Financial Accounting: An Integrated Approach, Sixth Edition Chapter 7 Recordkeeping and Control Solution Outline for Problem 7.1 • • • • • •
Packing slips (goods) and/or supplier invoices (goods and/or services): received with inventory orders, matched to one another, related purchase orders, and recorded in a purchases register. Cheques: issued to pay accounts payable, payroll, etc., and recorded in a cheque register or cash disbursements journal. Sales invoice: created upon completion of a sale and recorded in a sales journal. Payments received from customers: received upon collection of receivables and recorded in a cash receipts journal. Journal entries: created for nonroutine events and recorded in a general journal. Specialized or subsidiary ledgers: detailed backup, for example, by supplier (accounts payable subledger) or customer (accounts receivable subledger).
Solution Outline for Problem 7.2 1.
The source documents are outlined in the chapter's reading on accounting “CDs” and records (Section 7.2), for example purchase order, sales invoice, packing slip. Instructors may wish to suggest other examples.
2.
The “trial balance” is produced regularly so that the CDkeeper may check to ensure that the accounts are in balance (sum of debits equals sum of credits) and to provide a list of balances that may be reviewed for other kinds of errors or incompleteness, such as balances that seem improper.
Solution Outline for Problem 7.3 An e-commerce transaction like this involves different source documents and CDs of original entry than traditional transactions. Much of the information is transmitted and records are maintained electronically For you, the order is transmitted using a web-page. Instead of phoning or mailing information to Musi.ca, you use the internet to order the CD and to provide credit card information to the CDseller. Soon after you place the order, you receive an e-mail confirmation of the order. When you receive the CD, a copy of the order that acts as a packing slip is enclosed. Subsequently, when you receive a credit card statement, the amount of the purchase is included. Musi.ca establishes an electronic order when you contact the web-page. They then transmit information, probably electronically, to Disko Inc.. instructing them to deliver the CD to you. At the same time, they verify your credit card details and start to collect the sales amount from your credit card company. Musi.ca also establishes an account payable to Disko Inc.. that is paid when they confirm that the CD has been shipped. On receiving the order from the CDseller, Disko Inc.. checks for availability and if the goods are on hand commence the shipping process. At the same time, an accounts receivable is set up for the amount owing by Musi.ca. Where goods are not in stock an order is placed with the CD printer. Your credit card company processes this transaction much like it does for transactions from other retailers. The credit card company likely charges a commission to Musi.ca based on a set percentage of the sales amount. The item is then added to your next monthly statement and they either collect from you next month or charge you interest on the overdue balance.
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Solution Outline for Problem 7.4 The purpose of this problem is to prompt thinking about the effects of size on accounting systems and therefore to reinforce the idea that accounting systems should match the organization’s information needs. Some of the differences we might expect are (worded from the larger organization’s point of view for expository convenience): • more complex and elaborate • more costly • more departmentalized (separated from other functions of the organization) • tracks more accruals (e.g., receivables and payables) as routine and less likely to be mainly oriented to cash transactions • more likely run by trained accountants and/or accounting professionals • more computerized (though many small organizations have largely computerized systems too) • more features providing accounting data for internal control purposes (e.g., inventory control, records of long-term assets) • more capability to produce performance reports for management (e.g., ad hoc, monthly, not necessarily in financial statement format) • less flexible and “personal” to the manager(s) • more systematic documentation and other “audit” functions The sophistication of a company’s accounting system would likely correspond with more elaborate accounting policies. The more accounting information that is collected, the more evidence there is available to determine appropriate accounting policies. Solution Outline for Problem 7.5 The basic point is that accounting records and financial statements need not be complex or expensive to be useful. Every manager needs to know how the business is performing and to be able to explain that to bankers and others. This performance goes beyond mere sales records, even if sales are the lifeblood of the firm. For example, is enough cash on hand to pay all the bills that re due next week or next month? The accounting system provides information about profitability, cash flows, debts and other factors important to the business besides sales. Bankers and tax authorities want to know about such things, even if the businessperson claims not to. It should be said also that the entrepreneur mentioned may well have an accounting system that fits the modest needs of their business well. They understand cost-benefit: accounting, like everything else, should be worth its cost. But they should ask if they could be a better manager if they had more information, and perhaps accounting could help there. Solution Outline for Problem 7.6 1) a. A donor would want to have assurances that a strong internal control system exists so that all the money being donated is properly accounted for. Also, detailed accounting would show how much of a donation actually reaching the intended beneficiaries of the charity and how much is spent on administration. Without these assurances, many people may be wary of donating. b. A beneficiary of the charity would be indirectly affected by a strong internal control system. With a proper system, there would be less chance of fraud or failure allowing the people who need the money to properly receive it. Conversely, a careful internal control system may be expensive increasing administration fees.
