1. Internal Control and Cash Financial Accounting, Sixth Edition
Chapter 8
Internal Control and Cash
Financial Accounting, Sixth Edition

2. Study Objectives Define internal control.
Identify the principles of internal control.
Explain the applications of internal control principles to cash receipts.
Explain the applications of internal control principles to cash disbursements.
Describe the operation of a petty cash fund.
Indicate the control features of a bank account.
Prepare a bank reconciliation.
Explain the reporting of cash.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

3. Internal Control and Cash
Cash Controls
Use of a Bank
Reporting Cash
The Sarbanes-Oxley Act
Principles
Limitations
Control over cash receipts
Control over cash disbursements
Making deposits
Writing checks
Bank statements
Reconciling the bank account
Cash equivalents
Restricted cash
Compensating balances
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

4. Internal Control Methods and measures adopted to: Safeguard assets.
Enhance accuracy and reliability of accounting records. Reduce risk of:
Errors (unintentional)
Irregularities (intentional)
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control.
SO 1 Define internal control.

5. The Sarbanes-Oxley Act
Internal Control
The Sarbanes-Oxley Act
Companies must
develop principles of control over financial reporting.
continually verify that controls are working.
Independent auditors must attest to the level of internal control.
SOX created the Public Company Accounting Oversight Board (PCAOB).
SO 1 Define internal control.

6. Principles of Internal Control
Illustration 8-1
Measures vary with
size and nature of the business.
management’s control philosophy.
SO 2 Identify the principles of internal control.

7. Principles of Internal Control
ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible for a given task.
SEGREGATION OF DUTIES
Related duties should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents and all documents should be accounted for.
SO 2 Identify the principles of internal control.

8. Mechanical and Electronic
Internal Control
Principles of Internal Control
Illustration 8-3
PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS
Physical
Mechanical and Electronic
SO 2 Identify the principles of internal control.

9. Principles of Internal Control
INDEPENDENT INTERNAL VERIFICATION
Records periodically verified by an employee who is independent.
Discrepancies reported to management.
OTHER CONTROLS
Bond employees.
Rotate employees’ duties and require vacations.
Conduct background checks.
SO 2 Identify the principles of internal control.

10. Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
SO 2 Identify the principles of internal control.

11. Internal Control over Cash Receipts
Cash Controls
Illustration 8-5
Internal Control over Cash Receipts
Establishment of Responsibility
Only designated personnel are authorized to handle cash receipts (cashiers)
Documentation Procedures
Use remittance advice (mail receipts), cash register tapes, and deposit slips
Independent Internal Verification
Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily
Segregation of Duties
Different individuals receive cash, record cash receipts, and hold the cash
Physical, Mechanical, and Electronic Controls
Store cash in safes and bank vaults; limit access to storage areas; use cash registers
Other Controls
Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily
SO 3 Explain the applications of internal control principles to cash receipts.

12. Cash Controls
Cash consists of coins, currency, checks, money orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets
SO 3 Explain the applications of internal control principles to cash receipts.

13. Over-the-Counter Receipts
Cashier’s Department
Over-the-Counter Receipts
Sales Department
Illustration 8-7
Prepare daily summary
Prepare deposit slip
Cashier ring up sales
Supervisor
reads register totals
makes cash counts
prepares cash count sheets
Bank
(deposit)
Treasurer
(verification)
Accounting
(record)
SO 3 Explain the applications of internal control principles to cash receipts.

14. Mail Receipts Control Procedures:
Mail receipts should be opened by two people, a list prepared, and each check endorsed.
Copy of the list, along with the checks and remittance advices, sent to cashier’s department.
Cashier adds the checks to the over-the-counter receipts and prepares a daily cash summary and makes the daily bank deposit.
Copy of list sent to treasurer’s office for comparison with total shown on daily cash summary.
SO 3 Explain the applications of internal control principles to cash receipts.

15. Internal Control over Cash Disbursements
Cash Controls
Illustration 8-8
Internal Control over Cash Disbursements
Establishment of Responsibility
Only designated personnel are authorized to sign checks (treasurer)
Documentation Procedures
Use prenumbered checks and account for them in sequence; each check must have an approved invoice
Independent Internal Verification
Compare checks to invoices; reconcile bank statement monthly
Physical, Mechanical, and Electronic Controls
Store blank checks in safes, with limited access; print check amounts by machine in indelible ink
Segregation of Duties
Different individuals approve and make payments; check signers do not record disbursements
Other Controls
Stamp invoices
PAID
SO 4 Explain the applications of internal control principles to cash disbursements.

16. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash.
Applications:
Voucher system
Electronic funds transfers (EFT) system
Petty cash fund
SO 4 Explain the applications of internal control principles to cash disbursements.

17. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Voucher System
Network of approvals, by authorized individuals, to ensure all disbursements by check are proper.
A voucher is an authorization form prepared for each expenditure.
SO 4 Explain the applications of internal control principles to cash disbursements.

18. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Electronic Funds Transfers (EFT)
Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations.
SO 4 Explain the applications of internal control principles to cash disbursements.

19. Internal Control over Cash Disbursements
Cash Controls
Internal Control over Cash Disbursements
Petty Cash Fund - Used to pay small amounts.
Involves:
establishing the fund,
making payments from the fund, and
replenishing the fund.
SO 5 Describe the operation of a petty cash fund.

20. Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The fund was established on March 1 with a balance of $100. During March the following petty cash receipts were found in the petty cash box.
The fund was replenished on March 15 when the fund contained $3 in cash. On March 20, the amount in the fund was increased to $150.
Instructions: Journalize the entries in March that pertain to the operation of the petty cash fund.
Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows :
( b ) Business transaction occurs.
( c ) Information entered in the journal.
( a ) Debits and credits are posted to the ledger.
( e ) Trial balance is prepared.
( d ) Financial statements are prepared.
SO 5 Describe the operation of a petty cash fund.

