Cash and Internal Control Chapter 5 Cash and Internal Control Financial Accounting, Alternate 4e by Porter and Norton

Gap Inc. Consolidated Balance Sheets (partial) ASSETS (in thousands) Feb. 1, 2003 Feb 2, 2002 Current Assets: Cash and equivalents $3,388,514 $1,035,749 Merchandise inventory 2,047,879 1,768,613 Other current assets 303,332 331,685 Total current assets $5,739,725 $3,136,047 higher

Gap Inc. Consolidated Balance Sheets (partial) ASSETS (in thousands) Current Assets: Cash and equivalents Key to classification as cash: readily available to pay debts

Cash Coin & currency Checking, savings & money market accounts Undeposited, cashier, and certified checks Pay to the order of: ABC Co.

Cash Equivalents and the Statement of Cash Flows Gap Inc.’s Consolidated Balance Sheets (partial) (in thousands) Feb. 1, 2003 Feb 2, 2002 Current Assets: Cash and equivalents $3,388,514 $1,035,749 Merchandise inventory 2,047,879 1,768,613 Other current assets 303,332 331,685 Total current assets $5,739,725 $3,136,047 Gap Inc.’s Consolidated Statement of Cash Flows (partial) Year ended Year ended (in thousands) Feb. 1, 2003 Feb 2, 2002 Net increase (decrease) in cash and equivalents 2,352,765 626,955 Cash and equivalents at beg. of year 1,035,749 408,794 Cash and equivalents at end of year $3,388,514 $1,035,749

Cash Equivalents Readily convertible to cash Original maturity to investor of 3 months or less 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27 Commercial paper U.S. Treasury bills Certain money market funds

Cash Management Necessary to ensure company has neither too little nor too much cash on hand Tools: Cash Flows Statement Cash Budgets Bank Reconciliations Petty Cash Funds

Bank Statements Cash balance, beginning of period + Deposits = Cash balance, end of period Deposits Customer notes and interest collected by bank Interest earned Canceled checks NSF checks Service charges

Bank Reconciliation - Step 1 Trace deposits on bank statement to books. Identify deposits in transit. Add to bank balance. Deposits in Transit: Late period deposits not yet reflected on bank statement

Example of Reconciliation Bank Statement Adjustments: Deposits Balance per statement, June 30 $ 3,308.59 Add: Deposit in transit 642.30 10 1

Bank Reconciliation - Step 2 Trace checks cleared by bank to books. Identify outstanding checks. Subtract from bank balance. Outstanding checks: Checks written but not yet presented to bank ABC Co. Pay to the order of: XYZ Co.

Example of Reconciliation Bank Statement Adjustments: Checks Outstanding Balance per statement, June 30 $3,308.59 Add: Deposit in transit 642.30 Deduct: Outstanding checks: Check No. 496 $ 79.89 Check No. 501 213.20 Check No. 502 424.75 (717.84) Adjusted balance, June 30 $3,233.05 12 1

Bank Reconciliation - Step 3 List all other additions (credit memoranda) shown on the bank statement. Add to book balance. Credit memoranda: Interest earned, customer notes collected

Example of Reconciliation Cash Account Adjustments: Credit Memoranda Balance per books, June 30 $ 2,895.82 Add: Note collected $500.00 Interest on note 50.00 Interest earned 15.45 Recording error, #498 54.00 619.45 14 2

Bank Reconciliation - Step 4 List all other subtractions (debit memoranda) shown on the bank statement. Subtract from book balance. Date Non-Sufficient Funds Debit memoranda: NSF checks, service charges, etc.

Example of Reconciliation Cash Account Adjustments: Debit Memoranda Balance per books, June 30 $ 2,895.82 Add: Note collected $500.00 Interest on note 50.00 Interest earned 15.45 Recording error, #498 54.00 619.45 Deduct: NSF check $245.72 Collection fee – note 16.50 Service charge 20.00 (282.22) Adjusted balance, June 30 $ 3,233.05 2

Bank Reconciliation - Step 5 Identify errors made by the bank or the company in recording transactions during the period.

Bank Reconciliation - Step 6 Use the information collected in Steps 1 - 5 to prepare the bank reconciliation. Bank Reconciliation Balance per bank $$$ : Adjusted balance $$$ Balance per books $$$ Adjusted balances for book and bank must agree

Example of Reconciliation Bank Statement Adjustments Balance per statement, June 30 $ 3,308.59 : Adjusted balance, June 30 $ 3,233.05 Cash Account Adjustments Balance per books, June 30 $ 2,895.82 : Adjusted balance, June 30 $ 3,233.05 19 1

Bank Reconciliation Adjusting Entries Balance per bank $$$ : Adjusted balance $$$ Balance per books $$$ Book adjustments are the basis for adjusting entries

Petty Cash Dr. Cr. RECEIPT RECEIPT Paycheck for Jane Doe Date Dept. of Treasurer Jane Doe RECEIPT Dr. Cr. RECEIPT

Responsibility for Internal Control Auditors Audit Committee of Board of Directors External Auditors Management

Internal Control Control Environment Internal Accounting Control Procedures Accounting System

The Control Environment Management’s competence and operating style Personnel policies and practices Influence of board of directors

The Accounting System Methods and records used to report transactions and maintain financial information Can be manual or automated systems or a combination of both Use of journals is an integral part of any system

Internal Control Procedures Independent Review and Appraisal Independent Verification Design & Use of Business Documents Safeguarding Assets and Records Proper Authorizations Segregation of Duties 26

Proper Authorizations Authority and responsibility go hand in hand LOAN APPROVED

Segregation of duties Separate physical custody from the accounting for assets

Independent Verification One individual or department acts as a check on the work of another

Safeguarding Assets and Records Protect assets and accounting records from loss, theft, unauthorized use, etc.

Independent Review and Appraisal Provide for periodic review and appraisal of the accounting system and the people operating it. Audit Report

Design and Use of Business Documents Capture all relevant information about a transaction and assist in proper recording and classification. Are properly controlled

Limitations on Internal Control No system is entirely foolproof Employees in collusion can override the best controls Cost vs. benefit tradeoff

Controls Over Cash All cash receipts deposited intact daily All cash disbursements made by check Paycheck for Dept. of Treasurer John Doe Date Jane Doe

Controls Over Cash Received Over the Counter Cash registers Prenumbered customer receipts Investigation of recurring discrepancies

Controls Over Cash Received in the Mail Two employees open mail Prelist prepared Monthly customer statements

Computerized Business Documents and Internal Control Appendix Computerized Business Documents and Internal Control

Controls over Cash Disbursements: Business Documents Purchase Requisition Receiving Report Purchase Order Invoice Approval Purchase Invoice Check prepared

End of Chapter 5