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Financial Accounting: An Integrated Approach, Sixth Edition c. The charity’s board of directors would need assurances that the money the charity received is being properly handled. Detailed financial records would assist in preventing theft or fraud. d. The government would be interested in a strong system since charities have a special income tax status. In order to become a licensed charity and give out income tax receipts, a charity must demonstrate that its activities actually help out the people that it intends to aid. 2) A nonprofit organization would not differ greatly from the way a large corporation keeps its records. A charity must be accountable for its funds and where they are going thus a strong accounting system must be behind all donations. Without it, contributions may not be used efficiently. Solution Outline for Problem 7.7 Numbering the components of internal control as in Section 7.3 (a) violates #5; (b) violates #4; (c) violates #3; (d) violates #2; (e) violates #7; and (f) violates #1. Solution Outline for Problem 7.8 Weaknesses in the internal control system: • cash receipts apparently not supported by adequate records • expenditures made in cash which are less secure • lack of segregation of functions (possible collusion of married couple) • employees may influence the board of directors • no separate storage of assets • deposits to bank not made daily • cash expenses paid out of cash receipts • cheques written for cash Strengths of the system: • board of directors meets regularly • board reviews financial reports • board discusses major trips, equipment purchases, and large expenditures Solution Outline for Problem 7.9 Using the main components of internal control discussed in section 7.3, some ideas are: • Manage competently – New management may “clean up” the financial statements in the first period, resulting in a large loss. This may indeed be due to poor management by the prior management. • Have good records – Large write-offs may be necessary if management does not keep good records. For example, if capital assets are not accounted for correctly, management may have equipment or other assets on the CDs that have been disposed of or otherwise no longer exist. This would be discovered if the management or the auditors couldn’t locate a large asset that is on the CDs. • Use the records and learn from them – The accounting records can help identify trends, for example, the percentage of customers who do not pay their accounts receivable. Management can take advantage of this knowledge and use a contra account to make an estimate each period, resulting in smoother earnings. Without this knowledge and estimate process, there could be large periodic adjustments to accounts receivable and bad debt expense.
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Instructor’s Solution Manual •
•
• •
•
•
Segregate duties – If duties aren’t segregated, there is a greater risk of error or fraud. For example, if the same person collects receipts and maintains the bank records, he or she could steal some of the receipts and the theft would be difficult to discover. Management would be alerted to a problem if customers claimed they had already paid amounts that the records show as receivable. The records would then need to be adjusted. Treat employees well – Again, if employees aren’t treated well, there is a greater risk of error or fraud. For example, an employee who feels underpaid may steal company assets in order to increase his or her “compensation,” leaving the assets on the CDs overstated and requiring an adjustment downwards. Carry insurance – If assets aren’t insured and there is a fire, for example, a write-down or write-off would be required and there would be no insurance proceeds to offset this adjustment. Physically protect assets – If assets aren’t physically protected, they can easily disappear or become damaged and less valuable. Inventory is a main one that should be protected and if it is not, auditors would discover at the year-end inventory count that it is overvalued on the balance sheet and would require a write-down. Independent scrutiny – If there is no board of directors, audit committee, or even auditors, this could hurt management’s incentive or maybe even ability to operate competently, keep goods records, etc. Perhaps the management of a company is not strong in its accounting knowledge and mistakenly records assets at fair market value instead of cost. When discovered, a write-down would be required. Set an ethical example – If management does not set a good example, many of the problems noted above could occur.
Solution Outline for Problem 7.10 The owner is correct that hiring the right people and letting them get on with managing the business is a good philosophy. However, as section 7.4 indicates top management must still be sufficiently involved to establish the appropriate tone for the whole company. Top management is responsible for the information contained in the annual report, for establishing an internal control system, and for liaising with the external auditor. Top management should also monitor directly, or via the internal audit department, the actions of the company’s accountants. Given that the company is successful, one could argue that neglecting these top management responsibilities does not matter. However, if the company ever starts to fail and is faced by difficult management choices, it would be better to establish appropriate controls and monitoring now. Solution Outline for Problem 7.11 1.
Great control effort is required simply because cash, as the medium of exchange, is the asset easiest to use if stolen and therefore is likely to be tempting to a variety of employees, customers and others. It is widely accepted, readily available and despite it’s extreme liquidity, has not title or ownership labels attached to it.
2.
For this part, the lists below are suggestions to get thinking started. Students should use their imaginations to think of items! a. • hectic conditions, increasing likelihood of honest mistakes and opportunity for fraud by employees or customers • some sales might not be recorded in the tills • returns/refunds may not be handled properly
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Financial Accounting: An Integrated Approach, Sixth Edition • • • • • b.
• • • • •
c.
•
•
d.
• • •
e.
• • •
disagreements with customers over change due different tills might have quite different cash flows and balances depending on location in the outlet high volumes of cash handled mean large amounts of cash could pile up in the tills vulnerability of outlet to robbery if cash is not put in bank frequently (and vulnerability of employees making such bank deposits) high volume of individually low value transactions. recordkeeping problems for names of employees and hours worked in remote locations (Overstatement of hours worked, nonexistent employees on payroll). likely high turnover of employees, increasing the recordkeeping problems possible collusion at work sites between those keeping records and those doing work (may identify with each other more than with head office) problems tracking down employees to make sure they get paid associated problems with collection and remittance of income taxes and various employee benefits handling of cash: canvassers may not turn over all that is collected, due to honest mistakes, loss, volunteers' unfamiliarity or impatience with forms and cash control, and even theft handling of cheques: some of same problems as above, plus difficulties with cheques not honoured by banks because of insufficient funds or other problems not caught by canvasser at the door slugs, foreign coins and other improper objects, having to be separated from “real” cash and often jamming the mechanisms theft from the machine, often producing severe damage to the machine. the large volume and weight of the coins are a problem, as is counting and organizing all the coins back at head office. possible theft by just about anyone who knows that cash is on hand at the receptionist's desk improper purchases, such as personal items, or loans to others who are temporarily short of lunch money mixing of receptionist's and company's cash (often happens in such cases when there is not the right amount of change on hand, or not enough cash, and the receptionist is trying to do a good job for the company)
Solution Outline for Problem 7.12 a. This is an example of segregation of duties. The person who handles the cash is not the same person who records the receipts in the receivables records, thereby identifying differences between the two records and lessening the possibility for the cash handler to pocket the cash without recording it. b. In the petty cash fund, the cash on hand plus the receipts of cash paid expenses should equal the total petty cash fund. This reconciliation reveals any cash shortages. c. The retail inventory method combines inventory control with cash control. Inventory at the beginning of the period plus purchases less sales should equal inventory at the end of the period, with all inventory calculated at the retail price of the goods. Differences between actual ending inventory and the calculated amount could be the result of unrecorded cash sales or missing inventory.
