© 2000 prentice hall business publishing financial accounting, 4/e harrison and horngren 4-1...

© 2000 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren

4-1

CHAPTER 4

Internal Control and

Managing Cash


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INTERNAL CONTROL

• Internal control is the organizational plan and all the related measures that an entity adopts to– Safeguard assets– Encourage adherence to company policies– Promote operational efficiency– Ensure accurate and reliable accounting

records


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INTERNAL CONTROL

• Competent, reliable, and ethical personnel

• Assignment of responsibilities to each employee

• Proper authorization for deviation from standard policy

An effective system of internal control has the following characteristics:


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INTERNAL CONTROL

• Separation of duties– Separation of operations from the

accounting function– Separation of the custody of assets from

accounting for them– Separation of the authorization of

transactions from the custody of related assets

– Separation of duties within the accounting function


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INTERNAL CONTROL• Internal and external audits

– An audit is the examination of the company’s financial statements and the accounting systems, internal controls, and records that produced them

– An internal auditor is an employee of the business who reports directly to the audit committee

– An external auditor is an independent auditor hired by a company to audit the financial statements and the factors affecting them


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AuditAuditCommitteeCommittee

Board of Directors

Vice President,Finance andAccounting

Treasurer

Vice President,Marketing

Vice President,Production

SeniorVice President

President

Collectionsand

Credits

Systems

CashManagement

Investor Relations

BankingRelations

OtherVice Presidents

ExternalExternalAuditingAuditing

Controller

GeneralAccounting Taxes InternalInternal

AuditingAuditing

Budgeting

Organizational

Chart of a

Corporation

Organizational

Chart of a

Corporation


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INTERNAL CONTROL

• Documents and records– Business documents and records include

• Source documents – Invoices, purchase orders, receipts, etc.

• Accounting journals• Accounting ledgers

• Electronic and computer controls– Electronic sensors on merchandise– Control totals


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INTERNAL CONTROL

• Other controls– Fireproof vaults– Burglar alarms– Point of sale terminals– Frequent bank deposits– Bonded cashiers

• A bond is an insurance policy that reimburses the company for losses due to employee theft

– Mandatory vacations– Job rotation


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INTERNAL CONTROL

• The limitations of internal control– A system designed to thwart an individual

employee’s fraud can be beaten by collusion between two or more employees to defraud the system

– A system of internal control that is too complex can hurt efficiency and control


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USING THE BANK ACCOUNT AS A CONTROL DEVICE

• The business should deposit all cash receipts in a bank account and make all cash payments through it. The documents used to control a bank account include the…

• Signature card• Deposit ticket• Check• Bank statement• Bank reconciliation


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• Signature Card– A card signed by each person authorized

to transact business through an account in a bank

• It protects both the bank and the depositor against forgery


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• Deposit ticket– A form supplied by the bank which serves

as proof of a transaction• Check

– A document instructing the bank to pay the designated person or business a specified amount of money

• The three parties to a check are– The maker– The payee– The bank



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California Products

Bay Area National Bank

319 47

Three hundred nineteen and 47/100-----Dollars

Check Serial NumberBank Payee

Maker


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• The bank statement shows the account’s beginning and ending balance and lists the month’s transactions processed by the bank as well as the maker’s canceled checks– An electronic funds transfer (EFT) transfers

cash by electronic communications • EFTs are listed among the deposits and

payments on the bank statement



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BAY AREA NATIONAL BANK ACCOUNT STATEMENTSOUTH PALO ALTO #136 P.O. BOX 22985 PALO ALTO, CA 94306

Business Research, Inc. CHECKING ACCOUNT 136-2137333814 Glenwood ParkwayPalo Alto, CA 94306

CHECKING ACCOUNT SUMMARY AS OF 01/31/X1

Beginning Balance Total Deposits Total W ithdrawals Service Charges Ending Balance

6,556.12 4,352.64 4,963.00 14.25 5,931.51

CHECKING ACCOUNT TRANSACTIONSDEPOSITS DATE AMOUNTDeposit 01/04 1,000.00Deposit 01/04 112.00Deposit 01/08 194.60EFT-Collection of rent 01/17 904.03Bank Collection 01/26 2,114.00Interest 01/31 28.01

CHARGES DATE AMOUNTService Charge 01/31 14.25Checks:

CHECKS BALANCES Number Date Amount Date Balance Date Balance332 01/12 3,000.00 12/31 6,556.12 01/17 5,264.75656 01/06 100.00 01/04 7,616.12 01/20 4,903.75333 01/12 150.00 01/06 7,416.12 01/26 7,017.75334 01/10 100.00 01/08 7,610.72 01/31 5,931.51335 01/06 100.00 01/12 4,360.72336 01/31 1,100.00

