Internal Control, Managing Cash and Making Ethical Judgments Chapter 7 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

7 - 2 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objectives 1.Define internal control. 2.Identify the characteristics of an effective system of internal control 3.Prepare a bank reconciliation and the related journal entries 4.Apply internal control to cash receipts 5.Apply internal control to cash payments 6.Use a budget to manage cash 7.Make ethical judgements in business Appendix – the voucher system

7 - 3 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Define internal control. Objective 1

7 - 4 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Internal Control l What is internal control? l It is the organisational plan and all the related measures that an entity adopts to… – safeguard assets, – encourage adherence to company policies, – promote operational efficiency, and... – ensure accurate and reliable accounting records.

7 - 5 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Operational Controls Financial Reporting Controls Internal Control

7 - 6 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Identify the characteristics of an effective system of internal control. Objective 2

7 - 7 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Establishing an Effective System of Internal Control l Characteristics of an effective internal control system include: 1 Competent, reliable, and ethical personnel 2 Assignment of responsibilities 3 Proper authorisation 4 Separation of duties

7 - 8 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Separation of operations from accounting Separation of the custody of assets from accounting Separation of the authorisation of transactions from the custody of related assets Separation of the authorisation of transactions from the custody of related assets Separation of duties within the accounting function Separation of Duties

7 - 9 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Stolen credit card numbers Computer virus and Trojan horses Impersonation of companies Internal Controls for e-Commerce

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Internal Controls for e-Commerce l What is an encryption? l It is the primary method of achieving confidentiality in e-commerce. l Plain-text messages are rearranged by some mathematical process. l The encrypted message cannot be read by anyone who does not know the process.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Internal Controls for e-Commerce The Internet Corporate Intranet Firewall Network Computers

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Limitations of Internal Control l Most internal control measures can be circumvented or overcome. l Collusion is when two or more employees work as a team with the purpose to defraud the firm.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Account as a Control Device l Documents used to control a bank account include: – signature card – deposit ticket – cheque – bank statement – bank reconciliation

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation l What are two records of a business’s cash? 1 Cash account in the business’s own general ledger. 2 The bank statement which tells the actual amount of cash the business has in the bank.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation l Items recorded by a company not on the bank statement: – deposit in transit – outstanding cheques

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation l Items on a bank statement and not recorded by the business: – bank collections – bank fees – interest earned on account – NSF cheques

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Paths That Two Cheques Take (Good Cheque)  aker writes cheque to payee.  aker writes cheque to payee. Payee deposits cheque in bank. Payee deposits cheque in bank. Payee’s bank sends cheque to maker’s bank. Payee’s bank sends cheque to maker’s bank. Maker’s bank pays the cheque. Maker’s bank pays the cheque.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Paths That Two Cheques Take (Dishonoured Cheque) Maker’s bank balance is not sufficient to pay the cheque. Maker’s bank balance is not sufficient to pay the cheque. Maker’s bank sends the worthless cheque back to payee’s bank. Maker’s bank sends the worthless cheque back to payee’s bank. Payee’s bank decreases payee’s balance. Payee’s bank decreases payee’s balance. Payee holds worthless cheque. Payee holds worthless cheque.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Prepare a bank reconciliation and the related journal entries. Objective 3

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation Example l At the beginning of July, Sahita, Inc. received the June’s bank statement. l It indicated the following: l The bank balance was $63,275. l The bank had collected a note receivable from one of Sahita’s customers in the amount of $1,325.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation Example l The bank paid the electric bill of $1,500. l There was a $200 cheque returned for NSF. l Interest earned on the account was $265. l Bank service charges were $12.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation Example l Sahita’s books indicates a cash balance of $66,647. l A deposit of $11,250 was mailed to the bank on June 30. l Cheques issued in June for $8,000 have not yet been paid by the bank.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Balance per bank, June 30$63,275 Add deposit in transit 11,250 $74,525 Less outstanding cheque 8,000 Adjusted bank balance$66,525 Balance per bank, June 30$63,275 Add deposit in transit 11,250 $74,525 Less outstanding cheque 8,000 Adjusted bank balance$66,525 The Bank Reconciliation Example

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Balance per books, June 30$66,647 Add: Note receivable collected by the bank 1,325 Interest revenue 265 $68,237 Less: Payment of electric bill 1,500 NSF cheque 200 Service charge 12 Adjusted book balance$ 66,525 Balance per books, June 30$66,647 Add: Note receivable collected by the bank 1,325 Interest revenue 265 $68,237 Less: Payment of electric bill 1,500 NSF cheque 200 Service charge 12 Adjusted book balance$ 66,525 The Bank Reconciliation Example

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Bank Reconciliation Example Balance per books $66,525 Balance per books $66,525 Balance per bank $66,525 Balance per bank $66,525 Equal amounts

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Record Reconciling Items June 30, 2005 Cash 1,325 Bills Receivable 1,325 Bill collected by the bank June 30, 2005 Cash 1,325 Bills Receivable 1,325 Bill collected by the bank June 30, 2005 Cash 265 Interest Revenue 265 Interest earned on bank balance June 30, 2005 Cash 265 Interest Revenue 265 Interest earned on bank balance

