Thursday 12 September 2013
Thursday 5 September 2013
In 2012, Hadicke Company had a break-even point of $350,000 based on a selling price of $7 per unit and fixed costs of $105,000. In 2013, the selling price and the variable cost per unit did not change, but the break-even point increased to $420,000.
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Question 2 In the month of June, Barbara's Beauty Salon gave 2,700 haircuts, shampoos, and permanents at an average price of $30. During the month, fixed costs were $18,000 and variable costs were 70% of sales. Determine the contribution margin in dollars, per unit, and as a ratio. Contribution margin (in dollars) $ Contribution margin per unit $ Contribution margin ratio % Using the contribution margin technique, compute the break-even point in dollars and in units. Break-even point (in dollars) $ Break-even point (in units) units Compute the margin of safety in dollars and as a ratio. (Round answers to 0 decimal places, e.g. 125.) Margin of safety (in dollars) $ Margin of safety (ratio) %
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Black Brothers Furniture Corporation incurred the following costs. Instructions Identify the costs above as variable, fixed, or mixed.
Black Brothers Furniture Corporation incurred the following costs.
CLICK HERE TO GET THE ANSWER !!!!
Instructions
Identify the costs above as variable, fixed, or mixed.
| 1. | Wood used in the production of furniture. | |
| 2. | Fuel used in delivery trucks. | |
| 3. | Straight-line depreciation on factory building. | |
| 4. | Screws used in the production of furniture. | |
| 5. | Sales staff salaries. | |
| 6. | Sales commissions. | |
| 7. | Property taxes. | |
| 8. | Insurance on buildings. | |
| 9. | Hourly wages of furniture craftsmen. | |
| 10. | Salaries of factory supervisors. | |
| 11. | Utilities expense. | |
| 12. | Telephone bill. | |
Tuesday 6 August 2013
Santo Birch opens a Web consulting business called Show-Me-the-Money and completes the following transactions in its first month of operations.
Problem 2-4A Preparing and posting journal entries; preparing a trial balance L.O. C3, C4, A1, P1, P2
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Santo Birch opens a Web consulting business called Show-Me-the-Money and completes the following transactions in its first month of operations. |
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March 1 |
Birch invests $95,000 cash along with office equipment valued at $22,800 in the company in exchange for common stock. |
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2 |
The company prepaid $7,200 cash for twelve months' rent for office space. (Hint: Debit Prepaid Rent for $7,200.) |
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3 |
The company made credit purchases for $11,400 in office equipment and $2,280 in office supplies. Payment is due within 10 days. |
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6 |
The company completed services for a client and immediately received $2,000 cash. |
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9 |
The company completed a $7,600 project for a client, who must pay within 30 days. |
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13 |
The company paid $13,680 cash to settle the account payable created on March 3. |
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19 |
The company paid $6,000 cash for the premium on a 12-month insurance policy. (Hint: Debit Prepaid Insurance for $6,000.) |
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22 |
The company received $6,080 cash as partial payment for the work completed on March 9. |
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25 |
The company completed work for another client for $2,640 on credit. |
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29 |
The company paid $6,200 cash for dividends. |
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30 |
The company purchased $760 of additional office supplies on credit. |
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31 |
The company paid $700 cash for this month's utility bill. |
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Required: |
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1. |
Record these transactions using the following titles: Cash, Accounts Receivable, Office Supplies, Prepaid Insurance, Prepaid Rent, Office Equipment, Accounts Payable, Common stock, Dividends, Services Revenue, and Utilities Expense. (Omit the "$" sign in your response.) |
Friday 12 April 2013
Page 1 of 9
MONTGOMERY COLLEGE
Department of Business and Economics
Rockville Campus
AC 201 REVIEW 2 (CHAPTERS 5-8)
Spring 2013
I. True/False
T
F
1.
Under a perpetual inventory system, cost of goods sold is determined
each time a sale occurs.
2.
The operating cycle involves the purchase and sale of merchandise as well as the subsequent collection of cash from credit sales.
3.
Operating expenses are subtracted from revenue for a service enterprise and
from gross profit for a merchandising enterprise.
4.
Net sales minus cost of goods sold is called gross profit.
5.
Under the perpetual inventory system, purchases of merchandise for sale are
recorded in the Merchandise Inventory account.
6.
The terms 2/10, net/30 mean that a 2 percent discount is allowed on
payments made within the 10 days discount period.
7.
If merchandise costing $2,500, with terms 2/10, n/30, is paid within
10 days, the amount of the purchase discount is $50.
8.
The Sales Returns and Allowances account and the Sales Discount account are
both classified as expense accounts.
9.
The revenue recognition principle applies to merchandising companies by
recognizing sales revenues when they are earned.
10.
When the terms of sale include a sales discount, it usually is advisable
for the buyer to pay within the discount period.
11.
The multiple-step income statement is considered more useful than the
single-step income statement because it highlights the components of net
income.
12.
Advertising Expense appears as a selling expense on the Income Statement.
13.
Non-operating activities include revenues and expenses that are related to
the company's main line of operations.
14.
Sales revenue, cost of goods sold, and gross profit are amounts on a
merchandising company's Income Statement not commonly found on the Income
Statement of a service company.
15.
If net sales are $1,000,000 and cost of goods sold is $800,000, the gross
profit rate is 20%.
16.
Under a periodic inventory system, the merchandise on hand at the end of
the period is determined by a physical count of the inventory.
17.
Goods held on consignment should be included in the consignor's ending
inventory.
18.
If prices never changed there would be no need for alternative inventory
methods.
19.
The specific identification method of costing inventories tracks the actual
physical flow of the goods available for sale.
20.
Management may choose any inventory costing method it desires as long as
the cost flow assumption chosen is consistent with the physical movement of
goods in the company.
21.
The First-In, First-Out (FIFO) inventory method results in an ending
inventory valued at the most recent cost.
22.
The matching principle requires that cost of goods sold be matched
against the ending Merchandise Inventory in order to determine income.
23.
The specific identification method of inventory valuation is desirable when
a company sells a large number of low-unit cost items.
24.
If a company has no beginning inventory and the unit cost of inventory
items does not change during the year, the value assigned to the ending
inventory will be the same under LIFO and average cost flow assumptions.
25.
If the unit price of inventory is increasing during a period, a company
using the LIFO inventory method will show less gross profit for the period,
than if it had used the FIFO inventory method.
26.
If a company changes its inventory valuation method, the effect of the
change on net income should be disclosed in the financial statements.
Page 2 of 9
T
F
27.
In periods of falling prices, LIFO will result in a higher ending inventory
valuation than FIFO.
28.
When the market value of inventory is lower than its cost, the inventory is
written down to its market value.
29.
The inventory turnover ratio is calculated as cost of goods sold divided by
ending inventory.
30.
An inventory turnover ratio that is too high may indicate that the company
is losing sales opportunities because of inventory shortages.
31.
The LIFO reserve is the difference between ending inventory using LIFO and
ending inventory if FIFO were used instead.
32.
The safeguarding of assets is an objective of a company's system of
internal control.
33.
An effective system of internal control centralizes functions in a single
capable individual.
34.
Requiring employees to take vacations is a weakness in the system of
internal controls because it does not promote operational efficiency.
35.
Bonding means insuring a company against theft by employees.
36.
An effective system of internal control requires that at least two
individuals be assigned to one cash drawer so that each can serve as a check on the other.
37.
The responsibility for ordering, receiving, and paying for merchandise
should be assigned to different individuals.
38.
Control over cash disbursements is improved if major expenditures are paid
by check.
39.
An example of segregation of duties is having a check signer recording cash
disbursements.
40.
To obtain maximum benefit from a bank reconciliation, the reconciliation
should be prepared by the employee authorized to sign checks.
41.
Cash equivalents include money market accounts, commercial paper, and U.S.
treasury bills held for ninety days or less.
42.
A basic principle of cash management is to increase the speed of paying
liabilities.
43.
A cash budget contributes to more effective cash management.
44.
The petty cash fund eliminates the need for a bank checking account.
45.
Trade Receivables can be an Account Receivable or a Note Receivable.
46.
Advances to employees are referred to as Trade Accounts Receivable.
47.
Accounts Receivable are one of a company's least liquid assets.
48.
An aging of Accounts Receivable is based on the premise that the longer the period an account remains unpaid, the greater the probability that it will eventually be collected.
49.
The allowance method of accounting for bad debts violates the matching
principle.
50.
If a company uses the allowance method to account for uncollectible
accounts, the entry to write off an uncollectible account only involves
balance sheet accounts.
51.
When the allowance method is used, the write-off of an account receivable
results in an expense at the time of write-off.
52.
When using the direct write-off method, year-end adjustments for Bad Debt
Expense must be made.
53.
Under the allowance method, the cash realizable value of receivables is the
same both before and after an account has been written off.
54.
In computing the maturity date of a note, the date the note is issued is
included but the due date is omitted.
55.
Interest on a 6-month, 10 percent, $10,000 note is calculated by multiplying $10,000 x 0.10 x 6/12.
56.
When a note is written to settle an open account, no entry is necessary.
57.
If a promissory note is dishonored, the payee should not record interest
income.
58.
The holder of a note adjusts for accrued interest by debiting Interest
Receivable and crediting Interest Revenue.
Page 3 of 9
T
F
59.
A concentration of credit risk is a threat of nonpayment from a single
customer or class of customers that could adversely affect the financial
health of the company.
60.
The receivables turnover ratio is calculated by dividing average receivables into cost of goods sold.
61.
The average collection period is frequently used to assess the effectiveness of a company's credit and collection policies.
62.
A factor buys receivables from businesses for a fee and collects the payment directly from customers.
63.
A major advantage of national credit cards to retailers is that there is no
charge to the retailer by the credit card companies for their services.
Page 4 of 9
II. Inventory Costing
Assume the following data for Vincent Vega Company for 2005:
January 1
Beginning Inventory
10 Units at $ 7.00 per Unit
March 18
Purchase
15 Units at $ 8.00 per Unit
March 22
Sale
20 Units at $10.00 per Unit
June 10
Purchase
20 Units at $ 8.50 per Unit
June 16
Sale
22 Units at $10.00 per Unit
October 30
Purchase
12 Units at $ 9.00 per Unit
a. Compute the inventory on hand on December 31 under the FIFO Periodic Method.
b. Compute the Cost of Goods Sold under the FIFO Periodic Method.
c. Compute the inventory on hand on December 31 under the LIFO Periodic Method.
d. Compute the Cost of Goods Sold under the LIFO Periodic Method.
e. Compute the inventory on hand on December 31 under the Average Cost Periodic
Method.
f. Compute the Cost of Goods Sold under the Average Cost Periodic Method.
Page 5 of 9
III. Matching
1.
The excess of sales revenue over Cost of Goods Sold
A.
Gross Profit
2.
Expenses, other than Cost of Goods Sold, that are
incurred in a business’ major line of business
B.
Sales Returns and Allowances
3.
Gross profit minus operating expenses
C.
Single-step Income Statement
4.
Gross profit divided by net Sales Revenue
D.
Operating Expenses
5.
Ratio of cost of goods sold to average inventory
E.
Operating Income
6.
The largest single expense of most merchandising businesses
F.
Inventory Turnover
7.
A contra account to Sales Revenue
G.
Cost of Goods Sold
8.
A format that groups all revenues together and
then lists and deducts all expenses together without drawing any subtotals
H.
Other Revenue
9.
Revenue that originates outside the main operations of a business
I.
Gross Profit Percentage
10.
Purchases minus Purchase Discounts and minus Purchase Returns and Allowances
J.
Net Purchases
IV. Matching
1.
A concept by which the least favorable figures are
presented in the financial statements
A.
LIFO
2.
A principle requiring the use of the same accounting methods and procedures from period to period
B.
Lower-of-cost-or-market Rule
3.
A principle requiring the financial statements to report enough information for outsiders to make knowledgeable decisions about the business
C.
Conservatism
4.
Requires that an asset be reported in the
financial statements at whichever is lower, its historical cost or its current replacement cost
D.
FIFO
5.
Inventory costing method in which ending inventory
is based on the costs of the most recent purchases
E.
Consistency Principle
6.
Inventory costing method in which ending inventory
is based on the oldest costs
F.
Full Disclosure Principle
7.
Inventory system maintaining a continual count of inventory
G.
Perpetual Inventory System
8.
Cost to the merchant for accepting a credit card
H.
Allowance for Doubtful Accounts
9.
A contra account to accounts receivable that holds the estimated amount of collection losses
J.
Direct Write-off Method
10.
The sum of the principal and interest due on the due date of a note
K.
Maturity Value
11.
A method of accounting for uncollectible accounts by which the company waits until the credit department decides that a customer's account is uncollectible, and then writes it off directly to Bad Debt Expense
L.
Allowance Method
12.
A method of recording collection losses based on estimates made before identification of specific uncollectible accounts
M.
Service Charge Expense
Page 6 of 9
V. Bank Reconciliation
The following information is available to prepare the Jules Winnfield Company’s
December 31 bank reconciliation.
1. Check No. 453, written for $250, was outstanding on November 30 and was not
returned with the December bank statement.
2. Check No. 478, written on December 26 for $400, was not returned with the
canceled checks.
3. Check No. 480, correctly written for $96 was incorrectly entered in the
Cash Disbursements Journal and posted as though it were for $69.
4. A deposit of $2,000, placed in the bank’s night depository after banking hours
on November 30, appeared on the December bank statement.
5. A deposit of $1,500, placed in the bank’s night depository after banking hours
on December 31, did not appear on the December bank statement.
6. Enclosed with the December bank statement was a debit memorandum for the monthly
bank service charge of $25.
7. Enclosed with the December bank statement was a memorandum that a $738 check received from Zed and deposited on December 27 was returned by the bank marked “Non-Sufficient Funds.”
8. The Cash balance on the December bank statement was $10,000.
9. Winnfield Company’s Cash ledger balance on December 31 is $11,640.
a. Prepare the appropriate bank reconciliation, in good form, in the space
provided on page 7.
b. Certain of the above items require entries on Jules Winnfield Company’s books. Prepare the necessary adjusting journal entries in the space provided on page 7.
Page 7 of 9
General Journal
Date
Description
Debit
Credit
Page 8 of 9
VI. Recording Transactions
Journalize the following transactions for M. Wallace Company using the perpetual
inventory method.
January 4 Purchased $5,300 merchandise from Marvin Company on account,
terms 3/10, n/30.
January 7 Paid $700 freight on January 4 transaction.
January 12 Received $300 credit from Marvin Company for merchandise returned.
January 13 Paid Marvin Company for merchandise in full, less discounts.
January 20 Made sales of $10,000 to customers on account, terms 2/10, n/30.
The merchandise cost $8,000.
January 22 Gave credit of $1,500 to customers for merchandise returns.
The merchandise cost $1,200.
January 29 Received payment in full, less discounts, from customers.
General Journal
Date
Description
Debit
Credit
Page 9 of 9
VII. Maturity Values
Calculate the maturity value for each of the following notes.
TERM
INTEREST RATE
PRINCIPAL
MATURITY VALUE
60 Days
10%
$ 8,000
3 Months
12%
$60,000
90 Days
5%
$ 4,000
VIII. Allowance Method
Butch Coolidge Company has accounts receivable of $340,000 and a normal balance in
allowance for doubtful accounts of $7,180.
a. Assuming that the aging of accounts receivable method is used, create the
journal entry needed to record bad debt expense if 4% of receivables will
become uncollectible.
b. Assume the same facts as above, but now assume a debit balance in allowance for
doubtful accounts of $2,000.
c. What is the difference between the direct write-off method versus the allowance
method for bad debts?
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CLICK HERE TO GET THE ANSWER !!!! Page 1 of 9 MONTGOMERY COLLEGE Department of Business and Economics Rockville Campus AC 201 REVIEW 2 (CHAPTERS 5-8) Spring 2013 I. True/False T F 1. Under a perpetual inventory system, cost of goods sold is determined each time a sale occurs. 2. The operating cycle involves the purchase and sale of merchandise as well as the subsequent collection of cash from credit sales. 3. Operating expenses are subtracted from revenue for a service enterprise and from gross profit for a merchandising enterprise. 4. Net sales minus cost of goods sold is called gross profit. 5. Under the perpetual inventory system, purchases of merchandise for sale are recorded in the Merchandise Inventory account. 6. The terms 2/10, net/30 mean that a 2 percent discount is allowed on payments made within the 10 days discount period. 7. If merchandise costing $2,500, with terms 2/10, n/30, is paid within 10 days, the amount of the purchase discount is $50. 8. The Sales Returns and Allowances account and the Sales Discount account are both classified as expense accounts. 9. The revenue recognition principle applies to merchandising companies by recognizing sales revenues when they are earned. 10. When the terms of sale include a sales discount, it usually is advisable for the buyer to pay within the discount period. 11. The multiple-step income statement is considered more useful than the single-step income statement because it highlights the components of net income. 12. Advertising Expense appears as a selling expense on the Income Statement. 13. Non-operating activities include revenues and expenses that are related to the company's main line of operations. 14. Sales revenue, cost of goods sold, and gross profit are amounts on a merchandising company's Income Statement not commonly found on the Income Statement of a service company. 15. If net sales are $1,000,000 and cost of goods sold is $800,000, the gross profit rate is 20%. 16. Under a periodic inventory system, the merchandise on hand at the end of the period is determined by a physical count of the inventory. 17. Goods held on consignment should be included in the consignor's ending inventory. 18. If prices never changed there would be no need for alternative inventory methods. 19. The specific identification method of costing inventories tracks the actual physical flow of the goods available for sale. 20. Management may choose any inventory costing method it desires as long as the cost flow assumption chosen is consistent with the physical movement of goods in the company. 21. The First-In, First-Out (FIFO) inventory method results in an ending inventory valued at the most recent cost. 22. The matching principle requires that cost of goods sold be matched against the ending Merchandise Inventory in order to determine income. 23. The specific identification method of inventory valuation is desirable when a company sells a large number of low-unit cost items. 24. If a company has no beginning inventory and the unit cost of inventory items does not change during the year, the value assigned to the ending inventory will be the same under LIFO and average cost flow assumptions. 25. If the unit price of inventory is increasing during a period, a company using the LIFO inventory method will show less gross profit for the period, than if it had used the FIFO inventory method. 26. If a company changes its inventory valuation method, the effect of the change on net income should be disclosed in the financial statements. Page 2 of 9 T F 27. In periods of falling prices, LIFO will result in a higher ending inventory valuation than FIFO. 28. When the market value of inventory is lower than its cost, the inventory is written down to its market value. 29. The inventory turnover ratio is calculated as cost of goods sold divided by ending inventory. 30. An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. 31. The LIFO reserve is the difference between ending inventory using LIFO and ending inventory if FIFO were used instead. 32. The safeguarding of assets is an objective of a company's system of internal control. 33. An effective system of internal control centralizes functions in a single capable individual. 34. Requiring employees to take vacations is a weakness in the system of internal controls because it does not promote operational efficiency. 35. Bonding means insuring a company against theft by employees. 36. An effective system of internal control requires that at least two individuals be assigned to one cash drawer so that each can serve as a check on the other. 37. The responsibility for ordering, receiving, and paying for merchandise should be assigned to different individuals. 38. Control over cash disbursements is improved if major expenditures are paid by check. 39. An example of segregation of duties is having a check signer recording cash disbursements. 40. To obtain maximum benefit from a bank reconciliation, the reconciliation should be prepared by the employee authorized to sign checks. 41. Cash equivalents include money market accounts, commercial paper, and U.S. treasury bills held for ninety days or less. 42. A basic principle of cash management is to increase the speed of paying liabilities. 43. A cash budget contributes to more effective cash management. 44. The petty cash fund eliminates the need for a bank checking account. 45. Trade Receivables can be an Account Receivable or a Note Receivable. 46. Advances to employees are referred to as Trade Accounts Receivable. 47. Accounts Receivable are one of a company's least liquid assets. 48. An aging of Accounts Receivable is based on the premise that the longer the period an account remains unpaid, the greater the probability that it will eventually be collected. 49. The allowance method of accounting for bad debts violates the matching principle. 50. If a company uses the allowance method to account for uncollectible accounts, the entry to write off an uncollectible account only involves balance sheet accounts. 51. When the allowance method is used, the write-off of an account receivable results in an expense at the time of write-off. 52. When using the direct write-off method, year-end adjustments for Bad Debt Expense must be made. 53. Under the allowance method, the cash realizable value of receivables is the same both before and after an account has been written off. 54. In computing the maturity date of a note, the date the note is issued is included but the due date is omitted. 55. Interest on a 6-month, 10 percent, $10,000 note is calculated by multiplying $10,000 x 0.10 x 6/12. 56. When a note is written to settle an open account, no entry is necessary. 57. If a promissory note is dishonored, the payee should not record interest income. 58. The holder of a note adjusts for accrued interest by debiting Interest Receivable and crediting Interest Revenue. Page 3 of 9 T F 59. A concentration of credit risk is a threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of the company. 60. The receivables turnover ratio is calculated by dividing average receivables into cost of goods sold. 61. The average collection period is frequently used to assess the effectiveness of a company's credit and collection policies. 62. A factor buys receivables from businesses for a fee and collects the payment directly from customers. 63. A major advantage of national credit cards to retailers is that there is no charge to the retailer by the credit card companies for their services. Page 4 of 9 II. Inventory Costing Assume the following data for Vincent Vega Company for 2005: January 1 Beginning Inventory 10 Units at $ 7.00 per Unit March 18 Purchase 15 Units at $ 8.00 per Unit March 22 Sale 20 Units at $10.00 per Unit June 10 Purchase 20 Units at $ 8.50 per Unit June 16 Sale 22 Units at $10.00 per Unit October 30 Purchase 12 Units at $ 9.00 per Unit a. Compute the inventory on hand on December 31 under the FIFO Periodic Method. b. Compute the Cost of Goods Sold under the FIFO Periodic Method. c. Compute the inventory on hand on December 31 under the LIFO Periodic Method. d. Compute the Cost of Goods Sold under the LIFO Periodic Method. e. Compute the inventory on hand on December 31 under the Average Cost Periodic Method. f. Compute the Cost of Goods Sold under the Average Cost Periodic Method. Page 5 of 9 III. Matching 1. The excess of sales revenue over Cost of Goods Sold A. Gross Profit 2. Expenses, other than Cost of Goods Sold, that are incurred in a business’ major line of business B. Sales Returns and Allowances 3. Gross profit minus operating expenses C. Single-step Income Statement 4. Gross profit divided by net Sales Revenue D. Operating Expenses 5. Ratio of cost of goods sold to average inventory E. Operating Income 6. The largest single expense of most merchandising businesses F. Inventory Turnover 7. A contra account to Sales Revenue G. Cost of Goods Sold 8. A format that groups all revenues together and then lists and deducts all expenses together without drawing any subtotals H. Other Revenue 9. Revenue that originates outside the main operations of a business I. Gross Profit Percentage 10. Purchases minus Purchase Discounts and minus Purchase Returns and Allowances J. Net Purchases IV. Matching 1. A concept by which the least favorable figures are presented in the financial statements A. LIFO 2. A principle requiring the use of the same accounting methods and procedures from period to period B. Lower-of-cost-or-market Rule 3. A principle requiring the financial statements to report enough information for outsiders to make knowledgeable decisions about the business C. Conservatism 4. Requires that an asset be reported in the financial statements at whichever is lower, its historical cost or its current replacement cost D. FIFO 5. Inventory costing method in which ending inventory is based on the costs of the most recent purchases E. Consistency Principle 6. Inventory costing method in which ending inventory is based on the oldest costs F. Full Disclosure Principle 7. Inventory system maintaining a continual count of inventory G. Perpetual Inventory System 8. Cost to the merchant for accepting a credit card H. Allowance for Doubtful Accounts 9. A contra account to accounts receivable that holds the estimated amount of collection losses J. Direct Write-off Method 10. The sum of the principal and interest due on the due date of a note K. Maturity Value 11. A method of accounting for uncollectible accounts by which the company waits until the credit department decides that a customer's account is uncollectible, and then writes it off directly to Bad Debt Expense L. Allowance Method 12. A method of recording collection losses based on estimates made before identification of specific uncollectible accounts M. Service Charge Expense Page 6 of 9 V. Bank Reconciliation The following information is available to prepare the Jules Winnfield Company’s December 31 bank reconciliation. 1. Check No. 453, written for $250, was outstanding on November 30 and was not returned with the December bank statement. 2. Check No. 478, written on December 26 for $400, was not returned with the canceled checks. 3. Check No. 480, correctly written for $96 was incorrectly entered in the Cash Disbursements Journal and posted as though it were for $69. 4. A deposit of $2,000, placed in the bank’s night depository after banking hours on November 30, appeared on the December bank statement. 5. A deposit of $1,500, placed in the bank’s night depository after banking hours on December 31, did not appear on the December bank statement. 6. Enclosed with the December bank statement was a debit memorandum for the monthly bank service charge of $25. 7. Enclosed with the December bank statement was a memorandum that a $738 check received from Zed and deposited on December 27 was returned by the bank marked “Non-Sufficient Funds.” 8. The Cash balance on the December bank statement was $10,000. 9. Winnfield Company’s Cash ledger balance on December 31 is $11,640. a. Prepare the appropriate bank reconciliation, in good form, in the space provided on page 7. b. Certain of the above items require entries on Jules Winnfield Company’s books. Prepare the necessary adjusting journal entries in the space provided on page 7. Page 7 of 9 General Journal Date Description Debit Credit Page 8 of 9 VI. Recording Transactions Journalize the following transactions for M. Wallace Company using the perpetual inventory method. January 4 Purchased $5,300 merchandise from Marvin Company on account, terms 3/10, n/30. January 7 Paid $700 freight on January 4 transaction. January 12 Received $300 credit from Marvin Company for merchandise returned. January 13 Paid Marvin Company for merchandise in full, less discounts. January 20 Made sales of $10,000 to customers on account, terms 2/10, n/30. The merchandise cost $8,000. January 22 Gave credit of $1,500 to customers for merchandise returns. The merchandise cost $1,200. January 29 Received payment in full, less discounts, from customers. General Journal Date Description Debit Credit Page 9 of 9 VII. Maturity Values Calculate the maturity value for each of the following notes. TERM INTEREST RATE PRINCIPAL MATURITY VALUE 60 Days 10% $ 8,000 3 Months 12% $60,000 90 Days 5% $ 4,000 VIII. Allowance Method Butch Coolidge Company has accounts receivable of $340,000 and a normal balance in allowance for doubtful accounts of $7,180. a. Assuming that the aging of accounts receivable method is used, create the journal entry needed to record bad debt expense if 4% of receivables will become uncollectible. b. Assume the same facts as above, but now assume a debit balance in allowance for doubtful accounts of $2,000. c. What is the difference between the direct write-off method versus the allowance method for bad debts? Here is link for file (http://www.google.com.pk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CDEQFjAA&url=http%3A%2F%2Fcms.montgomerycollege.edu%2FWorkArea%2Flinkit.aspx%3FLinkIdentifier%3Did%26ItemID%3D49843&ei=G-hnUbexI82OrgfPxIDgBw&usg=AFQjCNG3PRGSRAqJ_ha4hHbBlkYepvzneg&sig2=361Ye9BKstwdwODke2DtXQ&bvm=bv.45175338,d.bmk) CLICK HERE TO GET THE ANSWER !!!!
