fraud usually commit fraud for their own short-term economic gain. Answer: TRUE Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. Fraud is a major problem. Answer: TRUE Diff: 1 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. One of the most common types of fraud that impacts the financial statements is the misappropriation of assets. Answer: TRUE Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  5. Fraudulent financial reporting is committed by company managers. Answer: TRUE Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  1. An environment of weak internal controls can lead to fraud. Answer: TRUE Diff: 1 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. The type of fraud committed by company managers who make false and misleading entries in the books, making the financial results of the company appear better than they actually are, is called: A) misappropriation of assets. B) fraudulent financial reporting. C) embezzlement. D) collusion. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. According to a recent survey taken by the Association for Certified Fraud Examiners (ACFE), occupational fraud and abuse results in losses equal to approximately ________ of total business revenue. A) 45% B) 10% C) 6% D) an unknown amount Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. The type of fraud committed by employees of an entity who steal money from the company and cover it up through erroneous entries in the books is called: A) misappropriation of assets. B) fraudulent financial reporting. C) embezzlement. D) collusion. Answer: A Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  1. Fraud is the ultimate unethical act in business because: A) the perpetrators usually do so for their own short-term economic gain at the expense of others. B) fraud is illegal. C) fraud violates the rights of many for the temporary betterment of a few. D) of all of the above. Answer: D Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  2. Which of the following is a true statement regarding fraud? A) Fraud is committed when an error is made. B) Fraud does not occur in not-for-profit organizations. C) The expansion of e-commerce has caused fraud to decrease. D) Most businesses surveyed had experienced fraud. Answer: D Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  3. Fraudulent financial reporting: A) is committed by lower level employees of a company. B) makes the company appear in poor financial condition. C) deceives investors and creditors. D) involves stealing cash or inventory from the company. Answer: C Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. Several large frauds occurred in 2001 and 2002. Which of the following was NOT a consequence of these frauds? A) Arthur Anderson, LLP was convicted of fraud but was allowed to stay in business. B) There were adverse market reactions throughout the world. C) Thousands of jobs were lost when Enron and WorldCom went out of business. D) There was a loss of confidence in the financial reporting system. Answer: A Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  5. An employee states that he committed fraud because he was "underpaid and overworked." This is an example of: A) opportunity. B) motive. C) rationalization. D) understanding.

Answer: C Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis

  1. Sharon is the receptionist and office manager for The Best Construction Company. Sharon handles all of the office duties including billing, cash receipts, payroll, depositing checks and preparing the monthly bank reconciliation. She also prepares all of the checks for disbursements and is an authorized signer on all checks under $25,000. For checks above this amount, two signatures are required. She has been a trusted employee of The Best Construction Company for many years, but still makes just a small amount above minimum wage. She is even the godmother to two of the owner's children and often watches them while their parents go on exotic vacations. Sharon is such a good employee that she rarely takes vacations. Since the owner trusts her completely, he concentrates on the construction business and leaves all of the office work to Sharon. He would never interfere with her work since he has very little accounting knowledge. Sharon has recently become a grandmother and enjoys buying her grandchildren expensive toys and clothes. She has just bought a new Hummer for herself and an exclusive condo in the Virgin Islands. What are the three elements of the fraud triangle? Which element(s) of the triangle are present in this case? Explain briefly. Answer: The three elements of the fraud triangle are motive, opportunity, and rationalization. All three elements of the fraud triangle are present in this case. Motive includes the need to have money to spend on her grandchild, and the apparent high lifestyle she has, as evidenced by her luxury car and exclusive condo. The opportunity exists because there are little or no internal controls and no segregation of duties. The rationalization could be that she deserves more–she has been an employee for a long time and still makes very little money. Since there are no controls, she may rationalize that she will never get caught. Diff: 2 LO: 4- AASCB: Ethical Understanding and Reasoning Abilities AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis