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Instructor’s Solution Manual d. Since inventory is usually susceptible to theft, keeping it in a locked warehouse is an important way to physically safeguard it. e. The employee deductions liabilities are control accounts. Reconciling the control accounts to the payroll register and to actual payments is important since employee benefits are often a complicated area. The reconciliation ensures that payroll has been recorded correctly in the accounts and that the proper payments have been made. Solution Outline for Problem 7.13 The answer to this problem could be quite wide-ranging. One approach is to say that internal control involves managing and safeguarding assets and that managers such as Janet should care about it because they are responsible for such managing and safeguarding on behalf of the owners. Some details that might be included would be to list particular components of internal control and note management's responsibility for each. Some such components are: • keeping control over the company is part of management's general objective and so internal control is consistent with and helpful to managers' general purposes; • some specific aspects of internal control Janet may want to think about: o physical protection of assets (fences, dry storage, safes, locks, etc.); o economic protection of assets (avoiding obsolescence, keeping assets maintained, etc.); o insurance against loss (probably cheaper the better the control is); o generally staying aware of the location, condition, economic value and other important features of assets; • some techniques that are helpful to managers like Janet: o segregation of duties; o good, reliable records; o timely reports on assets' use and condition; o periodic verification of records; o cost-effective physical protection; o proper motivation and monitoring of employees, customers and others with access to assets. Solution Outline for Problem 7.14 The president is right to consider improving internal controls, but the specific changes should be based on a cost-benefit decision. The president should consider areas of greatest risk and assets that are most susceptible to theft or fraud. The president should evaluate the possible improvements to systems in the light of the increased costs. The president should look at areas where there is a lack of adequate separation of duties or specific staff members with high levels of responsibility. The external auditor may be able to advise where there are specific internal control weaknesses. Assets that are most susceptible are cash balances and inventory that could be used or sold by staff. Other noncurrent assets like tools and equipment may also be potential targets. Accounts receivable, although not physical, may give a staff person an opportunity to defraud the company if control accounts are not properly maintained. The president should prioritise the planned control improvements and implement the most important ones first.
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Financial Accounting: An Integrated Approach, Sixth Edition Solution Outline for Problem 7.15 Control points/procedures: The ticket taker ensures each person has a ticket but has no access to the cash. The usher confirms patron has ticket again without access to cash. Tickets are numbered (seat number and possibly serially numbered) – if control is kept over unsold tickets the cashier’s cash balance can be reconciled to tickets sold. Both presales and date of performance sales would have to be included in the reconciliation. This segregation of duties involves three persons making collusion much less likely. Solution Outline for Problem 7.16 a. DR Accounts receivable
81,360
DR Cash DR PST due DR GST due DR Inventories DR GST due b. DR Wages expense
69,030 3,900 3,100 26,286 1,840 39,250
DR Fringes or wage expense 6,315 DR Employee tax deductions due12,668 DR Fringes or other deductions due
CR Revenue CR PST due CR GST due CR Accounts receivable CR Cash CR Cash CR Accounts payable
72,000 4,320 5,040 69,030 3,900 3,100 28,126
CR Employee tax deductions due CR Fringes and other deductions due CR Wages payable CR Fringes and other deductions due CR Cash 11,894 CR Cash 11,894
11,180 4,990 23,080 6,315 12,668
Solution Outline for Problem 7.17 a)
b)
c)
DR Cash DR Accounts receivable CR Revenue CR GST Due CR PST Due
361,460 131,240
DR Inventory DR GST Due CR Cash CR Accounts Payable
277,570 19,430
428,696 30,009 34,295
190,000 107,000
DR GST Due CR Cash DR PST Due CR Cash Total GST Due : Total PST Due:
8,000 8,000 20,000 20,000 $30,009 – $9,430– $8,000 = $2,575 $34,295 – 20,000= $14,295
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Instructor’s Solution Manual Solution Outline for Problem 7.18
1. Sales tax is not a company expense. It is the customers’ expense. Impromptu is just collecting it on behalf of the government from customers and remitting it.
2. Such taxes are the employees’ obligations. As in (1), Have Fun is just deducting (collecting) it on behalf of the government from the employees and remitting it.
3. Over time, wages expense debits exceed wages payable credits because the former is the gross amount earned while the latter is the net payable after deductions.
4. Revenue up $40,000; Sales taxes payable up $6,000. 5. Sales taxes payable goes down $420. 6. Amount due = $7,620 + $6,000 - $420 = $13,200. 7. Wages expense up $2,200, Fringes expense up $570, Employee tax deductions due up $760, Other deductions and fringes due up $663 ($570 + $93), Wages payable up $1,347 ($2,200 - ($760 +$93)). (If this is written as a journal entry, it balances: debits total $2,770 ($2,200 + $570), as do credits ($760 + $663 + $1,347).) Solution Outline for Problem 7.19 1. $1,693,784 2. $1,599,005 3. $8,293 4. $9,117 5. Expense/Sales: $9,117/$1,693,784 = 0.0054 Written off/Sales: $8,293/$1,693,784 = 0.0049 Both are about half a cent per dollar. The first number tells management the estimated economic loss. The second number tells management the real loss of what has been given up on. 6. $331,106 – $12,738 = $318,368 7. Accounts receivable = $244,620 + $1,693,784 – $1,599,005 = $339,399 Allowance = $11,914 + $9,117 = $21,031 Collectible value = $339,399 – $21,031 = $318,368 (same as part 6) Solution Outline for Problem 7.20 a. b.
c.
