INTERNAL CONTROL AND CASHINTERNAL CONTROL AND CASH

STUDY OBJECTIVES

After studying this chapter, you should understand:

Definition of internal control Petty Cash

Principles of internal controlControl features of a bank

account

Internal control for cash receipts Bank reconciliations

Internal control for cash disbursements Cash reporting

The plan of organization and all related methods and measures

adopted by a business in order to:

STUDY OBJECTIVE 1

DEFINITION OF INTERNAL CONTROL

STUDY OBJECTIVE 1

DEFINITION OF INTERNAL CONTROL

Safeguard assetsEnhance accuracyand reliability of

accounting records

STUDY OBJECTIVE 2

PRINCIPLES OF INTERNAL CONTROL

STUDY OBJECTIVE 2

PRINCIPLES OF INTERNAL CONTROL

Other Controls

Documentation procedures

Independent internal

verification

Segregation of

duties

Physical, mechanical, &

electronic controls

Establishment of

responsibility

Control is most effective when only one person is responsible for a given task.

ESTABLISHMENT OF RESPONSIBILITY

ESTABLISHMENT OF RESPONSIBILITY

Only one cashier should operatea cash register during a shift.

Cash is reconciled at the beginning and end of the shift.

• Related activities should be assigned to different employees

• Record-keeping separate from custody

SEGREGATION OF DUTIESSEGREGATION OF DUTIES

The cashier should not update the accounting records.

• Documents are pre-numbered• Sequence is accounted for• Documents are forwarded to accounting department

promptly

DOCUMENTATION PROCEDURESDOCUMENTATION PROCEDURES

Checks have sequential numbers.

Missing check numbers are investigated.

• Designed to safeguard assets and accounting records

• Also designed to restrict access

PHYSICAL, MECHANICAL, & ELECTRONIC CONTROLS

PHYSICAL, MECHANICAL, & ELECTRONIC CONTROLS

Bank vaultLocked warehouse

Access codesPasswords

AlarmsTime clocks

• Review, comparison, & reconciliation of data prepared by another employee

• On a surprise basis

• By an independent person

• Discrepancies noted and reported

INDEPENDENT INTERNAL VERIFICATION

INDEPENDENT INTERNAL VERIFICATION

Manager compares daily sales summaries

with cash register tapes.

INTERNAL AUDITDEPARTMENT

• Bonding employees who handle cash• Rotation of duties• Mandatory vacation

OTHER CONTROLSOTHER CONTROLS

Mandatory vacations make itimpossible for a bookkeeper

to permanently conceal “irregular” activities.

Independent Internal Verification

Accounting Employee A

Assistant Cashier B

Assistant Treasurer C

Segregation of Duties

SEGREGATION OF DUTES VS.

INDEPENDENT INTERNAL VERIFICATION

SEGREGATION OF DUTES VS.

INDEPENDENT INTERNAL VERIFICATION

Maintains cash balance per books

Maintains custody of cash on hand

Makes monthly comparisons. Reports differences to treasurer.

LIMITATIONS OF

INTERNAL CONTROL

LIMITATIONS OF

INTERNAL CONTROL

Cost-Benefit ConsiderationsThe cost of implementing a control

should be less than the perceived benefit.

Human ElementA system is only as goodas the people operating it.

CollusionTwo people may conspire

to override a control

• Only designated personnel are authorized to handle or have access to cash receipts.

• Different individuals should:

1 receive cash

2 record cash receipt transactions

3 have custody of cash

STUDY OBJECTIVE 3

INTERNAL CONTROL FOR CASH RECEIPTS

STUDY OBJECTIVE 3

INTERNAL CONTROL FOR CASH RECEIPTS

• Register tapes, remittance advices and deposit slips

• Cash should be stored in safes and bank vaults

• Access to storage areas should be limited to authorized personnel

• Cash registers should be used in executing over-the-counter receipts

INTERNAL CONTROL FOR CASH RECEIPTSINTERNAL CONTROL FOR CASH RECEIPTS

• Daily cash counts and daily comparisons of total receipts.

• All personnel who handle cash receipts are bonded and required to take vacations.

• Cash registers are visible to customers.

INTERNAL CONTROL FOR CASH RECEIPTSINTERNAL CONTROL FOR CASH RECEIPTS

• Payments made by pre-numbered check.• Pay only approved invoices.• Limit & specify check-signing authority.• Store blank checks in a safe, and limit access.• Separate approval and payment functions• Stamp invoices when paid.

STUDY OBJECTIVE 4

INTERNAL CONTROL FOR CASH DISBURSEMENTS

STUDY OBJECTIVE 4

INTERNAL CONTROL FOR CASH DISBURSEMENTS

• Enhances control over cash disbursements.• A network of approvals by authorized individuals

acting independently to ensure that disbursements by check are proper.

• A voucher is an authorization form prepared for each expenditure.

• Vouchers are recorded in a journal called the voucher register.

VOUCHER SYSTEMVOUCHER SYSTEM

The use of pre-numbered checks in disbursing cash

is an application of what internal control principle?

REVIEW QUESTIONREVIEW QUESTION

Answer: Documentation

procedures

• A disbursement system that uses wire, phone, or computer to transfer cash.

• Regular payments such as those for house, car, and utilities are frequently made by EFT.

EFT SYSTEMEFT SYSTEM

• Used to pay small amounts• An IMPREST SYSTEM involves:• 1 establishing the fund• 2 making payments from the fund• 3 replenishing the fund• Accounting entries are required when:• 1 the fund is established• 2 the fund is replenished• 3 the amount of the fund is changed

STUDY OBJECTIVE 5

PETTY CASH FUNDS

STUDY OBJECTIVE 5

PETTY CASH FUNDS

• Two steps to establish a petty cash fund

1 appoint a responsible custodian who will be responsible

2 determine the size of the fund (to cover 3-4 weeks)

ESTABLISHING THE FUNDESTABLISHING THE FUND

100100

The check is written to the custodian.

