Business School

ACCT1501 Accounting and Financial Management 1A

Session 1 2016

Week 6
Accrual Accounting Wrap Up
Internal Control and Cash

Student Handout

Lecturer:
Jeffrey Knapp
School of Accounting
UNSW

QUAD 3103
j.knapp@unsw.edu.au

Moodle: https://moodle.telt.unsw.edu.au/login/index.php

ACCT 1501 s1, 2016

 WEEK 6: Internal Control and Cash

1. Lecturer comments
This week we quickly finalise our study of the main components of accrual accounting and
complete the accounting cycle using a ten column worksheet. Then we consider the main
topic for the week of internal controls and cash. Internal controls are vital to the management
of an organisation and the integrity of the internal and external accounting information of the
organisation. Internal controls protect assets including cash. Internal control can prevent
fraud, minimise errors and provide a means of checking the accuracy and integrity of the
accounting records.
It is important to note that while we focus on cash in our discussion of internal control, good
internal control is not limited to protecting cash. An organisation should have controls over
all of its asset classes. We concentrate on cash for two reasons: Firstly, cash is the most liquid
asset, and hence one where the risk of theft is high. Secondly, cash gives us an opportunity to
consider key types of internal control mechanisms.

We introduce two management and control mechanisms – Petty Cash fund and the Bank
Reconciliation. Petty Cash is a way to deal with small amounts of cash outside the main
accounting system.

The bank reconciliation statement is the most important check on whether an organisation’s
accounting records for cash are complete. The idea is to reconcile between the accounting
records and the independent record of the bank. We align the information in our accounts
with the bank records and identify the differences in the information. We adjust for any
differences where necessary.

The bank reconciliation ensures that all cash movements have been included in our
accounting system and enables us to maintain control over cash and its recording. It is
important to note that the reconciliation process doesn’t only apply to cash. It is used in any
circumstances where we have information asymmetry between independent records and our
accounting records. So, for example, we might regularly reconcile supplier statements of
account with the accounts payable ledger.

ACCT 1501 s1, 2016 2

Learning objectives
At the end of this topic, you should be able to:
1. Prepare a ten-column worksheet.
2. Define internal control and describe the objectives of internal control.
3. Outline the components of a good internal control system.
4. Explain internal controls for cash including the use of a petty cash fund.
5. Explain the role of bank reconciliations and prepare a bank reconciliation statement.

Required readings
Trotman, Gibbins & Carson Chapter 7: pages 283-299

2. Tutorial Questions – Due in Week 8 because Week 7 is the

Midsession class test
Preparation Questions
Students should review the following preparation questions using the solutions available from
Moodle.
Discussion Questions DQ7.1, DQ7.7, DQ7.11, DQ7.12
Problems P7.12, P7.14, P7.18

Tutorial Questions
Students should attempt the following tutorial questions before class.
Problem 7.17

ACCT 1501 s1, 2016 3

3. Lecture Examples
Bank Reconciliation – Lecture Exercise

The following information was taken from the cash journals (cash receipts
journal and cash payments journal) for GGG Ltd.

Deposits Made Cheques Written

November 1 $1,828 November 1 Cheque 721 $28
November 7 $2,024 November 2 Cheque 722 $566
November 14 $6,480 November 3 Cheque 723 $832
November 21 $5,292 November 4 Cheque 724 $54
November 30 $3,884 November 5 Cheque 726 $40
November 10 Cheque 727 $11,492
November 11 Cheque 728 $1,814
November 20 Cheque 729 $2,492
November 21 Cheque 730 $152

Cheque number 725 was prepared incorrectly and has been cancelled.

The last bank reconciliation (October) revealed the following:

Balance as per bank statement 7,570 Cr

Less: Unpresented cheques 700 $ 200
707 $1,000
719 $ 520
720 $ 920 2,640 Dr
Adjusted cash balance: bank 4,930 Cr

Balance as per cash at bank ledger 4,930 Dr

ACCT 1501 s1, 2016 4

The following is the bank statement of November for GGG Ltd:

AUSTRALIA BANK
Statement for GGG Ltd

Date Particulars Debit Credit Balance

1 November Balance 7,570 Cr
2 November 700 200 7,370 Cr
2 November 707 1,000 6,370 Cr
2 November Deposit 1,828 8,198 Cr
4 November 720 920 7,278 Cr
4 November 721 28 7,250 Cr
6 November 723 832 6,418 Cr
8 November 724 54 6,364 Cr
8 November Deposit 2,024 8,388 Cr
12 November 726 40 8,348 Cr
14 November 728 1,814 6,534 Cr
15 November Deposit 6,480 13,014 Cr
22 November Deposit 5,292 18,306 Cr
24 November 727 11,492 6,814 Cr
26 November 730 152 6,662 Cr
30 November Service Charge 8 6,654Cr
30 November Interest 84 6,738 Cr

Required:

1) Prepare a bank reconciliation statement as at 30 November, 2015.

