Accounting: Tools for Business

Decision Making
Eighth Edition
Kimmel ● Weygandt ● Mitchell

Chapter 7

Fraud, Internal Control, and Cash

Prepared by
Diane Tanner
University of North Florida
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Chapter Outline
Learning Objectives
LO 1 Define fraud and the principles of internal control.
LO 2 Apply internal control principles to cash.
LO 3 Identify the control features of a bank account.
LO 4 Explain the reporting of cash and the basic
principles of cash management.
Learning Objective 1
Describe Fraud and the Principles of
Internal Control

LO 1
Fraud and Internal Control
• A dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer
• Fraud triangle
o Three factors that contribute to fraudulent activity

LO 1
 Fraud Triangle Factors
Opportunity
When the workplace lacks sufficient
controls to deter and detect fraud

Financial Pressure Rationalization

When employees have personal Employees believing
financial problems caused by too their dishonest
much debt, or a desire to lead a actions are justified
lifestyle they cannot afford on
their current salary

LO 1
The Sarbanes-Oxley Act (SOX)
Resulted from corporate scandals in early 2000s
• Applies to publicly traded U.S. corporations
• Required to maintain a system of internal control
• Corporate executives and boards of directors must
ensure that the controls are reliable and effective
• Independent outside auditors must attest to the
adequacy of the internal control system
• SOX created the Public Company Accounting
Oversight Board (PCAOB)

LO 1
Internal Control
• A process designed to provide reasonable assurance
regarding the achievement of company objectives
related to operations, reporting, and compliance
• Purposes
o To safeguard assets
o To enhance the reliability of accounting records
o To increase efficiency of operations
o To ensure compliance with laws and regulations

LO 1
Primary Components of Internal
Control Systems
From COSO’s Internal Control—Integrated Framework
• A control environment
• Risk assessment
• Control activities
• Information and communication
• Monitoring

LO 1
People, Planet, and Profit Insight
And the Controls Are…
Internal controls are important for an effective financial reporting system. The
same is true for sustainability reporting. An effective system of internal controls
for sustainability reporting helps in the following ways:
(1) It prevent the unauthorized use of data.
(2) It provide reasonable assurance that the information is accurate, valid, and
complete.
(3) It reports information that is consistent with overall sustainability
accounting policies.
With these types of controls, users will have the confidence that they can use
the sustainability information effectively.
Some regulators are calling for even more assurance through audits of this
information. Companies that potentially can cause environmental damage
through greenhouse gases, as well as companies in the mining and extractive
industries, are subject to reporting requirements. And, as demand for more
information in the sustainability area expands, the need for audits of this
information will grow.

LO 1
Principles of Internal Control
Activities
• Establishment of responsibility
• Segregation of duties
• Documentation procedures
• Physical controls
• Independent internal verification
• Human resource controls

LO 1
Establishment of Responsibility
• Assign responsibility to specific
employees
• Most effective when only one
person is responsible for a given
task
• Often requires limiting access
only to authorized personnel,
and then identifying those
personnel

LO 1
Anatomy of a Fraud: Colossal Healthcare
Maureen Frugali was a training supervisor for claims processing at Colossal
Healthcare. As a standard part of the claims processing training program, Maureen
created fictitious claims for use by trainees. These fictitious claims were then sent to
the accounts payable department. After the training claims had been processed, she
was to notify Accounts Payable of all fictitious claims, so that they would not be paid.
However, she did not inform Accounts Payable about every fictitious claim. She
created some fictitious claims for entities that she controlled (that is, she would
receive the payment), and she let Accounts Payable pay her.
Total take: $11 million

The Missing Control

Establishment of responsibility. The healthcare company did not adequately restrict
the responsibility for authorizing and approving claims transactions. The training
supervisor should not have been authorized to create claims in the company’s “live”
system.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 61–70.

LO 1
Segregation of Duties
• Applications
o Different individuals should be responsible for related
activities
o Responsibility for record-keeping for an asset should be
separate from physical custody of that asset
• Rationale
o The work of one employee should, without a
duplication of effort, provide a reliable basis for
evaluating the work of another employee

LO 1
Segregation of Related
Purchasing Activities
Assign related purchasing activities to different
individuals.
• Decreases the potential for errors and irregularities
• To avoid kickbacks that may occur if a purchasing agent
is allowed to order goods without obtaining supervisory
approval
• To avoid the creation of a fictitious invoice that may
occur if an employee who orders goods also handles the
invoice and receipt of the goods and payment
authorization
LO 1
Anatomy of a Fraud: Aesop University
Lawrence Fairbanks, the assistant vice-chancellor of communications at Aesop University,
was allowed to make purchases of under $2,500 for his department without external
approval. Unfortunately, he also sometimes used university funds to buy items for
himself, such as expensive antiques and other collectibles. How did he do it? He replaced
the vendor invoices he received with fake vendor invoices that he created. The fake
invoices had descriptions that were more consistent with the communications
department’s purchases. He submitted these fake invoices to the accounting department
as the basis for their journal entries and to the accounts payable department as the basis
for payment.
Total take: $475,000
The Missing Control
Segregation of duties. The university had not properly segregated related purchasing
activities. Lawrence was ordering items, receiving the items, and receiving the invoice.
By receiving the invoice, he had control over the documents that were used to account
for the purchase and thus was able to substitute a fake invoice.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 3–15.

