2. INTERNAL CONTROL AND CASH Accounting Principles, Eighth Edition
CHAPTER 8
INTERNAL CONTROL AND CASH
Accounting Principles, Eighth Edition

3. Study Objectives Define internal control.
Identify the principles of internal control.
Explain the applications of internal control principles to cash receipts.
Explain the applications of internal control principles to cash disbursements.
Describe the operation of a petty cash fund.
Indicate the control features of a bank account.
Prepare a bank reconciliation.
Explain the reporting of cash.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

4. Internal Control and Cash
Cash Controls
Use of a Bank
Reporting Cash
The Sarbanes-Oxley Act
Principles
Limitations
Control over cash receipts
Control over cash disbursements
Making deposits
Writing checks
Bank statements
Reconciling the bank account
Cash equivalents
Restricted cash
Compensating balances
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

5. Internal Control Methods and measures adopted to: Safeguard assets.
Enhance accuracy and reliability of accounting records. Reduce risk of:
Errors (unintentional)
Irregularities (intentional)
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control.
LO 1 Define internal control.

6. The Sarbanes-Oxley Act
Internal Control
The Sarbanes-Oxley Act
Companies must
develop principles of control over financial reporting.
continually verify that controls are working.
Independent auditors must attest to the level of internal control.
SOX created the Public Company Accounting Oversight Board (PCAOB).
LO 1 Define internal control.

7. Principles of Internal Control
Illustration 8-1
Measures vary with
size and nature of the business.
management’s control philosophy.
LO 2 Identify the principles of internal control.

8. Principles of Internal Control
ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible for a given task.
SEGREGATON OF DUTIES
Related duties, including physical custody and record keeping, should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents for all documents should be accounted for.
LO 2 Identify the principles of internal control.

9. Mechanical and Electronic
Internal Control
Principles of Internal Control
Illustration 8-3
PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS
Physical
Mechanical and Electronic
LO 2 Identify the principles of internal control.

10. Principles of Internal Control
INDEPENDENT INTERNAL VERIFICATION
Records periodically verified by an employee who is independent.
Discrepancies reported to management.
OTHER CONTROLS
Bond employees.
Rotate employees’ duties and require vacations.
Conduct background checks.
LO 2 Identify the principles of internal control.

11. Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
LO 2 Identify the principles of internal control.

12. Internal Control over Cash Receipts
Cash Controls
Internal Control over Cash Receipts
Establishment of Responsibility
Only designated personnel are authorized to handle cash receipts (cashiers)
Documentation Procedures
Use remittance advice (mail receipts), cash register tapes, and deposit slips
Independent Internal Verification
Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily
Segregation of Duties
Different individuals receive cash, record cash receipts, and hold the cash
Physical, Mechanical, and Electronic Controls
Store cash in safes and bank vaults; limit access to storage areas; use cash registers
Other Controls
Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily
Illustration 8-5
LO 3 Explain the applications of internal control principles to cash receipts.

13. Discussion Question Cash Controls
Q8-3. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why?
See notes page for discussion
Question 8-3 (textbook)
This is a violation of the internal control principle of establishing responsibility. In this case, each sales clerk should have a separate cash register or cash register drawer.
LO 3 Explain the applications of internal control principles to cash receipts.

14. Cash Controls
Cash consists of coins, currency, checks, money orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets
LO 3 Explain the applications of internal control principles to cash receipts.

15. Discussion Question Cash Controls
Q8-8. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control.
See notes page for discussion
Question 8-8 (textbook)
( a ) The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit.
(b) The human element is an important factor in a system of internal control. A good system can become ineffective through empoloyee fatigue, carelessness, or in difference. Moreover, internal control may become ineffective as a result of collusion.
LO 3 Explain the applications of internal control principles to cash receipts.

16. Over-the-Counter Receipts
Cashier’s Department
Over-the-Counter Receipts
Sales Department
Illustration 8-7
Prepare daily summary
Prepare deposit slip
Cashier ring up sales
Supervisor
reads register totals
makes cash counts
prepares cash count sheets
Bank
(deposit)
Treasurer
(verification)
Accounting
(record)
LO 3 Explain the applications of internal control principles to cash receipts.

