Chapter 7

2 Chapter 7 Internal Control and Cash After studying Chapter 7, you should be able to: zIdentify the principles of internal control. zExplain the application of internal control to cash receipts. zExplain the application of internal control to cash disbursements. zPrepare a bank reconciliation. zExplain the reporting of cash. zDiscuss the basic principles of cash management. zIdentify the primary elements of a cash budget.

3 Internal Control consists of... all the related methods and measures adopted within a business to: ysafeguard its assets from: xEmployee theft xRobbery xUnauthorized Use yenhance accuracy and reliability of its accounting records by reducing: xRisk of Errors xIrregularities

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5 Establishment of Responsibility Control is most effective when only one person is responsible for a given task.

6 Segregation of Duties Responsibility for related activities should be assigned to different individuals Responsibility for record keeping for an asset should be separate from the physical custody of the asset

7 Documentation zProvide evidence that transactions and events occurred: yShipping documents ySales invoices

8 Documentation Procedures zDocuments should be pre-numbered. zAll documents should be accounted for. zSources documents should be promptly forwarded to accounting department.

9 Physical, Mechanical and Electronic Controls OR FINGERPRINT, EYEBALL Scan

10 Independent Internal Verification Involves review, comparison, and reconciliation of data prepared by employees Verification should be made periodically or on surprise basis Verification should be done by employee who is independent of the personnel responsible for the information Discrepancies and exceptions should be reported to management

11 Independent Internal Verification

12 Other Controls zBonding of employees who handle cash zRotating employee’s duties and requiring employees to take vacations

13 Limitations of Internal Controls zCost/Benefit - cost of establishing procedure should not exceed expected benefit zHuman element - fatigue, carelessness, indifference zCollusion - two or more individuals who work together to get around controls zSize of business

14 Cash consists of... zcoins zcurrency zchecks zmoney orders zmoney on hand zdeposits in bank

15 Cash is the most desirable asset... because it is readily convertible into any other asset.

16 Page 297 in book Internal Control Over Cash Receipts

17 Internal Control Over Cash Disbursements

18 Electronic Funds Transfer (EFT) zAn approach to transfer funds among parties without paper (deposit tickets, checks, etc.) zEFT uses wire, telephone, telegraph or computer to transfer from one location to another.

19 Petty Cash Fund is a cash fund used to pay relatively small amounts

20 Use of a Bank... zis good internal control. zminimizes the amount of cash that must be kept on hand. zprovides a double record of all bank transactions yone by the business yone by the bank zhelps a company safeguard its cash by using a bank as a depository and clearinghouse for checks received and written.

21 Bank Statement shows check & other debits deposits & other credits daily cash balance Bank Statement - a copy of the bank’s records sent to the customer for periodic review. Apri l 30, 2004

22 Company Balance and Bank Balance of Cash Usually Differ Because... zTime lags that prevent one of the parties from recording the transaction in the same period. yDays pass between the time a check is written and dated and date it is paid by the bank. yA day may pass between the time receipts are recorded by the company and the time they are recorded by the bank. yA time lag may occur when the bank mails a debit or credit memo to the company. zErrors by either party in recording transactions.

23 Reconciliation Procedure zreconcile balance per books and balance per bank to their adjusted or correct balances. zthe reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.

24 Terms zDeposits in transit - deposits recorded by the depositor that have not yet been recorded by the bank. zOutstanding checks - checks issued and recorded by the company that have not yet been paid by the bank. zNSF check - a check that is not paid by the bank because of insufficient funds in the customer’s bank account. zAdjusted balance - same as true cash balance, correct cash balance

Bank Reconciliation Procedures $ Per Bank Statement -outstanding checks +deposits +/- bank errors correct cash amount $ Per Books -NSF Checks -check printing or other service charge +notes collected by bank correct cash amount

W.A. Laird Company Bank Reconciliation April 30, 2004 Cash balance per bank statement15, Add: Deposits in transit 2, , Less: Outstanding checks No. 4533, No. 4571, No. 4601, , Adjusted cash balance per bank12, Cash balance per books11, Add: Collection of N/R for $ 1,000 plus interest earned $50, less collection fee $ 151, Error on recording check No , , Less:NSF check Bank service charge Adjusted cash balance per bank12, Illustration 7-9

27 Each reconciling item in determining the adjusted balance per books must be journalized and posted. For Cash To Show the Correct Balance

W.A. Laird Company Bank Reconciliation April 30, 2004 Cash balance per bank statement15, Add: Deposits in transit 2, , Less: Outstanding checks No. 4533, No. 4571, No. 4601, , Adjusted cash balance per bank12, Cash balance per books11, Add: Collection of N/R for $ 1,000 plus interest earned $50, less collection fee $ 151, Error on recording check No , , Less:NSF check Bank service charge Adjusted cash balance per bank12, Illustration 7-9

Apr 30 Cash 1, Miscellaneous Expense Notes Receivable 1, Interest Revenue Apr 30Cash Accounts Payable Apr 30Accounts Receivable-Baron Cash Apr 30Miscellaneous Expense Cash JOURNAL

30 Reporting Cash zCash is recorded in both the balance sheet and the statement of cash flows. zThe balance sheet shows the amount of cash available at a given point in time. zThe statement of cash flows shows the sources and uses of cash during a period of time.

31 Cash Equivalents zReadily convertible to known amount of cash zSo near maturity that their market value is relatively insensitive to changes in interest rates zExamples: yTreasury bills yCommercial paper yMoney market funds

32 Restricted Cash... zIs cash that is not available for general use. zIs set aside for special purpose.  If not to be used within next year, report as noncurrent asset.

Operating Cycle of a Merchandising Company…is the average time it takes to go from cash to cash in producing revenues.

34 Principles of Cash Management zIncrease the speed of collection on receivables. zKeep inventory levels low. zDelay payment of liabilities. zPlan the timing of major expenditures. zInvest idle cash.

35 Reporting Cash zCash on hand, cash in banks, and petty cash are often combined and reported as cash. zCash is the most liquid asset and listed first in the current asset section of the balance sheet.

36 Cash Budget zCash is vital. zPlanning the company's cash needs is a key business activity. zCash budget shows the anticipated cash flows, over a 1 to 22-year period.

37 Cash Budget The cash budget contains : zCash receipts section; zCash disbursements section; zFinancing section.

38 Cash Receipts Section zincludes expected receipts from the company's principal source(s) of revenue, such as cash sales and collections from customers on credit sales zalso shows anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock

39 Cash Disbursements Section zshows expected payments for direct materials, direct labor, manufacturing overhead, and selling and administrative expenses zincludes projected payments for income taxes, dividends, investments, and plant assets

40 Financing Section shows... òexpected borrowings òthe repayment of the borrowings and interest