ACCT 1501 s1, 2016 5

 GGG Ltd
Bank Reconciliation Statement as at 30 Nov, 2015

Bank balance as per bank statement

Add:

Less:

Adjusted balance as per bank

Bank balance as per books

Add:

Less:

Adjusted balance as per books

2) Prepare the journal entries to adjust cash balance.

Adjusting the cash balance:

Journal Entries:

ACCT 1501 s1, 2016 6

 ACCT1501
Semester 1, 2016

Week 6
Internal Control and Cash

Jeffrey Knapp
Quad 3103
 Recap of the Course so far…

Assets Liabilities Equity

Next we drill down and look at certain asset categories

Cash
Accounts Receivable
Inventory
Property, Plant and Equipment

2
 Topic 6: Learning Objectives (LO)

At the end of Topic 6, you should be able to:

LO1: Prepare a ten-column worksheet

LO2: Define internal control and describe the objectives of internal control.

LO3: Outline the components of a good internal control system.

LO4: Explain internal controls for cash and use of a petty cash fund.

LO5: Explain the role of bank reconciliations and prepare a bank reconciliation
statement.

Essential reading for Week 6

Trotman, Gibbins & Carson Ch.7, 283-299

3
 Recap: Accounting Cycle LO1

1 SOURCE DOCUMENTS

During the
2 JOURNAL ENTRIES
accounting
period
3 POST TO LEDGERS

4 A TRIAL BALANCE

5 ADJUSTING JOURNAL ENTRIES

End of
6 AN ADJUSTED TRIAL BALANCE accounting
period
7 CLOSING JOURNAL ENTRIES

8 POST-CLOSING TRAIL BALANCE

4 9 FINANCIAL STATEMENTS
 Worksheet LO1

A “tool” to help you prepare your financial statements.

Use of worksheet is optional

lists all the accounts vertically down the page

Current assets/Non current assets
Current liabilities/Non-current liabilities
Shareholder’s equity
Revenue
Expense

5
 Worksheet LO1

Income
Statement

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 Worksheet LO1

A multiple-column form
10 columns, or 5 sets of “2” columns. Each set has a “debit”
and a “credit” column

1. Trial Balance
2. Adjustments
3. Adjusted Trial Balance
4. Income Statement (IS)
5. Balance Sheet (BS)

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 Worksheet LO1

Income
Statement

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Worksheet
Worksheet – Steps LO1

The Trial Balance

From the general ledger get your “pre-adjustment” balance
Adjustments
Adjusting journal entries
Calculate the adjusted trial balance
Prepare IS
Closing Entries
Prepare BS

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 Worksheet – Steps LO1

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 Preparing financial statements LO1

After completing the worksheet, transfer the information

from the IS and BS columns to financial statements, in
the correct format.
Important to classify accounts correctly
Not just at A, L, SE, R, and E
Also categories of A, L and E
Expenses need to be classified into:
Selling expenses
Administration expenses
Financing expenses
Other expenses

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 Comprehensive class example LO1

Let’s look at the Comprehensive Class Example

worksheet

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 Worksheet LO1

Income
Statement

13
 Worksheet
Worksheet LO1

Income
Statement

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 Adjusting journal entries – Lecture 5 LO1

ADJUSTING JOURNAL ENTRIES

PR Debit Credit
9 Supplies Expense E3 370
370
Supplies A4
10 Interest Expense E6 240
240
Interest Payable L2
11 Insurance Expense E4 820
820
Prepaid Insurance A3
12 Depreciation Expense – MV E2 5 350
5 350
Accumulated Depreciation – MV A5.1
13 Telephone Expense E5 180
180
Telephone Expense Payable L4

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 Worksheet LO1

Income
Statement

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 Worksheet LO1

Income
Statement

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 Closing journal entries – Lecture 5 LO1

PR Debit Credit
1 Piano Tuning Fees R1 28 600
Piano Repair Fees R2 24 380
Profit and Loss Summary SE3 52 980

2 Profit and Loss Summary SE3 12 300

Petrol and Oil Expense E1 2 680
Depreciation Expense – MV E2 5 350
Supplies Expense E3 370
Insurance Expense E4 820
Telephone Expense E5 2 420
Interest Expense E6 660