LO 1
Segregation of Related Sales Activities
Assign related sales activities to different individuals.
• Decreases the potential for errors and irregularities
o To avoid an increase in sales commissions by making sales
at unauthorized prices
• May occur if a salesperson can make a sale without
obtaining supervisory approval
o To avoid an employee shipping goods to himself
• May occur if a shipping clerk also has access to
accounting records
o To avoid understatement of the amount billed for sales
made to friends and relatives

LO 1
Segregation of Recordkeeping from
Physical Custody
• Two controls
o Accountant should have neither physical custody
of the asset nor access to assets
o Custodian of the asset should not maintain or
have access to the accounting records
• Reduces the likelihood that the custodian of the asset
will convert the asset to personal use
• Especially important for cash and inventories

LO 1
Anatomy of a Fraud: Aggasiz Construction
Angela Bauer was an accounts payable clerk for Aggasiz Construction Company. Angela
prepared and issued checks to vendors and reconciled bank statements. She perpetrated
a fraud in this way: She wrote checks for costs that the company had not actually
incurred (e.g., fake taxes). A supervisor then approved and signed the checks. Before
issuing the check, though, Angela would “white-out” the payee line on the check and
change it to personal accounts that she controlled. She was able to conceal the theft
because she also reconciled the bank account. That is, nobody else ever saw that the
checks had been altered.
Total take: $570,000
The Missing Control
Segregation of duties. Aggasiz Construction Company did not properly segregate
recordkeeping from physical custody. Angela had physical custody of the checks,
which essentially was control of the cash. She also had recordkeeping responsibility
because she prepared the bank reconciliation.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 100–107.

LO 1
Documentation Procedures
Use prenumbered documents, and all
documents should be accounted for
• To prevent double recording or
omission of transactions
Documents should be promptly
forwarded for accounting entries to the
accounting department
• To ensure timely recording
• To ensure the accuracy and
reliability of the accounting records

LO 1
Anatomy of a Fraud: Mod Fashions
To support their reimbursement requests for travel costs incurred, employees at Mod
Fashions Corporation’s design center were required to submit receipts. The receipts could
include the detailed bill provided for a meal, the credit card receipt provided when the
credit card payment was made, or a copy of the employee’s monthly credit card bill that
listed the item. A number of the designers who frequently traveled together came up with a
fraud scheme: They submitted claims for the same expenses. For example, if they had a meal
together that cost $200, one person submitted the detailed meal bill, another submitted the
credit card receipt, and a third submitted a monthly credit card bill showing the meal as a
line item. Thus, all three received a $200 reimbursement.
Total take: $75,000
The Missing Control
Documentation procedures. Mod Fashions should require the original, detailed receipt. It
should not accept photocopies, and it should not accept credit card statements. In addition,
documentation procedures could be further improved by requiring the use of a corporate
credit card (rather than a personal credit card) for all business expenses.

Source: Adapted from Wells, Fraud Casebook (2007), pp. 79–90.

LO 1
Physical Controls
• Relate to the safeguarding of assets and enhance the
accuracy and reliability of the accounting records

LO 1
Anatomy of a Fraud: Centerstone Health
At Centerstone Health, a large insurance company, the mailroom each day received insurance applications from
prospective customers. Mailroom employees scanned the applications into electronic documents before the
applications were processed. Once the applications were scanned, they could be accessed online by authorized
employees. Insurance agents at Centerstone Health earn commissions based upon successful applications. The
sales agent’s name is listed on the application. However, roughly 15% of the applications are from customers
who did not work with a sales agent. Two friends—Alex, an employee in recordkeeping, and Parviz, a sales agent
—thought up a way to perpetrate a fraud. Alex identified scanned applications that did not list a sales agent.
After business hours, he entered the mailroom and found the hardcopy applications that did not show a sales
agent. He wrote in Parviz’s name as the sales agent and then rescanned the application for processing. Parviz
received the commission, which the friends then split.
Total take: $240,000
The Missing Control
Physical controls. Centerstone Health lacked two basic physical controls that could have prevented this fraud.
First, the mailroom should have been locked during nonbusiness hours, and access during business hours
should have been tightly controlled. Second, the scanned applications supposedly could be accessed only by
authorized employees using their passwords. However, the password for each employee was the same as the
employee’s user ID. Since employee user-ID numbers were available to all other employees, all employees
knew each other’s passwords. Thus, Alex could enter the system using another employee’s password and
access the scanned applications.