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Record Reconciling Items June 30, 2005 Electricity Expense 1,500 Cash 1,500 Monthly electricity expense June 30, 2005 Electricity Expense 1,500 Cash 1,500 Monthly electricity expense June 30, 2005 Accounts Receivable – NSF 200 Cash 200 NSF cheque returned by bank June 30, 2005 Accounts Receivable – NSF 200 Cash 200 NSF cheque returned by bank

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Record Reconciling Items June 30, 2005 Bank Service Fees 12 Cash 12 Bank service charges June 30, 2005 Bank Service Fees 12 Cash 12 Bank service charges

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Apply internal controls to cash receipts. Objective 4

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Receipts Over the Counter l The terminal should be positioned so that customers can see the amount the cashier enters into the cash register. l The cash drawer should open only when the sales clerk enters an amount on the keypad. l The roll of tape locked inside the machine records each sale and cash transaction.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Receipts Over the Counter l Pricing merchandise at “uneven” amounts means that the sales assistant has to open the cash drawer. l This requires entering the amount of the sale on the keypad and so onto the register.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Receipts Over the Counter l At the end of the day, the cashier deposits the cash in the bank. l The register record goes to accounting.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Receipts by Mail l All incoming mail should be opened by a mailroom employee. l This person should compare the cheques received with the remittance advice. l Cash receipts should be given to the cashier. l The mailroom employee forwards the remittance advice to accounting.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Receipts by Mail l Many companies use a bank direct deposit system. l Customers send their cheques directly to an address that is a bank account. Or use electronic funds transfer. l Company personnel do not handle the cash.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash24,980 Cash Short and Over 20 Sales Revenue 25,000 Daily cash sales Cash24,980 Cash Short and Over 20 Sales Revenue 25,000 Daily cash sales Cash Short and Over l Assume that the cash register tapes indicate sales revenue of $25,000. l However, the cash received was $24,980. l What entry would record the day’s sales?

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Apply internal controls to cash payments. Objective 5

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Control Over Approval of Payments Purchase Request Purchase Order Invoice Receiving Report Document Set

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Control Over Approval of Payments l The accounting department... – combines all of these documents, – checks them for accuracy, and... – forwards this document set to designated officers for approval and payment.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Controlling Petty Cash Payments l On June 15, Sahita Inc. manager decided to establish a $250 petty cash fund. l What is the entry? June 15, 2005 Petty Cash 250 Cash in Bank 250 To open the petty cash fund June 15, 2005 Petty Cash 250 Cash in Bank 250 To open the petty cash fund

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Controlling Petty Cash Payments l Ly is the petty cash custodian responsible for the fund. l On June 20, she purchased supplies in the amount of $70. l For each disbursement, she prepares a petty cash ticket. l At all times the amount of cash in the petty cash fund plus the petty cash tickets must equal $250.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Controlling Petty Cash Payments l Ly also spent $20 for delivery charges and $60 for coffee and other miscellaneous expenses. l What is the journal entry to record the replenishment of the fund?

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia June 30, 2005 Supplies70 Delivery Expense20 Miscellaneous Expense60 Cash in Bank150 To replenish the petty cash fund June 30, 2005 Supplies70 Delivery Expense20 Miscellaneous Expense60 Cash in Bank150 To replenish the petty cash fund Controlling Petty Cash Payments

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Using a budget to manage cash. Objective 6

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Budget Example l On June 1, the cash balance of Clara’s Boutique amounted to $20,000. l She expected collections during the month to be $100,000. l Clara budgeted $110,000 cash payments during the month. l She would like to keep a $20,000 balance at all times. l How much money must she borrow?

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Budget Example l Beginning balance$ 20,000  Budgeted collections 100,000  Cash available 120,000  Less budgeted payments 110,000  Cash balance 10,000 l She needs to borrow $10,000.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Budget Example l Not included in the budgeted collections is a US$13,000 sale to a store in America l She expects to collect this amount in July. l Assume the exchange rate is.65 l How much does she expect to collect? l US $13,000 /.65 = Aust. $20,000

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Make ethical judgments in business. Objective 7

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Ethics and Accounting l Most businesses have a code of ethics l CPAA and ICAA have a joint code of conduct l Decision guideline (page 306 text) ä What are the facts ä Identify the ethical issue ä Specify the alternatives ä Identify the stakeholders ä Assess the possible outcomes / consequences ä Make a decision.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Professional Code of Ethics l Accountants are held to very high standards of conduct. l There is no compromising. l Would you hire an accountant who is “almost always” honest? l Internal controls rely upon basic honesty and integrity.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Appendix The Voucher System l System for recording cash payments. l Improves internal control. l A voucher is a document authorising a cash payment. l The voucher system uses five sets of files or documents.

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia The Voucher System Vouchers Voucher Register Unpaid Voucher File Cheque Register Paid Voucher File The Voucher System

Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia End of Chapter 7