© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Chapter 6 Reporting and Analyzing Cash and Internal Controls 6-1

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-2 Purpose of Internal Control Policies and procedures managers use to...  Protect assets.  Ensure reliable accounting.  Promote efficient operations.  Urge adherence to company policies. Policies and procedures managers use to...  Protect assets.  Ensure reliable accounting.  Promote efficient operations.  Urge adherence to company policies.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-3 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.  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.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-4 Technology and Internal Control Reduced Processing Errors Reduced Processing Errors More Extensive Testing of Records More Extensive Testing of Records Limited Evidence of Processing Limited Evidence of Processing Crucial Separation of Duties Crucial Separation of Duties

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-5 Limitations of Internal Control Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-6 Limitations of Internal Control The costs of internal controls must not exceed their benefits. The costs of internal controls must not exceed their benefits. Costs Benefits

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-7 Control of Cash 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. Cash disbursements are made by check.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-8 Cash, Cash Equivalents, and Liquidity Cash Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Cash 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. 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.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-9 Cash, Cash Equivalents, and Liquidity Liquidity How easily an asset can be converted into another asset or be used in paying for services or obligations. Liquidity How easily an asset can be converted into another asset or be used in paying for services or obligations. InventoryCash

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-10 Control of Cash Receipts Over-the-Counter Cash Receipts Cash register with locked-in record of transactions. Compare cash register record with cash reported. 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. Cash Receipts By Mail Two people open the mail. Money to cashier’s office. List to accounting dept. Copy of list filed.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-11 Control of Cash Disbursements All expenditures made by check. The only exception is for small payments from petty cash. Separate authorization, check signing and recordkeeping duties. Use a voucher system. All expenditures made by check. The only exception is for small payments from petty cash. Separate authorization, check signing and recordkeeping duties. Use a voucher system.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-12 Voucher System of Control A voucher system establishes procedures for: Verifying, approving and recording obligations for eventual cash disbursement. Issuing checks for payment of verified, approved and recorded obligations. A voucher system establishes procedures for: Verifying, approving and recording obligations for eventual cash disbursement. Issuing checks for payment of verified, approved and recorded obligations.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-13 Voucher System of Control Cashier Accounting Receiving Supplier (Vendor) Purchasing Requesting Cashier Accounting, Requesting & Purchasing Accounting Supplier (Vendor) Purchasing and Accounting Supplier, Requesting, Receiving & Accounting Check Invoice Approval Receiving Report Invoice Purchase Order Purchase Requisition Voucher

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-14 Petty Cash System of Control Small payments required in most companies for items such as postage, courier fees, repairs and supplies.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-15 Petty Cash Operating a Petty Cash Fund Company Cashier Petty Cashier

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-16 Petty Cash Operating a Petty Cash Fund Company Cashier Petty Cashier Accountant

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-17 Petty Cash Operating a Petty Cash Fund Petty Cashier

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin ¢ Stamps $45 Courier $80 Operating a Petty Cash Fund Petty Cashier A petty cash fund is used only for business expenses.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-19 Operating a Petty Cash Fund Receipts Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Petty Cashier 37¢ Stamps $45 Courier $80

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-20 Receipts Company Cashier $125 To reimburse petty cash fund Use a Cash Over and Short account if needed. Use a Cash Over and Short account if needed. Operating a Petty Cash Fund Petty Cashier Accountant

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-21 Petty Cash Example 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 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 $

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-22 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$ What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$137.80

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-23 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$ What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$ Let’s prepare the journal entry to replenish the petty cash fund.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-24 Petty Cash Example Here is the journal entry to replenish the petty cash fund.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-25 Banking Activities as Controls Bank Accounts Signature Cards Deposit Tickets Checks Electronic Funds Transfer Bank Statements

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-26 Bank Reconciliation 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? Why are the balances different? *

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-27 Reconciling Items Bank Statement Balance Deduct: Outstanding checks. Add: Deposits in transit. Add or Deduct: Bank errors. 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. 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.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-28 Bank Reconciliation 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. 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.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-29 Bank Reconciliation Example Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610. The cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610. The cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-30 Bank Reconciliation Example  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment on account receivable.  The bank statement showed $30 interest earned during July.  Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240. ‘ A $486 deposit by Acme Company was erroneously credited to our account by the bank.

 ‘    

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-32 Recording Adjusting Entries from a Bank Reconciliation Only amounts shown on the book portion of the reconciliation require an adjusting entry.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-33 Recording Adjusting Entries from a Bank Reconciliation After posting the reconciling entries the cash account looks like this... Adjusted balance on July 31.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-34 Days’ Sales Uncollected Days’ Sales Uncollected Accounts Receivable Net Sales × 365= How much time is likely to pass before we receive cash receipts from credit sales. How much time is likely to pass before we receive cash receipts from credit sales.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 6-35 End of Chapter 6