Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Edited by: Carolyn Doering, HHSS Weygandt · Kieso · Kimmel · Trenholm

INTERNAL CONTROL AND CASH CHAPTER 8

Internal control consists of the policies and procedures adopted within a business in order to: 1. Optimize resources 2. Prevent and detect errors and irregularities 3. Safeguard its assets 4. Maintain the accuracy and reliability of its accounting records INTERNAL CONTROL

Authorization Segregation of duties Documentation procedures Safeguarding assets and records Independent verification ILLUSTRATION 8-1 PRINCIPLES OF INTERNAL CONTROL

Authorization of transactions and activities: Authorization by the proper individual is important. Control is most effective when only one person is responsible for a given task. Segregation of duties: The work of one employee should provide a reliable basis for evaluating the work of another employee. PRINCIPLES OF INTERNAL CONTROL

Documentation procedures: Documents should provide evidence that transactions and events have occured. Safeguards to control access to, and use of, assets and records: Physical, mechanical, and electronic controls relate primarily to the safeguarding of assets and enhancing accuracy and reliability of the accounting records. PRINCIPLES OF INTERNAL CONTROL

Independent verification: External verification indicates whether the company’s financial statements fairly present its financial position and results of operations in accordance with GAAP and IFRS Internal verification involves review, comparison, and reconciliation of information from two sources. PRINCIPLES OF INTERNAL CONTROL

Independent Internal Verification ILLUSTRATION 8-3 RELATIONSHIP BETWEEN SEGREGATION OF DUTIES AND INDEPENDENT INTERNAL VERIFICATION ILLUSTRATION 8-3 RELATIONSHIP BETWEEN SEGREGATION OF DUTIES AND INDEPENDENT INTERNAL VERIFICATION Accounting Employee AAssistant Cashier B Assistant Controller C Maintains cash balances Maintains custody of per books cash on hand Makes monthly comparisons: reports any irreconcilable differences to Controller Segregation of Duties

LIMITATIONS OF INTERNAL CONTROL Cost/benefit Collusion Size of business Human element

Cash includes coins, currency, cheques, money orders, and money on hand or on deposit at a bank or similar depository. Internal control over cash is imperative in order to safeguard cash and assure the accuracy of the accounting records for cash. CASHCASH

Only designated personnel should be authorized to handle or have access to cash receipts. Different individuals should: 1. receive cash 2. record cash receipt transactions 3. have custody of cash CONTROL OVER CASH RECEIPTS

Documents should include: 1. remittance advices 2. cash register tapes 3. deposit slips Cash should be stored in safes and bank vaults. Access to storage areas should be limited to authorized personnel. Cash registers should be used in executing over-the-counter receipts. CONTROL OVER CASH RECEIPTS

Daily cash counts and daily comparisons of total receipts should be made. All personnel who handle cash receipts should be bonded and required to take vacations. An important tool in control of over-the- counter receipts is cash registers that are visible to customers. CONTROL OVER CASH RECEIPTS

Payments are made by cheque rather than by cash, except for petty cash transactions. Only specified individuals should be authorized to sign cheques. Different departments or individuals should be assigned the duties of approving an item for payment and paying it. CONTROL OVER CASH DISBURSEMENTS

Prenumbered cheques should be used and each cheque should be supported by an approved invoice or other document. Blank cheques should be stored in a safe. 1. Access should be restricted to authorized personnel. 2. A cheque writer machine should be used to imprint the amount on the cheque in indelible ink. CONTROL OVER CASH DISBURSEMENTS

Each cheque should be compared with the approved invoice before it is issued. Following payment, the approved invoice should be stamped PAID. Paid CONTROL OVER CASH DISBURSEMENTS

A petty cash fund is used to pay relatively small amounts. Operation of the fund, often called an imprest system, involves 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund. Accounting entries are required when 1. the fund is established, 2. the fund is replenished, and 3. the amount of the fund is changed. PETTY CASH FUND

