Internal Control and Cash PowerPoint Slides to accompany Fundamental Accounting Principles, 14ce Prepared by Joe Pidutti, Durham College CHAPTER 8 © 2013 McGraw-Hill Ryerson Limited.

1. Define, explain the purpose, and identify the principles of internal control. (LO 1 ) 2. Define cash and explain how it is reported. (LO 2 ) 3. Apply internal control to cash. (LO 3 ) 4. Explain and record petty cash fund transactions. (LO 4 ) 2 © 2013 McGraw-Hill Ryerson Limited. Learning Objectives

5. Explain and identify banking activities and the control features they provide. (LO 5 ) 6. Prepare a bank reconciliation and journalize any resulting adjustment(s). (LO 6 ) 7. Calculate the acid-test ratio and explain its use as an indicator of a company’s liquidity. (Appendix 8A) (LO 7 ) 3 © 2013 McGraw-Hill Ryerson Limited. Learning Objectives

All policies and procedures used to : Protect assets Ensure reliable accounting Promote efficient operations Encourage adherence to company policies 4 © 2013 McGraw-Hill Ryerson Limited. Internal Control System LO 1

5 © 2013 McGraw-Hill Ryerson Limited. 1. Ensure transactions and activities are authorized. 2. Maintain adequate records. 3. Insure assets and bond key employees. 4. Separate recordkeeping and custody of assets. 5. Establish a separation of duties. Principles of Internal Control LO 1

6 © 2013 McGraw-Hill Ryerson Limited. 6. Apply technological controls. 7. Perform internal and external audits. Internal controls will vary based on the nature and size of the organization. Principles of Internal Control LO 1

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 7 © 2013 McGraw-Hill Ryerson Limited. LO 1

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 8 © 2013 McGraw-Hill Ryerson Limited. Cash LO 2

Refers to how easily an asset can be converted into another asset or used in paying for services or obligations. Cash and similar assets are called liquid assets. Companies must own some liquid assets to pay their obligations. 9 © 2013 McGraw-Hill Ryerson Limited. Liquidity LO 2

Guidelines: 1. Separate handling of cash from recordkeeping of cash. 2. Deposit cash receipts daily. 3. Make cash disbursements by cheque. 10 © 2013 McGraw-Hill Ryerson Limited. Internal Control for Cash LO 3

Internal control over cash receipts ensures that all cash received is properly recorded and deposited. These controls include: The use of cash registers for over-the- counter cash sales. The separation of recordkeeping and custody of cash. 11 © 2013 McGraw-Hill Ryerson Limited. Control of Cash Receipts LO 3

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. 12 © 2013 McGraw-Hill Ryerson Limited. Control of Cash Disbursements LO 3

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. 13 © 2013 McGraw-Hill Ryerson Limited. Petty Cash System of Internal Control LO 4

Cashier’s Office Petty Cashier Operating a Petty Cash Fund Prepares cheque to establish petty cash fund. 14 © 2013 McGraw-Hill Ryerson Limited. LO 4

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. 15 © 2013 McGraw-Hill Ryerson Limited. Operating a Petty Cash Fund LO 4

A cheque is issued and the fund is replenished when the amount of cash on hand becomes low. 16 © 2013 McGraw-Hill Ryerson Limited. Operating a Petty Cash Fund A cash over and short account is used if needed. LO 4

17 © 2013 McGraw-Hill Ryerson Limited. Operating a Petty Cash Fund LO 4 Cash required to replenish petty cash = Fund size Cash remaining - Cash over/(short) = Total of petty cash receipts - Cash required to replenish petty cash

Basic Bank Services Bank account Bank deposits and cheques Electronic funds transfer Bank credit card transactions Debit card transactions 18 © 2013 McGraw-Hill Ryerson Limited. Banking Activities as Controls LO 5

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. 19 © 2013 McGraw-Hill Ryerson Limited. Credit Card Transactions LO 5

TechCom has $100 of credit card sales with a 4% fee and cash is received immediately (assume cost of sales is $40). 20 © 2013 McGraw-Hill Ryerson Limited. Illustration-Credit Card Transaction LO 5

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. 21 © 2013 McGraw-Hill Ryerson Limited. Debit Card Transactions LO 5

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 22 © 2013 McGraw-Hill Ryerson Limited. LO 6

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 23 © 2013 McGraw-Hill Ryerson Limited. LO 6

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. 24 © 2013 McGraw-Hill Ryerson Limited. LO 6

* Bank Reconciliation - Example 25 © 2013 McGraw-Hill Ryerson Limited. Why are the balances different? Some items are reflected on the bank statement but not in the accounting records and vice versa. LO 6

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. 26 © 2013 McGraw-Hill Ryerson Limited. LO 6

Let’s prepare the bank reconciliation for VideoBuster Company at the end of October 31, © 2013 McGraw-Hill Ryerson Limited. LO 6

These items appear on both the Cash Receipts Journal and the bank statement; therefore, none of these items is a reconciling item. 28 © 2013 McGraw-Hill Ryerson Limited. LO 6

These items appear on both the Cash Disbursements Journal AND the bank statement; therefore, none of these items is a reconciling item. 29 © 2013 McGraw-Hill Ryerson Limited. LO 6

These items appear only in the Cash Receipts Journal OR the Cash Disbursements Journal OR the bank statement; therefore, each of these items is a reconciling item. 30 © 2013 McGraw-Hill Ryerson Limited. LO 6

The items that show up only on the bank statement are reconciling items on the book side of the bank reconciliation. 31 © 2013 McGraw-Hill Ryerson Limited. LO 6

32 © 2013 McGraw-Hill Ryerson Limited. LO 6

33 © 2013 McGraw-Hill Ryerson Limited. LO 6

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. 34 © 2013 McGraw-Hill Ryerson Limited. LO 6

35 © 2013 McGraw-Hill Ryerson Limited. LO 6

The Final Product 36 © 2013 McGraw-Hill Ryerson Limited. LO 6

Recording Adjusting Entries from the Bank Reconciliation 37 © 2013 McGraw-Hill Ryerson Limited. LO 6

Recording Adjusting Entries from the Bank Reconciliation 38 © 2013 McGraw-Hill Ryerson Limited. LO 6

Recording Adjusting Entries from Bank Reconciliation After posting the reconciling entries the cash account looks like this © 2013 McGraw-Hill Ryerson Limited. Adjusted balance on October 31 LO 6

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. 40 © 2013 McGraw-Hill Ryerson Limited.

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. 41 © 2013 McGraw-Hill Ryerson Limited. Using the Information-Appendix 8A LO 7

Acid-Test Ratio = 42 © 2013 McGraw-Hill Ryerson Limited. Quick assets* Current liabilities * cash, short-term investments, and receivables LO 7 Using the Information-Appendix 8A

End of Chapter 43 © 2013 McGraw-Hill Ryerson Limited.