Adjustments and Internal Controls

Transcription

1 Question 1: How do accounting systems differ depending on the size of a business? Answer 1: In a smaller business, the accounting system evolves through time as the business grows. However, in larger and more structured businesses, the accounting system is developed through a process of identifying the needs of the business, designing the system, and then implementing it. Once implemented, the system is changed and tailored to reflect the changing needs of the business. Question 2: What are examples of adjustments and how are they shown in an accounting system? Answer 2: Error Correction: An error correction transaction occurs when a recorded transaction is done incorrectly. An example would be posting the receipt of $1,000 cash as $100. A correcting entry of $900 would need to be made. This error caused cash to be understated by $900 and accounts receivable to be overstated by $900. The journal entry to correct this would be as follows: Dec. 31 Cash Accounts Receivable Deferred Revenue: An adjustment transaction for income received and not earned is an example of deferred revenue. Once the service is preformed, the unearned income will be credited and income will be debited. A good example of this is an insurance company that receives an annual premium of $1,200 from a customer on January 1. One twelfth of the income is earned each month. At the end of January, the following entry would be made: 1

2 Jan. 31 Unearned Income Accounts Receivable Deferred Expense: An adjustment transaction for expenses paid and not used is an example of a deferred expense. An example of this is when supplies are purchased in the current accounting period but will be used by the business in future periods. As the supplies are used, supply expense is debited and supplies are credited. The following entry is an example of the journal entry for one month's usage of supplies: Dec. 31 Supplies Expense 55 1,000 Supplies 10 1,000 Accrued Revenue: An example of accrued revenue is when a product or service has been completed but the payment has not been received. The following journal entry records the earned income by crediting fees earned and debiting accounts receivable. Dec. 31 Accounts Receivable 55 1,000 Fees Earned 10 1,000 Accrued Expense: An accrued expense is an accrued liability. An example of this is when wages are earned and not paid. Wages are earned hour-by-hour but paid weekly, biweekly, or monthly. If an accounting period ends in the middle of the week or the middle of a pay period, the wages earned must be accounted for by 2

3 debiting wage expense and crediting wages payable. Dec. 31 Wage Expense 55 1,000 Wages Payable 10 1,000 Once the adjustment transactions have been entered into the journal, they change the total for each ledger account affected by the transactions. The adjustments, as shown in the aforementioned, can affect an asset account, an expense account, or a liability account which in turn affects the income statement or the balance sheet. Question 3: How would you go about setting up a petty cash fund for miscellaneous purchases of supplies by authorized employees? Answer 3: Many businesses have petty cash funds. This enables authorized employees to purchase miscellaneous supplies as needed for business purposes. First, a petty cash account is established in the ledger. As cash is put into the petty cash draw, the petty cash account is debited and the business cash account is credited. Secondly, a pre-numbered petty cash voucher system is setup and a voucher is made out for each use of petty cash. When a purchase for supplies is made using petty cash, the petty cash account is credited and the supplies account is debited. The petty cash draw and the petty cash account is balanced monthly. Over a period of time, this account should balance to zero. If it does not balance, then a write-off of cash is required. This would be a loss to the business. Question 4: What are accounts and notes receivable? Answer 4: Most business transactions today are done using credit. A business may invoice a customer with terms of 30 or 60 days to pay the invoice. The money owed to the business for these terms is known as its accounts receivable. Notes receivable are used for money owed to a business for a period greater than 60 days but usually less than one year. Notes are used when a business gives its customer a minimum required down payment and 6 to 12 months to 3

4 pay off the balance. When a customer does not pay balances, a write-off must occur. This is handled by using allowance accounts to write off bad debt. The bad debt account is debited and the notes/accounts receivable is credited. This would represent a loss to the business. Question 5: What is an example of an accounts receivable transaction? Answer 5: A business creates a receivable when it sells merchandise or a service on credit. An example would be when an appliance retail business sells a refrigerator to a customer with a payment schedule of net 60 days. The transaction for this would be a debit to accounts receivable and a credit to sales. The journal entry would be recorded as follows: Jun. 1 Accounts Receivable 55 1,000 Sales 10 1,000 Assume at the end of the 60 days the customer sends the appliance retail business a check for the $1,000. This transaction would debit cash and credit accounts receivable. The journal entry to record the receipt would be as follows: Dec. 31 Cash 12 1,000 Accounts Receivable 55 1,000 Question 6: What adjustment entry would the retailer make to the journal if the customer does not pay the appliance retail business? Answer 6: Assume at the end of the 60 days the customer has left town with the refrigerator and does not pay the $1,000. The journal entry to write off the bad debt would be as follows: 4

5 Dec. 31 Bad Debit 55 1,000 Accounts Receivable 10 1,000 Question 7: What provision would the retailer make to account for the future bad debt accounts? Answer 7: Many businesses that sell merchandise or services on account setup an allowance for bad debt. This is an accrued expense against the receivable accounts. The journal entry to account for bad debts for multiple accounts would be as follows: Dec. 31 Bad Debt Accounts Expense 55 3,000 Allowance for Bad Debt 10 3,000 The balance sheet for such a business would be as follows: Balance Sheet Assets Debit Credit Current Assets Cash 10,000 Notes receivable 25,000 Accounts Receivable 16,000 Less allowance for bad debts 3,000 13,000 Question 8: What is "separation of duties" as it relates to internal controls? Answer 8: The separation of duties as it relates to internal controls is not having the same person who performed the transaction activity also be the same person who records the transaction in the accounting records. One example is for the person responsible for physically receiving cash not to be responsible for posting the cash transaction to the accounting journal. Another example is to not have the salesman record the sales transaction in 5

6 the accounting journal. If his/her pay is based on a percentage of sales, he or she might be tempted to overstate the sale to get a larger paycheck. Question 9: What other control procedure might be put into place to further enhance the separation of duties control? Answer 9: The cross-training of personnel and job rotation is another control that makes it more difficult for employees to commit fraud. Personnel in all departments of a business can be cross-trained within their departments and rotated. Typically, this is done in the more clerical ranks of the business. Personnel in the payroll, accounts payable, accounts receivable, purchasing, and cash management are rotated. Question 10: What area of the business should have the most controls in place? Why? Answer 10: The area of the business where cash transactions or cash handling and recording take place should be the area of major focus. Cash is the most readily available asset of the business. It is the easiest to steal, hide, and misuse. One way to address this is to utilize a bank. One of the first things required when setting up a bank account is to name and sign the authorization cards. These cards identify who in the business may have access to the bank account and who has the authority to sign the business checks. The statement that the bank creates each month should be checked against the checks written, the deposit slips, and the cash transactions recorded in the accounting records of the business. This three-way check assures the business that all cash transactions are properly identified and recorded. 6