Using the data shown in Exercise 6-38, journalize the entries for the transactions, assuming that Air Systems Company uses the perpetual inventory systemAnswer:
Jan. 2 Merchandise Inventory 18,200Accounts Payable 18,2005 Merchandise Inventory 190Cash 1906 Accounts Payable 2,750Merchandise Inventory 2,75013 Accounts Receivable 37,300Sales 37,30013 Cost of Merchandise Sold 22,400Merchandise Inventory 22,40015 Delivery Expense 215Cash 21517 Accounts Payable 15,450Merchandise Inventory 309Cash 15,14123 Cash 36,927Sales Discounts 373Accounts Receivable 37,300
United Rug Company is a small rug retailer owned and operated by Pat Kirwan. After the accounts have been adjusted on December 31, the following selected account balances were taken from the ledger:
Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 36,000Depreciation Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,000Freight In . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,000Merchandise Inventory, December 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375,000Merchandise Inventory, December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460,000Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,760,000Purchases Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000Purchases Returns and Allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000Pat Kirwan, Drawing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65,000Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375,000Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300,000Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000Sales Returns and Allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000Journalize the closing entries on December 31.Answer:
Closing EntriesDec. 31 Merchandise Inventory 460,000Sales 2,300,000Purchases Discounts 35,000Purchases Returns and Allowances 45,000Income Summary 2,840,00031 Income Summary 2,665,000Merchandise Inventory 375,000Sales Discounts 30,000Sales Returns and Allowances 50,000Purchases 1,760,000Freight In 17,000Salaries Expense 375,000Advertising Expense 36,000Depreciation Expense 13,000Miscellaneous Expense 9,00031 Income Summary 175,000Pat Kirwan, Capital 175,00031 Pat Kirwan, Capital 65,000Pat Kirwan, Drawing 65,000
The following are some quotes provided by a number of managers at Hawkeye Machining Company regarding the company’s planned move toward a just-in-time manufacturing system:Director of Sales: I’m afraid we’ll miss some sales if we don’t keep a large stock of items on hand just in case demand increases. It only makes sense to me to keep large inventories in order to assure product availability for our customers.Director of Purchasing: I’m very concerned about moving to a just-in-time system for materials. What would happen if one of our suppliers were unable to make a shipment? A supplier could fall behind in production or have a quality problem. Without some safety stock in our materials, our whole plant would shut down.Director of Manufacturing: If we go to just-in-time, I think our factory output will drop. We need in-process inventory in order to “smooth out” the inevitable problems that occur during manufacturing. For example, if a machine that is used to process a product breaks down, it would starve the next machine if I don’t have in-process inventory between the two machines. If I have in-process inventory, then I can keep the next operation busy while I fix the broken machine. Thus, the in-process inventories give me a safety valve that I can use to keep things running when things go wrong.How would you respond to these managers?Answer:The Hawkeye Machining managers are displaying typical fears to a just-in-time processing system. Just-in-time removes the safety provided by materials, inprocess, and finished goods inventory balances. Indeed, these types of comments reflect conventional manufacturing philosophy, which views inventory as a necessary buffer against surprises and other unwelcome events. The just-in-time philosophy focuses on removing the causes that require a need for inventory.In the case of materials inventories, a just-in-time philosophy requires all suppliers to provide high-quality materials on a daily basis in just the right quantities needed for a day’s production. If the supplier has unreliable production schedules or quality, then the sources of unreliability would need to be fixed before moving to just-in-time delivery. Only when suppliers are reliable can Hawkeye Machining move to a just-in-time strategy without exposing the company to significant risk.The in-process inventories can be reduced significantly if the underlying manufacturing processes are made reliable. The director of manufacturing is correct in his observation, but his solution is wrong. The solution is not to increase inventory but to improve the reliability of the machines so that they do not experience emergency breakdowns. Thus, the manufacturing operation must be improved to produce the right product, in the right quantities, at the right quality, and at the right time. Only with this level of reliability can a plant responsibly remove in-process inventories from the system.The finished goods inventory can also be reduced if the manufacturing system can be made responsive to customer demands. A company will no longer have to stock warehouses with product based on guesses at what the customer will wantmany weeks ahead of demand. Rather, goods are produced at the time the customer orders them. This is what Dell Inc. does. It builds a computer to order, rather than stocking the computer and selling it from inventory.In other words, inventory covers a “multitude of sins.” When the “sins” are removed, the inventory can be removed.