17. Mail Receipts Control Procedures:
Mail receipts should be opened by two people, a list prepared, and each check endorsed.
Copy of the list, along with the checks and remittance advices, sent to cashier’s department.
Cashier adds the checks to the over-the-counter receipts and prepares a daily cash summary and makes the daily bank deposit.
Copy of list sent to treasurer’s office for comparison with total shown on daily cash summary.
LO 3 Explain the applications of internal control principles to cash receipts.

18. Review Question Cash Controls
Permitting only designated personnel to handle cash receipts
is an application of the principle of:
a. segregation of duties.
b. establishment of responsibility.
c. independent check.
d. other controls.
LO 3 Explain the applications of internal control principles to cash receipts.

19. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash.
Applications:
Voucher system
Electronic funds transfers (EFT) system
Petty cash fund
LO 4 Explain the applications of internal control principles to cash disbursements.

20. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Establishment of Responsibility
Only designated personnel are authorized to sign checks (treasurer)
Documentation Procedures
Use prenumbered checks and account for them in sequence; each check must have an approved invoice
Independent Internal Verification
Compare checks to invoices; reconcile bank statement monthly
Physical, Mechanical, and Electronic Controls
Store blank checks in safes, with limited access; print check amounts by machine in indelible ink
Segregation of Duties
Different individuals approve and make payments; check signers do not record disbursements
Other Controls
Stamp invoices
PAID
Illustration 8-8
LO 4 Explain the applications of internal control principles to cash disbursements.

21. Discussion Question Cash Controls
Q8-14. Joe Griswold Company’s internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls.
See notes page for discussion
Question 8-14 (textbook)
LO 4 Explain the applications of internal control principles to cash disbursements.

22. Review Question Cash Controls
The use of prenumbered checks in disbursing cash is an application of the principle of:
a. establishment of responsibility.
b. segregation of duties.
c. physical, mechanical, and electronic controls.
d. documentation procedures.
LO 4 Explain the applications of internal control principles to cash disbursements.

23. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Voucher System
Network of approvals, by authorized individuals, to ensure all disbursements by check are proper.
A voucher is an authorization form prepared for each expenditure.
LO 4 Explain the applications of internal control principles to cash disbursements.

24. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Electronic Funds Transfers (EFT)
Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations.
LO 4 Explain the applications of internal control principles to cash disbursements.

25. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Petty Cash Fund - Used to pay small amounts.
Involves:
establishing the fund,
making payments from the fund, and
replenishing the fund.
LO 5 Describe the operation of a petty cash fund.

26. Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The fund was established on March 1 with a balance of $100. During March the following petty cash receipts were found in the petty cash box.
March 5 Stamp inventory $39
March 7 Freight-out
March 9 Miscellaneous expense
March 11 Travel expense
March 14 Miscellaneous expense
The fund was replenished on March 15 when the fund contained $3 in cash. On March 20, the amount in the fund was increased to $150.
Instructions: Journalize the entries in March that pertain to the operation of the petty cash fund.
Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows :
( b ) Business transaction occurs.
( c ) Information entered in the journal.
( a ) Debits and credits are posted to the ledger.
( e ) Trial balance is prepared.
( d ) Financial statements are prepared.
LO 5 Describe the operation of a petty cash fund.

27. Cash Controls
E8-8 The fund was established on March 1 with a balance of $100.
March 1
Petty cash 100
Cash 100
LO 5 Describe the operation of a petty cash fund.

28. Cash Controls
E8-8 The fund was replenished on March 15 when the fund contained $3 in cash.
March 15
Postage expense 39
Freight-out 21
Miscellaneous expense 11
Travel expense 24
Cash over and short 2
Cash 97
LO 5 Describe the operation of a petty cash fund.

29. Cash Controls
E8-8 On March 20, the amount in the fund was increased to $150.
March 20
Petty cash 50
Cash 50
LO 5 Describe the operation of a petty cash fund.

30. Use of a Bank Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.
LO 6 Indicate the control features of a bank account.