ESTABLISHING THE FUND When the fund is established, a cheque payable to the petty cash custodian is issued for the stipulated amount

REPLENISHING THE FUND On March 15 the petty cash custodian requests a cheque for $87. The fund contains $13 cash and petty cash receipts for postage, $44, freight out, $38, and miscellaneous expenses, $5. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Mar. 15Postage Expense Freight Out Miscellaneous Expense Cash To replenish petty cash fund

REPLENISHING THE FUND (Cash Short or Over) REPLENISHING THE FUND (Cash Short or Over) On March 15 the petty cash custodian requests a cheque for $88. The fund contains $12 cash and petty cash receipts for postage, $44, freight out, $38, miscellaneous expenses, $5, and Cash Short $1. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Mar. 15Postage Expense Freight Out Miscellaneous Expense Cash Over and Short Cash To replenish petty cash fund

The use of a bank minimizes the amount of currency that must be kept on hand and contributes significantly to good internal control over cash. A company can safeguard its cash by using a bank as a depository and clearing house for cheques received and cheques written. USE OF A BANK

BANK STATEMENTS ACCOUNT W. A. LEE COMPANYStatement Date/Credit STATEMENT 500 QUEEN STREETLine Closing Date FREDERICTON, NB, E3B 5C2April 30, ACCOUNT NUMBER Balance Deposits and CreditsCheques and Debits Balance Last Statement No.Total Amount This Statement 13, , , , DEPOSITS AND CHEQUES AND DEBITSCREDITSDAILY BALANCE DateNo.AmountDateAmountDateAmount , , , , , , , , , , , , , CM1, , , , , , , , , , ============================================ 4-29NSF , , , , , DM , , Symbols:CMCredit MemoECError CorrectionNSFNot Sufficient FundsReconcile Your DMDebit MemoINTInterest EarnedSCService ChargeAccount Promptly A bank statement shows: 1. cheques paid and other debits charged against the account 2. deposits and other credits made to the account 3. account balance after each day’s transactions A bank statement shows: 1. cheques paid and other debits charged against the account 2. deposits and other credits made to the account 3. account balance after each day’s transactions

RECONCILING THE BANK ACCOUNT Reconciliation is necessary because the balance per bank and balance per books are seldom in agreement due to time lags and errors. A bank reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.

Reasons to Reconcile Deposits in transit Deposits recorded by depositor that have not been recorded by bank Outstanding cheques Cheques written (issued) and recorded by company that have not been presented to/paid by bank Adjusted balance Reconciled or correct cash balance

Reasons to Reconcile con’t. Debit memoranda Charges against depositor’s account (e.g. service charges, RC (returned)/NSF (insufficient funds) cheques) Credit for your bank account! Credit memoranda Amounts that increase depositor’s account (e.g., interest earned) Debit for your bank account!

Bank Reconciliation Procedures $ Per Bank Statement -outstanding cheques +deposits in transit +/- bank errors = correct cash amount $ Per Books -NSF cheques -cheque printing or other service charges +notes collected by bank +/- book errors = correct cash amount Illustration 8-11

Reconciling Journal Entries Books Each reconciling item in determining the adjusted balance per books MUST be journalized and posted Bank Do NOT journalize any entries on bank side

Cash reported on the Balance Sheet includes: 1. Cash on hand 2. Cash in banks 3. Petty cash Cash is listed first in the balance sheet because it is the most liquid asset. REPORTING CASH

Cash equivalents are highly liquid investments, with maturities of three months or less when purchased, that can be converted into a specific amount of cash. Examples include money market funds, short-term notes, and treasury bills. CASH EQUIVALENTS

USING THE INFORMATION IN THE FINANCIAL STATEMENTS Most important asset Pervasive impact Vulnerable to theft or misuse Balancing act needed to ensure sufficient, but not excess, quantity

USING THE INFORMATION IN THE FINANCIAL STATEMENTS Cash Flow Statement : shows where cash came from and what is was used for. Management report: states management’s responsibility for internal controls.

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