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8-1 8 Internal Control and Cash Principles of Financial Accounting, 11e Reeve Warren Duchac.

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Presentation on theme: "8-1 8 Internal Control and Cash Principles of Financial Accounting, 11e Reeve Warren Duchac."— Presentation transcript:

1 8-1 8 Internal Control and Cash Principles of Financial Accounting, 11e Reeve Warren Duchac

2 Internal Control and Cash 1 Describe the impact on internal controls and financial reporting. 2 Describe and illustrate the objectives and elements of internal control. 3 Describe and illustrate the application of internal controls to cash. After studying this chapter, you should be able to: 8-2

3 Internal Control and Cash (continued) 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. 4 Describe the nature of a bank account and its use in controlling cash. 8-3

4 9-4 Describe the impact of internal controls and financial reporting. 1 8-4

5 8-5 Internal control is broadly defined as the procedures and processes used by a company to: 1.Safeguard its assets. 2.Process information accurately. 3.Ensure compliance with laws and regulations. 1

6 8-6 Describe and illustrate the objectives and elements of internal control. 2 8-10

7 8-7 2

8 8-8 Employee fraud is the intentional act of deceiving an employer for personal gain. 2

9 8-9 1.Control environment 2.Risk assessment 3.Control procedures 4.Monitoring 5.Information and communication Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are as follows: Five Elements of Internal Control 2

10 8-10 Limitations of Internal Control 1.The human element of control 2.Cost-benefit considerations 2

11 8-11 Describe and illustrate the application of internal controls to cash. 3 8-26

12 8-12 Cash includes coins, currency (paper money), checks, and money orders. Cash is the asset most likely to be stolen or used improperly in a business. 3

13 8-13 Sources of Cash Businesses normally receive cash from two main sources: 1.Customers purchasing products or services. 2.Customers making payments on account. 3

14 8-14 One of the most important controls to protect cash received in over-the-counter sales is a cash register. Control of Cash Receipts 3

15 8-15 A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund. Control of Cash Receipts 3

16 8-16 Cash sales for March 19 totaled $35,690 per the cash register tape. After removing the change fund, only $35,668 was on hand. Cash Short and Over If there had been cash over, Cash Short and Over would have been credited for the overage. 3

17 8-17 Cash is received in the mail when customers pay their bills. Most companies design their invoices so that customers return a portion of the invoice, called a remittance advice, with their payment. Cash Received in Mail 3

18 8-18 Cash may be received from customers through electronic funds transfers (EFT). Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills. 3

19 8-19 The control of cash payments should provide reasonable assurance that: Control of Cash Payments 1.Payments are made for only authorized transactions. 2.Cash is used effectively and efficiently. 3

20 8-20 A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized. 3

21 8-21 A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer. 3

22 8-22 Describe the nature of a bank account and its use in controlling cash. 4 8-38

23 8-23 A major reason that businesses use bank accounts is for internal control. Some of the control advantages of using bank accounts are as follows: Bank Accounts 1.Bank accounts reduce the amount of cash on hand. 2.Bank accounts provide an independent recording of cash transactions. 3.Use of bank accounts facilitates the transfer of funds using EFT systems. 4

24 8-24 A summary received from the bank of all checking account transactions is called a bank statement. 4

25 8-25 4 Exhibit 5 Bank Statement (continued)

26 8-26 4 Exhibit 5 Bank Statement (continued)

27 8-27 Typical credit or debit memorandum entries found on the bank statement: EC —Error correction to correct bank error. NSF—Not sufficient funds check. SC—Service charge. ACH—Automated Clearing House entry for electronic funds transfer. MS—Miscellaneous items. 4

28 8-28 Example Exercise 8-2 4 The following items may appear on a bank statement: (1)NSF check (2)EFT Deposit (3)Service Charge (4)Bank correction of an error from recording a $400 check as $40. Indicate whether the item would appear as a debit or credit memorandum on the bank statement and whether the item would increase or decrease the balance of the company’s account. Items on Company’s Bank Statement 8-45

29 8-29 Example Exercise 8-2 (continued) 4 Appears on the Bank Statement as a Debit or Credit Memo Increases or Decreases the Balance of the Company’s Bank Account Item No. (1)debit memodecreases (2)credit memoincreases (3)debit memodecreases (4)debit memodecreases 8-46 For Practice: PE 8-2A, PE 8-2B Follow My Example 8-2

30 8-30 4 Power Networking’s Records and Bank Statement Exhibit 6

31 8-31 Describe and illustrate the use of a bank reconciliation in controlling cash. 5 8-48

32 8-32 A bank reconciliation is an analysis of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger in order to determine the adjusted cash balance. 5

33 8-33 The Adjusted Balance 5 Must be equal

34 8-34 Steps in a Bank Reconciliation 5 (continued)

