CASH AND INTERNAL CONTROLS

Chapter 8

2009 The McGraw-Hill Companies, Inc., All Rights Reserved

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PURPOSE OF INTERNAL CONTROL

Policies and procedures managers use to:

Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies.

McGraw-Hill/Irwin

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PURPOSE OF INTERNAL CONTROL

The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal controls. Specific requirements related to auditors are: Auditors must evaluate internal controls and issue internal control reports. Auditors of a client are restricted as to what consulting services they can perform for that client. The person leading an audit can serve no more than seven years without a two-year break. Auditors work is overseen by the Public Company Accounting Oversight Board. Harsh penalties exist for violators sentences up to 25 years in prison with severe fines.
McGraw-Hill/Irwin
Slide 3

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PRINCIPLES OF INTERNAL CONTROL

Internal control principles common to all companies:

1.
2. 3.

Establish responsibilities.
Maintain adequate records. Insure assets and bond key employees.

4.
5. 6.

Separate recordkeeping from custody of assets.

Divide responsibility for related transactions. Apply technological controls.

7.

Perform regular and independent reviews.

McGraw-Hill/Irwin

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TECHNOLOGY AND INTERNAL CONTROL

Reduced Processing Errors More Extensive Testing of Records

Limited Evidence of Processing Increased e-commerce

McGraw-Hill/Irwin

Crucial Separation of Duties

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LIMITATIONS OF INTERNAL CONTROL

Human Error

Human Fraud

Negligence Fatigue Misjudgment Confusion

McGraw-Hill/Irwin

Intent to defeat internal controls for personal gain

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LIMITATIONS OF INTERNAL CONTROL

The costs of internal controls must not exceed their benefits.

Benefits Costs

McGraw-Hill/Irwin

Slide 7

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CONTROL OF CASH
An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines:
Handling cash is separated from recordkeeping for cash. Cash disbursements are made by check. Cash receipts are promptly deposited in a bank.

McGraw-Hill/Irwin

Slide 8

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CASH, CASH EQUIVALENTS, AND LIQUIDITY

Cash

Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders.

Cash Equivalents
Short-term, highly liquid investments that are: 1. Readily convertible to a known cash amount. 2. Close to maturity date and not sensitive to interest rate changes.
McGraw-Hill/Irwin
Slide 9

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CASH, CASH EQUIVALENTS, AND LIQUIDITY

Liquidity
How easily an asset can be converted into cash to be used to pay for services or obligations.

Inventory
McGraw-Hill/Irwin

Cash
Slide 10

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CASH MANAGEMENT
Plan cash receipts to meet cash payments when due. Keep a minimum level of cash necessary to operate.

The goals of cash management are twofold:

1. 2.

Effective cash management involves applying the following cash management principles:
Encourage collection of receivables. Delay payment of liabilities. Keep only necessary levels of assets. Plan expenditures. Invest excess cash.
McGraw-Hill/Irwin
Slide 11

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CONTROL OF CASH RECEIPTS

Over-the-Counter Cash Receipts

Cash register with locked-in record of transactions. Compare cash register record with cash reported.

Cash Receipts by Mail

Two people open the mail. Money to cashiers office. List to accounting dept. Copy of list filed.

McGraw-Hill/Irwin

Slide 12

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CASH OVER AND SHORT

Sometimes errors in making change are discovered from differences between the cash in the cash register and the record of the amount of cash receipts. If a cash registers record shows $550 but the count of cash in the register is $555, we would prepare the following journal entry:
Dr. 555 Cr. 5 550

Dec. 1

Cash Cash Over and Short Sales

McGraw-Hill/Irwin

Slide 13

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CONTROL OF CASH DISBURSEMENTS

All expenditures should be made by check. The only exception is for small payments from petty cash. Separate authorization for check signing and recordkeeping duties. Use a voucher system.

McGraw-Hill/Irwin

Slide 14

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VOUCHER SYSTEM OF CONTROL

A voucher system establishes procedures for:
Verifying, approving and recording obligations for eventual cash disbursements.

Issuing checks for payment of verified, approved and recorded obligations.

McGraw-Hill/Irwin

Slide 15

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VOUCHER SYSTEM OF CONTROL

Sender Cashier Accounting
Check Invoice Approval Receiving Report Invoice Purchase Order Purchase Requisition

Receiver Supplier (Vendor) Cashier Accounting, Requesting & Purchasing

Receiving
Supplier (Vendor)

Accounting
Supplier, Requesting, Receiving & Accounting Purchasing and Accounting

Purchasing
Requesting

Voucher
McGraw-Hill/Irwin
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PETTY CASH SYSTEM OF CONTROL

Small payments required in most companies for items such as postage, courier fees, repairs and supplies.

McGraw-Hill/Irwin

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OPERATING A PETTY CASH FUND

Petty Cash

Company Cashier

Petty Cashier

May 1

Petty cash Cash

400 400

Accountant
McGraw-Hill/Irwin
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OPERATING A PETTY CASH FUND

Petty Cashier
Petty Cash

McGraw-Hill/Irwin

Slide 19

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OPERATING A PETTY CASH FUND

A petty cash fund is used only for business expenses.

Petty Cashier

43 Stamps $43
McGraw-Hill/Irwin

Courier $80
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OPERATING A PETTY CASH FUND

Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash.

Receipts
Petty Cashier

43 Stamps $43
McGraw-Hill/Irwin

Courier $80
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OPERATING A PETTY CASH FUND

Receipts
$123

Company Cashier

To reimburse petty cash fund

Petty Cashier

May 31

Postage expense Delivery expense Cash

43 80 123

Accountant
McGraw-Hill/Irwin

Use a Cash Over and Short account if needed.

