1. Accounting for Cash and Internal Controls
Chapter 6
Accounting for Cash
and Internal Controls
In this chapter, we will learn more about cash, internal controls, petty cash, and bank reconciliations.

2. Purpose of Internal Control
Policies and procedures managers use to:
Protect assets.
Ensure reliable accounting.
Promote efficient operations.
Urge adherence to company policies.
An internal control system is a collection of policies and procedures that protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies.

3. Principles of Internal Control
Establish responsibilities.
Maintain adequate records.
Insure assets and bond key employees.
Separate recordkeeping from custody of assets.
Divide responsibility for related transactions.
Apply technological controls.
Perform regular and independent reviews.
Principles of internal control include:
Establish responsibilities.
Maintain adequate records.
Insure assets and bond key employees.
Separate recordkeeping from custody of assets.
Divide responsibility for related transactions.
Apply technological controls.
Perform regular and independent reviews.

4. Technology and Internal Control
Reduced
Processing
Errors
More
Extensive Testing
of Records
The use of technology has an impact on internal controls. Technology can help reduce processing errors and allow more extensive testing of records. However, it can also limit evidence of processing because of the lack of a paper trail. Because more work can be performed by one person, it can also create situations that cause a lack of separation of duties.
Limited
Evidence of
Processing
Crucial
Separation of
Duties

5. Limitations of Internal Control
Human Error
Negligence
Fatigue
Misjudgment
Confusion
Human Fraud
Intent to
defeat internal
controls for
personal gain
Any internal control system has limitations. Because humans are involved in the internal control system, our negligence, fatigue, misjudgment, and confusion can negatively impact the goals of the system. Also, an internal control system can be circumvented by individuals who desire to commit fraud and who are willing to work together to do so.

6. Limitations of Internal Control
The costs of internal controls
must not exceed their benefits.
We also must keep in mind that the costs of internal controls must not exceed their benefits. A department store could drastically cut shoplifting losses by having an armed guard escort each customer while in the store. Obviously, the cost of this internal control exceeds the benefit, not to mention the impact it would have on customer morale.
Due to scandal such as Enron and World com, this issue has come under intense debate, due to measures such as the passage of Sarbanes-Oxley and the added cost that it places on companies (Section 404), which requires companies not only go through a financial statement audit as we discussed, but an additional audit to assure that they have proper internal controls in place.
Its actually this measure that is very heavily responsible for the GREAT job demand that exists for accountants, and why you should look into the field as a career!!
Benefits
Costs

7. Control of Cash C2
An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines:
Handling cash is separated from recordkeeping of cash.
Cash receipts are promptly deposited in a bank.
When dealing with internal controls, cash is one of the biggest problem areas, because its SO easy to steal!
Control of cash focuses on three areas.
One, those who handle cash should be separate from those who keep records of cash.
Two, cash receipts should be deposited daily in the bank.
Three, cash disbursements should be made by check.
Cash disbursements are made by check.

8. Cash, Cash Equivalents, and Liquidity
Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts.
Cash Equivalents
Short-term, highly liquid investments that are:
Readily convertible to a known cash amount.
Close to maturity date and not sensitive to interest rate changes.
On a balance sheet, cash is combined with cash equivalents. Cash includes currency, coins and amounts on deposit in bank accounts, checking accounts, and savings accounts. Cash equivalents include short-term, highly liquid investments that are easily converted into a known cash amount and that are close to maturity and are not sensitive to interest rate changes.

9. Cash, Cash Equivalents, and Liquidity
How easily an asset can be converted into another asset or be used to pay for services or obligations.
Liquidity refers to how easily an asset can be converted into another asset or be used to pay for services and obligations.
Inventory
Cash

10. Control of Cash Receipts
Cash Receipts By Mail
Two people open the mail.
Money to cashier’s office.
List to accounting dept.
Copy of list filed.
Over-the-Counter Cash Receipts
Cash register with locked-in record of transactions.
Compare cash register record with cash reported.
Because cash is the most liquid asset, it is the most susceptible to theft. As a result, the controls over cash receipts are important.
A cash registers’ listing of cash transactions can be compared to actual cash in the register to determine if cash in the register is correct.
When cash is received by mail, have two people present when opening the mail to deter theft. The cash is sent to the cashier, a list of who paid the cash is sent to the accounting department, and a copy of the list is filed.

