Chapter
8
Internal Control
and
d Cash
h
Chapter
8-1
Internal Control and Cash
Internal
Control
The SarbanesSarbanesOxley Act
Principles
Limitations
Chapter
8-2
Cash
Controls
Control over
cash receipts
Control over
cash
disbursements
Use of a Bank
Making
deposits
Writing checks
Bank
statements
Reconciling the
bank account
Reporting
Cash
Cash
equivalents
Restricted
cash
Compensating
b l
balances
Internal
I t
l C
Control
t l
Internal control consists of all the related methods and
measures adopted within an organization to:
1 Safeguard
1.
S f
d it
its assets.
t
2. Enhance the accuracy
y and reliability
y of its
accounting records. Reduce risk of:
a Errors (unintentional)
a.
b. Irregularities (intentional)
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations
q
to maintain an adequate
q
system
y
of internal control.
are required
Chapter
8-3
Internal Control
The SarbanesSarbanes-Oxley
y Act
Companies must
develop sound principles of control over financial
reporting.
continually
i
ll verify
if that
h controls
l are working.
ki
Independent outside auditors must attest to the level
of
f internal
i t
l control.
t l
SOX created the Public Company Accounting
Oversight Board (PCAOB), which now establishes
auditing standards and regulates auditor activity.
Chapter
8-4
Internal Control
Principles of Internal Control
Measures vary
y with
size and nature of
the business.
business
management’s control
hil
h
philosophy.
There are six principles
p
p
apply to most enterprises:
Chapter
8-5
Illustration 8-1
Internal Control
Principles of Internal Control
ESTABLISHMENT OF RESPONSIBILITY
Controll is most effective
ff
when
h only
l one person is
responsible for a given task.
SEGREGATION OF DUTIES
- Related duties should be assigned to different individuals.
- Record keeping separate from physical custody.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents and all
documents should be accounted for
for.
Chapter
8-6
Internal Control
Principles of Internal Control
Illustration 8-3
PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS
Physical
Mechanical
Mechan
cal
and
Electronic
Chapter
8-7
Internal Control
Principles
p
of Internal Control
INDEPENDENT INTERNAL VERIFICATION
1 Records periodically or on a surprise basis verified by
1.
an employee who is independent.
2 Discrepancies and exceptions should be reported to a
2.
management level that can take corrective actions.
OTHER CONTROLS
1. Bond employees who handle cash.
2 R
2.
Rotate employees’
l
’d
duties
i and
d require
i employees
l
to
take vacations.
3 Conduct
3.
C d t thorough
th
h background
b k
d checks.
h k
Chapter
8-8
Internal Control
Limitations of Internal Control
Costs should not exceed benefit so that
internal control generally provides reasonable
assurance.
Human element should be considered to
collusion
prevent the impairments of collusion.
Size of the business.
Chapter
8-9
Cash Controls
Illustration 8-5
Internal Control over Cash Receipts
Establishment of
Responsibility
Documentation
Procedures
Independent Internal
Verification
Only
l designated
d
d
personnel are
authorized to handle
cash receipts
(cashiers)
Use remittance
advice (mail
receipts), cash
register tapes
tapes, and
deposit slips
Supervisors count cash
h
receipts daily;
treasurer compares
total receipts to bank
deposits daily
Segregation of Duties
Physical,
Physical
Mechanical, and
Electronic Controls
Other Controls
Different individuals
receive cash, record
cash receipts
receipts, and hold
the cash
Chapter
8-10
Store cash in safes
and bank vaults; limit
access to storage
areas;; use cash
registers
Bond personnel who
handle cash; require
employees to take
vacations; deposit all
cash in bank daily
Cash Controls
Discussion Question
Q…At the corner grocery store, all sales clerks
make change out of one cash register drawer.
drawer Is
this a violation of internal control? Why?
Chapter
8-11
Cash Controls
Cash consists of coins, currency,
y checks, money
y
orders, and money on hand or on deposit in a bank.
Cash receipts come from
from:
cash sales
collections
ll ti
on accountt from
f
customers
t
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets
Chapter
8-12
Cashier’s Department
OverOver
-the
the-Counter Receipts
Sales Department
Illustration 8-7
8 7
Prepare daily cash summary
Prepare deposit slip
Cashier ring up sales on
registers
S
Supervisor
i
1. reads register totals
2. makes cash counts
3. prepares cash count
sh ts
sheets
Chapter
8-13
Bank
(deposit)
Treasurer Accounting
(verification)
(record)
Mail Receipts
Control Procedures:
Mail receipts should be opened by two people, a
llist
st prepared, and each check endorsed.
