Internal Control and Cash

1
Chapter 7

• Internal Control and Cash

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Objectives of the Chapter

• 1. Introduce the internal control to safeguard
  assets and to produce reliable accounting
  records.
• 2. Internal control for the most liquid asset
  cash.

3
The Sarbanes-Oxley Act (SOX) and the Internal
Control

• Under SOX, companies must develop sound internal
  control for financial reporting.
• Mangers need to document and assess the
  effectiveness of the internal control.
• Managers assessment on the internal control
  needs to be attested by outsider auditors.
• Outsider auditors would also make their
  evaluation on the effectiveness of companies
  internal control.

4
Internal Control

• An organizational plan to (source Financial
  Accounting by Harrison and Horngren (H H))
• 1. Safeguard assets (i.e., cash, inventory,
  etc.)
• 2. Encourage employees adherence to company
  policies
• 3. Promote operational efficiency and
• 4. Ensure accurate and reliable accounting
  records.

5
Internal Control (contd.)

• The plan includes(source Financial Accounting by
  H H)
• 1. To have competent, reliable and ethical
  personnel
• 2. Assignment of responsibilities (see Exhibit on
  p6 for an organizational chart of a corp.).
• Each employee is assigned certain
  responsibilities and
• 3. Proper authorization Any deviation from
  standard policy requires a proper authorization.

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Organizational Chart of a Corporation (source
HH)
6
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Internal Control (contd.)

• 4. Separation of duties this procedure can
  reduce the chances for fraud and promote the
  accuracy of accounting records. The procedure may
  include
• a. separation of operation from accounting,
• b. separation the custody of assets from
  accounting,
• c. separation of the authorization of
  transactions from the custody of related assets,
• d. separation of duties within the accounting
  function.

The plan includes
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Internal Control (contd.)

• 5. Internal and external audits.
• 6. Documents and records.
• 7. Electronic and corporate control.
• 8. Other controls.
• The limitations of internal control human
  element and the size of a company.

The plan includes
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Internal Control for Cash

• Cash is the most liquid asset and is easy to
  steal. Therefore, most companies use internal
  control to safeguard their cash.

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Internal Control of Cash (Contd.)

• 1. Immediate deposit of cash to bank accounts.
• 2. Cash payments by checks except for small
  amount (paid by petty cash fund).
• 3. Separation of duties.
• 4. Prepare bank account reconciliation.

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The Voucher System in Cash Disbursements

• A system to ensure all payments made by checks
  are proper.
• The system involves a network of approvals by
  authorized individuals.
• All cash disbursements require a voucher (except
  for those from petty cash fund).

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The Voucher System (contd.)

• Purchase Order a document issued by a buyer to a
  seller, specifying the products and the agreed
  prices for products the seller will provided to
  the buyer.
• Invoice (Bill) a document issued by a vendor to
  the buyer upon the delivery of products
  indicating the quantity of products delivered and
  agreed prices for products
• Voucher A document representing an intent to pay
  a vendor.

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The Voucher System (contd.)

• Upon the receipt of vendors invoice (and the
  products), an employee in accounts payable will
  match the invoice with the purchase order.
• With a successful match, the employee will record
  the purchase and accounts payable.
• A voucher will be produced and filed.

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The Voucher System (contd.)

• Upon the approval (i.e., by a controller), a
  check will be issued (i.e., by a treasurer) and
  sent to the vendor before the required payment
  date.
• The paid voucher is sent to the accounting
  department for recording.

15
Petty Cash Fund

• Establishing a petty cash fund on 3/1
• Petty Cash 500
• Cash 500
• Making Payments from the fund
• Petty cash fund is used for the payments of small
  expenditures of the office (i.e., office drinks,
  office supplies, stamps, etc.)
• The payments require petty cash receipts.

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Petty Cash Fund (Contd.)