Page 1 of 9
MONTGOMERY COLLEGE
Department of Business and Economics
Rockville Campus
AC 201 REVIEW 2 (CHAPTERS 5-8)
Spring 2013
I. True/False
T
F
1.
Under a perpetual inventory system, cost of goods sold is determined
each time a sale occurs.
2.
The operating cycle involves the purchase and sale of merchandise as well as the subsequent collection of cash from credit sales.
3.
Operating expenses are subtracted from revenue for a service enterprise and
from gross profit for a merchandising enterprise.
4.
Net sales minus cost of goods sold is called gross profit.
5.
Under the perpetual inventory system, purchases of merchandise for sale are
recorded in the Merchandise Inventory account.
6.
The terms 2/10, net/30 mean that a 2 percent discount is allowed on
payments made within the 10 days discount period.
7.
If merchandise costing $2,500, with terms 2/10, n/30, is paid within
10 days, the amount of the purchase discount is $50.
8.
The Sales Returns and Allowances account and the Sales Discount account are
both classified as expense accounts.
9.
The revenue recognition principle applies to merchandising companies by
recognizing sales revenues when they are earned.
10.
When the terms of sale include a sales discount, it usually is advisable
for the buyer to pay within the discount period.
11.
The multiple-step income statement is considered more useful than the
single-step income statement because it highlights the components of net
income.
12.
Advertising Expense appears as a selling expense on the Income Statement.
13.
Non-operating activities include revenues and expenses that are related to
the company's main line of operations.
14.
Sales revenue, cost of goods sold, and gross profit are amounts on a
merchandising company's Income Statement not commonly found on the Income
Statement of a service company.
15.
If net sales are $1,000,000 and cost of goods sold is $800,000, the gross
profit rate is 20%.
16.
Under a periodic inventory system, the merchandise on hand at the end of
the period is determined by a physical count of the inventory.
17.
Goods held on consignment should be included in the consignor's ending
inventory.
18.
If prices never changed there would be no need for alternative inventory
methods.
19.
The specific identification method of costing inventories tracks the actual
physical flow of the goods available for sale.
20.
Management may choose any inventory costing method it desires as long as
the cost flow assumption chosen is consistent with the physical movement of
goods in the company.
21.
The First-In, First-Out (FIFO) inventory method results in an ending
inventory valued at the most recent cost.
22.
The matching principle requires that cost of goods sold be matched
against the ending Merchandise Inventory in order to determine income.
23.
The specific identification method of inventory valuation is desirable when
a company sells a large number of low-unit cost items.
24.
If a company has no beginning inventory and the unit cost of inventory
items does not change during the year, the value assigned to the ending
inventory will be the same under LIFO and average cost flow assumptions.
25.
If the unit price of inventory is increasing during a period, a company
using the LIFO inventory method will show less gross profit for the period,
than if it had used the FIFO inventory method.
26.
If a company changes its inventory valuation method, the effect of the
change on net income should be disclosed in the financial statements.
Page 2 of 9
T
F
27.
In periods of falling prices, LIFO will result in a higher ending inventory
valuation than FIFO.
28.
When the market value of inventory is lower than its cost, the inventory is
written down to its market value.
29.
The inventory turnover ratio is calculated as cost of goods sold divided by
ending inventory.
30.
An inventory turnover ratio that is too high may indicate that the company
is losing sales opportunities because of inventory shortages.
31.
The LIFO reserve is the difference between ending inventory using LIFO and
ending inventory if FIFO were used instead.
32.
The safeguarding of assets is an objective of a company's system of
internal control.
33.
An effective system of internal control centralizes functions in a single
capable individual.
34.
Requiring employees to take vacations is a weakness in the system of
internal controls because it does not promote operational efficiency.
35.
Bonding means insuring a company against theft by employees.
36.
An effective system of internal control requires that at least two
individuals be assigned to one cash drawer so that each can serve as a check on the other.
37.
The responsibility for ordering, receiving, and paying for merchandise
should be assigned to different individuals.
38.
Control over cash disbursements is improved if major expenditures are paid
by check.
39.
An example of segregation of duties is having a check signer recording cash
disbursements.
40.
To obtain maximum benefit from a bank reconciliation, the reconciliation
should be prepared by the employee authorized to sign checks.
41.
Cash equivalents include money market accounts, commercial paper, and U.S.
treasury bills held for ninety days or less.
42.
A basic principle of cash management is to increase the speed of paying
liabilities.
43.
A cash budget contributes to more effective cash management.
44.
The petty cash fund eliminates the need for a bank checking account.
45.
Trade Receivables can be an Account Receivable or a Note Receivable.
46.
Advances to employees are referred to as Trade Accounts Receivable.
47.
Accounts Receivable are one of a company's least liquid assets.
48.
An aging of Accounts Receivable is based on the premise that the longer the period an account remains unpaid, the greater the probability that it will eventually be collected.
49.
The allowance method of accounting for bad debts violates the matching
principle.
50.
If a company uses the allowance method to account for uncollectible
accounts, the entry to write off an uncollectible account only involves
balance sheet accounts.
51.
When the allowance method is used, the write-off of an account receivable
results in an expense at the time of write-off.
52.
When using the direct write-off method, year-end adjustments for Bad Debt
Expense must be made.
53.
Under the allowance method, the cash realizable value of receivables is the
same both before and after an account has been written off.
54.
In computing the maturity date of a note, the date the note is issued is
included but the due date is omitted.
55.
Interest on a 6-month, 10 percent, $10,000 note is calculated by multiplying $10,000 x 0.10 x 6/12.
56.
When a note is written to settle an open account, no entry is necessary.
57.
If a promissory note is dishonored, the payee should not record interest
income.
58.
The holder of a note adjusts for accrued interest by debiting Interest
Receivable and crediting Interest Revenue.
Page 3 of 9
T
F
59.
A concentration of credit risk is a threat of nonpayment from a single
customer or class of customers that could adversely affect the financial
health of the company.
60.
The receivables turnover ratio is calculated by dividing average receivables into cost of goods sold.
61.
The average collection period is frequently used to assess the effectiveness of a company's credit and collection policies.
62.
A factor buys receivables from businesses for a fee and collects the payment directly from customers.
63.
A major advantage of national credit cards to retailers is that there is no
charge to the retailer by the credit card companies for their services.
Page 4 of 9
II. Inventory Costing
Assume the following data for Vincent Vega Company for 2005:
January 1
Beginning Inventory
10 Units at $ 7.00 per Unit
March 18
Purchase
15 Units at $ 8.00 per Unit
March 22
Sale
20 Units at $10.00 per Unit
June 10
Purchase
20 Units at $ 8.50 per Unit
June 16
Sale
22 Units at $10.00 per Unit
October 30
Purchase
12 Units at $ 9.00 per Unit
a. Compute the inventory on hand on December 31 under the FIFO Periodic Method.
b. Compute the Cost of Goods Sold under the FIFO Periodic Method.
c. Compute the inventory on hand on December 31 under the LIFO Periodic Method.
d. Compute the Cost of Goods Sold under the LIFO Periodic Method.
e. Compute the inventory on hand on December 31 under the Average Cost Periodic
Method.
f. Compute the Cost of Goods Sold under the Average Cost Periodic Method.
Page 5 of 9
III. Matching
1.
The excess of sales revenue over Cost of Goods Sold
A.
Gross Profit
2.
Expenses, other than Cost of Goods Sold, that are
incurred in a business’ major line of business
B.
Sales Returns and Allowances
3.
Gross profit minus operating expenses
C.
Single-step Income Statement
4.
Gross profit divided by net Sales Revenue
D.
Operating Expenses
5.
Ratio of cost of goods sold to average inventory
E.
Operating Income
6.
The largest single expense of most merchandising businesses
F.
Inventory Turnover
7.
A contra account to Sales Revenue
G.
Cost of Goods Sold
8.
A format that groups all revenues together and
then lists and deducts all expenses together without drawing any subtotals
H.
Other Revenue
9.
Revenue that originates outside the main operations of a business
I.
Gross Profit Percentage
10.
Purchases minus Purchase Discounts and minus Purchase Returns and Allowances
J.
Net Purchases
IV. Matching
1.
A concept by which the least favorable figures are
presented in the financial statements
A.
LIFO
2.
A principle requiring the use of the same accounting methods and procedures from period to period
B.
Lower-of-cost-or-market Rule
3.
A principle requiring the financial statements to report enough information for outsiders to make knowledgeable decisions about the business
C.
Conservatism
4.
Requires that an asset be reported in the
financial statements at whichever is lower, its historical cost or its current replacement cost
D.
FIFO
5.
Inventory costing method in which ending inventory
is based on the costs of the most recent purchases
E.
Consistency Principle
6.
Inventory costing method in which ending inventory
is based on the oldest costs
F.
Full Disclosure Principle
7.
Inventory system maintaining a continual count of inventory
G.
Perpetual Inventory System
8.
Cost to the merchant for accepting a credit card
H.
Allowance for Doubtful Accounts
9.
A contra account to accounts receivable that holds the estimated amount of collection losses
J.
Direct Write-off Method
10.
The sum of the principal and interest due on the due date of a note
K.
Maturity Value
11.
A method of accounting for uncollectible accounts by which the company waits until the credit department decides that a customer's account is uncollectible, and then writes it off directly to Bad Debt Expense
L.
Allowance Method
12.
A method of recording collection losses based on estimates made before identification of specific uncollectible accounts
M.
Service Charge Expense
Page 6 of 9
V. Bank Reconciliation
The following information is available to prepare the Jules Winnfield Company’s
December 31 bank reconciliation.
1. Check No. 453, written for $250, was outstanding on November 30 and was not
returned with the December bank statement.
2. Check No. 478, written on December 26 for $400, was not returned with the
canceled checks.
3. Check No. 480, correctly written for $96 was incorrectly entered in the
Cash Disbursements Journal and posted as though it were for $69.
4. A deposit of $2,000, placed in the bank’s night depository after banking hours
on November 30, appeared on the December bank statement.
5. A deposit of $1,500, placed in the bank’s night depository after banking hours
on December 31, did not appear on the December bank statement.
6. Enclosed with the December bank statement was a debit memorandum for the monthly
bank service charge of $25.
7. Enclosed with the December bank statement was a memorandum that a $738 check received from Zed and deposited on December 27 was returned by the bank marked “Non-Sufficient Funds.”
8. The Cash balance on the December bank statement was $10,000.
9. Winnfield Company’s Cash ledger balance on December 31 is $11,640.
a. Prepare the appropriate bank reconciliation, in good form, in the space
provided on page 7.
b. Certain of the above items require entries on Jules Winnfield Company’s books. Prepare the necessary adjusting journal entries in the space provided on page 7.
Page 7 of 9
General Journal
Date
Description
Debit
Credit
Page 8 of 9
VI. Recording Transactions
Journalize the following transactions for M. Wallace Company using the perpetual
inventory method.
January 4 Purchased $5,300 merchandise from Marvin Company on account,
terms 3/10, n/30.
January 7 Paid $700 freight on January 4 transaction.
January 12 Received $300 credit from Marvin Company for merchandise returned.
January 13 Paid Marvin Company for merchandise in full, less discounts.
January 20 Made sales of $10,000 to customers on account, terms 2/10, n/30.
The merchandise cost $8,000.
January 22 Gave credit of $1,500 to customers for merchandise returns.
The merchandise cost $1,200.
January 29 Received payment in full, less discounts, from customers.
General Journal
Date
Description
Debit
Credit
Page 9 of 9
VII. Maturity Values
Calculate the maturity value for each of the following notes.
TERM
INTEREST RATE
PRINCIPAL
MATURITY VALUE
60 Days
10%
$ 8,000
3 Months
12%
$60,000
90 Days
5%
$ 4,000
VIII. Allowance Method
Butch Coolidge Company has accounts receivable of $340,000 and a normal balance in
allowance for doubtful accounts of $7,180.
a. Assuming that the aging of accounts receivable method is used, create the
journal entry needed to record bad debt expense if 4% of receivables will
become uncollectible.
b. Assume the same facts as above, but now assume a debit balance in allowance for
doubtful accounts of $2,000.
c. What is the difference between the direct write-off method versus the allowance
method for bad debts?
Here is link for file (http://www.google.com.pk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CDEQFjAA&url=http%3A%2F%2Fcms.montgomerycollege.edu%2FWorkArea%2Flinkit.aspx%3FLinkIdentifier%3Did%26ItemID%3D49843&ei=G-hnUbexI82OrgfPxIDgBw&usg=AFQjCNG3PRGSRAqJ_ha4hHbBlkYepvzneg&sig2=361Ye9BKstwdwODke2DtXQ&bvm=bv.45175338,d.bmk)
CLICK HERE TO GET THE ANSWER !!!!
MONTGOMERY COLLEGE
Department of Business and Economics
Rockville Campus
AC 201 REVIEW 2 (CHAPTERS 5-8)
Spring 2013
I. True/False
T
F
1.
Under a perpetual inventory system, cost of goods sold is determined
each time a sale occurs.
2.
The operating cycle involves the purchase and sale of merchandise as well as the subsequent collection of cash from credit sales.
3.
Operating expenses are subtracted from revenue for a service enterprise and
from gross profit for a merchandising enterprise.
4.
Net sales minus cost of goods sold is called gross profit.
5.
Under the perpetual inventory system, purchases of merchandise for sale are
recorded in the Merchandise Inventory account.
6.
The terms 2/10, net/30 mean that a 2 percent discount is allowed on
payments made within the 10 days discount period.
7.
If merchandise costing $2,500, with terms 2/10, n/30, is paid within
10 days, the amount of the purchase discount is $50.
8.
The Sales Returns and Allowances account and the Sales Discount account are
both classified as expense accounts.
9.
The revenue recognition principle applies to merchandising companies by
recognizing sales revenues when they are earned.
10.
When the terms of sale include a sales discount, it usually is advisable
for the buyer to pay within the discount period.
11.
The multiple-step income statement is considered more useful than the
single-step income statement because it highlights the components of net
income.
12.
Advertising Expense appears as a selling expense on the Income Statement.
13.
Non-operating activities include revenues and expenses that are related to
the company's main line of operations.
14.
Sales revenue, cost of goods sold, and gross profit are amounts on a
merchandising company's Income Statement not commonly found on the Income
Statement of a service company.
15.
If net sales are $1,000,000 and cost of goods sold is $800,000, the gross
profit rate is 20%.
16.
Under a periodic inventory system, the merchandise on hand at the end of
the period is determined by a physical count of the inventory.
17.
Goods held on consignment should be included in the consignor's ending
inventory.
18.
If prices never changed there would be no need for alternative inventory
methods.
19.
The specific identification method of costing inventories tracks the actual
physical flow of the goods available for sale.
20.
Management may choose any inventory costing method it desires as long as
the cost flow assumption chosen is consistent with the physical movement of
goods in the company.
21.
The First-In, First-Out (FIFO) inventory method results in an ending
inventory valued at the most recent cost.
22.
The matching principle requires that cost of goods sold be matched
against the ending Merchandise Inventory in order to determine income.
23.
The specific identification method of inventory valuation is desirable when
a company sells a large number of low-unit cost items.
24.
If a company has no beginning inventory and the unit cost of inventory
items does not change during the year, the value assigned to the ending
inventory will be the same under LIFO and average cost flow assumptions.
25.
If the unit price of inventory is increasing during a period, a company
using the LIFO inventory method will show less gross profit for the period,
than if it had used the FIFO inventory method.
26.
If a company changes its inventory valuation method, the effect of the
change on net income should be disclosed in the financial statements.
Page 2 of 9
T
F
27.
In periods of falling prices, LIFO will result in a higher ending inventory
valuation than FIFO.
28.
When the market value of inventory is lower than its cost, the inventory is
written down to its market value.
29.
The inventory turnover ratio is calculated as cost of goods sold divided by
ending inventory.
30.
An inventory turnover ratio that is too high may indicate that the company
is losing sales opportunities because of inventory shortages.
31.
The LIFO reserve is the difference between ending inventory using LIFO and
ending inventory if FIFO were used instead.
32.
The safeguarding of assets is an objective of a company's system of
internal control.
33.
An effective system of internal control centralizes functions in a single
capable individual.
34.
Requiring employees to take vacations is a weakness in the system of
internal controls because it does not promote operational efficiency.
35.
Bonding means insuring a company against theft by employees.
36.
An effective system of internal control requires that at least two
individuals be assigned to one cash drawer so that each can serve as a check on the other.
37.
The responsibility for ordering, receiving, and paying for merchandise
should be assigned to different individuals.
38.
Control over cash disbursements is improved if major expenditures are paid
by check.
39.
An example of segregation of duties is having a check signer recording cash
disbursements.
40.
To obtain maximum benefit from a bank reconciliation, the reconciliation
should be prepared by the employee authorized to sign checks.
41.
Cash equivalents include money market accounts, commercial paper, and U.S.
treasury bills held for ninety days or less.
42.
A basic principle of cash management is to increase the speed of paying
liabilities.
43.
A cash budget contributes to more effective cash management.
44.
The petty cash fund eliminates the need for a bank checking account.
45.
Trade Receivables can be an Account Receivable or a Note Receivable.
46.
Advances to employees are referred to as Trade Accounts Receivable.
47.
Accounts Receivable are one of a company's least liquid assets.
48.
An aging of Accounts Receivable is based on the premise that the longer the period an account remains unpaid, the greater the probability that it will eventually be collected.
49.
The allowance method of accounting for bad debts violates the matching
principle.
50.
If a company uses the allowance method to account for uncollectible
accounts, the entry to write off an uncollectible account only involves
balance sheet accounts.
51.
When the allowance method is used, the write-off of an account receivable
results in an expense at the time of write-off.
52.
When using the direct write-off method, year-end adjustments for Bad Debt
Expense must be made.
53.
Under the allowance method, the cash realizable value of receivables is the
same both before and after an account has been written off.
54.
In computing the maturity date of a note, the date the note is issued is
included but the due date is omitted.
55.
Interest on a 6-month, 10 percent, $10,000 note is calculated by multiplying $10,000 x 0.10 x 6/12.
56.
When a note is written to settle an open account, no entry is necessary.
57.
If a promissory note is dishonored, the payee should not record interest
income.
58.
The holder of a note adjusts for accrued interest by debiting Interest
Receivable and crediting Interest Revenue.
Page 3 of 9
T
F
59.
A concentration of credit risk is a threat of nonpayment from a single
customer or class of customers that could adversely affect the financial
health of the company.
60.
The receivables turnover ratio is calculated by dividing average receivables into cost of goods sold.
61.
The average collection period is frequently used to assess the effectiveness of a company's credit and collection policies.
62.
A factor buys receivables from businesses for a fee and collects the payment directly from customers.
63.
A major advantage of national credit cards to retailers is that there is no
charge to the retailer by the credit card companies for their services.
Page 4 of 9
II. Inventory Costing
Assume the following data for Vincent Vega Company for 2005:
January 1
Beginning Inventory
10 Units at $ 7.00 per Unit
March 18
Purchase
15 Units at $ 8.00 per Unit
March 22
Sale
20 Units at $10.00 per Unit
June 10
Purchase
20 Units at $ 8.50 per Unit
June 16
Sale
22 Units at $10.00 per Unit
October 30
Purchase
12 Units at $ 9.00 per Unit
a. Compute the inventory on hand on December 31 under the FIFO Periodic Method.
b. Compute the Cost of Goods Sold under the FIFO Periodic Method.
c. Compute the inventory on hand on December 31 under the LIFO Periodic Method.
d. Compute the Cost of Goods Sold under the LIFO Periodic Method.
e. Compute the inventory on hand on December 31 under the Average Cost Periodic
Method.
f. Compute the Cost of Goods Sold under the Average Cost Periodic Method.
Page 5 of 9
III. Matching
1.
The excess of sales revenue over Cost of Goods Sold
A.
Gross Profit
2.
Expenses, other than Cost of Goods Sold, that are
incurred in a business’ major line of business
B.
Sales Returns and Allowances
3.
Gross profit minus operating expenses
C.
Single-step Income Statement
4.
Gross profit divided by net Sales Revenue
D.
Operating Expenses
5.
Ratio of cost of goods sold to average inventory
E.
Operating Income
6.
The largest single expense of most merchandising businesses
F.
Inventory Turnover
7.
A contra account to Sales Revenue
G.
Cost of Goods Sold
8.
A format that groups all revenues together and
then lists and deducts all expenses together without drawing any subtotals
H.
Other Revenue
9.
Revenue that originates outside the main operations of a business
I.
Gross Profit Percentage
10.
Purchases minus Purchase Discounts and minus Purchase Returns and Allowances
J.
Net Purchases
IV. Matching
1.
A concept by which the least favorable figures are
presented in the financial statements
A.
LIFO
2.
A principle requiring the use of the same accounting methods and procedures from period to period
B.
Lower-of-cost-or-market Rule
3.
A principle requiring the financial statements to report enough information for outsiders to make knowledgeable decisions about the business
C.
Conservatism
4.
Requires that an asset be reported in the
financial statements at whichever is lower, its historical cost or its current replacement cost
D.
FIFO
5.
Inventory costing method in which ending inventory
is based on the costs of the most recent purchases
E.
Consistency Principle
6.
Inventory costing method in which ending inventory
is based on the oldest costs
F.
Full Disclosure Principle
7.
Inventory system maintaining a continual count of inventory
G.
Perpetual Inventory System
8.
Cost to the merchant for accepting a credit card
H.
Allowance for Doubtful Accounts
9.
A contra account to accounts receivable that holds the estimated amount of collection losses
J.
Direct Write-off Method
10.
The sum of the principal and interest due on the due date of a note
K.
Maturity Value
11.
A method of accounting for uncollectible accounts by which the company waits until the credit department decides that a customer's account is uncollectible, and then writes it off directly to Bad Debt Expense
L.
Allowance Method
12.
A method of recording collection losses based on estimates made before identification of specific uncollectible accounts
M.
Service Charge Expense
Page 6 of 9
V. Bank Reconciliation
The following information is available to prepare the Jules Winnfield Company’s
December 31 bank reconciliation.
1. Check No. 453, written for $250, was outstanding on November 30 and was not
returned with the December bank statement.
2. Check No. 478, written on December 26 for $400, was not returned with the
canceled checks.
3. Check No. 480, correctly written for $96 was incorrectly entered in the
Cash Disbursements Journal and posted as though it were for $69.
4. A deposit of $2,000, placed in the bank’s night depository after banking hours
on November 30, appeared on the December bank statement.
5. A deposit of $1,500, placed in the bank’s night depository after banking hours
on December 31, did not appear on the December bank statement.
6. Enclosed with the December bank statement was a debit memorandum for the monthly
bank service charge of $25.
7. Enclosed with the December bank statement was a memorandum that a $738 check received from Zed and deposited on December 27 was returned by the bank marked “Non-Sufficient Funds.”
8. The Cash balance on the December bank statement was $10,000.
9. Winnfield Company’s Cash ledger balance on December 31 is $11,640.
a. Prepare the appropriate bank reconciliation, in good form, in the space
provided on page 7.
b. Certain of the above items require entries on Jules Winnfield Company’s books. Prepare the necessary adjusting journal entries in the space provided on page 7.
Page 7 of 9
General Journal
Date
Description
Debit
Credit
Page 8 of 9
VI. Recording Transactions
Journalize the following transactions for M. Wallace Company using the perpetual
inventory method.
January 4 Purchased $5,300 merchandise from Marvin Company on account,
terms 3/10, n/30.
January 7 Paid $700 freight on January 4 transaction.
January 12 Received $300 credit from Marvin Company for merchandise returned.
January 13 Paid Marvin Company for merchandise in full, less discounts.
January 20 Made sales of $10,000 to customers on account, terms 2/10, n/30.
The merchandise cost $8,000.
January 22 Gave credit of $1,500 to customers for merchandise returns.
The merchandise cost $1,200.
January 29 Received payment in full, less discounts, from customers.
General Journal
Date
Description
Debit
Credit
Page 9 of 9
VII. Maturity Values
Calculate the maturity value for each of the following notes.
TERM
INTEREST RATE
PRINCIPAL
MATURITY VALUE
60 Days
10%
$ 8,000
3 Months
12%
$60,000
90 Days
5%
$ 4,000
VIII. Allowance Method
Butch Coolidge Company has accounts receivable of $340,000 and a normal balance in
allowance for doubtful accounts of $7,180.
a. Assuming that the aging of accounts receivable method is used, create the
journal entry needed to record bad debt expense if 4% of receivables will
become uncollectible.
b. Assume the same facts as above, but now assume a debit balance in allowance for
doubtful accounts of $2,000.
c. What is the difference between the direct write-off method versus the allowance
method for bad debts?
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Sunday 7 April 2013
Randall Company is a merchandising company that sells a single product. The company's inventories, production, and sales in units for the next three months have been forecasted as follows:
Randall
Company is a merchandising company that sells a single product. The company's
inventories, production, and sales in units for the next three months have been
forecasted as follows:
Units are sold for $12 each. One fourth of all sales are paid for in the month
of sale and the balance are paid for in the following month. Accounts
receivable at September 30 totaled $450,000.
Merchandise is purchased for $7 per unit. Half of the purchases are paid for in
the month of the purchase and the remainder are paid for in the month following
purchase. Selling and administrative expenses are expected to total $120,000
each month. One half of these expenses will be paid in the month in which they are
incurred and the balance will be paid in the following month. There is no
depreciation. Accounts payable at September 30 totaled $290,000.
Cash at September 30 totaled $80,000. A payment of $300,000 for purchase of
equipment is scheduled for November, and a dividend of $200,000 is to be paid
in December.
Required:
a. Prepare a schedule of expected cash collections for each of the months of
October, November, and December.
b. Prepare a schedule showing expected cash disbursements for merchandise
purchases and selling and administrative expenses for each of the months
October, November, and December.
c. Prepare a cash budget for each of the months October, November, and
December. There is no minimum required ending cash balance.
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1. The production budget is typically prepared prior to the sales budget. (Points : 3)
True
False
2. One benefit of budgeting is that it coordinates the activities of the entire organization. (Points : 3)
True
False
3. One difficulty with self-imposed budgets is that they are not subject to any type of review. (Points : 3)
True
False
4. The master budget is a network consisting of many separate budgets that are interdependent. (Points : 3)
True
False
5. Planning and control are essentially the same thing. (Points : 3)
True
False
6. Sales forecasts are drawn up after the cash budget has been completed because only then are the funds available for marketing known. (Points : 3)
True
False
7. In the selling and administrative budget, the non-cash charges (such as depreciation) are added to the total budgeted selling and administrative expenses to determine the expected cash disbursements for selling and administrative expenses. (Points : 3)
True
False
8. Which of the following represents the correct order in which the indicated budget documents for a manufacturing company would be prepared? (Points : 3)
Sales budget, cash budget, direct materials budget, direct labor budget
Production budget, sales budget, direct materials budget, direct labor budget
Sales budget, cash budget, production budget, direct materials budget
Selling and administrative expense budget, budgeted income statement, budgeted balance sheet
9. National Telephone company has been forced by competition to put much more emphasis on planning and controlling its costs. Accordingly, the company's controller has suggested initiating a formal budgeting process. Which of the follow steps will NOT help the company gain maximum acceptance by employees of the proposed budgeting system? (Points : 3)
Implementing the change quickly.
