Reporting and Analyzing Cash and Internal Controls Chapter 6 Reporting and Analyzing Cash and Internal Controls Financial Accounting John J. Wild – Fifth Edition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Purpose and 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. Purpose of Internal Control Managers use policies and procedures to: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies. 6-2

The Sarbanes-Oxley Act The Sarbanes-Oxley Act, also known as SOX, requires management and auditors of publicly held companies to adhere to or perform specific requirements, such as: Evaluation of internal controls. Auditor’s work is overseen by the Public Company Accounting Oversight Board (PCAOB). Restriction on consulting services performed by auditors. Term limits on person leading the audit. Harsh penalties for violators, including prison time with severe fines. 6-3

Technology and Internal Control Reduced Processing Errors More Extensive Testing of Records Crucial Separation of Duties Limited Evidence of Processing Increased E-commerce 6-4

Limitations of Internal Control Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain The costs of internal controls must not exceed their benefits. 6-5

Control of Cash C1 An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cash is separate from recordkeeping of cash. Cash receipts are promptly deposited in a bank. Cash disbursements are made by check. 6-6

Control of Cash Receipts and Cash Disbursements Over-the-Counter Cash Receipts Cash register with locked-in record of transactions. Compare cash register record with cash reported. Cash Receipts By Mail Two people open the mail. Money to cashier’s office. List to accounting dept. Copy of list filed. 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. 6-7

Operating a Petty Cash Fund Company Cashier Petty Cashier Accountant 6-8

Operating a Petty Cash Fund Petty Cashier Petty Cash 6-9

Operating a Petty Cash Fund A petty cash fund is used only for business expenses. Petty Cashier Courier $80 39¢ Stamps $45 6-10

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 Courier $80 39¢ Stamps $45 6-11

Operating a Petty Cash Fund Receipts $125 To reimburse petty cash fund Company Cashier Petty Cashier Use a Cash Over and Short account if needed. Accountant 6-12

Banking Activities as Controls Bank Accounts Signature Cards Deposit Tickets Checks Electronic Funds Transfer Bank Statements 6-13

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? * 6-14

Bank Statement Balance Reconciling Items P3 Book Balance Add: Collections made by the bank. Add: Interest earned on checking account. Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge. Add or Deduct: Book errors. Bank Statement Balance Add: Deposits in transit. Deduct: Outstanding Checks Add or Deduct: Bank errors. 6-15

Bank Reconciliation Example Only amounts shown on the book portion of the reconciliation require an adjusting entry. 6-16

Days’ Sales Uncollected How much time is likely to pass before we receive cash receipts from credit sales? Days’ sales uncollected Accounts receivable Net sales × 365 = 6-17

End of Chapter 6 6-18