Madonna Epstein has recently been hired as the manager of Beans Coffee Shop. Beans Coffee Shop is a national chain of franchised coffee shops. During her first month as store manager, Madonna encountered the following internal control situations:a. Beans Coffee Shop has one cash register. Prior to Madonna’s joining the coffee shop, each employee working on a shift would take a customer order, accept payment, and then prepare the order. Madonna made one employee on each shift responsible for taking orders and accepting the customer’s payment. Other employees prepare the orders.b. Since only one employee uses the cash register, that employee is responsible for counting the cash at the end of the shift and verifying that the cash in the drawer matchesthe amount of cash sales recorded by the cash register. Madonna expects each cashier to balance the drawer to the penny every time—no exceptions.c. Madonna caught an employee putting a case of 500 single-serving tea bags in her car. Not wanting to create a scene, Madonna smiled and said, “I don’t think you’re putting those tea bags on the right shelf. Don’t they belong inside the coffee shop?” The employee returned the tea bags to the stockroom.State whether you agree or disagree with Madonna’s method of handling each situation and explain your answer.Answer:a. Agree. Madonna has made one employee responsible for the cash drawer in accordance with the internal control principle of assignment of responsibility. In addition, Madonna has segregated the operations (preparing the orders) from the accounting (taking orders and payments).b. Disagree. It is commendable that Madonna has given the employee a specific responsibility and is holding that employee accountable for it. However, after the cashier has counted the cash, another employee (or perhaps Madonna) should remove the cash register tape and compare the amount on the tape with the cash in the drawer. Also, Madonna’s standard of no mistakes may encourage the cashiers to overcharge a few customers in order to cover any possible shortages in the cash drawer.c. Disagree. Stealing is a serious issue. An employee who can justify taking a box of tea bags can probably justify “borrowing” cash from the cash register.
Using Wikipedia (www.wikipedia.com), look up the entry for Sarbanes-Oxley Act. Look over the table of contents and find the section that describes Section 404.What does Section 404 require of management’s internal control report?Answer:Section 404 requires management’s internal control report to:(1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and(2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.The complete AICPA summary of Section 404 of Sarbanes-Oxley is as follows:Section 404: Management Assessment of Internal Controls. Requires each annual report of an issuer to contain an “internal control report,” which shall:(1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and(2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.Each issuer’s auditor shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this section shall be in accordance with standards for attestation engagements issued or adopted by the Board. An attestation engagement shall not be the subject of a separate engagement.The language in the report of the Committee which accompanies the bill to explain the legislative intent states, “…the Committee does not intend that the auditor’s evaluation be the subject of a separate engagement or the basis for increased charges or fees.”Directs the SEC to require each issuer to disclose whether it has adopted a code of ethics for its senior financial officers and the contents of that code.Directs the SEC to revise its regulations concerning prompt disclosure on Form 8-K to require immediate disclosure “of any change in, or waiver of,” an issuer’s code of ethics.
Pacific Bank provides loans to businesses in the community through its Commercial Lending Department. Small loans (less than $100,000) may be approved by an individual loan officer, while larger loans (greater than $100,000) must be approved by a board of loan officers. Once a loan is approved, the funds are made available to the loan applicant under agreed-upon terms. Pacific Bank has instituted a policy whereby its president has the individual authority to approve loans up to $5,000,000. The president believes that this policy will allow flexibility to approve loans to valued clients much quicker than under the previous policy.As an internal auditor of Pacific Bank, how would you respond to this change in policy?Answer:As an internal auditor, you would probably disagree with the change in policy. Pacific Bank has some normal business risk associated with default on bankloans. One way to help minimize this is to carefully evaluate loan applications. Large loans present greater risk in the event of default than do smaller loans. Thus, it is reasonable to have more than one person involved in making the decision to grant a large loan. In addition, loans should be granted on their merits, not on the basis of favoritism or mere association with the bank president. Allowing the bank president to have sole authority to grant large loans can lead to the president granting loans to friends and business associates, without the required due diligence. This can result in a bank becoming exposed to very poor credit risks. Indeed, this scenario is one of the causes of the savings and loan failures of the past.