Including in department resonsibility reports only those items that are under the department manager's control.
Demonstrating top management support for the budgeting program.
Ensuring that favorable deviations of actual results from the budget, as well as unfavorable deviations, are discussed with the responsible managers.
10. Which of the following statements is not correct? (Points : 3)
The sales budget is the starting point in preparing the master budget.
The sales budget is constructed by multiplying the expected sales in units by the sales price.
The sales budget generally is accompanied by a computation of expected cash receipts for the forthcoming budget period.
The cash budget must be prepared prior to the sales budget because managers want to know the expected cash collections on sales made to customers in prior periods before projecting sales for the current period.
11. Budgeted production needs are determined by: (Points : 3)
adding budgeted sales in units to the desired ending inventory in units and deducting the beginning inventory in units from this total.
adding budgeted sales in units to the beginning inventory in units and deducting the desired ending inventory in units from this total.
adding budgeted sales in units to the desired ending inventory in units.
deducting the beginning inventory in units from budgeted sales in units.
12. The budgeted amount of raw materials to be purchased is determined by: (Points : 3)
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule.
subtracting the beginning inventory of raw materials to the raw materials needed to meet the production schedule.
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the beginning inventory of raw materials.
adding the beginning inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the desired ending inventory of raw materials.
13. Which of the following is not correct regarding the manufacturing overhead budget? (Points : 3)
Total budgeted cash disbursements for manufacturing overhead is equal to the total of budgeted variable and fixed manufacturing overhead.
Manufacturing overhead costs should be broken down by cost behavior.
The manufacturuing overhead budget should provide a schedule of all costs of production other than direct materials and direct labor.
A schedule showing budgeted cash disbursements for manufacturing overhead should be prepared for use in developing the cash budget.
14. Walsh Company expects sales of Product W to be 60,000 units in April, 75,000 units in May and 70,000 units in June. The company desires that the inventory on hand at the end of each month be equal to 40% of the next month's expected unit sales. Due to excessive production during March, on March 31 there were 25,000 units of Product W in the ending inventory. Given this information, Walsh Company's production of Product W for the month of April should be: (Points : 3)
60,000 units
65,000 units
75,000 units
66,000 units
15. Hagos Corporation is working on its direct labor budget for the next two months. Each unit of output requires 0.84 direct labor-hours. The direct labor rate is $9.40 per direct labor-hour. The production budget calls for producing 2,100 units in June and 1,900 units in July. If the direct labor work force is fully adjusted to the total direct labor-hours needed each month, what would be the total combined direct labor cost for the two months? (Points : 3)
$15,792
$15,002.40
$16,584.60
$31,584
16. Shuck Inc. bases its manufacturing overhead budget on budgeted direct labor-hours. The direct labor budget indicates that 8,100 direct labor-hours will be required in May. The variable overhead rate is $1.40 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $100,440 per month, which includes depreciation of $8,910. All other fixed manufacturing overhead costs represent current cash flows. The May cash disbursements for manufacturing overhead on the manufacturing overhead budget should be: (Points : 3)
$102,870
$11,340
$91,530
$11,780
17. The selling and administrative expense budget of Breckinridge Corporation is based on budgeted unit sales, which are 5,500 units for June. The variable selling and administrative expense is $1.00 per unit. The budget fixed selling and administrative expense is $101,200 per month, which includes depreciation of $6,050 per month. The remainder of the fixed selling and administrative expense represents current cash flows. The cash disbursements for selling and administrative expenses on the June selling and administrative expense budget should be: (Points : 3)
$100,650
$106,700
$5,500
$95,150
18. Avril Company makes collections on sales according to the following schedule:
30% in the month of sale
60% in the month following sale
8% in the second month following sale
The following sales are expected:
Expected Sales
January.........$100,000
February........$120,000
March.............$110,000
Cash collections in March should be budgeted to be: (Points : 3)
$110,000
$110,800
$105,000
$113,000
CLICK HERE TO GET THE ANSWER !!!! 1. The production budget is typically prepared prior to the sales budget. (Points : 3) True False 2. One benefit of budgeting is that it coordinates the activities of the entire organization. (Points : 3) True False 3. One difficulty with self-imposed budgets is that they are not subject to any type of review. (Points : 3) True False 4. The master budget is a network consisting of many separate budgets that are interdependent. (Points : 3) True False 5. Planning and control are essentially the same thing. (Points : 3) True False 6. Sales forecasts are drawn up after the cash budget has been completed because only then are the funds available for marketing known. (Points : 3) True False 7. In the selling and administrative budget, the non-cash charges (such as depreciation) are added to the total budgeted selling and administrative expenses to determine the expected cash disbursements for selling and administrative expenses. (Points : 3) True False 8. Which of the following represents the correct order in which the indicated budget documents for a manufacturing company would be prepared? (Points : 3) Sales budget, cash budget, direct materials budget, direct labor budget Production budget, sales budget, direct materials budget, direct labor budget Sales budget, cash budget, production budget, direct materials budget Selling and administrative expense budget, budgeted income statement, budgeted balance sheet 9. National Telephone company has been forced by competition to put much more emphasis on planning and controlling its costs. Accordingly, the company's controller has suggested initiating a formal budgeting process. Which of the follow steps will NOT help the company gain maximum acceptance by employees of the proposed budgeting system? (Points : 3) Implementing the change quickly. Including in department resonsibility reports only those items that are under the department manager's control. Demonstrating top management support for the budgeting program. Ensuring that favorable deviations of actual results from the budget, as well as unfavorable deviations, are discussed with the responsible managers. 10. Which of the following statements is not correct? (Points : 3) The sales budget is the starting point in preparing the master budget. The sales budget is constructed by multiplying the expected sales in units by the sales price. The sales budget generally is accompanied by a computation of expected cash receipts for the forthcoming budget period. The cash budget must be prepared prior to the sales budget because managers want to know the expected cash collections on sales made to customers in prior periods before projecting sales for the current period. 11. Budgeted production needs are determined by: (Points : 3) adding budgeted sales in units to the desired ending inventory in units and deducting the beginning inventory in units from this total. adding budgeted sales in units to the beginning inventory in units and deducting the desired ending inventory in units from this total. adding budgeted sales in units to the desired ending inventory in units. deducting the beginning inventory in units from budgeted sales in units. 12. The budgeted amount of raw materials to be purchased is determined by: (Points : 3) adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule. subtracting the beginning inventory of raw materials to the raw materials needed to meet the production schedule. adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the beginning inventory of raw materials. adding the beginning inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the desired ending inventory of raw materials. 13. Which of the following is not correct regarding the manufacturing overhead budget? (Points : 3) Total budgeted cash disbursements for manufacturing overhead is equal to the total of budgeted variable and fixed manufacturing overhead. Manufacturing overhead costs should be broken down by cost behavior. The manufacturuing overhead budget should provide a schedule of all costs of production other than direct materials and direct labor. A schedule showing budgeted cash disbursements for manufacturing overhead should be prepared for use in developing the cash budget. 14. Walsh Company expects sales of Product W to be 60,000 units in April, 75,000 units in May and 70,000 units in June. The company desires that the inventory on hand at the end of each month be equal to 40% of the next month's expected unit sales. Due to excessive production during March, on March 31 there were 25,000 units of Product W in the ending inventory. Given this information, Walsh Company's production of Product W for the month of April should be: (Points : 3) 60,000 units 65,000 units 75,000 units 66,000 units 15. Hagos Corporation is working on its direct labor budget for the next two months. Each unit of output requires 0.84 direct labor-hours. The direct labor rate is $9.40 per direct labor-hour. The production budget calls for producing 2,100 units in June and 1,900 units in July. If the direct labor work force is fully adjusted to the total direct labor-hours needed each month, what would be the total combined direct labor cost for the two months? (Points : 3) $15,792 $15,002.40 $16,584.60 $31,584 16. Shuck Inc. bases its manufacturing overhead budget on budgeted direct labor-hours. The direct labor budget indicates that 8,100 direct labor-hours will be required in May. The variable overhead rate is $1.40 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $100,440 per month, which includes depreciation of $8,910. All other fixed manufacturing overhead costs represent current cash flows. The May cash disbursements for manufacturing overhead on the manufacturing overhead budget should be: (Points : 3) $102,870 $11,340 $91,530 $11,780 17. The selling and administrative expense budget of Breckinridge Corporation is based on budgeted unit sales, which are 5,500 units for June. The variable selling and administrative expense is $1.00 per unit. The budget fixed selling and administrative expense is $101,200 per month, which includes depreciation of $6,050 per month. The remainder of the fixed selling and administrative expense represents current cash flows. The cash disbursements for selling and administrative expenses on the June selling and administrative expense budget should be: (Points : 3) $100,650 $106,700 $5,500 $95,150 18. Avril Company makes collections on sales according to the following schedule: 30% in the month of sale 60% in the month following sale 8% in the second month following sale The following sales are expected: Expected Sales January.........$100,000 February........$120,000 March.............$110,000 Cash collections in March should be budgeted to be: (Points : 3) $110,000 $110,800 $105,000 $113,000 CLICK HERE TO GET THE ANSWER !!!!
1. The production budget is typically prepared prior to the sales budget. (Points : 3)
True
False
2. One benefit of budgeting is that it coordinates the activities of the entire organization. (Points : 3)
True
False
3. One difficulty with self-imposed budgets is that they are not subject to any type of review. (Points : 3)
True
False
4. The master budget is a network consisting of many separate budgets that are interdependent. (Points : 3)
True
False
5. Planning and control are essentially the same thing. (Points : 3)
True
False
6. Sales forecasts are drawn up after the cash budget has been completed because only then are the funds available for marketing known. (Points : 3)
True
False
7. In the selling and administrative budget, the non-cash charges (such as depreciation) are added to the total budgeted selling and administrative expenses to determine the expected cash disbursements for selling and administrative expenses. (Points : 3)
True
False
8. Which of the following represents the correct order in which the indicated budget documents for a manufacturing company would be prepared? (Points : 3)
Sales budget, cash budget, direct materials budget, direct labor budget
Production budget, sales budget, direct materials budget, direct labor budget
Sales budget, cash budget, production budget, direct materials budget
Selling and administrative expense budget, budgeted income statement, budgeted balance sheet
9. National Telephone company has been forced by competition to put much more emphasis on planning and controlling its costs. Accordingly, the company's controller has suggested initiating a formal budgeting process. Which of the follow steps will NOT help the company gain maximum acceptance by employees of the proposed budgeting system? (Points : 3)
Implementing the change quickly.
Including in department resonsibility reports only those items that are under the department manager's control.
Demonstrating top management support for the budgeting program.
Ensuring that favorable deviations of actual results from the budget, as well as unfavorable deviations, are discussed with the responsible managers.
10. Which of the following statements is not correct? (Points : 3)
The sales budget is the starting point in preparing the master budget.
The sales budget is constructed by multiplying the expected sales in units by the sales price.
The sales budget generally is accompanied by a computation of expected cash receipts for the forthcoming budget period.
The cash budget must be prepared prior to the sales budget because managers want to know the expected cash collections on sales made to customers in prior periods before projecting sales for the current period.
11. Budgeted production needs are determined by: (Points : 3)
adding budgeted sales in units to the desired ending inventory in units and deducting the beginning inventory in units from this total.
adding budgeted sales in units to the beginning inventory in units and deducting the desired ending inventory in units from this total.
adding budgeted sales in units to the desired ending inventory in units.
deducting the beginning inventory in units from budgeted sales in units.
12. The budgeted amount of raw materials to be purchased is determined by: (Points : 3)
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule.
subtracting the beginning inventory of raw materials to the raw materials needed to meet the production schedule.
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the beginning inventory of raw materials.
adding the beginning inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the desired ending inventory of raw materials.
13. Which of the following is not correct regarding the manufacturing overhead budget? (Points : 3)
Total budgeted cash disbursements for manufacturing overhead is equal to the total of budgeted variable and fixed manufacturing overhead.
Manufacturing overhead costs should be broken down by cost behavior.
The manufacturuing overhead budget should provide a schedule of all costs of production other than direct materials and direct labor.
A schedule showing budgeted cash disbursements for manufacturing overhead should be prepared for use in developing the cash budget.
14. Walsh Company expects sales of Product W to be 60,000 units in April, 75,000 units in May and 70,000 units in June. The company desires that the inventory on hand at the end of each month be equal to 40% of the next month's expected unit sales. Due to excessive production during March, on March 31 there were 25,000 units of Product W in the ending inventory. Given this information, Walsh Company's production of Product W for the month of April should be: (Points : 3)
60,000 units
65,000 units
75,000 units
66,000 units
15. Hagos Corporation is working on its direct labor budget for the next two months. Each unit of output requires 0.84 direct labor-hours. The direct labor rate is $9.40 per direct labor-hour. The production budget calls for producing 2,100 units in June and 1,900 units in July. If the direct labor work force is fully adjusted to the total direct labor-hours needed each month, what would be the total combined direct labor cost for the two months? (Points : 3)
$15,792
$15,002.40
$16,584.60
$31,584
16. Shuck Inc. bases its manufacturing overhead budget on budgeted direct labor-hours. The direct labor budget indicates that 8,100 direct labor-hours will be required in May. The variable overhead rate is $1.40 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $100,440 per month, which includes depreciation of $8,910. All other fixed manufacturing overhead costs represent current cash flows. The May cash disbursements for manufacturing overhead on the manufacturing overhead budget should be: (Points : 3)
$102,870
$11,340
$91,530
$11,780
17. The selling and administrative expense budget of Breckinridge Corporation is based on budgeted unit sales, which are 5,500 units for June. The variable selling and administrative expense is $1.00 per unit. The budget fixed selling and administrative expense is $101,200 per month, which includes depreciation of $6,050 per month. The remainder of the fixed selling and administrative expense represents current cash flows. The cash disbursements for selling and administrative expenses on the June selling and administrative expense budget should be: (Points : 3)
$100,650
$106,700
$5,500
$95,150
18. Avril Company makes collections on sales according to the following schedule:
30% in the month of sale
60% in the month following sale
8% in the second month following sale
The following sales are expected:
Expected Sales
January.........$100,000
February........$120,000
March.............$110,000
Cash collections in March should be budgeted to be: (Points : 3)
$110,000
$110,800
$105,000
$113,000
CLICK HERE TO GET THE ANSWER !!!!
True
False
2. One benefit of budgeting is that it coordinates the activities of the entire organization. (Points : 3)
True
False
3. One difficulty with self-imposed budgets is that they are not subject to any type of review. (Points : 3)
True
False
4. The master budget is a network consisting of many separate budgets that are interdependent. (Points : 3)
True
False
5. Planning and control are essentially the same thing. (Points : 3)
True
False
6. Sales forecasts are drawn up after the cash budget has been completed because only then are the funds available for marketing known. (Points : 3)
True
False
7. In the selling and administrative budget, the non-cash charges (such as depreciation) are added to the total budgeted selling and administrative expenses to determine the expected cash disbursements for selling and administrative expenses. (Points : 3)
True
False
8. Which of the following represents the correct order in which the indicated budget documents for a manufacturing company would be prepared? (Points : 3)
Sales budget, cash budget, direct materials budget, direct labor budget
Production budget, sales budget, direct materials budget, direct labor budget
Sales budget, cash budget, production budget, direct materials budget
Selling and administrative expense budget, budgeted income statement, budgeted balance sheet
9. National Telephone company has been forced by competition to put much more emphasis on planning and controlling its costs. Accordingly, the company's controller has suggested initiating a formal budgeting process. Which of the follow steps will NOT help the company gain maximum acceptance by employees of the proposed budgeting system? (Points : 3)
Implementing the change quickly.
Including in department resonsibility reports only those items that are under the department manager's control.
Demonstrating top management support for the budgeting program.
Ensuring that favorable deviations of actual results from the budget, as well as unfavorable deviations, are discussed with the responsible managers.
10. Which of the following statements is not correct? (Points : 3)
The sales budget is the starting point in preparing the master budget.
The sales budget is constructed by multiplying the expected sales in units by the sales price.
The sales budget generally is accompanied by a computation of expected cash receipts for the forthcoming budget period.
The cash budget must be prepared prior to the sales budget because managers want to know the expected cash collections on sales made to customers in prior periods before projecting sales for the current period.
11. Budgeted production needs are determined by: (Points : 3)
adding budgeted sales in units to the desired ending inventory in units and deducting the beginning inventory in units from this total.
adding budgeted sales in units to the beginning inventory in units and deducting the desired ending inventory in units from this total.
adding budgeted sales in units to the desired ending inventory in units.
deducting the beginning inventory in units from budgeted sales in units.
12. The budgeted amount of raw materials to be purchased is determined by: (Points : 3)
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule.
subtracting the beginning inventory of raw materials to the raw materials needed to meet the production schedule.
adding the desired ending inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the beginning inventory of raw materials.
adding the beginning inventory of raw materials to the raw materials needed to meet the production schedule and subtracting the desired ending inventory of raw materials.
13. Which of the following is not correct regarding the manufacturing overhead budget? (Points : 3)
Total budgeted cash disbursements for manufacturing overhead is equal to the total of budgeted variable and fixed manufacturing overhead.
Manufacturing overhead costs should be broken down by cost behavior.
The manufacturuing overhead budget should provide a schedule of all costs of production other than direct materials and direct labor.
A schedule showing budgeted cash disbursements for manufacturing overhead should be prepared for use in developing the cash budget.
14. Walsh Company expects sales of Product W to be 60,000 units in April, 75,000 units in May and 70,000 units in June. The company desires that the inventory on hand at the end of each month be equal to 40% of the next month's expected unit sales. Due to excessive production during March, on March 31 there were 25,000 units of Product W in the ending inventory. Given this information, Walsh Company's production of Product W for the month of April should be: (Points : 3)
60,000 units
65,000 units
75,000 units
66,000 units
15. Hagos Corporation is working on its direct labor budget for the next two months. Each unit of output requires 0.84 direct labor-hours. The direct labor rate is $9.40 per direct labor-hour. The production budget calls for producing 2,100 units in June and 1,900 units in July. If the direct labor work force is fully adjusted to the total direct labor-hours needed each month, what would be the total combined direct labor cost for the two months? (Points : 3)
$15,792
$15,002.40
$16,584.60
$31,584
16. Shuck Inc. bases its manufacturing overhead budget on budgeted direct labor-hours. The direct labor budget indicates that 8,100 direct labor-hours will be required in May. The variable overhead rate is $1.40 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $100,440 per month, which includes depreciation of $8,910. All other fixed manufacturing overhead costs represent current cash flows. The May cash disbursements for manufacturing overhead on the manufacturing overhead budget should be: (Points : 3)
$102,870
$11,340
$91,530
$11,780
17. The selling and administrative expense budget of Breckinridge Corporation is based on budgeted unit sales, which are 5,500 units for June. The variable selling and administrative expense is $1.00 per unit. The budget fixed selling and administrative expense is $101,200 per month, which includes depreciation of $6,050 per month. The remainder of the fixed selling and administrative expense represents current cash flows. The cash disbursements for selling and administrative expenses on the June selling and administrative expense budget should be: (Points : 3)
$100,650
$106,700
$5,500
$95,150
18. Avril Company makes collections on sales according to the following schedule:
30% in the month of sale
60% in the month following sale
8% in the second month following sale
The following sales are expected:
Expected Sales
January.........$100,000
February........$120,000
March.............$110,000
Cash collections in March should be budgeted to be: (Points : 3)
$110,000
$110,800
$105,000
$113,000
CLICK HERE TO GET THE ANSWER !!!!
Tuesday 26 March 2013
For accounting purposes, the use of the cost method or the equity method used to account for long-term investments in common stock is determined by
A. the amount paid for the stock by the investor.
B. the extent of an investor's influence on the operating and financial affairs of the investee.
C. whether the stock has paid dividends in past years.
D. whether the market price of the stock changed during the year.
The balance in the Unrealized Loss-Available for Sale account will
A. appear on the balance sheet as a contra asset.
B. appear on the income statement under Other Expenses and Losses.
C. appear as a deduction in the stock/bIders' equity section.
D. not be shown on the financial statements until the securities are sold.
A company projects an increase in net income of $45,000 each year (or the next five years if it invests $300,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $100,000. What is the annual (accounting) rate of return on this investment?
A. 17%. (rounded)
8. 25%.
C. 20%.
D. 33%. (rounded)
E. Some other rate of return.
Prior period adjustments are reported
A. in the footnotes of the current year's financial statements.
B. on the current year's balance sheet.
C. on the current year's income statement.
D. on the current year's retained earnings statement.
Which one of the following would be classified as an extraordinary item?
A. Expropriation of property by a foreign government.
B. Losses attributed to a labor strike.
C. Write-down of inventories.
D. Gains or losses from sales of equipment.
Which of the following capital budgeting techniques explicitly takes the time value of money into consideration?
A. Annual rate of return
B. Cash payback
C. Net present value
D. Incremental analysis
Information that is generally reported for each class of stock on the balance sheet is
A. the market value.
B. the par value_
C. shares authorized.
D. shares issued.
The call price of callable preferred stock
A. usually sets a floor for the market price of the shares.
B. tends to set a ceiling on the market price of the shares.
C. is usually slightly below the par or stated value of the shares.
D. does not affect the market price of the shares.
On the balance sheet, Organization Costs
A. appears immediately below Retained Earnings in the stockholder's equity section.
B. appears as part of paid-in capital in the stockholder's equity section.
C. appears in the asset section.
D. appears in the liabilities section.
Which one of the following would not be considered an advantage of the corporate form of organization?
A. Limited liability of owners.
B Separate legal existence.
C Continuous life.
On December 31, 1996, the Dorsey Company reports the following amounts in its stockholders' equity section:
Preferred stock $1,000,000
Common stock 2,000,000
Paid-in capital in excess of par value - preferred 100,000
Paid-in capital in excess of stated value - common 1,900,000
Retained earnings 1,780,000
Treasury stock - common 180,000
The preferred stock is 7%, $50 par value, and cumulative. The common stock has a stated value of $10 per share. One million shares of common stock are authorized and 40,000 shares are held in the treasury.
Compute the following:
---------------------------------1. Total stockholders' equity
----------------------shares 2. Number of common shares issued.
_____________________ 3. Total legal capital for common stock.
_____________________ 4 Assuming that all the preferred stock was issued at the same time, what was the
issue price per share of the preferred stock.
_____________________ 5. Annual dividend for preferred stock.
6. Assume preferred dividends are two years in arrears (1995 and 1996). Book value per share would be
computed by dividing_________________ by___________________ (use numbers not words).
During 1996, the Quest Corporation had the following transactions and events:
1. Completed a 2 for 1 stock split in which the $10 par value common stock was changed to $5 par value stock.
2. Declared a cash dividend.
3. Made a prior period adjustment for understatement of net income
4. Declared a 10% stock dividend when the market price is $23.
Indicate the effects) of each of the foregoing items on the subdivisions of stockholders' equity. Present your answers in tabular form with the following columns. Use (I) for increase, (D) for decrease, and (NE) for no effect.
Paid-in Capital
Capital Additional Retained
Item Stock Paid-in Capital Earnings
1
2
3
4
The McGee Company had a net loss of $100,000 in 1996 when the selling price per unit was $20, the variable costs per unit were $10, and the fixed costs were $500,000. Management expects per unit data and total fixed costs to be the same in 199 6 Management has set a goal of earning net income of $150,000 in 1997.
units I. Compute the units sold in 1996.
units 2. Compute the number of units that would have to be sold in 1997 to reach management's desired net income level.
$------------------------------- 3. Assume that McGee actually sells 50,000 units in 1997. What would the unit selling
price have to be in order to reach the target net income?
For each item given, identify the two budgets in which it will appear. (12 points)
S Sales Budget
P Production Budget
DM Direct Materials Budget
DL Direct Labor Budget
MOH Manufacturing Overhead Budget
SA Selling and Administrative Expense Budget
C Cash Budget
BIS Budgeted Income Statement
BBS Budgeted Balance Sheet
I. Ending cash balance.
2. Total selling and administrative expenses
3. 
Total sales (in dollars)
4. 
Interest expense
5. 
Ending raw materials inventory (in dollars)
6. 
Ending finished goods inventory (in dollars)
Selected accounts of the Justice Manufacturing Company at year-end appear below. This is their first year of operations.
Raw Materials Inventory Work in Process Inventory
50,000 35,000 35.000 130,000
85,000
80,000
Finished Goods Inventory Cost of Goods Sold
130,000 100,000 100,000
Factory Labor Manufacturing Overhead
110,000 110,000 75,000 80,000
25,000
Answer the following questions based on the most probable explanation of the transactions above.
Example: $50,000 Ex. Cost of raw materials purchased.
$__________________ 1. Actual manufacturing overhead costs incurred.
$__________________ 2. Direct materials requisitioned for production.
$__________________ 3. Manufacturing overhead applied to production.
$__________________ 4. Direct Labor applied to production.
$____________________ 5. Indirect labor.
$__________________ 6. Cost of goods completed during the year.
The corporate charter of Hunter Corporation allows the issuance of a maximum of 2,000,000 shares of $1 par value common stock. During its first three years of operation, Hunter issued 1,200,000 shares at $15 per share. It later acquired 25,000 of these shares as treasury stock for $25 per share. Based on the above information, answer the following questions: (5 points)
shares 1. How many shares are outstanding?
$ ------------------------------ 2. What is the balance of the Common Stock account?
___________________ 3. What is the balance of the Treasury Stock account?
Use the categories (A-I) to correctly classify the following items (1-9) on the financial statements. Categories may be used more than once, or not at all.
A. Current Assets F. Long-term liabilities
B. Investments G. Stockholders Equity
C. Property, Plant, and Equipment H. Income Statement
D. Intangibles
E. Current Liabilities I.Amount will appear in either the Income Statement or the balance sheet
I. Bond Interest Receivable
2. Bond Interest Payable
3. 
Unrealized Loss on Investments - Income
4. 
Loss on Sale of Debt Investment
5. 
Bond sinking fund
6. 
An investment in stock of a 20-50% owned company, at equity
7. 
Federal Income Taxes Payable
8. 
Temporary investments
9. 
Discount on Bonds Payable
Put a "yes" in the blank if the category of investments require a year-end adjusting journal entry to revalue the investment to market value. Put a -no" if no year-end adjustment is required.
------------------------------1 Debt held to maturity.
------------------------------2 Available-for-sale portfolio.
------------------------------3 Trading portfolio.
-----------------------------4 Stock ownership representing 20-50% of shares outstanding.
If bonds can be converted into common stock,
a. they will sell at a lower price than comparable bonds without a conversion feature.
b. they will carry a higher interest rate than comparable bonds without the conversion feature.
c. they will be converted only if the issuer calls them in for conversion.
d. the bondholder may benefit if the market price of the common stock increases substantially.
Stockholders of a company may be reluctant to finance expansion through issuing more equity because
Under which of the following cases may a percentage change be computed?
a. The trend of the balances is decreasing but all balances are positive.
b. There is no balance in the base year.
c. There is a positive balance in the base year and a negative balance in the subsequent year.
d. There is a negative balance in the base year and a positive balance in the subsequent year.
