Chapter 6 Cash and Internal Control

Cash  Cash:  Readily available to pay debts  Various forms of cash:  Coin and currency on hand  Cash on deposit in the form of checking and savings accounts  Undeposited, cashier, and certified checks LO 1

Cash Equivalents  Investment readily convertible to known amount of cash  Maturity—three months or less  Example:  Commercial paper  Treasury bills issued by the federal government  Money market funds  Six-month bank certificate of deposit would not be a cash equivalent

Exhibit 6.1—Cash and Cash Equivalents on the Balance Sheet and the Statement of Cash Flows

Cash Management  Tools of cash management:  Cash flows statement  Cash budgets  Bank reconciliations  Petty cash funds LO 2

Reading a Bank Statement  Bank statement : a detailed list, provided by the bank, of all activity for a particular account during the month.  Outstanding check : check written by a company but not yet presented to the bank for payment  Deposit in transit : deposit recorded on the books but not yet reflected on the bank statement

Bank Reconciliation  Reconcile or resolve any differences between balance on the bank statement with balance shown in the accounting records  Steps used in preparing a bank reconciliation: 1. Prepare a list of the deposits in transit 2. Prepare a list of the outstanding checks 3. Prepare a list of credit memoranda 4. Prepare a list of debit memoranda 5. Identify any errors

Credit Memoranda and Debit Memoranda  Credit memoranda  Additions on a bank statement for such items as interest paid on the account and notes collected by the bank for the customer  Debit memoranda  Deductions on a bank statement for items such as NSF checks and various service charges

Step 1: Prepare a list of the deposits in transit  Trace deposits listed on the bank statement to the books  Identify the deposits in transit  Any deposits recorded on the books but not yet shown on the bank statement  Add to the bank balance

Step 2: Prepare a List of the Outstanding Checks  Arrange the canceled checks in numerical order  Trace each of them to the books  Any checks recorded on the books but not yet listed on the bank statement are outstanding  Subtract from the bank balance

Step 3: Prepare a List of Credit Memoranda  List all items, other than deposits, shown as additions on the bank statement  Interest paid by the bank  Amounts collected by the bank for the customer  For these items, bank increases, or credits, its liability to the company on its own books

Step 4: Prepare a List of Debit Memoranda  List all amounts, other than canceled checks, shown as subtractions on the bank statement  NSF checks  Service charges  A liability is created on the books of the bank when a company deposits money in a bank  Bank reduces the amount of its liability for these various items and debits the liability on its own books

Step 5: Identify any Errors  Identify any errors made by the bank or by the company in recording cash transactions

Bank Reconciliation Balance per bank$$$ Adjusted balance$$$ Balance per books$$$ Adjusted balance$$$

Example 6.2—Preparing a Bank Reconciliation

Need for Adjustments to the Records Book adjustments are basis for adjusting entries

Petty Cash fund  Money kept on hand for making minor disbursements rather than by writing checks  Periodically, the fund is replenished  When fund is replenished, an adjustment is made to record its replenishment and to recognize the various expenses incurred

Internal Control System  Policies and procedures necessary to ensure:  Safeguarding of an entity’s assets  Reliability of accounting records  Accomplishment of overall company objectives LO 3

Sarbanes-Oxley Act of 2002—SOX  An act of Congress in 2002  Intended to bring reform to corporate accountability and stewardship in the wake of a number of major corporate scandals

Sarbanes-Oxley Act of 2002—SOX (continued)  Internal control report: a report required by Section 404 of the Sarbanes-Oxley Act  Maintain an adequate internal control structure  Assesses effectiveness of internal control structure  Outside auditors must issue report on company’s internal control

Sarbanes-Oxley Act of 2002—SOX (continued)  Public Company Accounting Oversight Board (PCAOB): five-member body created by SOX  Set auditing standards in the United States  Board of directors: consists of key officers of a corporation and outside members responsible for general oversight of the affairs of the entity  Audit committee: a subset of the board of directors  Provides direct contact between the stockholders and the independent accounting firm

The Control Environment  Factors that influence internal control:  Management’s competence and operating style  Personnel policies and practices  Board of directors, particularly audit committee

The Accounting System  Methods and records used to accurately report entity’s transactions and maintain accountability for assets and liabilities  Use of a journal is an integral part of all accounting systems  Can be completely manual, fully computerized, or a mixture of both

Internal Control Procedures  Administrative controls:  Procedures concerned with efficient operation of the business and adherence to managerial policies  Accounting controls:  Procedures concerned with safeguarding the assets or the reliability of the financial statements LO 4

Internal Control System  Important internal control procedures:  Proper authorizations  Segregation of duties  Independent verification  Safeguarding of assets and records  Independent review and appraisal  Design and use of business documents

Internal audit staff  Department responsible for monitoring and evaluating the internal control system

Business Documents  Crucial link between economic transactions entered into by an entity and the accounting record of those events  Often called source documents  Key feature:  Sequential numbering system  Multiple copies

Limitations on Internal Control  Not totally foolproof  Does not ensure prevention of collusion  Maintenance of controls can be costly  Small businesses cannot afford  Human errors can weaken the system  Misunderstood instructions, carelessness, fatigue, and distraction can lead to errors

Computerized Business Documents and Internal Control  All cash receipts should be deposited intact in the bank on a daily basis  Intact means that no disbursements should be made from the cash received from customers  All cash disbursements should be made by check LO 5

Control over Cash Receipts  Most merchandisers receive checks and currency from customers in two ways  Cash received over the counter from cash sales  Cash received in the mail from credit sales  Cash discrepancies  Discrepancies occur occasionally due to theft by dishonest employees and to human error

Role of Computerized Business Documents in Controlling Cash Disbursements  Purchase Requisition  A form a department uses to initiate a request to order merchandise  Purchase order  A form sent by the purchasing department to the supplier

Exhibit 6.5—Document Flow for the Purchasing Function

Exhibit 6.6—Purchase Requisition

Exhibit 6.7—Computer-Generated Purchase Order

Exhibit 6.8—Invoice  A form sent by the seller to the buyer as evidence of a sale

Exhibit 6.9—Computer-Generated Receiving Report

Blind Receiving Report  A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier

Exhibit 6.10—Invoice Approval Form  A form the accounting department uses before making payment to document the accuracy of all information about a purchase

Exhibit 6.11—Check with Remittance Advice  A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier

End of Chapter 6