OTHER CHARGES DATE AMOUNTNSF 01/04 52.00EFT-insurance 01/20 361.00

MONTHLY SUMMARY W ithdrawals: 8 Minimum Balance: 4,360.00 Average Balance: 6,091.00





6,556.12 4,352.64 4,963.00 14.25 5,931.51







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• The bank reconciliation– Explains the difference between the firm’s

cash balance and the bank statement balance on a certain date

– Ensures that all cash transactions have been accounted for and that the bank and book records of cash are correct



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• Items that cause differences between the bank balance and the book balance are– Items recorded by the company but not yet

recorded by the bank• Deposits in transit - recorded by the company

but not by the bank• Outstanding checks - issued and recorded by

the company, but not yet paid by the bank



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– Items recorded by the bank but not yet recorded by the company

• Bank collections received on behalf of the business

• Electronic funds transfers paid or received on behalf of the business

• Service charge assessed by the bank for processing the business’s transactions

• Interest revenue on checking account



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• NSF (nonsufficient funds) checks received from customers which are worthless and returned to the payee

• Checks collected, deposited, and returned to the payee by the bank for reasons other than NSF

• The cost of printed checks

– Errors by either the company or the bank



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1Maker writes check

to payee

2Payee depositscheck in bank,

which increasespayee’s balance

3Payee’s bank sends

check to Maker’sbank

4Maker’s bank

decreases Maker’sbalance and sendscancelled check to

Maker

1Maker writes check

to payee

2Payee deposits check

in bank, whichincreases Payee’s

balance

4Maker’s bank accountnot sufficient to pay

the check

3Payee’s bank sends check to Maker’s

bank

5 Maker’s bank returns

worthless check toPayee’s bank

6Payee’s bank

decreases payeesbalance and

returns worthlesscheck to payee

7Payee holds

worthless check

The Paths That Two Checks Take


4-21

BANK RECONCILIATION ILLUSTRATED

• The bank statement for Business Research, Inc., on the next slide indicates that the January 31 bank balance is $5,931.51


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6,556.12 4,352.64 4,963.00 14.25 5,931.51










6,556.12 4,352.64 4,963.00 14.25 5,931.51







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• The detail of Business Research, Inc.’s, cash records is presented on the following slide

• The company’s Cash account has a balance of $3,294.21

Cash


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20X1

Jan 1 Balance 6,556.12

2 Cash receipt 1,112.00 7,668.12

7 Cash receipt 194.60 7,862.72

31 Cash paymentsCash payments 6,160.146,160.14 1,702.58

31 Cash receipt 1,591.63 3,294.21

Ledger:

ACCOUNT Cash

Date Item Debit Credit Balance

332 $3,000.00 337 $286.00333 510.00 338 319.47334 100.00 339 83.00335 100.00 340 203.14336 1,100.00 341 458.53

Cash PaymentsCash PaymentsCheck No. Amount Check No. Amount


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The following reconciling items explain why the two balances differ:

The January 31 deposit of $1,591.63 does not appear on the bank statement

The bank erroneously charged to the account a $100 check (No. 656) written by Business Research Associates


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Five company checks issued late in January and recorded in the journal have not been paid by the bank


Check No. Date Amount

337 Jan. 27 $286.00

338 28 319.47

339 28 83.00

340 29 203.14

341 30 458.53

Check No. Date Amount

337 Jan. 27 $286.00

338 28 319.47

339 28 83.00

340 29 203.14

341 30 458.53


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The bank received $904.03 by EFT on behalf of Business Research, Inc.

The bank collected on behalf of the company a note receivable, $2,114 (including interest of $214)

The bank statement shows interest revenue of $28.01



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Check number 333 for $150 paid to Brown Company on account was recorded as a cash payment of $510

The bank service charge for the month was $14.25

The bank statement shows an NSF check for $52

Business Research pays insurance expense by EFT and has not recorded this $361 payment



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Business Research, Inc.Bank Recondiliation

January 31, 20X1

Bank Books Balance, January 31 $5,931.51 Balance, January 31 $3,294.21Add: Add:1. Deposit of January 30 in transit 1,591.63 4. EFT receipt of rent revenue 904.032. Correction of bank error—Business 5. Bank collection of note receivable, Research Associates check including interest revenue of $214 2,114.00 Erroneously charged against 6. Interest revenue earned on Company account 100.00 bank balance 28.01