21. Cash Controls
E8-8 The fund was established on March 1 with a balance of $100
March 1
Petty cash 100
Cash 100
SO 5 Describe the operation of a petty cash fund.

22. Cash Controls
E8-8 The fund was replenished on March 15 when the fund contained $3 in cash.
March 15
Postage inventory 39
Freight-out 21
Miscellaneous expense 11
Travel expense 24
Cash over and short 2
Cash 97
SO 5 Describe the operation of a petty cash fund.

23. Cash Controls
E8-8 On March 20, the amount in the fund was increased to $150.
March 20
Petty cash 50
Cash 50
SO 5 Describe the operation of a petty cash fund.

24. Use of a Bank Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.
SO 6 Indicate the control features of a bank account.

25. Use of a Bank Making Bank Deposits
Illustration 8-10
Making Bank Deposits
Authorized employee should make deposit.
Bank Code Numbers
Reverse Side
Front Side
SO 6 Indicate the control features of a bank account.

26. Use of a Bank Writing Checks
Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient.
Illustration 8-11
Maker
Payee
Payer
SO 6 Indicate the control features of a bank account.

27. Use of a Bank Bank Statements Debit Memorandum Credit Memorandum
Illustration 8-12
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient funds)
Credit Memorandum
Collect notes receivable.
Interest earned.
SO 6 Indicate the control features of a bank account.

28. Review Question Use of a Bank
The control features of a bank account do not include:
having bank auditors verify the correctness of the bank balance per books.
minimizing the amount of cash that must be kept on hand.
providing a double record of all bank transactions.
safeguarding cash by using a bank as a depository.
SO 6 Indicate the control features of a bank account.

29. Use of a Bank Reconciling the Bank Account
Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances.
Reconciling Items:
Deposits in transit.
Outstanding checks.
Errors.
Bank memoranda.
SO 7 Prepare a bank reconciliation.

30. Use of a Bank Reconciliation Procedures + Deposit in Transit
Illustration 8-13
+ Deposit in Transit
- Outstanding Checks
+/- Bank Errors
+ Notes collected by bank
- NSF (bounced) checks
- Check printing or other service charges
+/- Book Errors
CORRECT BALANCE
CORRECT BALANCE
SO 7 Prepare a bank reconciliation.

31. Use of a Bank
E8-11 The following information pertains to Family Video Company.
Cash balance per bank, July 31, $7,263.
Cash balance per books, July 31, $7,284.
July bank service charge not recorded by the depositor $28.
Deposits in transit, July 31, $1,500.
Bank collected $900 note for Family in July, plus interest $36, less fee $20.The collection has not been recorded by Family, and no interest has been accrued.
Outstanding checks, July 31, $591.
Instructions
Prepare a bank reconciliation at July 31.
Journalize the adjusting entries at July 31 on the books of Family Video Company.
SO 7 Prepare a bank reconciliation.

32. Use of a Bank E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement $7,288
Add: Deposit in transit 1,500
Less: Outstanding checks (591)
Adjusted cash balance per bank $8,172
Cash balance per books $7,284
Add: Collection of notes receivable 900
Collection of interest 36
Less: Bank service charge (28)
Note collection fee (20)
Adjusted cash balance per books $8,172
SO 7 Prepare a bank reconciliation.

33. Use of a Bank
E8-11 b) Journalize the adjusting entries at July 31 on the books of Family Video Company.
Dr.
Cr.
July 31
Cash 888
Bank charge expense 28
Miscellaneous expense 20
Notes receivable 900
Interest revenue 36
Note: Adjusting journal entry includes only the adjustments to the cash balance per books.
SO 7 Prepare a bank reconciliation.

34. Review Question Use of a Bank
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
SO 7 Prepare a bank reconciliation.

35. Reporting Cash
Most liquid asset, listed first in current assets section of balance sheet.
Illustration 8-16
Cash equivalents
Restricted cash
Compensating balances
SO 8 Explain the reporting of cash.

36. Review Question Use of a Bank
Which of the following statements correctly describes the reporting of cash?
Cash cannot be combined with cash equivalents.
Restricted cash funds may be combined with Cash.
Cash is listed first in the current assets section.
Restricted cash funds cannot be reported as a current asset.
SO 8 Explain the reporting of cash.

37. Protecting Yourself from Identity Theft
All About You
Protecting Yourself from Identity Theft
What have you done lately to shore up your own personal internal controls?
What can you do to protect yourself?
Some Facts:
In a recent year, more than 7 million people were victims of identity theft.
During a single computer-virus outbreak, called the “Hearse,” thieves stole 90,000 pieces of personal data.
The average identity-theft victim spends 600 hours clearing up his or her finances and financial records

38. Protecting Yourself from Identity Theft
All About You
Protecting Yourself from Identity Theft
Some Facts:
The Victims incur an average of $1,400 in out-of-pocket expenses.
Consumers have $1.7 trillion worth of assets with online brokerage firms. Many of the largest identity theft losses have been the result of thieves completely cleaning out online brokerage accounts.
Identify theft is the No. 1 fraud complaint among consumers. Phoenix and Las Vegas top the list for identity theft per capita.

39. All About You
Chart shows the most common survey responses from victims of identity theft when asked how their information was used by the thieves.
Source: The Identity Theft Resource Center, Identity Theft: The Aftermath 2003.

40. All About You What Do You Think?
Do you feel it is safe to store personal financial data (such as Social Security numbers and bank and credit account numbers) on your computer?
YES: I have anti-virus software that will detect and stop any intruder.
NO: Even the best anti-virus software does not detect every kind of intruder.

41. Copyright
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