11. Control of Cash DisbursementsP1
All expenditures should be made by check. The only exception is for small payments from petty cash.
Separate authorization for check signing and recordkeeping duties.
Use a voucher system.
Requiring all disbursements to be made by check is a common internal control policy. Other controls include the separation of the following duties: authorization for the disbursement, check signing, and recordkeeping. Use of a voucher system also provides a good control over disbursements. Let’s look at the voucher system described on the next slide.

12. Voucher System of ControlP4
A voucher system establishes procedures for:
Verifying, approving and recording obligations for eventual cash disbursements.
Issuing checks for payment of verified, approved and recorded obligations.
A voucher system establishes procedures that help to verify, approve and properly record cash disbursements.

13. Voucher System of ControlP4
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting
Cashier
Accounting, Requesting & Purchasing
Accounting
Supplier (Vendor)
Purchasing and
Supplier, Requesting, Receiving & Accounting
Voucher
In a voucher system, a purchase requisition initiates the process for a purchase. If approved, the purchase requisition triggers the issuance of a purchase order. An invoice is received from the vendor once a purchase is made. A receiving report indicates that we actually received the goods. The invoice approval indicates that we ordered the goods, we received the goods we ordered, and that we were billed for the goods we ordered and received. The invoice approval triggers the check preparation for a valid purchase.
Copies of all of these documents are kept as supporting documentation for the disbursement in the voucher file.
One job of the auditor is to look at the final numbers on the financial statements and be sure that vouchers actually exist for all steps in the process.

14. Petty Cash System of Control
Small payments required in most companies for items such as postage, courier fees, repairs and supplies.
Sometimes, a quick disbursement is needed to be made for an immediate need. Trying to go through all of the approval processes needed to have a check prepared is too time consuming and would take too long. Companies usually keep a petty cash amount on hand to use for small, immediate needs.

15. Operating a Petty Cash Fund
A petty cash fund is used only for business expenses.
Petty Cashier
As petty cash is needed, the petty cashier supplies the cash for the purchases.
Courier
$80
37¢
Stamps
$45

16. Operating a Petty Cash Fund
Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash.
Receipts
Petty Cashier
Receipts supporting the petty cash disbursements are given to the petty cashier.
Courier
$80
37¢
Stamps
$45

17. Petty Cash Example P2
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
Express Mail Postage
Miscellaneous Office Supplies
Let’s look at replenishing the fund if the balance on July 31 was $
Tension Company maintains a petty cash fund of four hundred dollars. The receipts for the month of July include:
Seventy nine dollars and thirty cents for travel expenses
Ninety three dollars and forty two cents for business lunches
Fifty five dollars for postage, and
Thirty two dollars and forty eight cents for office supplies.
On July 31st, the fund has a balance of one hundred thirty seven dollars and eighty cents.
Let’s look at how to replenish the fund.

18. Petty Cash Example P2
What amount of cash will be required to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
What amount of cash will be required to replenish the petty cash fund?

19. Let’s prepare the journal entry to replenish the petty cash fund.
Petty Cash Example P2
What amount of cash will be required to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
Tension Company will need two hundred sixty two dollars and twenty cents to replenish the fund up to its original balance of four hundred dollars.
Now, let’s look at the journal entry to replenish the petty cash fund.
At the end of the period, one would take the cash left in the fund, add up the receipts in the box, and the two together should equal $400. if this is the case, the difference, or receipts taken out should be the amount that re-stocks the account back to $400.
Let’s prepare the journal entry to replenish the petty cash fund.

