Internal Control and Cash C H A P T E R 9 © 2007 McGraw-Hill Ryerson Ltd. Electronic Presentations in Microsoft® PowerPoint®

1. Define, explain the purpose of, and identify the principles of internal control. 2. Define cash and explain how it is reported. 3. Apply internal control to cash. 4. Explain and record petty cash fund transactions. 5. Explain and identify banking activities and the control feature they provide. Learning Objectives © 2007 McGraw-Hill Ryerson Ltd.

6. Prepare a bank reconciliation and journalize any resulting adjustment(s). 7. Calculate the acid-test ratio and explain its use as an indicator of a company’s liquidity. (Appendix 9A) Learning Objectives © 2007 McGraw-Hill Ryerson Ltd.

All policies and procedures used to :  Protect assets  Ensure reliable accounting  Promote efficient operations  Encourage adherence to company policies Internal Control System © 2007 McGraw-Hill Ryerson Ltd.

1. Ensure transactions and activities are authorized. 2. Maintain adequate records. 3. Insure assets. 4. Separate recordkeeping and custody of assets. 5. Establish a separation of duties Fundamental Principles of Internal Control © 2007 McGraw-Hill Ryerson Ltd.

6. Apply technological controls. 7. Perform internal and external audits. Internal controls will vary based on the nature and size of the organization. Fundamental Principles of Internal Control © 2007 McGraw-Hill Ryerson Ltd.

Human Error  Negligence  Fatigue  Misjudgment  Confusion Human Fraud Intent to defeat internal controls for personal gain. Costs vs. Benefits The costs of internal control must not exceed their benefits. Limitations of Internal Control © 2007 McGraw-Hill Ryerson Ltd.

 Is an important asset for every company.  Control of cash on hand and access to it is critical. Cash includes:  Currency  Coins  Deposits in bank accounts  Other items acceptable for deposit Cash © 2007 McGraw-Hill Ryerson Ltd.

Refers to how easily an asset can be converted into another asset or used in paying for services or obligations. Examples:  Cash — highly liquid  A specialized piece of equipment — not very liquid Liquidity © 2007 McGraw-Hill Ryerson Ltd.

Guidelines: 1. Separate handling of cash from recordkeeping of cash. 2. Deposit cash receipts daily. 3. Make cash disbursements by cheque. Internal Control for Cash © 2007 McGraw-Hill Ryerson Ltd.

 All expenditures should be made by cheque. The only exception is for small payments from petty cash.  Separate authorization, cheque signing, and recordkeeping duties.  Apply a voucher system. Control of Cash Disbursements © 2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz An internal control system is all policies and procedures managers use to: a)Protect assets. b)Ensure reliable accounting. c)Promote efficient operations. d)Urge adherence to company policies. e)All of the above. © 2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz An internal control system is all policies and procedures managers use to: a)Protect assets. b)Ensure reliable accounting. c)Promote efficient operations. d)Urge adherence to company policies. e)All of the above. © 2007 McGraw-Hill Ryerson Ltd.

Good internal control procedures require cash disbursements be made by cheque. The exception: Small payments required in most companies for items such as postage, courier fees, repairs, and supplies. This is an example of the cost-benefit limitation Petty Cash System of Internal Control © 2007 McGraw-Hill Ryerson Ltd.

Treasurer and Accountant Petty Cashier Operating a Petty Cash Fund Prepares cheque to establish petty cash fund. © 2007 McGraw-Hill Ryerson Ltd.

Operating a Petty Cash Fund The petty cashier makes payments from this fund for small disbursements. … and ensures a petty cash receipt is signed by the person receiving the money to easily identify the expenses paid from petty cash. © 2007 McGraw-Hill Ryerson Ltd.

We use a Cash Over and Short account if needed. Operating a Petty Cash Fund A cheque is issued and the fund is replenished when the amount of cash on hand becomes low. © 2007 McGraw-Hill Ryerson Ltd.

 Bank account  Bank deposits and cheques  Electronic funds transfer  Bank credit card transactions  Debit card transactions Banking Activities and Services © 2007 McGraw-Hill Ryerson Ltd.

 Many companies allow customers to use bank credit cards for their purchases.  The risk of bad debts is transferred to the credit card company.  The company collects cash from the sale quickly.  The credit card companies charge a fee to the vendor. Bank Credit Card Transactions © 2007 McGraw-Hill Ryerson Ltd.

