1. Cash and Internal Control
Chapter 6
Cash and Internal Control

2. Learning Objectives
LO1 Identify and describe the various forms of cash reported on a balance sheet.
LO2 Describe the various techniques that companies use to control cash.
LO3 Explain the importance of internal control to a business and the significance of the Sarbanes-Oxley Act of 2002.
LO4 Describe the basic internal control procedures.
LO5 Describe the various documents used in recording purchases and their role in controlling cash disbursements.

3. Module 1 Accounting and Controlling for Cash
There are various forms of cash and cash equivalents reported on the balance sheet
Companies use various techniques to control cash
Module 1

4. Cash Coin and currency on hand
Cash on deposit in the form of checking and savings accounts
Undeposited, cashier, and certified checks
Module 1: LO 1

5. Cash Equivalents Investment readily convertible to cash Example:
Maturity—three months or less
Example:
Commercial paper
Treasury bills issued by the federal government
Money market funds
Six-month bank certificate of deposit would not be a cash equivalent
Module 1: LO 1

6. Exhibit 6-1—Cash and Cash Equivalents on the Balance Sheet and the Statement of Cash Flows
Module 1: LO 1

7. Cash Management Tools of cash management Cash flows statement
Cash budgets
Bank reconciliations
Petty cash funds
Module 1: LO 2

8. Bank Statements Two principles of internal control for cash:
Cash receipts should be deposited intact daily
Cash payments should be made by check
Bank statement: a detailed list, provided by the bank, of all activity for a particular account during the month
Module 1: LO 2

9. Reading a Bank Statement
Outstanding check: a check written by a company but not yet presented to the bank for payment
Deposit in transit: a deposit recorded on the books but not yet reflected on the bank statement
Module 1: LO 2

10. Exhibit 6-2—Bank Statement
Module 1: LO 2

11. The Bank Reconciliation
Reconcile or resolve any differences between balance on the bank statement with balance shown in the accounting records
Steps used in preparing a bank reconciliation:
Prepare a list of the deposits in transit
Prepare a list of the outstanding checks
Prepare a list of credit memoranda
Prepare a list of debit memoranda
Identify any errors
Module 1: LO 2

12. Step 1: Prepare a List of the Deposits in Transit
Trace deposits listed on the bank statement to the books
Identify the deposits in transit
Any deposits recorded on the books but not yet shown on the bank statement
Add to the bank balance
Module 1: LO 2

13. Step 2: Prepare a List of the Outstanding Checks
Arrange the canceled checks in numerical order
Trace each of them to the books
Any checks recorded on the books but not yet listed on the bank statement are outstanding
Subtract from the bank balance
Module 1: LO 2

14. Step 3: Prepare a List of Credit Memoranda
Credit memoranda: additions on a bank statement for such items as interest paid and notes collected
List all items, other than deposits, shown as additions on the bank statement
Interest paid by the bank
Amounts collected by the bank for the customer
For these items, bank increases, or credits, its liability to the company on its own books
Module 1: LO 2

15. Step 3: Prepare a List of Credit Memoranda (continued)
List all items, other than deposits, shown as additions on the bank statement
Interest paid by the bank
Amounts collected by the bank for the customer
For these items, bank increases, or credits, its liability to the company on its own books
Module 1: LO 2

16. Step 3: Prepare a List of Credit Memoranda (continued)
List all items, other than deposits, shown as additions on the bank statement
Interest paid by the bank
Amounts collected by the bank for the customer
For these items, bank increases, or credits, its liability to the company on its own books
Module 1: LO 2

17. Step 4: Prepare a List of Debit Memoranda
Debit memoranda: deductions on a bank statement for items such as NSF checks and various service charges
Module 1: LO 2

18. Step 4: Prepare a List of Debit Memoranda (continued)
List all amounts, other than canceled checks, shown as subtractions on the bank statement
NSF checks
Service charges
A liability is created on the books of the bank when a company deposits money in a bank
Bank reduces the amount of its liability for these various items and debits the liability on its own books
Module 1: LO 2

