6-1 internal control and cash chapter 6 electronic presentation by douglas cloud pepperdine...

6-1

Internal Control and Cash

Chapter 6

Electronic Presentation by Douglas Cloud

Pepperdine University

Electronic Presentation by Douglas Cloud

Pepperdine University

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1. Describe and illustrate the objectives and elements of internal control.

2. Describe and illustrate methods of preventing and detecting employee fraud.

3. Describe and illustrate the application of internal controls to cash.

4. Describe the nature of a bank account and its use in controlling cash.

Learning GoalsLearning GoalsLearning GoalsLearning Goals

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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5. Describe and illustrate the use of a bank reconciliation in controlling cash.6. Describe the accounting for special-purpose cash funds.7. Describe and illustrate the reporting of cash and cash equivalents in the

financial statements.8. Describe, illustrate, and interpret the cash flow to net income ratio and the

cash to monthly cash expense ratio.

Learning GoalsLearning GoalsLearning GoalsLearning Goals

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1Learning GoalLearning GoalLearning GoalLearning Goal

Describe and illustrate the objectives and elements of internal control.

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Internal controls help business guide their operations and

prevent abuses.

Internal controls help business guide their operations and

prevent abuses.

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Objectives of Internal ControlObjectives of Internal ControlObjectives of Internal ControlObjectives of Internal Control

1. Assets are safeguarded and used for business purposes.

2. Business information is accurate.

3. Employees comply with laws and regulations.

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Control EnvironmentControl EnvironmentControl EnvironmentControl EnvironmentThe control environment is

the overall attitude of management and

employees about the importance of controls.

The control environment is the overall attitude of

management and employees about the

importance of controls.

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Risk AssessmentRisk AssessmentRisk AssessmentRisk Assessment

Changes in customer requirements

Competitive threats Changes in economic factors Employee violations of

company policies and procedures

Risk includes:Risk includes:

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Control ProceduresControl ProceduresControl ProceduresControl Procedures

Control procedures are established to provide reasonable assurance that

business goals will be achieved, including the prevention of fraud.

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Control ProceduresControl ProceduresControl ProceduresControl Procedures

Competent personnel Rotating duties Mandatory vacations Separating responsibilities for related

operations Separate operations Custody of assets Accounting proofs Security measures Monitor the internal control system

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Security MeasuresSecurity MeasuresSecurity MeasuresSecurity Measures

Locate the cash register near the door, so that it is fully visible from outside the store.

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Have two employees work late

hours.

Employ a security guard

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Deposit cash in bank daily before 5 p.m.

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Keep only small amounts of cash on hand after 5 p.m. by depositing excess cash in a store safe that

can’t be opened by employees on duty.

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Install cameras and alarm systems.

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Warning Signs With Warning Signs With Regard to PeopleRegard to People

Warning Signs With Warning Signs With Regard to PeopleRegard to People

1. Abrupt change in lifestyle.

2. Close social relationship with suppliers.

3. Refusing to take a vacation.

4. Frequent borrowing from other employees.

5. Excessive use of alcohol or drugs.

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Warning Signs From the Warning Signs From the Accounting SystemAccounting System

Warning Signs From the Warning Signs From the Accounting SystemAccounting System

1. Missing documents or gaps in transaction numbers.

2. An unusual increase in customer fraud.

3. Differences between daily cash receipts and bank deposits.

4. Sudden increase in slow payments.

5. Backlog in record transactions.

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Describe and illustrate methods of preventing and detecting employee fraud.2

Learning GoalLearning GoalLearning GoalLearning Goal

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Elements Common to Most Elements Common to Most Employee FraudEmployee Fraud


An employee’s perceived financial need

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An opportunity to use a fraudulent scheme to satisfy the need

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A rationalization that the fraud is justified

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Preventive ControlsPreventive ControlsPreventive ControlsPreventive Controls

Company Assets

The company assets should be

controlled in such a way that an employee’s

ability to steal the assets is limited.

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Preventive ControlsPreventive ControlsPreventive ControlsPreventive Controls

Proper authorization and approval

procedures can be effectively

used to prevent employee fraud.

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Detective ControlsDetective ControlsDetective ControlsDetective Controls

Periodic reviews of the accounting records are useful in identifying unusual transactions or accounts for further investigation.

Independent checks are useful in detecting employee fraud.

Reconciliations are useful in detecting employee theft.

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Risk Factors Relating to Risk Factors Relating to Employee FraudEmployee Fraud


Lack of proper record keeping for assets susceptible to theft.

Lack of proper segregation of duties.

Lack of independent checks.

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Lack of a proper system of authorization.

Lack of proper physical safeguarding of assets susceptible to theft.

Lack of timely and proper documentation for transactions.

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Lack of a proper management oversight.

Lack of proper screening procedures for employees in sensitive positions.

Lack of mandatory vacations for employees in sensitive position.

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Describe and illustrate the application of internal controls to cash.


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What is Cash?Cash includes coins,

currency (paper money), checks,

money orders, and money on deposit

that is available for unrestricted withdrawal.

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Control of Cash ReceiptsControl of Cash ReceiptsControl of Cash ReceiptsControl of Cash Receipts

One of the most important controls

to protect cash received in over-the-counter sales

is the cash register.

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After a cash register clerk’s cash has been

counted and recorded on a memorandum form, the cash is then placed in a store safe until it can be deposited in the bank.

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The employee who opens the mail should initially compare the

amount of cash received with the amount shown

on the remittance advice.

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The employee opening the mail normally also stamps the checks and

money orders “For Deposit Only” in the bank account of the

business.

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When cash is deposited in the bank, the bank cashier

normally stamps a duplicate copy of the

deposit ticket. This bank receipt is returned to the

Accounting Department for comparison and recording.

