© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide Reporting and analyzing Cash and Internal Controls

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-2 Purpose of Internal Control All policies and procedures managers use to...  Protect assets.  Ensure reliable accounting.  Promote efficient operations.  Urge adherence to company policies. All policies and procedures managers use to...  Protect assets.  Ensure reliable accounting.  Promote efficient operations.  Urge adherence to company policies.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-3 Principles of Internal Control  Establish responsibilities.  Maintain adequate records.  Insure assets and bond employees.  Separate recordkeeping and custody over assets.  Divide responsibility for related transactions. ‘Apply technological controls. ’Perform regular and independent reviews.  Establish responsibilities.  Maintain adequate records.  Insure assets and bond employees.  Separate recordkeeping and custody over assets.  Divide responsibility for related transactions. ‘Apply technological controls. ’Perform regular and independent reviews.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-4 Technology and Internal Control ReducedProcessingErrorsReducedProcessingErrorsMore Extensive Testing of Records More Extensive Testing of Records Limited Evidence of ProcessingLimited ProcessingCrucial Separation of DutiesCrucial Duties

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-5 Limitations of Internal Control Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-6 Limitations of Internal Control The costs of internal controls must not exceed their benefits. The costs of internal controls must not exceed their benefits. Costs Benefits

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-7 Cash Currency, coins and amounts on deposit in bank account, checking accounts, and some savings accounts. Cash Cash Equivalents Short-term, highly liquid investments that are:  Readily convertible to a known cash amount  Close to maturity date and not sensitive to interest rate changes Cash Equivalents Short-term, highly liquid investments that are:  Readily convertible to a known cash amount  Close to maturity date and not sensitive to interest rate changes Cash, Cash Equivalents, and Liquidity

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-8 Liquidity How easily an asset can be converted into another asset or be used in paying for services or obligations. Liquidity InventoryCash Cash, Cash Equivalents, and Liquidity

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-9 Control of Cash  Segregate handling of cash from recordkeeping of cash.  Cash receipts are promptly (daily) deposited in a bank.  Cash disbursements are made by check.  Segregate handling of cash from recordkeeping of cash.  Cash receipts are promptly (daily) deposited in a bank.  Cash disbursements are made by check.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-10 Control of Cash Receipts Over-the-Counter Cash Receipts Over-the-Counter Cash Receipts Cash register with locked- in record of transactions. Cash register with locked- in record of transactions. Compare cash register record with cash reported. Compare cash register record with cash reported. Over-the-Counter Cash Receipts Over-the-Counter Cash Receipts Cash register with locked- in record of transactions. Cash register with locked- in record of transactions. Compare cash register record with cash reported. Compare cash register record with cash reported. Cash Receipts By Mail Two people open the mail. Money to cashier’s officeMoney to cashier’s office List to accounting dept.List to accounting dept. Copy of list filedCopy of list filed Cash Receipts By Mail Two people open the mail. Money to cashier’s officeMoney to cashier’s office List to accounting dept.List to accounting dept. Copy of list filedCopy of list filed

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-11 Control of Cash Disbursements All expenditures made by check. The only exception is for small payments from petty cash. All expenditures made by check. The only exception is for small payments from petty cash. Separate authorization, check signing and recordkeeping duties. Separate authorization, check signing and recordkeeping duties. Apply a voucher system. Apply a voucher system. All expenditures made by check. The only exception is for small payments from petty cash. All expenditures made by check. The only exception is for small payments from petty cash. Separate authorization, check signing and recordkeeping duties. Separate authorization, check signing and recordkeeping duties. Apply a voucher system. Apply a voucher system.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-12 Voucher System of Control A voucher system establishes procedures for: Accepting obligations resulting in cash disbursements. Accepting obligations resulting in cash disbursements. Verifying, approving and recording obligations. Verifying, approving and recording obligations. Issuing checks for payment of verified, approved and recorded obligations. Issuing checks for payment of verified, approved and recorded obligations. Requiring obligations be recorded when incurred. Requiring obligations be recorded when incurred. Treating each purchase as an independent transaction. Treating each purchase as an independent transaction. A voucher system establishes procedures for: Accepting obligations resulting in cash disbursements. Accepting obligations resulting in cash disbursements. Verifying, approving and recording obligations. Verifying, approving and recording obligations. Issuing checks for payment of verified, approved and recorded obligations. Issuing checks for payment of verified, approved and recorded obligations. Requiring obligations be recorded when incurred. Requiring obligations be recorded when incurred. Treating each purchase as an independent transaction. Treating each purchase as an independent transaction.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-13 CheckInvoice ApprovalReceiving ReportInvoicePurchase Order Voucher System of Control Purchase Requisition Voucher Cashier’s Office Accounting Dept. Receiving Dept. Supplier (Vendor) Purchasing Dept. Requesting Dept. Cashier’s Office Accounting, Requesting, Purchasing Depts. Accounting Dept. Supplier (Vendor) Purchasing and Accounting Depts. Supplier (Vendor)

