CASH AND
INTERNAL CONTROLS
Chapter 8
© 2009 The McGraw-Hill Companies, Inc.,
All Rights Reserved
C1
PURPOSE OF INTERNAL
CONTROL
Policies and procedures managers use to:
Protect assets.
Ensure reliable accounting.
Promote efficient operations.
Urge adherence to company policies.
McGraw-Hill/Irwin Slide 2
C1
PURPOSE OF INTERNAL
CONTROL
The Sarbanes-Oxley Act requires managers and auditors of
public companies to document and certify the system of internal
controls. Specific requirements related to auditors are:
Auditors must evaluate internal controls and issue
internal control reports.
Auditors of a client are restricted as to what consulting
services they can perform for that client.
The person leading an audit can serve no more than
seven years without a two-year break.
Auditors’ work is overseen by the Public Company
Accounting Oversight Board.
Harsh penalties exist for violators – sentences up to 25
years in prison with severe fines.
McGraw-Hill/Irwin Slide 3
C1
PRINCIPLES OF INTERNAL
CONTROL
Internal control principles common to all companies:
1. Establish responsibilities.
2. Maintain adequate records.
3. Insure assets and bond key employees.
4. Separate recordkeeping from custody of assets.
5. Divide responsibility for related transactions.
6. Apply technological controls.
7. Perform regular and independent reviews.
McGraw-Hill/Irwin Slide 4
TECHNOLOGY AND INTERNAL
C1
CONTROL
Reduced More
Processing Extensive Testing
Errors of Records
Limited Crucial
Evidence of Separation of
Processing Duties
Increased
e-commerce
McGraw-Hill/Irwin Slide 5
LIMITATIONS OF INTERNAL
C1
CONTROL
Human Error Human Fraud
Negligence Intent to
Fatigue defeat internal
Misjudgment controls for
Confusion personal gain
McGraw-Hill/Irwin Slide 6
LIMITATIONS OF INTERNAL
C1
CONTROL
The costs of internal controls
must not exceed their benefits.
Benefits
Costs
McGraw-Hill/Irwin Slide 7
C2 CONTROL OF CASH
An effective system of internal control that
protects cash and cash equivalents should meet
three basic guidelines:
Handling cash Cash receipts
is separated from are promptly
recordkeeping for deposited in a
cash. bank.
Cash
disbursements
are made by
check.
McGraw-Hill/Irwin Slide 8
C2
CASH, CASH EQUIVALENTS,
AND LIQUIDITY
Cash
Currency, coins and amounts on deposit in bank
accounts, checking accounts, and some savings
accounts. Also includes items such as customer checks,
cashier checks, certified checks, and money orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
interest rate changes.
McGraw-Hill/Irwin Slide 9
C2
CASH, CASH EQUIVALENTS,
AND LIQUIDITY
Liquidity
How easily an asset can be converted into cash
to be used to pay for services or obligations.
Inventory Cash
McGraw-Hill/Irwin Slide 10
C2
CASH MANAGEMENT
The goals of cash management are twofold:
1. Plan cash receipts to meet cash payments when due.
2. Keep a minimum level of cash necessary to operate.
Effective cash management involves applying
the following cash management principles:
Encourage collection of receivables.
Delay payment of liabilities.
Keep only necessary levels of assets.
Plan expenditures.
Invest excess cash.
McGraw-Hill/Irwin Slide 11
P1
CONTROL OF CASH RECEIPTS
Over-the-Counter Cash Receipts by Mail
Cash Receipts Two people open the mail.
Cash register with Money to cashier’s
locked-in record of
transactions. office.
Compare cash register List to accounting dept.
record with cash Copy of list filed.
reported.
McGraw-Hill/Irwin Slide 12
P1
CASH OVER AND SHORT
Sometimes errors in making change are discovered from
differences between the cash in the cash register and the
record of the amount of cash receipts. If a cash register’s
record shows $550 but the count of cash in the register is
$555, we would prepare the following journal entry:
Dr. Cr.
Dec. 1 Cash 555
Cash Over and Short 5
Sales 550
McGraw-Hill/Irwin Slide 13
P1
CONTROL OF CASH
DISBURSEMENTS
All
All expenditures
expenditures should
should bebe made
made by
by check.
check.
The
The only
only exception
exception is
is for
for small
small payments
payments
from
from petty
petty cash.
cash.
Separate
Separate authorization
authorization for
for check
check signing
signing
and
and recordkeeping
recordkeeping duties.
duties.
Use
Use aa voucher
voucher system.
system.
