PAGES 239-242

Exercise 1
The following misstatements are sometimes found in the sales and collection cycle’s
account balances:

a. Cash received from collections of accounts receivable in the subsequent period

is recorded as current period receipts.
b. The allowance for uncollectible accounts is inadequate because of the client’s
failure to reflect depressed economic conditions in the allowance.
c. Several accounts receivable are in dispute as a result of claims of defective
merchandise.
d. The pledging of accounts receivable to the bank for a loan is not disclosed in the
financial statements.
e. Goods shipped and included in the current period sales were returned in the
subsequent period.
f. Several accounts receivable in the accounts receivable master file are not
included in the aged trial balance.
g. One account receivable in the accounts receivable master file is included on the
aged trial balance twice.
h. Long-term interest-bearing notes receivable from affiliated companies are
included in accounts receivable.
i. The trial balance total does not equal the amount in the general ledger.

Required: For each misstatement, list an internal control that should prevent it.

Exercise 2
You have been asked by the board of trustees of a local church to review its accounting
procedures. As a part of this review you have prepared the following comments about
the collections made at weekly services and record keeping for members’ pledges and
contributions.

a. The church’s board of trustees has delegated responsibility for financial

management and audit of the financial records to the finance committee. This
 group prepares the annual budget and approves major disbursements but is not
involved in collections or record keeping. No audit has been considered
necessary in recent years because the same trusted employee has kept church
records and served as financial secretary for 15 years.
b. The collection at the weekly service is taken by a team of ushers. The head
usher counts the collection in the church following each service. He then places
the collection and a notation of the amount counted in the church safe. The next
morning, the financial secretary opens the safe and recounts the collection. She
withholds about P1,000 to meet cash expenditures during the coming week and
deposits the remainder intact. To facilitate the deposit, members who contribute
by check are asked to draw their checks to cash.
c. At their request, a few members are furnished prenumbered predated envelopes
in which to insert their weekly contributions. The head usher removes the cash
from the envelopes to be counted with the loose cash included in the collection
and discards the envelopes. No record is maintained of issuance or return of the
envelopes, and the envelope system is not encouraged.
d. Each member is asked to prepare a contribution pledge card annually. The
pledge is regarded as a moral commitment by the member to contribute a stated
weekly amount. Based on the amounts shown on the pledge cards, the financial
secretary furnishes a letter to members, upon request, to support tax deductibility
of their contributions.

Required:

Identify the weakness and recommend improvements in procedures for collections

made at weekly services and record keeping for members’ pledges and contributions.

Exercise 3
For each of the following misstatements in property, plants, and equipment accounts,
state an internal control that the client can implement to prevent the misstatement from
occurring.
 1. The asset lives used to depreciate equipment are less than reasonable, expected
useful lives.
2. Capitalizable assets are routinely expensed as repairs and maintenance,
perishable tools, or supplies expense.
3. Construction equipment that is abandoned or traded for replacement equipment
is not removed from the accounting records.
4. Depreciation expense for manufacturing operations is charged to administrative
expenses.
5. Tools necessary for the maintenance of equipment are stolen by company
employees for their personal use.
6. Acquisitions of property are recorded at incorrect amounts.
7. A loan against existing equipment is not recorded in the accounting records. The
cash receipts from the loan never reached the company because they were used
for the down payment on a piece of equipment now being used as an operating
asset. The equipment is also not recorded in the records.

Exercise 4
The following types of internal controls are commonly used by organizations for property,
plant, and equipment:

1. A fixed asset master file is maintained with a separate record for each fixed asset.
2. Written policies exist and are known by accounting personnel to differentiate
between capitalizable additions, freight, installation costs, replacements, and
maintenance expenditures.
3. Acquisitions of fixed assets in excess of $20,000 are approved by the board of
directors.
4. When practical, equipment is labeled with metal tags and is inventoried on a
systematic basis.
5. Depreciation charges for individual assets are calculated for each asset; recorded
in a fixed asset master file that includes cost, depreciation, and accumulated
depreciation for each asset; and verified periodically by an independent clerk.