Source: Adapted from Wells, Fraud Casebook (2007), pp. 316–326.

LO 1
Independent Internal Verification
• Involves the review of data prepared by employees
• Useful in comparing recorded accountability with
existing assets
• Required to obtain maximum benefit
o Independent employee should verify records
periodically or on a surprise basis
o Report discrepancies to management

LO 1
Comparing Segregation of Duties with
Independent Internal Verification Principle

LO 1
Human Resource Controls
• Bond employees who handle cash
o Involves obtaining insurance
protection against theft by employees
• Rotate employees’ duties and require
vacations
o Deters employees from attempting
thefts since they will not be able to
permanently conceal their improper
actions
• Conduct background checks

LO 1
Anatomy of a Fraud: Excelsior Inn
Ellen Lowry was the desk manager and Josephine Rodriguez was the head of housekeeping at
the Excelsior Inn, a luxury hotel. The two best friends were so dedicated to their jobs that they
never took vacations, and they frequently filled in for other employees. In fact, Ms. Rodriguez,
whose job as head of housekeeping did not include cleaning rooms, often cleaned rooms
herself, “just to help the staff keep up.” These two “dedicated” employees, working as a team,
found a way to earn a little more cash. Ellen, the desk manager, provided significant discounts to
guests who paid with cash. She kept the cash and did not register the guests in the hotel’s
computerized system. Instead, she took the room out of circulation “due to routine
maintenance.” Because the room did not show up as being used, it did not receive a normal
housekeeping assignment. Instead, Josephine, the head of housekeeping, cleaned the rooms
during the guests’ stay.
Total take: $95,000
The Missing Control
Human resource controls. Ellen, the desk manager, had been fired by a previous employer after
being accused of fraud. If the Excelsior Inn had conducted a thorough background check, it
would not have hired her. The hotel fraud was detected when Ellen missed work for a few days
due to illness. A system of mandatory vacations and rotating days off would have increased the
chances of detecting the fraud before it became so large.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 145–155.

LO 1
Accounting Across the Organization
SOX Boosts the Role of Human Resources
Under SOX, a company needs to keep track of employees’
degrees and certifications to ensure that employees continue to
meet the specified requirements of a job. Also, to ensure proper
employee supervision and proper separation of duties,
companies must develop and monitor an organizational chart.
When one corporation went through this exercise, it found
that out of 17,000 employees, there were 400 people who did
not report to anyone. The corporation also had 35 people who
reported to each other. In addition, if an employee complains of
an unfair firing and mentions financial issues at the company,
the human resource department must refer the case to the
company audit committee and possibly to its legal counsel.

LO 1
Data Analytics and Internal Controls
Data analytics enable a company to
• Employ continuous monitoring of virtually every
transaction
o Identifies spikes or developing trends timely
o Allows investigations to be made more quickly
Examples
• Systems can automatically identify who recorded a
particular journal entry
o Helps to ensure that the segregation of duties control
principle is not violated
• Recipients of large dollar amounts in risky areas can be
flagged
LO 1
Limitations of Internal Control
Internal control is designed to provide reasonable assurance of
safeguarding of assets and reliability of the accounting records.

• Costs should not exceed benefits

o Human element
• Affected by employee fatigue, carelessness, or
indifference
• Reduced effectiveness by collusion
o Size of the business
• Difficult for small companies to segregate duties
or to provide for independent internal
verification
LO 1
Knowledge Check:
Principles of Control Activities: Case 1
Identify which control activity is violated and explain
how the situation creates an opportunity for a fraud.
The person with primary responsibility for reconciling
the bank account and making all bank deposits is also
the company’s accountant.
Violates: Segregation of duties
• Recordkeeping should be separate from
physical custody
o Employee could embezzle cash and
make journal entries to hide the theft
LO 1
Knowledge Check:
Principles of Control Activities: Case 2
Identify which control activity is violated and explain
how the situation creates an opportunity for a fraud.
Wellstone Company’s treasurer received an award for
distinguished service because he had not taken a
vacation in 30 years.
Violates: Human resource controls
• Key employees must take vacations
• Treasurer, who manages the company’s cash,
might embezzle cash and think he will be able
to permanently conceal any theft

LO 1
Knowledge Check:
Principles of Control Activities: Case 3
Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
In order to save money spent on order slips and to reduce time
spent keeping track of order slips, a local restaurant does not
buy prenumbered order slips.
Violates: Documentation procedures
• Failing to use prenumbered documents makes
it virtually impossible to account for the
documents
• An employee could write up a dinner sale,
receive cash from the customer, and then
throw away the order slip and keep the cash
LO 1
Learning Objective 2
Apply Internal Control Principles to
Cash

