5-1 Electronic Presentation by Douglas Cloud Pepperdine University Carl S.Warren Survey of Accounting

5-2 Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

5-3 Internal Control and Cash Chapter 5

5-4 1.Describe and illustrate the objectives and elements of internal control. 2.Describe and illustrate methods of preventing and detecting employee fraud. 3.Describe and illustrate the application of internal controls to cash. 4.Describe the nature of a bank account and its use in controlling cash. Learning Objectives After studying this chapter, you should be able to: ContinuedContinued

5-5 5.Describe and illustrate the use of a bank reconciliation in controlling cash. 6.Describe the accounting for special-purpose cash funds. 7.Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 8.Describe, illustrate, and interpret the cash flow to net income ratio and the cash to monthly cash expenses ratio. Learning Objectives

5-6 1 Learning Objective Describe and illustrate the objectives and elements of internal control.

5-7 Internal controls help businesses guide their operations and prevent abuses.

5-8 Objectives of Internal Control 1.Assets are safeguarded and used for business purposes. 2.Business information is accurate. 3.Employees comply with laws and regulations.

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5-11 Control Environment The control environment is the overall attitude of management and employees about the importance of controls.

5-12 Risk Assessment  Changes in customer requirements  Competitive threats  Changes in economic factors  Employee violations of company policies and procedures Risk includes:

5-13 Control Procedures Control procedures are established to provide reasonable assurance that business goals will be achieved, including the prevention of fraud.

5-14 Control Procedures Competent personnel Rotating duties Mandatory vacations Separating responsibilities for related operations Separate operations Custody of assets Accounting proofs Security measures Monitoring the internal control system

5-15 Security Measures Locate the cash register near the door, so that it is fully visible from outside the store.

5-16 Security Measures Have two employees work late hours. Employ a security guard

5-17 Security Measures Deposit cash in bank daily before 5 p.m.

5-18 Security Measures 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.

5-19 Security Measures Install cameras and alarm systems.

5-20 Warning Signs With Regard to People 1.Abrupt change in lifestyle. 2.Close social relationship with suppliers. 3.Refusing to take a vacation. 4.Frequent borrowing from other employees. 5.Excessive use of alcohol or drugs.

5-21 Warning Signs From the Accounting System 1.Missing documents or gaps in transaction numbers. 2.An unusual increase in customer fraud. 3.Differences between daily cash receipts and bank deposits. 4.Sudden increase in slow payments. 5.Backlog in record transactions.

5-22 Describe and illustrate methods of preventing and detecting employee fraud. 2 Learning Objective

5-23 Elements Common to Most Employee Fraud  An employee’s perceived financial need

5-24 Elements Common to Most Employee Fraud  An opportunity to use a fraudulent scheme to satisfy the need

5-25 Elements Common to Most Employee Fraud  A rationalization that the fraud is justified

5-26 Preventive Controls Company Assets The company assets should be controlled in such a way that an employee’s ability to steal the assets is limited.

5-27 Preventive Controls Proper authorization and approval procedures can be effectively used to prevent employee fraud.

5-28 Detective Controls  Periodic reviews of the accounting records are useful in identifying unusual transactions or accounts for further investigation.  Independent checks are useful in detecting employee fraud.  Reconciliations are useful in detecting employee theft.

5-29 Risk Factors Relating to Employee Fraud  Lack of proper record keeping for assets susceptible to theft.  Lack of proper segregation of duties.  Lack of independent checks.

5-30 Risk Factors Relating to Employee Fraud  Lack of a proper system of authorization.  Lack of proper physical safeguarding of assets susceptible to theft.  Lack of timely and proper documentation for transactions.

5-31 Risk Factors Relating to Employee Fraud  Lack of a proper management oversight.  Lack of proper screening procedures for employees in sensitive positions.  Lack of mandatory vacations for employees in sensitive position.

5-32 Describe and illustrate the application of internal controls to cash. 3 Learning Objective

5-33 What is Cash? Cash includes coins, currency (paper money), checks, money orders, and money on deposit that is available for unrestricted withdrawal.

5-34 Control of Cash Receipts One of the most important controls to protect cash received in over- the-counter sales is the cash register.