AICPA Functional: Risk Analysis

  1. Access to sensitive data files should be protected by passwords and data encryption. Answer: TRUE Diff: 2 LO: 4- AASCB: Information Technology AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  2. Collusion is the method widely used to defeat the adequate segregation of duties. Answer: TRUE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. Smart hiring practices and separation of duties is part of the control environment. Answer: FALSE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. Which is NOT an objective of an internal control system? A) Safeguarding of assets B) Compliance with company policies C) Compliance with legal requirements D) Risk minimization Answer: D Diff: 2 LO: 4- AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  1. The objective of internal control that minimizes waste, which lowers costs and increases profits is: A) operational efficiency. B) asset safeguards. C) cost minimization. D) reliable accounting records. Answer: A Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. The Sarbanes-Oxley Act of 2002: A) requires companies to switch external auditors every two years. B) requires companies to consider adopting a system of internal controls. C) prohibits external auditors from auditing a public client and providing consulting services to the client. D) created the Securities and Exchange Commission. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. A system of handling cash receipts by mail whereby customers remit payments directly to the bank, rather than through the company's mail is a(n): A) imprest system. B) lock-box system. C) phishing system. D) online banking system. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. The primary way that fraud is prevented and detected is through a proper system of: A) checks and balances. B) management directives. C) internal control. D) internal and external audits. Answer: C Diff: 2 LO: 4- AASCB: Analytical Skills AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  1. Requiring employees to take annual vacations is a part of which characteristic of internal control? A) Assignment of responsibilities B) Separation of duties C) Proper authorization D) Competent and reliable personnel Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. A fidelity bond is a(n): A) employment contract for a specified period of time. B) insurance policy that reimburses a company for employee theft. C) contract prohibiting former employees from working for a competitor. D) promise by a company to safeguard customers' personal information. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. When a company is determining its risk assessment: A) the risks for all companies in the same industry must be the same. B) the risks will offer hints of where fraud or mistakes may arise. C) it must report the risks to the SEC. D) it must report the risks to the PCAOB. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  4. The "tone at the top": A) is a component of the control procedures. B) starts with low level employees. C) means that owners and top managers must behave honorably to set a good example for employees. D) is set by the PCAOB. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  1. Hints of where fraud, mistakes or financial harm can occur in a company is called: A) the control environment. B) risk assessment. C) control procedures. D) the tone at the top. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. The information system component of internal control: A) ensures that every system that processes accounting data should have the ability to capture transactions as they occur. B) monitors controls. C) offers hints of where fraud or errors could occur. D) ensures that the IT department has adequate control procedures in place to ensure that no one can hack into the company's database. Answer: A Diff: 2 LO: 4- AASCB: Analytical Skills AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  3. Smart hiring practices and separation of duties includes: A) background checks only on top-level management. B) vague job position descriptions. C) payment of competitive salaries D) the preparation of operating budgets. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. Proper separation of duties and physical safeguards to protect assets from theft are part of a company's: A) information system. B) control procedures. C) control monitoring. D) personnel maintenance. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  5. When determining what duties need to be segregated: A) it is not necessary to separate the accounting department from the operating departments. B) it is not necessary to separate the receiving of cash from the recording of cash. C) it is necessary to separate the owner from the cash receipts function. D) it is necessary to separate the cash disbursements function form the bank reconciliation function. Answer: D
  1. A company has a policy that all checks over $5,000 need to have the signature of the owner in addition to the signature of the bookkeeper. This is an example of: A) limited access. B) proper approvals. C) adequate records. D) encryption. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  2. A company's comparisons and compliance monitoring: A) should include cash budgets, which are the budgets of future period's net income. B) can contain "rolling" budgets which are constantly updated. C) should include internal auditors who are completely independent of the business. D) should contain adequate hiring practices. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  3. A malicious program that enters program code without consent and performs destructive actions in the victim's computer files or programs is a(n): A) encryption device. B) phishing expedition. C) computer virus. D) Trojan horse. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Leverage Technology AICPA Functional: Risk Analysis
  4. E-commerce pitfalls include all of the following EXCEPT: A) stolen credit card numbers. B) phishing expedition. C) encryption reporting. D) trojan horses. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Leverage Technology AICPA Functional: Risk Analysis
  1. Creating bogus websites for the purpose of stealing unauthorized data is a(n): A) encryption device. B) phishing expedition. C) computer virus. D) Trojan horse. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Leverage Technology AICPA Functional: Risk Analysis
  2. ________ rearranges messages by a mathematical formula making the message impossible to read by someone who does not know the code. A) Encryption B) Firewall C) Security wall D) Access device Answer: A Diff: 2 LO: 4- AICPA Bus Persp: Leverage Technology AICPA Functional: Risk Analysis
  3. An internal control system can be circumvented by: A) collusion, encryption and management override. B) collusion, management override and segregation of duties. C) collusion, management override and human limitations. D) nothing, if it is a good internal control system. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Risk Analysis
  4. Explain why separation of duties is such an important procedure for safeguarding assets. Provide two examples of this control procedure. Answer: Separation of duties divides related duties between two or more people. This limits fraud and mistakes and promotes accuracy of the accounting records. Separation of duties can be divided into two parts– separating operations from accounting (such as purchasing and accounting) and separating the custody of assets from accounting (such as cash handling and accounting). Examples may vary. Diff: 2 LO: 4- AASCB: Analytical Skills AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis
  1. Sharon is the receptionist and office manager for The Best Construction Company. Sharon handles all of the office duties including billing, cash receipts, payroll, depositing checks and preparing the monthly bank reconciliation. She also prepares all of the checks for disbursements and is an authorized signer on all checks under $25,000. For checks above this amount, two signatures are required. She has been a trusted employee of The Best Construction Company for many years, but still makes just a small amount above minimum wage. She is even the godmother to two of the owner's children and often watches them while their parents go on exotic vacations. Sharon is such a good employee that she rarely takes vacations. Since the owner trusts her completely, he concentrates on the construction business and leaves all of the office work to Sharon. He would never interfere with her work since he has very little accounting knowledge. Sharon has recently become a grandmother and enjoys buying her grandchildren expensive toys and clothes. She has just bought a new Hummer for herself and an exclusive condo in the Virgin Islands. What are the five basic control procedures for any class of transactions? Using these five basic control procedures, what can be done to strengthen the internal control procedures for The Best Construction Company? Answer: The five basic control procedures are:
  1. smart hiring practices and segregation of duties
  2. comparisons and compliance monitoring
  3. adequate records
  4. limited access to both assets and records
  5. proper approvals (either general or specific) for each class of transaction Segregation of duties: At The Best Construction Company, the three key duties of asset handling, record keeping, and transaction approval are not segregated. Sharon handles the cash, records the cash and can approve the transactions. Since this is a small business, it may not be practical to hire someone else to share these duties. The owner must get involved by approving all large-transactions, signing the checks, making the deposits or at the very least preparing the monthly bank reconciliation. Sharon should also be required to take a vacation. Many times when employees are on vacation, their frauds are uncovered. Frauds are committed by people who are put in a position of trust. Comparisons and compliance monitoring: The owner can prepare operating and cash budgets and look for variances. It is probably cost prohibitive to have any type of internal or external audit. Adequate records: Documents should be prenumbered and gaps analyzed. The owner should sign the checks after looking at the supporting documentation. Limited access: See segregation of duties. Records should be protected by lock and key or passwords. Proper approvals: The owner should approve large transactions. Diff: 2 LO: 4- AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Risk Analysis