LO 2
Cash Controls
• The one asset that is readily convertible into any other
type of asset
• Easily concealed and transported, and is highly desired
• The asset most susceptible to fraudulent activities
• May result in numerous errors because of the large
volume of cash transactions
• Requires effective internal control over cash

LO 2
Cash Receipts Controls

LO 2
Over-the-Counter Receipts
• Focus on cash registers through payments with cash,
credit cards, debit cards
• Controls
o All sales must be entered into the register through
the point-of-sale (POS) software
o Access to the system should be restricted (physical
control) so that cashiers cannot adjust the amount
o Receipts must be on-hand for sales made by debit or
credit cards and these should match sales that were
recorded with the type of payment

LO 2
Cash Receipts Shortages
• Often results due to incorrect change given back
• Differences between the actual cash and the amount
reported on the cash register tape reported in the Cash
Over and Short account
o Income statement account

The cash register tape indicated sales of $6,956.20 but the

amount of cash was only $6,946.10.
Cash shortfall = $6,959.20 − $6,946.10 = $10.10

LO 2
Electronic Receipts
• Occur with electronic funds transfer (EFT)
• Use wire, telephone, or computers to transfer funds
from one location to another
• Examples
o Direct deposit of payroll amounts to employees
o Online bill payments for utilities and loans
o Use of a debit card at point-of-sale (POS) terminals
• Reduce some of the opportunities for employee theft
o Because EFT transactions do not involve employees
handling cash
o Assignment of responsibility or segregation of duties is
still needed
LO 2
Check Receipts
• Checks received at the time of sale
o Will be included in the cash register which is used in an
employee’s reconciliation of daily sales to cash on hand
• Checks received in the mail
o Mailroom employees send the accompanying remittance
advices to the accountants for recording cash receipts
o Checks are sent to another employee for deposit at the
bank (segregation of duties)
o Each day, an independent employee compares the deposit
slip with the amount of cash receipts recorded to ensure
the funds deposited were also recorded
LO 2
Knowledge Check:
Cash Receipt Controls

Permitting only designated personnel such as cashiers to

handle cash receipts is an application of the principle of
a. segregation of duties.
b. establishment of responsibility.
c. independent internal verification.
d. human resource controls.

LO 2
Knowledge Check:
Cash Receipt Controls
Answer
Permitting only designated personnel such as cashiers to
handle cash receipts is an application of the principle of
a. segregation of duties.
b. Answer: establishment of responsibility.
c. independent internal verification.
d. human resource controls.

LO 2
Applications of Cash
Disbursement Controls
• Internal control is more effective when companies
pay by check or electronic funds transfer (EFT)
rather than cash
• Applications
o Electronic funds transfer
o Checks
o Voucher system controls
o Petty cash fund

LO 2
Cash Disbursement Controls

LO 2
More Cash Disbursement Controls

LO 2
Voucher System
• A network of approvals by authorized individuals,
acting independently, to ensure all disbursements by
check are proper
• Voucher system process
o Voucher is prepared to authorize a cost or expense
o Accounts payable department records the liability in a
voucher register
o Check for the liability is issued and voucher stamped
“paid” PA
o Paid voucher is recorded in the check register by ID
accounting department
LO 2
Voucher System Controls
Improves internal control over cash disbursements in
two ways
• Establishes responsibility through the authorization
process
o Each individual has responsibility to review the
underlying documentation
• Keeps track of the documents that back up each
transaction in one place
o Supervisors can independently verify the
authenticity of each transaction
LO 2
Petty Cash Fund
• Used to pay small amounts
o Often impractical and a nuisance to use checks to
pay small amounts
• Aids in internal control
• Referred to as an imprest system
• Involves
o Establishing the fund
o Making payments from the fund
o Replenishing the fund

LO 2
Ethics Insight
How Employees Steal
Occupational fraud is using your own occupation for personal gain
through the misuse or misapplication of the company’s resources
or assets. This type of fraud is one of three types:
1. Asset misappropriation, such as theft of cash on hand,
fraudulent disbursements, false refunds, ghost employees,
personal purchases, and fictitious employees. This fraud is the
most common but the least costly.
2. Corruption, such as bribery, illegal gratuities, and economic
extortion. This fraud generally falls in the middle between
asset misappropriation and financial statement fraud as
regards to frequency and cost.
3. Financial statement fraud, such as fictitious revenues,
concealed liabilities and expenses, improper disclosures, and
improper asset values. This fraud occurs less frequently than
other types of fraud, but it is the most costly.
Source: 2018 Report to the Nations on Occupational Fraud and Abuse,
Association of Certified Fraud Examiners, p. 12.

LO 2
Ethics Insight: Occupational Frauds
Frequency and the median loss for each type of
occupational fraud
• Sum of percentages exceeds 100% because some cases of
fraud involved more than one type

Source: 2018 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners, p. 12.

