Review of Chapter 3

What were the steps in the accounting cycle in Chapter 3? What is the difference between the accrual and the cash basis of accounting. What were the accounting principles? What were the 3 types of adjustments? What accounts do we close? What ratios did we look at?

Review of Chapter 3 Question #1

A company collected one year of rent in advance on August 1, 2010. The entry made at that date was a Debit to Cash and a Credit to Unearned Revenue of $24,000. At Dec. 31, 2010, the adjusting entry is:

Unearned Revenue a) Debit $10,000 b) Debit $14,000 c) Credit $10,000 d) Credit $14,000

Rent Revenue Credit $10,000 Credit $14,000 Debit $10,000 Debit $14,000

Internal Control and Cash

Chapter 4

Learning Objective 1
Learn about fraud and how much it costs

Fraud
Fraud is an intentional misrepresentation of facts, made for the purpose of persuading another party to act in a way that causes injury or damage to that party It is a huge problem and is getting bigger not only in Canada, but across the globe

Fraud
The two most common types of fraud that impact financial statements are: 1. Misappropriation of assets 2. Fraudulent reporting

Internal Control
A plan of organization and system procedures designed, implemented and maintained by company management and board of directors to deal with risks related to:
Reliability of financial records and reporting Ability to operate effectively and efficiently Compliance with legal requirements

Sarbanes Oxley Act (SOX)

The US congress passed SOX SOX is regulated corporate governance in United States In March 2004, the Canadian Securities Administrators (CSA) instituted a policy that requires the CEO and CFO to certify their financial statements

Learning Objective 2

Set up an internal control system

Components of Internal Control

Control environment Monitoring of controls Risk assessment Information system Control procedures

Internal Control Procedures

Smart hiring practices & separation of duties Comparison & Compliance monitoring

Adequate records
Limited access Proper approvals

Information technology
Safeguard controls

Smart Hiring and Separation of Duties

It starts with hiring background checks proper training and supervision paying competitive salaries Then: Responsibilities should be clearly laid out in position descriptions

Comparisons and Compliance Monitoring

An audit is an examination by an outside party of the companys financial statements, accounting systems, and internal controls. An internal auditor is an employee of the business. An external auditor is entirely independent of the business.

Adequate Records

All major groups of transactions should be supported by either hard copy documents or electronic records

Limited Access
Company policy should limit access to assets only to those persons or departments that have custodial responsibilities

Proper Approvals
No transaction should be processed without managements general or specific approval The bigger the transaction, the more specific the approval

Information Technology
The basic attributes of internal control of sophisticated IT does not change but the implementation procedures do.

Safeguard Controls
Fireproof vaults Burglar alarms Security cameras Loss prevention specialist Fidelity bonds Mandatory vacations Job rotation

Encryption
It is the transformation of data by a mathematical process into a form that is unreadable by anyone who does not have the secret decryption key.
Same key

Clear message Encryption

Encoded message Decryption

Clear message

Firewall
It is a technique that limits access to hardware, software, or data to persons within a network.

Inquirers Inquirers Customers Customers Customers

Hackers
Firewall 1 Firewall 2 Firewall 3

The Limitations of Internal Control

Systems designed to thwart one persons fraud can be beaten by two or more employees working together colluding to defraud the firm.

A system of internal control that is too complex can hurt efficiency and control.

Question #2
The concept of internal control refers to:
a. Audit procedures used to detect theft b. Policies of the Accounting Standards Board c. Policies and procedures of a company designed to safeguard assets d. A method used to reconcile the bank statement

Learning Objective 3
Prepare and use a bank reconciliation

The Bank Account as a Control Device

Banks safeguard and help control cash.

Companies should deposit all cash receipts and make all cash payments through the bank.

The Bank Reconciliation

There are two records of a businesss cash:
the companys cash account on its own books the bank statement, which shows the actual amount of cash in the bank.