Required:
State the purpose of each of the internal controls just listed. Your answer should be in the
form of the type of misstatement that is likely to be reduced because of the control.

PAGES 260-261
Exercise 1
The auditor has always received good cooperation from a particular client and has no
reason to question management's integrity. The controller has requested that the
auditor inform her about which warehouse locations that the auditor will visit during the
upcoming inventory count. In addition, the controller has requested copies of the
auditor's observations on the physical inventory because she wants to make sure that a
good inventory was taken. Should the auditor comply with these requests? State your
rationale, including a discussion of professional skepticism.

Exercise 2
Using the following categories, define the purpose of each of the common controls over
cash listed below. You may use multiple categories for each control.

Categories of Purpose of each Common Control

1. To prevent theft of cash.

2. To ensure complete recording of cash.
3. To prevent modification of the recording of cash.
4. To detect inaccuracy of ending cash balance or misstatement therein.
5. To ensure that all items are uniquely identified and that an adequate audit trail
exists for transactions.
6. To serve as a deterrent for fraud.

Common Controls Over Cash

a. Segregation of duties.
b. Restrictive endorsements of customer checks.
c. Independent bank reconciliations by employees who do not handle cash.
d. Computerized controls totals and edit tests.
e. Authorization of transactions.
 f. Prenumbered cash receipts documents and turn around documents.
g. Periodic internal audits.
h. Competent, well-trained employees.

PAGES 228-230
Exercise 1
The fraud triangle asserts that the following three factors must exist for a person to
commit fraud:

A. Opportunity B. Pressure C. Rationalization

Identify the fraud risk factor (A, B, or C) in each of the following situations:

1. The business has no cameras or security devices at its warehouse.

2. Managers are expected to grow business or be fired.
3. A worker sees other employees regularly take inventory for personal use.
4. No one matches the cash in the register to receipts when shifts end.
5. Officers are expected to show rising income or risk dismissal.
6. A worker feels that fellow employees are not honest.

Exercise 2
Each of the following scenarios is based on facts in an actual fraud. Categorize each
scenario as primarily indicating (1) an incentive to commit fraud, (2) an opportunity to
commit fraud, or (3) a rationalization for committing fraud. Also state your reasoning for
each scenario.

a. There was intense pressure to keep the corporation’s stock from declining
further. This pressure came from investors, analysis, and the CEO, whose
financial well-being was significantly dependent on the corporation’s stock price.
b. A group of top-level management was compensated (mostly in the form of stock
options) well in excess of what would be considered normal for their positions in
this industry.
 c. Top management of the company closely guards internal financial information, to
the extent that even some employers on a need-to-know basis are denied full
access.
d. Managing specific financial ratios is very important to the company and both
management and analysis are keenly observant of variability in key ratios. Key
ratios for the company changed very little even though the ratios for the overall
industry were quite volatile during the time period.
e. In an effort to reduce certain accrued expenses to meet budget targets, the CEO
directs the general accounting department to reallocate a division’s expenses by
a significant amount. The general accounting department refuses to acquiesce to
the request, but the journal entry is made through the corporate office. An
accountant in the general accounting department is uncomfortable with the
journal entries required to reallocate divisional expenses. He brings his concerns
to the CFO, who assures him that everything will be fine and that the entries are
necessary. The accountant considers resigning, but he does not have another
job lined up and is worried about supporting his family. Therefore, he never
voices his concerns to either the internal or external auditors.
f. Accounting records were either nonexistent or in a state of such disorganization
that significant effort was required to locate or compile them.

Exercise 3
A competent auditor has done a conscientious job of conducting an audit, but because
of a clever fraud by management, a material fraud is included in the financial
statements. The fraud, which is an overstatement of inventory, took place over several
years, and it covered up the fact that the company’s financial position was rapidly
declining. The fraud was accidentally discovered in the latest audit by an unusually
capable audit senior, and the SEC was immediately informed. Subsequent investigation
indicated that the company was actually near bankruptcy, and the value of the stock
dropped from P260 per share to P10 in less than one month. Among the losing
stockholders were pension funds, university endowment funds, retired couples, and
widows. The individuals responsible for perpetrating the fraud were also bankrupt.
After making extensive investigation of the audit performance on previous years, the
SEC was satisfied that the auditor had done a high-quality audit and had followed
generally accepted auditing standards in every respect. The commission concluded that
it would be unreasonable to expect auditors to uncover this type of fraud.