4.3 Learning Objective 4-

  1. The person to whom a check is paid is referred to as the drawee. Answer: FALSE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  2. The person performing the bank reconciliation should not have any other cash duties. Answer: TRUE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  3. Outstanding checks are checks that have been recorded by the bank, but are not yet recorded on the books. Answer: FALSE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  4. There are two records of a business's cash-the cash account in the company's general ledger and the bank statement. Answer: TRUE Diff: 1 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  5. Every adjustment on the bank side of the bank reconciliation needs to be recorded in the books. Answer: FALSE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  6. With online banking, a company still needs to wait until the bank statement is received before they can complete the bank reconciliation. Answer: FALSE Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  1. There are three parties to a check. The person or company to whom the check is paid is the: A) maker. B) payee. C) draftee. D) promissee. Answer: B Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  2. When preparing a bank reconciliation, which of the following items should be added to the book balance? A) EFT receipts B) Deposits in transit C) Collection items D) Both EFT receipts and collection items Answer: D Diff: 2 LO: 4- AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Measurement
  3. Deposits that have been recorded on the book, but have not yet been recorded by the bank are: A) nonsufficient funds deposits. B) outstanding deposits. C) deposits in transit. D) electronic funds deposits. Answer: C Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  4. Differences between the amount of cash reported on a company's bank statement and the balance in the company's cash account before the bank reconciliation are primarily due to: A) errors in the accounting process by the company. B) errors made by the bank. C) differences between the cash basis and accrual basis of accounting. D) the timing difference in recording transactions. Answer: D Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  1. All of the following will appear on the bank statement EXCEPT for: A) Electronic funds transfers (EFT). B) beginning and ending cash balance. C) cash receipts and cash payments. D) deposits in transit. Answer: D Diff: 2 LO: 4- AICPA Bus Persp: Legal/Regulatory AICPA Functional: Measurement
  2. When preparing a bank reconciliation: A) deposits in transit are added to the bank balance. B) service charges are subtracted from the bank balance. C) outstanding checks are deducted from the book balance. D) book errors are subtracted from the bank balance. Answer: A Diff: 2 LO: 4- AASCB: Analytical Skills AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Measurement
  3. Herbert Company deposited $25,000 in its bank on the same day as, but after the bank prepared Herbert Company's bank statement. The deposit should appear on the bank reconciliation as a(n) ________ and is called a(n) ________. A) addition to the bank balance; outstanding deposit B) addition to the bank balance; deposit in transit C) deduction to the bank balance; deposit in transit D) deduction to the bank balance; outstanding deposit Answer: B Diff: 2 LO: 4- AASCB: Analytical Skills AICPA Bus Persp: Strategic/Critical Thinking AICPA Functional: Measurement