internal control and accounting for cash © paradigm publishing, inc.1 chapter 6

Internal Control and Accounting for Cash

© Paradigm Publishing, Inc. 1

Chapter 6

1. Define internal control and identify and describe its objectives.

2. Define cash as it is used in accounting.

3. Describe internal control procedures related to cash.

4. Describe the purpose of and need for a petty cash fund.


Learning Objectives

5. Record the establishment of a petty cash fund.

6. Record the replenishment of a petty cash fund.

7. Record the establishment of a change fund.


Learning Objectives

8. Record cash shortages and overages.

9. Prepare a bank reconciliation.


Learning Objectives

Accounting scandals at Enron and WorldCom Accounting scandals at Enron and WorldCom shook the public’s confidence in the reliability of shook the public’s confidence in the reliability of financial statements.financial statements.

Congress responded by passing the Sarbanes-Congress responded by passing the Sarbanes-Oxley Act of 2002.Oxley Act of 2002.


The purpose of this act, abbreviated as SOX, was The purpose of this act, abbreviated as SOX, was to restore public confidence and trust in the to restore public confidence and trust in the financial statements of companies.financial statements of companies.

SOX created a new body, the SOX created a new body, the Public Company Public Company Accounting Oversight BoardAccounting Oversight Board, to oversee the , to oversee the work of auditors of public companies.work of auditors of public companies.


Harsh penalties for violatorsHarsh penalties for violators

Public accounting firms may not audit a client’s Public accounting firms may not audit a client’s books and also provide certain consulting services books and also provide certain consulting services for the same clientfor the same client

Increased responsibility of the boards of directorsIncreased responsibility of the boards of directors

Companies are required to maintain strong and Companies are required to maintain strong and effective internal controls over recording business effective internal controls over recording business transactions and preparing financial statementstransactions and preparing financial statements



Learning Objective 1

Define internal control and identify and describe its objectives

The methods and procedures a business uses to The methods and procedures a business uses to internally protect its assetsinternally protect its assets

A good system of internal control is designed toA good system of internal control is designed to Safeguard assetsSafeguard assets

Ensure the accuracy and reliability of Ensure the accuracy and reliability of accounting recordsaccounting records

Promote operational efficiencyPromote operational efficiency

Ensure compliance with laws and regulationsEnsure compliance with laws and regulations




Define cash as it is used in accounting

Includes currency, coins, checks made payable to Includes currency, coins, checks made payable to the business, money orders, and amounts on the business, money orders, and amounts on deposit in banks and other financial institutionsdeposit in banks and other financial institutions

Generally considered the most precious of all assetsGenerally considered the most precious of all assets

Almost everyone wants itAlmost everyone wants it

Easily taken if not protectedEasily taken if not protected




Describe internal control procedures related to cash

Establish ResponsibilityEstablish ResponsibilityOnly properly designated personnel are Only properly designated personnel are authorized to handle cash receipts.authorized to handle cash receipts.

Separation of DutiesSeparation of DutiesThe individual who accounts for cash is The individual who accounts for cash is different from the persons who receive different from the persons who receive and deposit cash.and deposit cash.


Physical ProtectionPhysical ProtectionCash on hand should be in a secure Cash on hand should be in a secure location and cash should be deposited location and cash should be deposited daily.daily.

DocumentationDocumentationCash register tapes, summaries of Cash register tapes, summaries of checks received, etc. should be kept checks received, etc. should be kept to show the amount of cash received.to show the amount of cash received.


Independent VerificationIndependent VerificationCashiers check cash registers, Cashiers check cash registers, supervisors count cash receipts daily, supervisors count cash receipts daily, and company treasurer compares cash and company treasurer compares cash receipts with bank deposits.receipts with bank deposits.

Keep Only a Small Amount of Cash on HandKeep Only a Small Amount of Cash on HandOnly a small amount of cash should be Only a small amount of cash should be maintained on hand to make small maintained on hand to make small expenditures.expenditures.



a.a. Keep only a small amount of cash on handKeep only a small amount of cash on hand

b.b. Physical protectionPhysical protection

c.c. Petty cashPetty cash

d.d. DocumentationDocumentation

e.e. Separation of dutiesSeparation of duties

Quick Check

The bookkeeper receives cash from customers, The bookkeeper receives cash from customers, makes the journal entry to record the deposit, and makes the journal entry to record the deposit, and deposits the cash at the bank. What internal deposits the cash at the bank. What internal control procedure is being violated?control procedure is being violated?