Bad debts expense = $66,650 provided during the year + $83,700 additional provision = $150,350. Allowance for doubtful accounts = $110,000 preliminary balance + $83,700 additional provision $55,800 written off = $137,900. Estimated collectible value of receivables = $643,250 original receivables - $55,800 written off $137,900 allowance = $449,550. (Note the $55,800 write-off has not affected this net figure. If there were no write-off, the receivables would total $643,259, the allowance would total $193,700 and the net amount would still be $449,950.)
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Solution Outline for Problem 7.21 1. Account Status Account Balance Total Not yet due Past Due: 1 - 30 days 31 – 60 days 61 – 90 days Over 90 days Total
Estimated Loss Required Percentage Allowance
$200,000
1%
$2,000
100,000 50,000 120,000 30,000 $500,000
3% 4% 5% 30%
3,000 2,000 6,000 9,000 $22,000
2. $19,500 (22,000 – 2,500) 3. DR Bad debt expense CR Allowance for doubtful accounts
19,500
4. Dr Allowance for doubtful accounts Cr Accounts receivable
642
19,500
642
Solution Outline for Problem 7.22
(a)
(1) $1,332,000 - $51,000 = $1,281,000 (2) $40,000 (no change) (3) $34,000 + $51,000 = $85,000 (4) effect is to reduce net collectible value by $51,000 (5) same effect on working capital as (4) (6) income goes down by same $51,000
(b)
(1) $1,332,000 (no change) (2) $92,000 (given) (3) $34,000 + ($92,000 - $40,000) = $86,000 (4) effect is to reduce net collectible value by $52,000 ($92,000 - $40,000) (5) same effect on working capital as (4) (6) income goes down by same $52,000
(c)
(1) $1,332,000 - $51,000 = $1,281,000 (2) $92,000 - $51,000 = $41,000 ($92K includes hopeless and doubtful accounts) (3) $34,000 + ($92,000 - $40,000) = $86,000 (4) effect is to reduce net collectible value by $52,000 ($92,000 - $40,000) (5) same effect on working capital as (4) (6) income goes down by same $52,000
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Instructor’s Solution Manual Solution Outline for Problem 7.23 1. $793,220 2. $1,032,568 3. Book value = $843,992 – $411,883 = $432,109 Book value minus proceeds = $432,109 – $350,000 = $82,109 loss on disposal DR Cash 350,000 DR Accumulated amortization 411,883 DR Loss on disposal 82,109 CR Factory assets 843,992 4. DR Accumulated amortization 59,200 DR Write-off loss (expense) 30,045 CR Factory assets 89,245 5. NBV = $5,597,219 – $2,299,458 = $3,297,761 Solution Outline for Problem 7.24 a)
b)
c)
DR Cash/Accounts receivable DR Accumulated amortization CR Aircraft asset DR Loss on sale expense
85,000,000 35,000,000
DR Cash/Accounts receivable DR Accumulated amortization CR Aircraft asset CR Gain on sale
95,000,000 56,000,000
DR Accumulated amortization CR Aircraft asset DR Property destruction expense
42,500,000
145,000,000 25,000,000
145,000,000 6,000,000
145,000,000 102,500,000
Solution Outline for Problem 7.25
1. Bad debt expense of $56,286 2. Amortization expense of $1,025,120 3. (a) Net collectible value = $8,423,119 - $113,402 = $8,309,717 (b) Net CD value = $10,399,163 - $3,725,021 = $6,674,142 4. (a) accounts receivable go down $69,579 (b) allowance goes down the same (c) no effect on bad debt expense (d) no effect on net collectible value (accounts receivable and allowance both go down the same amount)
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5. (a) (b) (c) (d)
cost goes down $55,250 accumulated amortization goes down $50,950 net CD value goes down $4,300 (difference between (a) and (b)) income goes down $4,300 (loss on disposal/retirement, or perhaps it would be recorded as donations expense)
6. (a) total assets go down $1,248,000 (80% x $1,560,000) (b) net income goes down the same Solution Outline for Problem 7.26 1. Cost of goods sold = Beginning inventory + Purchases – Ending inventory
$ 246,720 1,690,000 (324,800) $1,611,920 2. If the correct COGS is $1,548,325, this means that some of what appeared to have been sold was not. It was lost, or stolen, or it strayed! The amount lost is $63,595, which could be left in the COGS expense or could be shown separately, so that the COGS expense would be the accurate, smaller amount. Total expense would not be different; the perpetual method just allows it to be split into $1,548,325 COGS and $63,595 loss, which were lumped together under the periodic method. The need for the $63,595 adjustment indicates that the company has what seems a serious problem somewhere: there are errors in the records, inventories are being lost somehow (misplaced or customer pilferage), or there are more sinister things going on, like employee theft. 3. Companies may choose not to use the perpetual method because of its cost to operate, compared to the periodic method. It may be felt that the improved recordkeeping is not worth its cost. Here, the losses are large enough that a reasonable perpetual control system would probably be affordable because the costs of implementing a system are outweighed by the benefits (hopefully, lower shrinkage). Solution Outline for Problem 7.27 1. June 3 Dr Purchases Dr GST due Cr Accounts payable June 7 DR Accounts receivable CR GST due CR Sales June 12 DR Sales DR GST due CR Accounts receivable
5,000 350 5,350
3,531 231 3,300
600 42 642
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Instructor’s Solution Manual June 14 DR Accounts payable CR GST due CR Purchases
268 18 250
June 20 DR Cash Cr Accounts receivable June 22 DR Accounts payable CR Cash June 28 Dr Accounts receivable CR GST due CR Sales
1,800 1,800
4,000 4,000
5,618 368 5,250
2. a. Accounts receivable = 3,531 – 642 - 1,800 + 5,618 = 6,707 b. Accounts payable = 5,350 – 268 – 4,000 = 1,082 c. Inventory = 5,000 – (55 * 25) – (75 * 25) = 1,750 d. GST due = -350 + 231 – 42 + 18 + 368 = 225 Solution outline for Problem 27b 1.