19. Step 5: Identify Any Errors
Identify any errors made by the bank or by the company in recording cash transactions
Module 1: LO 2

20. Example 6-3—Recording Journal Entries from a Bank Reconciliation
Recognition of bank’s collection of a customer’s note, with interest
Module 1: LO 2

21. Example 6-3—Recording Journal Entries from a Bank Reconciliation (continued)
Record interest earned on checking account
Module 1: LO 2

22. Example 6-3—Recording Journal Entries from a Bank Reconciliation (continued)
Correction of error in recording purchase of supplies
Module 1: LO 2

23. Example 6-3—Recording Journal Entries from a Bank Reconciliation (continued)
Record customer’s NSF check
Module 1: LO 2

24. Example 6-3—Recording Journal Entries from a Bank Reconciliation (continued)
Recognize collection fee on note—charged by bank
Module 1: LO 2

25. Example 6-3—Recording Journal Entries from a Bank Reconciliation (continued)
Record rental charge on lockbox
Module 1: LO 2

26. Petty Cash Fund
Money kept on hand for making minor disbursements rather than by writing checks
Periodically, the fund is replenished
Module 1: LO 2

27. Example 6-4—Recording Journal Entries for a Petty Cash Fund
Establishment of petty cash fund
Module 1: LO 2

28. Example 6-4—Recording Journal Entries for a Petty Cash Fund (continued)
Replenishment of petty cash fund
Module 1: LO 2

29. Exhibit 6-3—Use of a Petty Cash Fund
Module 1: LO 2

30. Module 2 Internal Control
Companies must maintain an effective internal control system and use basic procedures to help make a system effective
The use of business documents can add to the effectiveness of an internal control system
Module 2

31. Internal Control System
Policies and procedures necessary to ensure:
Safeguarding of an entity’s assets
Reliability of accounting records
Accomplishment of overall company objectives
Module 2: LO 3

32. The Sarbanes-Oxley Act of 2002
An act of Congress in 2002
Intended to bring reform to corporate accountability and stewardship in the wake of a number of major corporate scandals
Module 2: LO 3

33. The Sarbanes-Oxley Act of 2002 (continued)
Internal control report: a report required by Section 404 of the Sarbanes-Oxley Act
Maintain an adequate internal control structure
Assesses effectiveness of internal control structure
Outside auditors must issue report on company’s internal control
Module 2: LO 3

34. The Sarbanes-Oxley Act of 2002 (continued)
Public Company Accounting Oversight Board (PCAOB): five-member body created by SOX
Set auditing standards in the United States
Board of directors: consists of key officers of a corporation and outside members responsible for general oversight of the affairs of the entity
Audit committee: a subset of the board of directors
Provides direct contact between the stockholders and the independent accounting firm
Module 2: LO 3

35. The Control Environment
Factors that influence internal control
Management’s competence and operating style
Personnel policies and practices
Board of directors, particularly audit committee
Module 2: LO 3

36. Exhibit 6-4—Management Report on Internal Control—Regal Entertainment
Module 2: LO 3

37. The Accounting System
Methods and records used to accurately report entity’s transactions and maintain accountability for assets and liabilities
Use of a journal is an integral part of all accounting systems
Can be completely manual, fully computerized, or a mixture of both
Module 2: LO 3

38. Internal Control Procedures
Administrative controls
Procedures concerned with efficient operation of the business and adherence to managerial policies
Accounting controls
Procedures concerned with safeguarding the assets or the reliability of the financial statements
Module 2: LO 4

39. Important Internal Control Procedures
Proper authorizations
Segregation of duties
Independent verification
Safeguarding of assets and records
Independent review and appraisal
Design and use of business documents
Module 2: LO 4