31. Use of a Bank Making Bank Deposits
Illustration 8-10
Making Bank Deposits
Authorized employee should make deposit.
Bank Code Numbers
Reverse Side
Front Side
LO 6 Indicate the control features of a bank account.

32. Use of a Bank Writing Checks
Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient.
Illustration 8-11
Maker
Payee
Payer
LO 6 Indicate the control features of a bank account.

33. Use of a Bank Bank Statements Debit Memorandum Credit Memorandum
Illustration 8-12
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient funds)
Credit Memorandum
Collect notes receivable.
Interest earned.
LO 6 Indicate the control features of a bank account.

34. Review Question Use of a Bank
The control features of a bank account do not include:
having bank auditors verify the correctness of the bank balance per books.
minimizing the amount of cash that must be kept on hand.
providing a double record of all bank transactions.
safeguarding cash by using a bank as a depository.
LO 6 Indicate the control features of a bank account.

35. Use of a Bank Reconciling the Bank Account
Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances.
Reconciling Items:
Deposits in transit.
Outstanding checks.
Errors.
Bank memoranda.
LO 7 Prepare a bank reconciliation.

36. Use of a Bank Reconciliation Procedures + Deposit in Transit
Illustration 8-13
+ Deposit in Transit
- Outstanding Checks
+- Bank Errors
+ Notes collected by bank
- NSF (bounced) checks
- Check printing or other service charges
+- Book Errors
CORRECT BALANCE
CORRECT BALANCE
LO 7 Prepare a bank reconciliation.

37. Use of a Bank
E8-11 The following information pertains to Family Video Company.
Cash balance per bank, July 31, $7,263.
Cash balance per books, July 31, $7,284.
July bank service charge not recorded by the depositor $28.
Deposits in transit, July 31, $1,500.
Bank collected $900 note for Family in July, plus interest $36, less fee $20.The collection has not been recorded by Family, and no interest has been accrued.
Outstanding checks, July 31, $591.
Instructions
Prepare a bank reconciliation at July 31.
Journalize the adjusting entries at July 31 on the books of Family Video Company.
LO 7 Prepare a bank reconciliation.

38. Use of a Bank E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement $7,263
Add: Deposit in transit 1,500
Less: Outstanding checks (591)
Adjusted cash balance per bank $8,172
Cash balance per books $7,284
Add: Collection of notes receivable 900
Collection of interest 36
Less: Bank service charge (28)
Note collection fee (20)
Adjusted cash balance per books $8,172
LO 7 Prepare a bank reconciliation.

39. Use of a Bank
E8-11 b) Journalize the adjusting entries at July 31 on the books of Family Video Company.
Dr.
Cr.
July 31
Miscellaneous expense 28
Cash
July 31
Cash
Miscellaneous expense
Interest revenue 36
Notes receivable
Note: Adjusting journal entry includes only the adjustments to the cash balance per books.
LO 7 Prepare a bank reconciliation.

40. Review Question Use of a Bank
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
LO 7 Prepare a bank reconciliation.

41. Review Question Use of a Bank
Which of the following statements correctly describes the reporting of cash?
Cash cannot be combined with cash equivalents.
Restricted cash funds may be combined with Cash.
Cash is listed first in the current assets section.
Restricted cash funds cannot be reported as a current asset.
LO 7 Prepare a bank reconciliation.

42. Discussion Question Recording Process
Q8-20. Lori Figgs is confused about the lack of agreement between the cash balance per books and the balance per the bank. Explain the causes for the lack of agreement to Lori, and give an example of each cause.
See notes page for discussion
Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows :
( b ) Business transaction occurs.
( c ) Information entered in the journal.
( a ) Debits and credits are posted to the ledger.
( e ) Trial balance is prepared.
( d ) Financial statements are prepared.
LO 7 Prepare a bank reconciliation.

43. Reporting Cash
Most liquid asset, listed first in current assets section of balance sheet.
Illustration 8-16
Cash equivalents
Restricted cash
Compensating balances
LO 8 Explain the reporting of cash.

44. Copyright
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