Accounting Review Exam 2

A company makes A deferral adjustment that increases a revenue account. This must mean what other types of account is affected? Page 153 ---each deferral adjustment involves 1 asset ad 1 expense or 1 liability and 1 revenue account

(if ya know please msg me)

five common principles of internal control

1. Establish Responsibility 2. Segregate Duties 3. Restrict Access 4. Document Procedures 5. Independently Verify

What is a Bank Reconciliation?

A bank reconciliation involves comparing the company's records to the bank's statement of account to determine whether they agree. The company's records can differ from the bank's records for two basic reasons: (1) the company has recorded items the bank doesn't know about at the time it prepares the statement of account or (2) the bank has recorded items the company doesn't know about until the bank statement is examined.

Step 1 in preparing a bank reconciliation Identify the deposits in transit.

A comparison of WMT's recorded deposits with those on the bank statement revealed WMT made a deposit of $1,800 on June 30 that was not listed on the bank statement. More than likely, the bank will process this deposit the next business day (July 1). WMT doesn't have to change its records for this item because it already was recorded in WMT's books on June 30. It is simply a timing difference, so WMT entered the amount on the bank reconciliation as an addition to update the bank's records.

Step 2 in preparing a bank reconciliation Identify the outstanding checks.

A comparison of the checks listed on the bank statement with the company's record of written checks showed checks numbered 103 and 105 were still outstanding at the end of June (that is, they had not cleared the bank). They were entered on the reconciliation (in Exhibit 5.9) as a deduction from the bank balance because the bank will eventually reduce the account balance when these checks clear the bank. (WMT had already deducted Checks 103 and 105, so WMT does not change its cash records.)

2 key things about accrual Adjustments

Accrual adjustments are used to record revenue or expenses when they occur prior to receiving or paying cash and to adjust corresponding balance sheet accounts. Each accrual adjustment involves one asset and one revenue account, or one liability and one expense account. Notice that this differs from deferral adjustments, which pair assets with expenses and liabilities with revenues. The right side of Exhibit 4.1 shows a partial list of accounts that require accrual adjustments.

The purpose of adjusting entries -page 152

Adjustments involve both income statement and balance sheet accounts. They are needed to ensure Revenues are recorded when (or as) the seller fulfills its performance obligation to the customer (the revenue recognition principle). Expenses are recorded in the same period as the revenues to which they relate (the expense recognition or "matching" principle). Assets are reported at amounts representing economic benefits that remain at the end of the current period. Liabilities are reported at amounts owed at the end of the current period that will require a future sacrifice of resources.

What is the purpose of adjustments? Why are they needed? Page 152 and 173

Adjustments- Entries necessary at the end of each accounting period to report revenues and expenses in the proper period and assets and liabilities at appropriate amounts. Aka as adjusting Journal Entires

Which are key requirements of the Sarbane-Oxley Act? Encourage honesty.

Admittedly, it's difficult for any law to achieve this, but some parts of SOX help honest employees confront those inclined to rationalize and conceal fraud. For example, public companies must have tip lines that allow employees to secretly submit concerns about questionable accounting or auditing practices. These whistleblower tips are the most common means for detecting fraud, according to the 2016 report referenced in Exhibit 5.1. SOX grants legal protection to whistleblowers so they aren't retaliated against by those charged with fraud. If you tattle on your boss for submitting a fraudulent expense claim, you can't be fired for it. Finally, companies are required to adopt a code of ethics for their senior financial officers. Google begins its code with "Don't be evil" and then explains what this means in plain English.

When is a check that you have written considered to have cleared the bank? page 227

After a check is written, the payee (to whom the check is written) either gives the check or sends a digital image of it to a financial institution for deposit. That financial institution contacts the check writer's bank, which in turn withdraws the amount of the check from the check writer's account and reports it as a deduction on the bank statement. The check is then said to have cleared the bank.

