2. ACCT 100 Chapter 7 Internal Control and Cash

3. Internal Control and Managing Cash 2 Objectives of the Chapter 1. Introduce the internal control to safeguard assets and to produce reliable accounting records. 2. Internal control for the most liquid asset – cash.

4. The Sarbanes-Oxley Act (SOX) and the Internal Control  Under SOX, companies must develop sound internal control for financial reporting.  Mangers need to document and assess the effectiveness of the internal control.  Managers’ assessment on the internal control needs to be attested by outsider auditors.  Outsider auditors would also make their evaluation on the effectiveness of companies’ internal control. 3

5. 4 Internal Control n An organizational plan to (source: Financial Accounting by Harrison and Horngren (H & H)) 1. Safeguard assets (i.e., cash, inventory, etc.); 2. Encourage employees’ adherence to company policies; 3. Promote operational efficiency; and 4. Ensure accurate and reliable accounting records.

6. 5 Internal Control (contd.) The plan includes (source: Financial Accounting by H & H) 1. To have competent, reliable and ethical personnel; 2. Assignment of responsibilities (see Exhibit on p6 for an organizational chart of a corp.). Each employee is assigned certain responsibilities; and 3. Proper authorization: Any deviation from standard policy requires a proper authorization.

7. Internal Control and Managing Cash 6 Board of Directors Board of Directors President Senior Vice President Senior Vice President Vice President, Marketing Vice President, Marketing Vice President, Production Vice President, Production Vice President, Finance and Accounting Vice President, Finance and Accounting Other Vice Presidents Other Vice Presidents Audit Committee Audit Committee External Auditing External Auditing Controller General Accounting General Accounting Taxes Internal Auditing Internal Auditing Budgeting Systems Treasurer Collections and Credits Collections and Credits Cash Management Cash Management Investor Relations Investor Relations Banking Relations Banking Relations Organizational Chart of a Corporation (source: H&H) 6

8. Internal Control and Managing Cash 7 Internal Control (contd.) 4. Separation of duties: this procedure can reduce the chances for fraud and promote the accuracy of accounting records. The procedure may include: a. separation of operation from accounting, b. separation the custody of assets from accounting, c. separation of the authorization of transactions from the custody of related assets, d. separation of duties within the accounting function. The plan includes:

9. Internal Control and Managing Cash 8 Internal Control (contd.) 5. Internal and external audits. 6. Documents and records. 7. Electronic and corporate control. 8. Other controls. The limitations of internal control: human element and the size of a company. The plan includes:

10. Internal Control and Managing Cash 9 Internal Control for Cash n Cash is the most liquid asset and is easy to steal. Therefore, most companies use internal control to safeguard their cash.

11. Internal Control and Managing Cash 10 Internal Control of Cash (Contd.) 1. Immediate deposit of cash to bank accounts. 2. Cash payments by checks except for small amount (paid by petty cash fund). 3. Separation of duties. 4. Prepare bank account reconciliation.

12. The Voucher System in Cash Disbursements  A system to ensure all payments made by checks are proper.  The system involves a network of approvals by authorized individuals.  All cash disbursements require a voucher (except for those from petty cash fund). 11

13. The Voucher System (contd.)  Purchase Order: a document issued by a buyer to a seller, specifying the products and the agreed prices for products the seller will provided to the buyer.  Invoice (Bill): a document issued by a vendor to the buyer upon the delivery of products indicating the quantity of products delivered and agreed prices for products  Voucher: A document representing an intent to pay a vendor. Internal Control and Managing Cash 12

14. The Voucher System (contd.)  Upon the receipt of vendor’s invoice (and the products), an employee in accounts payable will match the invoice with the purchase order.  With a successful match, the employee will record the purchase and accounts payable.  A voucher will be produced and filed. Internal Control and Managing Cash 13

15. The Voucher System (contd.)  Upon the approval (i.e., by a controller), a check will be issued (i.e., by a treasurer) and sent to the vendor before the required payment date.  The paid voucher is sent to the accounting department for recording. Internal Control and Managing Cash 14

16. Petty Cash Fund Establishing a petty cash fund on 3/1: Petty Cash 500 Cash 500 Making Payments from the fund: Petty cash fund is used for the payments of small expenditures of the office (i.e., office drinks, office supplies, stamps, etc.) The payments require petty cash receipts. 15