7,623.14 7. Correction of book error—overstated amount of check no. 333 360.00

6,700.253. Less: Outstanding checks

No. 337 $286.00 Less:No. 338 319.47 8. Service charge $ 14.25No. 339 83.00 9. NSF check 52.00No. 340 203.14 10. EFT payment ofNo. 344 458.53 (1,350.14) insurance expense 361.00 (427.25)

Adjusted bank balance $6,273.00 Adjusted book balance $6,273.00

Business Research, Inc.Bank Recondiliation

January 31, 20X1

Bank Books Balance, January 31 $5,931.51 Balance, January 31 $3,294.21Add: Add:1. Deposit of January 30 in transit 1,591.63 4. EFT receipt of rent revenue 904.032. Correction of bank error—Business 5. Bank collection of note receivable, Research Associates check including interest revenue of $214 2,114.00 Erroneously charged against 6. Interest revenue earned on Company account 100.00 bank balance 28.01

7,623.14 7. Correction of book error—overstated amount of check no. 333 360.00

6,700.253. Less: Outstanding checks

No. 337 $286.00 Less:No. 338 319.47 8. Service charge $ 14.25No. 339 83.00 9. NSF check 52.00No. 340 203.14 10. EFT payment ofNo. 344 458.53 (1,350.14) insurance expense 361.00 (427.25)

Adjusted bank balance $6,273.00 Adjusted book balance $6,273.00



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• To the bank balance always– Add deposits– Subtract outstanding checks– Add or subtract corrections of bank errors,

as appropriate


Reconciling items are treated as follows:


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• To the book balance always– Add bank collection items, interest

revenue, and EFT receipts– Subtract service charges, NSF checks, and

EFT payments– Add or subtract correction of book errors,

as appropriate


Reconciling items are treated as follows:


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On the basis of the reconciliation, Business Research, Inc., makes the following entries (numbers in parentheses correspond to the reconciling items):

Jan. 31 (4) Cash 904.03

Rent Revenue 904.03

Receipt of monthly rent

Jan. 31 (4) Cash 904.03

Rent Revenue 904.03

Receipt of monthly rent


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Jan. 31 (5) Cash 2,114.00

Notes Receivable 1,900.00

Interest Receivable 214.00

Note receivable collected by bank

Jan. 31 (5) Cash 2,114.00

Notes Receivable 1,900.00

Interest Receivable 214.00

Note receivable collected by bank

Jan. 31 (6) Cash 28.01

Interest Revenue 28.01

Interest earned on bank balance

Jan. 31 (6) Cash 28.01

Interest Revenue 28.01

Interest earned on bank balance


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Jan. 31 (7) Cash 360.00

Accounts Payable -

Brown Co. 360.00

Correction of check no. 333

Jan. 31 (7) Cash 360.00

Accounts Payable -

Brown Co. 360.00

Correction of check no. 333

Jan. 31 (8) Misc. Expense 14.25

Cash 14.25

Bank service charge

Jan. 31 (8) Misc. Expense 14.25

Cash 14.25

Bank service charge


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Jan. 31 (9) Accounts Receivable -

L. Ross 52.00

Cash 52.00

NSF check returned by bank

Jan. 31 (9) Accounts Receivable -

L. Ross 52.00

Cash 52.00

NSF check returned by bank

Jan 31. (10) Insurance Expense 361.00

Cash 361.00

Payment of monthly insurance

Jan 31. (10) Insurance Expense 361.00

Cash 361.00

Payment of monthly insurance


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CashCash

InventoryInventoryAccounts

ReceivableAccounts

Receivable

PurchasesPurchasesCollection Collection of Cashof Cash

Sales on AccountSales on Account

OPERATING CYCLE OF A BUSINESS


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MANAGING CASH

• Companies – Sell most of their goods on account– Keep a subsidiary accounts receivable

ledger with a separate account for each customer

– Use the accounts receivable ledger to pursue collection from individual customers

Speeding the collection of cash from sales


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Accounts Receivable

Toys “R” Us

Target

Kmart

Bal. 1,800

Bal. 1,000

Bal. 300

Bal. 500

GENERAL LEDGER

ACCOUNTS RECEIVABLE SUDSIDIARY LEDGER

Cash

Bal. XX

Total 1,800


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MANAGING CASH

• Companies offer sales discounts that motivate customers to pay within a specified period