LO 2
Knowledge Check:
Cash Disbursement Controls
The use of prenumbered checks in disbursing cash is an
application of the principle of
a. establishment of responsibility.
b. segregation of duties.
c. physical controls.
d. documentation procedures.

LO 2
Knowledge Check:
Cash Disbursement Controls
Answer
The use of prenumbered checks in disbursing cash is an
application of the principle of
a. establishment of responsibility.
b. segregation of duties.
c. physical controls.
d. Answer: documentation procedures.

LO 2
Knowledge Check:
Control over Cash Receipts
Identify the internal control principle applicable to each
procedure.
1. The duties of receiving cash, recording Segregation of duties
cash, and custody of cash are assigned
to different individuals.
Independent internal
2. Daily cash counts are made by cashier verification
department supervisors.
Physical controls
3. All over-the-counter receipts are
entered in cash registers.
Establishment of
4. Only cashiers may operate cash responsibility
registers.
Human resource
5. All cashiers are bonded. controls
LO 2
Knowledge Check:
Control over Cash Disbursements
Identify the internal control principle applicable to each procedure.
1. Only the treasurer may sign checks. Establishment of responsibility
2. Blank checks are stored in a safe in a Physical controls
treasurer’s office.
3. Check signers are not allowed to Segregation of duties
record cash disbursement
transactions.
4. Company checks are prenumbered. Documentation procedures

5. The bank statement is reconciled Independent internal

monthly by an internal auditor. verification

LO 2
Learning Objective 3
Identify the Control Features of a
Bank Account

LO 3
Control Features of a Bank Account
Use of a bank
• Contributes significantly to good internal control over
cash
• Safeguards cash as a depository and clearinghouse for
checks
• Minimizes amount of currency on hand
• Creates a double record of bank transactions—one by
the business and the other by the bank
A company's asset account Cash is the
“flipside” of the bank’s liability account
for that company.
LO 3
Bank Reconciliation
• The process of comparing the bank’s balance with the
company’s balance
• Explains the differences to make them agree
• For efficiency of operations and better control
o Regional bank accounts
o Payroll bank accounts

LO 3
Electronic Banking
• Enables companies to take advantage of electronic
banking through secure access to account
information
• Internal controls required by businesses
o Marking a check as deposited once a picture is taken
and electronically submitting to the bank to ensure the
check is not deposited twice
o Safeguarding checks to ensure they are not stolen or
misused
o Documenting the use of the cash withdrawn from the
ATM
LO 3
Mobile Banking Using a Smart Phone
Remote deposit capture enables the remote deposit of
a check

LO 3
Bank Statements
• Shows bank transactions and balances
o Amounts that reduce the depositor’s account balance
• Checks paid and other debits such as debit card
transactions or electronic funds transfers for bill
payments
o Amounts that increase the depositor’s account
balance
• Deposits by direct deposit, automated teller
machine, or electronic funds transfer and other
credits
o Account balance after each day’s transactions
LO 3
Bank
Statement
Illustration

LO 3
Bank Statement Contents
• Deposits made
o Listed by date
• Canceled checks
o Have been paid by the bank
• Listed in numerical sequence by date paid

• Bank statement memoranda

o Explains other debits and credits made to depositor’s account
• NSF check (insufficient funds)
o A check not paid by a bank because of insufficient funds in a
bank account

LO 3
Bank Accounts from the
Bank’s Perspective
Payments made by Deposits made by a
the bank are depositor are
decreases as debits to increases as credits to
the bank’s liability the bank’s liabilities

LO 3
Knowledge Check: Bank Account

The control features of a bank account do not include

a. having bank auditors verify the correctness of the
bank balance per books.
b. minimizing the amount of cash that must be kept on
hand.
c. providing a double record of all bank transactions.
d. safeguarding cash by using a bank as a depository.

LO 3
Knowledge Check: Bank Account
Answer
The control features of a bank account do not include
a. Answer: having bank auditors verify the correctness of
the bank balance per books.
b. minimizing the amount of cash that must be kept on
hand.
c. providing a double record of all bank transactions.
d. safeguarding cash by using a bank as a depository.

LO 3
Reconciling the Bank Account (Part 1)
• Requires the balance per books and balance per bank to
be reconciled to their adjusted cash balances
o Book balance: The cash balance that the company has in
the accounting records for the checking account
o Bank balance: The cash balance according to the monthly
bank statement
• Causes of the need for a reconciliation
o Time lags that prevent one party from recording the
transaction in the same period
o Errors by either party in recording transactions

LO 3
Reconciling the Bank Account (Part 2)
• Must determine the true cash balance
o By reconciling the balance per books and balance per
bank to their adjusted cash balances
• Independent internal verification
o Occurs when an employee who has no other
responsibilities (either handling or reporting) related to
cash prepares the reconciliation