2.
To determine the net cash provided (used) by operating activities, it is necessary to analyze
a. the current year's income statement.
b. a comparative balance sheet.
c. additional information.
d. all of these.
3. The acquisition of land by issuing common stock is
a. a noncash transaction which is not reported in the body of a statement of cash flows.
b. a cash transaction and would be reported in the body of a statement of cash flows.
c. a noncash transaction and would be reported in the body of a statement of cash flows.
d. only reported if the statement of cash flows is prepared using the direct method.
4. In preparing a statement of cash flows, a conversion of bonds into common stock will be reported in
a. the financing section.
b. the "extraordinary" section.
c. a separate schedule or note to the financial statements.
d. the stockholders' equity section.
5. Under which of the following cases may a percentage change be computed?
a. The trend of the balances is decreasing but all balances are positive.
b. There is no balance in the base year.
c. There is a positive balance in the base year and a negative balance in the subsequent year.
d. There is a negative balance in the base year and a positive balance in the subsequent year.
6. Evers, Inc. disposes of an unprofitable segment of its business. The operation of the segment suffered a $160,000 loss in the year of disposal. The loss on disposal of the segment was $80,000. If the tax rate is 30%, and income before income taxes was $1,000,000,
a. the income tax expense on the income before discontinued operations is $228,000.
b. the income from continuing operations is $700,000.
c. net income is $760,000.
d. the losses from discontinued operations are reported net of income taxes at $120,000.
7. A weakness of the current ratio is
a. the difficulty of the calculation.
b. that it doesn't take into account the composition of the current assets.
c. that it is rarely used by sophisticated analysts.
d. that it can be expressed as a percentage, as a rate, or as a proportion.
8. For the work of factory employees to be considered as direct labor, the work must be conveniently and
a. materially associated with raw materials conversion.
b. periodically associated with raw materials conversion.
c. physically associated with raw materials conversion.
d. promptly associated with raw materials conversion.
9. Tyler Manufacturing Company reported the following year-end information: beginning work in process inventory, $270,000; cost of goods manufactured, $774,000; beginning finished goods inventory, $378,000; ending work in process inventory, $330,000; and ending finished goods inventory, $396,000. Tyler Manufacturing Company's cost of goods sold for the year is
a. $756,000.
b. $792,000.
c. $714,000.
d. $378,000.
10. The labor costs that have been identified as indirect labor should be charged to
a. manufacturing overhead.
b. direct labor.
c. the individual jobs worked on.
d. salary expense.
11. An important assumption in using ABC is that
a. production must take place on a continuous basis.
b. all costs in an activity should respond proportionately to changes in the activity level of the cost driver.
c. production must take place on a just-in-time basis.
d. all costs are pushed through each process when customer orders are received.
12. Equivalent units are calculated by
a. multiplying the percentage of work done by the equivalent units of output.
b. dividing physical units by the percentage of work done.
c. multiplying the percentage of work done by the physical units.
d. dividing equivalent units by the percentage of work done.
13. Which is the true statement?
a. In a CVP income statement, costs and expenses are classified only by function.
b. The CVP income statement is prepared for both internal and external use.
c. The CVP income statement shows contribution margin instead of gross profit.
d. In a traditional income statement, costs and expenses are classified as either variable or fixed.
14. Which of the following statements about budget acceptance in an organization is true?
a. The most widely accepted budget by the organization is the one prepared by top management.
b. The most widely accepted budget by the organization is the one prepared by the department heads.
c. Budgets are hardly ever accepted by anyone except top management.
d. Budgets have a greater chance of acceptance if all levels of management have provided input into the budgeting process.
15. Which is true of budgets?
a. They are voted on and approved by stockholders.
b. They are used in the planning, but not in the control, process.
c. There is a standard form and structure for budgets.
d. They are used in performance evaluation.
16. If an investment center has generated a controllable margin of $90,000 and sales of $450,000, what is the return on investment for the investment center if average operating assets were $750,000 during the period?
a. 12%
b. 20%
c. 48%
d. 60%
17. The best measure of the performance of the manager of a profit center is the
a. rate of return on investment.
b. success in meeting budgeted goals for controllable costs.
c. amount of controllable margin generated by the profit center.
d. amount of contribution margin generated by the profit center.
18. A measure frequently used to evaluate the performance of the manager of an investment center is
a. the amount of profit generated.
b. the rate of return on funds invested in the center.
c. the percentage increase in profit over the previous year.
d. departmental gross profit.
19. The linens department of a large department store is
a. not a responsibility center.
b. a profit center.
c. a cost center.
d. an investment center.
20. A profit center is
a. a responsibility center that always reports a profit.
b. a responsibility center that incurs costs and generates revenues.
c. evaluated by the rate of return earned on the investment allocated to the center.
d. referred to as a loss center when operations do not meet the company's objectives.
21. The costing of inventories at standard cost for external financial statement reporting purposes is
a. not permitted.
b. preferable to reporting at actual costs.
c. in accordance with generally accepted accounting principles if significant differences exist between actual and standard costs.
d. in accordance with generally accepted accounting principles if significant differences do not exist between actual and standard costs.
22. A company uses 16,000 pounds of materials for which it paid $3.60 a pound. What is the materials price variance?
a. $.50.
b. $1.00.
c. $2.50.
d. Cannot be determined from the data provided.
CLICK HERE TO GET THE ANSWER !!!! For accounting purposes, the use of the cost method or the equity method used to account for long-term investments in common stock is determined by A. the amount paid for the stock by the investor. B. the extent of an investor's influence on the operating and financial affairs of the investee. C. whether the stock has paid dividends in past years. D. whether the market price of the stock changed during the year. The balance in the Unrealized Loss-Available for Sale account will A. appear on the balance sheet as a contra asset. B. appear on the income statement under Other Expenses and Losses. C. appear as a deduction in the stock/bIders' equity section. D. not be shown on the financial statements until the securities are sold. A company projects an increase in net income of $45,000 each year (or the next five years if it invests $300,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $100,000. What is the annual (accounting) rate of return on this investment? A. 17%. (rounded) 8. 25%. C. 20%. D. 33%. (rounded) E. Some other rate of return. Prior period adjustments are reported A. in the footnotes of the current year's financial statements. B. on the current year's balance sheet. C. on the current year's income statement. D. on the current year's retained earnings statement. Which one of the following would be classified as an extraordinary item? A. Expropriation of property by a foreign government. B. Losses attributed to a labor strike. C. Write-down of inventories. D. Gains or losses from sales of equipment. Which of the following capital budgeting techniques explicitly takes the time value of money into consideration? A. Annual rate of return B. Cash payback C. Net present value D. Incremental analysis Information that is generally reported for each class of stock on the balance sheet is A. the market value. B. the par value_ C. shares authorized. D. shares issued. The call price of callable preferred stock A. usually sets a floor for the market price of the shares. B. tends to set a ceiling on the market price of the shares. C. is usually slightly below the par or stated value of the shares. D. does not affect the market price of the shares. On the balance sheet, Organization Costs A. appears immediately below Retained Earnings in the stockholder's equity section. B. appears as part of paid-in capital in the stockholder's equity section. C. appears in the asset section. D. appears in the liabilities section. Which one of the following would not be considered an advantage of the corporate form of organization? A. Limited liability of owners. B Separate legal existence. C Continuous life. D Government regulation. Text Box: 6On December 31, 1996, the Dorsey Company reports the following amounts in its stockholders' equity section: Preferred stock $1,000,000 Common stock 2,000,000 Paid-in capital in excess of par value - preferred 100,000 Paid-in capital in excess of stated value - common 1,900,000 Retained earnings 1,780,000 Treasury stock - common 180,000 The preferred stock is 7%, $50 par value, and cumulative. The common stock has a stated value of $10 per share. One million shares of common stock are authorized and 40,000 shares are held in the treasury. Compute the following: ---------------------------------1. Total stockholders' equity ----------------------shares 2. Number of common shares issued. _____________________ 3. Total legal capital for common stock. _____________________ 4 Assuming that all the preferred stock was issued at the same time, what was the issue price per share of the preferred stock. _____________________ 5. Annual dividend for preferred stock. 6. Assume preferred dividends are two years in arrears (1995 and 1996). Book value per share would be computed by dividing_________________ by___________________ (use numbers not words). During 1996, the Quest Corporation had the following transactions and events: 1. Completed a 2 for 1 stock split in which the $10 par value common stock was changed to $5 par value stock. 2. Declared a cash dividend. 3. Made a prior period adjustment for understatement of net income 4. Declared a 10% stock dividend when the market price is $23. Indicate the effects) of each of the foregoing items on the subdivisions of stockholders' equity. Present your answers in tabular form with the following columns. Use (I) for increase, (D) for decrease, and (NE) for no effect. Paid-in Capital Capital Additional Retained Item Stock Paid-in Capital Earnings 1 2 3 4 Text Box: 7The McGee Company had a net loss of $100,000 in 1996 when the selling price per unit was $20, the variable costs per unit were $10, and the fixed costs were $500,000. Management expects per unit data and total fixed costs to be the same in 199 6 Management has set a goal of earning net income of $150,000 in 1997. units I. Compute the units sold in 1996. units 2. Compute the number of units that would have to be sold in 1997 to reach management's desired net income level. $------------------------------- 3. Assume that McGee actually sells 50,000 units in 1997. What would the unit selling price have to be in order to reach the target net income? For each item given, identify the two budgets in which it will appear. (12 points) S Sales Budget P Production Budget DM Direct Materials Budget DL Direct Labor Budget MOH Manufacturing Overhead Budget SA Selling and Administrative Expense Budget C Cash Budget BIS Budgeted Income Statement BBS Budgeted Balance Sheet I. Ending cash balance. 2. Total selling and administrative expenses 3. Total sales (in dollars) 4. Interest expense 5. Ending raw materials inventory (in dollars) 6. Ending finished goods inventory (in dollars) Text Box: 8Selected accounts of the Justice Manufacturing Company at year-end appear below. This is their first year of operations. Raw Materials Inventory Work in Process Inventory 50,000 35,000 35.000 130,000 85,000 80,000 Finished Goods Inventory Cost of Goods Sold 130,000 100,000 100,000 Factory Labor Manufacturing Overhead 110,000 110,000 75,000 80,000 25,000 Answer the following questions based on the most probable explanation of the transactions above. Example: $50,000 Ex. Cost of raw materials purchased. $__________________ 1. Actual manufacturing overhead costs incurred. $__________________ 2. Direct materials requisitioned for production. $__________________ 3. Manufacturing overhead applied to production. $__________________ 4. Direct Labor applied to production. $____________________ 5. Indirect labor. $__________________ 6. Cost of goods completed during the year. The corporate charter of Hunter Corporation allows the issuance of a maximum of 2,000,000 shares of $1 par value common stock. During its first three years of operation, Hunter issued 1,200,000 shares at $15 per share. It later acquired 25,000 of these shares as treasury stock for $25 per share. Based on the above information, answer the following questions: (5 points) shares 1. How many shares are outstanding? $ ------------------------------ 2. What is the balance of the Common Stock account? ___________________ 3. What is the balance of the Treasury Stock account? Use the categories (A-I) to correctly classify the following items (1-9) on the financial statements. Categories may be used more than once, or not at all. A. Current Assets F. Long-term liabilities B. Investments G. Stockholders Equity C. Property, Plant, and Equipment H. Income Statement D. Intangibles E. Current Liabilities I.Amount will appear in either the Income Statement or the balance sheet I. Bond Interest Receivable 2. Bond Interest Payable 3. Unrealized Loss on Investments - Income 4. Loss on Sale of Debt Investment 5. Bond sinking fund 6. An investment in stock of a 20-50% owned company, at equity 7. Federal Income Taxes Payable 8. Temporary investments 9. Discount on Bonds Payable Put a "yes" in the blank if the category of investments require a year-end adjusting journal entry to revalue the investment to market value. Put a -no" if no year-end adjustment is required. ------------------------------1 Debt held to maturity. ------------------------------2 Available-for-sale portfolio. ------------------------------3 Trading portfolio. -----------------------------4 Stock ownership representing 20-50% of shares outstanding. If bonds can be converted into common stock, a. they will sell at a lower price than comparable bonds without a conversion feature. b. they will carry a higher interest rate than comparable bonds without the conversion feature. c. they will be converted only if the issuer calls them in for conversion. d. the bondholder may benefit if the market price of the common stock increases substantially. Stockholders of a company may be reluctant to finance expansion through issuing more equity because Under which of the following cases may a percentage change be computed? a. The trend of the balances is decreasing but all balances are positive. b. There is no balance in the base year. c. There is a positive balance in the base year and a negative balance in the subsequent year. d. There is a negative balance in the base year and a positive balance in the subsequent year. 2. To determine the net cash provided (used) by operating activities, it is necessary to analyze a. the current year's income statement. b. a comparative balance sheet. c. additional information. d. all of these. 3. The acquisition of land by issuing common stock is a. a noncash transaction which is not reported in the body of a statement of cash flows. b. a cash transaction and would be reported in the body of a statement of cash flows. c. a noncash transaction and would be reported in the body of a statement of cash flows. d. only reported if the statement of cash flows is prepared using the direct method. 4. In preparing a statement of cash flows, a conversion of bonds into common stock will be reported in a. the financing section. b. the "extraordinary" section. c. a separate schedule or note to the financial statements. d. the stockholders' equity section. 5. Under which of the following cases may a percentage change be computed? a. The trend of the balances is decreasing but all balances are positive. b. There is no balance in the base year. c. There is a positive balance in the base year and a negative balance in the subsequent year. d. There is a negative balance in the base year and a positive balance in the subsequent year. 6. Evers, Inc. disposes of an unprofitable segment of its business. The operation of the segment suffered a $160,000 loss in the year of disposal. The loss on disposal of the segment was $80,000. If the tax rate is 30%, and income before income taxes was $1,000,000, a. the income tax expense on the income before discontinued operations is $228,000. b. the income from continuing operations is $700,000. c. net income is $760,000. d. the losses from discontinued operations are reported net of income taxes at $120,000. 7. A weakness of the current ratio is a. the difficulty of the calculation. b. that it doesn't take into account the composition of the current assets. c. that it is rarely used by sophisticated analysts. d. that it can be expressed as a percentage, as a rate, or as a proportion. 8. For the work of factory employees to be considered as direct labor, the work must be conveniently and a. materially associated with raw materials conversion. b. periodically associated with raw materials conversion. c. physically associated with raw materials conversion. d. promptly associated with raw materials conversion. 9. Tyler Manufacturing Company reported the following year-end information: beginning work in process inventory, $270,000; cost of goods manufactured, $774,000; beginning finished goods inventory, $378,000; ending work in process inventory, $330,000; and ending finished goods inventory, $396,000. Tyler Manufacturing Company's cost of goods sold for the year is a. $756,000. b. $792,000. c. $714,000. d. $378,000. 10. The labor costs that have been identified as indirect labor should be charged to a. manufacturing overhead. b. direct labor. c. the individual jobs worked on. d. salary expense. 11. An important assumption in using ABC is that a. production must take place on a continuous basis. b. all costs in an activity should respond proportionately to changes in the activity level of the cost driver. c. production must take place on a just-in-time basis. d. all costs are pushed through each process when customer orders are received. 12. Equivalent units are calculated by a. multiplying the percentage of work done by the equivalent units of output. b. dividing physical units by the percentage of work done. c. multiplying the percentage of work done by the physical units. d. dividing equivalent units by the percentage of work done. 13. Which is the true statement? a. In a CVP income statement, costs and expenses are classified only by function. b. The CVP income statement is prepared for both internal and external use. c. The CVP income statement shows contribution margin instead of gross profit. d. In a traditional income statement, costs and expenses are classified as either variable or fixed. 14. Which of the following statements about budget acceptance in an organization is true? a. The most widely accepted budget by the organization is the one prepared by top management. b. The most widely accepted budget by the organization is the one prepared by the department heads. c. Budgets are hardly ever accepted by anyone except top management. d. Budgets have a greater chance of acceptance if all levels of management have provided input into the budgeting process. 15. Which is true of budgets? a. They are voted on and approved by stockholders. b. They are used in the planning, but not in the control, process. c. There is a standard form and structure for budgets. d. They are used in performance evaluation. 16. If an investment center has generated a controllable margin of $90,000 and sales of $450,000, what is the return on investment for the investment center if average operating assets were $750,000 during the period? a. 12% b. 20% c. 48% d. 60% 17. The best measure of the performance of the manager of a profit center is the a. rate of return on investment. b. success in meeting budgeted goals for controllable costs. c. amount of controllable margin generated by the profit center. d. amount of contribution margin generated by the profit center. 18. A measure frequently used to evaluate the performance of the manager of an investment center is a. the amount of profit generated. b. the rate of return on funds invested in the center. c. the percentage increase in profit over the previous year. d. departmental gross profit. 19. The linens department of a large department store is a. not a responsibility center. b. a profit center. c. a cost center. d. an investment center. 20. A profit center is a. a responsibility center that always reports a profit. b. a responsibility center that incurs costs and generates revenues. c. evaluated by the rate of return earned on the investment allocated to the center. d. referred to as a loss center when operations do not meet the company's objectives. 21. The costing of inventories at standard cost for external financial statement reporting purposes is a. not permitted. b. preferable to reporting at actual costs. c. in accordance with generally accepted accounting principles if significant differences exist between actual and standard costs. d. in accordance with generally accepted accounting principles if significant differences do not exist between actual and standard costs. 22. A company uses 16,000 pounds of materials for which it paid $3.60 a pound. What is the materials price variance? a. $.50. b. $1.00. c. $2.50. d. Cannot be determined from the data provided. CLICK HERE TO GET THE ANSWER !!!!
For accounting purposes, the use of the cost method or the equity method used to account for long-term investments in common stock is determined by
A. the amount paid for the stock by the investor.
B. the extent of an investor's influence on the operating and financial affairs of the investee.
C. whether the stock has paid dividends in past years.
D. whether the market price of the stock changed during the year.
The balance in the Unrealized Loss-Available for Sale account will
A. appear on the balance sheet as a contra asset.
B. appear on the income statement under Other Expenses and Losses.
C. appear as a deduction in the stock/bIders' equity section.
D. not be shown on the financial statements until the securities are sold.
A company projects an increase in net income of $45,000 each year (or the next five years if it invests $300,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $100,000. What is the annual (accounting) rate of return on this investment?
A. 17%. (rounded)
8. 25%.
C. 20%.
D. 33%. (rounded)
E. Some other rate of return.
Prior period adjustments are reported
A. in the footnotes of the current year's financial statements.
B. on the current year's balance sheet.
C. on the current year's income statement.
D. on the current year's retained earnings statement.
Which one of the following would be classified as an extraordinary item?
A. Expropriation of property by a foreign government.
B. Losses attributed to a labor strike.
C. Write-down of inventories.
D. Gains or losses from sales of equipment.
Which of the following capital budgeting techniques explicitly takes the time value of money into consideration?
A. Annual rate of return
B. Cash payback
C. Net present value
D. Incremental analysis
Information that is generally reported for each class of stock on the balance sheet is
A. the market value.
B. the par value_
C. shares authorized.
D. shares issued.
The call price of callable preferred stock
A. usually sets a floor for the market price of the shares.
B. tends to set a ceiling on the market price of the shares.
C. is usually slightly below the par or stated value of the shares.
D. does not affect the market price of the shares.
On the balance sheet, Organization Costs
A. appears immediately below Retained Earnings in the stockholder's equity section.
B. appears as part of paid-in capital in the stockholder's equity section.
C. appears in the asset section.
D. appears in the liabilities section.
Which one of the following would not be considered an advantage of the corporate form of organization?
A. Limited liability of owners.
B Separate legal existence.
C Continuous life.
On December 31, 1996, the Dorsey Company reports the following amounts in its stockholders' equity section:
Preferred stock $1,000,000
Common stock 2,000,000
Paid-in capital in excess of par value - preferred 100,000
Paid-in capital in excess of stated value - common 1,900,000
Retained earnings 1,780,000
Treasury stock - common 180,000
The preferred stock is 7%, $50 par value, and cumulative. The common stock has a stated value of $10 per share. One million shares of common stock are authorized and 40,000 shares are held in the treasury.
Compute the following:
---------------------------------1. Total stockholders' equity
----------------------shares 2. Number of common shares issued.
_____________________ 3. Total legal capital for common stock.
_____________________ 4 Assuming that all the preferred stock was issued at the same time, what was the
issue price per share of the preferred stock.
_____________________ 5. Annual dividend for preferred stock.
6. Assume preferred dividends are two years in arrears (1995 and 1996). Book value per share would be
computed by dividing_________________ by___________________ (use numbers not words).
During 1996, the Quest Corporation had the following transactions and events:
1. Completed a 2 for 1 stock split in which the $10 par value common stock was changed to $5 par value stock.
2. Declared a cash dividend.
3. Made a prior period adjustment for understatement of net income
4. Declared a 10% stock dividend when the market price is $23.
Indicate the effects) of each of the foregoing items on the subdivisions of stockholders' equity. Present your answers in tabular form with the following columns. Use (I) for increase, (D) for decrease, and (NE) for no effect.
Paid-in Capital
Capital Additional Retained
Item Stock Paid-in Capital Earnings
1
2
3
4
The McGee Company had a net loss of $100,000 in 1996 when the selling price per unit was $20, the variable costs per unit were $10, and the fixed costs were $500,000. Management expects per unit data and total fixed costs to be the same in 199 6 Management has set a goal of earning net income of $150,000 in 1997.
units I. Compute the units sold in 1996.
units 2. Compute the number of units that would have to be sold in 1997 to reach management's desired net income level.
$------------------------------- 3. Assume that McGee actually sells 50,000 units in 1997. What would the unit selling
price have to be in order to reach the target net income?
For each item given, identify the two budgets in which it will appear. (12 points)
S Sales Budget
P Production Budget
DM Direct Materials Budget
DL Direct Labor Budget
MOH Manufacturing Overhead Budget
SA Selling and Administrative Expense Budget
C Cash Budget
BIS Budgeted Income Statement
BBS Budgeted Balance Sheet
I. Ending cash balance.
2. Total selling and administrative expenses
3. Total sales (in dollars)
4. Interest expense
5. Ending raw materials inventory (in dollars)
6. Ending finished goods inventory (in dollars)
Selected accounts of the Justice Manufacturing Company at year-end appear below. This is their first year of operations.
Raw Materials Inventory Work in Process Inventory
50,000 35,000 35.000 130,000
85,000
80,000
Finished Goods Inventory Cost of Goods Sold
130,000 100,000 100,000
Factory Labor Manufacturing Overhead
110,000 110,000 75,000 80,000
25,000
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|
|
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|
Answer the following questions based on the most probable explanation of the transactions above.
Example: $50,000 Ex. Cost of raw materials purchased.
$__________________ 1. Actual manufacturing overhead costs incurred.
$__________________ 2. Direct materials requisitioned for production.
$__________________ 3. Manufacturing overhead applied to production.
$__________________ 4. Direct Labor applied to production.
$____________________ 5. Indirect labor.
$__________________ 6. Cost of goods completed during the year.
The corporate charter of Hunter Corporation allows the issuance of a maximum of 2,000,000 shares of $1 par value common stock. During its first three years of operation, Hunter issued 1,200,000 shares at $15 per share. It later acquired 25,000 of these shares as treasury stock for $25 per share. Based on the above information, answer the following questions: (5 points)
shares 1. How many shares are outstanding?
$ ------------------------------ 2. What is the balance of the Common Stock account?
___________________ 3. What is the balance of the Treasury Stock account?
Unrealized Loss on Investments - IncomeLoss on Sale of Debt InvestmentBond sinking fundAn investment in stock of a 20-50% owned company, at equityFederal Income Taxes PayableTemporary investmentsDiscount on Bonds Payable
For accounting purposes, the use of the cost method or the equity method used to account for long-term investments in common stock is determined by
A. the amount paid for the stock by the investor.
B. the extent of an investor's influence on the operating and financial affairs of the investee.
C. whether the stock has paid dividends in past years.
D. whether the market price of the stock changed during the year.
The balance in the Unrealized Loss-Available for Sale account will
A. appear on the balance sheet as a contra asset.
B. appear on the income statement under Other Expenses and Losses.
C. appear as a deduction in the stock/bIders' equity section.
D. not be shown on the financial statements until the securities are sold.
Beauda Medical Center
Lance Popperson woke up in a sweat. He felt an anxiety attack coming on. Popperson popped two anti-anxiety pills, laid down to try and sleep for the third time that night, and thought once again about his dilemma.
Popperson is an associate with the accounting firm of Scoop and Shovel LLP. He recently discovered, through a casual conversation with Brad Snow, a friend of his on the audit staff, that one of the firm’s clients managed by Snow recently received complaints that its heart monitoring equipment was malfunctioning. Cardio-Systems Monitoring, Inc. (CSM) called for a meeting of the lawyers, auditors, and top management to discuss what to do about the complaints from health care facilities that had significantly increased between the first two months of 2010 and the last two months of that year. Doctors at these facilities claim the systems shut off for brief periods and, in one case, the hospital was unable to save a patient that went into cardiac arrest.
Popperson got out of bed, went for a glass of water, looked at the clock that said 2:58am, and tried to sleep for the fourth time. He tossed and turned and wondered what he should do about the fact that Beauda Medical Center, his current audit client, plans to buy 20 units of Cardio-Systems heart monitoring equipment for its brand new medical facility in the outskirts of Beauda.
This case discusses when and how to keep confidentiality of a client.
Ethical Issues
The CPA promises confidentiality to his clients so the client will trust him with information needed to perform an audit of the financial statements taken as a whole. Clients have a right to expect accountants to honor the promise of confidentiality. If the CPA should tell Beauda Medical Center confidential information about CSM, why would Beauda trust the CPA not to tell Beauda’s confidential information? The threat of harm or death to patients may be significant so Popperson should try to get CSM to correct or disclose the problem. If Popperson discloses the confidential information to Beauda, Beauda would probably cancel the order of 20 units. Would that cancellation cause financial distress or bankruptcy for CSM? Using virtue theories, the values of trustworthiness, respect, responsibility, fairness, caring and citizenship are challenged by the dilemma. Using utilitarianism theories, Popperson and the firm will have to decide whether keeping confidentiality or telling of harm to patients provides the greatest good.
Questions
- Assume both Popperson and Snow are CPAs. Do you think Snow violated his confidentiality obligation under the AICPA Code of Professional Conduct by informing Popperson about the faulty equipment at CSM? Why or why not?
- Popperson has not told anyone connected to the Beauda Medical Center audit about the situation at CSM. What do you think he should do with the information? Be sure to consider are Popperson’s ethical obligations in answering this question.
- Assume Popperson informs the senior in charge of the Beauda audit and the senior informs the manager, Kelly Korn. A meeting is held the next day with all parties in the office of Iceman Cometh, the managing partner of the firm. Here’s how it goes:
Iceman: If we tell Beauda about the problems at CSM, we will have violated our confidentiality obligation as a firm to CSM. Moreover, we may lose both clients.
Kelly: Lance, you are the closest to the situation. How do you think Beauda’s top hospital administrators would react if we told them?