Review Quiz 6-1

Which of the cash procedures are examples of weak Which of the cash procedures are examples of weak internal controls? Why?internal controls? Why?

Answer:Answer:


1.1. Responsibility not established; too many people Responsibility not established; too many people have accesshave access

2.2. GoodGood

3.3. Lacks independent verificationLacks independent verification

4.4. Lacks separation of dutiesLacks separation of duties

5.5. GoodGood



Describe the purpose of and need for a petty cash fund

To control cash-most businesses use bank checking To control cash-most businesses use bank checking accounts when making cash expendituresaccounts when making cash expenditures

It is not practical to write checks for very small It is not practical to write checks for very small amountsamounts

Most businesses maintain a Most businesses maintain a petty cash fundpetty cash fund which is a small amount of money kept in the office which is a small amount of money kept in the office for making small expendituresfor making small expenditures




Record the establishment of a petty cash fund

1.1. Estimate the amount of cash needed in the fund.Estimate the amount of cash needed in the fund.

2.2. A check for this amount is written payable to Petty A check for this amount is written payable to Petty Cash.Cash.

3.3. The check is then cashed, and the money is placed The check is then cashed, and the money is placed in a box, a drawer, or a safe to be used for the fund.in a box, a drawer, or a safe to be used for the fund.


4.4. The check is recorded in the journal byThe check is recorded in the journal by Debiting the Debiting the Petty CashPetty Cash account (an asset) account (an asset)

Crediting the Cash accountCrediting the Cash account


+ asset- asset


Petty cashierPetty cashier (usually) is the only person who (usually) is the only person who makes payments from the fund.makes payments from the fund.

Petty cash voucherPetty cash voucherPrepared for each paymentPrepared for each payment

Shows the details of the paymentShows the details of the payment

Serves as proof of paymentServes as proof of payment


Some firms prefer to record all petty cash Some firms prefer to record all petty cash payments on a single sheet called the payments on a single sheet called the petty cash petty cash payments recordpayments record..

A petty cash payments record is not a journal.A petty cash payments record is not a journal.

It is an It is an auxiliary recordauxiliary recordused as a basis for used as a basis for making a journal entry.making a journal entry.

An auxiliary record is a nonessential business An auxiliary record is a nonessential business record that is helpful in maintaining records that record that is helpful in maintaining records that are essential.are essential.



Record the replenishment of a petty cash fund

Normally replenished at month-end or when it Normally replenished at month-end or when it nears depletion or reaches a minimum amountnears depletion or reaches a minimum amount

When replenished, the Petty Cash account is When replenished, the Petty Cash account is NOTNOT debiteddebited

The accounts debited are determined by analyzing The accounts debited are determined by analyzing the petty cash vouchersthe petty cash vouchers

The Cash account is creditedThe Cash account is credited


Example


Here is a list of expenses and amounts taken from the Here is a list of expenses and amounts taken from the petty cash payments record.petty cash payments record.

Prepare the journal entry to replenish the petty cash Prepare the journal entry to replenish the petty cash fund.fund.

ExpenseExpense AmountAmount

Office Supplies ExpenseOffice Supplies Expense $15.00$15.00

Miscellaneous ExpenseMiscellaneous Expense 8.008.00

Postage ExpensePostage Expense 10.8410.84

Cathy Nash, Drawing Cathy Nash, Drawing 10.0010.00

Advertising ExpenseAdvertising Expense 25.0025.00

TotalTotal $68.84$68.84

Example


+ expense+ expense+ expense+ expense+ expense+ expense+ drawing+ drawing+ expense+ expense

- asset- asset


Remember!

The Petty Cash account is debited The Petty Cash account is debited onlyonly when the when the fund is being established or when the amount in fund is being established or when the amount in the fund is increased.the fund is increased.

