INTERNAL CONTROL

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Internal Control – process designed to achieve the entity’ objectives with regards to:
 Safeguard assets
 Minimize errors and prevent fraud for reliability of accounting records
 Promote operational efficiency
 Ensure compliance with laws and established managerial policies
Two Types of Accounting Controls
 Accounting Controls
 Safeguarding assets
- Maintain accountability for assets
- Proper authorization to access assets
 Accuracy of financial records
- Give assurance that transactions are properly authorized
- Allow for financial statement preparation in accordance with GAAP
- Periodic reconciliation between recorded assets per book and physical assets
 Administrative/Managerial Control
 Operational efficiency
 Managerial policies
 Management authorization of transaction
Responsibilities Over Controls – Management is responsible for designing effective internal control
Principles of Internal Control

 Competent and Reliable Personnel (employees should be carefully selected)

 Assignment of responsibilities (personnel understanding of objectives) 1 person = 1 task -can
easily identify the personnel)
 Segregation of Duties – ARCR (Authorization, Recording, Custody, Reconciliation)
(assignments should be divided so that related operations are not performed by the same
individual)
- Segregation of operations from accounting
- Segregation of custody of assets from accounting
- Segregation of authorization of transactions from the custody of assets.
- Segregation of duties from accounting function
 Rotation of Personnel (familiarizes the employees with all areas of the unit)
 Documents and Records (thorough documentation of its activity so that it can be traced and
verified)
 Internal and External Audits
- Internal- work independently to the accounting and operation functions (accuracy of
business records, uncover internal control problem and operational difficulties)
- External- entirely independent to the business (opinion to the fairness of financial
statements)
 Physical and Electronic Controls (to safeguard assets)
- Vaults and safety deposit boxes
- Locked warehouse

Limitations of Internal Control (provide reasonable but not absolute assurance about achieving the
entity’s financial reporting objectives)
Inherent Limitations

- Cost of internal control should not exceed benefit (benefit over cost)
- Employee errors (fatigue, carelessness, indifference)
- Employee collusion
- Management override (making decisions contrary to internal policies)

CASH AND CASH

EQUIVALENTS---------------------------------------------------------------------------------------
 CASH
Cash – includes money and other negotiable instruments (medium of exchange)
→ current assets, unless they are restricted for atleast 12 months after the end of reporting period
→ unrestricted and immediately available for current operations
Valuation and Classification / Measurement of Cash
o Cash is valued at face value (face of the document)
o Foreign currency is valued at current exchange rate at the reporting date
o Cash in bank undergoing bankruptcy is excluded from cash and presented as receivable –
measured at realizable value
Cash Items
 Cash on Hand
o Coins and currencies (undeposited cash collections)
o Checks
- Customer’ s Check (checks received from customers) – possibility of bounce check
- Manager’s or Cashier’s Check (guaranteed and issued by bank’s manager/cashier)-
automatically debited from the depositor’s account
- Personal Check (depositor’s slip)
- Traveler’s Check (issued by financial institutions)
o Bank Drafts (drawn and guaranteed by the bank)
o Money Orders (from institutions) ----by purchasing money order
o Postdated Check Drawn (checks drawn/delivered with a future date)
o Undelivered Check Drawn (unreleased checks as of the reporting date)
o Stale Checks (when checks delivered to payees are not encashed with a long period of time –
6months or more)

Note: The moment when checks are drawn, entities credit the “cash”

No actual payment is made in Postdated, Undelivered Check Drawn or in Stale Checks

A/P xx

Cash xx

(Reverted back to cash)

Cash xx

A/P xx

 Cash in Bank (deposits in banks)

- Demand Deposit/Checking account (can be withdrawn anytime without advance notice)
- Savings Deposit (regular savings)
- Deposit in Foreign Banks
Note: Unrestricted deposits in foreign banks available for immediate withdrawal →
included as cash in bank
Restricted deposits in foreign banks not available for immediate withdrawal → excluded
from cash in bank
- Compensating Balance (minimum amount that must be maintained in an entity’s bank
account)
Note: Compensating balances that are legally restricted as to withdrawal → excluded
from cash
Compensating balances that are not legally restricted as to withdrawal → included as
cash
 Cash Fund (restriction for current operation)
- Petty Cash Fund
- Revolving Fund
- Change fund
- Tax Fund
- Payroll Fund
 - Travel Fund
- Interest Fund
- Dividend fund

Items not included as Cash

 Post-dated checks received (written with a future date) → treated as receivables

Cash xx

A/R xx

(reverted back to A/R)

