Financial Accounting: Internal Control, Cash, and Receivables

Financial Accounting
Eleventh Edition
Global Edition
Chapter 5
Internal Control,
Cash, and
Receivables
Copyright © 2018 Pearson Education, Inc. All Rights Reserved.

Learning Objectives
5.1 Understand the role of internal controls and
corporate governance
5.2 Apply internal controls over cash receipts and cash
payments
5.3 Prepare and use a bank reconciliation
5.4 Account for receivables and its potential
impairment
5.5 Evaluate a company’s ability to collect receivables

Learning Objective 5.1
Understand the role of internal controls and
corporate governance

Understand the Role of Internal Controls
and Corporate Governance (1 of 15)
• Fraud
– Intentional misrepresentation of facts
– For the purpose of persuading another party to act
in a certain way
– Causes injury or damage
– Growing problem throughout the world with the
expansion of e-commerce
– Common examples include: insurance fraud,
check forgery 涂改支票及伪造签字保险 , Medicare fraud,
credit card fraud, and identity theft

Common Types of Fraud
• Misappropriation of assets
– Committed by employees
– Theft of money or inventory
– Bribery and kickback schemes
– Overstate expense reimbursements 费用报销
• Fraudulent 欺骗性的 financial reporting
– Committed by managers
– False and misleading journal entries
– Deceive investors and creditors
Exhibit 5-1 The Fraud Triangle

Internal Control
• Primary way to prevent, detect, and correct fraud
• Plan of organization and procedures implemented to
accomplish 5 objectives:
– Safeguard assets
– Encourage employees to follow company policy
– Promote operational efficiency
– Ensure accurate, reliable accounting records
– Comply with legal requirements

• The Sarbanes-Oxley Act (SOX) Provisions
‒ Passed by Congress in 2002
‒ Public companies must maintain a system of
internal control and issue an internal control report
‒ Auditors must evaluate and report on internal
controls
‒ Created Public Company Accounting Oversight
Board (PCAOB)
‒ Limits non-audit services of auditing firms
‒ Penalties for violators

Exhibit 5-2 The Shield of Internal
Controls

• Internal Control Procedures
– Means by which companies gain access to the 5
objectives of internal controls
• Monitoring of Controls
– Usually programmed into technology
– Internal and external auditors

• Smart Hiring Practices
‒ Background checks
‒ Training and supervision
‒ Competitive salaries
‒ Clear employee responsibility

• Separation of Duties
– Asset handling
– Record keeping
– Transaction approval

• Comparison and Compliance Monitoring
– Operating and cash budgets
– Exception reporting 异常报告
– Audit

• Adequate Records
– Details of business transactions
– Hard copy documents or electronic
– Prenumbered documents

• Limited Access
– Only persons with custodial 保管的 responsibilities
– Lock and key
– Lock-box system
– Physical access controls
– Password and encryption 加密

• Proper Approvals
– Management’s general or specific approval
– Credit approvals
– Purchasing department
– Human resources department

• Information Technology. Accounting systems
continue to rely less on manual procedures and more
on information technology (IT).
– Improved accuracy and speed
– Examples:
 Electronic sensors
 Bar codes

• E-commerce creates additional risks, including:
– Stolen credit card numbers
– Computer viruses and Trojan Horses
– Phishing expeditions
• Security measures to combat these risks include:
– Encryption
– Firewalls

The Limitations of Internal Control—Costs and
Benefits
• Ways to circumvent internal controls:
‒ Collusion: two or more people working together
‒ Management override
‒ Human limitations: fatigue and negligence
Benefits of internal controls should always outweigh the
costs

• Common Internal Controls
– Important documents in fireproof vaults 保管
– Burglar alarms 报警器
– and security cameras
– Loss prevention specialists
– Fidelity bonds on cashiers 忠诚保证保险
– Mandatory vacations and job rotation

Apply internal controls over cash receipts and cash
payments

Apply Internal Controls Over Cash
Receipts and Cash Payments (1 of 5)
Cash requires specific internal controls because it is
easy to steal and convert to other forms of wealth.