• Credit terms of “2/10, n/30” means the customer can – Take a 2% discount by paying within ten

days of the date of the sale or– Pay the full amount within 30 days


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MANAGING CASHSuppose Fisher-Price makes a $50,000 sale to Toys “R” Us on August 4. If credit terms are 2/10, n/30 and Fisher-Price collects on August 14, Fisher-Price would record the sale and collection with these journal entries:

Aug. 4 Accounts Receivable - Toys “R” Us 50,000

Sales Revenue 50,000

Sale on account

Aug. 4 Accounts Receivable - Toys “R” Us 50,000

Sales Revenue 50,000

Sale on account

Aug. 14 Cash ($50,000 x .98) 49,000

Sales Discount ($50,000 x .02) 1,000

Accounts Receivable - Toys “R” Us 50,000

Collection on account

Aug. 14 Cash ($50,000 x .98) 49,000

Sales Discount ($50,000 x .02) 1,000

Accounts Receivable - Toys “R” Us 50,000

Collection on account


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• Internal control over cash receipts ensures that– All cash receipts are deposited in the bank– The company’s cashier combines them

with any cash received over the counter and prepares the bank deposit

MANAGING CASH


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Competent, reliable, Companies carefully screen employees for ethical personnel undesirable personality traits. They also spend

large sums for training programs.

Assignment of Specific employees are designated as cashiers, responsibilities supervisors of cashiers, or accountants for cash

receipts.

Proper authorization Only designated employees, such as department managers, can grant exceptions for customers, approve check receipts above a certain amount, and allow customers to purchase on credit.

Separation of duties Cashiers and mailroom employees who handle cash do not have access to the accounting records. Accountants who record cash receipts have no opportunity to handle cash.

Element of Internal Control

Internal Controls over Cash Receipts

INTERNAL CONTROLS OVER CASH RECEIPTS


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Internal and external Internal auditors examine company transactions audits for agreement with management policies. External

auditors examine the internal controls over cash receipts to determine whether the accounting system produces accurate amounts for revenues, receivables, and other items related to cash receipts.

Documents and records Customers receive receipts as transaction records. Bank statements list cash receipts for

reconciliation with company records (deposit tickets). Customers who pay by mail include a remittance advice showing the amount of cash they sent to the company.

Electronic and computer Cash registers serve as transaction records. Each controls day’s receipts are matched with customer

remittance advices and with the day’s deposit ticket from the bank.

Other controls Cashiers are bonded. Cash is stored in vaults and banks. Employees are rotated among jobs and are required to take vacations.


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INTERNAL CONTROL OVER CASH PAYMENTS

Purchase request Sales department Purchasing department (requisition)

Purchase order Purchasing Outside company that department sells the needed

merchandise (supplier or vendor)

Invoice (bill) Outside company Accounting department that sells the needed merchandise (supplier or vendor)

Receiving report Receiving department Accounting department

Disbursement packet Accounting department Officer who signs the check

Business Document Prepared by Sent to

The Purchasing Process


4-45

Purchase RequestPurchase Request

Purchase OrderPurchase Order

InvoiceInvoice

Receiving ReportReceiving Report


Disbursement Packet


4-46

Competent, reliable, Cash payments are entrusted to high-level ethical personnel employees, with larger amounts paid by the

treasurer or assistant treasurer.

Assignment of Specific employees approve purchase documents responsibilities for payment. Executives examine approvals, then

sign checks.

Proper authorization Large expenditures must be authorized by the company owner or board of directors to ensure agreement with organizational goals.

Separation of duties Computer operators and other employees who handle checks have no access to the accounting records. Accountants who record cash payments have no opportunity to handle cash.

Element of Internal Control

Internal Controls over Cash Payments

INTERNAL CONTROLS OVER CASH PAYMENTS


4-47

Internal and external Internal auditors examine company transactions audits for agreement with management policies. External

auditors examine the internal controls over cash payments to determine whether the accounting system produces accurate amounts for expenses, assets, and other items related to cash disbursement .

Documents and records Suppliers issue invoices that document the need to pay cash. Bank statements list cash payments (checks and EFT disbursements) for reconciliation with company records. Checks are prenumbered in sequence to account for payments.

Electronic, computer, Blank checks are stored in a vault and controlled and other controls by a responsible official with no accounting duties.

Machines stamp the amount on a check in indelible ink. Paid invoices are punched to avoid duplicate payment.


