CHAPTER SEVEN ACCOUNTING FOR CASH

CASH Includes: –Currency, coins, and checking accounts –Checks received from customers –Money orders –Bank cashier’s checks Because cash plays such a central role in operating a business, it must be carefully managed and controlled.

INTERNAL CONTROL A set of procedures designed to: –Safeguard an organization’s assets from Employee theft, robbery, unauthorized use –Enhance the accuracy and reliability of accounting records by reducing Risk of errors and irregularities

PRINCIPLES OF INTERNAL CONTROL  Establishment of responsibility :  most effective when only one person is responsible for a given task  Segregation of duties:  the work of one employee should provide a reliable basis for evaluating the work of another employee

5 Documentation procedures: Documents provide evidence that transactions and events have occurred PRINCIPLES OF INTERNAL CONTROL

PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS

Independent Internal Verification

8 Bonding of employees who handle cash Rotating employee’s duties and requiring employees to take vacations Independent Internal Verification

9 Limitations of Internal Controls Cost/Benefit - cost of establishing procedure should not exceed expected benefit Human element - fatigue, carelessness, indifference Collusion - two or more individuals who work together to get around controls Size of business

INTERNAL CONTROL Other Good internal control for cash transactions: –All cash received should be deposited DAILY in a bank. –All disbursements, except for payments from petty cash, should be made by CHECK.

MAKING DEPOSITS Deposit Ticket is a form showing –A detailed listing of items being deposited –Currency, coins, and checks are listed separately. –Each check should be identified by its ABA number. American Bankers Association number Found in upper right hand corner of check Also shown in MICR code on the lower left side of front of each check ABA number is used to sort and route checks.

MAKING DEPOSITS Endorsements--each check being deposited must be endorsed by the depositor. –Blank endorsement--the depositor simply signs the back of the check. Check becomes payable to any bearer. –Restrictive endorsement--depositor adds words such as “For deposit,” “Pay to any bank,” or “Pay to Mary Adams only.”

WRITING CHECKS Check is a document ordering a bank to pay cash from a depositor’s account. Three parties to every check: –Drawer--the depositor who orders the bank to pay the cash –Drawee--the bank on which the check is drawn –Payee--the person being paid the cash Business checks often have a check stub.

BANK STATEMENT Includes: –The balance at the BEGINNING of the period –Deposits and other amounts ADDED during the period –Checks and other amounts SUBTRACTED during the period –The balance at the END of the period

BANK STATEMENT Sent with bank statement –Canceled checks, “imaged” sheets of check faces, or a listing of checks –Any other forms representing items added to or subtracted from the account

EXAMPLE Bank statement shows a balance of $4,350. But the general ledger account has a balance of $3,800. We need to prepare a BANK RECONCILIATION.

Mary Adams Consulting Bank Reconciliation October 31, 2009 Heading includes: Name of Company Bank Reconciliation Date

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Reconciliation begins with balance according to the bank statement. $4,350

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Reconciling items are listed as additions or subtractions from the bank balance. $4,350 Add: Deduct:

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Once all reconciling items are listed, the “Adjusted Bank Balance” is computed. $4,350 Add: Deduct: Adjusted Bank Balance

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Now the reconciliation turns to adjusting the BOOK balance. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 $3,800

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Additions and subtractions will be made to the book balance. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 “Adjusted book balance” is computed. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted Book Balance

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 We say it is “reconciled” when the Adjusted BANK and Adjusted BOOK balances agree. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted Book Balance

REASONS FOR DIFFERENCES Outstanding checks –Checks that have not been presented to the bank for payment Deposits in transit –Deposits that have not reached the bank or been recorded by the bank before the statement is prepared Service charges –E.g., check printing and processing, account fees

REASONS continued Collections –Made by the bank on behalf of the depositor Not sufficient funds (NSF) checks –Checks deposited but not paid because drawer did not have sufficient funds Errors –Made by bank or by the depositor in recording cash transactions

BANK RECONCILIATION THREE STEPS:

STEP #1 Identify deposits in transit and related errors. Compare bank statement with:  Last month’s deposits in transit They should all be on the bank statement.  Deposits listed in the accounting records If not found on the bank statement, the deposit is considered a deposit in transit.  $ amounts for deposits in the accounting records If they differ, the error needs to be corrected.

STEP #1 EXAMPLE A deposit in the accounting records of $635, dated October 31, had not been received by the bank. DEPOSIT IN TRANSIT

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 DEPOSITS IN TRANSIT are added to the bank balance. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635

STEP #2 Identify outstanding checks and related errors. Compare canceled checks with bank statement and accounting records: If they differ, error needs to be corrected.

STEP #2 EXAMPLE Check # 862 payable to XYZ Telephone Company was written for $46.25 but was entered on the check stub and on the books as $ $18.00 ERROR

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $18.00 is added back to the book balance. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check #862 18

STEP #2 Identify outstanding checks and related errors. Compare canceled checks with bank statement and accounting records:  Check mark the stub or accounting records to indicate check has cleared.  Checks written but not cleared are OUTSTANDING CHECKS. Subtracted from the bank balance on the reconciliation  If they differ, the error needs to be corrected.

STEP #2 EXAMPLE Check numbers 890, 892, and 893 do not appear on the bank statement. OUTSTANDING CHECKS

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 Outstanding checks are deducted from the bank balance. $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727

STEP #3 Identify additional reconciling items. Compare any additions and deductions on the bank statement that are not deposits or checks with the accounting records.  Items ADDED to the account by the bank are CREDIT MEMOS.  Items DEDUCTED from the account by the bank are DEBIT MEMOS.

