Financial Accounting: Tools for Business Decision Making, 3rd Ed. Kimmel, Weygandt, Kieso ELS

Chapter 7

Chapter 7 Internal Control and Cash PowerPoint Slides After studying Chapter 7, you should be able to: Identify the principles of internal control. Explain the application of internal control to cash receipts. Explain the application of internal control to cash disbursements. Prepare a bank reconciliation. Explain the reporting of cash. Discuss the basic principles of cash management. Identify the primary elements of a cash budget. 1

Internal Control consists of... all the related methods and measures adopted within a business to: safeguard its assets from; Employee theft Robbery Unauthorized Use enhance accuracy and reliability of its accounting records by reducing: Risk of Errors Irregularities

Establishment of Responsibility Control is most effective when only one person is responsible for a given task.

Segregation of Duties Responsibility for related activities should be assigned to different individuals Responsibility for record keeping for an asset should be separate from the physical custody of the asset

Documentation Provide evidence that transactions and events occurred: Shipping documents Sales invoices

Documentation Procedures Documents should be pre-numbered. All documents should be accounted for. Sources documents should be promptly forwarded to accounting department.

Physical, Mechanical and Electronic Controls OR FINGERPRINT, EYEBALL Scan

Independent Internal Verification Involves review, comparison, and reconciliation of data prepared by employees Verification should be made periodically or on surprise basis Verification should be done by employee who is independent of the personnel responsible for the information Discrepancies and exceptions should be reported to management

Independent Internal Verification

Other Controls Bonding of employees who handle cash Rotating employee’s duties and requiring employees to take vacations

Limitations of Internal Controls Cost/Benefit - cost of establishing procedure should not exceed expected benefit Human element - fatigue, carelessness, indifference Collusion - two or more individuals who work together to get around controls Size of business

Cash consists of... coins currency checks money orders money on hand deposits in bank

Cash is the most desirable asset... because it is readily convertible into any other asset.

Page 297 in book Internal Control Over Cash Receipts

Over Cash Disbursements Internal Control Over Cash Disbursements

Electronic Funds Transfer (EFT) An approach to transfer funds among parties without paper (deposit tickets, checks, etc.) EFT uses wire, telephone, telegraph or computer to transfer from one location to another.

Petty Cash Fund is a cash fund used to pay relatively small amounts

Use of a Bank... is good internal control. PowerPoint Slides Use of a Bank... is good internal control. minimizes the amount of cash that must be kept on hand. provides a double record of all bank transactions one by the business one by the bank helps a company safeguard its cash by using a bank as a depository and clearinghouse for checks received and written. 24

a copy of the bank’s records sent to the customer for periodic review. Bank Statement - a copy of the bank’s records sent to the customer for periodic review. Apri l 30, 2004 Bank Statement shows check & other debits deposits & other credits daily cash balance

Company Balance and Bank Balance of Cash Usually Differ Because... PowerPoint Slides Time lags that prevent one of the parties from recording the transaction in the same period. Days pass between the time a check is written and dated and date it is paid by the bank. A day may pass between the time receipts are recorded by the company and the time they are recorded by the bank. A time lag may occur when the bank mails a debit or credit memo to the company. Errors by either party in recording transactions. 27

Reconciliation Procedure PowerPoint Slides Reconciliation Procedure reconcile balance per books and balance per bank to their adjusted or correct balances. the reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash. 28

PowerPoint Slides Terms Deposits in transit - deposits recorded by the depositor that have not been recorded by the bank. Outstanding checks - checks issued and recorded by the company that have not been paid by the bank. NSF check - a check that is not paid by the bank because of insufficient funds in the customer’s bank account. Adjusted balance - same as true cash balance, correct cash balance 29

Bank Reconciliation Procedures $ Per Bank Statement -outstanding checks +deposits +/- bank errors correct cash amount $ Per Books -NSF Checks -check printing or other service charge +notes collected by bank

W.A. Laird Company Bank Reconciliation April 30, 2004 PowerPoint Slides W.A. Laird Company Bank Reconciliation April 30, 2004 Illustration 7-9 Cash balance per bank statement 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00 Adjusted cash balance per bank 12,204.85 Cash balance per books 11,589.45 Add: Collection of N/R for $ 1,000 plus interest earned $50, less collection fee $ 15 1,035.00 Error on recording check No. 443 36.00 1,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60 31

For Cash To Show the Correct Balance Each reconciling item in determining the adjusted balance per books must be journalized and posted.

W.A. Laird Company Bank Reconciliation April 30, 2004 PowerPoint Slides W.A. Laird Company Bank Reconciliation April 30, 2004 Illustration 7-9 Cash balance per bank statement 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00 Adjusted cash balance per bank 12,204.85 Cash balance per books 11,589.45 Add: Collection of N/R for $ 1,000 plus interest earned $50, less collection fee $ 15 1,035.00 Error on recording check No. 443 36.00 1,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60 31

JOURNAL Apr 30 Cash 1,035.00 Miscellaneous Expense 15.00 Notes Receivable 1,000.00 Interest Revenue 50.00 Apr 30 Cash 36.00 Accounts Payable 36.00 Apr 30 Accounts Receivable-Baron 425.60 Cash 425.60 Apr 30 Miscellaneous Expense 30.00 Cash 30.00

PowerPoint Slides Reporting Cash Cash is recorded in both the balance sheet and the statement of cash flows. The balance sheet shows the amount of cash available at a given point in time. The statement of cash flows shows the sources and uses of cash during a period of time. 38

Cash Equivalents Readily convertible to known amount of cash So near maturity that their market value is relatively insensitive to changes in interest rates Examples: Treasury bills Commercial paper Money market funds

Restricted Cash... Is cash that is not available for general use. Is set aside for special purpose. If not to be used within next year, report as noncurrent asset.

Operating Cycle of a Merchandising Company…is the average time it takes to go from cash to cash in producing revenues. PowerPoint Slides 33

Principles of Cash Management PowerPoint Slides Principles of Cash Management Increase the speed of collection on receivables. Keep inventory levels low. Delay payment of liabilities. Plan the timing of major expenditures. Invest idle cash. 39

Five Principles of Cash Management PowerPoint Slides 33

PowerPoint Slides Reporting Cash Cash on hand, cash in banks, and petty cash are often combined and reported as cash. Cash is the most liquid asset and listed first in the current asset section of the balance sheet. 39

Cash Budget Cash is vital. PowerPoint Slides Cash Budget Cash is vital. Planning the company's cash needs is a key business activity. Cash budget shows the anticipated cash flows, over a 1 to 22-year period. 42

Cash Budget The cash budget contains : Cash receipts section; PowerPoint Slides Cash Budget The cash budget contains : Cash receipts section; Cash disbursements section; Financing section. 43

PowerPoint Slides Cash Receipts Section includes expected receipts from the company's principal source(s) of revenue, such as cash sales and collections from customers on credit sales also shows anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock 44

Cash Disbursements Section PowerPoint Slides Cash Disbursements Section shows expected payments for direct materials, direct labor, manufacturing overhead, and selling and administrative expenses includes projected payments for income taxes, dividends, investments, and plant assets 45

Financing Section shows... PowerPoint Slides Financing Section shows... expected borrowings the repayment of the borrowings and interest 46