1 © Copyright Doug Hillman 2000 Internal Control and Cash

2 © Copyright Doug Hillman 2000 Internal Control l Policies and procedures for protecting assets from improper use

3 © Copyright Doug Hillman 2000 Internal Control l Policies and procedures for protecting assets from improper use and for the detection and prevention of errors or irregularities in accounting

4 © Copyright Doug Hillman 2000 Elements of the Internal Control Structure l Control Environment l Accounting System l Control Procedures

5 © Copyright Doug Hillman 2000 Control Environment l Management’s philosophy and operating style l Organizational structure l Audit committee of board of directors l Assigning authority and responsibility l Controlling performance l Policies and practices

6 © Copyright Doug Hillman 2000 Accounting System l Identification and recording of all valid transactions l Proper classification of transactions l Proper measurement of dollar amount l Assignment to proper period l Proper presentation in financial statements and notes

7 © Copyright Doug Hillman 2000 Control Procedures l Proper authorization of transactions and activities l Separation of duties l Documents and records l Safeguard over access to assets and records l Review of internal control system

8 © Copyright Doug Hillman 2000 Cash l Deposits in checking and savings accounts and any item bank customarily accepts for immediate deposit l Challenge is to control inflows and outflows of cash

9 © Copyright Doug Hillman 2000 Internal Control of Cash l Clear separation of duties and responsibilities among those who handle and account for cash l Proper equipment l Proper authorization for payment l Organization of flow so that work of one person checked by another l Periodic testing of controls

10 © Copyright Doug Hillman 2000 Petty Cash Fund l Special fund of cash used for small payments l Establishment »Imprest amount debited to asset account Petty Cash

11 © Copyright Doug Hillman 2000 Petty Cash Fund l Expenditures »No entry »Evidenced by petty cash voucher l Replenishment »Check written to bring fund back to imprest amount »Record expenses evidenced by petty cash vouchers

12 © Copyright Doug Hillman 2000 Petty Cash Fund l Cash Over and Short »When amount to replenish does not equal vouchers

13 © Copyright Doug Hillman 2000 Bank Checking Account l Monthly bank statement conceptually a mirror image of company’s cash account l Timing differences in recording of deposits and clearing of checks causes difference in balance between bank and books. l Requires reconciliation

14 © Copyright Doug Hillman 2000 Bank Reconciliation l Uses a record of an independent organization to prove the company’s records l Shows the items that account for the difference between Cash account balance and bank statement balance.

15 © Copyright Doug Hillman 2000 Bank Reconciliation Procedures l Compare deposits shown on bank statement with debits to Cash »Deposits late in period not on bank statement are deposits in transit l Compare checks clearing bank with credits to Cash »Checks not clearing bank are checks outstanding

16 © Copyright Doug Hillman 2000 Bank Reconciliation Procedures l Compare bank debit and credit memos to books to see if they have been recorded l List any errors as amounts are compared

17 © Copyright Doug Hillman 2000 Bank Reconciliation Per Books l Add increases in cash already recorded by bank but not book l Deduct decreases in cash already recorded by bank but not book l Add or deduct errors on books

18 © Copyright Doug Hillman 2000 Bank Reconciliation Per Bank l Add increases in cash recorded on book but not bank »Deposits in transit l Deduct decreases in cash already recorded on books but not bank »Checks outstanding l Add or deduct errors by bank

19 © Copyright Doug Hillman 2000 Bank Reconciliation l Journalize reconciling items from book side not recorded l Reconciliation not complete until all items have cleared l May take several months before we know that a specific month’s adjusted balance is in fact correct

20 © Copyright Doug Hillman 2000 Analyzing Information l Is balance higher or lower than previous year? l What restrictions exist on cash? »Compensating balances l Where is cash invested?

21 © Copyright Doug Hillman 2000 Comprehensive Analysis Case: Income Statement l Are total revenues higher or lower? l What is percent change in revenues? l Is percent of cost of goods sold to total revenues increasing or decreasing? l Is percent of total operating expenses to total revenues increasing or decreasing? l Is percent of net income to total revenues increasing or decreasing?

22 © Copyright Doug Hillman 2000 Comprehensive Analysis Case: Balance Sheet l Are total assets higher or lower? l What is percent change in total assets? l What are largest asset investments? l Are largest asset investments increasing faster or slower than percent change in total revenues? l Is percent total liabilities to total liabilities plus owners’ equity increasing or decreasing?

23 © Copyright Doug Hillman 2000 Comprehensive Analysis Case: Integrative l Is the company operating more or less efficiently using the least amount of assets to generate a given level of total revenues l Compute total asset turnover

24 © Copyright Doug Hillman 2000 Comp. Analysis Case: Short- term Liquidity Ratios l Current ratio l Quick ratio l Accounts receivable turnover l Inventory turnover l Is ration better or worse than previous year?

25 © Copyright Doug Hillman 2000 Comp. Analysis Case: Profitability Ratio l Return on total assets »Profit margin »Total asset turnover l Is ROA better or worse than prior years?