Lance: They wouldn’t buy the equipment.
Iceman: Once we tell them, we’re subject to investigation by our State Board of Accountancy for violating the confidentiality obligation we have to CSM. We don’t want to alert the board and have it investigate our actions. What’s worse is we may be flagged for the confidentiality violation in our next peer review.
Kelly: Who would do that? I mean, CSM won’t know about it and the Beauda people are going to be happy we prevented them from buying what may be faulty equipment.
Senior: I agree with Kelly. They are not likely to say anything.
Iceman: I don’t like it. I think we should be silent and find another way to warn Beauda Medical without violating confidentiality.
Lance: What about contacting the state board for advice?
Follow-up questions
3 (a) Discuss all ethical and professional matters of concern for the firm of Scoop and Shovel LLP, in deciding whether to do as Iceman Cometh suggests and not tell the administrators at Beauda Medical Center?
(b) What do you think about Lance’s suggestion to contact the state board for advice on the matter? Is that the function of a state board of accountancy?
First Community Church
First Community Church is the largest church in the city of Perpetual Happiness. Yes, it’s in California!
A meeting was held on Friday, November 16 to address the fact that money had been stolen from the weekly collection box during the course of the year and church leaders were getting quite concerned. At first, no one paid much attention as the amounts were small and could have been attributed to inadvertent errors due to discrepancies between the actual count and what really was collected. However, after 45 weeks of the continuous discrepancies, the total amount of differences had become alarming. Eddie Wong, the controller for the church, estimated the total was now $23,399. That represents well over 5 percent of their annual collections from church members totaling about $400,000.
The meeting began at 9am, a time that was early for the church leaders who often had late evening calls to make. The church staff brought donuts, bagels and coffee to help get the meeting off to a good start. But that’s not the way it happened.
“I want an explanation,” said Allen Yuen, the executive director of the church. “The boards of trustees are on my back about this matter. Some of them talk about this Sarbanes-Oxley Act and our lack of internal controls. All it’s foreign to me but I know indignation when I see it!”
“I can’t explain it, Allen,” responded Eddie Wong.
“Jennie. How about you?” Yuen asked. He was addressing Jennie Lin, the member of the executive committee of the board of trustees who was directly responsible for the count each week.
Jennie seemed uncomfortable. She hesitated before saying: “I think my count is correct. I take the money given to me by Joey, put it in the safe, and then Eddie opens the safe on Monday morning. He records the cash receipts and makes a bank deposit.”
Eddie said, “That’s right. My deposit always matches the amount of money reported by Jennie.”
“That doesn’t make sense,” Yuen said. “Someone is getting his or her hands on the money between the collection process and recording of the amount. I trust you, Jennie, to watch over these things and the internal control matter.”
“Perhaps the tally amount record independently submitted by the church volunteers has been overstated.” Jennie said.
“Why would that happen?” Yuen asked. “I mean, while it could happen and it would be an honest mistake, it seems unlikely.”
Jennie was starting to sweat. She decided a diversion was in order. “Maybe someone gets their hands on the collection box after the tally and before Joey gives it to me.”
Joey Ching is the accounting manager who delivers the collection box and tally sheet to Jennie after each service. Joey goes to church on a regular basis and volunteered to do the job in order to establish a control in the process.
At this point Jennie lowered her head while she waited for a response. It came from Alex Yuen. “Jennie, are you accusing Joey of stealing money from the church collection box?”
Jennie shook her head as if to say no. She was visibly upset. A phone call came in for Yuen and the meeting had to break up. The group agreed to continue the discussion in two days. In the meantime, Alan Yuen said he’d call Joey Ching and ask him to attend the next meeting.
Jennie went back to her office, closed the door, and started to reflect on what she had just done. The truth is that Jennie had been taking the money each week and giving it to a homeless shelter two blocks from the church. Some of the homeless attend church services and Jennie has befriended many of them. She knew it was wrong to take money from the collection box, but she thought it was for a very good cause and that the church clergy would approve. She never thought about getting caught since she told the bookkeeper to record the lower amount. Now, she feels guilty about bringing Joey into the picture.
This case looks at challenges facing many non-profits, using volunteers to provide internal controls.
Ethical Issues
Jennie has succumbed to the fraud triangle. Jennie is not fulfilling her fiduciary duty. By stealing monies, fraud and deceit, Jennie has committed acts discreditable to the profession. From the rights perspective, the church has a right to determine its donation to the shelter through the normal process. The church members have a right to expect the staff to uphold their fiduciary duties. From the deontology perspective, Jennie has a duty not to steal or take money without permission of the church. From a utilitarian perspective not all the constituencies of the church may have been considered.
Questions
- Assume Jennie Lin is a CPA. Evaluate her actions from an ethical perspective. Jennie believed her actions were proper because taking the money from the church and giving it to the homeless served a greater good. Do you agree with her position from an ethical perspective?
- As a member of the board of trustees of the church, what are Jennie’s ethical obligations to the church? Do you think it is more difficult to establish strong internal controls in a nonprofit such as First Community Church as compared to a public or privately-owned company? Why or why not?
- (a) Assume Jennie calls Joey and explains the situation. She tells Joey about the impending call from Alex Yuen and, as a friend, asks him not to come to the meeting so she could explain what she has done without his involvement. If you were Joey, would you stay away from the meeting? Why or why not?
4. (b) Assume Joey stays away, Jennie explains why she did what she did, and, after due deliberation, Yuen fires Jennie and tells her she must replace the money she “stole” from the collection box. How would you evaluate Yuen’s actions from an ethical perspective?
ZZZZ Best*
The story of ZZZZ Best is one of greed and audaciousness. It is the story of a 15-year old boy from Reseda, California who was driven to be successful regardless of the costs. His name is Barry Minkow.
Minkow had high hopes to make it big – to be a millionaire very early in life. He started a carpet cleaning business in the garage of his home. Minkow realized early on that he was not going to become a millionaire cleaning other people’s carpets. He had bigger plans than that. Minkow was going to make it big in the insurance restoration business. In other words, ZZZZ Best would contract to do carpet and drapery cleaning jobs after a fire or flood. Since the damage from the fire or flood probably would be covered by insurance, the customer would be eager to have the work done. The only problem with Minkow’s insurance restoration idea was that it was all a fiction. There were no insurance restoration jobs, at least for ZZZZ Best. In the process of creating the fraud, Minkow was able to dupe the auditors, Ernst & Whinney into thinking the insurance restoration business was real. In fact, over 80 percent of his revenue was allegedly from this work. The auditors never caught on until it was too late.
How Barry Became a Fraudster
Minkow wrote a book, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback** that provides some insights into the mind of a 15-year old kid
__________________
* The facts are derived from a video by the ACFE, Cooking the Books: What Every Accountant Should Know about Fraud.
**Barry Minkow, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback (Nashville, TN: Thomas Nelson, 1995).
who was called a “wonder boy” on Wall Street until the bubble burst. He was trying to find a way to drum up customers for his fledgling carpet cleaning business. One day, while he was alone in the garage-office, Minkow called Channel 4 in Los Angeles. He disguised his voice to sound not like a teenager and told a producer that he had just had his carpets cleaned by the 16-year owner of ZZZZ Best and was very impressed that a high school junior was running his own business. He sold the producer on the idea that it would be good for society to hear the success story about a high school junior running his own business. The producer bought it lock, stock and carpet cleaner. Minkow gave the producer the phone number of ZZZZ Best and waited. It took less than five minutes for the call to come in. Minkow answered the phone and when the producer asked to speak with Mr. Barry Minkow, Minkow said: “Who may I say is calling?” Within days a film crew was in his garage shooting ZZZZ Best at work. The story aired that night and it was followed by more calls from radio stations and other television shows wanting to do interviews. People called demanding that Barry Minkow personally clean their carpets.
As his income increased in the spring of 1983, Minkow found it increasingly difficult to run the company without a checking account. He managed to find a banker that was so moved by his story that the banker would agree to allow someone under-aged to open a checking account. Minkow used the money to buy cleaning supplies and other necessities. Even though his business was growing, Minkow ran into trouble paying back loans and interest when due.
Minkow developed a plan of action. He was tired of worrying about not having enough money. He went to his garage – where all his great ideas first began – and he looked at his bank account statement which showed that he had more money than he thought he had based on his own records. Minkow soon realized it was because some checks he had written had not been cashed by customers so it didn’t yet shown up on the bank statement. Voila! Minkow started to kite checks between two or more banks. He would write a check on one ZZZZ Best account and deposit it into another. Since it might take a few days for the check written on bank number one to clear that banks’ records, at least back then when checks weren’t always processed in real time, Minkow could pay some bills out of the second account and the first bank would not know – at least for a few days – that Minkow had written a check on his account when, in reality, he had a negative balance. The bank didn’t know it because some of the checks that Minkow had written before the visit to bank number two had not cleared his account in bank number one.
It wasn’t long thereafter that Minkow realized he could kite checks big-time. Not only that, he could make the transfer of funds at the end of a month or a year and show a higher balance than really existed in bank number one and carry it on to the balance sheet. Since Minkow did not count the check written on his account in bank one as an outstanding check, he was able to double-count.
Time to Expand the Fraud
Over time, Minkow moved on to bigger and bigger frauds like having his trusted cohorts confirm to banks and other interested parties that ZZZZ Best was doing insurance restoration jobs. Minkow used the phony jobs and phony revenue to convince bankers to make loans to ZZZZ Best. He had cash remittance forms made up from non-existent customers with whatever sales amount he wanted to appear on the document. He even had a co-conspirator write on the bogus remittance form, “job well done.” Minkow could then show a lot more revenue that he was really making.
Minkow’s phony financial statements enabled him to borrow more and more money and expand the number of carpet cleaning outlets. However, Minkow’s personal tastes had become increasingly more expensive including purchasing a Ferrari with the borrowed funds and putting a down payment on a 5,000-square foot home. So, the question was: How do you solve a perpetual cash flow problem? You go public! That’s right, Minkow made a public offering of stock in ZZZZ Best. Of course he owned a majority of the stock to maintain control of the company.
Minkow had made it to the big leagues. He was on Wall Street. He had investment bankers, CPAs and attorneys all working for him -- the 15-year old kid from Reseda who had turned a mom and pop operation into a publicly-owned corporation.
Barry Goes Public
Minkow’s first audit was for the twelve months ended April 30, 1986. A sole practitioner performed the audit. (There are eerie similarities in the Madoff fraud with its small practitioner firm – Frichling & Horowita – conducting the audit of a multi-billion dollar operation and that of the sole practitioner audit of ZZZZ Best).
Minkow had established two phony front companies that allegedly placed insurance restoration jobs for ZZZZ Best. He had one of his cohorts make out invoices for services and respond to questions about the company. There was enough paperwork to fool the auditor into thinking the jobs were real and the revenue was supportable. However, the auditor never visited any of the insurance restoration sites. If he had done so, there would have been no question in his mind that ZZZZ Best was a big fraud.
Pressured to get a big-time CPA firm to do his audit as he moved into the big leagues, Minkow hired Ernst &Whinney to perform the April 30, 1987 fiscal year-end audit. Minkow continued to be one step ahead of the auditors. That is until the Ernst & Whinney auditors insisted on going to see an insurance restoration site. They wanted to confirm that all the business – all the revenues --- that Minkow had said was coming in to ZZZZ Best, was real.
The engagement partner drove to an area in Sacramento, California where Minkow did a lot of work – supposedly. He looked for a building that seemed to be a restoration job. Why he did that isn’t clear but he identified a building that seemed to be the kind that would be a restoration job in process.
Earlier in the week, Minkow sent one of his cohorts to find a large building in Sacramento that appeared to be a restoration site. As luck would have it, Minkow’s associate picked out the same site as had the partner later on. Minkow’s cohorts found the leasing agent for the building. They convinced the agent to give them the keys so that they could show the building to some potential tenants over the weekend. Minkow’s helpers went up to the site before the arrival of the partner and placed placards on the walls that indicated ZZZZ Best was the contractor for the building restoration. In fact, the building was not fully constructed at the time but it looked as if some restoration work would have been going on at the site.
Minkow was able to pull it off in part due to luck and in part because the Ernst and Whinney auditors did not want to lose the ZZZZ Best account. It had become a large revenue producer for the firm and Minkow seemed destined for greater and greater achievements. Minkow was smart and he used the leverage of the auditors not wanting to lose the ZZZZ Best account as a way to complain whenever they became too curious about the insurance restoration jobs. He would even threaten to take his business away from Ernst and Whinney and give it to other auditors.
Minkow also took a precaution with the site visit. He had the auditors sign a confidentiality agreement that they would not make any follow-up calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration work. This prevented the auditors from corroborating the insurance restoration contracts with independent third parties.
The Fraud Starts to Unravel
It was a Los Angeles housewife that started the problems for ZZZZ Best that would eventually lead to the demise of the company. Since Minkow was a well known figure and flamboyant character, the Los Angeles Times did an expose about the carpet cleaning business. The Los Angeles housewife read the story about Minkow and recalled that ZZZZ Best had overcharged her for services in the early years by increasing the amount of the credit card charge for carpet cleaning services.
Minkow had gambled that most people don’t check their monthly statements so he could get away with the petty fraud. However, the housewife did notice the overcharge, complained to Minkow, and eventually he returned the overpayment. She couldn’t understand why Minkow would have had to resort to such low levels back then if he was as successful as the L.A. Times article made him out to be. So, she called the reporter to find out more and that ultimately led to the investigation of ZZZZ Best and future stories that weren’t so flattering.
Since Minkow continued to spend lavishly on himself and his possessions, he always seemed to need more and more money. It got so bad over time that he was to close to defaulting on loans and had to make up stories to keep the creditors at bay, and he couldn’t pay his suppliers. The complaints kept coming in and eventually the house of cards that was ZZZZ Best came crashing down.
During the time that the fraud was unraveling, Ernst and Whinney decided to resign from the ZZZZ best audit. The firm never did issue an audit report. It had started to doubt the veracity of Minkow and the reality of business at ZZZZ Best.
The procedure to follow when a change of auditor occurs is for the company to file an 8-K form with the SEC and the audit firms prepares an exhibit commenting on the accuracy of the disclosures in the 8-K. The exhibit is attached to the form that is sent to the SEC within 30 days of the change. Ernst & Whinney waited the full 30-day period and the SEC released the information to the public 45 days after the change had occurred. Meanwhile, ZZZZ Best had filed for bankruptcy. During the period of time that had elapsed, Minkow had borrowed more than $1 million dollars and the lenders never were repaid. The Bankruptcy laws protected Minkow and ZZZZ Best from having to make those payments.
Legal Liability Issues
The ZZZZ Best fraud was one of the largest of its time. ZZZZ Best reportedly settled a shareholder class action lawsuit for $35 million. Ernst & Whinney was sued by a bank that had made a multimillion-dollar loan based on the financial statements for the three-month period ending July 31, 1986. The bank claimed that it had relied on the review report[1] issued by Ernst & Whinney in granting the loan to ZZZZ Best. However, the firm had indicated in its review report that it was not issuing an opinion on the ZZZZ Best financial statements. The judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly disclaimed issuing any opinion on the statements.
Barry Minkow was charged with engaging in a $100 million fraud scheme. He was sentenced to a term of 25 years. Minkow was paroled after serving eight years in jail. During his time in prison, Minkow became involved in Christian ministry, which continued after his probationary release from prison in April 1995. Today he is senior pastor of the Community Bible Church in San Diego, California, having renounced his felonious acts. Minkow is recognized as an expert on fraud, and speaks on the subject to university students and the business community in an effort to prevent fraud.
This case discusses the actual case of ZZZZ Best and Barry Minkow. The auditors ignored common sense and did not use due care in the audit.
Ethical Issues
This case shows how auditors did not use due care or skepticism in the audit of ZZZZ Best. The auditors lost independence and became bedazzled by Barry Minkow, the whiz kid of Wall Street. Due care requires that an auditor discharges professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of the auditor’s ability with concern for the best interest of the public.
Questions
- Do you believe that auditors should be held liable for failing to discover fraud in situations such as ZZZZ Best where top management goes to great lengths to fool the auditors? Why or why not?
2. The AICPA Code obligates CPAs to follow specific standards of conduct in conducting audits. Answer the following questions with respect to those standards and the related ethical expectations.
(a) Why is it important to exercise sensitive moral judgments when conducting an audit? Did Ernst & Whinney meet its obligations in this regard? If not, describe why it failed to meet its obligations.
(b) What are the criteria for audit independence? Comment on the independence of Ernst & Whinney in conducting its audit of ZZZZ Best.
(c) ) Auditors are expected to exercise due care in the performance of professional services. Explain the purpose of the due care standard. Based on the facts of the case, do you think Ernst & Whinney met their due care obligations? Why or why not?
- These are selected numbers from the financial statements of ZZZZ Best for fiscal years 1985 and 1986: 1985 1986
Sales $1,240,524 $4,845,347
Cost of goods sold 576,694 2,050,779
Accounts receivable 0 693,773
Cash 30,321 87,014
Current liabilities 2,930 1,768,435
Notes payable-current 0 780,507
What calculations or financial analyses would you make with these numbers that might help you assess whether the financial relationships are “reasonable?” Given the facts of the case, what inquiries might you make of management based on your analysis?
HealthSouth
The HealthSouth case is unique because the CEO, Richard Scrushy, was initially acquitted on all accounts while five former HealthSouth employees were sentenced by a federal judge for their admitted roles in a scheme to inflate revenues and reported earnings of the company from 1999 through mid-2002. These amounts are presented in Exhibit 1.
You may want to review the facts of the case presented in the text before reading on.
HealthSouth was the nation’s largest provider of outpatient surgery, diagnostic imaging and rehabilitative services. In 2003, the SEC filed a complaint against the company and Scrushy for violating provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934[1] The complaint alleges that HealthSouth, under Scrushy’s direction and with the help of key employees, falsified its revenue to inflate earnings and “meet their numbers.” Specifically, false accounting entries were made to an account called “contractual adjustment.” The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that various healthcare insurers will pay for a specific treatment. HealthSouth deducted this account from gross revenues to derive net revenues, which were disclosed on the company’s periodic reports filed with the SEC. The allowances were deliberately understated to help meet financial analyst earnings estimates.
The SEC contends that in mid-2002, certain senior officers of Health South discussed with Scrushy the impact of the scheme to inflate earnings because they were concerned about the consequences of the August 14, 2002 financial statement certification required under Section 302 of the Sarbanes-Oxley Act of 2002. Allegedly, “Scrushy agreed that, going forward, he would not insist that earnings be inflated to meet Wall Street analysts’ expectations.”
The filing also alleges that Scrushy received at least $6.5 million from Health South during 2001 in “Bonus/Annual Incentive Awards.” Also, from 1999 through 2002, HealthSouth paid Scrushy $9.2 million in salary. Approximately $5.3 million of this salary was based on the company’s achievement of certain budget targets.
On December 10, 2003, U.S. District Judge Inge P. Johnson sentenced former vice president of finance Emery Harris, who pleaded guilty in March 2003 to a charge of conspiracy and willfully falsifying books and records, to a term of five months in prison on each count to run concurrently, three years of supervised release with five months of unsupervised house detention, and payment of a $3,000 fine and a $200 special assessment. Harris was also ordered to pay $106,500 in forfeiture.[2]
The Judge also sentenced each of the following to four years of probation with six months unsupervised home confinement and payment of a $2,000 fine: (1) former Accounting Department vice presidents Angela C. Ayers and Cathy C. Edwards; (2) group vice president Rebecca Kay Morgan; and (3) assistant vice president Virginia B. Valentine. Ayers and Valentine were also ordered to pay a $100 special assessment, and Edwards and Morgan, a $200 special assessment. Morgan was also ordered to pay $235,000 in forfeiture. The four officers all pleaded guilty in April 2003 to conspiracy to commit wire and securities fraud, and Edwards and Morgan also pleaded guilty to wire fraud.
Ayers, Edwards, Morgan and Valentine all made false entries into the accounts of HealthSouth during the fraud period. Harris admitted falsifying the company’s finances to generate false entries, knowing that those entries would be included in the company’s filings with the SEC.
On June 28, 2005, Richard Scrushy, the former CEO of HealthSouth, was acquitted on all charges despite the testimony of more than a half-dozen former lieutenants who said he had presided over a $2.7 billion accounting fraud while running the Health South national hospital chain. The jury had even heard secretly recorded conversations between Scrushy and a chief financial officer, William T. Owens, in March 2003 discussing balance sheet problems, with Scrushy asking “You’re not wired, are you?”
In an ironic twist in the HealthSouth saga, the key prosecution witness in the government’s case against Scrushy, William Owens, was sentenced on December 9, 2005, to five years in prison for his role in the accounting fraud at HealthSouth. Owens had manipulated the company’s books and instructed subordinates to make phony accounting entries. He also falsely certified the 2002 financial statements filed with the 10-K Report to the SEC.
U.S. District Judge Sharon Lovelace Blackburn knocked three years from the prosecutors sentencing request stating to Owens: “I believe you told the truth.” Blackburn called Scrushy’s acquittal a “travesty.” Nonetheless, Blackburn said white collar criminals merit stiff sentences, if only to send a message of deterrence to other business executives. “Corporate offenders are nothing more than common thieves wearing suits and wielding pens,” Blackburn said.[3]
The Fraud Investigation –Implications of Whistleblowing
HealthSouth said a forensic audit by PricewaterhouseCoopers found fraudulent entries to raise the total to a range of $3.8 billion to $4.6 billion, up from $3.5 billion, the government's original estimate. The fraud included $2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and $800 million to $1.6 billion in ''aggressive accounting'' from 1992 to March 2003.
Allegedly, HealthSouth's auditors—and maybe even government regulators—were tipped off to a possible massive accounting fraud at the company five years before it became public knowledge, or at least that's the takeaway from a shareholder's memo that was released by a congressional committee during its investigation. The memo, dated November 1998, was apparently written by an anonymous HealthSouth shareholder and sent to auditor Ernst & Young. In it, the shareholder alerts the audit firm to alleged bookkeeping violations at the rehabilitation-services company. Reportedly HealthSouth's top lawyer assured its independent auditor that it would conduct an internal investigation of the allegations. The committee notes no record of such an inquiry, however. "You bring the smoke, I'll bring the mirrors," the unnamed shareholder wrote in the memo.
The shareholder's list of alleged violations at HealthSouth included an assertion that the company booked charges to outpatient clinic patients before checking that insurers would reimburse the claims. The shareholder also alleged that HealthSouth continued to record these charges as revenue even after payments were denied. "How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days?" the shareholder asked in the letter.
More questions followed: "How can some hospitals have NO bad debt reserves? How did the E&Y auditors in Alabama miss this stuff? Are these clever tricks to pump up the numbers, or something that a novice accountant could catch?" In a statement issued by E&Y, the firm stated it had conducted a review at the time the allegations were made and "determined the issues raised did not affect the presentation of HealthSouth's financial statements.”You people and I have been hoodwinked," the shareholder concluded in the memo. "This note is all that I can do about it. You all can do much more, if all you do is look into it to see if what I say is true." At 10:06 a.m. on Feb. 13, 2003, someone made a sensational claim on the Yahoo bulletin board devoted to discussion of HealthSouth Corp."What I know about the accounting at HealthSouth will be the blow that will bring the company to its knees."
Michael Vines, a former bookkeeper in HealthSo uth's accounting department, tried to spread the word about alleged questionable practices while at HealthSouth but was turned away at every turn. According to Vine’s testimony at the April 2002 federal court hearing, he came to believe that people in the department were falsifying assets on the balance sheet. The accountants, he testified, would move expenses from the company’s income statement – where the expenses would have to be deducted from profits immediately – to its balance sheet, where they wouldn’t have to be deducted all at one time. Thus, the company’s expenses looked lower than they should have been, which helped artificially boost net income.
The individual expenses were relatively small – between $500 and $4,999 a piece, according to Vines’ testimony – because E&Y examined expenses over $5,000. Overall, according to the SEC complaint, about $1 billion in fixed assets were falsely entered. In his testimony, Vines identified about $1 million in entries he believed were fraudulent. He told his immediate superior, Cathy C. Edwards, a vice president in the accounting department, that he wouldn’t make such entries unless she first initialed them. “I wanted her signature on it,” Vines testified. Edwards, according to Vine’s testimony, signed off on the entries and he logged them. Vines also testified that he saw Edwards falsifying an invoice, which according to his testimony was a way to cover up the larger fraud involving the accounts. On April 3, Edwards pleaded guilty to conspiracy to commit wire and securities fraud. As part of the plea, she admitted to falsifying records, although the plea didn’t mention specific incidents.
Over time, Vines had grown more concerned about the accounting practices, particularly in light of the scandal that had recently erupted at Enron Corp. He quit his job and moved to the accounting office of a Birmingham country club. Not long afterward, he sent an e-mail to E&Y alleging fraudulent transactions between the company's accounts and identifying three account numbers that Ernst should investigate. The accounts covered expenses for "minor equipment," "repairs and maintenance" and "public information," which included costs for temporary workers and advertising job openings, he said in an interview and in court testimony.
Vines's e-mail was passed on to James Lamphron, a partner in Ernst's Birmingham office. Lamphron testified that he had contacted William T. Owens, who was then president and chief operating officer at HealthSouth, and George Strong, who served as chairman of the audit committee of HealthSouth's board. A HealthSouth spokesman said Strong felt the matter was being resolved. According to Mr. Lamphron's testimony, Owens defended the company's accounting practices. He acknowledged that the company had moved expenses from one category to another, but he argued that the company had done it for several years and that it was an acceptable practice. Lamphron testified that Owens called Vines a "disgruntled employee." On March 26, 2004, Owens pleaded guilty to wire and securities fraud and certifying a false financial report to the SEC.
Lamphron testified that E&Y conducted "audit-related procedures" with the accounts Vines pointed out. The result: Ernst "reached a point where we were satisfied with the explanation that the company had provided to us ... We then closed the process." According to Lamphron's testimony, Vines never specified that invoices were being falsified -- only that there was a problem with the three accounts he mentioned. So E&Y never investigated the falsified invoices and didn't find any evidence of fraud. Ernst defended itself by stressing the difficulty of detecting accounting fraud in the midst of a conspiracy involving senior executives and allegedly false documentation. Ernst wasn’t named or charged as a defendant in the government cases and the firm cooperated with investigators.
This case discusses the HealthSouth scandal, which was one of the first cases under the Sarbanes Oxley required that the CEO and CFO of a company certify the financial statements as non misleading.
Ethical Issues
The ethical issue of this case is whether it is fair that the former CEO of HealthSouth was acquitted of certifying misleading and false financial statements while the CFO is serving a five years for the same act.
Questions
- Do you think lower level employees should be excused from any liability for their actions that contribute towards financial statement fraud when the person in charge of the fraud is found not guilty in a court of law? Use ethical reasoning to support your answer.
2- What is the nature of the contractual allowance account? Can you equate it to other allowance accounts? Explain the rules under GAAP to account for such allowances
3-EY wasn’t named or charged as a defendant in the government case against HealthSouth. Based on the limited facts of the case, do you think EY should have been charged for its failure to exercise due care in the audit of HealthSouth? Be specific.