The Petty Cash account is credited The Petty Cash account is credited onlyonly when the when the amount of the fund is decreased or eliminated amount of the fund is decreased or eliminated completely.completely.


a.a. debited when the Petty Cash Fund is replenished.debited when the Petty Cash Fund is replenished.

b.b. credited when the Petty Cash Fund is replenished.credited when the Petty Cash Fund is replenished.

c.c. debited when the Petty Cash Fund is established.debited when the Petty Cash Fund is established.

d.d. credited when the Petty Cash Fund is established.credited when the Petty Cash Fund is established.

e.e. debited when the Petty Cash Fund is eliminated.debited when the Petty Cash Fund is eliminated.

Quick Check

Petty Cash isPetty Cash is

Review Quiz 6-2

1.1. In general journal form, record the establishment In general journal form, record the establishment of the fund on January 2.of the fund on January 2.


Review Quiz 6-2

2.2. In general journal form, record the replenishment In general journal form, record the replenishment of the fund on January 31.of the fund on January 31.




Record the establishment of a change fund

Businesses that have many cash transactions Businesses that have many cash transactions usually establish a usually establish a change fundchange fund.. An amount of money that is placed in the cash An amount of money that is placed in the cash

register drawerregister drawer

Used to make change for customers who pay in Used to make change for customers who pay in cashcash

The establishment of a change fund is recorded byThe establishment of a change fund is recorded by Debiting the Debiting the Change FundChange Fund account account

Crediting the Cash accountCrediting the Cash account


Example


Assume a business decides to establish a change fund on March 23 for $125. The following journal entry would be made.

+ asset+ asset- asset- asset



Record the cash shortages and overages

A A cash shortagecash shortage results when the amount of results when the amount of cash in the cash register is less than the amount cash in the cash register is less than the amount of cash sales rung up on the register.of cash sales rung up on the register.

A A cash overagecash overage results when the amount of cash results when the amount of cash in the cash register is more than the cash sales in the cash register is more than the cash sales rung up on the register.rung up on the register.


Used to bring the cash on hand into agreement Used to bring the cash on hand into agreement with the cash saleswith the cash sales

Used to handle both shortages and overagesUsed to handle both shortages and overages

Does not have a normal balanceDoes not have a normal balanceIf it has a debit balance, considered an If it has a debit balance, considered an

expenseexpense

If it has a credit balance, considered revenueIf it has a credit balance, considered revenue


Example


Assume cash in the cash register amounts to $598 and sales based on the cash register tapes amounts to $600.

The following entry would be prepared.

no normal balanceno normal balance+ asset+ asset

+ revenue+ revenue

Example


Assume cash in the cash register amounts to $774 and sales based on the cash register tapes amounts to $769.

The following entry would be prepared.

no normal balanceno normal balance

+ asset+ asset+ revenue+ revenue


a.a. debit to Cash for $595.debit to Cash for $595.

b.b. credit to Sales for $592.credit to Sales for $592.

c.c. debit to Cash Short and Over for $3.debit to Cash Short and Over for $3.

d.d. credit to Cash Short and Over for $3.credit to Cash Short and Over for $3.

e.e. debit to Sales for $595.debit to Sales for $595.

Quick Check

Cash sales based on the on the cash register tapes Cash sales based on the on the cash register tapes amount to $595. Cash in the cash register drawer amount to $595. Cash in the cash register drawer amounts to $592. The journal entry to record cash amounts to $592. The journal entry to record cash sales will include asales will include a

Review Quiz 6-3

Record the sales revenue and the cash shortage in Record the sales revenue and the cash shortage in general journal form.general journal form.


Bank Checking AccountBank Checking Accountan amount of cash on deposit with a bank that an amount of cash on deposit with a bank that the bank must pay at the written order of the the bank must pay at the written order of the depositordepositor

American Bankers Association (ABA) Transit American Bankers Association (ABA) Transit NumberNumber

a number printed on checks and deposit slips a number printed on checks and deposit slips that identifies the bank and the area in which that identifies the bank and the area in which the bank is located as well as other informationthe bank is located as well as other information


Lists personal information and contains the signature Lists personal information and contains the signature of the person or persons who are authorized to write of the person or persons who are authorized to write checks on the accountchecks on the account

Kept on file by the bank as an aid in identifying Kept on file by the bank as an aid in identifying possible forgeriespossible forgeries


Prepared when coin, currency, or checks are Prepared when coin, currency, or checks are deposited in a bank accountdeposited in a bank account

