Chapter 4 Internal Control and Cash

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Chapter 4Internal Control and Cash
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Learning Objectives

• Set up an effective system of internal control
• Use a bank reconciliation as a control device
• Apply internal controls to cash receipts and cash
  payments
• Use a budget to manage cash
• Weigh ethical judgments in business

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Internal Control

• Internal control is the organizational plan and
  related measures that an entity adopts to
• Safeguard assets
• Encourage adherence to company policies
• Promote operational efficiency
• Ensure accurate and reliable accounting records

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Sarbanes-Oxley Act (SOX)

• Created Public Company Accounting Oversight
  Board.
• Prohibits accounting firms from both auditing
  financial statements of a firm and providing
  certain consulting services for the same client.
• Requires periodic rotation of lead auditors.
• Requires public companies to issue internal
  control reports and the outside auditor to
  evaluate the clients internal controls.
• Provides stiff penalties for violators.

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Internal Control Systems

• Good internal control systems require
• Competent, reliable, ethical personnel
• Assignment of responsibilities
• Proper authorization
• Supervision of employees
• Separation of duties
• separation of operations from accounting
• separation of the custody of assets from
  accounting
• Internal and external audits
• Documents and records
• Electronic and computer controls

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E-Commerce

• Onion model of system security

Audits by external specialists
Sensitive Hardware, Software, and Data
Incident response procedures
Intrusion detection devices
Firewalls
Encryption
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E-Commerce

• Encryption is the transformation of data by a
  mathematical process into a form that is
  unreadable by those without a key.
• Firewall limits access to hardware, software, or
  data to persons within a network.
• Intrusion detection identifies unauthorized
  entries to the system.
• Incident response procedures apprehend hackers
  and remove them from the system.
• External audits (WebTrust, SysTrust, CPA firms,
  etc.) test e-commerce systems.

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Other Controls

• Fireproof vaults
• Burglar alarms
• Point-of-sale terminals
• Fidelity bonds on cashiers and others who have
  access to cash
• Mandatory vacations
• Job rotation

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Bank Accounts as Controls

• All cash should be deposited into a bank account
  daily.
• To draw money from the account, a check is
  written
• Three parties to a check
• maker signs the check
• payee to whom the check is written
• bank on which the check is drawn
• Remittance advice is an optional attachment that
  gives the reason for the payment.

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Bank Accounts as Controls

• Monthly bank statements are sent to the account
  holder and should be reconciled.
• Electronic fund transfer (EFT) is the electronic
  transfer of cash. No check is written.
• Bank statements include both physical checks and
  EFT payments as well as other transactions on the
  account.

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Bank Reconciliation

• Two independently maintained records of a
  businesss cash
• The companys Cash account
• The bank statement
• Differences between the two records generally
  arise because of timing differences.
• Reconciliations ensure that the two records agree.

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Bank Reconciliation

• Items for reconciliation
• Items recorded by the company but not yet
  recorded by the bank
• Deposits in transit
• Outstanding checks

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Bank Reconciliation

• Items for reconciliation
• Items recorded by the bank but not yet recorded
  by the company.
• Bank collections
• Electronic funds transfers
• Service charges and the cost of printed checks
• Interest revenue earned on checking account
• Nonsufficient funds (NSF) checks
• Errors by the company or the bank

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Bank Reconciliation

• The adjusted bank balance must equal the adjusted
  books balance.

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Reconciling Items

• Bank Balance
• Add deposits in transit
• Subtract outstanding checks
• Add or subtract corrections of bank errors, as
  appropriate

• Book Balance
• Add bank collection items, interest revenue, and
  EFT receipts
• Subtract service charges, NSF checks, and EFT
  payments
• Add or subtract corrections of book errors, as
  appropriate.

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Bank Reconciliation

• Journal entries are only made for
• Bank collection items, interest revenue, and EFT
  receipts
• Service charges, NSF checks, and EFT payments
• Errors made by the company (bank errors do not
  require journal entries on the companys books).

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Bank Reconciliation
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Journal Entries from Reconciliation
(4) Cash 904.03
Rent Revenue 904.03
Receipt of monthly rent
(5) Cash 2,114.00
Notes Receivable 1,900.00
Interest Revenue 214.00
Note receivable collected by the bank
(6) Cash 28.01
Interest Revenue 28.01
Interest earned on bank balance
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Journal Entries from Reconciliation
(7) Cash 360.00
Accounts Payable 360.00
Correction of check no. 333
(8) Miscellaneous Expense 14.25
Cash 14.25
Bank Service Charge
(9) Accounts Receivable 52.00
Cash 52.00
NSF customer check returned by bank
(10) Insurance Expense 361.00
Cash 361.00
Payment of monthly insurance
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Controlling Cash Receipts

• Over-the-counter receipts
• Point of sale terminal
• Mail Receipts
• Lockbox
• Checks removed and totaled in mailroom.
  Remittance advice to accounts receivable, checks
  to Treasurer for deposit. Controller compares
• control total from mail room
• bank deposit amount from cashier
• debit to cash from accounting department

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Controlling Cash Payments

• Payment by check
• Purchase requisition (request)
• Purchase order authorizes an order
• Payment packet matches
• purchase order,
• invoice, and
• receiving report
• Payment packet should be cancelled to ensure that
  the invoice is not paid twice.

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Petty Cash

• Petty cash fund is to pay for minor expenses.
• Fund is opened with a particular amount of cash.
• A custodian issues cash when needed and places
  all petty cash tickets and receipts in the box
  with the remaining cash.
• The sum of the remaining cash and petty cash
  tickets should equal the amount established for
  the fund.
• Petty cash is an example of an imprest fund.

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Cash Budgets

• Budget a financial plan
• Cash budget plans cash receipts and cash payments
• Beginning cash
• Plus Expected Receipts
• Less Expected Payments
• Equals Expected Ending cash
• Allows mangers to know in advance whether they
  will likely need to borrow money.

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Reporting Cash

• Cash and Cash Equivalents
• liquid assets such as time deposits and
  certificates of deposit
• Restricted cash must be disclosed separately.
• Compensating balances are not included as cash.

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Ethics

• Corporate and Professional Codes of Ethics
• Corporate Codes of Conduct
• AICPA Code of Professional Conduct
• IMA Standards of Ethical Conduct for Management
  Accountants
• Ethical Issue
• Conflicts of interest

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End of Chapter 4