3 Profit and Loss Summary SE3 40 680

Retained profits SE2 40 680

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 Post-closing Trial Balance LO1

Account
Account number Debit Credit
Cash at bank A1 46 300
Accounts receivable A2 2 220
Prepaid insurance A3 210
Supplies A4 180
Motor vehicle A5 21 400
Accumulated depreciation – motor A5.1 13 376
vehicle
Accounts payable L1 280
Interest payable L2 240
Bank loan L3 4 000
Share capital SE1 11 000
Retained profits SE2 41 234
$70 310 $70 310

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 Worksheet LO1

Income
Statement

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 Income Statement LO1

Revenue
Piano tuning fees 28 600
Piano repair fees 24 380

GROSS PROFIT 52 980

Expenses
Petrol and oil expenses 2 680
Depreciation expense – motor vehicle 5 350
Supplies expense 370
Insurance expense 820
Telephone Expense 2 420
Interest Expense 660 12 300

NET PROFIT/LOSS $40 680

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 Balance Sheet LO1

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 LO2
Internal control – definition

Internal control is a process effected by an entity’s board of

directors, management and other personnel, designed to
provide reasonable assurance regarding the achievement of
objectives in the following categories:
1. Effectiveness and efficiency of operations including
safeguarding assets against loss
2. Reliability of internal and external financial and non-
financial reporting
3. Compliance with applicable laws and regulations

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 Internal control systems – objectives LO2

Safeguard assets against waste, fraud, and inefficiency

locks, keys, insurance, patents, passwords, stocktakes

Promote the reliability of accounting data

Separation of accounting function, separation of duties

Encourage compliance with laws

Occupational health and safety, complaints, whistleblowing

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 Internal control systems LO2

Who is involved?
Everyone!
Directors, Managers, Employees, etc.

Managing “operational risk”

All operating activities

Responsibility of…..
The CEO

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 Internal control systems – Components LO3

FIVE Components:
1. Control environment: policies and procedures
2. Risk assessment: identify and analyze sources of risk
3. Control activities: preventive, detective
4. Information and communication: timely, flow, feedback
5. Monitoring: ongoing monitoring, separate evaluations

All must be present and function effectively to ‘control’

reliability of financial reporting

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Internal control systems – Features LO3

Tone from the top and human resources

Clearly established lines of responsibility
Security of assets
Approvals, authorizations, verifications, reconciliations, reviews
Maintenance of effective records
Separation of duties

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Internal control systems – Features LO3

Rotation of duties
Internal auditing
Physical protection of sensitive assets
Adequate insurance
Adequate pay and motivation for employees
Employees take regular leave

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Internal control systems – Limitations LO3

Reasonable (not absolute) assurance

Mistakes
Management override
Collusion among employees
Computer fraud
Cost versus benefit

29
Internal control systems – Disclosure LO3

Companies listed with the ASX are required to include a section

on corporate governance including a description of their
internal control.
E.g.

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 Internal control of cash LO4

Cash
transferred easily from one person to another (liquid)
cannot be specifically identified as belonging to one
particular person (anonymous).

Therefore:
Most susceptible to theft, misappropriation or fraud

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 Internal control of cash – Procedures LO4

1. Separation of duties for

recording and handling cash.
receiving and paying cash.

2. All cash receipts banked in entirety daily.

3. All payments (except petty cash) made by pre-numbered cheque or

EFT (Electronic Funds Transfer).

4. Authorised supporting documentation for payments.

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 Internal control of cash – Procedures LO4

5. Cheques or EFT countersigned – 2 signatures.

6. Pay on invoice and cancel documentation (stamped ‘paid’, defacing

spoiled cheques)

7. Physical safeguards over cash: locked petty cash box, close cash
drawer

8. Reconcile bank accounts regularly - (monthly)

33
 Petty cash fund LO4

A petty cash fund is established to handle small cash

payments
created by cashing a cheque from company’s regular bank
account.
Disbursement from the fund: Vouchers provide evidence for
amounts spent.
Petty cash fund is replenished on a regular basis.

Despite the small amounts involved, increased control is

necessary.

