Prepared by: Keri Norrie, Camosun College ACCOUNTING PRINCIPLES Third Canadian Edition Prepared by: Keri Norrie, Camosun College

INTERNAL CONTROL AND CASH CHAPTER 7 INTERNAL CONTROL AND CASH

INTERNAL CONTROL Internal control consists of the policies and procedures adopted within a business in order to: 1. optimize resources, and 2. prevent and detect errors and irregularities.

INTERNAL CONTROL Internal control consists of the policies and procedures adopted within a business in order to: 3. Safeguard its assets 4. Maintain the accuracy and reliability of its accounting records

PRINCIPLES OF INTERNAL CONTROL Illustration 7-1 Authorization Segregation of duties Documentation procedures Safeguarding assets and records Independent verification

PRINCIPLES OF INTERNAL CONTROL Authorization of transactions and activities: Authorization by the proper individual is important. Control is most effective when only one person is responsible for a given task. Segregation of duties: The work of one employee should provide a reliable basis for evaluating the work of another employee.

PRINCIPLES OF INTERNAL CONTROL Documentation procedures: Documents should provide evidence that transactions and events have occured. Safeguards to control access to, and use of, assets and records: Physical, mechanical, and electronic controls relate primarily to the safeguarding of assets and enhancing accuracy and reliability of the accounting records.

PRINCIPLES OF INTERNAL CONTROL Independent verification: External verification indicates whether the company’s financial statements fairly present its financial position and results of operations in accordance with GAAP. Internal verification involves review, comparison, and reconciliation of information from two sources.

RELATIONSHIP BETWEEN SEGREGATION OF DUTIES AND INDEPENDENT INTERNAL VERIFICATION Maintains cash balances cash on hand Accounting Employee A Maintains custody over books Assistant Cashier B Independent Internal Verification Makes monthly comparisons: reports any irreconcilable differences to comptroller Assistant Comptroller C

LIMITATIONS OF INTERNAL CONTROL Cost/benefit Collusion Size of business Human element

CASH Cash includes coins, currency, cheques, money orders, and money on hand or on deposit at a bank or similar depository. Internal control over cash is imperative in order to safeguard cash and assure the accuracy of the accounting records for cash.

CONTROL OVER CASH RECEIPTS Only designated personnel should be authorized to handle or have access to cash receipts. Different individuals should: 1. receive cash 2. record cash receipt transactions 3. have custody of cash

CONTROL OVER CASH RECEIPTS Documents should include: 1. remittance advices 2. cash register tapes 3. deposit slips Cash should be stored in safes and bank vaults. Access to storage areas should be limited to authorized personnel. Cash registers should be used in executing over-the-counter receipts.

CONTROL OVER CASH RECEIPTS Daily cash counts and daily comparisons of total receipts should be made. All personnel who handle cash receipts should be bonded and required to take vacations. An important tool in control of over-the-counter receipts is cash registers that are visible to customers.

CONTROL OVER CASH DISBURSEMENTS Payments are made by cheque rather than by cash, except for petty cash transactions. Only specified individuals should be authorized to sign cheques. Different departments or individuals should be assigned the duties of approving an item for payment and paying it.

CONTROL OVER CASH DISBURSEMENTS Pre-numbered cheques should be used and each cheque should be supported by an approved invoice or other document. Blank cheques should be stored in a safe. 1. Access should be restricted to authorized personnel. 2. A cheque writer machine should be used to imprint the amount on the cheque in indelible ink.

CONTROL OVER CASH DISBURSEMENTS Each cheque should be compared with the approved invoice before it is issued. Following payment, the approved invoice should be stamped PAID. Electronic payments should be authorized and verified by a person independent of the accounts payable department. Paid

PETTY CASH FUND A petty cash fund is used to pay relatively small amounts. Operation of the fund, often called an imprest system, involves 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund. Accounting entries are required when 1. the fund is established, 2. the fund is replenished, and 3. the amount of the fund is changed.

ESTABLISHING THE FUND G E N R A L J O U D a t e c o u n T i l s d x p b C r M . 1 P y h 100 100 T o e s t a b l i s h a p e t t y c a s h f u n d . When the fund is established, a cheque payable to the petty cash custodian is issued for the stipulated amount.

REPLENISHING THE FUND GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Mar. 15 Postage Expense 44 38 5 87 Merchandise Inventory Miscellaneous Expense Cash To replenish petty cash fund. On March 15 the petty cash custodian requests a cheque for $87. The fund contains $13 cash and petty cash receipts for postage, $44, freight, $38, and miscellaneous expenses, $5.