4-48


Controlling Petty Cash

• The petty cash fund is – A small amount of cash kept on hand to

pay for minor expenses– Opened with a particular amount of cash

• The custodian of the petty cash fund– Cashes a check and places the currency

and coin in the fund– Prepares a petty cash ticket for each petty

cash payment


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Petty Cash Ticket

Date Mar. 25, 20X4 No. 47

Amount $23.00

For Box of floppy diskettes

Debit Office supplies, Acct. No. 145

Received by Fund Custodian

Petty Cash Ticket

Date Mar. 25, 20X4 No. 47

Amount $23.00

For Box of floppy diskettes

Debit Office supplies, Acct. No. 145

Received by Fund Custodian


4-50

• In an imprest petty cash system– The sum of the cash in the petty cash fund

plus the total of the ticket amounts should equal the opening balance at all times

– The petty cash account keeps its prescribed balance at all times



4-51

USING A BUDGET TO MANAGE CASH

• A budget– Is a quantitative expression of a plan that

helps managers coordinate the entity’s activities

– Helps a company manage its cash by expressing the plan for the receipt and payment of cash during a future period


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To prepare for future cash needs, managers proceed in four steps:Start with the entity’s cash balance at

the beginning of the periodAdd the budgeted cash receipts and

subtract the budgeted cash payments– Revenue and expense transactions

(operating activities from the income statement)


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– Asset acquisition and sale transactions (investing activities from the statement of cash flows)

– Liability and stockholders’ equity transactions (financing activities from the statement of cash flows)

The beginning balance plus the expected receipts minus the expected payments equals the expected cash balance at the end of the period



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Compare the expected cash balance to the desired, or budgeted, cash balance at the end of the period– Excess cash can be invested– Cash balances below the budgeted

balance may require additional financing to reach the desired cash balance

• The following slide shows an example of a cash budget for The Gap, Inc.



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The Gap, Inc.Cash Budget

For the year Ended January 31, 20x2

(1) Cash balance, February 1, 20x1 $ 202.6

Estimated cash receipts: (2) Collections from customers 2,858.3 (3) Interest and dividends on investments 6.2 (4) Sale of store fixtures 4.9

3,072.0 Estimated cash payments: (5) Purchase of inventory $1,906.2 (6) Operating expenses 561.0 (7) Expansion of existing stores 206.4 (8) Opening of new stores 344.6 (9) Payment of long-term debt 148.7(10) Payment of dividends 219.0 3,385.9(11) Cash available (needed) before

new financing (313.9)(12) Budgeted cash balance, January 31, 20x2 (200.0)(13) Cash available for additional

investments or new financing needed $ (513.9)

(In millions)


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REPORTING CASH ON THE BALANCE SHEET

• Companies usually combine all cash amounts into a single total called “Cash and Cash Equivalents” on the balance sheet

• Cash equivalents include liquid assets such as– Time deposits– Certificates of deposit


4-57

AIR & SEA TRAVEL, INC.Balance SheetApril 30, 2001

Assets Liabilities

CCaasshh aanndd ccaasshh eeqquuiivvaalleennttss $$3333,,330000 Accounts payable $ 100Accounts receivable 2,000Office supplies 500 Stockholders’ EquityLand 18,000 Common stock 50,000

Retained earnings 3,700 Total stockholders’ equity 53,700

_______ Total liabilities and Total assets $53,800 stockholders’ equity $53,800

AIR & SEA TRAVEL, INC.Balance SheetApril 30, 2001

Assets Liabilities

CCaasshh aanndd ccaasshh eeqquuiivvaalleennttss $$3333,,330000 Accounts payable $ 100Accounts receivable 2,000Office supplies 500 Stockholders’ EquityLand 18,000 Common stock 50,000

Retained earnings 3,700 Total stockholders’ equity 53,700

_______ Total liabilities and Total assets $53,800 stockholders’ equity $53,800

REPORTING CASH ON THE BALANCE SHEET


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ETHICS AND ACCOUNTING


4-59

CORPORATE AND PROFESSIONAL CODES OF ETHICS

• Most large companies have a code of ethics designed to encourage ethical and responsible behavior by their employees


4-60

• Accountants have additional incentives to behave ethically– Independent accountants must abide by

the AICPA Code of Professional Conduct– Members of the Institute of Management

Accountants are bound by the Standards of Ethical Conduct for Management Accountants

CORPORATE AND PROFESSIONAL CODES OF ETHICS


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ETHICAL ISSUES IN ACCOUNTING

Determine the factsIdentify the ethical issuesSpecify the alternativesIdentify the people involvedAssess the possible outcomesMake the decision

To make ethical decisions, people should proceed in six steps:


4-62

End of Chapter 4

© 2000 prentice hall business publishing financial accounting, 4/e harrison and horngren 4-1...

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reliable accounting

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companys financial statements

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