Required:

State your opinion as to who should bear the loss of the fraudulent financial reporting.
Include in your discussion a list of your potential bearers of the loss, and state why you
believe they should or not should bear the loss.

PAGES 212-216
Exercise 1
Each of the following internal controls has been taken from a standard internal control
questionnaire for assessing control risk in the payroll and personnel cycle.

1. Approval of department head or foreman on time records is required before

preparing payroll.
2. All prenumbered time records are accounted for before beginning data entry for
preparation of checks.
3. The payroll accounting software application will not accept data input for an
employee number not contained in the employee master file.
4. Persons preparing the payroll do not perform other payroll duties (e.g.
timekeeping or distribution of checks) nor do they have access to payroll data
master files or cash.
5. The computer calculates gross and net pay based on hours inputted and
information in employee master files, and payroll accounting personnel double-
check the mathematical accuracy on a test basis.
6. All voided and spoiled payroll checks are properly mutilated and retained.
7. Personnel require an investigation of an employment application from new
employees. Investigation includes checking the employee's background, former
employers, and references.
 8. Written termination notices, with properly documented reasons for termination,
and approval by an appropriate official are required.
9. All checks and notices of electronic payments not distributed to employees are
returned to the treasurer for safekeeping and follow-up.
10.  On-line ability to add employees or change pay rates to the payroll master file is
restricted via passwords to authorized human resource personnel.

Required:

a. For each internal control, identify a specific misstatement that is likely to be

prevented if the control exists and is effective.
b. For each control, list a specific misstatement that could result from the absence
of the control.
c. For each control, identify one audit test that the auditor could use to uncover
misstatements resulting from the absence of the control.

Exercise 2
The division of the following is meant to provide the best possible controls for the
Meridian Paint Company, a small wholesale store.

1. Assemble supporting documents for general and payroll cash disbursements. +

2. Sign general cash disbursement checks. +
3. Input information to prepare checks for signature, record checks in the cash
disbursement journal, and update the appropriate master files. +
4. Mail checks to suppliers and deliver checks to employees. +
5. Cancel supporting documents to prevent their reuse. +
6. Approve credit for customers included in the customer credit master file. +
7. Input shipping and billing information to bill customers, record invoices in the
sales journal, and update the accounts receivable master file. +
8. Open the mail and prepare a prelisting of cash receipts. +
9. Enter cash receipts data to prepare the cash receipts journal and update the
accounts receivable master file. +
10. Prepare daily cash deposits. +
 11. Deliver daily cash deposit to the bank. +
12. Assemble the payroll time cards and input the data to prepare payroll checks and
update the payroll journal and payroll master files. +
13. Sign payroll checks. +
14. Update the general ledger at the end of each month and review all accounts for
unexpected balances.
15. Reconcile the accounts receivable master file with control account and review
accounts outstanding more than 90 days.
16. Prepare monthly statements for customers by printing the accounts receivable
master file; then mail the statements to customers.
17. Reconcile the monthly statements from vendors with the accounts payable
master file.
18. Reconcile the bank account.

Required:

You are to divide the accounting-related duties 1 through 18 among Robert Cruz,
James Santos and Bill Reyes. All of the responsibilities marked with a cross (+) are
assumed to take about the same amount of time and must be divided equally between
Robert and James. Both employees are equally competent. Bill, who is president of the
company, is not willing to perform any functions designated by a dagger and will
perform only a maximum of two of the other functions.