McGraw-Hill/Irwin Slide 14
P1
VOUCHER SYSTEM OF
CONTROL
AA voucher
voucher system
system establishes
establishes procedures
procedures
for:
for:
Verifying,
Verifying, approving
approving and
and recording
recording obligations
obligations
for
for eventual
eventual cash
cash disbursements.
disbursements.
Issuing
Issuing checks
checks for
for payment
payment of
of verified,
verified,
approved
approved and
and recorded
recorded obligations.
obligations.
McGraw-Hill/Irwin Slide 15
P1
VOUCHER SYSTEM OF
CONTROL
Sender
Sender Receiver
Receiver
Check
Cashier Supplier (Vendor)
Accounting Invoice Approval Cashier
Receiving Report Accounting, Requesting
Receiving
& Purchasing
Supplier (Vendor) Invoice Accounting
Purchasing Purchase Order Supplier, Requesting,
Receiving & Accounting
Purchase Requisition
Requesting Purchasing and
Accounting
Voucher
McGraw-Hill/Irwin Slide 16
P2
PETTY CASH SYSTEM OF
CONTROL
Small
Small payments
payments required
required in
in most
most companies
companies
for
for items
items such
such as
as postage,
postage, courier
courier fees,
fees,
repairs
repairs and
and supplies.
supplies.
McGraw-Hill/Irwin Slide 17
OPERATING A PETTY CASH
P2
FUND
Petty Cash
Company Petty
Cashier Cashier
May 1 Petty cash 400
Cash 400
Accountant
McGraw-Hill/Irwin Slide 18
OPERATING A PETTY CASH
P2
FUND
Petty
Cashier
Petty Cash
McGraw-Hill/Irwin Slide 19
OPERATING A PETTY CASH
P2
FUND
A petty cash fund is
used only for
business expenses. Petty
Cashier
43¢
Stamps Courier
$43 $80
McGraw-Hill/Irwin Slide 20
OPERATING A PETTY CASH
P2
FUND
Petty cash receipts
with either no Receipts
signature or a forged Petty
Cashier
signature usually
indicate misuse of
petty cash.
43¢
Stamps Courier
$43 $80
McGraw-Hill/Irwin Slide 21
OPERATING A PETTY CASH
P2
FUND
Receipts
$123
To reimburse
Company Petty
petty cash fund
Cashier Cashier
May 31 Postage expense 43
Delivery expense 80
Cash 123
Use a Cash
Accountant Over and Short
McGraw-Hill/Irwin account if needed. Slide 22
P2 PETTY CASH EXAMPLE
Tension Co. maintains a petty cash fund of $400. The
following summary information was taken from petty
cash vouchers for July:
Travel Expenses $79.30
Customer Business Lunches 93.42
Express Mail Postage 55.00
Miscellaneous Office Supplies 32.48
Let’s look at replenishing the fund if the balance on
July 31 was $137.80.
McGraw-Hill/Irwin Slide 23
P2 PETTY CASH EXAMPLE
What
What amount
amount ofof cash
cash will
will be
be required
required to
to
replenish
replenish the
the petty
petty cash
cash fund?
fund?
a.
a. $260.20
$260.20
b.
b. $262.20
$262.20
c.
c. $139.80
$139.80
d.
d. $137.80
$137.80
Let’s prepare the journal entry to
McGraw-Hill/Irwin
replenish the petty cash fund. Slide 24
P2 PETTY CASH EXAMPLE
Journal entry to replenish petty cash fund
Dr. Cr.
July 31 Travel Expense 79.30
Entertainment Expense 93.42
Postage Expense 55.00
Office Supplies Expense 32.48
Cash Over and Short 2.00
Cash 262.20
McGraw-Hill/Irwin Slide 25
BANKING ACTIVITIES AS
C3
CONTROLS
Bank Accounts Signature Cards Deposit Tickets
Electronic Bank
Checks
Funds Transfer Statements
McGraw-Hill/Irwin Slide 26
C3
BANK STATEMENT
Usually once a month, the bank sends each depositor
a bank statement showing the activity in the account.
Bank Statement
First National Bank
Beginning-of- Nashville, TN 37459 May 31, 2009 End-of-period
period balance. balance.
Clothes Mart
Nashville, TN
*
Acct No 278609
Previous Total Current
Balance Total Checks Deposits Balance
1488.79 1,367.09 2,604.22 2,725.92
5/1 107 55.00
5/2 1,251.88
5/4 108 279.50
5/7 109 44.75
5/9 110 21.81
Checks and other 5/12 111 37.55 Deposits and other
debits. 5/15 825.04
credits.