STEP #3 EXAMPLE Mary used an ATM machine to make a withdrawal from her account of $200 for personal use. However, she forgot to record this withdrawal on the books. Deduct $200 from the book balance.

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200

STEP #3 EXAMPLE The bank returned an NSF check of $350 written by one of Mary’s clients. Deduct $350 from the book balance.

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200 NSF check 350

STEP #3 EXAMPLE The bank deducted $10 from Mary’s account for service charges. Deduct $10 from the book balance.

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200 NSF check 350 Bank service charge10

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200 NSF check 350 Bank service charge10 The Bank section of the reconciliation is totaled. $4,985 $3,258

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200 NSF check 350 Bank service charge10 Then the Book section is totaled. $4,985 $3,258 $3,818 $560 $3,258

EXAMPLE We now know that the actual amount of cash is $3,258. But the General Ledger Cash account still shows $3,800. JOURNAL ENTRIES NEEDED

BANK RECONCILIATION JOURNAL ENTRIES Only two kinds of items appearing on a bank reconciliation require journal entries: –Errors in the books –Bank additions and deductions that do not already appear in the accounting records ALL items in the BOOK section of the reconciliation

Mary Adams Consulting Bank Reconciliation October 31, 2009 Bank statement balance, October 31 $4,350 Add: Deduct: Adjusted Bank Balance Book balance, October 31 Add: Deduct: $3,800 Adjusted book balance Deposit in transit $635 Error on check # Outstanding checks No. 890 No. 892 No. 893 $ ,727 Unrecorded ATM withdrawal$200 NSF check 350 Bank service charge10 These 4 items will require journal entries. $4,985 $3,258 $3,818 $560 $3,258

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash When check #862 was written, the Cash account was credited for $18.00 more than the check amount of $ This entry puts $18.00 back in the Cash account Oct. 31

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash Telephone Expense Error on Check #862 Oct. 31 Telephone Expense was originally debited for $ This was $18.00 more than the actual telephone bill of $ This entry removes the extra $18.00.

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash Since the ATM withdrawal was for “personal expenses,” Drawing should be debited. Telephone Expense Error on Check #862 M.A., Drawing Oct. 31

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash The $200 withdrawal was never recorded. This entry will remove the $200 from the Cash account. Telephone Expense Error on Check #862 M.A., Drawing Oct. 31 Cash

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash Telephone Expense Error on Check #862 M.A., Drawing Oct. 31 Cash Unrecorded ATM withdrawal

GENERAL JOURNAL cont. DATEDESCRIPTIONPRDEBITCREDIT Accounts Receivable Cash NSF check 31 The amount of the bounced check is placed into Accounts Receivable and Cash is reduced.

GENERAL JOURNAL cont. DATEDESCRIPTIONPRDEBITCREDIT Accounts Receivable Cash NSF check Miscellaneous Expense Cash Bank service charge Service charges are usually small. Often they are put into Misc. Expense.

PETTY CASH A fund set up to pay for small items with cash –Checks for very small amounts are cumbersome. To establish the fund: –Check is written to the petty cash custodian. –Check is cashed. –Money is placed into secure box/drawer. Custodian is the only person authorized to pay out petty cash.

EXAMPLE Mary wants to establish a $50 Petty Cash fund to be used to make small purchases CASH $50 $50 is withdrawn (by check) from the Cash account.

EXAMPLE Mary wants to establish a $50 Petty Cash fund to be used to make small purchases. CASH $50 Petty Cash is an ASSET account. $50 PETTY CASH

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Petty Cash Nov. 15 Cash Establish Petty Cash fund

PETTY CASH VOUCHER A receipt prepared for every payment from Petty Cash Voucher includes: –Name of Payee –Purpose and amount of payment –Account to be charged (e.g., Postage Expense) –Signature of custodian and payee

PETTY CASH PAYMENTS RECORD Multi-column record that supplements the regular accounting records Provides record of each Petty Cash payment –Broken down by account E.g.: Travel/Entertainment Expense, Postage Exp., etc. –Used to prepare Replenishment journal entry

REPLENISHING PETTY CASH Fund is replenished: –When funds run low, and –End of each accounting period Journal Entry is made: –Debiting the accounts charged (e.g., Postage Expense) –Crediting Cash for amount needed to replenish the fund –Petty Cash account is not debited or credited.

EXAMPLE After two weeks, Mary notices it contains the following vouchers and only $5.65 cash : Voucher # 1 $15.00 for expenses incurred while on a business trip (Travel/Entertainment Expense) Voucher # 2 $11.45 for express mailing a report to a client (Postage Expense) Voucher # 3 $17.90 for oil change on company van (Vehicle Maintenance Expense)

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Nov Travel/Entertainment Exp. Postage Expense Vehicle Maintenance Exp Cash Cash should be credited for the amount needed to restore the fund to its established amount. $50.00 fund - $5.65 in box = $44.35 needed

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Nov Travel/Entertainment Exp. Postage Expense Vehicle Maintenance Exp Cash Journal Entry balances!!! Vouchers (amounts debited) equal the amount needed to replenish the box (credit).

GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Nov Travel/Entertainment Exp. Postage Expense Vehicle Maintenance Exp Cash Replenishment of PC fund

CASH BUDGETING  Cash receipts section includes expected receipts from the company’s principal sources of revenue  Cash disbursements section includes expected payments for direct materials, direct labor, etc.  Financing section shows expected borrowings and their repayment