Copy of the list, along with the checks and
remittance advices
advices, sent to cashier’s
cashier s department
department.
Cashier adds the checks to the over-the-counter
receipts and prepares a daily cash summary and
makes the daily bank deposit.
Copy of list sent to treasurer’s
treasurer s office for
comparison with total shown on daily cash
summary.
Chapter
8-14
Cash Controls
Review Question
Permitting only designated personnel to handle
cash receipts
is an application of the principle of:
a. segregation of duties.
b establishment of responsibility.
b.
responsibility
c. independent check.
d. other controls.
Chapter
8-15
Cash Controls
Internal Control over Cash Disbursements
Generally,
y internal control over cash
disbursements is more effective when
companies
p
pay
p y by
y check, rather than by
y cash.
Applications:
Voucher system
y
Electronic funds transfers ((EFT)) system
Petty cash fund
Chapter
8-16
Cash Controls
Illustration 8-8
Internal Control over Cash Disbursements
Establishment of
Responsibility
p
y
Documentation
Procedures
Independent Internal
Verification
Only designated
personnel are
authorized to sign
checks (treasurer)
Use prenumbered
checks and account
for them in
sequence; each check
must have an
approved invoice
Compare checks to
invoices; reconcile bank
statement monthly
Other Controls
Store blank checks in
safes,, with limited
access; print check
amounts by machine in
indelible ink
Segregation
g g
of Duties
Different individuals
approve and make
payments;
p
y
check
signers do not record
disbursements
Chapter
8-17
p invoices
Stamp
PAID
Physical, Mechanical,
and Electronic
Controls
Cash Controls
Review Question
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,
c.
physical mechanical,
mechanical and electronic controls.
controls
d. documentation procedures.
Chapter
8-18
Cash Controls
Internal Control over Cash Disbursements
Voucher System
y
A network of approvals by authorized
individuals acting independently,
individuals,
independently to ensure all
disbursements by check are proper.
h is
i an authorization
th i ti f
d
A voucher
form prepared
for each expenditure.
Chapter
8-19
Cash Controls
Internal Control over Cash Disbursements
Electronic Funds Transfers (EFT)
Disbursement systems that use wire, telephone, or
computers to transfer cash balances between
locations.
P
d
th t companies
i and
db
k h
Procedures
that
banks
have
developed to transfer funds among parties without
the use of paper (deposit slips,
slips checks,
checks etc.)
etc )
Chapter
8-20
Cash Controls
Internal Control over Cash Disbursements
Petty
y Cash Fund - Used to pay relatively small
amounts. The operation of a petty cash fund, often
called an imprest system, involves three steps:
1. establishing the fund,
2 making
2.
ki payments
t from
f
th
the f
fund,
d and
d
3. replenishing the fund.
Chapter
8-21
Petty Cash Fund
Establishing
g The Fund: A p
petty
y cash custodian should be
appointed to be responsible for the fund.
To establish the fund,
fund a company issues a check payable
to the petty cash custodian for the stipulated amount.
For example,
F
l if L
Laird
i d Company
C
d
decides
id tto establish
t bli h a
$100 fund on March 1, the journal entry is:
March 1
Chapter
8-22
Petty cash
Cash
100
100
Petty Cash Fund
Making
g Payments
y
from The Fund: The ppettyy cash fund
custodian has the authority to make payments from the fund
that conform to prescribed management policies.
Each payment must be documented on a prenumbered petty
cash receipt (or petty cash voucher) attached with other
supporting documents such as freight bills or invoices. The
fund custodian keeps the receipts in the petty cash box until
the fund is replenished.
replenished
When each payment is made from petty cash, no accounting
entry
t iis recorded.
d d I
Instead,
t d th
the accounting
ti effects
ff t of
f each
h
payment are recognized when the petty fund is replenished.
Chapter
8-23
Petty Cash Fund
Replenishing
p
g the Fund
The timing for replenishing the petty fund:
1. When the money
y in the petty
p y cash fund reaches a
minimum level,
2. At the end of the accounting
g period.
p
Note that the replenishment
p
entry
y does not affect
the Petty Cash account.
Occasionally, in replenishing a petty cash fund, the
Cash Over and Short account is debited or
credited to recognize a cash shortage or overage.
