EXERCISES—SERIES A: Internal Control and Accounting for Cash

Internal Control and Accounting for Cash

Exercise 6-1A SOX and COSO’s internal control frameworks

Required

a. Discuss the requirements of Section 404 of the Sarbanes–Oxley Act and how it relates to COSO.
b. What type of companies do these rules apply to?

Exercise 6-2A Features of a strong internal control system

Required

List and describe nine features of a strong internal control system discussed in this chapter.

Exercise 6-3A Internal control procedures to prevent embezzlement

Anna Chun was in charge of the returns department at The Luggage Company. She was responsible for evaluating returned merchandise. She sent merchandise that was reusable back to the warehouse, where it was restocked in inventory. Chun was also responsible for taking the merchandise that she determined to be defective to the city dump for disposal. She had agreed to buy a friend a tax planning program at a discount through her contacts at work. That is when the idea came to her. She could simply classify one of the reusable returns as defective and bring it home instead of taking it to the dump.

She did so and made a quick $150. She was happy, and her friend was ecstatic; he was able to buy a $400 software package for only $150. He told his friends about the deal, and soon Chun had a regular set of customers. She was caught when a retail store owner complained to the marketing manager that his pricing strategy was being undercut by The Luggage Company’s direct sales to the public. The marketing manager was suspicious because The Luggage Company had no direct marketing program. When the outside sales were ultimately traced back to Chun, the company discovered that it had lost over $10,000 in sales revenue because of her criminal activity.

Required

Identify an internal control procedure that could have prevented the company’s losses. Explain how the procedure would have stopped the embezzlement.

Exercise 6-4A Internal control procedures to prevent deception

Regional Medical Centers (RMC) hired a new physician, Fred Clark, who was an immediate success. Everyone loved his bedside manner; he could charm the most cantankerous patient. Indeed, he was a master salesman, as well as an expert physician. Unfortunately, Clark misdiagnosed a case that resulted in serious consequences to the patient. The patient filed suit against RMC. In preparation for the defense, RMC’s attorneys discovered that Clark was indeed an exceptional salesman. He had worked for several years as district marketing manager for a pharmaceutical company. In fact, he was not a physician at all! He had changed professions without going to medical school. He had lied on his application form. His knowledge of medical terminology had enabled him to fool everyone. RMC was found negligent and lost a $3 million lawsuit.

Required

Identify the relevant internal control procedures that could have prevented the company’s losses. Explain how these procedures would have prevented Clark’s deception.

Exercise 6-5A Internal controls for small businesses

Required

Assume you are the owner of a small business that has only two employees.
a. Which of the internal control procedures are most important to you?
b. How can you overcome the limited opportunity to use the segregation-of-duties control procedure?

Exercise 6-6A Internal control for cash

Required
a. Why are special controls needed for cash?
b. What is included in the definition of cash?

Exercise 6-7A Treatment of NSF check

Han’s Supplies’ bank statement contained a $270 NSF check that one of its customers had written to pay for supplies purchased.
Required
a. Show the effects of recognizing the NSF check on the financial statements by recording the appropriate amounts in a horizontal statements model like the following one:
Assets = Liab. + Equity Rev. − Exp. = Net Inc. Cash Flow
Cash + Accts. Rec.
b. Is the recognition of the NSF check on Han’s books an asset source, use, or exchange transaction?
c. Suppose the customer redeems the check by giving Han’s $290 cash in exchange for the bad check. The additional $20 paid a service fee charged by Han’s. Show the effects on the financial statements in the horizontal statements model in Requirement a.
d. Is the receipt of cash referenced in Requirement c an asset source, use, or exchange transaction?
e. Record in general journal form the adjusting entry for the NSF check and the entry for redemption of the check by the customer.