Independence Violations at PricewaterhouseCoopersOn January 6, 2000, the SEC made public the report by independent consultant Jess Fardella, who was appointed by the Commission in March 1999 to conduct a review of possible independence rule violations by the public accounting firm PricewaterhouseCoopers (PwC) arising from ownership of client- issued securities. The report found significant violations of the firm's, the profession's, and the SEC's auditor independence rules.BackgroundOn January 14, 1999, the Commission issued an Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice In the Matter of PricewaterhouseCoopers LLP (Securities Exchange Act of 1934 Release No. 40945) ("Order"),[4] which censured PwC for violating auditor independence rules and improper professional conduct. Pursuant to the settlement reached with the Commission, PwC agreed to, among other things, complete an internal review by Fardella to identify instances in which the firm’s partners or professionals owned securities of public audit clients of PwC in contravention of applicable rules and regulations concerning independence. The independent consultant's report discloses that a substantial number of PwC professionals, particularly partners, had violations of the independence rules, and that many had multiple violations. The review found excusable mistakes, but also attributed the violations to laxity and insensitivity to the importance of independence compliance. According to Fardell’s report, PwC acknowledged that the reviewdisclosed widespread independence non-compliance that reflected serious structural and cultural problems in the firm.Results of Independent Consultant’s Report The report summarizes results of the internal review at PwC, which included two key parts: PwC professionals were requested in March 1999 to self-report independence violations; and the independent consultant randomly tested a sample of the responses for completeness and accuracy. The results are as follows.1. Almost half of the PwC partners -- 1,301 out of a total of 2,698 -- self-reported at least one independence violation. The 1,301 partners who reported a violation reported an average of five violations; 153 partners had more than ten violations each. Of 8,064 reported violations, 81.3% were reported by partners and 17.4% by managers; 45.2% of the violations were reported by partners who perform services related to audits of financial statements.
2. Almost half of the reported violations involved direct investments by the PwC professional in securities, mutual funds, bank accounts, or insurance products associated with a client. Almost 32% of reported violations, or 2,565 instances, involved holdings of a client's stock or stock options.
3. Six out of eleven partners at the senior management level who oversaw PwC's independence program self-reported violations. Each of the 12 regional partners who help administer PwC's independence program reported at least one violation; one reported 38 violations and another reported 34 violations.
4. Thirty-one of the 43 partners who comprise PwC's Board of Partners and its U.S. Leadership Committee self-reported at least one violation. Four of these had more than 20 violations; one of these partners had 41 violations and another had 40 violations.
The random tests of the self-reporting process summarized above indicated that a far greater percentage of individuals had independence violations than were reported. Despite clear warnings that the SEC was overseeing the self-reporting process,the random tests of those reports indicated that 77.5% of PwC partners failed to self-report at least one independence violation. The combined results of the self-reporting and random tests of those reports indicated that approximately 86.5% of PwC partners and 10.5% of all other PwC professionals had independence violations. The independent consultant's report identifies key weaknesses in the systems PwC had used to prevent or detect independence violations. These include:1. Reporting systems relied on the individuals themselves to sort through their own investments and interests for violations;
2. Efforts to educate professionals about the independence rules and their responsibilities to the client to comply with the rules were insufficient;
3. Resolution of reported violations were not adequately documented; and
4. Reporting systems did not focus on the reporting of violations that were deemed to be resolved before annual confirmations were submitted.
The consultant’s report concludes that . . . the numbers of violations alone, as PwC acknowledged, reflect serious structural and cultural problems that were rooted in both its legacy firms [Price Waterhouse and Coopers & Lybrand]. Although a large percentage of the reported and unreported violations is attributable solely to the Merger, an even larger portion is not; thus, the situation revealed by the internal investigation is not a one-time breakdown explained solely by the Merger. Nor can the magnitude of the reported and unreported violations be attributed simply to less familiar Independence Rules such as those pertaining to brokerage, bank and sweep accounts. At least half of the reported and unreported violations consisted of interests held by a reporting PwC professional himself or herself, and most of the violations arose from either mutual fund or stock holdings . . . .Independence compliance at PwC and its legacy firms was dependent largely on individual initiative. This system failed, as PwC has acknowledged . . . .Changes Needed As accounting firms have grown larger, acquired more clients and provided more services, and as investment opportunities and financial arrangements have increased in number and complexity, well-designed and extensive controls are needed both to facilitate Independence compliance and to discourage and detect non-compliance. The violations discussed in the consultant's report had come to light as a result of a Commission-ordered review after professional self-regulatory procedures failed to detect such violations. As a result, the SEC's requested the then current Public Oversight Board (largely replaced by PCAOB), to sponsor similar independent reviews at other firms and oversee development of enhancements to quality control and other professional standards. The firm also agreed in a settlement to conduct the review and create a $2.5 million education fund after the SEC alleged that some of its accountants compromised their independence by owning stock in corporations they audited. PricewaterhouseCoopers promised at the time to take steps to ensure that it didn’t happen again. As a result of the inquiry, five partners of the firm and a slightly larger number of other employees had been dismissed, and other employees were disciplined but not fired.
Two changes that resulted from the problems at PwC were: (1) to clearly define family members and other close relatives of members of the attest engagement team that might create an independence impairment for the auditors because of the formers ownership interests in a client and/or their position within the client including having a financial reporting oversight role (Interpretation 101-1); and (2) to restrict the ability of audit personnel from having loans to or from banks and other financial institution clients (Interpretation 101-5). This case describes the need for independence during an audit. Without it, the audit would be compromised. Ethical IssuesA lack of independence violates the rights theory because the stakeholders have a right to trust that the external auditors remain independent when conducting their audit so they avoid a bias. Under the fairness theory, all the stakeholders deserve that a fair audit be conducted. The theory of deontology requires that the auditor has a duty to report accurate information to the public and adhere to independence requirements. Questions1. In commenting on the findings in the consultant’s report, the then-chief-accountant of the SEC, Lynn E. Turner said, "This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental
principle of auditor independence." Why is it so important for auditors to be independent of their clients? Explain the nature of the independence impairments at PwC with respect to the threats to independence impairments discussed in the chapter. Review question 19 at the end of the chapter and the PeopleSoft case in the chapter. What are the commonalities between the facts of these two cases with respect to independence violations and the facts of PwC’s independence violations? How might the independence violations in these cases negatively affect the ability of an auditor to be objective in performing professional services and maintain her integrity
3- We have discussed the need for an ethical tone at the top and strong internal controls at public companies to help prevent and detect fraud. In Chapter 2 we point out that studies have shown most CPAs reason at stages 3 or 4 in Kohlberg’s model. Given the independence violations at PwC, do you think it is indicative of a stage 3 or 4 reasoning capacity? Or is it stage 1 or 2? Explain.
[1] Securities and Exchange Commission, Civil Action No. CV-03-J-0615-S, U.S. District Court Nirthern District of Alabama, SEC v. HealthSouth Corporation and Richard M. Scrushy, Defendants.
[2] Department of Justice, “Five Defendants Sentenced in HealthSouth Fraud Case,” www.usdov.gov.
[3] Carrie Johnson, “5 Years for HealthSouth Fraud: Former Chief Financial Officer was Key Witness,” Washington Post, December 10, 2005, D1.
[4] Available at: http://www.sec.gov.
CLICK HERE TO GET THE ANSWER !!!! Beauda Medical Center Lance Popperson woke up in a sweat. He felt an anxiety attack coming on. Popperson popped two anti-anxiety pills, laid down to try and sleep for the third time that night, and thought once again about his dilemma. Popperson is an associate with the accounting firm of Scoop and Shovel LLP. He recently discovered, through a casual conversation with Brad Snow, a friend of his on the audit staff, that one of the firm’s clients managed by Snow recently received complaints that its heart monitoring equipment was malfunctioning. Cardio-Systems Monitoring, Inc. (CSM) called for a meeting of the lawyers, auditors, and top management to discuss what to do about the complaints from health care facilities that had significantly increased between the first two months of 2010 and the last two months of that year. Doctors at these facilities claim the systems shut off for brief periods and, in one case, the hospital was unable to save a patient that went into cardiac arrest. Popperson got out of bed, went for a glass of water, looked at the clock that said 2:58am, and tried to sleep for the fourth time. He tossed and turned and wondered what he should do about the fact that Beauda Medical Center, his current audit client, plans to buy 20 units of Cardio-Systems heart monitoring equipment for its brand new medical facility in the outskirts of Beauda. This case discusses when and how to keep confidentiality of a client. Ethical Issues The CPA promises confidentiality to his clients so the client will trust him with information needed to perform an audit of the financial statements taken as a whole. Clients have a right to expect accountants to honor the promise of confidentiality. If the CPA should tell Beauda Medical Center confidential information about CSM, why would Beauda trust the CPA not to tell Beauda’s confidential information? The threat of harm or death to patients may be significant so Popperson should try to get CSM to correct or disclose the problem. If Popperson discloses the confidential information to Beauda, Beauda would probably cancel the order of 20 units. Would that cancellation cause financial distress or bankruptcy for CSM? Using virtue theories, the values of trustworthiness, respect, responsibility, fairness, caring and citizenship are challenged by the dilemma. Using utilitarianism theories, Popperson and the firm will have to decide whether keeping confidentiality or telling of harm to patients provides the greatest good. Questions Assume both Popperson and Snow are CPAs. Do you think Snow violated his confidentiality obligation under the AICPA Code of Professional Conduct by informing Popperson about the faulty equipment at CSM? Why or why not? Popperson has not told anyone connected to the Beauda Medical Center audit about the situation at CSM. What do you think he should do with the information? Be sure to consider are Popperson’s ethical obligations in answering this question. Assume Popperson informs the senior in charge of the Beauda audit and the senior informs the manager, Kelly Korn. A meeting is held the next day with all parties in the office of Iceman Cometh, the managing partner of the firm. Here’s how it goes: Iceman: If we tell Beauda about the problems at CSM, we will have violated our confidentiality obligation as a firm to CSM. Moreover, we may lose both clients. Kelly: Lance, you are the closest to the situation. How do you think Beauda’s top hospital administrators would react if we told them? Lance: They wouldn’t buy the equipment. Iceman: Once we tell them, we’re subject to investigation by our State Board of Accountancy for violating the confidentiality obligation we have to CSM. We don’t want to alert the board and have it investigate our actions. What’s worse is we may be flagged for the confidentiality violation in our next peer review. Kelly: Who would do that? I mean, CSM won’t know about it and the Beauda people are going to be happy we prevented them from buying what may be faulty equipment. Senior: I agree with Kelly. They are not likely to say anything. Iceman: I don’t like it. I think we should be silent and find another way to warn Beauda Medical without violating confidentiality. Lance: What about contacting the state board for advice? Follow-up questions 3 (a) Discuss all ethical and professional matters of concern for the firm of Scoop and Shovel LLP, in deciding whether to do as Iceman Cometh suggests and not tell the administrators at Beauda Medical Center? (b) What do you think about Lance’s suggestion to contact the state board for advice on the matter? Is that the function of a state board of accountancy? First Community Church First Community Church is the largest church in the city of Perpetual Happiness. Yes, it’s in California! A meeting was held on Friday, November 16 to address the fact that money had been stolen from the weekly collection box during the course of the year and church leaders were getting quite concerned. At first, no one paid much attention as the amounts were small and could have been attributed to inadvertent errors due to discrepancies between the actual count and what really was collected. However, after 45 weeks of the continuous discrepancies, the total amount of differences had become alarming. Eddie Wong, the controller for the church, estimated the total was now $23,399. That represents well over 5 percent of their annual collections from church members totaling about $400,000. The meeting began at 9am, a time that was early for the church leaders who often had late evening calls to make. The church staff brought donuts, bagels and coffee to help get the meeting off to a good start. But that’s not the way it happened. “I want an explanation,” said Allen Yuen, the executive director of the church. “The boards of trustees are on my back about this matter. Some of them talk about this Sarbanes-Oxley Act and our lack of internal controls. All it’s foreign to me but I know indignation when I see it!” “I can’t explain it, Allen,” responded Eddie Wong. “Jennie. How about you?” Yuen asked. He was addressing Jennie Lin, the member of the executive committee of the board of trustees who was directly responsible for the count each week. Jennie seemed uncomfortable. She hesitated before saying: “I think my count is correct. I take the money given to me by Joey, put it in the safe, and then Eddie opens the safe on Monday morning. He records the cash receipts and makes a bank deposit.” Eddie said, “That’s right. My deposit always matches the amount of money reported by Jennie.” “That doesn’t make sense,” Yuen said. “Someone is getting his or her hands on the money between the collection process and recording of the amount. I trust you, Jennie, to watch over these things and the internal control matter.” “Perhaps the tally amount record independently submitted by the church volunteers has been overstated.” Jennie said. “Why would that happen?” Yuen asked. “I mean, while it could happen and it would be an honest mistake, it seems unlikely.” Jennie was starting to sweat. She decided a diversion was in order. “Maybe someone gets their hands on the collection box after the tally and before Joey gives it to me.” Joey Ching is the accounting manager who delivers the collection box and tally sheet to Jennie after each service. Joey goes to church on a regular basis and volunteered to do the job in order to establish a control in the process. At this point Jennie lowered her head while she waited for a response. It came from Alex Yuen. “Jennie, are you accusing Joey of stealing money from the church collection box?” Jennie shook her head as if to say no. She was visibly upset. A phone call came in for Yuen and the meeting had to break up. The group agreed to continue the discussion in two days. In the meantime, Alan Yuen said he’d call Joey Ching and ask him to attend the next meeting. Jennie went back to her office, closed the door, and started to reflect on what she had just done. The truth is that Jennie had been taking the money each week and giving it to a homeless shelter two blocks from the church. Some of the homeless attend church services and Jennie has befriended many of them. She knew it was wrong to take money from the collection box, but she thought it was for a very good cause and that the church clergy would approve. She never thought about getting caught since she told the bookkeeper to record the lower amount. Now, she feels guilty about bringing Joey into the picture. This case looks at challenges facing many non-profits, using volunteers to provide internal controls. Ethical Issues Jennie has succumbed to the fraud triangle. Jennie is not fulfilling her fiduciary duty. By stealing monies, fraud and deceit, Jennie has committed acts discreditable to the profession. From the rights perspective, the church has a right to determine its donation to the shelter through the normal process. The church members have a right to expect the staff to uphold their fiduciary duties. From the deontology perspective, Jennie has a duty not to steal or take money without permission of the church. From a utilitarian perspective not all the constituencies of the church may have been considered. Questions Assume Jennie Lin is a CPA. Evaluate her actions from an ethical perspective. Jennie believed her actions were proper because taking the money from the church and giving it to the homeless served a greater good. Do you agree with her position from an ethical perspective? As a member of the board of trustees of the church, what are Jennie’s ethical obligations to the church? Do you think it is more difficult to establish strong internal controls in a nonprofit such as First Community Church as compared to a public or privately-owned company? Why or why not? (a) Assume Jennie calls Joey and explains the situation. She tells Joey about the impending call from Alex Yuen and, as a friend, asks him not to come to the meeting so she could explain what she has done without his involvement. If you were Joey, would you stay away from the meeting? Why or why not? 4. (b) Assume Joey stays away, Jennie explains why she did what she did, and, after due deliberation, Yuen fires Jennie and tells her she must replace the money she “stole” from the collection box. How would you evaluate Yuen’s actions from an ethical perspective? ZZZZ Best* The story of ZZZZ Best is one of greed and audaciousness. It is the story of a 15-year old boy from Reseda, California who was driven to be successful regardless of the costs. His name is Barry Minkow. Minkow had high hopes to make it big – to be a millionaire very early in life. He started a carpet cleaning business in the garage of his home. Minkow realized early on that he was not going to become a millionaire cleaning other people’s carpets. He had bigger plans than that. Minkow was going to make it big in the insurance restoration business. In other words, ZZZZ Best would contract to do carpet and drapery cleaning jobs after a fire or flood. Since the damage from the fire or flood probably would be covered by insurance, the customer would be eager to have the work done. The only problem with Minkow’s insurance restoration idea was that it was all a fiction. There were no insurance restoration jobs, at least for ZZZZ Best. In the process of creating the fraud, Minkow was able to dupe the auditors, Ernst & Whinney into thinking the insurance restoration business was real. In fact, over 80 percent of his revenue was allegedly from this work. The auditors never caught on until it was too late. How Barry Became a Fraudster Minkow wrote a book, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback** that provides some insights into the mind of a 15-year old kid __________________ * The facts are derived from a video by the ACFE, Cooking the Books: What Every Accountant Should Know about Fraud. **Barry Minkow, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback (Nashville, TN: Thomas Nelson, 1995). who was called a “wonder boy” on Wall Street until the bubble burst. He was trying to find a way to drum up customers for his fledgling carpet cleaning business. One day, while he was alone in the garage-office, Minkow called Channel 4 in Los Angeles. He disguised his voice to sound not like a teenager and told a producer that he had just had his carpets cleaned by the 16-year owner of ZZZZ Best and was very impressed that a high school junior was running his own business. He sold the producer on the idea that it would be good for society to hear the success story about a high school junior running his own business. The producer bought it lock, stock and carpet cleaner. Minkow gave the producer the phone number of ZZZZ Best and waited. It took less than five minutes for the call to come in. Minkow answered the phone and when the producer asked to speak with Mr. Barry Minkow, Minkow said: “Who may I say is calling?” Within days a film crew was in his garage shooting ZZZZ Best at work. The story aired that night and it was followed by more calls from radio stations and other television shows wanting to do interviews. People called demanding that Barry Minkow personally clean their carpets. As his income increased in the spring of 1983, Minkow found it increasingly difficult to run the company without a checking account. He managed to find a banker that was so moved by his story that the banker would agree to allow someone under-aged to open a checking account. Minkow used the money to buy cleaning supplies and other necessities. Even though his business was growing, Minkow ran into trouble paying back loans and interest when due. Minkow developed a plan of action. He was tired of worrying about not having enough money. He went to his garage – where all his great ideas first began – and he looked at his bank account statement which showed that he had more money than he thought he had based on his own records. Minkow soon realized it was because some checks he had written had not been cashed by customers so it didn’t yet shown up on the bank statement. Voila! Minkow started to kite checks between two or more banks. He would write a check on one ZZZZ Best account and deposit it into another. Since it might take a few days for the check written on bank number one to clear that banks’ records, at least back then when checks weren’t always processed in real time, Minkow could pay some bills out of the second account and the first bank would not know – at least for a few days – that Minkow had written a check on his account when, in reality, he had a negative balance. The bank didn’t know it because some of the checks that Minkow had written before the visit to bank number two had not cleared his account in bank number one. It wasn’t long thereafter that Minkow realized he could kite checks big-time. Not only that, he could make the transfer of funds at the end of a month or a year and show a higher balance than really existed in bank number one and carry it on to the balance sheet. Since Minkow did not count the check written on his account in bank one as an outstanding check, he was able to double-count. Time to Expand the Fraud Over time, Minkow moved on to bigger and bigger frauds like having his trusted cohorts confirm to banks and other interested parties that ZZZZ Best was doing insurance restoration jobs. Minkow used the phony jobs and phony revenue to convince bankers to make loans to ZZZZ Best. He had cash remittance forms made up from non-existent customers with whatever sales amount he wanted to appear on the document. He even had a co-conspirator write on the bogus remittance form, “job well done.” Minkow could then show a lot more revenue that he was really making. Minkow’s phony financial statements enabled him to borrow more and more money and expand the number of carpet cleaning outlets. However, Minkow’s personal tastes had become increasingly more expensive including purchasing a Ferrari with the borrowed funds and putting a down payment on a 5,000-square foot home. So, the question was: How do you solve a perpetual cash flow problem? You go public! That’s right, Minkow made a public offering of stock in ZZZZ Best. Of course he owned a majority of the stock to maintain control of the company. Minkow had made it to the big leagues. He was on Wall Street. He had investment bankers, CPAs and attorneys all working for him -- the 15-year old kid from Reseda who had turned a mom and pop operation into a publicly-owned corporation. Barry Goes Public Minkow’s first audit was for the twelve months ended April 30, 1986. A sole practitioner performed the audit. (There are eerie similarities in the Madoff fraud with its small practitioner firm – Frichling & Horowita – conducting the audit of a multi-billion dollar operation and that of the sole practitioner audit of ZZZZ Best). Minkow had established two phony front companies that allegedly placed insurance restoration jobs for ZZZZ Best. He had one of his cohorts make out invoices for services and respond to questions about the company. There was enough paperwork to fool the auditor into thinking the jobs were real and the revenue was supportable. However, the auditor never visited any of the insurance restoration sites. If he had done so, there would have been no question in his mind that ZZZZ Best was a big fraud. Pressured to get a big-time CPA firm to do his audit as he moved into the big leagues, Minkow hired Ernst &Whinney to perform the April 30, 1987 fiscal year-end audit. Minkow continued to be one step ahead of the auditors. That is until the Ernst & Whinney auditors insisted on going to see an insurance restoration site. They wanted to confirm that all the business – all the revenues --- that Minkow had said was coming in to ZZZZ Best, was real. The engagement partner drove to an area in Sacramento, California where Minkow did a lot of work – supposedly. He looked for a building that seemed to be a restoration job. Why he did that isn’t clear but he identified a building that seemed to be the kind that would be a restoration job in process. Earlier in the week, Minkow sent one of his cohorts to find a large building in Sacramento that appeared to be a restoration site. As luck would have it, Minkow’s associate picked out the same site as had the partner later on. Minkow’s cohorts found the leasing agent for the building. They convinced the agent to give them the keys so that they could show the building to some potential tenants over the weekend. Minkow’s helpers went up to the site before the arrival of the partner and placed placards on the walls that indicated ZZZZ Best was the contractor for the building restoration. In fact, the building was not fully constructed at the time but it looked as if some restoration work would have been going on at the site. Minkow was able to pull it off in part due to luck and in part because the Ernst and Whinney auditors did not want to lose the ZZZZ Best account. It had become a large revenue producer for the firm and Minkow seemed destined for greater and greater achievements. Minkow was smart and he used the leverage of the auditors not wanting to lose the ZZZZ Best account as a way to complain whenever they became too curious about the insurance restoration jobs. He would even threaten to take his business away from Ernst and Whinney and give it to other auditors. Minkow also took a precaution with the site visit. He had the auditors sign a confidentiality agreement that they would not make any follow-up calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration work. This prevented the auditors from corroborating the insurance restoration contracts with independent third parties. The Fraud Starts to Unravel It was a Los Angeles housewife that started the problems for ZZZZ Best that would eventually lead to the demise of the company. Since Minkow was a well known figure and flamboyant character, the Los Angeles Times did an expose about the carpet cleaning business. The Los Angeles housewife read the story about Minkow and recalled that ZZZZ Best had overcharged her for services in the early years by increasing the amount of the credit card charge for carpet cleaning services. Minkow had gambled that most people don’t check their monthly statements so he could get away with the petty fraud. However, the housewife did notice the overcharge, complained to Minkow, and eventually he returned the overpayment. She couldn’t understand why Minkow would have had to resort to such low levels back then if he was as successful as the L.A. Times article made him out to be. So, she called the reporter to find out more and that ultimately led to the investigation of ZZZZ Best and future stories that weren’t so flattering. Since Minkow continued to spend lavishly on himself and his possessions, he always seemed to need more and more money. It got so bad over time that he was to close to defaulting on loans and had to make up stories to keep the creditors at bay, and he couldn’t pay his suppliers. The complaints kept coming in and eventually the house of cards that was ZZZZ Best came crashing down. During the time that the fraud was unraveling, Ernst and Whinney decided to resign from the ZZZZ best audit. The firm never did issue an audit report. It had started to doubt the veracity of Minkow and the reality of business at ZZZZ Best. The procedure to follow when a change of auditor occurs is for the company to file an 8-K form with the SEC and the audit firms prepares an exhibit commenting on the accuracy of the disclosures in the 8-K. The exhibit is attached to the form that is sent to the SEC within 30 days of the change. Ernst & Whinney waited the full 30-day period and the SEC released the information to the public 45 days after the change had occurred. Meanwhile, ZZZZ Best had filed for bankruptcy. During the period of time that had elapsed, Minkow had borrowed more than $1 million dollars and the lenders never were repaid. The Bankruptcy laws protected Minkow and ZZZZ Best from having to make those payments. Legal Liability Issues The ZZZZ Best fraud was one of the largest of its time. ZZZZ Best reportedly settled a shareholder class action lawsuit for $35 million. Ernst & Whinney was sued by a bank that had made a multimillion-dollar loan based on the financial statements for the three-month period ending July 31, 1986. The bank claimed that it had relied on the review report[1] issued by Ernst & Whinney in granting the loan to ZZZZ Best. However, the firm had indicated in its review report that it was not issuing an opinion on the ZZZZ Best financial statements. The judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly disclaimed issuing any opinion on the statements. Barry Minkow was charged with engaging in a $100 million fraud scheme. He was sentenced to a term of 25 years. Minkow was paroled after serving eight years in jail. During his time in prison, Minkow became involved in Christian ministry, which continued after his probationary release from prison in April 1995. Today he is senior pastor of the Community Bible Church in San Diego, California, having renounced his felonious acts. Minkow is recognized as an expert on fraud, and speaks on the subject to university students and the business community in an effort to prevent fraud. This case discusses the actual case of ZZZZ Best and Barry Minkow. The auditors ignored common sense and did not use due care in the audit. Ethical Issues This case shows how auditors did not use due care or skepticism in the audit of ZZZZ Best. The auditors lost independence and became bedazzled by Barry Minkow, the whiz kid of Wall Street. Due care requires that an auditor discharges professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of the auditor’s ability with concern for the best interest of the public. Questions Do you believe that auditors should be held liable for failing to discover fraud in situations such as ZZZZ Best where top management goes to great lengths to fool the auditors? Why or why not? 2. The AICPA Code obligates CPAs to follow specific standards of conduct in conducting audits. Answer the following questions with respect to those standards and the related ethical expectations. (a) Why is it important to exercise sensitive moral judgments when conducting an audit? Did Ernst & Whinney meet its obligations in this regard? If not, describe why it failed to meet its obligations. (b) What are the criteria for audit independence? Comment on the independence of Ernst & Whinney in conducting its audit of ZZZZ Best. (c) ) Auditors are expected to exercise due care in the performance of professional services. Explain the purpose of the due care standard. Based on the facts of the case, do you think Ernst & Whinney met their due care obligations? Why or why not? These are selected numbers from the financial statements of ZZZZ Best for fiscal years 1985 and 1986: 1985 1986 Sales $1,240,524 $4,845,347 Cost of goods sold 576,694 2,050,779 Accounts receivable 0 693,773 Cash 30,321 87,014 Current liabilities 2,930 1,768,435 Notes payable-current 0 780,507 What calculations or financial analyses would you make with these numbers that might help you assess whether the financial relationships are “reasonable?” Given the facts of the case, what inquiries might you make of management based on your analysis? HealthSouth The HealthSouth case is unique because the CEO, Richard Scrushy, was initially acquitted on all accounts while five former HealthSouth employees were sentenced by a federal judge for their admitted roles in a scheme to inflate revenues and reported earnings of the company from 1999 through mid-2002. These amounts are presented in Exhibit 1. You may want to review the facts of the case presented in the text before reading on. HealthSouth was the nation’s largest provider of outpatient surgery, diagnostic imaging and rehabilitative services. In 2003, the SEC filed a complaint against the company and Scrushy for violating provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934[1] The complaint alleges that HealthSouth, under Scrushy’s direction and with the help of key employees, falsified its revenue to inflate earnings and “meet their numbers.” Specifically, false accounting entries were made to an account called “contractual adjustment.” The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that various healthcare insurers will pay for a specific treatment. HealthSouth deducted this account from gross revenues to derive net revenues, which were disclosed on the company’s periodic reports filed with the SEC. The allowances were deliberately understated to help meet financial analyst earnings estimates. The SEC contends that in mid-2002, certain senior officers of Health South discussed with Scrushy the impact of the scheme to inflate earnings because they were concerned about the consequences of the August 14, 2002 financial statement certification required under Section 302 of the Sarbanes-Oxley Act of 2002. Allegedly, “Scrushy agreed that, going forward, he would not insist that earnings be inflated to meet Wall Street analysts’ expectations.” The filing also alleges that Scrushy received at least $6.5 million from Health South during 2001 in “Bonus/Annual Incentive Awards.” Also, from 1999 through 2002, HealthSouth paid Scrushy $9.2 million in salary. Approximately $5.3 million of this salary was based on the company’s achievement of certain budget targets. On December 10, 2003, U.S. District Judge Inge P. Johnson sentenced former vice president of finance Emery Harris, who pleaded guilty in March 2003 to a charge of conspiracy and willfully falsifying books and records, to a term of five months in prison on each count to run concurrently, three years of supervised release with five months of unsupervised house detention, and payment of a $3,000 fine and a $200 special assessment. Harris was also ordered to pay $106,500 in forfeiture.