Internal Control and Managing Cash

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Internal Control and Managing Cash
Chapter 4
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Learning Objective 1
Set up an effective system of internal control.
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Internal Control
It is the organizational plan and all the related
measures that an entity adopts.
Safeguard assets.
Encourage adherence to company policies.
Promote operational efficiency.
Ensure accurate and reliable accounting records.
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Components of anEffective System
Competent, reliable, and ethical personnel
Assignment of responsibilities
Proper authorization
Separation of duties
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Separation of Duties
Separation of operations from accounting
Separation of the custody of assets from
accounting
Separation of the authorization of
transactions from the custody of related assets
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Internal and External Audits
An audit is an examination by an outside party of
the companys financial statements, accounting
systems, and internal controls.
An internal auditor is an employee of the
business.
An external auditor is an independent auditor.
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Documents and Records
Business documents and records include
invoices (bills)
paid checks
accounting journals
accounting ledgers
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Electronic and Computer Controls
Businesses use electronic devices to safeguard
assets.
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The Onion Model of E-Commerce System Security
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Encryption
It is the transformation of data by a
mathematical process into a form that is
unreadable by anyone who does not have the secret
decryption key.
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Firewall
It is a technique that limits access to
hardware, software, or data to persons within a
network.
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Other Controls
Fireproof vaults Burglar alarms Point of
sale terminals Frequent bank deposits Bonded
cashiers Mandatory vacations Job rotation
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The Limitations ofInternal Control
Systems designed to thwart one persons fraud can
be beaten by two or more employees working
together colluding to defraud the firm.
A system of internal control that is too complex
can hurt efficiency and control.
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Learning Objective 2
Use a bank reconciliation as a control device.
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The Bank Accountas a Control Device
Banks safeguard and help control cash.
A check is the document that instructs the bank
to pay a specified amount of money.
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Electronic Funds Transfer
EFT is a system that relies on electronic
communications not paper documents to
transfer cash.
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The Bank Reconciliation
There are two records of a businesss cash
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The Bank Reconciliation
Two common items that cause differences between
the bank balance and the book balance.
1. Items recorded by the company but not yet
recorded by the bank Deposits in transit
Outstanding checks
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The Bank Reconciliation
2. Items on a bank statement and not recorded
by the business Bank collections
Electronic funds transfers Service charge
Interest revenue earned on account NSF
checks Errors
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Bank Reconciliation Illustrated
The bank statement of Business Research,
Inc., shows a balance of 5,931.51 on January 31.
The company Cash account on the books has a
balance of 3,294.21.
The following reconciling items explain why the
two balances differ
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The Bank Reconciliation Illustrated
1. The January 30 deposit of 1,591.63 does
not appear on the bank statement.
2. The bank erroneously charged to the
account a 100 check (No. 656) written by
Business Research Associates.
3. Five company checks issued late in January
and recorded in the journal have not been
paid by the bank.
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The Bank Reconciliation Illustrated
Check No. Date Amount 337 Jan.
27 286.00 338 28
319.47 339 28 83.00 340
29 203.14 341 30 458.53
Total 1,350.14
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The Bank Reconciliation Illustrated
4. The bank received 904.03 by EFT on behalf
of Business Research, Inc.
5. The bank collected on behalf of the
company a note receivable, 2,114 (including
interest revenue of 214).
6. The bank statement shows interest revenue
of 28.01.
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The Bank Reconciliation Illustrated
7. Check number 333 for 150 paid to Brown
Company on account was recorded as a cash
payment of 510.
8. The bank service charge for the month was
14.25.
9. The bank statement shows an NSF check for
52.
10. Business Research pays insurance expense by
EFT and has not recorded this 361 payment.
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The Bank Reconciliation Illustrated
Balance per bank, January 31 5,931.51 Add
deposit in transit 1,591.63 Check
erroneously charged 100.00 7
,623.14 Less outstanding checks 1,350.14 Adju
sted bank balance 6,273.00
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The Bank Reconciliation Illustrated
Balance per books, January 31 3,294.21 Add
ETF receipt of rent revenue
904.03 Collection of note receivable
2,114.00 Interest revenue earned
28.01 Correction of book error
360.00 6,700.25 Less Service
charge 14.25 NSF check
52.00 Payment of insurance expense 361.00
427.25 Adjusted book balance 6,273.00
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Learning Objective 3
Apply internal controls to cash receipts
and cash payments.
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Controlling and Managing Cash
Internal control over cash receipts ensures that
all cash receipts are deposited in the bank and
no collections are lost.
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Over the Counter Receipts
The point-of-sale terminal (cash register)
offers control over the cash received in a store.
The cash drawer opens only when the sales clerk
enters an amount on the keypad.
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Over the Counter Receipts
At the end of the day, the cashier deposits the
cash in the bank.
The record of cash receipts goes to accounting.
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Mail Receipts
All incoming mail should be opened by a mailroom
employee.
This person should compare the check received
with the remittance advice.
The mailroom clerk keeps a running total of cash
receipts for the day.
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Mail Receipts
At the end of the day this control total is given
to a responsible official.
Cash receipts should be given to the cashier.
The mailroom employee forwards the remittance
advices to accounting.
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Mail Receipts
Many companies use a lock-box system.
Customers send checks directly to an address that
is essentially a bank account.
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Internal ControlsOver Cash Receipts
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Internal ControlsOver Cash Receipts
Employees who handle cash do not have access to
accounting records.
Separation of duties
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Internal Control Payments Purchasing Process
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Internal Control Payments Disbursement Packet
Purchase Request
Purchase Order
Receiving Report
Invoice
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Internal ControlsOver Cash Payments
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Internal ControlsOver Cash Payments
Employees who handle checks have no access to
accounting records.
Separation of duties
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Petty Cash
The petty cash fund is a small amount of
cash kept on hand to pay for minor expenses.
The custodian of the petty cash fund
Cashes a check and places the currency and coin
in the fund.
Prepares a petty cash ticket for each petty cash
payment.
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Learning Objective 4
Use a budget to manage cash.
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Using a Budget to Manage Cash
A budget is a financial plan that helps
coordinate business activities.
A cash budget helps a company, or an individual,
manage cash by planning the receipt and
payment of cash during a future period.
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Using a Budget to Manage Cash
Managers proceed as follows to determine how much
cash the company will need
1. Start with the entitys cash balance at
the beginning of the period.
2. Add the budgeted cash receipts and
subtract the budgeted cash payments.
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Using a Budget to Manage Cash
3. The beginning balance plus the expected
receipts minus the expected payments equals
the expected cash balance at the end of the
period.
4. Compare the expected cash balance at the
end of the period to the desired, or
budgeted, cash balance.
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Cash Budget
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Reporting Cash onthe Balance Sheet
Companies usually combine all cash amounts into a
single total called Cash and Cash Equivalents
on the balance sheet.
Cash equivalents include liquid assets
Time deposits
Certificates of deposit
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Reporting Cash onthe Balance Sheet
America Online, Inc. Consolidated Balance
Sheet December 31 Excerpts
(In Millions) 2000
Assets Current assets Cash and cash
equivalents 2,610 Short-term investments
886 Accounts receivable 464
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Learning Objective 5
Weigh ethical judgment in business.
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Ethics and Accounting
Most large companies have a code of
ethics designed to encourage ethical
and responsible behavior by employees.
Accountants have additional incentives to behave
ethically.
AICPA Code of Professional Conduct
Standards of Ethical Conduct for Management
Accountants
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Ethics and Accounting
Conflict of Interest
Enron Corporation A. Fastow, CEO
Outside Partnership A. Fastow, Principal
Business
transactions
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End of Chapter 4