LO 3
Bank Reconciliation
Process

LO 3
Reconciling Items per Bank
Step 1 - Deposits in transit
• Items recorded by the depositor that have not been
recorded by the bank
• Added to the bank statement balance
Step 2 - Outstanding checks
• Issued checks recorded by the company that have not been
paid by the bank
• Deducted from the bank statement balance
Step 3 - Bank errors
• Errors made by the bank
• Added or subtracted to or from the bank statement balance

LO 3
Reconciling Items per Books
Step 1 - Other deposits
• Unrecorded in the accounting records
• Added to the balance per books
Step 2 - Other payments
• Unrecorded in the accounting records
• Deducted from the balance per books
Step 3 - Book errors
• Errors made by the depositor
• Added or subtracted from the balance per books

LO 3
Bank Reconciling Items
Balance per Bank and Deposits In Transit

Begin with the April 30 on the bank statement

Balance per bank statement
$15,907.45
Add deposits in transit: April 30 deposit received by
bank on May 1
$2,201.40

Compare the individual deposits on the bank statement

• With the deposits in transit from the preceding bank
reconciliation
• With the deposits per company records or copies of
duplicate deposit slips for the current period

LO 3
Bank Reconciling Items
Outstanding Checks and Bank Errors

Subtract outstanding checks:

No. 453, $3,000.00; No. 457, $1,401.30;
No. 460, $1,502.70 $5,904.00

Bank errors (+/−): None

LO 3
Reconciling Items on the Books
Other Deposits
Begin with the April 30 in the Cash account in the
accounting records
Balance per accounting records $11,709.45

Add other deposits: Unrecorded electronic

customer receipt on account on April 9 $1,035.00

Compare the other deposits on the bank statement

with the company records.

LO 3
Reconciling Items on the Books
Other Payments
• Shown on the bank statement as deductions
• Electronic payments on April 3 and 7 were
previously recorded when initiated.

Subtract other payments: Unrecorded charge from the

bank statement:
Returned NSF check on April 29 $425.60
Debit and credit card fees on April 30 120.00
Bank service charges on April 30 30.00

LO 3
Reconciling Items on the Books
Company Errors
Add company error: Check No. 443 $36.00

• Add or subtract errors made by the depositor discovered

in the previous steps
• Check 443 was correctly written by Laird for $1,226 and
was correctly paid by the bank on April 12. However, it
was recorded as $1,262 on Laird’s books.

LO 3
Bank Reconciliation Illustrated

LO 3
Entries from Bank Reconciliation
• Depositor must record each reconciling item used to
determine the adjusted cash balance per books to
adjust the cash account to the correct balance

LO 3
Bank Reconciliation Entries
Collection of Electronic Funds Transfer and
Book Error
Payment on account by customer through E FT
Apr. 30 Cash 1,035
Accounts Receivable 1,035
(To record receipt of electronic funds
transfer)

Book error: The journal shows that check no.

443 was a payment on account to a supplier.
Apr. 30 Cash 36
Accounts Payable 36
(To record error in recording
check 443)
LO 3
Bank Reconciliation Entries
NSF Check and Bank Charge Expense
NSF check: Added to account receivables to await collection
Apr. 30 Accounts Receivable 425.60
Cash 425.60
(To record NSF check)

Bank charge: Fees for processing debit and credit

card transactions
Apr. 30 Bank Charge Expense 150
Cash 150
(To record charges for debit and
credit card fees of $120 and bank
service charges of $30)

LO 3
Adjusted Balance in Cash Account
Cash account after posting the reconciliation entries

Adjusted cash balance in the ledger should equal the

adjusted cash balance on the reconciliation.

LO 3
Knowledge Check: Bank Reconciliation
The reconciling item in a bank reconciliation that will
result in an adjusting entry by the depositor is
a. outstanding checks.
b. deposit in transit.
c. bank error.
d. bank service charges.

LO 3
Knowledge Check: Bank Reconciliation
Answer

The reconciling item in a bank reconciliation that will

result in an adjusting entry by the depositor is
a. outstanding checks.
b. deposit in transit.
c. bank error.
d. Answer: bank service charges.

LO 3
Investor Insight
Madoff’s Ponzi Scheme
Perhaps no fraud in recent memory has generated more notoriety and rage
than the one perpetrated by Bernard Madoff. Madoff was an elite New York
investment fund manager who was highly regarded by securities regulators.
Investors flocked to him because he delivered steady returns of between
10% and 15%, no matter whether the market was going up or going down.
However, for many years, Madoff did not actually invest the cash that
people gave to him. Instead, he was running a Ponzi scheme: He paid
returns to existing investors using cash received from new investors. As long
as the size of his investment fund continued to grow from new investments
at a rate that exceeded the amounts that he needed to pay out in returns,
Madoff was able to operate his fraud smoothly. To conceal his misdeeds,
Madoff fabricated false investment statements that were provided to
investors. In addition, Madoff hired an auditor that never verified the
accuracy of the investment records but automatically issued unqualified
opinions each year. A competing fund manager warned the SEC a number of
times over a nearly 10-year period that he thought Madoff was engaged in
fraud. The SEC never aggressively investigated the allegations. Investors,
many of which were charitable organizations, lost more than $18 billion.
Madoff was sentenced to a jail term of 150 years.