A/R xx

Cash xx

Note: all check collections are recorded as cash receipts and adjustments for postdated checks

- Unused Credit Line (difference between the amount of line of credit and the amount of that was
actually borrowed)
- Returned checks
- Cash funds not available for use in current operations (Sinking Fund, Plant Expansion Fund,
Depreciation Fund, Preference Share Redemption fund, Contingency Fund, and Insurance Fund)
- Unused Postage Stamps → treated as prepaid supplies
- Advances to employees-IOUs

CASH
EQUIVALENTS--------------------------------------------------------------------------------------------------------
 Cash Equivalents
→ short term and highly liquid investments (not medium of exchange)
→ debt instruments acquired within 3 months or less before maturity date (from the date of purchase)
Examples

- 3 month BSP Treasury bills- 90days (obligation acquired by the government)

- Notes 1-10yrs, and bonds – 10yrs or more acquired within 3 months or less before maturity date
- 3 months Money market instrument (investments in portfolios) or commercial paper -less than
270 days (issued by large companies)
- 3-month time deposit (pre-agreed maturity)
- XX Year Treasury bill/commercial paper purchased 3-month before maturity date

Not qualified as Cash Equivalents

- Check and bank drafts

- Equity Securities (investments in stocks) – do not have maturity date

However, Redeemable preference shares acquired 3 months before redemption date may qualify as cash
equivalent (has maturity date) – in substance it is a liability
Accounting for Bank
Overdraft-------------------------------------------------------------------------------------------
Bank Overdraft – negative (credit) balance in the cash in bank account (from overpaying of checks in
excess of the amount deposit)
→ presented as current liabilities, except when offsetting is permitted
(some banks will advance the required funds, rather than have the check bounce)
Overdrafts (payable on demand) – the bank will cover the check → presented as current liabilities
Offsetting – when two or more bank accounts in the same bank and one results to an overdraft, the
overdraft (that is immaterial) can may be offset from the other bank acc with positive balance
(unrestricted)
Note: Offsetting is not permitted if the other bank account is restricted
Financial Statement Presentation
 Unrestricted cash and cash equivalents are combined and presented on the Statement of Financial
Position in a single line as – “ Cash and Cash Equivalents
 Restricted cash is excluded from cash and presented under other line item (receivable or other
assets)
Internal Controls Over
Cash-----------------------------------------------------------------------------------------------------
1. Segregation of Duties
2. Imprest System (all cash receipts are deposited intact and all cash disbursement is made through
check)
3. Bank Reconciliation
4. Cash Counts
Note: Accounting for cash shortages and overages
o Cash Shortage – cash counts results to an amount less than the balance per records

Cash Shortage or overage xx

Cash on Hand xx

(after the investigation)

Receivable from cashier/loss on cash shortage xx

Cash Shortage or overage xx

o Cash Overage – cash counts results to an amount more than the balance per records.

Cash on Hand xx

Cash Shortage or overage xx

(after the investigation)

Cash Shortage or overage xx

Payable to Cashier/Gain on cash overage xx

5. Minimum cash balance

6. Lockbox accounts
7. Non-encashment of personal checks from petty cash fund
8. Voucher System
Concealment of Cash
Shortages-----------------------------------------------------------------------------------------
o Lapping (postponement) – occurs collection of receivables from one customer is misappropriated
and then concealed by applying a subsequent collection from another customer (combined related
tasks)
o Kiting – a check is written to transfer funds from one bank account to another bank account
where he misappropriated the money.
o Window Dressing – books are not closed at year-end and transactions in the subsequent period
are deliberately recorded in the current period.
Petty Cash
Fund----------------------------------------------------------------------------------------------------------------
Petty Cash Fund – amount of money kept by a business intended for small expenditures
Two methods in Accounting for Petty Cash Fund
o Imprest Fund System (expense intact before recorded)
o Fluctuating Fund System (disbursements are immediately recorded)

Transactions under Imprest fund system Vs. Fluctuating Fund System

A. Establishing the fund (drawn check from the business to establish cash fund)
Note: Petty Cash Custodian (responsible for the custody of funds)
 Imprest Fund System Fluctuating Fund System
Petty Cash Fund xx Petty Cash Fund xx
Cash in Bank xx Cash in Bank xx

B. Making Payments from the Fund

Imprest Fund System

Imprest Fund System Fluctuating Fund System

NO FORMAL ENTRY Expenses xx
Petty Cash Fund xx
Note: generally recorded in a summary
entry/petty cash memorandum book supported
by signed petty cash voucher (to eliminate the
need to journal numerous payments)

C. Replenishing the Fund (happens at periodic intervals or when cash fund is running low)

Imprest Fund System Fluctuating Fund System

Expenses xx Petty Cash Fund xx
Cash in Bank xx Cash in Bank xx
(increase of the fund)
Note:
 Recorded in the Journal by the
Accountant
 Replenishment check (supported by a
cash disbursement voucher) is usually
balance to the petty cash disbursement
 Expenses are only recorded whenever
there is replenishment.