Exercise 3
Recently, while eating lunch with your family at a local cafeteria, you observe a practice
that is somewhat unusual. As you reach the end of the cafeteria line, an adding
machine operator asks how many persons are in your party. He then totals the food
purchases on the trays for all your family and writes the number of persons included in
the group on the adding machine tape. He hands you the tape and asks you to pay
when you finish eating. Near the end of the meal, you decide you want a piece of pie
and coffee so you return to the line, select your food, and again go through the line. The
adding machine operator goes through the same procedures, but this time he staples
the second tape to the original and returns it to you.
When you leave the cafeteria, you hand the stapled adding machine tapes to the cash
register operator who totals the two tapes, takes your money and puts the tapes on a
spindle.

Required:

a. What internal controls has the cafeteria instituted for its operations?
b. How can the manager of the cafeteria evaluate the effectiveness of the controls?
c. How do these controls differ from those used by most cafeterias?
d. What are the costs and benefits of the cafeteria’s system?

Exercise 4
The following are partial descriptions of internal controls for companies engaged in the
manufacturing business:

1. When Mr. Clark orders materials, he sends a duplicate purchase order to the
receiving department. During the delivery of materials, Mr. Smith, the receiving
clerk, records the receipt of shipment on this purchase order and then sends the
purchase order to the accounting department, where it is used to record
materials purchased and accounts payable. The materials are transported to the
storage area by forklifts. The additional purchased quantities are recorded on
storage records.
2. Every day, hundreds of employees clock in using time cards at Generous Motors
Corporation. The timekeepers collect these cards once a week and deliver them
to the computer department, which handles data entry. There, the data on these
time cards are entered into the computer. The information entered is used in the
preparation of the labor cost distribution records, the payroll journal, and the
payroll checks. The treasurer, Mrs. Wan, compares the payroll journal with the
payroll checks, signs the checks, and returns them to Mr. Santos, the supervisor
of the computer department. The payroll checks are distributed to the employees
by Mr. Santos.
3. The smallest branch of Super Fresh Cosmetics in Iloilo City employs Mary
Santos, the branch manager, and her sales assistant, Jane Reyes. The branch
 uses a bank account to pay expenses. The account is kept in the name of “Super
Fresh Cosmetics—Special Account”. To pay expenses, checks must be signed
by Mary Santos or by the treasurer of Super Fresh Cosmetics, Juan Dy. Mary
receives the cancelled checks and bank statements. She reconciles the branch
account herself and files cancelled checks and bank statements in her records.
She also periodically prepares reports of cash disbursements and sends them to
the home office.

Required:

a. List the weaknesses in internal control for each of the above.

b. For each weakness, state the type(s) of misstatement(s) that is (are) likely to
result. Be specific as possible.
c. How would you improve internal controls for each of the three companies?

Exercise 5
The Art Appreciation Society operates a museum for the benefit and enjoyment of the
community.

When the museum is open to the public, two clerks who are positioned at the entrance
collects a P50.00 admission fee from each non-member patron. Members of the Art
Appreciation Society are permitted to enter free upon presentation of their membership
cards.

At the end of each day, one of the clerks delivers the proceeds to the treasurer. The
treasurer counts the cash in the presence of the clerk and places the cash in a safe.
Each Friday afternoon, the treasurer and one of the clerks deliver all of the cash in the
safe to the bank and receive an authenticated deposit slip that provides the basis for the
weekly entry in the accounting records.

The Art Appreciation Society board of directors has identified a need to improve its
internal controls over cash admission fees. The board has determined that the cost of
installing turnstiles, sales booths, or otherwise altering the physical layout of the
museum will greatly exceed any benefits.
However, the board has agreed that the sale of admission tickets must be an integral
part of its improvement efforts.

Amparo Cruz has been asked by the board of directors of the Art Appreciation Society
to review the internal control over cash admission fees and provide suggestions for
improvements.

Required:

Indicate weakness in the existing internal controls over cash admission fees that
Amparo Cruz should identify, and recommend one improvement for each of the
weakness identified. Use the following illustrative example below:

WEAKNESS RECOMMENDATION
1. There is no basis for establishing the Prenumbered admission tickets should be
documentation of the number of paying issued upon payment of the admission fee.
patrons.