17. Petty Cash Fund (Contd.) Replenishing the fund on 3/31: Postage expense 50 Freight-out 120 Office supplies 70 Cash over and short 5 Cash 245 Note: the petty cash receipts indicated the payments in March including postage exp. $50, freight charges, $120, and office supplies, $70. The cash balance of the fund on 3/31 amounted to $255 16

18. Internal Control and Managing Cash 17 Bank Reconciliation A. Causes of differences between the cash balances of bank and book. B. Adjusting procedures

19. Internal Control and Managing Cash 18 A. Causes of Differences 1. Errors made by banks or companies. 2. Outstanding checks. 3. Deposit in transit. 4. Some transaction recorded by banks, but not recorded by companies (i.e., service charge, interest earned, collections of notes...). 5. NSF check.

20. Internal Control and Managing Cash 19 A. Causes of Differences (Contd.) 6. Checks deposited but returned for reasons other than NSF (I.e., unauthorized signature, check has been altered,etc.). 7. Cash received, recorded, but not yet deposited (if adjusted to cash balance, this item needed to be considered).

21. Internal Control and Managing Cash 20 Bank Balance Book Balance +Deposit in transit+Interest earned * +Cash received, recorded, +Notes collected * but not deposited +- EFT* -Outstanding checks-Service charge * + -Errors made by banks-NSF checks - Checks deposited but returned to payee by bank for reasons other than NSF + -Errors made by companies Adjusted Cash Balance * Journal Entries Required Adjusting Procedures

22. Internal Control and Managing Cash 21 Example n From the following information for D.K, prepare a bank reconciliation and any journal entries needed to adjust the cash account as of 8/31/x1 1. August 31, 20x1, cash balance per book, $8,000. 2. August 31, 20x1, balance per bank, $7,500. 3. Deposit in transit as of 8/31/x1, $2,000.

23. Internal Control and Managing Cash 22 Example (contd.) 4. Checks outstanding as of 8/31/x1, $1,000. 5. The bank improperly recorded a $650 deposit $560. *6. Bank service charges, $100. (Not yet recorded by D.K.) *7. Interest earned, $90. (Not yet recorded by D.K.) * Journal entry required

24. Internal Control and Managing Cash 23 Example (contd.) *8.Notes collected by bank, $400. (Not yet recorded by D.K.) *9.NSF check, $100 (payment of an account receivable) *10.A check of $300 payable to Energy Express Company for delivery charges was mistakenly recorded in the book at $600. * Journal entry required

25. Internal Control and Managing Cash 24 Example (contd.) * Journal entries are required by D.K.as follows: 6. Miscellaneous Expense100 Cash100 7. Cash90 Interest Revenue90 8. Cash400 Notes Receivable400

26. Internal Control and Managing Cash 25 Example (contd.) 9. Accounts Receivable100 Cash100 10. Cash300 Delivery Exp.300

27. Internal Control and Managing Cash 26 Example (contd.) Bank Balance (8/31/98)$7,500 + Deposit In Transit2,000 - Checks Outstanding(1,000) + Error Made by Bank 90 Adjusted Cash Balance $8,590 Book Balance (8/31/98)$8,000 - Bank Service charge(100) + Interest Earned90 + Notes Collected400 - NSF Checks(100) +- Error made by the company 300 Adjusted Cash Balance $8,590

28. Internal Control and Managing Cash 27 Cash Management 1. To maintain sufficient cash on hand for day-to-day operation and for payment of current liabilities. 2. To prevent large amount of idle cash on hand. 3. To speed the collection of cash from sale, by offering sales discounts:

29. Internal Control and Managing Cash 28 Cash Management (contd.) 8/4 A/R, 2/10, n/30 50,000 Sales Revenue50,000 8/10 Cash49,000 Sales Discount1,000 A/R50,000 Also, Subsidiary ledger accounts are maintained for accounts receivable (see p26 for an example).

30. 29 Accounts Receivable General LedgerSubsidiary Ledger CashWalmart Bal. 9,000Bal. 1,800 Accounts ReceivableTarget Bal. 3,800Bal. 1,300 Toys “R” US Bal. 700 Total 3,800 Accounts Receivable Records

31. Internal Control and Managing Cash 30 Reporting Cash on the Balance Sheet (B/S) n Usually reported on the B/S as follows: Current Assets:20x220x1 Cash and Cash Equivalentsxxxxxxxx Cash Equivalents: highly liquid investments with insignificant interest rate risk and with original maturities of three months or less (i.e., commercial papers, U.S. Treasury bills, money market fund, etc.)