It is likely that Gap wants neither its customers nor its competitors to be able to determine the mark-up charged on the products they sell.
2.
2005 – 39.2 % 2004 – 37.6% 2003 – 34.0% 2005: 100 * (1-.392) = 60.80 2004: 100 * (1-.376) = 62.40 2003: 100 * (1-.340) = 66.00
3.
4.
Students may argue either way but most should be aware that a company like Gap is going to have a higher margin than calculated especially since rent is included in the cost of goods sold.
Solution Outline for Problem 7.28 1. a. b. c. d. e. f.
328,600 + 4,602,380 – 2,186,410 – 163,200 = 721,310 + 4,218,140 + 295,270 – 4,602,380 = 806,220 + 2,289,715 – 50% x 4,218,140 = 986,865 14,220 negative (accrued liability) 518,640 + 2,289,715 + 160,280 – 2,186,410 = 33,260 + 295,270 – 160,280 – 163,200 = 5,050
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2,581,370 632,340
782,225
Financial Accounting: An Integrated Approach, Sixth Edition 2.
i.
DR Accounts receivable CR Rev CR GST due ii. DR Cash CR Accounts receivable iii. DR Inventory DR GST due CR Accounts payable iv. DR Accounts payable CR Cash v. DR GST due CR Cash vi. DR COGS [50% x 4,218,140] CR Inventory vii. DR Expense CR Prepaid/Accrued [93,760 + 14,220] viii.DR Shortage Exp CR Inventory [806,220 + 2,289,715 - 2,109,070 - 968,320]
4,513,410 4,218,140 295,270 4,602,380 4,602,380 2,289,715 160,280 2,449,995 2,186,410 2,186,410 163,200 163,200 2,109,070 2,109,070 107,980 107,980 18,545
3. Entry iii. DR is to Purchases expense instead of inventory Entry vi. Not done Entry viii. DR Purchases expense (beg. inventory) 806,220 CR Inventory DR Inventory 968,320 CR Purchases expense (end. inventory) 968,320 Ending balance in control account less shortage (986,865 – 18,545)
18,545
806,220
Solution Outline for Problem 7.29 a. The bookkeeping process recognizes only routine transactions; therefore, adjustments are required to record nonroutine economic events or to correct errors. b. Contra accounts are used when an account needs to be adjusted to recognize an expense or loss but the original balance of the account needs to be preserved for informational or control purposes. The most common contra accounts are allowance for doubtful accounts and accumulated depreciation. c. Internal control comprises the methods that a company uses to provide physical security and management control over its assets. d. Control accounts are those supported by lists or “subsidiary ledgers” that contain details, thus the control account and the detailed lists provide a check on each other. Examples are accounts receivable (which should agree with the list of amounts due from individual customers), cash (which should agree with cash counts and bank records), and sales taxes due (which should agree with amounts determined from sales records and reported on government forms). e. Books of original entry are the journals in which transactions are first recorded. f. Writing off uncollectible accounts is the process of removing from accounts receivable and the allowance for doubtful accounts those receivables that will not be collected, on which the company is giving up and therefore are not worth keeping track of. g. Accounting control means using accounting records to provide checks and documentation for physical assets such as inventories and plant assets, financial assets such as cash and accounts receivable, and various liabilities. Such records provide something for other records to be compared to (see control accounts above).
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Solution Outline for Problem 7.30 1:d; 2:h; 3:g; 4:b; 5:f; 6:j; 7:c; 8:i; 9:a; 10:e Solution Outline for Problem 7.31 a. Disagree. Although HST is collected and submitted to the government, there is a legal obligation to submit the amount due to the government. A company collects it from it’s customers as an “agent of the crown.” b. Disagree. The system of internal control is the responsibility of the company’s management. Typically, it is the accountant which designs and monitors the system, but ultimate responsibility lies with management. c. Disagree. Such an event should be recorded, but there is always room for error or deliberate failure to record, and some enterprises may have CD bookkeeping systems that define transactions a little differently (e.g. recording only cash transactions). d. Disagree. E-Commerce transactions typically occur through credit card sales in which a company would debit accounts receivable and credit revenues. This meets the definition of a transaction in which an exchange of goods is transacted with a promise to pay. The evidence is noted by electronic transfers. e. Agree. The “perpetual” method provides an accounting record against which physical counts may be checked, whereas the “periodic” method does not. f. Disagree. A properly designed control system should make such theft very difficult and should make detection very likely (so as to discourage employees from even thinking about it), but nothing will ever prevent dishonest, desperate or clever people from stealing, and it might not be worthwhile to have such an elaborate control system as to try to prevent any theft at all. Solution Outline for Problem 7.32 a)
b)
c)
The responsibilities for internal control and profitability are connected. A good system of internal control contributes to an efficiently run corporation which in turn contributes to profitability. The cost of the internal control system must be compared to the benefits. For example, it would not be worth spending $5,000 to implement extensive controls over a $1,000 inventory of office supplies. This $5,000 would be better spent elsewhere, for example on new equipment to generate more revenue and to increase the return to the shareholders. The double-entry system helps identify transactions that were not recorded properly. If the trial balance does not balance, perhaps one side of a transaction was not recorded. The double-entry system helps to maintain an accurate set of accounting records, which is an important component of a good internal control system. Documents support the credibility of financial accounting information by making it verifiable. Sometimes accountants are accused of pulling numbers out of the air. However, if there is a sales invoice or a packing slip, etc. it can be verified that the transaction took place and that the dollar value of the transaction was recorded correctly.