[2] The Judge also sentenced each of the following to four years of probation with six months unsupervised home confinement and payment of a $2,000 fine: (1) former Accounting Department vice presidents Angela C. Ayers and Cathy C. Edwards; (2) group vice president Rebecca Kay Morgan; and (3) assistant vice president Virginia B. Valentine. Ayers and Valentine were also ordered to pay a $100 special assessment, and Edwards and Morgan, a $200 special assessment. Morgan was also ordered to pay $235,000 in forfeiture. The four officers all pleaded guilty in April 2003 to conspiracy to commit wire and securities fraud, and Edwards and Morgan also pleaded guilty to wire fraud. Ayers, Edwards, Morgan and Valentine all made false entries into the accounts of HealthSouth during the fraud period. Harris admitted falsifying the company’s finances to generate false entries, knowing that those entries would be included in the company’s filings with the SEC. On June 28, 2005, Richard Scrushy, the former CEO of HealthSouth, was acquitted on all charges despite the testimony of more than a half-dozen former lieutenants who said he had presided over a $2.7 billion accounting fraud while running the Health South national hospital chain. The jury had even heard secretly recorded conversations between Scrushy and a chief financial officer, William T. Owens, in March 2003 discussing balance sheet problems, with Scrushy asking “You’re not wired, are you?” In an ironic twist in the HealthSouth saga, the key prosecution witness in the government’s case against Scrushy, William Owens, was sentenced on December 9, 2005, to five years in prison for his role in the accounting fraud at HealthSouth. Owens had manipulated the company’s books and instructed subordinates to make phony accounting entries. He also falsely certified the 2002 financial statements filed with the 10-K Report to the SEC. U.S. District Judge Sharon Lovelace Blackburn knocked three years from the prosecutors sentencing request stating to Owens: “I believe you told the truth.” Blackburn called Scrushy’s acquittal a “travesty.” Nonetheless, Blackburn said white collar criminals merit stiff sentences, if only to send a message of deterrence to other business executives. “Corporate offenders are nothing more than common thieves wearing suits and wielding pens,” Blackburn said.[3] The Fraud Investigation –Implications of Whistleblowing HealthSouth said a forensic audit by PricewaterhouseCoopers found fraudulent entries to raise the total to a range of $3.8 billion to $4.6 billion, up from $3.5 billion, the government's original estimate. The fraud included $2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and $800 million to $1.6 billion in ''aggressive accounting'' from 1992 to March 2003. Allegedly, HealthSouth's auditors—and maybe even government regulators—were tipped off to a possible massive accounting fraud at the company five years before it became public knowledge, or at least that's the takeaway from a shareholder's memo that was released by a congressional committee during its investigation. The memo, dated November 1998, was apparently written by an anonymous HealthSouth shareholder and sent to auditor Ernst & Young. In it, the shareholder alerts the audit firm to alleged bookkeeping violations at the rehabilitation-services company. Reportedly HealthSouth's top lawyer assured its independent auditor that it would conduct an internal investigation of the allegations. The committee notes no record of such an inquiry, however. "You bring the smoke, I'll bring the mirrors," the unnamed shareholder wrote in the memo. The shareholder's list of alleged violations at HealthSouth included an assertion that the company booked charges to outpatient clinic patients before checking that insurers would reimburse the claims. The shareholder also alleged that HealthSouth continued to record these charges as revenue even after payments were denied. "How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days?" the shareholder asked in the letter. More questions followed: "How can some hospitals have NO bad debt reserves? How did the E&Y auditors in Alabama miss this stuff? Are these clever tricks to pump up the numbers, or something that a novice accountant could catch?" In a statement issued by E&Y, the firm stated it had conducted a review at the time the allegations were made and "determined the issues raised did not affect the presentation of HealthSouth's financial statements.”You people and I have been hoodwinked," the shareholder concluded in the memo. "This note is all that I can do about it. You all can do much more, if all you do is look into it to see if what I say is true." At 10:06 a.m. on Feb. 13, 2003, someone made a sensational claim on the Yahoo bulletin board devoted to discussion of HealthSouth Corp."What I know about the accounting at HealthSouth will be the blow that will bring the company to its knees." Michael Vines, a former bookkeeper in HealthSo uth's accounting department, tried to spread the word about alleged questionable practices while at HealthSouth but was turned away at every turn. According to Vine’s testimony at the April 2002 federal court hearing, he came to believe that people in the department were falsifying assets on the balance sheet. The accountants, he testified, would move expenses from the company’s income statement – where the expenses would have to be deducted from profits immediately – to its balance sheet, where they wouldn’t have to be deducted all at one time. Thus, the company’s expenses looked lower than they should have been, which helped artificially boost net income. The individual expenses were relatively small – between $500 and $4,999 a piece, according to Vines’ testimony – because E&Y examined expenses over $5,000. Overall, according to the SEC complaint, about $1 billion in fixed assets were falsely entered. In his testimony, Vines identified about $1 million in entries he believed were fraudulent. He told his immediate superior, Cathy C. Edwards, a vice president in the accounting department, that he wouldn’t make such entries unless she first initialed them. “I wanted her signature on it,” Vines testified. Edwards, according to Vine’s testimony, signed off on the entries and he logged them. Vines also testified that he saw Edwards falsifying an invoice, which according to his testimony was a way to cover up the larger fraud involving the accounts. On April 3, Edwards pleaded guilty to conspiracy to commit wire and securities fraud. As part of the plea, she admitted to falsifying records, although the plea didn’t mention specific incidents. Over time, Vines had grown more concerned about the accounting practices, particularly in light of the scandal that had recently erupted at Enron Corp. He quit his job and moved to the accounting office of a Birmingham country club. Not long afterward, he sent an e-mail to E&Y alleging fraudulent transactions between the company's accounts and identifying three account numbers that Ernst should investigate. The accounts covered expenses for "minor equipment," "repairs and maintenance" and "public information," which included costs for temporary workers and advertising job openings, he said in an interview and in court testimony. Vines's e-mail was passed on to James Lamphron, a partner in Ernst's Birmingham office. Lamphron testified that he had contacted William T. Owens, who was then president and chief operating officer at HealthSouth, and George Strong, who served as chairman of the audit committee of HealthSouth's board. A HealthSouth spokesman said Strong felt the matter was being resolved. According to Mr. Lamphron's testimony, Owens defended the company's accounting practices. He acknowledged that the company had moved expenses from one category to another, but he argued that the company had done it for several years and that it was an acceptable practice. Lamphron testified that Owens called Vines a "disgruntled employee." On March 26, 2004, Owens pleaded guilty to wire and securities fraud and certifying a false financial report to the SEC. Lamphron testified that E&Y conducted "audit-related procedures" with the accounts Vines pointed out. The result: Ernst "reached a point where we were satisfied with the explanation that the company had provided to us ... We then closed the process." According to Lamphron's testimony, Vines never specified that invoices were being falsified -- only that there was a problem with the three accounts he mentioned. So E&Y never investigated the falsified invoices and didn't find any evidence of fraud. Ernst defended itself by stressing the difficulty of detecting accounting fraud in the midst of a conspiracy involving senior executives and allegedly false documentation. Ernst wasn’t named or charged as a defendant in the government cases and the firm cooperated with investigators. This case discusses the HealthSouth scandal, which was one of the first cases under the Sarbanes Oxley required that the CEO and CFO of a company certify the financial statements as non misleading. Ethical Issues The ethical issue of this case is whether it is fair that the former CEO of HealthSouth was acquitted of certifying misleading and false financial statements while the CFO is serving a five years for the same act. Questions Do you think lower level employees should be excused from any liability for their actions that contribute towards financial statement fraud when the person in charge of the fraud is found not guilty in a court of law? Use ethical reasoning to support your answer. 2- What is the nature of the contractual allowance account? Can you equate it to other allowance accounts? Explain the rules under GAAP to account for such allowances 3-EY wasn’t named or charged as a defendant in the government case against HealthSouth. Based on the limited facts of the case, do you think EY should have been charged for its failure to exercise due care in the audit of HealthSouth? Be specific. Independence Violations at PricewaterhouseCoopers On January 6, 2000, the SEC made public the report by independent consultant Jess Fardella, who was appointed by the Commission in March 1999 to conduct a review of possible independence rule violations by the public accounting firm PricewaterhouseCoopers (PwC) arising from ownership of client- issued securities. The report found significant violations of the firm's, the profession's, and the SEC's auditor independence rules. Background On January 14, 1999, the Commission issued an Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice In the Matter of PricewaterhouseCoopers LLP (Securities Exchange Act of 1934 Release No. 40945) ("Order"),[4] which censured PwC for violating auditor independence rules and improper professional conduct. Pursuant to the settlement reached with the Commission, PwC agreed to, among other things, complete an internal review by Fardella to identify instances in which the firm’s partners or professionals owned securities of public audit clients of PwC in contravention of applicable rules and regulations concerning independence. The independent consultant's report discloses that a substantial number of PwC professionals, particularly partners, had violations of the independence rules, and that many had multiple violations. The review found excusable mistakes, but also attributed the violations to laxity and insensitivity to the importance of independence compliance. According to Fardell’s report, PwC acknowledged that the review disclosed widespread independence non-compliance that reflected serious structural and cultural problems in the firm. Results of Independent Consultant’s Report The report summarizes results of the internal review at PwC, which included two key parts: PwC professionals were requested in March 1999 to self-report independence violations; and the independent consultant randomly tested a sample of the responses for completeness and accuracy. The results are as follows. 1. Almost half of the PwC partners -- 1,301 out of a total of 2,698 -- self-reported at least one independence violation. The 1,301 partners who reported a violation reported an average of five violations; 153 partners had more than ten violations each. Of 8,064 reported violations, 81.3% were reported by partners and 17.4% by managers; 45.2% of the violations were reported by partners who perform services related to audits of financial statements. 2. Almost half of the reported violations involved direct investments by the PwC professional in securities, mutual funds, bank accounts, or insurance products associated with a client. Almost 32% of reported violations, or 2,565 instances, involved holdings of a client's stock or stock options. 3. Six out of eleven partners at the senior management level who oversaw PwC's independence program self-reported violations. Each of the 12 regional partners who help administer PwC's independence program reported at least one violation; one reported 38 violations and another reported 34 violations. 4. Thirty-one of the 43 partners who comprise PwC's Board of Partners and its U.S. Leadership Committee self-reported at least one violation. Four of these had more than 20 violations; one of these partners had 41 violations and another had 40 violations. The random tests of the self-reporting process summarized above indicated that a far greater percentage of individuals had independence violations than were reported. Despite clear warnings that the SEC was overseeing the self-reporting process, the random tests of those reports indicated that 77.5% of PwC partners failed to self-report at least one independence violation. The combined results of the self-reporting and random tests of those reports indicated that approximately 86.5% of PwC partners and 10.5% of all other PwC professionals had independence violations. The independent consultant's report identifies key weaknesses in the systems PwC had used to prevent or detect independence violations. These include: 1. Reporting systems relied on the individuals themselves to sort through their own investments and interests for violations; 2. Efforts to educate professionals about the independence rules and their responsibilities to the client to comply with the rules were insufficient; 3. Resolution of reported violations were not adequately documented; and 4. Reporting systems did not focus on the reporting of violations that were deemed to be resolved before annual confirmations were submitted. The consultant’s report concludes that . . . the numbers of violations alone, as PwC acknowledged, reflect serious structural and cultural problems that were rooted in both its legacy firms [Price Waterhouse and Coopers & Lybrand]. Although a large percentage of the reported and unreported violations is attributable solely to the Merger, an even larger portion is not; thus, the situation revealed by the internal investigation is not a one-time breakdown explained solely by the Merger. Nor can the magnitude of the reported and unreported violations be attributed simply to less familiar Independence Rules such as those pertaining to brokerage, bank and sweep accounts. At least half of the reported and unreported violations consisted of interests held by a reporting PwC professional himself or herself, and most of the violations arose from either mutual fund or stock holdings . . . .Independence compliance at PwC and its legacy firms was dependent largely on individual initiative. This system failed, as PwC has acknowledged . . . . Changes Needed As accounting firms have grown larger, acquired more clients and provided more services, and as investment opportunities and financial arrangements have increased in number and complexity, well-designed and extensive controls are needed both to facilitate Independence compliance and to discourage and detect non-compliance. The violations discussed in the consultant's report had come to light as a result of a Commission-ordered review after professional self-regulatory procedures failed to detect such violations. As a result, the SEC's requested the then current Public Oversight Board (largely replaced by PCAOB), to sponsor similar independent reviews at other firms and oversee development of enhancements to quality control and other professional standards. The firm also agreed in a settlement to conduct the review and create a $2.5 million education fund after the SEC alleged that some of its accountants compromised their independence by owning stock in corporations they audited. PricewaterhouseCoopers promised at the time to take steps to ensure that it didn’t happen again. As a result of the inquiry, five partners of the firm and a slightly larger number of other employees had been dismissed, and other employees were disciplined but not fired. Two changes that resulted from the problems at PwC were: (1) to clearly define family members and other close relatives of members of the attest engagement team that might create an independence impairment for the auditors because of the formers ownership interests in a client and/or their position within the client including having a financial reporting oversight role (Interpretation 101-1); and (2) to restrict the ability of audit personnel from having loans to or from banks and other financial institution clients (Interpretation 101-5). This case describes the need for independence during an audit. Without it, the audit would be compromised. Ethical Issues A lack of independence violates the rights theory because the stakeholders have a right to trust that the external auditors remain independent when conducting their audit so they avoid a bias. Under the fairness theory, all the stakeholders deserve that a fair audit be conducted. The theory of deontology requires that the auditor has a duty to report accurate information to the public and adhere to independence requirements. Questions 1. In commenting on the findings in the consultant’s report, the then-chief-accountant of the SEC, Lynn E. Turner said, "This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental principle of auditor independence." Why is it so important for auditors to be independent of their clients? Explain the nature of the independence impairments at PwC with respect to the threats to independence impairments discussed in the chapter. Review question 19 at the end of the chapter and the PeopleSoft case in the chapter. What are the commonalities between the facts of these two cases with respect to independence violations and the facts of PwC’s independence violations? How might the independence violations in these cases negatively affect the ability of an auditor to be objective in performing professional services and maintain her integrity 3- We have discussed the need for an ethical tone at the top and strong internal controls at public companies to help prevent and detect fraud. In Chapter 2 we point out that studies have shown most CPAs reason at stages 3 or 4 in Kohlberg’s model. Given the independence violations at PwC, do you think it is indicative of a stage 3 or 4 reasoning capacity? Or is it stage 1 or 2? Explain. [1] Securities and Exchange Commission, Civil Action No. CV-03-J-0615-S, U.S. District Court Nirthern District of Alabama, SEC v. HealthSouth Corporation and Richard M. Scrushy, Defendants. [2] Department of Justice, “Five Defendants Sentenced in HealthSouth Fraud Case,” www.usdov.gov. [3] Carrie Johnson, “5 Years for HealthSouth Fraud: Former Chief Financial Officer was Key Witness,” Washington Post, December 10, 2005, D1. [4] Available at: http://www.sec.gov. CLICK HERE TO GET THE ANSWER !!!!
[1] Securities and Exchange Commission, Civil Action No. CV-03-J-0615-S, U.S. District Court Nirthern District of Alabama, SEC v. HealthSouth Corporation and Richard M. Scrushy, Defendants.
[2] Department of Justice, “Five Defendants Sentenced in HealthSouth Fraud Case,” www.usdov.gov.
[3] Carrie Johnson, “5 Years for HealthSouth Fraud: Former Chief Financial Officer was Key Witness,” Washington Post, December 10, 2005, D1.
[4] Available at: http://www.sec.gov.
Beauda Medical Center
Lance Popperson woke up in a sweat. He felt an anxiety attack coming on. Popperson popped two anti-anxiety pills, laid down to try and sleep for the third time that night, and thought once again about his dilemma.
Popperson is an associate with the accounting firm of Scoop and Shovel LLP. He recently discovered, through a casual conversation with Brad Snow, a friend of his on the audit staff, that one of the firm’s clients managed by Snow recently received complaints that its heart monitoring equipment was malfunctioning. Cardio-Systems Monitoring, Inc. (CSM) called for a meeting of the lawyers, auditors, and top management to discuss what to do about the complaints from health care facilities that had significantly increased between the first two months of 2010 and the last two months of that year. Doctors at these facilities claim the systems shut off for brief periods and, in one case, the hospital was unable to save a patient that went into cardiac arrest.
Popperson got out of bed, went for a glass of water, looked at the clock that said 2:58am, and tried to sleep for the fourth time. He tossed and turned and wondered what he should do about the fact that Beauda Medical Center, his current audit client, plans to buy 20 units of Cardio-Systems heart monitoring equipment for its brand new medical facility in the outskirts of Beauda.
This case discusses when and how to keep confidentiality of a client.
Ethical Issues
The CPA promises confidentiality to his clients so the client will trust him with information needed to perform an audit of the financial statements taken as a whole. Clients have a right to expect accountants to honor the promise of confidentiality. If the CPA should tell Beauda Medical Center confidential information about CSM, why would Beauda trust the CPA not to tell Beauda’s confidential information? The threat of harm or death to patients may be significant so Popperson should try to get CSM to correct or disclose the problem. If Popperson discloses the confidential information to Beauda, Beauda would probably cancel the order of 20 units. Would that cancellation cause financial distress or bankruptcy for CSM? Using virtue theories, the values of trustworthiness, respect, responsibility, fairness, caring and citizenship are challenged by the dilemma. Using utilitarianism theories, Popperson and the firm will have to decide whether keeping confidentiality or telling of harm to patients provides the greatest good.
Questions
- Assume both Popperson and Snow are CPAs. Do you think Snow violated his confidentiality obligation under the AICPA Code of Professional Conduct by informing Popperson about the faulty equipment at CSM? Why or why not?
- Popperson has not told anyone connected to the Beauda Medical Center audit about the situation at CSM. What do you think he should do with the information? Be sure to consider are Popperson’s ethical obligations in answering this question.
- Assume Popperson informs the senior in charge of the Beauda audit and the senior informs the manager, Kelly Korn. A meeting is held the next day with all parties in the office of Iceman Cometh, the managing partner of the firm. Here’s how it goes:
Iceman: If we tell Beauda about the problems at CSM, we will have violated our confidentiality obligation as a firm to CSM. Moreover, we may lose both clients.
Kelly: Lance, you are the closest to the situation. How do you think Beauda’s top hospital administrators would react if we told them?
Lance: They wouldn’t buy the equipment.
Iceman: Once we tell them, we’re subject to investigation by our State Board of Accountancy for violating the confidentiality obligation we have to CSM. We don’t want to alert the board and have it investigate our actions. What’s worse is we may be flagged for the confidentiality violation in our next peer review.
Kelly: Who would do that? I mean, CSM won’t know about it and the Beauda people are going to be happy we prevented them from buying what may be faulty equipment.
Senior: I agree with Kelly. They are not likely to say anything.
Iceman: I don’t like it. I think we should be silent and find another way to warn Beauda Medical without violating confidentiality.
Lance: What about contacting the state board for advice?
Follow-up questions
3 (a) Discuss all ethical and professional matters of concern for the firm of Scoop and Shovel LLP, in deciding whether to do as Iceman Cometh suggests and not tell the administrators at Beauda Medical Center?
(b) What do you think about Lance’s suggestion to contact the state board for advice on the matter? Is that the function of a state board of accountancy?
First Community Church
First Community Church is the largest church in the city of Perpetual Happiness. Yes, it’s in California!
A meeting was held on Friday, November 16 to address the fact that money had been stolen from the weekly collection box during the course of the year and church leaders were getting quite concerned. At first, no one paid much attention as the amounts were small and could have been attributed to inadvertent errors due to discrepancies between the actual count and what really was collected. However, after 45 weeks of the continuous discrepancies, the total amount of differences had become alarming. Eddie Wong, the controller for the church, estimated the total was now $23,399. That represents well over 5 percent of their annual collections from church members totaling about $400,000.
The meeting began at 9am, a time that was early for the church leaders who often had late evening calls to make. The church staff brought donuts, bagels and coffee to help get the meeting off to a good start. But that’s not the way it happened.
“I want an explanation,” said Allen Yuen, the executive director of the church. “The boards of trustees are on my back about this matter. Some of them talk about this Sarbanes-Oxley Act and our lack of internal controls. All it’s foreign to me but I know indignation when I see it!”
“I can’t explain it, Allen,” responded Eddie Wong.
“Jennie. How about you?” Yuen asked. He was addressing Jennie Lin, the member of the executive committee of the board of trustees who was directly responsible for the count each week.
Jennie seemed uncomfortable. She hesitated before saying: “I think my count is correct. I take the money given to me by Joey, put it in the safe, and then Eddie opens the safe on Monday morning. He records the cash receipts and makes a bank deposit.”
Eddie said, “That’s right. My deposit always matches the amount of money reported by Jennie.”
“That doesn’t make sense,” Yuen said. “Someone is getting his or her hands on the money between the collection process and recording of the amount. I trust you, Jennie, to watch over these things and the internal control matter.”
“Perhaps the tally amount record independently submitted by the church volunteers has been overstated.” Jennie said.
“Why would that happen?” Yuen asked. “I mean, while it could happen and it would be an honest mistake, it seems unlikely.”
Jennie was starting to sweat. She decided a diversion was in order. “Maybe someone gets their hands on the collection box after the tally and before Joey gives it to me.”
Joey Ching is the accounting manager who delivers the collection box and tally sheet to Jennie after each service. Joey goes to church on a regular basis and volunteered to do the job in order to establish a control in the process.
At this point Jennie lowered her head while she waited for a response. It came from Alex Yuen. “Jennie, are you accusing Joey of stealing money from the church collection box?”
Jennie shook her head as if to say no. She was visibly upset. A phone call came in for Yuen and the meeting had to break up. The group agreed to continue the discussion in two days. In the meantime, Alan Yuen said he’d call Joey Ching and ask him to attend the next meeting.
Jennie went back to her office, closed the door, and started to reflect on what she had just done. The truth is that Jennie had been taking the money each week and giving it to a homeless shelter two blocks from the church. Some of the homeless attend church services and Jennie has befriended many of them. She knew it was wrong to take money from the collection box, but she thought it was for a very good cause and that the church clergy would approve. She never thought about getting caught since she told the bookkeeper to record the lower amount. Now, she feels guilty about bringing Joey into the picture.
This case looks at challenges facing many non-profits, using volunteers to provide internal controls.
Ethical Issues
Jennie has succumbed to the fraud triangle. Jennie is not fulfilling her fiduciary duty. By stealing monies, fraud and deceit, Jennie has committed acts discreditable to the profession. From the rights perspective, the church has a right to determine its donation to the shelter through the normal process. The church members have a right to expect the staff to uphold their fiduciary duties. From the deontology perspective, Jennie has a duty not to steal or take money without permission of the church. From a utilitarian perspective not all the constituencies of the church may have been considered.
Questions
- Assume Jennie Lin is a CPA. Evaluate her actions from an ethical perspective. Jennie believed her actions were proper because taking the money from the church and giving it to the homeless served a greater good. Do you agree with her position from an ethical perspective?
- As a member of the board of trustees of the church, what are Jennie’s ethical obligations to the church? Do you think it is more difficult to establish strong internal controls in a nonprofit such as First Community Church as compared to a public or privately-owned company? Why or why not?
- (a) Assume Jennie calls Joey and explains the situation. She tells Joey about the impending call from Alex Yuen and, as a friend, asks him not to come to the meeting so she could explain what she has done without his involvement. If you were Joey, would you stay away from the meeting? Why or why not?
4. (b) Assume Joey stays away, Jennie explains why she did what she did, and, after due deliberation, Yuen fires Jennie and tells her she must replace the money she “stole” from the collection box. How would you evaluate Yuen’s actions from an ethical perspective?
ZZZZ Best*
The story of ZZZZ Best is one of greed and audaciousness. It is the story of a 15-year old boy from Reseda, California who was driven to be successful regardless of the costs. His name is Barry Minkow.
Minkow had high hopes to make it big – to be a millionaire very early in life. He started a carpet cleaning business in the garage of his home. Minkow realized early on that he was not going to become a millionaire cleaning other people’s carpets. He had bigger plans than that. Minkow was going to make it big in the insurance restoration business. In other words, ZZZZ Best would contract to do carpet and drapery cleaning jobs after a fire or flood. Since the damage from the fire or flood probably would be covered by insurance, the customer would be eager to have the work done. The only problem with Minkow’s insurance restoration idea was that it was all a fiction. There were no insurance restoration jobs, at least for ZZZZ Best. In the process of creating the fraud, Minkow was able to dupe the auditors, Ernst & Whinney into thinking the insurance restoration business was real. In fact, over 80 percent of his revenue was allegedly from this work. The auditors never caught on until it was too late.
How Barry Became a Fraudster
Minkow wrote a book, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback** that provides some insights into the mind of a 15-year old kid
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* The facts are derived from a video by the ACFE, Cooking the Books: What Every Accountant Should Know about Fraud.