Chapter
8-24
Petty Cash Fund
Replenishing
p
g the Fund
Assume that on March 15 Laird’s petty cash custodian
requests a check for $88. The fund contains $12 cash
and petty cash receipts for postage $44, freight-out
$38, and miscellaneous expenses $5. The journal entry to
record the check is:
March 15
Chapter
8-25
Postage expense
Freight-out
F
g
Miscellaneous expense
Cash over and short
Cash
44
38
5
1
88
Petty Cash Fund
E8-7 Lincolnville Company uses an imprest petty cash system. The
f d was established
fund
bl h d on M
March
h 1 with
h a balance
b l
of
f $100.
$100 During
D
March the following petty cash receipts were found in the petty cash
box.
Receipt
Date
No.
For
3/5
1
Postage Expense
7
2
Freight-out
9
3
Miscellaneous expense
11
4
Travel expense
p
14
5
Miscellaneous expense
Amount
$
39
21
6
24
5
The fund was replenished on March 15 when the fund contained $3 in
cash.
h O
On M
March
h 20
20, the
h amount in the
h f
fund
d was increased
d to $150.
$150
Instructions: Journalize the entries in March that pertain to the
operation of the petty cash fund.
fund
Chapter
8-26
Petty Cash Fund
E8-7 The fund was established on March 1 with a
E8balance of $100
March 1
Chapter
8-27
Petty cash
Cash
100
100
Petty Cash Fund
E8-7 The fund was replenished
E8p
on March 15 when the
fund contained $3 in cash.
March 15
Chapter
8-28
Postage expense
Freight-out
39
21
Miscellaneous expense
Travel expense
p
Cash over and short
Cash
11
24
2
97
Petty Cash Fund
E8-7 On March 20, the amount in the fund was
E8increased to $150.
March 20
Chapter
8-29
Petty cash
Cash
50
50
Use of a Bank
Contributes significantly to good internal
control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
transactions
Bank reconciliation.
Chapter
8-30
Use of a Bank
Making
Ma
ng Bank
an D
Deposits
p
Authorized employee
should make deposit.
deposit
F
Front
Side
d
Chapter
8-31
Illustration 8-10
Bank Code
Numbers
Reverse Side
Use of a Bank
Writing
Wr
ng Checks
Illustration 8-11
Written order signed by depositor directing bank to pay
a specified sum of money to a designated recipient.
recipient
Maker
Payee
Payer
Chapter
8-32
WRITING CHECKS
Three pparties to a check are:



Chapter
8-33
1 Maker/drawer issues the check
2 Bank/payer
p y on which check is drawn
3 Payee to whom check is payable
Use of a Bank
Bank
an Statements
a m n
Debit Memorandum
Bank service charge
NSF (not sufficient
f d )
funds)
Credit Memorandum
Collect notes
receivable.
Interest earned.
Chapter
8-34
Illustration 8-12
BANK STATEMENTS
A bank statement shows:
1 checks paid and other debits charged against the account
2 deposits and other credits made to the account
3 account balance after each day
day’ss transactions
•
•
Chapter
8-35
Debit memorandum indicate charges against the depositor’s
account. (ATM service charges).
di memorandum
d
i di
h increase
i
h
Credit
indicate
amounts that
the
depositor’s account. (Interest revenue).
Use of a Bank
Review Question
The control features of a bank account do not
include:
a. having bank auditors verify the correctness of
the bank balance per books.
books
b. minimizing the amount of cash that must be kept
on hand.
hand
c. providing a double record of all bank
t
transactions.
ti
d. safeguarding cash by using a bank as a
d
depository.
it
Chapter
8-36
RECONCILING THE BANK ACCOUNT


Chapter
8-37
Reconciliation is necessary because the balance
per bank and balance per books are seldom in
agreement due to time lags and errors.
errors
Reconciliation should be prepared by an employee
who
h has
h no other
th responsibilities
ibiliti pertaining
t i i to
t
cash.
RECONCILING THE BANK ACCOUNT
The lack of agreement between the two balances has
two causes:
1. Time lags that prevent one of the parties from
g the transaction in the same
m period
p
as
recording
the other party.
2 Errors by either party in recording transactions.
2.
transactions
Chapter
8-38
RECONCILING THE BANK ACCOUNT
Reconcile
R
c ncil b
balance
l nc p
per books
b ks and
nd balance
b l nc per
p bank
b nk tto
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Errors.
4 Bank memoranda.
4.
memoranda
Chapter
8-39
RECONCILING THE BANK ACCOUNT


Chapter
8-40
Steps in preparing a bank reconciliation:
1. Determine deposits in transit
2 Determine
2.