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Financial Accounting: An Integrated Approach, Sixth Edition d)
e)
The more effort that goes into recording initial transactions, the fewer adjustments there are required to meet the objectives of accrual accounting. Some small companies have very simple manual accounting records which simply copy the transactions as they appear on the bank statement. In this case, adjustments will be required for cheques which have been written but have not cleared the bank, and deposits which have been made which have not cleared the bank. A company which records cheques as they are written and sales as they are received would not have to make these adjustments. Since adjustments are required for accruals that the accounting system doesn’t do routinely, the more transactions that the system routinely records, the fewer adjustment there are to be made. Payroll and sales taxes collected on behalf of government are liabilities of enterprises. These liability accounts are control accounts that tell the enterprise at a given time, how much is owing to the government. The control accounts include taxes collected less any remittances made.
Solution Outline for Problem 7.33 Some examples: • Sales records are also records of the additions to cash for cash sales and to accounts receivable for credit sales, as well as to sales taxes due for all sales. • If a retail inventory control method is used, sales records also connect to inventory records directly. If not, sales records still provide evidence about reductions in inventory quantities that can be combined with cost information to determine reductions in the inventory asset. • Employment records provide control information for wages expense and employee deductions due, plus the employer’s share of any amounts due (for fringe benefits). • Cash collection records provide control information for additions to cash on hand and reductions in accounts receivable. • Accounts payable records provide control information for additions to inventories (among other accounts). • Cash payment records provide control information for deductions from cash on hand, accounts payable, employee deductions and fringe benefits due, and sales taxes due. Solution Outline for Problem 7.34 1. For physical assets, the asset control account is supported by a list of assets owned and their costs, which can be checked periodically. There are no internal control reasons to maintain separate accounts for intangible and the amortization is deducted from the asset cost account. 2. Having an allowance contra account leaves the accounts receivable control account alone. The company may be able to collect on the accounts and therefore doesn’t want to alter the accounts receivable amount. 3. The perpetual inventory approach provides better control, but costs more than the periodic method. If the benefit from reduced losses is less than the cost of the system, companies may choose to continue with the cheaper periodic method. 4. The company is able to deduct the GST paid on purchases from its GST liability. The company effectively pays GST on the net difference between its purchase price and its selling price. 5. The use of a contra account for the decline in market value of short-term investments is appropriate if the company wishes to maintain the original cost as a control. The company may also find that the market value of the short term investments may subsequently increase so the write-down may be temporary.
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Instructor’s Solution Manual Solution Outline for Problem 7.35
1. Pro: disclosing all contra accounts •
provides various kinds of information to the readers of the statements, including information about management’s control performance • informs the reader of the historical cost of assets and liabilities Pro: disclosing no contra accounts • may provide undesirable information to competitors • reduces balance sheet clutter and information overload • many contra accounts are useful for internal control purposes and for managing accruals, but provide no useful information to readers
2. Pro: considering sales taxes as company expenses • •
• • •
company has some discretion in how sales tax is presented to customers, especially with GST such taxes doubtless are a cost of doing business, affecting customers’ willingness/ability to buy disclosing the total tax collected as an expense might be informative to readers some companies do disclose similar taxes (e.g. liquor taxes charged to breweries, wineries, etc.) such taxes are not really all that different from others that are considered expenses, such as corporate income tax and property taxes
Solution Outline for Problem 7.36 a. b. c. d.
DR Bad debts expense 2,800 CR Allowance for doubtful accounts DR Amortization expense 7,200 CR Accumulated amort. DR GST due 420 CR Inventory DR Employee tax CR Wages expense deductions due 39,650 e. If an allowance for doubtful accounts exists: DR Allowance for doubtful CR Accounts receivable accounts 235 Direct write-off if there is no allowance: DR Bad debts expense 235 CR Accounts receivable f. DR Cash 14,200 CR Machine cost DR Accumulated amortization 52,900 DR Loss on disposal 5,500 g. DR Inventory shortage expense 4,620 CR Inventory asset h. DR Insurance claim receivable 10,000 CR Accounts receivable DR Loss from employee theft 25,000 i. DR Accumulated amortization 63,000 CR Storage shed cost DR Loss from storm 26,000 j. No adjustment is needed.
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2,800 7,200 420 39,650
235
235 72,600
4,620 35,000 89,000
Financial Accounting: An Integrated Approach, Sixth Edition Solution Outline for Problem 7.37 a. DR Amortization expense CR Goodwill
23,500 23,500
b. DR CR DR CR
Development cost asset [1/2 x 380,000] Development cost expense Amortization expense Development cost asset [1/5 x (185,000 + 190,000)]
c. DR CR DR CR
Accounts receivable Cost [38,650 + 73,250] Accumulated amortization Gain on sale [45,000 – 35,650]
190,000 190,000 75,000 75,000 45,000 119,900 73,250 6,350
d. No entry e. DR CR DR CR f.