What is the Internal method of control? Information and communication

An effective internal control system generates and communicates information about activities affecting the organization to support sound decision making.

One of the three types of fraud is Asset misappropriation. What is Asset misappropriation?

Asset misappropriation is, quite simply, theft (embezzlement). Cash is usually the target, but other assets can be misappropriated. A vice president of product development at Tiffany & Co. admitted to stealing and reselling $1.3 million of jewelry that belonged to her employer. The company discovered the pieces missing when counting its inventory.

What is the report called that is used to verify the accuracy of both the bank statement and the cash account? page 228/229

Bank Reconciliation

When are adjusting entries typically prepared? Page 152

Companies wait until the end of the accounting period to adjust their accounts because daily adjustments would be time-consuming and costly. In practice, almost every financial statement account could require adjustment. Rather than memorize endless examples, instead focus on learning the nature of adjustments and the process for determining them. In general, adjustments can be grouped into two categories: (1) deferrals and (2) accruals.

What is the Internal method of control? Control activities.

Control activities include various work responsibilities and duties completed by employees to reduce risks to an acceptable level.

One of the three types of fraud is Corruption. What is Corruption ?

Corruption involves misusing one's position for inappropriate personal gain. A former mayor of Detroit was sentenced to 28 years in federal prison for corruption after he accepted payments from people seeking to do business with the city (bribery) and awarded contracts to a friend who redirected money to him (kickbacks).

What is cost of goods sold? page 261

Cost of Goods Sold indicate the total selling price and cost of all goods that the merchandiser did sell to customers during the period. By subtracting Cost of Goods Sold from Sales Revenue, a merchandiser determines its gross profit, which represents the profit earned before taking into account other expenses such as salaries, wages, depreciation, and so on.

2 key things about Deferral Adjustments

Deferral adjustments are used to decrease balance sheet accounts and increase corresponding income statement accounts. Previously deferred amounts exist on the balance sheet because the company paid cash before incurring the expense or received cash before earning revenue. When revenues are generated (as defined by the revenue recognition principle) or expenses incurred (as defined by the expense recognition principle), the previously deferred amounts are adjusted and amounts are transferred to the income statement using a deferral adjustment. Each deferral adjustment involves one asset and one expense account, or one liability and one revenue account. The left side of Exhibit 4.1 shows a partial list of accounts that commonly require deferral adjustments.

How are pre-paid expenses(deferred expenses) treated? Are they an asset or a liability? Income Statement or Balance Sheet? -Page153

Deferral adjustments are used to decrease balance sheet accounts and increase corresponding income statement accounts. Previously deferred amounts exist on the balance sheet because the company paid cash before incurring the expense or received cash before earning revenue. When revenues are generated (as defined by the revenue recognition principle) or expenses incurred (as defined by the expense recognition principle), the previously deferred amounts are adjusted and amounts are transferred to the income statement using a deferral adjustment. Each deferral adjustment involves one asset and one expense account, or one liability and one revenue account. The left side of Exhibit 4.1 shows a partial list of accounts that commonly require deferral adjustments.

A strong system internal(control??) reduces what ? page 216

Effective internal control reduces the risk of asset loss, and helps ensure that plan information is complete and accurate, financial statements are reliable, and the plan's operations are conducted in accordance with the provisions of applicable laws and regulations

Understand the journal entry required to record sales if there is an cash overage or shortage . Page 222