40. Limitations on Internal Control
Not totally foolproof
Does not ensure prevention of collusion
Maintenance of controls can be costly
Small businesses cannot afford
Human errors can weaken the system
Misunderstood instructions, carelessness, fatigue, and distraction can lead to errors
Module 2: LO 4

41. Computerized Business Documents and Internal Control
All cash receipts should be deposited intact in the bank on a daily basis
Intact means that no disbursements should be made from the cash received from customers
All cash disbursements should be made by check
Module 2: LO 5

42. Control Over Cash Receipts
Most merchandisers receive checks and currency from customers in two ways:
Cash received over the counter
Cash received in the mail
Cash discrepancies
Discrepancies occur occasionally due to theft by dishonest employees and to human error
Module 2: LO 5

43. The Role of Computerized Business Documents in Controlling Cash Disbursements
Purchase requisition form
A form a department uses to initiate a request to order merchandise
Purchase order
A form sent by the purchasing department to the supplier
Invoice
A form sent by the seller to the buyer as evidence of a sale
Module 2: LO 5

44. Exhibit 6-6—Document Flow for the Purchasing Function
Module 2: LO 5

45. Exhibit 6-7—Purchase Requisition
Module 2: LO 5

46. Exhibit 6-8—Computer-Generated Purchase Order
Module 2: LO 5

47. Exhibit 6-9—Invoice
A form sent by the seller to the buyer as evidence of a sale
Module 2: LO 5

48. Blind Receiving Report
A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier
Module 2: LO 5

49. Exhibit 6-10—Computer-Generated Receiving Report
Module 2: LO 5

50. Exhibit 6-11—Invoice Approval Form
A form the accounting department uses before making payment to document the accuracy of all information about a purchase
Module 2: LO 5

51. Exhibit 6-12—Check with Remittance Advice
A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier
Module 2: LO 5

52. Review
LO1 Identify and describe the various forms of cash reported on a balance sheet.
Cash can take many forms; however, the key attribute is that the asset is readily available to pay debts.
Cash equivalents are investments that are readily convertible to a known amount of cash. Readily means three months or less.

53. Review
LO2 Describe the various techniques that companies use to control cash.
The liquidity of cash makes controls over it very important to have in place.
Cash management means managing the need to have enough cash on hand to ensure cash flow needs but not so much that excess funds earn little return and may be vulnerable to misappropriation.
Bank reconciliations use third-party documents (bank statements) to reconcile differences between the amount in the bank and on the books. Done by an independent party, bank reconciliations are effective control procedures.
Petty cash funds are an effective way to minimize access to large cash accounts to pay for relatively small expenditures.

54. Review
LO3 Explain the importance of internal control to a business and the significance of the Sarbanes-Oxley Act of 2002.
The Sarbanes-Oxley Act of 2002 required publicly traded companies to improve the documentation and functioning of their internal controls.
Management must now render an opinion on the efficiency of the company’s internal control system. A strong control environment is a must for companies.
Auditors also must increase their documentation and understanding of the internal controls of their clients.
Significant amounts of resources have been devoted to comply with the provisions of Sarbanes-Oxley.

55. Review LO4 Describe the basic internal control procedures.
Control procedures are actions that company personnel take to make sure that policies set forth by management are followed.
Important accounting controls are concerned with safeguarding assets and producing accurate and timely financial statements. They include:
Proper authorizations—only certain personnel may authorize transactions.
Segregation of duties—physical custody of assets must not be combined with the ability to account for those assets.
Independent verification—for example, an inventory count.
Safeguarding of assets and records—both must be adequately protected.
Independent review and appraisal—done primarily by internal audit.
Design and use of business documents—source document control.

56. Review
LO5 Describe the various documents used in recording purchases and their role in controlling cash disbursements.
The documents used to record purchase transactions are instrumental in controlling both cash and inventory.
The document flow diagram in Exhibit 6-6 provides an excellent summary of documents in the purchasing process. Some of the key documents are as follows:
Purchase order
Receiving report
Vendor invoice
Check

57. End of Chapter 6