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Control of Cash PaymentsControl of Cash PaymentsControl of Cash PaymentsControl of Cash Payments

A voucher system is a set of procedures for authorizing

and recording liabilities and cash payments.

A voucher system is a set of procedures for authorizing

and recording liabilities and cash payments.

A voucher is any document that serves as proof of authority to pay cash.

A voucher is any document that serves as proof of authority to pay cash.

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Describe the nature of a bank account and its use in controlling cash.4


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A summary of all checking account transactions, called a bank statement, is mailed to

the depositor each month.

A summary of all checking account transactions, called a bank statement, is mailed to

the depositor each month.

It shows the beginning It shows the beginning balance, additions, balance, additions,

deductions, and the balance at deductions, and the balance at the end of the period.the end of the period.

It shows the beginning It shows the beginning balance, additions, balance, additions,

deductions, and the balance at deductions, and the balance at the end of the period.the end of the period.

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Businesses usually require that all cash receipts be initially deposited in the

bank account.

Businesses usually require that all cash receipts be initially deposited in the

bank account.

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Likewise, businesses usually use checks or bank account transfers to make

all cash payments.

Likewise, businesses usually use checks or bank account transfers to make

all cash payments.

Except very small ones.Except very small ones.Except very small ones.Except very small ones.

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Describe and illustrate the use of a bank reconciliation in controlling cash.5


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A bank reconciliation is a listing of the items and amounts that cause the

cash balance reported in the bank statement…

A bank reconciliation is a listing of the items and amounts that cause the

cash balance reported in the bank statement…

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…to differ from the balance of the cash

account in the ledger.

…to differ from the balance of the cash

account in the ledger.

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Steps in a Bank ReconciliationSteps in a Bank ReconciliationSteps in a Bank ReconciliationSteps in a Bank Reconciliation

1. Compare cash deposit listed on the bank statement with unrecorded deposits appearing in the preceding period’s reconciliation and with deposit receipts or other records of deposits.

Cash balance according to bank statement:Add deposits not on bank statement

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2. Compare paid checks with outstanding checks appearing on the preceding period’s reconciliation and with recorded checks.

Cash balance according to bank statement:Deduct outstanding checks:

No. 1512xxx

No. 1515xxx

No. 1521xxxx

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3. Compare bank credit memorandums to entries in the journal.

Cash balance according to depositor’s record:

Add note and interest collect by bank

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4. Compare bank debit memorandums to entries recording cash payments journal.

Cash balance according to depositor’s record:Deduct: Check returned because of

insufficient funds Bank service charge

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5. List any errors discovered during the preceding steps.

Cash balance according to depositor’s record:Deduct: Error in recording Check No. 1509

Assume that Check No. 1509 was written for $193 and recorded as $139.

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Typical Journal EntriesTypical Journal EntriesTypical Journal EntriesTypical Journal Entries

July 31 Cash 408Notes Receivable 400Interest Income 8

31 Accounts Receivable—Ivey 300Miscellaneous Expense 18Accounts Payable—Taylor Co. 9

Cash 327

Entries are based only on the information from the Entries are based only on the information from the depositor’s side of the reconciliation.depositor’s side of the reconciliation.

Entries are based only on the information from the Entries are based only on the information from the depositor’s side of the reconciliation.depositor’s side of the reconciliation.

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Describe the accounting for special-purpose cash funds.6


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It is usually not practical for a business to write checks to pay small

amounts, like postage.

It is usually not practical for a business to write checks to pay small

amounts, like postage.

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To control these small payments, a petty cash fund is used. This is a small cash fund under the control of a

petty cashier.

To control these small payments, a petty cash fund is used. This is a small cash fund under the control of a

petty cashier.

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If a secretary needs a book of stamps, the secretary signs a

voucher that provides a description and amount in

exchange for the necessary cash.

If a secretary needs a book of stamps, the secretary signs a

voucher that provides a description and amount in

exchange for the necessary cash.

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The petty cashier places the voucher in a locked

drawer for later reconciliation and

recording.

The petty cashier places the voucher in a locked

drawer for later reconciliation and

recording.

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Most businesses use a payroll bank account to pay

employees. This is known as a special-purpose fund.

Most businesses use a payroll bank account to pay

employees. This is known as a special-purpose fund.

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Describe and illustrate the reporting of cash and cash equivalents in the financial statements.


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A company may have cash in excess of operating needs. These funds are placed in

highly liquid investments and are called cash equivalents.

A company may have cash in excess of operating needs. These funds are placed in

highly liquid investments and are called cash equivalents.

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Examples of Cash EquivalentsExamples of Cash EquivalentsExamples of Cash EquivalentsExamples of Cash Equivalents

Commercial paper Certificates of deposit U.S. government and agency

securities Corporate notes and bonds Municipal securities

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Describe, illustrate, and interpret the cash flow to net income ratio and the cash to monthly cash expense ratio.


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Ratio of Cash Flow to Ratio of Cash Flow to Net IncomeNet Income


$151,250

$83,725

Net cash flow from

operations

Net cash flow from

operations

From the statement of cash flows


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$151,250

$83,725 Net incomeNet incomeFrom the income

statement

From the income

statementCash flow ratio = 1.81

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Ratio of Cash to Monthly Ratio of Cash to Monthly Cash ExpensesCash Expenses


Cash at the end of the year

Cash at the end of the year

$38,450

$12,604

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$38,450

$12,604

Net cash flow from

operations per month

Net cash flow from

operations per month



$151,250

12= $12,604

Ratio of cash to Ratio of cash to monthly expenses monthly expenses

= 3.05= 3.05

Ratio of cash to Ratio of cash to monthly expenses monthly expenses

= 3.05= 3.05

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The EndThe End

Chapter 6Chapter 6