LO 3
Knowledge Check: Bank Reconciliation
Part 1
Prepare the bank section of the bank reconciliation for
Abet, Inc. for June based on the following information.
1. June 30: 3. Deposits in transit, June 30, $98
Cash balance per bank,
4. EFT collection from a customer
$1,245
by bank $187, not yet recorded
Cash balance per books,
by Abet.
$1,136
5. Outstanding checks, June 30, $42
2. June bank service charge not
recorded
Cashbybalance
the depositor,
per$22
bank $1,245
Add: Deposits in transit 98
Less: Outstanding checks
Adjusted cash balance per bank (42)
$1,301
LO 3
Knowledge Check: Bank Reconciliation
Part 2
Prepare the books section of the bank reconciliation for
Abet, Inc. for June based on the following information.
1. June 30: 3. Deposits in transit, June 30, $98
Cash balance per bank, 4. EFT collection from a customer
$1,245 by bank $187, not yet recorded
Cash balance per books, by Abet.
$1,136
5. Outstanding checks, June 30, $42
2. June bank service charge not
Cashbybalance
recorded per $22
the depositor, books $1,136
Add: EFT collection from customer 187
Less: June service charge (22)
Adjusted cash balance per books $1,301
LO 3
Learning Objective 4
Explain the Reporting of Cash and the
Basic Principles of Cash Management

LO 4
Reporting Cash
• Cash consists of coins, currency, checks,
money orders, and money on hand or
deposit
• Balance sheet
o Reports the amount of cash available
at a given point in time
o Listed first in current assets section
• Statement of cash flows
o Shows sources and uses of cash
during a period
LO 4
Cash Equivalents
• Short-term, highly liquid investments that are both
o Readily convertible to known amounts of cash
o So near their maturity that their market value is
relatively insensitive to changes in interest rates
• Examples
o Treasury bills
o Commercial paper (short-term corporate notes)
o Money market funds

LO 4
Restricted Cash
• Not available for general use but is restricted for a
special purpose
• Reported separately on the balance sheet as
restricted cash
o As a current asset
• If the company expects to use the restricted cash
within the next year
o As a noncurrent asset
• If the company does not expect to use the restricted
cash within the next year
LO 4
Illustration of Reporting Cash
Delta Air Lines, Inc.
Balance Sheet (partial)
(in millions)
Assets
Current assets
Cash and cash equivalents $2,844
Short-term investments 959
Restricted cash 122

LO 4
Knowledge Check: Reporting Cash

Which of the following statements correctly describes

the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with Cash.
c. Cash is listed first in the current assets section.
d. Restricted cash funds exists when a cash account has
a net negative balance.

LO 4
Knowledge Check: Reporting Cash
Answer
Which of the following statements correctly describes
the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with Cash.
c. Answer: Cash is listed first in the current assets
section.
d. Restricted cash funds exists when a cash account has a
net negative balance.

LO 4
Knowledge Check:
Presentation of Cash
Indicate whether each of the following statements is true or false.
1. Cash and cash equivalents are often comprised of True
coins, currency, money orders, and treasury bills.

2. Restricted cash must be classified as a noncurrent False

asset.

3. A negative balance in a bank account is reported True

as a current liability because the company owes
the amount to the bank.

4. The sources and uses of cash during a period are False

reported on the balance sheet as a current asset.

LO 4
Managing and Monitoring Cash
Operating Cycle of a Merchandising Company
Objective is to ensure that a company has sufficient cash to meet
payments as they come due yet minimize the amount of non-
revenue-generating cash on hand.

LO 4
Basic Principles of Cash Management

LO 4
Cash Management
Increase the Speed of Receivables Collection
• The more quickly customers pay, the
more quickly funds can be used
• Carefully weigh any attempt to force
customers to pay earlier against the
possibility that they may not continue
to be customers
• Common way to increase the speed at
which customers pay
o Offer cash discounts for early payment

LO 4
Cash Management
Keep Inventory Levels Low
• Large inventory levels
o Costly as they tie up large amounts of cash
o Uses warehouse space
• Must avoid inadequate inventory
o Causes lost sales

LO 4
Cash Management
Monitor Payment of Liabilities
• Monitor when bills are due
o Avoid paying too early
• Use the full payment period
o Avoid paying late
• Could damage credit rating and future borrowing
ability
• Can damage important supplier relationships

LO 4
Cash Management
Plan Timing of Major Expenditures
• Make any major expenditure when excess cash is
available
o Usually during the off-season
• To obtain outside financing
o Consider the timing of major expenditures in light
of the company’s operating cycle

