1 Financial Accounting: Tools for Business Decision Making, 2nd Ed. Kimmel, Weygandt, Kieso ELS

Chapter 7

3 Chapter 7 Internal Control and Cash After studying Chapter 7, you should be able to: zIdentify the principles of internal control. zExplain the application of internal control to cash receipts. zExplain the application of internal control to cash disbursements.  Prepare a bank reconciliation.

4 Chapter 7 Internal Control and Cash After studying Chapter 7, you should be able to: zExplain the reporting of cash. zDiscuss the basic principles of cash management. zIdentify the primary elements of a cash budget.  Identify and interpret measures that evaluate the adequacy of cash.

5 Internal Control consists of... all the related methods and measures adopted within a business to: ysafeguard its assets; yenhance accuracy and reliability of accounting of its accounting records.

6 Illustration 7-1

7 Establishment of Responsibility Control is most effective when only one person is responsible for a given task.

8 Segregation of Duties Responsibility for related activities should be assigned to different individuals Responsibility for keeping records for an asset should be separate from the physical custody of the asset Accountability for Assets

9 Documentation zProvide evidence that transactions and events occurred: yShipping documents ySales invoices

10 Documentation Procedures zDocuments should be pre-numbered zAll documents should be accounted for zSources documents should be promptly forwarded to accounting department

11 Physical, Mechanical and Electronic Controls Illustration 7-3

12 Independent Internal Verification Involves review, comparison, and reconciliation of data prepared by employees Verification should be made periodically or on surprise basis Verification should be done by employee who is independent of the personnel responsible for the information Discrepancies and exceptions should be reported to management

13 Independent Internal Verification Illustration 7-4

14 Other Controls zBonding of employees who handle cash zRotating employee’s duties and requiring employees to take vacations

15 Limitations of Internal Controls zCost/Benefit - cost of establishing procedure should not exceed expected benefit zHuman element - fatigue, carelessness, indifference zCollusion - two or more individuals who work together to get around controls zSize of business

16 Cash consists of... zcoins zcurrency zchecks zmoney orders zmoney on hand zdeposits in bank

17 Cash is the most desirable asset... because it is readily convertible into any other asset.

18 Page 297 in book Internal Control Over Cash Receipts Illustration 7-5

19 Internal Control Over Cash Disbursements Illustration 7-6

20 Electronic Funds Transfer (EFT) zAn approach to transfer funds among parties without paper (deposit tickets, checks, etc.) zEFT uses wire, telephone,telegraph or computer to transfer from one location to another

21 Petty Cash Fund is a cash fund used to pay relatively small amounts

22 Use of a Bank... zis good internal control. zminimizes the amount of cash that must be kept on hand. zprovides a double record of all bank transactions yone by the business yone by the bank zhelps a company safeguard its cash by using a bank as a depository and clearinghouse for checks received and written.

23 Bank Statement shows check & other debits deposits & other credits daily cash balance Bank Statement - a copy of the bank’s records sent to the customer for periodic review. Illustration7-7 Apri l 30, 2001

24 Company Balance and Bank Balance of Cash Usually Differ Because... zTime lags that prevent one of the parties from recording the transaction in the same period. yDays pass between the time a check is written and dated and date it is paid by the bank. yA day may pass between the time receipts are recorded by the company and the time they are recorded by the bank. yA time lag may occur when the bank mails a debit or credit memo to the company. zErrors by either party in recording transactions.