Petty cash custodian

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 Petty cash fund – Establishment LO4

Establishing a $200 petty cash fund

Dr Petty Cash $200
Cr Cash at bank $200
To establish petty cash fund

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 Petty Cash Fund – Disbursements LO4

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 Petty cash fund – Disbursements LO4

Petty Cash Expenses

Postage $20
Stationery $50
Coffee $15

We spent $85
Our Petty Cash Fund $200

i.e. we need to replenish our Petty Cash Fund by $85

37
 Petty cash fund – Replenishment LO4

Journal entries to replenish Petty Cash Fund:

Dr Postage Expense $20
Dr Office Supplies Expense $50
Dr Miscellaneous Expense $15
Cr Cash at Bank $85
To replenish petty cash fund

i.e. Petty Cash Fund= $200

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 Bank reconciliation LO5

Major internal control for cash

Compares the cash balance in the bank statement with the

cash account in the general ledger.

Reconciliation means explain the difference between two

sources of information about cash.

Why aren’t the balances the same?

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 Bank reconciliation – An example LO5

30/6/15 Cash balance per bank statement $3 527 Cr

30/6/15 Cash balance per cash at bank ledger $3 200 Dr
Difference 327

The reconciliation involves the explaining the difference

Credit balance versus Debit balance

A credit balance on a bank statement means ‘bank has a liability, the
account holder has an asset.’

40
 Reasons for differences LO5

1. Recorded in Ledger before recorded by Bank

Deposits recorded in the company’s ledger but not yet
received by the bank (‘Deposits in transit’)
E.g. cash received from customers

Payments recorded in the company’s ledger but not yet paid

from the bank account (‘Unpresented/Outstanding cheques’)
E.g. cheques written to suppliers
Company Ledger Yes
Bank Statement No
Adjusting Journal Entry No

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 Reasons for differences LO5

2. Recorded by Bank before recorded in Ledger

Deposits not recorded in the company’s ledger but recorded by
the bank
E.g. notes receivable/interest collected by the bank, direct
deposits, EFT in
Payments not recorded in the accounting records but recorded
by the bank
E.g. bank charges, interest, direct withdrawals, EFT out,
dishonoured cheques-NSF:Non-sufficient Fund
Company Ledger No
Bank Statement Yes
Adjusting Journal Entry Yes

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 Reasons for differences LO5

3. Errors
Made by the company in the general ledger
E.g. Transposition error ‘198’ recorded as ‘918’

Made by the bank in the bank statement

E.g. Bank fees overcharged

Company Ledger Yes/No

Bank Statement No/Yes
Adjusting Journal Entry Yes/No

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 Bank reconciliation – Illustration LO5

Balance per bank statement Balance per ledger account

$xxx CR $xxx DR
Deposits in transit Add EFT in
Add
Add Interest income

Unpresented cheques Less EFT out

Less Less Interest expense
Less Bank charges
Add
/Less Bank errors Add/Less Book errors

Adjusted cash balance: BANK = Adjusted cash balance: BOOK

$xxx CR $xxx DR

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 Bank reconciliation – Steps LO5

1. Check our records [CPJ (Cash Payment Journal), CRJ (Cash Receipt
Journal), last bank reconciliation] against bank statement
Tick items or check off the items

2. Items in accounting records that have not been ticked

Represent items that have not yet been recorded by the bank

3. Items in the bank statement that have not been ticked

Represent items that have not been recorded in our ledger
Prepare journals to update the cash balance in the ledger

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 Bank reconciliation – Lecture exercise
(please refer to your Lecture Notes– pp. 6-7) LO5

Cash Receipt Journal CRJ Cash Payment Journal CPJ Statement for GGG Ltd
Deposits Made Cheques Written
November 1 $1,828 √ November 1 Cheque 721 $28 Date Particulars Debit Credit Balance
November 7 $2,024 November 2 Cheque 722 $566 1 November Balance 7,570 Cr
November 14 $6,480 November 3 Cheque 723 $832 2 November 700 200 7,370 Cr
November 21 $5,292 November 4 Cheque 724 $54 2 November 707 1,000 6,370 Cr
November 30 $3,884 November 5 Cheque 726 $40 2 November Deposit 1,828√ 8,198 Cr
November 10 Cheque 727 $11,492 4 November 720 920 7,278 Cr
November 11 Cheque 728 $1,814 4 November 721 28 7,250 Cr
November 20 Cheque 729 $2,492
6 November 723 832 6,418 Cr
November 21 Cheque 730 $152
8 November 724 54 6,364 Cr
8 November Deposit 2,024 8,388 Cr
Cheque number 725 was prepared incorrectly and has been 12 November 726 40 8,348 Cr
cancelled. 14 November 728 1,814 6,534 Cr
The last bank reconciliation (October) revealed the 15 November Deposit 6,480 13,014
following: Cr
Balance as per bank statement 7,570 Cr 22 November Deposit 5,292 18,306
Less: Unpresented cheques 700 $200 Cr
707 1,000 24 November 727 11,492 6,814 Cr
719 520 26 November 730 152 6,662 Cr
720 920 2,640Dr 30 November Service Charge 8 6,654Cr
Adjusted cash balance: bank 4,930Cr 30 November Interest 84 6,738 Cr
Balance as per cash at bank ledger 4,930Dr