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PETTY CASH EXAMPLE

Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses Customer Business Lunches Express Mail Postage Miscellaneous Office Supplies $79.30 93.42 55.00 32.48

Lets look at replenishing the fund if the balance on July 31 was $137.80.
McGraw-Hill/Irwin
Slide 23

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PETTY CASH EXAMPLE

What amount of cash will be required to replenish the petty cash fund? a. b. c. d. $260.20 $262.20 $139.80 $137.80

Desired Balance Actual Balance Amount Needed

$ 400.00 137.80 $ 262.20

McGraw-Hill/Irwin

Lets prepare the journal entry to replenish the petty cash fund.

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PETTY CASH EXAMPLE

Journal entry to replenish petty cash fund
Dr. July 31 Travel Expense Entertainment Expense Postage Expense Office Supplies Expense Cash Over and Short Cash 79.30 93.42 55.00 32.48 2.00 262.20
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Cr.

McGraw-Hill/Irwin

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BANKING ACTIVITIES AS CONTROLS

Bank Accounts

Signature Cards

Deposit Tickets

Checks
McGraw-Hill/Irwin

Electronic Funds Transfer

Bank Statements
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BANK STATEMENT
Usually once a month, the bank sends each depositor a bank statement showing the activity in the account.
Beginning-ofperiod balance.
Bank Statement First National Bank
Nashville, TN 37459 Clothes Mart Nashville, TN
May 31, 2009

*
Acct No 278609

End-of-period balance.

Previous Balance 1488.79 5/1 5/2 5/4

Total Checks 1,367.09 107 108 109 110 111 112 113 114 115

Total Deposits 2,604.22 55.00 279.50 44.75 21.81 37.55

Current Balance 2,725.92 1,251.88

Checks and other debits.

5/7 5/9 5/12 5/15 5/18 5/21 5/27 5/30 5/31

825.04 175.98 288.31 12.54 527.30 451.65

Deposits and other credits.

McGraw-Hill/Irwin

Slide 27

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BANK RECONCILIATION

A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on companys books.
Bank Statement First National Bank
Nashville, TN 37459 Clothes Mart Nashville, TN
May 31, 2006

*
Acct No 278609

Why are the balances different?

Account: Cash GENERAL LEDGER Acct. No.
PR Debit Credit

Previous Balance Total Checks 1488.79 1,367.09 5/1 107 5/2 5/4 108 5/7 109 5/9 110 5/12 111 5/15 5/18 112 5/21 113 5/27 114 5/30 5/31 115 McGraw-Hill/Irwin

Total Deposits 2,604.22 55.00 279.50 44.75 21.81 37.55

Current Balance 2,725.92 1,251.88

102
Balance DR (CR) 2,481.18

Date Item May 31 Balance

825.04

175.98 288.31 12.54 527.30 451.65

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RECONCILING ITEMS
Book Balance Add: Collections made by the bank. Add: Interest earned on checking account.

Bank Statement Balance Add: Deposits in transit. Deduct: Outstanding Checks Add or Deduct: Bank errors.

Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge. Add or Deduct: Book errors.
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McGraw-Hill/Irwin

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BANK RECONCILIATION
Two sections:
1. Reconcile bank statement balance to the adjusted bank balance. 2. Reconcile book balance to the adjusted book balance.

The adjusted balances should be equal.

McGraw-Hill/Irwin

Slide 30

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BANK RECONCILIATION EXAMPLE

Lets prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610. The cash general ledger account on that date shows a balance of $7,430.

Additional information necessary for the reconciliation is shown on the next screen.

McGraw-Hill/Irwin

Slide 31

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BANK RECONCILIATION EXAMPLE

Outstanding checks totaled $2,417.

1.

2.
3. 4. 5. 6.

A $500 check mailed to the bank for deposit had not reached the bank at the statement date.
The bank returned a customers NSF check for $225 received as payment on account receivable. The bank statement showed $30 interest earned during July. Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank.
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McGraw-Hill/Irwin

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Simmons Company Bank Reconciliation July 31, 2010 Bank Balance, July 31 Add: Deposit in Transit Less: Bank Error $ 486 Outstanding Checks 2,417 Adjusted Balance, July 31

$ 9,610 500 (2,903) $ 7,207

McGraw-Hill/Irwin

Slide 33

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Simmons Company Bank Reconciliation July 31, 2010 Bank Balance, July 31 Add: Deposit in Transit Less: Bank Error $ 486 Outstanding Checks 2,417 Adjusted Balance, July 31 Book Balance, July 31 Add: Interest Less: Recording Error NSF Check Adjusted Balance, July 31

$ 9,610 500 (2,903) $ 7,207 $ 7,430 30

28 225

(253) $ 7,207
Slide 34

McGraw-Hill/Irwin

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RECORDING ADJUSTING ENTRIES FROM A BANK RECONCILIATION

Only amounts shown on the book portion of the reconciliation require an adjusting entry.
Dr. 30 Interest revenue July 31 Supplies expense Accounts receivable Cash 28 225 253
Slide 35

Cr. 30

July 31 Cash

McGraw-Hill/Irwin

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RECORDING ADJUSTING ENTRIES FROM A BANK RECONCILIATION

After posting the reconciling entries the cash account looks like this:

Account: Cash

GENERAL LEDGER Acct. No.

PR Debit 30 253 Credit

101
Balance DR (CR) 7,430 7,460 7,207

Date Item July 31 Balance 31 Adjusting entry 31 Adjusting entry

Adjusted balance on July 31.

McGraw-Hill/Irwin
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DAYS SALES UNCOLLECTED

How much time is likely to pass before we receive cash receipts from credit sales.
Days Sales Uncollected Accounts Receivable Net Sales

365

McGraw-Hill/Irwin

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END OF CHAPTER 8

McGraw-Hill/Irwin

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