One of the largest losses in history from unauthorized securities trading involved a securities trader for the French bank, Societe Generale. The trader was able to circumventinternal controls and create over $7 billion in trading losses in six months. The trader apparently escaped detection by using knowledge of the bank’s internal control systemslearned from a previous back-office monitoring job. Much of this monitoring involved the use of software to monitor trades. In addition, traders were usually kept to tight trading limits. Apparently, these controls failed in this case.What general weaknesses in Societe Generale’s internal controls contributed to the occurrence and size of the losses?Answer:The Societe Generale trading losses show how small lapses in internal control can have large consequences. When the losses became so large that they could no longer be hidden, it was too late. The loss could have been avoided with a number of internal controls. First, the separation of duties control was overcome by the trader’s intimate knowledge of the monitoring software. This knowledge of the monitoring system allowed the trader to effectively hide trades. The design of the monitoring software would need to be improved, and access prohibited by traders. If traders have access to the monitoring software, then the separation of duties control is violated. Second, the trader should be under managerial oversight. For example, trades that exceed a certain amount of exposure should require management approval. In this way, a trader would be forced to slow down or stop once trades have reached a certain limit. This would avoid the trader’s tendency to try to “make up” losses with even larger bets. Lastly, required vacation time may have alerted managers to the hidden losses once the trader was unable to attend to the trading positions
Ramona’s Clothing is a retail store specializing in women’s clothing. The store has established a liberal return policy for the holiday season in order to encourage gift purchases. Any item purchased during November and December may be returned through January 31, with a receipt, for cash or exchange. If the customer does not have a receipt, cash will still be refunded for any item under $75. If the item is more than $75, a check is mailed to the customer.Whenever an item is returned, a store clerk completes a return slip, which the customer signs. The return slip is placed in a special box. The store manager visits the return counter approximately once every two hours to authorize the return slips. Clerks are instructed to place the returned merchandise on the proper rack on the selling floor as soon as possible.This year, returns at Ramona’s Clothing have reached an all-time high. There are a large number of returns under $75 without receipts.a. How can sales clerks employed at Ramona’s Clothing use the store’s return policy to steal money from the cash register?b. What internal control weaknesses do you see in the return policy that make cash thefts easier?c. Would issuing a store credit in place of a cash refund for all merchandise returned without a receipt reduce the possibility of theft? List some advantages and disadvantages of issuing a store credit in place of a cash refund.d. Assume that Ramona’s Clothing is committed to the current policy of issuing cash refunds without a receipt. What changes could be made in the store’s procedures regarding customer refunds in order to improve internal control?Answer:a. The sales clerks could steal money by writing phony refunds and pocketing the cash supposedly refunded to these fictitious customers.b. Ramona’s Clothing suffers from inadequate separation of responsibilities for related operations, since the clerks issue refunds and restock all merchandise. In addition, there is a lack of proofs and security measures, since the supervisors authorize returns two hours after they are issued.c. A store credit for any merchandise returned without a receipt would reduce the possibility of theft of cash. In this case, a clerk could only issue a phony store credit rather than taking money from the cash register. A store credit is not as tempting as cash. In addition, sales clerks could only use a few store credits to purchase merchandise for themselves without management getting suspicious.An advantage of issuing a store credit for returns without a receipt is that the possibility of stealing cash is reduced. The store will also lose less revenue if customers must choose other store merchandise instead of getting a cash refund. The overall level of returns/exchanges may be reduced, since customers will not return an acceptable gift simply because they need cash more than the gift. The policy will also reduce the “cash drain” during the weeks immediately following the holidays, allowing Ramona’s Clothing to keepmore of its money earning interest or use that cash to purchase spring merchandise or pay creditors.A disadvantage of issuing a store credit for returns without a receipt is that preholiday sales might drop as gift-givers realize that the return policy has tightened. After the holidays, customers wishing to return items for cash refunds may be frustrated when they learn the store policy has changed. Theill will may reduce future sales. It may take longer to explain the new policy and fill out the paperwork for a store credit, lengthening lines at the returncounter after the holidays. Sales clerks will need to be trained to apply the new policy and write up a store credit. Sales clerks also will need to be trained to handle the redemption of the store credit on future merchandise purchases.d. The potential for abuse in the cash refund system could be eliminated if clerks were required to get a supervisor’s authorization for a refund before giving the customer the cash. The supervisor should only authorize the refund after seeing both the customer and the merchandise that is being returned.An alternative would be to use security measures that would detect a sales clerk attempting to ring up a refund and remove cash when a customer is notpresent at the sales desk. These security measures could include cameras or additional security personnel discreetly monitoring the sales desk.Finally, an employee on the following work shift could be assigned the responsibility to restock returned merchandise and reconcile the returns to a refund list for the department.
All-Around Sound Co. discovered a fraud whereby one of its front office administrative employees used company funds to purchase goods, such as computers, digital cameras, andother electronic items for her own use. The fraud was discovered when employees noticed an increase in delivery frequency from vendors and the use of unusual vendors. After some investigation, it was discovered that the employee would alter the description or change the quantity on an invoice in order to explain the cost on the bill.What general internal control weaknesses contributed to this fraud?Answer:All-Around Sound Co. should not have relied on the unusual nature of the vendors and delivery frequency to uncover this fraud. The purchase and payment cycle is one of the most critical business cycles to control, because the potential for abuse is so great. Purchases should be initiated by a requisition document. This document should be countersigned by a superior so that two people agree as to what is being purchased. The requisition should initiate a purchase order to a vendor for goods or services. The vendor responds to the purchase order by delivering the goods. The goods should be formally received using a receiving document. An accounts payable clerk matches the requisition, purchase order, and invoice before any payment is made. Such “triple matching” prevents unauthorized requests and payments. In this case, the requests were unauthorized, suggesting that the employee has sole authority to make a request. Second, this employee had access to the invoices. This access allowed the employee to change critical characteristics of the invoice to hide the true nature of the goods being received. The invoice should have been delivered directly to the accounts payable clerk to avoid corrupting the document. There apparently was no receiving document (common for smaller companies); thus, only the invoice provided proof of what was received and needed to be paid. If there had been a receiving report, the invoice could not have been doctored and gone undetected, because it would nothave matched the receiving report.