35 8-35 Steps in a Bank Reconciliation 5

36 8-36 Bank’s Records Power Networking prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of $3,359.78. The company’s Cash account has a July 31 balance of $2,549.99. Step 1 Beginning balance$3,359.78 Beginning balance$2,549.99 5 Power Networking’s Records

37 8-37 A deposit of $816.20 did not appear on the bank statement. Add deposit not recorded by bank 816.20 $4,175.98 5 Step 2 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99

38 8-38 Three checks that were written during the period did not appear on the bank statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60. Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 5 Step 3 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98

39 8-39 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking Add note and interest collected by bank 408.00 $2,957.99 5 Step 4 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Add deposit not recorded by bank 816.20 $4,175.98

40 8-40 The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF). Deduct check NSF$300.00 5 Step 5 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Add note and interest collected by bank 408.00 $2,957.99 Add deposit not recorded by bank 816.20 $4,175.98

41 8-41 Bank service charges for the month, $18. Bank service charges18.00 5 Step 6 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF$300.00

42 8-42 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26. Error recording Chk. No. 879 9.00 5 Step 7 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF$300.00 Bank service charges18.00

43 8-43 5 Bank’s Records Power Networking’s Records Beginning balance$3,359.78 Beginning balance$2,549.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF$300.00 Error recording Chk. No. 879 9.00 Bank service charges18.00 327.00 $2,630.99 Adjusted balance

44 8-44 5 Exhibit 7 Bank Reconciliation for Power Networking

45 8-45 The journal entries for Power Networking, based on the bank reconciliation in Slide 61 are as follows: 5

46 8-46 Example Exercise 8-3 5 Bank Reconciliation The following data were gathered to use in reconciling the bank account of Photo Op. Balance per bank.............................................$14,500 Balance per company records……………….13,875 Bank service charges…………………………75 Deposit in transit……………………………..3,750 NSF check…………………………………….800 Outstanding checks…………………………..5,250 a. What is the adjusted balance on the bank reconciliation? b. Journalize any necessary entries for Photo OP based upon the bank reconciliation. 8-63

47 8-47 Example Exercise 8-3 (continued) 5 a.$13,000, as shown below. Bank section of reconciliation: $14,500 + $3,750 – $5,250 = $13,000 Company section of reconciliation: $13,875 – $75 – $800 = $13,000 b.Accounts Receivable…………………800 Miscellaneous Expense………………75 Cash…………………………………875 8-64 For Practice: PE 8-3A, PE 8-3B Follow My Example 8-3

48 8-48 Describe the accounting for special-purpose cash funds. 6 8-65

49 8-49 It is usually not practical for a business to write checks to pay small amounts. Thus, it is desirable to control such payments by using a special cash fund, called a petty cash fund. 6 Petty Cash Fund

50 8-50 A petty cash fund of $500 is established on August 1. The entry to record the transaction is as follows: 6

51 8-51 IMPORTANT! The only time Petty Cash is debited is when the fund is initially established or when the fund is increased. The only time Petty Cash is credited is when the fund is being decreased. 6

52 8-52 At the end of August, the petty cash receipts indicate expenditures for the following items: Office supplies$380 Postage (debit Office Supplies)22 Store supplies35 Misc. administrative expenses 30 Total$467 6

53 8-53 Example Exercise 8-4 6 Petty Cash Fund Prepare journal entries for each of the following; a) Issued check to establish a petty cash fund of $500. b) The amount of cash in the petty cash fund is currently $120. Issued a check to replenish the fund, based on the following summary of petty cash receipts: office supplies, $300 and miscellaneous administrative expense, $75. Record any missing funds in the cash short and over account. 8-70

54 8-54 Example Exercise 8-4 (continued) 6 a)Petty Cash………………………........500 Cash…………………………........500 b)Office Supplies……………………….300 Miscellaneous Admin. Expense…..75 Cash Short and Over………………..5 Cash………………………………..380 8-71 For Practice: PE 8-4A, PE 8-4B Follow My Example 8-4

55 8-55 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 7 8-72

56 8-56 A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents. 7 Cash Equivalents

57 8-57 Companies that have invested excess cash in cash equivalents usually report Cash and cash equivalents as one amount on the balance sheet. 7

58 8-58 Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance. 7 Compensating Balance

59 8-59 A cash ratio that is especially useful for companies, starting up or in financial distress, is the ratio of cash to monthly cash expenses. First, the monthly cash expenses are determined. Monthly Cash Expenses = Negative Cash Flows from Operations 12 Monthly Cash Expenses 7

60 8-60 The ratio of cash to monthly cash expenses can then be computed as follows: Ratio of Cash to Monthly Cash Expenses Cash and Cash Equivalent as of Year-End Monthly Cash Expenses = Ratio of Cash to Monthly Cash Expenses 7


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