IndicatesIndicatesName of the depositorName of the depositor

Account numberAccount number

Summarizes the amount depositedSummarizes the amount deposited



ABA transit number

A signature or stamp on the back of the checkA signature or stamp on the back of the check

Transfers ownership of the check to the bank Transfers ownership of the check to the bank (or to another person or to an individual)(or to another person or to an individual)

Authorizes payment of the checkAuthorizes payment of the check


Blank EndorsementBlank Endorsement

Full EndorsementFull Endorsement

Restrictive EndorsementRestrictive Endorsement


A check is a written order directing a bank to pay A check is a written order directing a bank to pay a specified sum of money to a designated person a specified sum of money to a designated person or business.or business.

The person or business who writes a check is The person or business who writes a check is called the called the drawerdrawer..

The bank on which the check is written is called The bank on which the check is written is called the the draweedrawee..

The person or business to whom a check is made The person or business to whom a check is made payable is called the payable is called the payeepayee..


Shows what the bank Shows what the bank did with the did with the customer’s moneycustomer’s money

Shows the account’sShows the account’sBeginning Beginning

BalanceBalanceEnding BalanceEnding BalanceCash ReceiptsCash ReceiptsPaymentsPaymentsChargesCharges




Prepare a bank reconciliation

The balance shown on the bank statement and the The balance shown on the bank statement and the balance in the checkbook normally do not agree at balance in the checkbook normally do not agree at the end of the monththe end of the month

Bank reconciliationBank reconciliation— the process of making the — the process of making the bank statement agree with the checkbook balancebank statement agree with the checkbook balance


Common reasons why the bank statement balance Common reasons why the bank statement balance may not agree with the checkbook balance include:may not agree with the checkbook balance include:

Outstanding checksOutstanding checks

Deposits in transitDeposits in transit

Service charges and other bank feesService charges and other bank fees

Errors, either the depositor’s or the bank’sErrors, either the depositor’s or the bank’s

Bank collectionsBank collections

NSF checksNSF checks


1.1. AddAdd the amount of the amount of depositsdeposits in transit to the in transit to the bank statement balancebank statement balance

2.2. SubtractSubtract the amount of the amount of outstanding checksoutstanding checks from the bank statement balancefrom the bank statement balance


3.3. AddAdd to the checkbook balance the amount of any to the checkbook balance the amount of any interest earnedinterest earned on the account or any on the account or any collection made by the bank for the depositorcollection made by the bank for the depositor

4.4. SubtractSubtract any any chargescharges appearing on the bank appearing on the bank statement from the checkbook balancestatement from the checkbook balance


Example



a.a. added to the checkbook balance.added to the checkbook balance.

b.b. ignored.ignored.

c.c. added to the bank statement balance.added to the bank statement balance.

d.d. subtracted from the bank statement balance.subtracted from the bank statement balance.

e.e. subtracted from the checkbook balance.subtracted from the checkbook balance.

Quick Check

On a bank reconciliation, a NSF check isOn a bank reconciliation, a NSF check is

Review Quiz 6-4


Stacy’s Bank Reconciliation StatementStacy’s Bank Reconciliation Statement

Example


All checkbook adjustments require a journal entry.Assume the bank deducted $12 for its service charge on the depositor’s checking account.The following journal entry would be required:

+ expense+ expense- asset- asset


a.a. Deposits in transit and a NSF checkDeposits in transit and a NSF check

b.b. Outstanding checks and a bank collectionOutstanding checks and a bank collection

c.c. Bank service charge and a NSF checkBank service charge and a NSF check

d.d. Bank error and a depositor’s errorBank error and a depositor’s error

e.e. Bank error and a bank service chargeBank error and a bank service charge

Quick Check

When updating the cash account based on a bank When updating the cash account based on a bank reconciliation, which of the following requires a reconciliation, which of the following requires a journal entry?journal entry?


Are churches and not-for-profit organizations more or less susceptible to fraud than for profit businesses?

Focus on Ethics


The Bank The Bank Reconciliation Reconciliation Procedure Procedure

Joining the Pieces

internal control and accounting for cash © paradigm publishing, inc.1 chapter 6

Documents

cash paradigm publishing

accounting paradigm

deposit cash

cash receipts

petty cash fund

record cash shortages

internal control procedures

accounting scandals