D. Adjustment to Petty Cash Fund at the end of Accounting Period

Note: It is necessary to adjust the unreplenished expenses (not yet recorded) in order to state the correct
balance of the fund.

Imprest Fund System Fluctuating Fund System

Expenses xx NO ENTRY
Petty Cash Fund xx

Note: The adjustment is to be reversed at the

beginning of the next accounting period.

E. Increase in the Fund

Imprest Fund System Fluctuating Fund System

Petty Cash Fund xx Petty Cash Fund xx
Cash in Bank xx Cash in Bank xx

F. Decrease in the Fund

Imprest Fund System Fluctuating Fund System

Cash in Bank xx Cash in Bank xx
Petty Cash Fund xx Petty Cash Fund xx

G. Cash Shortage and Overage

Petty Cash Fund Shortage

Imprest Fund System Fluctuating Fund System

Cash Shortage and overage xx Cash shortage and Overage xx
Cash in Bank xx Petty Cash Fund xx
Note: cash shortage is closed to Receivable or Loss Account
Petty Cash Fund Overage
 Imprest Fund System Fluctuating Fund System
Cash in Bank xx Petty Cash Fund xx
Cash shortage or overage xx Cash shortage or overage xx
Note : cash overage is closed to Payable Account or Gain Account
BANK
RECONCILIATION---------------------------------------------------------------------------------------------------
Three Kinds of Bank Deposits
Reconciliation of Bank and Book Cash Balances
Bank Reconciliation – report/statement prepared to reconcile the cash balance per books with the balance
per bank statement (agreement)
 Explain the differences between the two
 To determine if both cash balances will agree after considering unrecorded items
 Isolate recording errors
 Establish adjusted ending cash balance
 Provide information for adjusting entries
Take Note: The bank’s treatment of the deposit liability is the exact opposite of the entity’s treatment of
the current account.
Reconciling Items (that should be adjusted)
Common Items that causes difference between the bank balance and the book balance
(Bank Reconciling Items) ---- Items recorded by the entity but not yet recorded by the bank

- Deposits in Transit (deposits recorded by the company but not yet recorded/credited by its
bank)
- Outstanding Checks (checks drawn and released to payees but not yet encashed with the
bank)
- Bank Errors

(Book Reconciling Items) --- Items recorded by the bank but not yet recorded by the entity

 Credit Memo (additions made by the account)

- Bank Collections (collection of a check by the bank on behalf of a depositor)
- Interest income earned by the deposit
- Proceeds from loan
- Matured time deposits transferred by the bank to the current account
 Debit memos – deductions made by the bank
- Returned Items (return checks when drawn against uncleared deposits DAUD or drawn
against insufficient funds DAIF) ---bank will reverse the initial credit by a debit due
- Service Charge (amount charged by the bank for servicing transactions)
- Automatic debits (automatic payments by the bank on behalf of the depositor)
- Payment of loans (made out directly from the depositor’s bank account)
 Book Errors
Required Reconciling Entries

Book Items Bank Items

Notes Collected by the Bank

Cash in Bank xx
Notes Receivable xx
NSF customer check

Accounts Receivable xx
Cash in Bank xx
Bank Service Charge

Bank Service Charge xx

Cash in Bank xx

Forms of Bank Reconciliation

 Adjusted Balance Method Book to Bank Method Bank to Book Method
Book Balance xx Book Balance Bank Balance
Add: Credit Memo xx Add: Credit Memo Add: Deposit in Transit
Less: Debit Memo xx Outstanding Check Debit Memo
Adjusted Book Balance xx Less: Debit Memo Less: Outstanding Checks
Deposit in Transit Credit Memo
Bank Balance xx Unadjusted Book Balance Unadjusted Bank Balance
Add: Deposit in Transit xx xx
Less: Outstanding Check xx
Adjusted Bank Balance xx

Pro Forma Bank Reconciliation Statement