LO 4
Cash Management
Invest Idle Cash
Treasurer’s job
• To ensure that the company invests any excess cash
• To avoid a cash crisis
o Must invest in highly liquid and risk-free investments
• Liquid investment
 In a market in which someone is always willing to buy or
sell the investment
o Risk-free investment
• In which there is no concern that the party will default on
its promise to pay its principal and interest
LO 4
Cash Budgeting
• Shows anticipated cash flows, usually over a one- to
two-year period
o Cash receipts
o Cash disbursements
o Financing activities
• Enables company to plan ahead to cover possible cash
shortfalls and to make investments of idle funds
• Contributes to more effective cash management

LO 4
Basic Form of a Cash Budget

LO 4
Cash Receipts Section of Cash Budget
Includes
• Expected receipts from the company’s principal
source(s) of cash
• Anticipated receipts of interest and dividends, and
proceeds from planned sales of investments, plant
assets, and the company’s capital stock

LO 4
Cash Disbursements Section of Cash
Budget
• Includes
o Expected payments for inventory, labor, overhead,
and selling and administrative expenses
o Projected payments for income taxes, dividends,
investments, and plant assets
• Does not include
o Depreciation since depreciation expense does not
use cash

LO 4
Financing Section of Cash Budget
Shows expected
• Borrowings
o Financing is needed when there is a cash
deficiency or when the cash balance is less than
management’s minimum required balance
• Repayments of borrowed funds
• Payment of interest

LO 4
Cash Budget
• Quarters must be
prepared in
sequence.
• Ending cash balance
of one period
becomes beginning
cash of next period.

LO 4
Knowledge Review: Cash Budget
Key Mart’s management wants to maintain a minimum monthly cash
balance of $3,000. At May 1, its cash balance is $3,100, expected cash
receipts for May are $98,400, and cash disbursements are expected to
be $104,200. How much cash must Key Mart borrow to maintain the
desired minimum monthly balance?
Beginning cash balance $ 3,100
Add: Cash receipts for May 98,400
Total available cash 101,500
Less: Cash disbursements for May 104,200
Excess of cash disbursements over available cash (2,700)
Financing:
Add: Borrowings 5,700

Ending cash balance $ 3,000

LO 4
Learning Objective 5
Appendix 7A
Explain the Operation of a Petty Cash
Fund

LO 5
Operation of a Petty Cash Fund
Involves three events
• Establishing the fund
• Making payments from the fund
• Replenishing the fund
o When cash balance is low
o At end of period

LO 5
Establishing the Petty Cash Fund
Two steps in establishing a petty cash fund
1. Appoint a petty cash custodian who will be
responsible for the fund
2. Determine the size of the fund

Laird Company decides to establish a $100 fund on March 1.

Mar. 1 Petty Cash 100

Cash 100
(To establish a petty cash fund)

LO 5
Making Payments from the Petty
Cash Fund
Petty cash custodian
• Makes payments from the fund
o Documented by a prenumbered petty cash receipt with
any other supporting documents
• Receipts are held in the petty cash box until replenished

LO 5
Internal Control Over Petty Cash
• Sum of the petty cash receipts and the money in the
fund should equal the established total at all times

• Internal control principles satisfied by the receipts

o Establishment of responsibility as indicated by the
signature of custodian
o Documentation procedures evidenced by petty cash
receipts

LO 5
Replenishing the Petty Cash Fund
• Petty cash custodian requests reimbursement
• Treasurer’s office issues check for receipts submitted

On March 15, Laird’s petty cash custodian requests a check for

$87. The fund contains $13 cash and petty cash receipts for
postage $44, freight-out $38, and miscellaneous expenses $5.
Mar. 15 Postage Expense 44
Freight-Out 38
Miscellaneous Expense 5
Cash 87
(To replenish petty cash fund)

LO 5
Replenishing the Petty Cash Fund
with a Shortage
On March 15, Laird’s petty cash custodian requests a
check for reimbursement. The fund contains $12 cash and
petty cash receipts for postage $44, freight-out $38, and
miscellaneous expenses $5.
Shortage: $100 − $44 − $38 − $5 − $12 = $1
Mar. 15 Postage Expense 44
Freight-Out 38
Miscellaneous Expense 5
Cash Over and Short 1
Cash 88
(To replenish petty cash fund)

LO 5
Knowledge Check: Petty Cash Fund
Seal Mate established a $100 petty cash fund on June 1. On
June 30, the fund had $13 cash and petty cash receipts for
postage $22, and tolls and parking $66.
Prepare the entry on June 1 to establish the fund.
Jun. 1 Petty Cash 100
Cash 100

Prepare the entry on June 30 to replenish the fund.

Jun. 30 Postage Expense 22
Tolls and Parking Expense 66
Cash Over and Short 1
Cash 87

LO 5
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