Exhibit 5.5 shows, in boxes 1-3, the cashier uses the cash register and its accompanying point-of-sale accounting system to perform three important functions: (1) document the amount charged for each item sold, (2) restrict access to cash, and (3) document the total cash sales. In documenting each item sold (both on screen and on a paper or e-mailed receipt), the cash register reduces errors by allowing customers to dispute overcharges. By restricting access, the cash register reduces the risk of cash being lost or stolen. By documenting the total cash sales, the cash register provides an independent record of the amount of cash the cashier should have collected and passed on for deposit at the bank. The cashier uses this information when completing a cash count sheet at the end of each shift. The cash count sheet documents the amount of cash the cashier received and determines any cash shortage or overage that occurred during the shift. Exhibit 5.5 also shows, in boxes 4-6, that the supervisor performs important controls such as independently verifying each cashier's count sheet, a copy of which is sent to the accounting department. The supervisor is also responsible for placing the cash in a locked vault until it is taken to the bank for deposit. At that time, a deposit slip listing the amounts included in the deposit is prepared and presented to the bank. After verifying and receiving the funds, the bank employee issues a verified deposit slip, which is then forwarded to the company's accounting department. The accounting department performs two key tasks, shown in boxes 7 and 8 of Exhibit 5.5. It compares the record of cash sales maintained by the cash register with the count sheet prepared by the cashier and the bank deposit slip returned by the bank. This comparison provides independent verification that the amount of cash rung up at the time of sale was deposited into the bank account. Based on this information, a journal entry is prepared to record Sales Revenue at the amount rung up by the cash register and increase the Cash account for the amount deposited in the bank. Any difference between the two amounts is recorded in a Cash Shortage (or Overage) account, which is reported on the income statement as a miscellaneous expense (or revenue). For example, if cashiers rung up sales totaling $6,100 but had only $6,097 to deposit, the following financial statement effects would be recorded with the journal entry that follows.

Memorize the equation for cost of goods sold. page 262 Example. Be able to answer Elm CorporationIs a merchandising company.The year began with an inventory of $xx Purchases for the year were $xx and the Ending Inventory was $xx What is the cost of goods sold that would be reported on the income statement.

Expreses the relationship between inventory on hand, purchased, and sold; BI+P-EI=CGS or BI+P-CGS=EL

Employee fraud is often grouped into three categories. What are they? Page 214

Fraud is generally defined as an attempt to deceive others for personal gain. Employee fraud is often grouped into three categories:

Research has found that three factors exist when fraud occurs. What are they? Page 214/215

Incentive, Opportunity, Rationalization

Step 3 in preparing a bank reconciliation Record other transactions on the bank statement and correct your errors.

Interest received from the bank, $20—entered on the bank reconciliation in Exhibit 5.9 as an addition to the company's books because it's included in the bank balance but not yet in the company's books. Electronic funds transfer received from customer, $100—entered on the bank reconciliation as an addition to the book balance because it's included in the bank balance but not yet in the company's books. NSF check rejected, $18—entered on the bank reconciliation as a deduction from the company's books because it was deducted from the bank statement balance but has not yet been deducted from the company's cash records. Service charges, $6—entered on the bank reconciliation as a deduction from the company's books because it has been deducted from the bank balance but not yet removed from the Cash account in the company's books. Your company errors, $9—after accounting for the items listed above, WMT found the reconciliation was out of balance by $9. Upon checking the journal entries made during the month, WMT discovered Check 104 was recorded in the company's accounts as $56 when, in fact, the check had been filled out for $65 (in payment of Accounts Payable). As Exhibit 5.7 shows, the bank correctly processed the check (on June 30) as $65. To correct its own error, WMT must deduct $9 ($65 − $56) from the company's books side of the bank reconciliation and record a corresponding journal entry (below).

What are objectives of the company system of internal control? page 217

Internal control consists of the actions taken by people at every level of an organization to achieve its objectives relating to. Operations. Operational objectives focus on completing work efficiently and effectively and protecting assets by reducing the risk of fraud. Reporting. Reporting objectives include producing reliable and timely accounting information for use by people internal and external to the organization. Compliance. Compliance objectives focus on adhering to laws and regulations. In your personal life, these actions include basic steps such as locking your door (operations), checking the accuracy of your banking records (reporting), and staying within the speed limit when driving (compliance).