REPLENISHING THE FUND GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Mar. 15 Postage Expense 44 38 5 1 88 Merchandise Inventory Miscellaneous Expense Cash Over and Short Cash To replenish petty cash fund. On March 15 the petty cash custodian requests a cheque for $88. The fund contains $12 cash and petty cash receipts for postage, $44, freight, $38, and miscellaneous expenses, $5.

USE OF A BANK The use of a bank minimizes the amount of currency that must be kept on hand and contributes significantly to good internal control over cash. A company can safeguard its cash by using a bank as a depository and clearing house for cheques received and cheques written.

BANK STATEMENTS A bank statement shows: 1. cheques paid and other debits charged against the account 2. deposits and other credits made to the account 3. account balance after each day’s transactions ACCOUNT W. A. LEE COMPANY Statement Date/Credit STATEMENT 500 QUEEN STREET Line Closing Date FREDERICTON, NB, E3B 5C2 April 30, 2005 457923 ACCOUNT NUMBER Balance Deposits and Credits Cheques and Debits Balance Last Statement No. Total Amount Total Amount This Statement 13,256.90 20 34,805.10 26 32,154.55 15,907.45 DEPOSITS AND CHEQUES AND DEBITS CREDITS DAILY BALANCE Date No. Amount Date Amount Date Amount 4-2 435 644.95 4-2 4,276.85 4-2 16,888.80 4-5 436 3,260.00 4-3 2,137.50 4-3 18,249.65 4-4 437 1,185.79 4-5 1,350.47 4-4 17,063.86 4-3 438 776.65 4-7 982.46 4-5 15,154.33 4-8 439 1,781.70 4-8 1,320.28 4-7 14,648.89 4-7 440 1,487.90 4-9 CM 1,036.00 4-8 11,767.47 4-8 441 2,420.00 4-11 2,720.00 4-9 12,802.47 4-11 442 1,585.60 4-12 757.41 4-11 13,936.87 4-12 443 1,226.00 4-13 1,218.56 4-12 13,468.28 ================= ============== ============= 4-29 NSF 425.60 4-27 1,545.57 4-27 13,005.45 4-29 459 1,080.30 4-29 2,929.45 4-29 14,429.00 4-30 DM 30.00 4-30 2,128.60 4-30 15,907.45 4-30 461 620.15 Symbols: CM Credit Memo EC Error Correction NSF Not Sufficient Funds Reconcile Your DM Debit Memo INT Interest Earned SC Service Charge Account Promptly

RECONCILING THE BANK ACCOUNT Reconciliation is necessary because the balance per bank and balance per books are seldom in agreement due to time lags and errors. A bank reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.

TERMS Deposits in transit PowerPoint Slides TERMS Deposits in transit Deposits recorded by depositor that have not been recorded by bank Outstanding cheques Cheques written (issued) and recorded by company that have not been presented to/paid by bank Adjusted balance Reconciled or correct cash balance 29

TERMS Debit memoranda Charges against depositor’s account (e.g. service charges, RC (returned)/NSF (insufficient funds) cheques) Credit memoranda Amounts that increase depositor’s account (e.g., interest earned)

BANK RECONCILIATION PROCEDURES Illustration 7-8 $ Per Bank Statement -outstanding cheques +deposits in transit +/- bank errors = correct cash amount $ Per Books -NSF cheques -cheque printing or other service charges +notes collected by bank +/- book errors

Reconciling Journal Entries Books Each reconciling item in determining the adjusted balance per books MUST be journalized and posted Bank Do NOT journalize any entries on bank side

REPORTING CASH Cash reported on the Balance Sheet includes: 1. Cash on hand 2. Cash in banks 3. Petty cash Cash is listed first in the balance sheet because it is the most liquid asset.

CASH EQUIVALENTS Cash equivalents are highly liquid investments, with maturities of three months or less when purchased, that can be converted into a specific amount of cash. Examples include money market funds, short-term notes, and treasury bills.

USING THE INFORMATION IN THE FINANCIAL STATEMENTS Most important asset Pervasive impact Vulnerable to theft or misuse Balancing act needed to ensure sufficient, but not excess, quantity

USING THE INFORMATION IN THE FINANCIAL STATEMENTS Cash Flow Statement: shows where cash came from and what is was used for. Management report: states management’s responsibility for internal controls.

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