• Replenishing the fund on 3/31
• Postage expense 50
• Freight-out 120
• Office supplies 70
• Cash over and short 5
• Cash 245
• Note the petty cash receipts indicated the
  payments in March including postage exp. 50,
  freight charges, 120, and office supplies, 70.
  The cash balance of the fund on 3/31 amounted to
  255

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Bank Reconciliation

• A. Causes of differences between the cash
  balances of bank and book.
• B. Adjusting procedures

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A. Causes of Differences

• 1. Errors made by banks or companies.
• 2. Outstanding checks.
• 3. Deposit in transit.
• 4. Some transaction recorded by banks, but not
  recorded by companies (i.e., service charge,
  interest earned, collections of notes...).
• 5. NSF check.

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A. Causes of Differences (Contd.)

• 6. Checks deposited but returned for reasons
  other than NSF (I.e., unauthorized signature,
  check has been altered,etc.).
• 7. Cash received, recorded, but not yet
  deposited (if adjusted to cash balance, this item
  needed to be considered).

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Adjusting Procedures
Bank Balance Book Balance
Deposit in transit Interest earned
Cash received, recorded, Notes collected
but not deposited -
EFT - Outstanding checks - Service charge
- Errors made by banks - NSF checks - Checks
deposited but returned to payee by bank
for reasons other than NSF - Errors made
by
companies Adjusted Cash
Balance Adjusted Cash Balance Journal
Entries Required
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Example

• From the following information for D.K, prepare a
  bank reconciliation and any journal entries
  needed to adjust the cash account as of 8/31/x1
• 1. August 31, 20x1, cash balance per book,
  8,000.
• 2. August 31, 20x1, balance per bank, 7,500.
• 3. Deposit in transit as of 8/31/x1, 2,000.

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Example (contd.)

• 4. Checks outstanding as of 8/31/x1, 1,000.
• 5. The bank improperly recorded a 650 deposit
  560.
• 6. Bank service charges, 100. (Not yet recorded
  by D.K.)
• 7. Interest earned, 90. (Not yet recorded by
  D.K.)
• Journal entry required

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Example (contd.)

• 8. Notes collected by bank, 400. (Not yet
  recorded by D.K.)
• 9. NSF check, 100 (payment of an account
  receivable)
• 10. A check of 300 payable to Energy Express
  Company for delivery charges was mistakenly
  recorded in the book at 600.
• Journal entry required

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Example (contd.)

• Journal entries are required by D.K.as follows
  
• 6. Miscellaneous Expense 100
• Cash 100
• 7. Cash 90
• Interest Revenue 90
• 8. Cash 400
• Notes Receivable 400

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Example (contd.)

• 9. Accounts Receivable 100
• Cash 100
• 10. Cash 300
• Delivery Exp. 300

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Example (contd.)

• Bank Balance (8/31/98) 7,500
• Deposit In Transit 2,000
• - Checks Outstanding (1,000)
• Error Made by Bank 90
• Adjusted Cash Balance 8,590
• Book Balance (8/31/98) 8,000
• - Bank Service charge (100)
• Interest Earned 90
• Notes Collected 400
• - NSF Checks (100)
• - Error made by the company 300
• Adjusted Cash Balance 8,590

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Cash Management

• 1. To maintain sufficient cash on hand for
  day-to-day operation and for payment of current
  liabilities.
• 2. To prevent large amount of idle cash on hand.
• 3. To speed the collection of cash from sale, by
  offering sales discounts

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Cash Management (contd.)

• 8/4 A/R, 2/10, n/30 50,000
• Sales Revenue 50,000
• 8/10 Cash 49,000
• Sales Discount 1,000
• A/R 50,000
• Also, Subsidiary ledger accounts are maintained
  for accounts receivable (see p26 for an example).

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Accounts Receivable Records
Accounts Receivable General
Ledger Subsidiary Ledger Cash Walmart Bal.
9,000 Bal. 1,800 Accounts Receivable Target B
al. 3,800 Bal. 1,300 Toys R US Bal.
700 Total 3,800
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Reporting Cash on the Balance Sheet (B/S)

• Usually reported on the B/S as follows
• Current Assets 20x2 20x1
• Cash and Cash Equivalents xxxx xxxx
• Cash Equivalents highly liquid investments with
  insignificant interest rate risk and with
  original maturities of three months or less
  (i.e., commercial papers, U.S. Treasury bills,
  money market fund, etc.)