Cash Receipts Over the Counter
• Point-of-sale terminals
– Provide control over cash receipts
– Record sale, cost of item sold, and reduction to inventory
– Effective inventory control
• Customer issued a receipt as proof of purchase
• Sales associate turns in cash drawer at end of shift
– Combined with other cash and deposited
• Accounting department reconciles sales per terminal to cash in drawer

Exhibit 5-6 Cash Receipts by Mail
Remittance 汇票通知

Internal Control over Cash Payments
• Companies make most payments by check. This in an
important internal control because:
‒ Provides record of payment
‒ Must be signed by authorized official
‒ Payment supported by evidence

Controls over Purchase and Payment
• Split the following duties
– Purchasing goods
– Receiving goods
– Preparing check for payment
– Approval of payment

Exhibit 5-7 Cash Payments by Check

Exhibit 5-8 Payment Packet

• Petty Cash
– Used to pay for minor expenses
– Opened with a particular amount of cash
– Custodian 管理人 prepares a petty cash voucher list
– Imprest system 定额备用金制度 sum of fund plus
vouchers paid should equal specified balance
– Debit cards may be used

Prepare and use a bank reconciliation

Prepare and Use a Bank
Reconciliation (1 of 7)
• Documents used to control a bank account
include:
– Signature card 银行）签字样卡
– Deposit ticket 存款单
– Check
– Bank Statement
– Bank Reconciliation

• Signature Card
‒ Banks require each person authorized to sign on
an account to provide a signature card
‒ Protects against forgery 伪造

• Deposit Ticket
‒ Banks supply standard deposit tickets
‒ Customer fills out deposit ticket and receives a
receipt as proof of the transaction

Check
• Three parties to a check
– Maker → signs check
– Payee → whom the check is paid
– Bank → check drawn from

• Bank Statement
‒ Sent to customer monthly
‒ Reports customer’s cash activity

Exhibit 5-10 Bank Statement

• Bank Reconciliation
‒ Explanation for the differences between the book
(company’s cash records) and bank balance
‒ Differences due to time lag in recording
transactions

Preparing the Bank Reconciliation
• Bank Side • Book Side
– Deposits in transit – Bank collections
– Outstanding checks – Electronic funds transfers
– Bank errors – Service charge
– Interest revenue
– NSF checks 存款不足支票
– Cost of printed checks 印
刷支票费用
– Book errors
Exhibit 5-12 Bank Reconciliation (1 of 3)
Bank Reconciliation (Assume your bank statement shows a balance of
$5,900 and your Cash ledger shows a balance of $3,340)
Bank side:
1. Deposit in transit, $ 1,600.
2. Bank error: the bank deducted $ 100 for a check written by another
company. Add $ 100 to the bank balance.
3. Outstanding check-total of $ 1,340

Book side:
4. EFT receipt of your dividend revenue earned on an investment, $900
5. Bank collection of your account receivable, $2,100.
6. interest revenue earned on your bank balance, $30.
7. Book error: you recorded check no. 333 for $510. the amount you
actually paid on account was $150. add $360 to your book balance.
8. Bank service charge, $20.
9. NSF check from a customer, $50. subtract $50 from your book
balance.
10. EFT payment of insurance expense, $400.

Bank Reconciliation
• Next, you must journalize the Book side of the reconciliation

Journalizing Transactions from the
Bank Reconciliation

Summary of Various Reconciling
Items
• Bank Balance—Always
‒ Add deposits in transit.
‒ Subtract outstanding checks.
‒ Add or subtract corrections of bank errors.
• Book Balance—Always
‒ Add bank collection, interest revenue, and EFT
receipts. 电子转账凭证 Electronic Funds Transfer
‒ Subtract service charges, NSF checks, and EFT
payments.
‒ Add or subtract corrections of book errors.
Exhibit 5-13 Online Banking—
Account History

Using a Budget to Manage Cash
• Budget – financial plan that helps coordinate
business activities
• Cash budget – helps a company manage cash by
planning receipts and payments
– Start with beginning cash balance
– Add budgeted receipts and subtract budgeted
payments
– Equals cash available before new financing
– Compare cash available before new financing to
budgeted cash at end of period
Exhibit 5-14 Cash Budget

Report Cash on the Balance Sheet (1 of 3)
• Cash and Cash Equivalents
– Time deposits
– Certificates of deposit
– High-grade government securities (close to
maturity)

Report Cash on the Balance Sheet (2 of 3)
Most public companies will include a footnote to their
financial statements such as the following:
Cash equivalents…
All highly liquid investment with maturities of three
months or less at the date of purchase are classified as
cash equivalents.