Know the Principles of control activities page 218 and 219 Example which principle of internal control states that you should assign each task to only one employee? If the company hired an auditor to check that the work done by others within the company is supported by documentation, What principle is demonstrated? What is the control principle related to assigning responsibilities so that one employee cannot make a mistake or commit a dishonest act without someone else discovering it? Be able to identify examples of restricting access

Know the principles of control activities ..

What is the Internal method of control? Risk assessment.

Managers should continuously assess the potential for fraud and other risks that could prevent the company from achieving its objectives.

Why was the Sarbane-Oxley Act(SOX) enacted? page 216

SOX was created in response to financial statement frauds that occurred in the early 2000s. Confidence in the stock markets had been shaken by frauds involving Enron and WorldCom, so the U.S. Congress passed the act in an attempt to improve financial reporting and restore investor confidence.

What is the control principle related to assigning responsibilities so that one employee cannot make a mistake or commit a dishonest act without someone else discovering it?

Segregation of duties

Be able to Recognize a service organization versus a merchandiser give a description of events. page 260

Service organization-such as Planet Fitness follows a simple operating cycle: sell services to customers, collect cash from them, and use that money to pay for operating expenses. merchandiser-differ in that their cycle begins with buying products. These products, which are called Inventories, are sold to customers, which leads to collecting cash that can be used to pay operating expenses and buy more inventory

What act was passed by Congress in the early 2000s ? Page 216

The Sarbanes-Oxley Act (SOX)

What is the Internal method of control? Control environment

The control environment refers to the attitude people in the organization hold regarding internal control. Do they appreciate its importance, or do they view internal control as just bureaucratic hurdles? The control environment is influenced by the policies a company's board of directors and senior managers set, their demonstrated commitment to integrity and ethical values, the character of the people they hire, and how they evaluate others. A strong control environment helps employees understand the value of internal controls to their organization's success.

What is opportunity in regards to the three factors of fraud?

The employee has a means of committing fraud. Opportunities to commit fraud usually stem from weak internal controls. That was certainly the case at Koss, where the VP transferred $16 million out of the company without approval or review by the chief financial officer. She also took advantage of deficiencies in the company's petty cash authorizations to pay $390,000 of her personal purchases. Finally, she was able to cover up these thefts because she did not require proper authorization for journal entries she recorded.

What is Incentive in regards to the three factors of fraud?

The employee has a reason for committing fraud. For example, personal financial pressure may lead to asset misappropriation. The VP at Koss stole because her $145,000 salary was not enough to pay for the monthly credit card bills that reached as high as $1 million. In financial statement fraud cases, the incentive can be to make the business appear successful so as to attract investors, bring in new business partners, or meet loan requirements. The loan covenants in lending agreements may require the company to achieve financial targets, such as maintaining specific levels of assets or stockholders' equity. If loan covenants are not met, the lender can require the company to pay a higher interest rate, repay its loan balance on demand, or put up extra collateral to secure the loan. To avoid this, dishonest managers may misreport the company's financial statements.

What is Rationalization in regards to the three factors of fraud?

The employee perceives the misdeed as unavoidable or justified. In the Koss case, the defense attorney argued the VP suffered from addiction and mental illness, which led to uncontrollable compulsive behavior. In many other cases, fraudsters rationalize their actions through a feeling of personal entitlement, which outweighs moral principles, such as honesty and concern for others. These employees often feel they are underpaid, so fraud is their way to get even and be paid what they think they deserve.

What is the Internal method of control? Monitoring activities

The internal control system is evaluated often to determine whether it is working as intended. Deficiencies should be communicated to those responsible for taking corrective action, including senior management and/or the board of directors.

Deferral Adjustments

The word defer means to postpone until later. In accounting, we say an expense or revenue has been deferred if we have postponed reporting it on the income statement until a later period. As you saw in Chapter 3, when Noodlecake pays its rent in advance, the expense is initially deferred as an asset on the balance sheet (in an account called Prepaid Rent). The adjustment part comes later, at the end of the month, when one month of the prepaid rent benefits has been used up. The deferral adjustment involves reducing Prepaid Rent on the balance sheet and increasing Rent Expense on the income statement.

