Internal Control and Cash Chapter 10 Internal Control and Cash

7-1 Internal control is broadly defined as the procedures and processes used by a company to safeguard its assets, process information accurately, and ensure compliance with laws and regulations.

10-1 Principles of Internal Control Establishment of responsibility Segregation of duties Documentation procedures Physical, mechanical, and electronic controls Independent internal verification Other controls

7-2 Objectives of Internal Control Objectives of Internal Control 7-2 To provide reasonable assurance that: assets are safeguarded and used for business purposes, business information is accurate, and employees comply with laws and regulations.

7-2 Employee fraud is the intentional act of deceiving an employer for personal gain.

7-2 Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are— the control environment, risk assessment, control procedures, monitoring, and information and communication.

Control Environment 7-2 A business’s control environment is the overall attitude of management and employees about the importance of controls.

Management’s philosophy and operating style Factors That Influence the Control Environment 7-2 Management’s philosophy and operating style The business’s organizational structure Personnel policies

Limitations of Internal Control Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain Any internal control system has limitations. Because humans are involved in the internal control system, our negligence, fatigue, misjudgment, and confusion can negatively impact the goals of the system. Also, an internal control system can be circumvented by individuals who desire to commit fraud and who are willing to work together to do so.

Limitations of Internal Control The costs of internal controls must not exceed their benefits. We also must keep in mind that the costs of internal controls must not exceed their benefits. A department store could drastically cut shoplifting losses by having an armed guard escort each customer while in the store. Obviously, the cost of this internal control exceeds the benefit, not to mention the impact it would have on customer morale. Benefits Costs

10-2 Application of Internal Control to Cash Receipts Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Physical, Mechanical, and Electronic Controls Store cash in safes and bank vaults; limit access to storage areas; use cash registers Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips Other Controls Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily

10-3 Application of Internal Control to Cash Disbursements Establishment of Responsibility Only designated personnel authorized to sign checks (treasurer) 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 Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly Documentation Procedures Use prenumbered checks and account for them in sequence; each check must have approved invoice Other Controls Stamp invoices PAID

Control of Cash C2 An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cash is separated from recordkeeping of cash. Cash receipts are promptly deposited in a bank. Control of cash focuses on three areas. One, those who handle cash should be separate from those who keep records of cash. Two, cash receipts should be deposited daily in the bank. Three, cash disbursements should be made by check. Cash disbursements are made by check.

7-7 Companies that have invested excess cash in cash equivalents usually report cash and cash equivalents as one amount on the balance sheet.

Control of Cash Receipts Control of Cash Receipts 28

Electronic Funds Transfers 7-3 Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills.

7-3 Control of Cash Payments—The Voucher System Control of Cash Payments—The Voucher System 7-3 A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized. A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer.

Voucher System of Control P4 Sender Receiver Check Invoice Approval Receiving Report Invoice Purchase Order Purchase Requisition Cashier Accounting Receiving Supplier (Vendor) Purchasing Requesting Cashier Accounting, Requesting & Purchasing Accounting Supplier (Vendor) Purchasing and Supplier, Requesting, Receiving & Accounting Voucher In a voucher system, a purchase requisition initiates the process for a purchase. If approved, the purchase requisition triggers the issuance of a purchase order. An invoice is received from the vendor once a purchase is made. A receiving report indicates that we actually received the goods. The invoice approval indicates that we ordered the goods, we received the goods we ordered, and that we were billed for the goods we ordered and received. The invoice approval triggers the check preparation for a valid purchase. Copies of all of these documents are kept as supporting documentation for the disbursement in the voucher file.

Use of Bank Accounts 7-4 A major reason that businesses use bank accounts is for control purposes. Why open a bank account?(3:06) http://www.youtube.com/watch?v=YF5NPDok9ng

7-4 Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions.

Bank Statement 7-4 A summary received from the bank of all checking account transaction is called a bank statement.

EC — Error correction to correct bank error. 7-4 Typical credit or debit memorandum entries found on the bank statement: EC — Error correction to correct bank error. NSF — Not sufficient funds check. SC — Service charge. ACH — Automated Clearing House entry for electronic funds transfer. MS — Miscellaneous items.

Power Networking’s Records and Bank Statement The company should determine the reason for difference in these two amounts.

7-5 A bank reconciliation is an analysis of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger in order to determine the adjusted cash balance.

7-5 Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation.

7-6 It is usually not practical for a business to write checks to pay small amounts. Thus, it is desirable to control such payments by using a special cash fund, called a petty cash fund.