46
 Bank reconciliation – Lecture exercise LO5

Deposits Made CRJ Cheques Written CPJ Statement for GGG Ltd
$28√
November 1 $1,828
√ November 1 Cheque 721
November 7 $2,024 √ November 2 Cheque 722 $566 Date Particulars Debit Credit Balance
November 14 $6,480 √ November 3 Cheque 723 $832√ 1 November Balance 7,570 Cr
November 21 $5,292 √ November 4 Cheque 724 $54√ 2 November 700 200 √ 7,370 Cr
November 30 $3,884 November 5 Cheque 726 $40√
$19,508 November 10 Cheque 727 $11,492√
2 November 707 1,000 √ 6,370 Cr
2 November Deposit 1,828√ 8,198 Cr
November 11 Cheque 728 $1,814√
November 20 Cheque 729 $2,492
4 November 720 920 √ 7,278 Cr
November 21 Cheque 730 $152√
4 November 721 28 √ 7,250 Cr
$17,470 6 November 723 832 √ 6,418 Cr
Cheque number 725 was prepared incorrectly and has been 8 November 724 54 √ 6,364 Cr
cancelled. 8 November Deposit 2,024√ 8,388 Cr
12 November 726 40 √ 8,348 Cr
The last bank reconciliation (October) revealed the 14 November 728 1,814 √ 6,534 Cr
following: 15 November Deposit 6,480√ 13,014 Cr
Balance as per bank statement 7,570 Cr 22 November Deposit 5,292√ 18,306 Cr
Less: Unpresented cheques 700 $200 √ 24 November 727 11,492 √ 6,814 Cr
26 November 730 152 6,662 Cr
707 1,000 √
30 November Service Charge 8
√ 6,654Cr
719 520
30 November Interest 84 6,738 Cr
720 920 √ 2,640Dr
Adjusted cash balance: bank 4,930Cr
Balance as per cash at bank ledger 4,930Dr

47
 Bank Reconciliation – Lecture Exercise LO5

Before we continue…
Cash balance as at 30 Nov 2015 per Company Records
Cash balance
31 October! Cash at Bank – 30 Nov 2015
o/b 4,930 CPJ 17,470
CRJ 19,508 c/b 6,968

24, 438 24, 438

48
 Bank reconciliation – Lecture exercise LO5

GGG Ltd
Bank Reconciliation Statement as of 30 Nov
Balance as per bank statement $ 6,738 Cr
Add: Outstanding deposits (30 Nov.) 3,884
$ 10,622
Less: Unpresented cheques
# 719 $ 520
# 722 566
# 729 2,492
(3,578)
Adjusted cash balance: BANK $ 7,044 Cr

Balance as per Co’s books $6,968 Dr

Add: Interest income 84
$ 7,052
Less: Service charge (8)
Adjusted cash balance: BOOK $7,044Dr

49
 Bank reconciliation – Lecture exercise LO5

Adjusting entries
Information in the bank statement but not in company
records
$84 interest revenue
Dr Cash 84
Cr Interest Revenue 84
$8 service charge
Dr Service Charge Expense 8
Cr Cash 8

50
 Revision Question 1

Which of the following statements is not true about an

internal control system?

A. It encourages efficient use of resources

B. It helps management in safeguarding physical assets
C. It assists management in controlling the enterprise
D. It can increase the reliability of financial reporting
E. It can prevent collusion between employees

51
 Revision Question 2

Which of the following is not an effective internal control

measure of cash?

A. Cash is kept under lock and key

B. Bank reconciliation is carried out by the cashier
C. All payments are made using pre-numbered cheques
D. Bank reconciliation statements are prepared at regular
intervals
E. The book-keeper should be granted regular leave

52
 Revision Question 3

Which of the following items require(s) an adjusting

journal following preparation of a bank reconciliation
statement?

A. Error in the bank statement

B. Unpresented cheques
C. Deposit in transit
D. Error in company records
E. A and D

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Next lecture…

Accounts receivable, Allowance for bad debts, Special

journals, subsidiary & control accounts

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