Know how to prepare a bank reconciliation -page 229

Theres 3 main steps in preparing a bank reconciliation -Identify the deposits in transit. -Identify the outstanding checks -Record other transactions on the bank statement and correct your errors.

Which are key requirements of the Sarbane-Oxley Act? Reduce opportunities.

This is the part of the fraud triangle most affected by SOX. To reduce fraud opportunities and improve companies' internal control over financial reporting, SOX requires all public companies to Establish an audit committee of independent directors. This committee strives to ensure the company's accounting, internal control, and audit functions are effective. Evaluate and report on the effectiveness of internal control over financial reporting. This evaluation must be completed by management and, for large public companies, by external auditors as well. An external audit of control effectiveness can be expensive, so it is optional for small public companies. Sadly, Koss executives felt the company's resources "would be better spent on strategic planning" than auditing, so they did not ask external auditors to test and report on their company's internal control. Had they done so, the massive fraud might have been detected earlier.

One of the three types of fraud is Financial statement fraud. What is Finacial statement fraud?

This type of fraud involves misreporting amounts in the financial statements, usually to portray more favorable financial results than what actually exist. The most famous cases occurred at Enron (now bankrupt) and WorldCom (now part of Verizon). WorldCom violated GAAP by recording $11 billion of expenses as assets, the result of which was larger total assets on the balance sheet and more net income on the income statement.

Which are key requirements of the Sarbane-Oxley Act? Counteract incentives.

Those who willfully misrepresent financial results face stiff penalties, including fines of up to $5 million plus repayment of any fraud proceeds. Also, maximum jail sentences have been increased to 20 years, which can quickly add up because federal sentencing guidelines allow judges to declare consecutive jail terms for each violation. The VP at Koss was charged with six counts of fraud, so she was facing a maximum prison term of 120 years.

Which are the key requirements of the Sarbane-Oxley Act? triangle picture page 216

Triangle picture(broke this question in to multiple parts)

Which of the following would overstate the company's net income? Example on page 215 a. Counting shipments of customers' orders as revenue before payment has been received. b. Shipping goods to customers without receiving orders from those customers, and recording the transactions as revenue. c. Accruing liabilities for marketing expenses before they are incurred. d. Making an accrual adjusting entry for interest earned on a bond investment.

b. Shipping goods to customers without receiving orders from those customers, and recording the transactions as revenue. Managers at Bausch & Lomb shipped as much as two years' worth of contact lenses to opticians who hadn't even ordered them. These shipments were counted as sales revenue, which overstated net income. Reporting revenue before cash is received and accruing interest earned would increase net income and is in accordance with GAAP. Accruing liabilities before they are incurred would decrease net income and is not in accordance with GAAP.

which principle of internal control states that you should assign each task to only one employee?

establish responsibilities?? (if this is wrong lmk)

If the company hired an auditor to check that the work done by others within the company is supported by documentation, What principle is demonstrated?

independent verification

What is the definition of fraud? Page 214

is generally defined as an attempt to deceive others for personal gain.

What type of adjustment is made when a company uses up a prepaid expense existing and the company adjusted its accounts accordingly. Page 153

not sure

How is an income statement different for a service company vs a Merchandiser? page 261

three key differences in the balance sheet and income statement of a service company (Planet Fitness) and a merchandising company (Walmart). The balance sheet excerpts show that (1) merchandisers report Inventories as a current asset, but service companies do not. Service companies often report Supplies, which differ from Inventories because supplies are goods acquired for internal use whereas inventories include goods acquired for resale to customers. The income statement excerpts show that (2) service companies earn revenue from services whereas merchandisers earn revenue from sales. Finally, (3) merchandisers report an expense called Cost of Goods Sold, which represents the total cost of all goods sold to customers during the period. Service companies do not incur this expense because they do not sell goods.