The Bank Reconciliation

Two common items that cause differences between the bank balance and the book balance. 1. Items recorded by the company but not yet recorded by the bank: Deposits in transit Outstanding cheques

The Bank Reconciliation

2. Items on a bank statement and not recorded by the business: Bank collections Electronic funds transfers Service charge Interest revenue earned on account NSF cheques Errors

Steps in Preparing a Bank Reconciliation

Reconciling the Bank Statement

Bank Balance:
Balance per bank statement Add: Deposits in transit Less:Outstanding cheques +/- Bank errors = Adjusted balance Book Balance: Balance per general ledger Add: Bank collection items, interest revenue, EFT receipts Less:Service charges, NSF cheques, EFT payments +/-Book errors = Adjusted balance

Question #3
A cheque was written for $542 to purchase supplies. The cheque was recorded in the journal as $425. The entry to correct the error:
a. b. c. d. Dr Supplies expense, Cr Cash, $117 Dr Supplies expense, Cr Cash, $425 Dr Supplies, Cr Cash, $117 Dr Supplies, Cr Cash, $425

Learning Objective 4

Apply internal controls to cash receipts and cash payments.

Controlling and Managing Cash

Internal controls should be in place for:
a) Cash Receipts b) Cash Payments

Internal Control Cash Receipts

Internal control over cash receipts ensures that all cash receipts are deposited in the bank and no collections are lost.

Cash Receipts over the Counter

Cash Receipts by Mail

Cash Receipts over the Counter

The point-of-sale terminal (cash register) offers control over the cash received in a store.

The cash drawer opens only when the sales clerk enters an amount on the keypad. At the end of the day, the cashier deposits the cash in the bank.
The record of cash receipts goes to accounting.

Cash Receipts by Mail

All incoming mail should be opened by a mailroom employee. This person should compare the cheque received with the remittance advice. The mailroom clerk keeps a running total of cash receipts for the day.

Cash Receipts by Mail

At the end of the day this control total is given to a responsible official.

Cash receipts should be given to the cashier.

The mailroom employee forwards the remittance advices to accounting.

Internal Control over Cash Payments

Companies make most payments by cheque
Control over payment by cheque: - provides a record of payment - must be signed by an authorized official - before signing, should study the evidence

Question #4
All of the following are objectives of internal control except a. b. c. d. To safeguard assets To comply with legal requirements To maximize net income To ensure accurate and reliable accounting records

Learning Objective 5
Use a budget to manage your cash.

Using a Budget to Manage Cash

A budget is a financial plan that helps coordinate business activities. A cash budget helps a company, or an individual, manage cash by planning the receipt and payment of cash during a future period.

Using a Budget to Manage Cash

1. Start with the beginning cash balance. 2. Add the budgeted cash receipts and subtract the budgeted cash payments. 3. The beginning balance + expected receipts expected payments = expected cash balance at the end of the period. 4. Compare the expected cash balance at the end of the period to the budgeted cash balance

Cash Budget
Cash Budget For the Year Ended January 31, 2011 1. Cash balance, February 1, 2010 Estimated cash receipts: 2. Collections from customers 3. Interest and dividends on investments 4. Sale of store fixtures
Estimated cash payments: 5. Purchases of inventory 6. Operating expenses 7. Expansion of existing stores 8. Opening of new stores 9. Payment of long-term debt 10. Payment of dividends 11. Cash available (needed) before new financing 12. Budgeted cash balance, January 31, 2011 13. New financing needed $ 245.0 82.5 14.6 12.4 16.0 8.0

(In millions) $ 12.0

360.0 6.2 4.9 $ 383.1

378.5 4.6 13.5 $ ( 8.9)

Reporting Cash on the Balance Sheet

Companies usually combine all cash amounts into a single total called Cash and Cash Equivalents on the balance sheet. Cash equivalents include liquid assets Time deposits Certificates of deposit

Reporting Cash on the Balance Sheet

Sobeys Inc. Consolidated Balance Sheet May 4 Excerpts
(In Millions) 2002

Assets Current assets: Cash and cash equivalents Temporary investments Accounts receivable

$196.7 77.7 251.0

Learning Objective 6
Make ethical business judgment.

Ethics and Accounting

Most large companies have a code of ethics designed to encourage ethical and responsible behaviour by employees. Accountants have additional incentives to behave ethically. Standards of Professional Conduct: CICA, CGAAC, and SMAC

Ethical Decision Guidelines

What is the issue?
Who are the important stakeholders? What are the alternatives and consequences? Make the decision.

End of Chapter 4