Cash Cost Accumulated amortization Gain [320,000 – (300,000 – 40,000)]
320,000 300,000 40,000 60,000
DR Accounts receivable CR Inventory
20,000 20,000
g. If a previous liability for the fringe benefits had not been set up, the entry is correct. For clarification, the original entry would have been: DR Wages expense 93,210 CR Cash 93,210 If a previous liability for the fringe benefits had been set up, the entry is incorrect and the adjustment would be: DR Fringe benefits liability 93,210 CR Wages expense 93,210 h. To record the cash remitted to the government the following entry s necessary. This assumes that the GST due control account was properly updated at the time the purchases and sales were recorded. DR GST Due 31,120 CR Cash 31,120 i.
j.
DR Loss on unusable land CR Land DR CR OR DR DR CR
236,640 236,640
Bad debt expense Allowance [1/2 x 69,800 – 6,980]
27,920
Allowance Bad debt expense Accounts receivable [69,800 – 6,980]
34,900 27,920
27,920
62,820
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Instructor’s Solution Manual Solution Outline for Problem 7.38 Entries to correct what CDkeeper did: (a) DR Revenue CR Share capital
50,000
(b) DR Truck asset
23,000
CR
Effect of correction on income: - 50,000 50,000
Noncurrent bank loan ($38,000 - $15,000)
none 23,000
(c) Entry was right but have to correct for truck DR CR
Amortization expense Accumulated amortization (10% x entry #(b))
(d) First reverse the backwards cash entry DR Cash CR Imbalance revenue Next record the sale properly DR Cash CR Machinery cost DR Accumulated amortization DR Loss on sale
(e) DR Wages payable CR
- 2,300 2,300
200 200
+ 200
200 2,100 1,660 240
- 240
78,200
Income tax expense
(f) DR Inventory shortage exp. CR
2,300
78,200 2,700
Inventory ($6,400 - $3,700)
+ 78,200 - 2,700
2,700
(g) CDkeeper’s entry was correct (h) DR Bad debts expense CR CR
(i) DR Revenue CR
Dividend expense Retained earnings Dividend payable
- 640 405 235
400
Customer deposits liability
(j) DR Retained earnings CR DR CR
640
($320 + $405 - $85) Allowance for doubtful accts Accounts receivable ($320 - $85)
- 400 400
5,000 5,000
+ 5,000
5,000 5,000 net total - 27,120
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Financial Accounting: An Integrated Approach, Sixth Edition
(k) This was an incorrect closing entry. It should first be eliminated: DR Retained earnings 52,340 CR Cash 52,340 Then the correct income should be recorded by closing out all revenue + expense accounts. Corrected income is $79,460 ($52,340 - $27,120). This would be CR to retained earnings as part of the closing entry. Solution Outline for Problem 7.39 Income tax effects are ignored in each answer below. a. Income increased by $18,000 gain on sale ($28,000 – $10,000 book value). b. Income decreased by the direct write-off of $2,800. c. Income decreased by the $350,000 book value written off. d. Income decreased by $152,000 shortage expense ($2,850,000 – $2,698,000). e. Income decreased by $8,000 book value written off ($37,000 – $29,000). f. No effect on income. g. Income decreased by $4,000 loss on sale ($6,000 – $10,000 book value). h. Income increased by $350,000 for capitalized portion. i. Income decreased by $129,000 ($110,000 + $19,000). Deductions are irrelevant. j. No effect on income, and $2,000 remains on A/R. Solution Outline for Problem 7.40
a. b. c. d. e. f. g.
CA nil down 6,800 up 179,000 down 149,000 nil down 28,000 down 4,200
NCA nil nil down 252,000 nil nil nil nil
Income nil down 6,800 down 73,000 down 149,000 nil down 28,000 nil
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(746,400 – 739,600) (BV=252,000; Loss=73,000) (BV=0) (58,000 – 30,000) (Inv. up $60K, cash down $64.2K; GST is in liabilities)
Instructor’s Solution Manual Solution Outline for Problem 7.41 Account change Probable reason • Accounts receivable down Write-off of uncollectible • Allowance up Additional doubtful accounts • Inventory down Inventory shortage • Prepaid expense down Expired Prepaid expenses • Factory down Write-off of assets • Accum. amort. down Write-off of assets • Investments down Write-off or write-down • Accounts payable up Additional expenses billed • Accrued liabilities up Additional expenses estimated • Wages and deductions payable up Additional wages accrued • Income tax payable up Estimated tax on income • Deferred income tax liability up Estimated long-term tax • Warranty liability up Worse warranty experience • Retained earnings up Revenues and expensed closed • Net effect of the adjustments • Using the unadjusted accounts, the deduced retained earnings = 62,700. That minus 42,900 = 19,800, the adjusted retained earnings.
