1. Principles of Financial Accounting, 11e8
Internal Control
and Cash
Principles of Financial Accounting, 11e
Reeve • Warren • Duchac

2. 1 2 3 Internal Control and Cash
After studying this chapter, you should be able to: 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.
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3. Internal Control and Cash (continued)4
Describe the nature of a bank account and its use in controlling cash. 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.
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4. 1 Describe the impact of internal controls and financial reporting.
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8-4

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

6. 2
Describe and illustrate the objectives and elements of internal control.
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7. 2

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

9. Five Elements of Internal Control2
Five Elements of Internal Control
Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are as follows:
Control environment
Risk assessment
Control procedures
Monitoring
Information and communication

10. Limitations of Internal Control2
Limitations of Internal Control
The human element of control
Cost-benefit considerations

11. Describe and illustrate the application of internal controls to cash.3
Describe and illustrate the application of internal controls to cash.
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12. 3
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.

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

14. Control of Cash Receipts3
Control of Cash Receipts
One of the most important controls to protect cash received in over-the-counter sales is a cash register.

15. Control of Cash Receipts3
Control of Cash Receipts
A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund.

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

17. 3
Cash Received in Mail
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.

18. 3
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.

19. Control of Cash Payments3
Control of Cash Payments
The control of cash payments should provide reasonable assurance that:
Payments are made for only authorized transactions.
Cash is used effectively and efficiently.

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

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

22. Describe the nature of a bank account and its use in controlling cash.4
Describe the nature of a bank account and its use in controlling cash.
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23. 4
Bank Accounts
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 reduce the amount of cash on hand.
Bank accounts provide an independent recording of cash transactions.
Use of bank accounts facilitates the transfer of funds using EFT systems.

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

25. 4
Exhibit 5
Bank Statement
(continued)

26. 4
Exhibit 5
Bank Statement (continued)

27. 4
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.

28. 4 Example Exercise 8-2 Items on Company’s Bank Statement
The following items may appear on a bank statement:
(1) NSF check
(2) EFT Deposit
Service Charge
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.
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29. Example Exercise 8-2 (continued)4
Follow My Example 8-2
Increases or Decreases the Balance of the Company’s Bank Account
Appears on the Bank Statement as a Debit or Credit Memo
Item No.
(1) debit memo decreases
(2) credit memo increases
(3) debit memo decreases
(4) debit memo decreases
For Practice: PE 8-2A, PE 8-2B
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30. 4
Power Networking’s Records and Bank Statement
Exhibit 6

31. 5
Describe and illustrate the use of a bank reconciliation in controlling cash.
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32. 5
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.

33. 5
The Adjusted Balance
Must be equal

34. Steps in a Bank Reconciliation5
Steps in a Bank Reconciliation
(continued)

35. Steps in a Bank Reconciliation5
Steps in a Bank Reconciliation

36. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Step 1
Power Networking prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of $3, The company’s Cash account has a July 31 balance of $2,

37. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
$4,175.98
Step 2
A deposit of $ did not appear on the bank statement.

38. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
Step 3
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.

39. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
$2,957.99
Step 4
The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking

40. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
$2,957.99
Deduct check
NSF $300.00
Step 5
The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF).

41. Power Networking’s Records Bank service charges for the month, $18.5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
$2,957.99
Deduct check
NSF $300.00
Bank service
charges 18.00
Step 6
Bank service charges for the month, $18.

42. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
$2,957.99
Deduct check
NSF $300.00
Bank service
charges 18.00
Error recording
Chk. No
Step 7
Check No. 879 for $ to Taylor Co. on account, erroneously recorded in journal as $

43. Power Networking’s Records5
Bank’s Records
Power Networking’s Records
Beginning balance $3,359.78
Beginning balance $2,549.99
Add deposit not
recorded by bank
Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00 No
No ,544.99
$2,957.99
Deduct check
NSF $300.00
Bank service
charges 18.00
Error recording
Chk. No
327.00
$2,630.99
Adjusted balance

44. 5
Exhibit 7
Bank Reconciliation for Power Networking

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

46. 5 Example Exercise 8-3 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
What is the adjusted balance on the bank reconciliation?
Journalize any necessary entries for Photo OP based upon the bank reconciliation.
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47. 5 Follow My Example 8-3 $13,000, as shown below.
Example Exercise 8-3 (continued) 5
Follow My Example 8-3
$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
For Practice: PE 8-3A, PE 8-3B
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48. Describe the accounting for special-purpose cash funds.6
Describe the accounting for special-purpose cash funds.
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49. 6
Petty Cash Fund
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.

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

51. 6
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.

52. 6
At the end of August, the petty cash receipts indicate expenditures for the following items:
Office supplies $380
Postage (debit Office Supplies) 22
Store supplies 35
Misc. administrative expenses 30
Total $467

53. 6 Example Exercise 8-4 Petty Cash Fund
Prepare journal entries for each of the following;
Issued check to establish a petty cash fund of $500.
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.
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54. 6 Follow My Example 8-4 Petty Cash………………………........ 500
Example Exercise 8-4 (continued) 6
Follow My Example 8-4
Petty Cash………………………
Cash…………………………
Office Supplies………………………. 300
Miscellaneous Admin. Expense….. 75
Cash Short and Over……………….. 5
Cash………………………………
For Practice: PE 8-4A, PE 8-4B
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55. 7
Describe and illustrate the reporting of cash and cash equivalents in the financial statements.
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56. 7
Cash Equivalents
A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents.

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

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

59. Negative Cash Flows from Operations7
Monthly Cash Expenses
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

60. Ratio of Cash to Monthly Cash Expenses7
Ratio of Cash to Monthly Cash Expenses
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 =