Account for receivables and its potential impairment

Account for Receivables and its
Potential Impairment (1 of 7)
Types of Receivables
• Third most liquid asset (after cash and short-term
investments)
• Monetary claims against others
• Acquired by:
– Selling goods and services (accounts receivable)
– Lending money (notes receivable)

Journal entries to record receivables

Accounts Receivable
• Current assets
• Sometimes called trade receivables
• Serves as a control account
– Summarizes total receivable for each customer
– Subsidiary ledger kept with separate account for each
customer


Internal Controls Over Cash Collections on Account
• Separation of duties – opening mail and making deposits
• Separate cash handling and recording duties
– Bookkeeper should not handle cash
• Bank lockbox system

Allowance Method
• Records losses from failure to collect receivable
• Based on company’s past collection experiences
• Record Uncollectible-Account Expense
• Set up contra-account
– Allowance for Uncollectible Accounts
– Shows the amount the business expects not to collect



Writing Off Uncollectible Accounts: At the beginning of the
year, Apple had these accounts receivable (in millions):

Write Off Uncollectible Accounts. Early in 20X7, LEGO’s
credit department determines that LEGO can’t collect from
Toys Kingdom and Hamley’s. LEGO then writes off the
receivables from these customers with the following entry:

Writing Off Uncollectible Accounts

Direct Write-Off Method (1 of 2)
• Alternative way to account for uncollectible receivables
• Records expense when specific customer’s account
proves to be uncollectible
– No allowance for uncollectible  may overstate assets
on the balance sheet
– Fails to recognize uncollectible accounts in the same
period in which the related revenue is earned
– (Only used by small businesses or when doubtful
accounts is negligible.)

Direct Write-Off Method (2 of 2)
The journal entry to write off Fiesta and Stop-N-Shop using
the direct write-off method is as follows:

Computing Cash Collections from
Customers
Receivables typically hold five items:
If you know all other items except for collections, you can
compute collections by solving for X.

Account for Notes Receivable (1 of 6)
Creditor Party to whom money is owed; lender
Debtor Party that borrowed and owes money; maker, borrower
Interest Cost of borrowing money; stated as annual percentage rate
Maturity Date Date at which debtor must pay the note
Maturity Value The sum of principal and interest
Principal Amount of money borrowed by the debtor
Term Length of time from when the note was signed to when
payment must be made

Exhibit 5-16 Promissory Note

Accounting for Notes Receivable (2 of 6)
Consider the promissory note in Exhibit 5-16. After Lauren
Holland signs the note, Rabobank gives her $1,000 cash.
The bank makes the following entry to record the loan.

Rabobank earns interest revenue during September,
October, November, and December. At December 31, 20X6,
the bank accrues 9% interest revenue for four months:

Rabobank reports these amounts in its financial statement at
December 31, 20X6 as follows:

The bank collects the note on February 28, 20X7.

Show How to Speed up Cash Flow
from Receivables (1 of 4)
• Strategies to shorten credit cycle and collect cash more
quickly:
– Sales discounts for early payment
– Charge interest after a certain time period
– Adopt more effective credit and collection procedures
– Emphasize credit card or bankcard sales

Credit Card or Bankcard Sales. Fujitsu sells computers for
$2,000, and the customer pays with a VISA card. Fujitsu
records the sale as follows:

• Selling (Factoring) Receivable
– Sells receivables to another company, a factor
– Factor pays discounted price for receivable and then
tries to collect from the customer to earn revenue
– Benefits company with immediate receipt of cash
– Expensive and lose control over collection
– Used by companies with
 Weak or insufficient credit history (start-ups)
 Significant amount of debt

Selling (Factoring) Receivables. A company wishes to
speed up cash flow and therefore sells $100,000 of accounts
receivables, receiving cash of $95,000. The record is as
follows:

Evaluate a company’s ability to collect receivables

Evaluate a Company’s Ability To
Collect Receivables
Receivable Turnover

Financial Accounting: Internal Control, Cash, and Receivables

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Financial Accounting

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• Next, you must journalize the Book side of the reconciliation

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Journal entries to record receivables

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