Effect on income -4,500 - 1,500 (1) - 6,400 + 700 -3,000 - 2,800 (2) - 10,500 - 3,400 - 1,300 - 2,900 - 8,600 - 2,200 + 700 - 42,900
(1) Accounts receivable decreased $4,500 due to the write-off of uncollectible amounts, so the allowance would have decrease by the same $4,500. Since the allowance has in fact increased by $1,500, the amount of additional doubtful accounts would be $6,000 ($1,500 + $4,500). Proof: Beg 6,400 – 4,500 + 6,000 = 7,900 ending. (2) The factory decreased $3,000 and accum. amort. Decreased $2,800. The net effect on income is the difference between the cost change and the accum. amort change, or $200. Solution outline for Problem 7.42
Cases
Sales Revenue
Beginning Inventory
Purchases
Total Available
Ending Inventory
A B C D E
$850 900 800 1,200 950
$150 125 325 200 100
$800 750 650 900 650
$950 875 975 1,100 750
$200 100 250 325 75
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Cost of Goods Sold $750 775 725 775 675
Gross Profit
Expenses
$100 125 75 425 275
$25 50 125 150 150
Pretax Income Or (Loss) $75 75 (50) 275 125
Financial Accounting: An Integrated Approach, Sixth Edition Solution Outline for Case 7A The case features two rather different organizations, with Tiffany’s role also being rather different in each. Mountain Crest is a profit-seeking company, smaller than the usual public companies considered in the text, and Tiffany is a new employee well down the hierarchy but with the job of reviewing the company’s internal control and suggesting improvements. Earth Friends is a not-for-profit interest group raising funds to meet its social objectives, and Tiffany is a senior member of the group, being on the board of directors and now president. Both organizations are people-oriented. Mountain Crest encourages employees to make client service their top priority, expecting employees to do whatever is helpful to customers and, not incidentally, increasing sales thereby. Earth Friends depends on volunteers for all its activities, only recently paying some part-time people for their time. Neither organization would want accounting and control procedures to interfere with its operation and apparent success, but both do have significant internal control weaknesses that are potentially troublesome. Some practical constraints on internal control solutions: • Neither organization is large and so neither can afford sophisticated control systems. • Both organizations’ success is based on a particular human resources strategy that should be maintained in any control improvements. • The very nature of the organizations’ operations (maybe especially Earth Friends’) constitutes a “control problem” and so any solutions have to balance this against any specific costs and benefits of better control. Some internal control weaknesses (students’ discussion should elaborate these and raise others, and note that some are strategic strengths in spite of associated control weakness): Mountain Crest • Inventory control – many parts, some old – obsolescence/deterioration risk • Many people have access to the parts room • Keeping track of general returned goods and the refunds associated with them • Keeping track of returns of originally-bulk products (would be in broken lots) • Ensuring restocking fees are properly charged and received & goods not defective • Many people have access to the trucks (misuse, gas consumption, insurance, etc.) • Many people can make sales deals • Credit sales and related credit checks • Segregation of duties on customer service: single employee can do an order, retrieve parts, do invoicing and delivery • Risk of being involved in illegal activity (pot growing) Earth Friends • Donations received in pails (someone could steal the money from the pails) • Donations pledged (numerous people don’t honour their pledges, so someone could steal donations received and claim that the pledge hadn’t been honoured) • Expense reimbursements (how to ensure the funds had been properly spent) • Keeping close enough track of receipts and expenditures to assure accountability to donors and agencies • Reliance on part-time people and volunteers means many people may get access to cash and/or records
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Instructor’s Solution Manual Some specifics the accounting and control procedures will have to deal with: • Cost-benefit (e.g. a perpetual inventory control system would be an attractive idea for Mountain Crest but likely would be too expensive, unless there is some off-the-shelf system that could be bought and used for at least the main inventory items; and controlling donations at the point of receipt would be useful for Earth Friends but the cost of trying to do that when people are throwing money into pails would be considerable, and might reduce the volume of donations as well as the motivation of volunteers if they felt they were not trusted). • Mountain Crest’s policy of taking back products sold earlier. • Mountain Crest’s approval of credit. • Mountain Crest’s use of restocking fees (probably these are highly discretionary). • Mountain Crest might benefit from better information for management than the present rather informal system provides (though senior management is probably quite hands-on). • Mountain Crest has a particular control problem for all the one-of-a-kind and old products that could get lost or become unnecessary. • Tiffany’s formal responsibility as president of Earth Friends gives her a more serious role and more serious potential liability and responsibility if controls are inadequate and problems occur. • Earth Friends has different control problems for donations receipts, pledges, and grants applied for or received. • Earth Friends also has to have a good system for membership records and fees. • Earth Friends might benefit from good records of volunteer time and contribution – making sure that volunteers feel their work is worthwhile and recognized is likely to be important, especially as the organization grows as it seems to be. Solution Outline for Case 7B The case provides a number of ideas for discussion, and suggests placing the discussion in the context of a specific interesting company. While some such companies may be suggested from the textCD (Tyco, Enron, WorldCom, et al., or more positively CPR, Tyson or Petro-Canada), it is likely that the particular company will arise from the instructor’s interest or another company used in the course. Here are some very general ideas for structuring the discussion: 1. Start with the general points in the case’s preamble: a. Top management needs a strategy for internal control b. Part of control and satisfying others involves producing a reasonable return for owners and satisfying creditors c. Role of an internal ethical culture d. Top management does have the final responsibility 2. Discuss points made in the various remarks in the case (some of which are intended to provoke disagreement and allow some exploration if the instructor wishes), using examples from the media or from the textCD’s FYI and other items; a. Return maximization all that matters? b. Buccaneer culture the main problem, not accounting manipulation? c. Don’t restrain the entrepreneur d. Moral failure at the top e. Charisma overstated, dull managers (and control) understated f. Lack of control leads to lack of confidence by others g. Individual managers have a choice to behave or not h. Individual managers really don’t have a choice – trapped in a culture created by others i. It’s all a matter of incentives (e.g. not ethics or morals)
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Financial Accounting: An Integrated Approach, Sixth Edition
3. Make some points from textCD sections 7.3 and 7.4, related to the above points or to the company chosen as the example: a. Review CPR’s “management responsibility for financial reporting” statement in section 7.4 (or the chosen company’s equivalent statement) b. Discuss other aspects of internal control not included in that statement, such as the 9 “main components of internal control” listed in section 7.3 4. The instructor should enjoy bringing in his/her own perspective on these issues
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