5/18 112 175.98
5/21 113 288.31
5/27 114 12.54
5/30 527.30
McGraw-Hill/Irwin 5/31 115 451.65 Slide 27
P3 BANK RECONCILIATION
A bank reconciliation is prepared periodically to explain
the difference between cash reported on the bank
statement and the cash balance on company’s books.
Bank Statement
First National Bank
Nashville, TN 37459 M ay 31, 2006
Why are the
Clothes Mart *
Nashville, TN
Acct No 278609
balances different?
Previous Total Current
Balance Total Checks Deposits Balance
1488.79 1,367.09 2,604.22 2,725.92
5/1 107 55.00
5/2 1,251.88
5/4 108 279.50
5/7 109 44.75
5/9 110 21.81
5/12 111 37.55
5/15 825.04
5/18 112 175.98
5/21 113 288.31
5/27 114 12.54
5/30 527.30
5/31 115 451.65
McGraw-Hill/Irwin Slide 28
P3 RECONCILING ITEMS
Book
Book Balance
Balance
Bank
Bank Statement
Statement Balance
Balance •• Add:
Add: Collections
Collections made
made
•• Add:
Add: by
by the
the bank.
bank.
Deposits
Deposits in
in transit.
transit. •• Add:
Add: Interest
Interest earned
earned
•• Deduct:
Deduct: on
on checking
checking account.
account.
Outstanding
Outstanding Checks
Checks •• Deduct:
Deduct: Nonsufficient
Nonsufficient
•• Add
Add or
or Deduct:
Deduct: funds
funds check
check (NSF).
(NSF).
Bank
Bank errors.
errors. •• Deduct:
Deduct: Bank
Bank service
service
charge.
charge.
•• Add
Add oror Deduct:
Deduct:
Book
Book errors.
errors.
McGraw-Hill/Irwin Slide 29
P3 BANK RECONCILIATION
Two
Two sections:
sections:
1.
1. Reconcile
Reconcile bank
bank statement
statement balance
balance to
to the
the
adjusted
adjusted bank
bank balance.
balance.
2.
2. Reconcile
Reconcile book
book balance
balance to
to the
the adjusted
adjusted
book
book balance.
balance.
The
The adjusted
adjusted balances
balances should
should be
be equal.
equal.
McGraw-Hill/Irwin Slide 30
BANK RECONCILIATION
P3
EXAMPLE
Let’s
Let’s prepare
prepare aa July
July 31
31 bank
bank reconciliation
reconciliation
statement
statement for
for the
the Simmons
Simmons Company.
Company.
The
The July
July 31
31 bank
bank statement
statement indicated
indicated aa
balance
balance of
of $9,610.
$9,610.
The
The cash
cash general
general ledger
ledger account
account on
on that
that
date
date shows
shows aa balance
balance of
of $7,430.
$7,430.
Additional
Additional information
information necessary
necessary for
for the
the
reconciliation
reconciliation is
is shown
shown on
on the
the next
next screen.
screen.
McGraw-Hill/Irwin Slide 31
BANK RECONCILIATION
P3
EXAMPLE
1. Outstanding checks totaled $2,417.
2. A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
3. The bank returned a customer’s NSF check for $225
received as payment on account receivable.
4. The bank statement showed $30 interest earned during
July.
5. Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.
6. A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
McGraw-Hill/Irwin Slide 32
P3
McGraw-Hill/Irwin Slide 33
P3
McGraw-Hill/Irwin Slide 34
RECORDING ADJUSTING
P3 ENTRIES FROM A BANK
RECONCILIATION
Only amounts shown on the book portion of
the reconciliation require an adjusting entry.
Dr. Cr.
July 31 Cash 30
Interest revenue 30
July 31 Supplies expense 28
Accounts receivable 225
Cash 253
McGraw-Hill/Irwin Slide 35
RECORDING ADJUSTING
P3 ENTRIES FROM A BANK
RECONCILIATION
After posting the reconciling entries the cash account
looks like this:
Adjusted
Adjusted balance
balance on
on July
July 31.
31.
McGraw-Hill/Irwin Slide 36
A1 DAYS’ SALES UNCOLLECTED
How
How much
much time
time is
is likely
likely to
to pass
pass before
before
we
we receive
receive cash
cash receipts
receipts from
from credit
credit sales.
sales.
Days’
Sales Accounts Receivable
= Net Sales × 365
Uncollected
McGraw-Hill/Irwin Slide 37
END OF CHAPTER 8
McGraw-Hill/Irwin Slide 38