D
i outstanding
di checks
h k
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 ACCOUNT
Reconciliation Procedures
Illustration 8-13
+ Deposit in Transit
+ Notes collected by bank
-
-
NSF (bounced)
(b
d) checks
h k
-
Check printing or other
service charges
g
O t t di Checks
Outstanding
Ch k
+/- Bank Errors
+/- Company Errors
CORRECT BALANCE
Chapter
8-41
CORRECT BALANCE
BANK RECONCILIATION
LAIRD COMPANY
Bank Reconciliation
April 30, 2008
Cash balance per bank statement
Add: Deposits in transit
Less: Outstanding
g checks
No. 453
No. 457
No. 460
Adjusted
j
cash balance p
per bank
The bank statement for
the Laird Company
shows
h
a balance
b l
per
bank of $15,907.45 on
April 30, 2008.
Cash balance per books
Add: Collection of $1,000 note receivable plus interest earned
$50, less collection fee $15
Error in recording check 443
Less: NSF check
Bank service charge
Adjusted cash balance per books
Chapter
8-42
On this date the
balance of cash p
per
books is $11,589.45.
$ 15,907.45
2,201.40
18,108.85
$ 3,000.00
1,401.30
1,502.70
5,904.00
$
$12,204.85
,
$ 11,589.45
$ 1,035.00
36.00
425.60
30.00
1,071.00
12,660.45
455.60
$12,204.85
ENTRIES FROM THE
BANK RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Cash
Miscellaneous Expense
Notes Receivable
Interest Revenue
(To record collection of notes
receivable by bank)
Debit Credit
1,035.00
15.00
1,000.00
50.00
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.
Chapter
8-43
ENTRIES FROM THE
BANK RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Debit
Cash
36.00
Accounts Payable — Andrea Company
((To correct error in recording
g
check No. 443)
Credit
36.00
Book Error. An examination of the cash disbursements
journal shows that check No
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.
Chapter
8-44
ENTRIES FROM THE
BANK RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Accounts Receivable — J. R. Baron
Cash
((To record NSF check))
Debit
425.60
NSF Check An NSF check becomes an
accounts receivable to the depositor.
Chapter
8-45
Credit
425.60
ENTRIES FROM THE
BANK RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Miscellaneous Expense
Cash
((To record charge
g for printing
p
g
company checks)
Debit
Credit
30.00
30.00
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.
Chapter
8-46
RECONCILING THE BANK ACCOUNT
E8E8
-9 The following information pertains to Vince’s Video Company.
1.
Cash balance per bank, July 31, $2,542.
2.
Cash balance per books, July 31, $2,549.
3.
July bank service charge not recorded by the depositor $10.
4.
Deposits in transit, July 31, $525.
5.
Bank collected $300
$
note for Family in July, plus interest $
$36,
less fee $15.The collection has not been recorded by Vince’s, and
no interest
n
nt r t ha
has been
n accru
accrued..
6.
Outstanding checks, July 31, $207.
Instructions
a) Prepare a bank reconciliation at July 31.
b) Journalize the adjusting entries at July 31 on the books of
Vince’s Video Company.
Chapter
8-47
RECONCILING THE BANK ACCOUNT
E8E8
-9 a) Prepare
p
a bank reconciliation at July
y 31.
Cash balance per bank statement
Add:
Deposit in transit
Less:
Outstanding checks
Adjusted cash balance per bank
(207)
$2,860
Cash balance per books
$2,549
300
Add:
Less:
Collection of notes receivable
Collection of interest
36
Bank service charge
(10)
Note collection fee
(15)
Adjusted cash balance per books
Chapter
8-48
$2,542
525
$2,860
RECONCILING THE BANK ACCOUNT
E8-9 b) Journalize the adjusting
E8j
entries at July
y 31 on
the books of Vince’s Video Company.
Dr.
Cr.
July 31
Cash
Bank charge expense
Miscellaneous expense
Notes receivable
Interest revenue
311
10
15
Note: Adjusting journal entry includes only the
adjustments to the cash balance per books.
Chapter
8-49
300
36
RECONCILING THE BANK ACCOUNT
Review Question
The reconciling item in a bank reconciliation that
will result in an adjusting entry by the depositor
is:
a. outstanding checks.
k
p
in transit.
b. deposit
c. a bank error.
d bank
d.
b k service
i charges.
h
Chapter
8-50
Reporting Cash
Most liquid
q
asset, listed first in current assets
section of balance sheet.
Illustration 8-16
Cash equivalents
Restricted cash
Compensating
p
g balances
Chapter
8-51
Use of a Bank
Review Question
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 cannot be reported as a
current asset.
Chapter
8-52