25 Reconciliation Procedure zreconcile balance per books and balance per bank to their adjusted or correct balances zthe reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash

26 Terms zDeposits in transit - deposits recorded by the depositor that have not been recorded by the bank. zOutstanding Checks - checks issued and recorded by the company that have not been paid by the bank. zNSF Check - a check that is not paid by the bank because of insufficient funds in the customer’s bank account. zAdjusted balance - same as true cash balance, correct cash balance

Bank Reconciliation Procedures $ Per Bank Statement -outstanding checks +deposits +/- bank errors correct cash amount $ Per Books -NSF Checks -check printing or other service charge +notes collected by bank correct cash amount Illustration 7-8

W.A. Laird Company Bank Reconciliation April 30, 2001 Cash balance per bank statement15, Add: Deposits in transit 2, , Less: Outstanding checks No. 4533, No. 4571, No. 4601, , Adjusted cash balance per bank12, Cash balance per books11, Add: Collection of N/R for $ 1000 plus interest earned $50, less collection fee $ 151, Error on recording check No , , Less:NSF check Bank service charge Adjusted cash balance per bank12, Illustration 7-9

29 Each reconciling item in determining the adjusted balance per books must be journalized and posted. For Cash To Show the Correct Balance

W.A. Laird Company Bank Reconciliation April 30, 2001 Cash balance per bank statement15, Add: Deposits in transit 2, , Less: Outstanding checks No. 4533, No. 4571, No. 4601, , Adjusted cash balance per bank12, Cash balance per books11, Add: Collection of N/R for $ 1000 plus interest earned $50, less collection fee $ 151, Error on recording check No , , Less:NSF check Bank service charge Adjusted cash balance per bank12, Illustration 7-9

Apr 30 Cash 1, Miscellaneous Expense Notes Receivable 1, Interest Revenue Apr 30Cash Accounts Payable Apr 30Accounts Receivable-Baron Cash Apr 30Miscellaneous Expense Cash JOURNAL

32 Reporting Cash zCash is recorded in both the balance sheet and the statement of cash flows. zThe balance sheet shows the amount of cash available at a given point in time. zThe statement of cash flows shows the sources and uses of cash during a period of time.

33 Cash Equivalents zReadily convertible to known amount of cash zSo near maturity that market value is relatively insensitive to changes in interest rates zExamples: yTreasury bills yCommercial paper yMoney Market Funds

34 Restricted Cash... zIs cash that is not available for general use. zIs set aside for special purpose.  If not to be used within next year, report as noncurrent asset.

Operating Cycle of a Merchandising Company…is the average time it takes to go from cash to cash in producing revenues. Illustration 7-12

Five Principles of Cash Management Illustration 7-13

37 Reporting Cash zCash on hand, cash in banks, and petty cash are often combined and reported as cash. zCash is the most liquid asset and listed first in the current asset section of the balance sheet.

38 Cash Budget zCash is vital. zPlanning the company's cash needs is a key business activity. zCash budget shows the anticipated cash flows, over a 1 to 21-year period.

39 Cash Budget The cash budget contains : zCash receipts section; zCash disbursements section; zFinancing section.

40 Cash Receipts Section zincludes expected receipts from the company's principal source(s) of revenue, such as cash sales and collections from customers on credit sales zalso shows anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock

41 Cash Disbursements Section zshows expected payments for direct materials, direct labor, manufacturing overhead, and selling and administrative expenses. zincludes projected payments for income taxes, dividends, investments, and plant assets.

42 Financing Section shows... òexpected borrowings òthe repayment of the borrowings and interest

43 Two Tools to Measure the Adequacy of Cash ucash to daily cash expenses ratio;  free cash flow.

44 Cash to Daily Cash Expenses Ratio zComputes the number of days of cash expenses that cash on hand can cover zAverage daily cash expenses can be approximated by subtracting depreciation (a noncash expense) from total expenses and dividing by 365 days

45 Cash to Daily Cash Expenses Ratio Cash and cash equivalent Average daily cash expenses Illustration 7-16

46 Free Cash Flow Free cash flow is the amount of discretionary cash flow a company has for: zpurchasing additional investments zreducing its debt  adding to its liquidity Net cash provided by operations $250,000 Less: Capital expenditures $80,000 Cash Dividends 50,000130,000 Free Cash Flow $120,000 Illustration 7-17