20. Petty Cash Example Journal entry to replenish petty cash fund P2
Tension Company would debit each expense account for the amount on the receipts. Cash would be credited for the amount needed to replenish the fund to four hundred dollars.
In this example, Tension Company had a cash shortage in the petty cash fund of two dollars. This means that a receipt was lost, an error was made, or a theft occurred. Management monitors the balance in the Cash Over and Short account to determine if there is a problem with cash shortages or overages.

21. Banking Activities as Controls
Bank Accounts
Signature Cards
Deposit Tickets
Banks offer certain protections for your cash. For example, use of a bank account is a more secure place for your cash than a safe at the office. Signature cards are used so the bank knows whose signature is approved for use on checks. Deposit tickets provide support for deposits to your account. Checks provide authorization for disbursements from your account. Electronic funds transfers limit the number of people who have their hands on the cash and so it reduces theft and fraud. Bank statements are provided so customers can reconcile their accounts in a timely manner and notice any unusual or unauthorized activity.
Checks
Electronic Funds Transfer
Bank Statements

22. Bank Reconciliation P3
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.
Why are the
balances different? *
Anyone who has a bank account should prepare a bank reconciliation on a regular basis. If you do not, you are “banking” that the bank and you will not make any errors. And remember, humans are involved on both sides so the chances are likely that an error will occur. A bank reconciliation will identify any errors that need to be corrected by you or the bank.
Why are the balances different on the bank statement and on the Cash account? Because of timing differences. Let’s look at how to prepare a bank reconciliation in more detail.

23. Bank Statement Balance
Reconciling Items P3
Bank Statement Balance
Deduct: Outstanding checks.
Add:
Deposits in transit.
Add or Deduct: Bank errors.
Book Balance
Deduct: Nonsufficient funds check (NSF).
Deduct: Bank service charge.
Add: Interest earned on checking account.
Add: Collections made by the bank.
Add or Deduct: Book errors.
There are two sides to a bank reconciliation. On the bank’s side, we will start with the balance on the bank statement and adjust it for outstanding checks, deposits in transit, and errors made by the bank.
On the book’s side, we will start with the Cash balance in the ledger and adjust it for customer checks that were drawn on accounts that were nonsufficient, bank service charges, interest earned, collections made by the bank on our behalf, and errors we made.
Examples of collections made by the bank on our behalf would be when the bank acts as a collection medium for customer payments or when the bank collects a note receivable for us from a customer.

24. Bank Reconciliation Two sections:P3
Two sections:
Reconcile bank statement balance to the adjusted bank balance.
Reconcile book balance to the adjusted book balance.
The adjusted balances should be equal.
When we prepare a bank reconciliation, there are two sections. In one section, we reconcile the bank statement balance to an adjusted bank balance. In the other section, we reconcile the book balance to an adjusted book balance. The adjusted balances in both sections should be equal.
Now, let’s look at an example of a bank reconciliation.
Lets look at an assigned HW problem from the text to explain this.

25. Recording Adjusting Entries from a Bank ReconciliationP3
Only amounts shown on the book portion of the reconciliation require an adjusting entry.
We only make entries for the items on the book side of the reconciliation. First, we debit Cash and credit Interest Revenue for the amount of the revenue earned. Second, we debit Supplies Expense and Accounts Receivable and credit Cash. The debit to Supplies Expense is to correct the error we made earlier. The debit to Accounts Receivable creates an account for the amount of the nonsufficient fund check the customer gave us. This debit to accounts receivable indicates that the customer has not satisfied his/her account.
In other words, transactions that show up on our bank statement but have not yet been recorded on our books (and belong on our books), must be added as an adjusting entry at the end of the month when the bank statement is rec’d.

26. End of Chapter 6
In this chapter we learned about internal controls over cash, petty cash, and bank reconciliations.
In the next chapter, we will learn more about Accounts Receivable.