**Barry Minkow, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback (Nashville, TN: Thomas Nelson, 1995).
who was called a “wonder boy” on Wall Street until the bubble burst. He was trying to find a way to drum up customers for his fledgling carpet cleaning business. One day, while he was alone in the garage-office, Minkow called Channel 4 in Los Angeles. He disguised his voice to sound not like a teenager and told a producer that he had just had his carpets cleaned by the 16-year owner of ZZZZ Best and was very impressed that a high school junior was running his own business. He sold the producer on the idea that it would be good for society to hear the success story about a high school junior running his own business. The producer bought it lock, stock and carpet cleaner. Minkow gave the producer the phone number of ZZZZ Best and waited. It took less than five minutes for the call to come in. Minkow answered the phone and when the producer asked to speak with Mr. Barry Minkow, Minkow said: “Who may I say is calling?” Within days a film crew was in his garage shooting ZZZZ Best at work. The story aired that night and it was followed by more calls from radio stations and other television shows wanting to do interviews. People called demanding that Barry Minkow personally clean their carpets.
As his income increased in the spring of 1983, Minkow found it increasingly difficult to run the company without a checking account. He managed to find a banker that was so moved by his story that the banker would agree to allow someone under-aged to open a checking account. Minkow used the money to buy cleaning supplies and other necessities. Even though his business was growing, Minkow ran into trouble paying back loans and interest when due.
Minkow developed a plan of action. He was tired of worrying about not having enough money. He went to his garage – where all his great ideas first began – and he looked at his bank account statement which showed that he had more money than he thought he had based on his own records. Minkow soon realized it was because some checks he had written had not been cashed by customers so it didn’t yet shown up on the bank statement. Voila! Minkow started to kite checks between two or more banks. He would write a check on one ZZZZ Best account and deposit it into another. Since it might take a few days for the check written on bank number one to clear that banks’ records, at least back then when checks weren’t always processed in real time, Minkow could pay some bills out of the second account and the first bank would not know – at least for a few days – that Minkow had written a check on his account when, in reality, he had a negative balance. The bank didn’t know it because some of the checks that Minkow had written before the visit to bank number two had not cleared his account in bank number one.
It wasn’t long thereafter that Minkow realized he could kite checks big-time. Not only that, he could make the transfer of funds at the end of a month or a year and show a higher balance than really existed in bank number one and carry it on to the balance sheet. Since Minkow did not count the check written on his account in bank one as an outstanding check, he was able to double-count.
Time to Expand the Fraud
Over time, Minkow moved on to bigger and bigger frauds like having his trusted cohorts confirm to banks and other interested parties that ZZZZ Best was doing insurance restoration jobs. Minkow used the phony jobs and phony revenue to convince bankers to make loans to ZZZZ Best. He had cash remittance forms made up from non-existent customers with whatever sales amount he wanted to appear on the document. He even had a co-conspirator write on the bogus remittance form, “job well done.” Minkow could then show a lot more revenue that he was really making.
Minkow’s phony financial statements enabled him to borrow more and more money and expand the number of carpet cleaning outlets. However, Minkow’s personal tastes had become increasingly more expensive including purchasing a Ferrari with the borrowed funds and putting a down payment on a 5,000-square foot home. So, the question was: How do you solve a perpetual cash flow problem? You go public! That’s right, Minkow made a public offering of stock in ZZZZ Best. Of course he owned a majority of the stock to maintain control of the company.
Minkow had made it to the big leagues. He was on Wall Street. He had investment bankers, CPAs and attorneys all working for him -- the 15-year old kid from Reseda who had turned a mom and pop operation into a publicly-owned corporation.
Barry Goes Public
Minkow’s first audit was for the twelve months ended April 30, 1986. A sole practitioner performed the audit. (There are eerie similarities in the Madoff fraud with its small practitioner firm – Frichling & Horowita – conducting the audit of a multi-billion dollar operation and that of the sole practitioner audit of ZZZZ Best).
Minkow had established two phony front companies that allegedly placed insurance restoration jobs for ZZZZ Best. He had one of his cohorts make out invoices for services and respond to questions about the company. There was enough paperwork to fool the auditor into thinking the jobs were real and the revenue was supportable. However, the auditor never visited any of the insurance restoration sites. If he had done so, there would have been no question in his mind that ZZZZ Best was a big fraud.
Pressured to get a big-time CPA firm to do his audit as he moved into the big leagues, Minkow hired Ernst &Whinney to perform the April 30, 1987 fiscal year-end audit. Minkow continued to be one step ahead of the auditors. That is until the Ernst & Whinney auditors insisted on going to see an insurance restoration site. They wanted to confirm that all the business – all the revenues --- that Minkow had said was coming in to ZZZZ Best, was real.
The engagement partner drove to an area in Sacramento, California where Minkow did a lot of work – supposedly. He looked for a building that seemed to be a restoration job. Why he did that isn’t clear but he identified a building that seemed to be the kind that would be a restoration job in process.
Earlier in the week, Minkow sent one of his cohorts to find a large building in Sacramento that appeared to be a restoration site. As luck would have it, Minkow’s associate picked out the same site as had the partner later on. Minkow’s cohorts found the leasing agent for the building. They convinced the agent to give them the keys so that they could show the building to some potential tenants over the weekend. Minkow’s helpers went up to the site before the arrival of the partner and placed placards on the walls that indicated ZZZZ Best was the contractor for the building restoration. In fact, the building was not fully constructed at the time but it looked as if some restoration work would have been going on at the site.
Minkow was able to pull it off in part due to luck and in part because the Ernst and Whinney auditors did not want to lose the ZZZZ Best account. It had become a large revenue producer for the firm and Minkow seemed destined for greater and greater achievements. Minkow was smart and he used the leverage of the auditors not wanting to lose the ZZZZ Best account as a way to complain whenever they became too curious about the insurance restoration jobs. He would even threaten to take his business away from Ernst and Whinney and give it to other auditors.
Minkow also took a precaution with the site visit. He had the auditors sign a confidentiality agreement that they would not make any follow-up calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration work. This prevented the auditors from corroborating the insurance restoration contracts with independent third parties.
The Fraud Starts to Unravel
It was a Los Angeles housewife that started the problems for ZZZZ Best that would eventually lead to the demise of the company. Since Minkow was a well known figure and flamboyant character, the Los Angeles Times did an expose about the carpet cleaning business. The Los Angeles housewife read the story about Minkow and recalled that ZZZZ Best had overcharged her for services in the early years by increasing the amount of the credit card charge for carpet cleaning services.
Minkow had gambled that most people don’t check their monthly statements so he could get away with the petty fraud. However, the housewife did notice the overcharge, complained to Minkow, and eventually he returned the overpayment. She couldn’t understand why Minkow would have had to resort to such low levels back then if he was as successful as the L.A. Times article made him out to be. So, she called the reporter to find out more and that ultimately led to the investigation of ZZZZ Best and future stories that weren’t so flattering.
Since Minkow continued to spend lavishly on himself and his possessions, he always seemed to need more and more money. It got so bad over time that he was to close to defaulting on loans and had to make up stories to keep the creditors at bay, and he couldn’t pay his suppliers. The complaints kept coming in and eventually the house of cards that was ZZZZ Best came crashing down.
During the time that the fraud was unraveling, Ernst and Whinney decided to resign from the ZZZZ best audit. The firm never did issue an audit report. It had started to doubt the veracity of Minkow and the reality of business at ZZZZ Best.
The procedure to follow when a change of auditor occurs is for the company to file an 8-K form with the SEC and the audit firms prepares an exhibit commenting on the accuracy of the disclosures in the 8-K. The exhibit is attached to the form that is sent to the SEC within 30 days of the change. Ernst & Whinney waited the full 30-day period and the SEC released the information to the public 45 days after the change had occurred. Meanwhile, ZZZZ Best had filed for bankruptcy. During the period of time that had elapsed, Minkow had borrowed more than $1 million dollars and the lenders never were repaid. The Bankruptcy laws protected Minkow and ZZZZ Best from having to make those payments.
Legal Liability Issues
The ZZZZ Best fraud was one of the largest of its time. ZZZZ Best reportedly settled a shareholder class action lawsuit for $35 million. Ernst & Whinney was sued by a bank that had made a multimillion-dollar loan based on the financial statements for the three-month period ending July 31, 1986. The bank claimed that it had relied on the review report[1] issued by Ernst & Whinney in granting the loan to ZZZZ Best. However, the firm had indicated in its review report that it was not issuing an opinion on the ZZZZ Best financial statements. The judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly disclaimed issuing any opinion on the statements.
Barry Minkow was charged with engaging in a $100 million fraud scheme. He was sentenced to a term of 25 years. Minkow was paroled after serving eight years in jail. During his time in prison, Minkow became involved in Christian ministry, which continued after his probationary release from prison in April 1995. Today he is senior pastor of the Community Bible Church in San Diego, California, having renounced his felonious acts. Minkow is recognized as an expert on fraud, and speaks on the subject to university students and the business community in an effort to prevent fraud.
This case discusses the actual case of ZZZZ Best and Barry Minkow. The auditors ignored common sense and did not use due care in the audit.
Ethical Issues
This case shows how auditors did not use due care or skepticism in the audit of ZZZZ Best. The auditors lost independence and became bedazzled by Barry Minkow, the whiz kid of Wall Street. Due care requires that an auditor discharges professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of the auditor’s ability with concern for the best interest of the public.
Questions
- Do you believe that auditors should be held liable for failing to discover fraud in situations such as ZZZZ Best where top management goes to great lengths to fool the auditors? Why or why not?
2. The AICPA Code obligates CPAs to follow specific standards of conduct in conducting audits. Answer the following questions with respect to those standards and the related ethical expectations.
(a) Why is it important to exercise sensitive moral judgments when conducting an audit? Did Ernst & Whinney meet its obligations in this regard? If not, describe why it failed to meet its obligations.
(b) What are the criteria for audit independence? Comment on the independence of Ernst & Whinney in conducting its audit of ZZZZ Best.
(c) ) Auditors are expected to exercise due care in the performance of professional services. Explain the purpose of the due care standard. Based on the facts of the case, do you think Ernst & Whinney met their due care obligations? Why or why not?
- These are selected numbers from the financial statements of ZZZZ Best for fiscal years 1985 and 1986: 1985 1986
Sales $1,240,524 $4,845,347
Cost of goods sold 576,694 2,050,779
Accounts receivable 0 693,773
Cash 30,321 87,014
Current liabilities 2,930 1,768,435
Notes payable-current 0 780,507
What calculations or financial analyses would you make with these numbers that might help you assess whether the financial relationships are “reasonable?” Given the facts of the case, what inquiries might you make of management based on your analysis?
HealthSouth
The HealthSouth case is unique because the CEO, Richard Scrushy, was initially acquitted on all accounts while five former HealthSouth employees were sentenced by a federal judge for their admitted roles in a scheme to inflate revenues and reported earnings of the company from 1999 through mid-2002. These amounts are presented in Exhibit 1.
You may want to review the facts of the case presented in the text before reading on.
HealthSouth was the nation’s largest provider of outpatient surgery, diagnostic imaging and rehabilitative services. In 2003, the SEC filed a complaint against the company and Scrushy for violating provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934[1] The complaint alleges that HealthSouth, under Scrushy’s direction and with the help of key employees, falsified its revenue to inflate earnings and “meet their numbers.” Specifically, false accounting entries were made to an account called “contractual adjustment.” The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that various healthcare insurers will pay for a specific treatment. HealthSouth deducted this account from gross revenues to derive net revenues, which were disclosed on the company’s periodic reports filed with the SEC. The allowances were deliberately understated to help meet financial analyst earnings estimates.
The SEC contends that in mid-2002, certain senior officers of Health South discussed with Scrushy the impact of the scheme to inflate earnings because they were concerned about the consequences of the August 14, 2002 financial statement certification required under Section 302 of the Sarbanes-Oxley Act of 2002. Allegedly, “Scrushy agreed that, going forward, he would not insist that earnings be inflated to meet Wall Street analysts’ expectations.”
The filing also alleges that Scrushy received at least $6.5 million from Health South during 2001 in “Bonus/Annual Incentive Awards.” Also, from 1999 through 2002, HealthSouth paid Scrushy $9.2 million in salary. Approximately $5.3 million of this salary was based on the company’s achievement of certain budget targets.
On December 10, 2003, U.S. District Judge Inge P. Johnson sentenced former vice president of finance Emery Harris, who pleaded guilty in March 2003 to a charge of conspiracy and willfully falsifying books and records, to a term of five months in prison on each count to run concurrently, three years of supervised release with five months of unsupervised house detention, and payment of a $3,000 fine and a $200 special assessment. Harris was also ordered to pay $106,500 in forfeiture.[2]
The Judge also sentenced each of the following to four years of probation with six months unsupervised home confinement and payment of a $2,000 fine: (1) former Accounting Department vice presidents Angela C. Ayers and Cathy C. Edwards; (2) group vice president Rebecca Kay Morgan; and (3) assistant vice president Virginia B. Valentine. Ayers and Valentine were also ordered to pay a $100 special assessment, and Edwards and Morgan, a $200 special assessment. Morgan was also ordered to pay $235,000 in forfeiture. The four officers all pleaded guilty in April 2003 to conspiracy to commit wire and securities fraud, and Edwards and Morgan also pleaded guilty to wire fraud.
Ayers, Edwards, Morgan and Valentine all made false entries into the accounts of HealthSouth during the fraud period. Harris admitted falsifying the company’s finances to generate false entries, knowing that those entries would be included in the company’s filings with the SEC.
On June 28, 2005, Richard Scrushy, the former CEO of HealthSouth, was acquitted on all charges despite the testimony of more than a half-dozen former lieutenants who said he had presided over a $2.7 billion accounting fraud while running the Health South national hospital chain. The jury had even heard secretly recorded conversations between Scrushy and a chief financial officer, William T. Owens, in March 2003 discussing balance sheet problems, with Scrushy asking “You’re not wired, are you?”
In an ironic twist in the HealthSouth saga, the key prosecution witness in the government’s case against Scrushy, William Owens, was sentenced on December 9, 2005, to five years in prison for his role in the accounting fraud at HealthSouth. Owens had manipulated the company’s books and instructed subordinates to make phony accounting entries. He also falsely certified the 2002 financial statements filed with the 10-K Report to the SEC.
U.S. District Judge Sharon Lovelace Blackburn knocked three years from the prosecutors sentencing request stating to Owens: “I believe you told the truth.” Blackburn called Scrushy’s acquittal a “travesty.” Nonetheless, Blackburn said white collar criminals merit stiff sentences, if only to send a message of deterrence to other business executives. “Corporate offenders are nothing more than common thieves wearing suits and wielding pens,” Blackburn said.[3]
The Fraud Investigation –Implications of Whistleblowing
HealthSouth said a forensic audit by PricewaterhouseCoopers found fraudulent entries to raise the total to a range of $3.8 billion to $4.6 billion, up from $3.5 billion, the government's original estimate. The fraud included $2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and $800 million to $1.6 billion in ''aggressive accounting'' from 1992 to March 2003.
Allegedly, HealthSouth's auditors—and maybe even government regulators—were tipped off to a possible massive accounting fraud at the company five years before it became public knowledge, or at least that's the takeaway from a shareholder's memo that was released by a congressional committee during its investigation. The memo, dated November 1998, was apparently written by an anonymous HealthSouth shareholder and sent to auditor Ernst & Young. In it, the shareholder alerts the audit firm to alleged bookkeeping violations at the rehabilitation-services company. Reportedly HealthSouth's top lawyer assured its independent auditor that it would conduct an internal investigation of the allegations. The committee notes no record of such an inquiry, however. "You bring the smoke, I'll bring the mirrors," the unnamed shareholder wrote in the memo.
The shareholder's list of alleged violations at HealthSouth included an assertion that the company booked charges to outpatient clinic patients before checking that insurers would reimburse the claims. The shareholder also alleged that HealthSouth continued to record these charges as revenue even after payments were denied. "How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days?" the shareholder asked in the letter.
More questions followed: "How can some hospitals have NO bad debt reserves? How did the E&Y auditors in Alabama miss this stuff? Are these clever tricks to pump up the numbers, or something that a novice accountant could catch?" In a statement issued by E&Y, the firm stated it had conducted a review at the time the allegations were made and "determined the issues raised did not affect the presentation of HealthSouth's financial statements.”You people and I have been hoodwinked," the shareholder concluded in the memo. "This note is all that I can do about it. You all can do much more, if all you do is look into it to see if what I say is true." At 10:06 a.m. on Feb. 13, 2003, someone made a sensational claim on the Yahoo bulletin board devoted to discussion of HealthSouth Corp."What I know about the accounting at HealthSouth will be the blow that will bring the company to its knees."
Michael Vines, a former bookkeeper in HealthSo uth's accounting department, tried to spread the word about alleged questionable practices while at HealthSouth but was turned away at every turn. According to Vine’s testimony at the April 2002 federal court hearing, he came to believe that people in the department were falsifying assets on the balance sheet. The accountants, he testified, would move expenses from the company’s income statement – where the expenses would have to be deducted from profits immediately – to its balance sheet, where they wouldn’t have to be deducted all at one time. Thus, the company’s expenses looked lower than they should have been, which helped artificially boost net income.
The individual expenses were relatively small – between $500 and $4,999 a piece, according to Vines’ testimony – because E&Y examined expenses over $5,000. Overall, according to the SEC complaint, about $1 billion in fixed assets were falsely entered. In his testimony, Vines identified about $1 million in entries he believed were fraudulent. He told his immediate superior, Cathy C. Edwards, a vice president in the accounting department, that he wouldn’t make such entries unless she first initialed them. “I wanted her signature on it,” Vines testified. Edwards, according to Vine’s testimony, signed off on the entries and he logged them. Vines also testified that he saw Edwards falsifying an invoice, which according to his testimony was a way to cover up the larger fraud involving the accounts. On April 3, Edwards pleaded guilty to conspiracy to commit wire and securities fraud. As part of the plea, she admitted to falsifying records, although the plea didn’t mention specific incidents.
Over time, Vines had grown more concerned about the accounting practices, particularly in light of the scandal that had recently erupted at Enron Corp. He quit his job and moved to the accounting office of a Birmingham country club. Not long afterward, he sent an e-mail to E&Y alleging fraudulent transactions between the company's accounts and identifying three account numbers that Ernst should investigate. The accounts covered expenses for "minor equipment," "repairs and maintenance" and "public information," which included costs for temporary workers and advertising job openings, he said in an interview and in court testimony.
Vines's e-mail was passed on to James Lamphron, a partner in Ernst's Birmingham office. Lamphron testified that he had contacted William T. Owens, who was then president and chief operating officer at HealthSouth, and George Strong, who served as chairman of the audit committee of HealthSouth's board. A HealthSouth spokesman said Strong felt the matter was being resolved. According to Mr. Lamphron's testimony, Owens defended the company's accounting practices. He acknowledged that the company had moved expenses from one category to another, but he argued that the company had done it for several years and that it was an acceptable practice. Lamphron testified that Owens called Vines a "disgruntled employee." On March 26, 2004, Owens pleaded guilty to wire and securities fraud and certifying a false financial report to the SEC.
Lamphron testified that E&Y conducted "audit-related procedures" with the accounts Vines pointed out. The result: Ernst "reached a point where we were satisfied with the explanation that the company had provided to us ... We then closed the process." According to Lamphron's testimony, Vines never specified that invoices were being falsified -- only that there was a problem with the three accounts he mentioned. So E&Y never investigated the falsified invoices and didn't find any evidence of fraud. Ernst defended itself by stressing the difficulty of detecting accounting fraud in the midst of a conspiracy involving senior executives and allegedly false documentation. Ernst wasn’t named or charged as a defendant in the government cases and the firm cooperated with investigators.
This case discusses the HealthSouth scandal, which was one of the first cases under the Sarbanes Oxley required that the CEO and CFO of a company certify the financial statements as non misleading.
Ethical Issues
The ethical issue of this case is whether it is fair that the former CEO of HealthSouth was acquitted of certifying misleading and false financial statements while the CFO is serving a five years for the same act.
Questions
- Do you think lower level employees should be excused from any liability for their actions that contribute towards financial statement fraud when the person in charge of the fraud is found not guilty in a court of law? Use ethical reasoning to support your answer.
2- What is the nature of the contractual allowance account? Can you equate it to other allowance accounts? Explain the rules under GAAP to account for such allowances
3-EY wasn’t named or charged as a defendant in the government case against HealthSouth. Based on the limited facts of the case, do you think EY should have been charged for its failure to exercise due care in the audit of HealthSouth? Be specific.
Independence Violations at PricewaterhouseCoopersOn January 6, 2000, the SEC made public the report by independent consultant Jess Fardella, who was appointed by the Commission in March 1999 to conduct a review of possible independence rule violations by the public accounting firm PricewaterhouseCoopers (PwC) arising from ownership of client- issued securities. The report found significant violations of the firm's, the profession's, and the SEC's auditor independence rules.BackgroundOn January 14, 1999, the Commission issued an Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice In the Matter of PricewaterhouseCoopers LLP (Securities Exchange Act of 1934 Release No. 40945) ("Order"),[4] which censured PwC for violating auditor independence rules and improper professional conduct. Pursuant to the settlement reached with the Commission, PwC agreed to, among other things, complete an internal review by Fardella to identify instances in which the firm’s partners or professionals owned securities of public audit clients of PwC in contravention of applicable rules and regulations concerning independence. The independent consultant's report discloses that a substantial number of PwC professionals, particularly partners, had violations of the independence rules, and that many had multiple violations. The review found excusable mistakes, but also attributed the violations to laxity and insensitivity to the importance of independence compliance. According to Fardell’s report, PwC acknowledged that the reviewdisclosed widespread independence non-compliance that reflected serious structural and cultural problems in the firm.Results of Independent Consultant’s Report The report summarizes results of the internal review at PwC, which included two key parts: PwC professionals were requested in March 1999 to self-report independence violations; and the independent consultant randomly tested a sample of the responses for completeness and accuracy. The results are as follows.1. Almost half of the PwC partners -- 1,301 out of a total of 2,698 -- self-reported at least one independence violation. The 1,301 partners who reported a violation reported an average of five violations; 153 partners had more than ten violations each. Of 8,064 reported violations, 81.3% were reported by partners and 17.4% by managers; 45.2% of the violations were reported by partners who perform services related to audits of financial statements.
2. Almost half of the reported violations involved direct investments by the PwC professional in securities, mutual funds, bank accounts, or insurance products associated with a client. Almost 32% of reported violations, or 2,565 instances, involved holdings of a client's stock or stock options.
3. Six out of eleven partners at the senior management level who oversaw PwC's independence program self-reported violations. Each of the 12 regional partners who help administer PwC's independence program reported at least one violation; one reported 38 violations and another reported 34 violations.
4. Thirty-one of the 43 partners who comprise PwC's Board of Partners and its U.S. Leadership Committee self-reported at least one violation. Four of these had more than 20 violations; one of these partners had 41 violations and another had 40 violations.
The random tests of the self-reporting process summarized above indicated that a far greater percentage of individuals had independence violations than were reported. Despite clear warnings that the SEC was overseeing the self-reporting process,the random tests of those reports indicated that 77.5% of PwC partners failed to self-report at least one independence violation. The combined results of the self-reporting and random tests of those reports indicated that approximately 86.5% of PwC partners and 10.5% of all other PwC professionals had independence violations. The independent consultant's report identifies key weaknesses in the systems PwC had used to prevent or detect independence violations. These include:1. Reporting systems relied on the individuals themselves to sort through their own investments and interests for violations;
2. Efforts to educate professionals about the independence rules and their responsibilities to the client to comply with the rules were insufficient;
3. Resolution of reported violations were not adequately documented; and
4. Reporting systems did not focus on the reporting of violations that were deemed to be resolved before annual confirmations were submitted.
The consultant’s report concludes that . . . the numbers of violations alone, as PwC acknowledged, reflect serious structural and cultural problems that were rooted in both its legacy firms [Price Waterhouse and Coopers & Lybrand]. Although a large percentage of the reported and unreported violations is attributable solely to the Merger, an even larger portion is not; thus, the situation revealed by the internal investigation is not a one-time breakdown explained solely by the Merger. Nor can the magnitude of the reported and unreported violations be attributed simply to less familiar Independence Rules such as those pertaining to brokerage, bank and sweep accounts. At least half of the reported and unreported violations consisted of interests held by a reporting PwC professional himself or herself, and most of the violations arose from either mutual fund or stock holdings . . . .Independence compliance at PwC and its legacy firms was dependent largely on individual initiative. This system failed, as PwC has acknowledged . . . .Changes Needed As accounting firms have grown larger, acquired more clients and provided more services, and as investment opportunities and financial arrangements have increased in number and complexity, well-designed and extensive controls are needed both to facilitate Independence compliance and to discourage and detect non-compliance. The violations discussed in the consultant's report had come to light as a result of a Commission-ordered review after professional self-regulatory procedures failed to detect such violations. As a result, the SEC's requested the then current Public Oversight Board (largely replaced by PCAOB), to sponsor similar independent reviews at other
firms and oversee development of enhancements to quality control and other professional standards. The firm also agreed in a settlement to conduct the review and create a $2.5 million education fund after the SEC alleged that some of its accountants compromised their independence by owning stock in corporations they audited. PricewaterhouseCoopers promised at the time to take steps to ensure that it didn’t happen again. As a result of the inquiry, five partners of the firm and a slightly larger number of other employees had been dismissed, and other employees were disciplined but not fired.
Two changes that resulted from the problems at PwC were: (1) to clearly define family members and other close relatives of members of the attest engagement team that might create an independence impairment for the auditors because of the formers ownership interests in a client and/or their position within the client including having a financial reporting oversight role (Interpretation 101-1); and (2) to restrict the ability of audit personnel from having loans to or from banks and other financial institution clients (Interpretation 101-5). This case describes the need for independence during an audit. Without it, the audit would be compromised. Ethical IssuesA lack of independence violates the rights theory because the stakeholders have a right to trust that the external auditors remain independent when conducting their audit so they avoid a bias. Under the fairness theory, all the stakeholders deserve that a fair audit be conducted. The theory of deontology requires that the auditor has a duty to report accurate information to the public and adhere to independence requirements. Questions1. In commenting on the findings in the consultant’s report, the then-chief-accountant of the SEC, Lynn E. Turner said, "This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental
principle of auditor independence." Why is it so important for auditors to be independent of their clients? Explain the nature of the independence impairments at PwC with respect to the threats to independence impairments discussed in the chapter.
Review question 19 at the end of the chapter and the PeopleSoft case in the chapter. What are the commonalities between the facts of these two cases with respect to independence violations and the facts of PwC’s independence violations? How might the independence violations in these cases negatively affect the ability of an auditor to be objective in performing professional services and maintain her integrity
3- We have discussed the need for an ethical tone at the top and strong internal controls at public companies to help prevent and detect fraud. In Chapter 2 we point out that studies have shown most CPAs reason at stages 3 or 4 in Kohlberg’s model. Given the independence violations at PwC, do you think it is indicative of a stage 3 or 4 reasoning capacity? Or is it stage 1 or 2? Explain.
[1] Securities and Exchange Commission, Civil Action No. CV-03-J-0615-S, U.S. District Court Nirthern District of Alabama, SEC v. HealthSouth Corporation and Richard M. Scrushy, Defendants.
[2] Department of Justice, “Five Defendants Sentenced in HealthSouth Fraud Case,” www.usdov.gov.
[3] Carrie Johnson, “5 Years for HealthSouth Fraud: Former Chief Financial Officer was Key Witness,” Washington Post, December 10, 2005, D1.
[4] Available at: http://www.sec.gov.
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