 Many companies allow customers to use debit cards for their purchases.  The bank transfers funds from the customer’s account to the vendor’s bank account.  The bank charges a fee to the vendor.  The entries are identical to a bank credit card sale. Debit Card Transactions © 2007 McGraw-Hill Ryerson Ltd.

Illustration-Bank Credit Card Transactions TechCom has $100 of credit card sales with a 4% fee and cash is received immediately (assume cost of sales is $40). © 2007 McGraw-Hill Ryerson Ltd.

Bank reconciliations are:  Prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books.  An important element of internal control. Bank Reconciliations © 2007 McGraw-Hill Ryerson Ltd.

The bank statement provides information about everything that has gone through the bank account for a given period of time. CM – Credit Memo DM – Debit Memo EC – Error Correction IN – Interest Earned NSF – Non-sufficient Funds OD – Overdraft SC – Service Charge © 2007 McGraw-Hill Ryerson Ltd.

The general ledger, cash receipts, and cash disbursements journals provide information about everything that has gone through our accounting records for a given period of time. © 2007 McGraw-Hill Ryerson Ltd.

Why are the balances different? * Bank Reconciliation — Example Some items are reflected on the bank statement but not in the accounting records and vice versa. © 2007 McGraw-Hill Ryerson Ltd.

Reconciling Items  Bank Statement  Outstanding cheques.  Deposits in transit.  Bank errors.  General Ledger  Non-sufficient funds cheque (NSF).  Bank service charges.  Interest earned on bank account.  Collections made by the bank.  Book errors. © 2007 McGraw-Hill Ryerson Ltd.

Let’s prepare the bank reconciliation for VideoBuster Company at the end of October 31, © 2007 McGraw-Hill Ryerson Ltd.

On both the cash receipts journal AND the bank statement; therefore, none of these items is a reconciling item. © 2007 McGraw-Hill Ryerson Ltd.

On both the cash disbursements journal AND the bank statement; therefore, none of these items is a reconciling item. © 2007 McGraw-Hill Ryerson Ltd.

Only in the cash receipts journal OR the cash disbursements journal OR the bank statement; therefore, each of these items is a reconciling item. © 2007 McGraw-Hill Ryerson Ltd.

The items that show up only on the bank statement are reconciling items on the book side of the bank reconciliation. © 2007 McGraw-Hill Ryerson Ltd.

The items that show up only on the cash receipts or cash disbursements journal are reconciling items on the bank side of the bank reconciliation. © 2007 McGraw-Hill Ryerson Ltd.

The Final Product © 2007 McGraw-Hill Ryerson Ltd.

Recording Adjusting Entries from the Bank Reconciliation We journalize the items not previously recorded in the accounting records. © 2007 McGraw-Hill Ryerson Ltd.

Recording Adjusting Entries from Bank Reconciliation © 2007 McGraw-Hill Ryerson Ltd.

Recording Adjusting Entries from Bank Reconciliation After posting the reconciling entries the cash account looks like this... Adjusted balance on October 31. © 2007 McGraw-Hill Ryerson Ltd.

Review Discuss the purpose of a bank reconciliation. A bank reconciliation is a procedure designed to explain the differences between the balance in a firm's bank account and the balance on the period's bank statement. The reconciliation procedure examines the differences based on the information available to each party and adjusts for the differences. It also serves as a format for the discovery and correction of recording errors. © 2007 McGraw-Hill Ryerson Ltd.

Review Identify the principles of internal control. Principles of internal control include the following:  establishing responsibilities  maintaining adequate records  insuring assets and bonding employees  separating recordkeeping from custody of assets  dividing responsibilities for related transactions  applying technological controls  performing regular independent reviews © 2007 McGraw-Hill Ryerson Ltd.

Acid-Test Ratio  A measure of a company’s liquidity.  Similar to current ratio but excludes less liquid assets.  Ratio will vary from industry to industry. Using the Information-Appendix 9A © 2007 McGraw-Hill Ryerson Ltd.

Acid-Test Ratio = Quick assets* Current liabilities * cash, short-term investments, and receivables Using the Information-Appendix 9A © 2007 McGraw-Hill Ryerson Ltd.

End of Chapter © 2007 McGraw-Hill Ryerson Ltd.