On March 15 the 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.

On March 15 the 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.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

Mar. 15 Postage ExpenseFreight-out

Miscellaneous Expense Cash

(To replenish petty cash fund)

4438 5

87

REPLENISHING THE FUNDREPLENISHING THE FUND

• Custodian initiates request for reimbursement.

• Custodian prepares a schedule of payments with documentation

• Treasurer approves replenishment.

Using a bank minimizes currency that must be kept on hand and contributes significantly to good internal control over

cash.

A company can safeguard its cash by using

a bank as a depository and as a clearing house.

STUDY OBJECTIVE 6

CONTROL FEATURES--BANKS

STUDY OBJECTIVE 6

CONTROL FEATURES--BANKS

• A written order signed by the depositor directing the bank to pay a specified sum of money to a designated recipient.

• Three parties to a check are:• 1 Maker/drawer issues the check• 2 Bank/payer on which check is drawn• 3 Payee to whom check is payable

WRITING CHECKSWRITING CHECKS

A bank statement shows:

1 checks paid & other debits charged against the account

2 deposits and other credits made to the account

3 account balance after each day’s transactions

A bank statement shows:

1 checks paid & other debits charged against the account

2 deposits and other credits made to the account

3 account balance after each day’s transactions

BANK STATEMENTSBANK STATEMENTS

• Debit memorandum indicate charges against the depositor’s account. (ATM service charges).

• Credit memorandum indicate amounts that increase the depositor’s account. (Interest income).

• Reconciliation is necessary because the balance per bank and balance per books are seldom in agreement due to time lags and errors.

• Reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.

STUDY OBJECTIVE 7

RECONCILING THE BANK ACCOUNT

STUDY OBJECTIVE 7

RECONCILING THE BANK ACCOUNT

• Steps in preparing a bank reconciliation:

1 Determine deposits in transit

2 Determine outstanding checks

3 Note any errors discovered

4 Trace bank memoranda to the records• Each reconciling item used in determining the adjusted cash balance per books should be recorded by the depositor.

RECONCILING THE BANK ACCOUNTRECONCILING THE BANK ACCOUNT

LAIRD COMPANY

Bank Reconciliation

April 30, 2006

Cash balance per bank statement $ 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 $ 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00

Cash balance per books $ 11,589.45 Add: Collection of $1,000 note receivable plus interest earned $50, less collection fee $15 $ 1,035.00 Error in recording check 443 36.00 1,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60

Adjusted cash balance per bank $ 12,204.85

Adjusted cash balance per books $ 12,204.85

The bank statement for the Laird Company shows a balance per bank of $15,907.45 on April 30, 2006.

The bank statement for the Laird Company shows a balance per bank of $15,907.45 on April 30, 2006.

On this date the balance of cash per books is $11,589.45.

On this date the balance of cash per books is $11,589.45.

BANK RECONCILIATIONBANK RECONCILIATION

Collection of Note Receivable. This entry involves four accounts. Interest of $50 has not been accrued and the collection fee is charged to Miscellaneous Expense.

Collection of Note Receivable. This entry involves four accounts. Interest of $50 has not been accrued and the collection fee is charged to Miscellaneous Expense.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit Apr. 30 Cash Miscellaneous Expense Notes Receivable Interest Revenue (To record collection of notes receivable by bank)

1035 15 1000 50

ENTRIES FROM THE

BANK RECONCILIATION

ENTRIES FROM THE

BANK RECONCILIATION

Book Error. An examination of the cash disbursements journal shows that check No. 443 was a payment on account to Andrea Company, a supplier. The check, with a correct amount of $1,226.00, was recorded at $1,262.00.

Book Error. An examination of the cash disbursements journal shows that check No. 443 was a payment on account to Andrea Company, a supplier. The check, with a correct amount of $1,226.00, was recorded at $1,262.00.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

Apr. 30 Cash Accounts Payable — Andrea Company (To correct error in recording check No. 443)

3636

ENTRIES FROM THE

BANK RECONCILIATION

ENTRIES FROM THE

BANK RECONCILIATION

NSF Check An NSF check becomes an accounts receivable to the depositor.NSF Check An NSF check becomes an accounts receivable to the depositor.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

Apr. 30 Accounts Receivable — J. R. Baron Cash (To record NSF check)

425.6425.6

ENTRIES FROM THE

BANK RECONCILIATION

ENTRIES FROM THE

BANK RECONCILIATION

Bank Service Charges Check printing charges (DM) and other bank service charges (SC) are debited to Miscellaneous Expense because they are usually nominal in amount.

Bank Service Charges Check printing charges (DM) and other bank service charges (SC) are debited to Miscellaneous Expense because they are usually nominal in amount.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

Apr. 30 Miscellaneous Expense Cash (To record charge for printing company checks)

30 30

ENTRIES FROM THE

BANK RECONCILIATION

ENTRIES FROM THE

BANK RECONCILIATION

Which of the following items requires

an adjusting entry by the depositor?

1. Outstanding checks

2. Deposits in transit

3. A bank error

4. Bank service charges

REVIEW QUESTIONREVIEW QUESTION

Answer: Bank service

charges

•Cash reported on the Balance Sheet includes:

1 Cash on hand (includes petty cash)

2 Cash in banks• Cash is the most liquid asset• Cash is listed first in the balance sheet.•Cash equivalents are investments with maturities of 3 months or less, such as money market funds, CD’s, and treasury bills and notes.

STUDY OBJECTIVE 8

REPORTING CASH

STUDY OBJECTIVE 8

REPORTING CASH