8 – Internal Control & Cash 8 – Internal Control & Cash After studying this chapter, you should be able to: Objective 2 - Describe the objectives of internal control. Objective 3 - Describe and illustrate the application of internal controls to cash. Objective 4 - Describe and illustrate the application of internal controls to cash. Objective 5 - Describe and illustrate the use of a bank reconciliation in controlling cash. Objective 6 - Describe the accounting for special-purpose cash funds.

Objective 2 To provide reasonable assurance that: Objectives of Internal Control 8-2 To provide reasonable assurance that: assets are safeguarded and used for business purposes, business information is accurate, and employees comply with laws and regulations.

Example of control procedures for an all-night convenience store: 8-2 Example of control procedures for an all-night convenience store: Locate the cash register near the door, so that it is fully visible from outside the store; have two employees work late hours; employ a security guard. Deposit cash in the bank daily, before 5 p.m. Keep only small amounts of cash on hand after 5 p.m. by depositing excess cash in a store safe that can’t be opened by employees on duty. Install cameras and alarm systems.

Warning Signs With Regard to People Indicators of Internal Control Problems 8-2 Warning Signs With Regard to People Abrupt change in lifestyle. Close social relationships with suppliers. Refusing to take a vacation. Frequent borrowing from other employees. Excessive use of alcohol or drugs.

Warning Signs from the Accounting System Indicators of Internal Control Problems 8-2 Warning Signs from the Accounting System Missing documents or gaps in transaction numbers. An unusual increase in customer refunds. Differences between daily cash receipts and bank deposits. Sudden increase in slow payments. Backlog in recording transactions.

Describe and illustrate the application of internal controls to cash. Objective 3 Describe and illustrate the application of internal controls to cash. 8-3 Control of Cash Receipts One of the most important controls to protect cash received in over-the-counter sales is a cash register. Change Fund A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund.

Cash Short and Over 8-3 Cash sales for March 19 totaled $3,150.00 per the cash register tape. After removing the change fund, only $3,142.00 was on hand. Mar 19 Cash 3 142 00 Cash Short and Over 8 00 Sales 3 150 00 To record cash sales and actual cash on hand. Note that the shortage (an expense) was debited to Cash Short and Over. If there were a surplus (i.e. a revenue), the there would be a credit to Cash Short and Over.

Electronic Funds Transfers – ensure some kind of control over cash 8-3 Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills.

Describe the nature of a bank account and its use in controlling cash. Objective 4 Describe the nature of a bank account and its use in controlling cash. 8-4 Use of Bank Accounts A major reason that businesses use bank accounts is for control purposes. Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions.

Bank Statement 8-4 A summary received from the bank of all checking account transaction is called a bank statement.

Bank Statement 8-4

Bank Statement 8-4 (Concluded)

EC — Error correction to correct bank error. 8-4 Typical credit or debit memorandum entries found on the bank statement: EC — Error correction to correct bank error. NSF — Not sufficient funds check. SC — Service charge. ACH — Automated Clearing House entry for electronic funds transfer. MS — Miscellaneous items.

8-4 - Example Exercise 8-2 The following items may appear on a bank statement: (1) NSF check (2) EFT Deposit Service Charge Bank correction of an error from recording a $400 check drawn by the depositor as $40. Indicate whether the item would appear as a debit or credit memorandum on the bank statement and whether the item would increase or decrease the balance of depositor’s account.

Appears on the Bank Statement as a Debit or Credit Memorandum 8-4 Follow My Example 8-2 Appears on the Bank Statement as a Debit or Credit Memorandum Increases or Decreases the Balance of the Depositor’s Bank Account Item No. (1) Debit Memorandum Decreases (2) Credit Memorandum Increases (3) Debit Memorandum Decreases (4) Debit Memorandum Decreases For Practice: PE 8-2A, PE 8-2B

8-4 Power Networking’s Records and Bank Statement 8-4 Power Networking’s Records and Bank Statement Power Networking should determine the reason for difference in these two amounts.

Objective 5 8-5 Describe and illustrate the use of a bank reconciliation in controlling cash. A bank reconciliation is an analysis of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger in order to determine the adjusted cash balance.

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Power Network prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of $3,359.78. The company’s Cash account has a July 31 balance of $2,549.99.

A deposit of $816.20 did not appear on the bank statement. 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 A deposit of $816.20 did not appear on the bank statement.

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Three checks that were written during the period did not appear on the bank statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60.

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 The bank returned a check for $300 from Power Networking’s customer (Thomas Ivey) because of insufficient funds (NSF).

The bank service charges totaled $18.00. 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 Bank service charges 18.00 The bank service charges totaled $18.00.

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327.00 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

Bank’s records Company’s records 8-5 Bank’s records Company’s records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327.00 Adjusted balance $2,630.99 Adjusted balance $2,630.99

8-5

Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation. 8-5 Company’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327.00

8-5 Entry to Record Plus Items July 31 Cash 408 00 Entry to Record Plus Items 8-5 July 31 Cash 408 00 Notes Receivable 400 00 Interest Income 8 00 Note collected by bank.

8-5 Entry to Record Minus Items July 31 Cash 408 00 Entry to Record Minus Items 8-5 July 31 Cash 408 00 Note collected by bank. Notes Receivable 400 00 Interest Income 8 00 31 Accounts Receivable—Thomas Ivey 300 00 Miscellaneous Expense 18 00 Accounts Payable—Taylor Co. 9 00 Cash 327 00 NSF check, bank service charges, and error in recording Check no. 879.

Balance per company records 13,875 Bank service charges 75 8-5 Example The following data was gathered to use in reconciling the bank account of Photo Op. Balance per bank $14,500 Balance per company records 13,875 Bank service charges 75 Deposit in transit 3,750 NSF check 800 Outstanding checks 5,250 What is the adjusted balance on the bank reconciliation? Journalize any necessary entries for Photo OP based upon the bank reconciliation.

Describe the accounting for special-purpose cash funds. Objective 6 Describe the accounting for special-purpose cash funds. 8-6 It is usually not practical for a business to write checks to pay small amounts. Thus, it is desirable to control such payments by using a special cash fund, called a petty cash fund.

8-6 On August 1, issued Check No. 511 for $500 to established a petty cash fund. JOURNAL Page 9 Post. Ref. Date Description Debit Credit 2008 Aug. 1 Petty Cash 500 00 Cash 500 00 Established petty cash fund issuing Check 511.

8-6 At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, $380, postage (office supplies), $22; store supplies, $35, and miscellaneous administrative items, $30. Aug. 31 Office Supplies 402 00 Store Supplies 35 00 Miscellaneous Administrative Exp. 30 00 Cash 467 00 Replenished petty cash fund. Replenishing the petty cash fund physically restores it to its original amount of $500. Note that no entry to Petty Cash is required when the fund is replenished.

8-6 Example Exercise 8-4 Prepare journal entries for each of the following; Issued check to establish a petty cash fund of $500. The amount of cash in the petty cash fund is currently $120. Issued a check to replenish the fund based on the following summary of petty cash receipts: office supplies, $300 and miscellaneous administrative expense, $75. Record any missing or additional funds in the cash short and over account.

8-6 Example Petty Cash 500 Cash 500 Office Supplies 300 Miscellaneous Admin. Expense 75 Cash Short and Over 5 Cash 380