5-35 Control of Cash Receipts After a cash register clerk’s cash has been counted and recorded on a memorandum form, the cash is then placed in a store safe until it can be deposited in the bank.

5-36 Control of Cash Receipts The employee who opens the mail should initially compare the amount of cash received with the amount shown on the remittance advice.

5-37 Control of Cash Receipts The employee opening the mail normally also stamps the checks and money orders “For Deposit Only” in the bank account of the business.

5-38 Control of Cash Receipts When cash is deposited in the bank, the bank cashier normally stamps a duplicate copy of the deposit ticket. This bank receipt is returned to the Accounting Department for comparison and recording.

5-39 Control of Cash Payments A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. A voucher is any document that serves as proof of authority to pay cash.

5-40 Describe the nature of a bank account and its use in controlling cash. 4 Learning Objective

5-41 A summary of all checking account transactions, called a bank statement, is mailed to the depositor each month. It shows the beginning balance, additions, deductions, and the balance at the end of the period.

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5-43 Businesses usually require that all cash receipts be initially deposited in the bank account.

5-44 Likewise, businesses usually use checks or bank account transfers to make all cash payments. Except very small ones.

5-45 Describe and illustrate the use of a bank reconciliation in controlling cash. 5 Learning Objective

5-46 A bank reconciliation is a listing of the items and amounts that cause the cash balance reported in the bank statement…

5-47 …to differ from the balance of the cash account in the ledger.

5-48 Steps in a Bank Reconciliation 1.Compare cash deposit listed on the bank statement with unrecorded deposits appearing in the preceding period’s reconciliation and with deposit receipts or other records of deposits. Cash balance according to bank statement: Add deposits not on bank statement

5-49 Steps in a Bank Reconciliation 2.Compare paid checks with outstanding checks appearing on the preceding period’s reconciliation and with recorded checks. Cash balance according to bank statement: Deduct outstanding checks: No. 1512xxx No. 1515xxx No. 1521xxxx

5-50 Steps in a Bank Reconciliation 3.Compare bank credit memorandums to the accounting records. Cash balance according to depositor’s record: Add note and interest collect by bank

5-51 Steps in a Bank Reconciliation 4.Compare bank debit memorandums to records of cash payments. Cash balance according to depositor’s record: Deduct: Check returned because of insufficient funds Bank service charge

5-52 Steps in a Bank Reconciliation 5.List any errors discovered during the preceding steps. Cash balance according to depositor’s record: Deduct: Error in recording Check No Assume that Check No was written for $193 and recorded as $139.

5-53 Typical Journal Entries Entries are based only on the information from the depositor’s side of the reconciliation.

5-54 Describe the accounting for special-purpose cash funds. 6 Learning Objective

5-55 It is usually not practical for a business to write checks to pay small amounts, like postage.

5-56 To control these small payments, a petty cash fund is used. This is a small cash fund under the control of a petty cashier.

5-57 If a secretary needs a book of stamps, the secretary signs a voucher that provides a description and amount in exchange for the necessary cash.

5-58 The petty cashier places the voucher in a locked drawer for later reconciliation and recording.

5-59 Most businesses use a payroll bank account to pay employees. This is known as a special-purpose fund.

5-60 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 7 Learning Objective

5-61 A company may have cash in excess of operating needs. These funds are placed in highly liquid investments and are called cash equivalents.

5-62 Examples of Cash Equivalents  Commercial paper  Certificates of deposit  U.S. government and agency securities  Corporate notes and bonds  Municipal securities

5-63 Describe, illustrate, and interpret the cash flow to net income ratio and the cash to monthly cash expense ratio. 8 Learning Objective

5-64 Ratio of Cash Flow to Net Income $151,250 $83,725 Net cash flow from operations From the statement of cash flows

5-65 Ratio of Cash Flow to Net Income $151,250 $83,725 Net income From the income statement Cash flow ratio = 1.81

5-66 Ratio of Cash to Monthly Cash Expenses Cash at the end of the year $38,450 $12,604

5-67 Ratio of Cash to Monthly Cash Expenses $38,450 $12,604 Net cash flow from operations per month From the statement of cash flows $151, = $12,604 Ratio of cash to monthly expenses = 3.05

5-68 The End Chapter 5

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