PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 08 C ASH AND I NTERNAL C ONTROLS

8 - 2 I NTERNAL C ONTROL S YSTEM Policies and procedures managers use to:  Protect assets.  Ensure reliable accounting.  Promote efficient operations.  Urge adherence to company policies. C1

8 - 3 S ARBANES -O XLEY A CT (SOX) The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal controls. C1 Section 404 of SOX requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting. Sen. Paul Sarbanes (D-MD) Rep. Mike Oxley (R-OH)

8 - 4 P RINCIPLES OF I NTERNAL C ONTROL Internal control principles common to all companies: 1.Establish responsibilities. 2.Maintain adequate records. 3.Insure assets and bond key employees. 4.Separate recordkeeping from custody of assets. 5.Divide responsibility for related transactions. 6.Apply technological controls. 7.Perform regular and independent reviews. C1

8 - 5 T ECHNOLOGY AND I NTERNAL C ONTROL Reduced Processing Errors Reduced Processing Errors More Extensive Testing of Records More Extensive Testing of Records Limited Evidence of Processing Limited Evidence of Processing Crucial Separation of Duties Crucial Separation of Duties Increased E-Commerce Increased E-Commerce C1

8 - 6 L IMITATIONS OF I NTERNAL C ONTROL Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain C1 Human fraud triple-threat: Opportunity, Pressure, and Rationalization.

8 - 7 L IMITATIONS OF I NTERNAL C ONTROL The costs of internal controls must not exceed their benefits. The costs of internal controls must not exceed their benefits. Costs Benefits C1

8 - 8 C ONTROL OF C ASH An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cash is separated from recordkeeping for cash. Cash disbursements are made by check. C2 Cash receipts are promptly deposited in a bank.

8 - 9 C ASH, C ASH E QUIVALENTS, AND L IQUIDITY Cash Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders. Cash Equivalents Short-term, highly liquid investments that are: 1.Readily convertible to a known cash amount. 2.Close to maturity date and not sensitive to interest rate changes. C2 Cash and similar assets are called liquid assets because they can be readily used to settle such obligations.

C ASH M ANAGEMENT The goals of cash management are twofold: 1.Plan cash receipts to meet cash payments when due. 2.Keep a minimum level of cash necessary to operate. Effective cash management involves applying the following cash management principles:  Encourage collection of receivables.  Delay payment of liabilities.  Keep only necessary levels of assets.  Plan expenditures.  Invest excess cash. C2

O VER - THE -C OUNTER C ASH R ECEIPTS P1 This graphic illustrates that none of the people involved can make a mistake or divert cash without the difference being revealed.

C ASH O VER AND S HORT Sometimes errors in making change are discovered from differences between the cash in the cash register and the record of the amount of cash receipts. P1 If a cash register’s record shows $550 but the count of cash in the register is $555, we would prepare the following journal entry:

C ASH R ECEIPTS BY M AIL P1 Mailroom Preferably, two people are assigned the task of opening the mail. Cashier The cashier deposits the money in a bank. Recordkeeper The recordkeeper records the amounts received in the accounting records.

C ONTROL OF C ASH D ISBURSEMENTS Keys to Controlling Cash Disbursements  Require all expenditures to be made by check.  Limit access to checks except for those who have the authority to sign checks. P1 Control of cash disbursements is especially important as most large thefts occur from payment of fictitious invoices.

V OUCHER S YSTEM OF C ONTROL A voucher system establishes procedures for: 1.Verifying, approving, and recording obligations for eventual cash disbursements. 2.Issuing checks for payment of verified, approved, and recorded obligations. A voucher system establishes procedures for: 1.Verifying, approving, and recording obligations for eventual cash disbursements. 2.Issuing checks for payment of verified, approved, and recorded obligations. P1

V OUCHER S YSTEM OF C ONTROL P1

P ETTY C ASH S YSTEM OF C ONTROL Small payments required in most companies for items such as postage, courier fees, repairs, and supplies. P2

O PERATING A P ETTY C ASH F UND Petty Cash Company Cashier P2 Accountant Petty Cashier

Petty Cash Petty Cashier O PERATING A P ETTY C ASH F UND P2

Delivery Petty Cashier A petty cash fund is used only for business expenses. O PERATING A P ETTY C ASH F UND P2 Supplies Services Transportation-in

O PERATING A P ETTY C ASH F UND Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Petty Cashier P2 Delivery Supplies Services Transportation-in

Company Cashier $71.30 To reimburse petty cash fund Petty Cashier O PERATING A P ETTY C ASH F UND P2 Accountant

B ASIC B ANK S ERVICES Bank Accounts Signature Cards Deposit Tickets Checks Electronic Funds Transfer Bank Statements

B ANK S TATEMENT Usually once a month, the bank sends each depositor a bank statement showing the activity in the account. C2

B ANK R ECONCILIATION A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books. P3

B ANK R ECONCILIATION P3 The balance of a checking account reported on the bank statement rarely equals the balance in the depositor’s accounting records. Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance Cash Balance per Book + Collections & Interest - Uncollectible items +/- Errors Adjusted Cash Balance Adjusting entries are recorded for the reconciling items on the book side of the reconciliation. =

I LLUSTRATION OF A B ANK R ECONCILIATION P3 Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance We follow nine steps in preparing the bank reconciliation.

I LLUSTRATION OF A B ANK R ECONCILIATION P3 We follow nine steps in preparing the bank reconciliation. Cash Balance per Book + Collections & Interest - Uncollectible items +/- Errors Adjusted Cash Balance

I LLUSTRATION OF A B ANK R ECONCILIATION P3 We follow nine steps in preparing the bank reconciliation. Adjusting entries are recorded for the reconciling items on the book side of the reconciliation.

I LLUSTRATION OF A B ANK R ECONCILIATION P3 Only the items reconciling the book balance require adjustment.

G LOBAL V IEW Control of Cash Accounting definitions for cash are similar for U.S. GAAP and IFRS. Banking Activities as Controls There is a global demand for banking services, bank statements, and bank reconciliations. To the extent feasible, companies utilize banking services as part of their effective control procedures. Internal Control Purposes, Principles and Procedures The purposes and principles of internal control systems are fundamentally the same across the globe.

D AYS ’ S ALES U NCOLLECTED Days’ Sales Uncollected Accounts Receivable Net Sales × 365= Indicates how much time is likely to pass before we receive cash receipts from credit sales. Indicates how much time is likely to pass before we receive cash receipts from credit sales. A1 56 days $612,000,000 $4,022,000,000 × 365=

A PPENDIX 8A: D OCUMENTATION AND V ERIFICATION P4 Receiving Report Purchase Requisition Purchase Order Invoice Voucher

A PPENDIX 8B: C ONTROL OF P URCHASE D ISCOUNTS P5 The net method gives management an advantage in controlling and monitoring cash payments involving purchase discounts. When purchases are recorded at net amounts, a Discounts Lost expense account is recorded and brought to management’s attention.

END OF CHAPTER 08