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-14 Copy 2 Purchasing Requesting Department Accounting One copy of purchase requisition used to prepare the voucher. One copy of purchase requisition used to prepare the voucher. Copy 1

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-15 Copy 1 Copy 3 Copy 2 Retained in Purchasing Accounting Vendor Requesting Dept.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-16 Inside of a Voucher

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-17 Outside of a Voucher

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-18 Petty Cash System of Control Small payments required in most companies for items such as postage, courier fees, repairs and supplies.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-19 Operating a Petty Cash Fund Petty Cashier Treasurer and Accountant Petty Cashier

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-20 Petty Cashier Operating a Petty Cash Fund

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-21 Petty Cashier 34¢ Stamps Courier Operating a Petty Cash Fund

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-22 Petty Cashier 34¢ Stamps Courier Operating a Petty Cash Fund Receipts

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-23 Petty Cashier Receipts Treasurer and Accountant $125 To reimburse petty cash fund We use a Cash Over and Short account if needed. We use a Cash Over and Short account if needed. Operating a Petty Cash Fund

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-24 Petty Cash Example Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses$79.30 Customer Business Lunches Express Mail Postage Miscellaneous Office Supplies Let’s look at replenishing the fund if the balance on July 31 was $ Let’s look at replenishing the fund if the balance on July 31 was $ Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses$79.30 Customer Business Lunches Express Mail Postage Miscellaneous Office Supplies Let’s look at replenishing the fund if the balance on July 31 was $ Let’s look at replenishing the fund if the balance on July 31 was $

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-25 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$ What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$137.80

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-26 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$ What amount of cash will be required to replenish the petty cash fund? a.$ b.$ c.$ d.$137.80

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-27 Petty Cash Example Let’s make the journal entry to replenish the petty cash fund.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-28 PurchaseDiscountsPurchaseDiscounts Control of Purchase Discounts Let’s take a closer look at purchase discounts.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-29 Control of Purchase Discounts Previously we have recorded purchases of Merchandise Inventory at the gross amount. Discounts were not recognized until payment was made.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-30 Control of Purchase Discounts As an alternative, we may record the purchase net of any discount. We assume that all discounts will be taken.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-31 Control of Purchase Discounts When we use the net method, attention is drawn when available discounts are not taken. Discounts Lost is an expense account and is included on the income statement. Discounts Lost is an expense account and is included on the income statement.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-32 Bank Reconciliation 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. Why are the balances different? Why are the balances different? *

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-33 Reconciling Items Bank Statement Balance Deduct: Outstanding checks. Deduct: Outstanding checks. Add: Deposits in transit. Add: Deposits in transit. Add or Deduct: Bank errors. Add or Deduct: Bank errors. Bank Statement Balance Deduct: Outstanding checks. Deduct: Outstanding checks. Add: Deposits in transit. Add: Deposits in transit. Add or Deduct: Bank errors. Add or Deduct: Bank errors. Book Balance Deduct: Nonsufficient funds check (NSF). Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge. Deduct: Bank service charge. Add: Interest earned on checking account. Add: Interest earned on checking account. Add: Collections made by the bank. Add: Collections made by the bank. Add or Deduct: Book errors. Add or Deduct: Book errors. Book Balance Deduct: Nonsufficient funds check (NSF). Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge. Deduct: Bank service charge. Add: Interest earned on checking account. Add: Interest earned on checking account. Add: Collections made by the bank. Add: Collections made by the bank. Add or Deduct: Book errors. Add or Deduct: Book errors.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-34 Bank Reconciliation Two sections:  Reconcile bank statement balance to the adjusted bank balance.  Reconcile book balance to the adjusted book balance. The adjusted balances should be equal. Two sections:  Reconcile bank statement balance to the adjusted bank balance.  Reconcile book balance to the adjusted book balance. The adjusted balances should be equal.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-35 Bank Reconciliation Example Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610, while the cash general ledger account on that date shows a balance of $7,430. Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610, while the cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. Additional information necessary for the reconciliation is shown on the next screen. Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610, while the cash general ledger account on that date shows a balance of $7,430. Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. The July 31 bank statement indicated a balance of $9,610, while the cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. Additional information necessary for the reconciliation is shown on the next screen.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-36  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment on account receivable.  The bank statement showed $30 interest earned during July.  Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240. ‘A $486 deposit by Acme Company was erroneously credited to our account by the bank. Bank Reconciliation Example

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-37 Simmons Company Bank Reconciliation July 31, 2002  ‘ 

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-38 Simmons Company Bank Reconciliation July 31, 2002  ‘    

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-39 Recording Adjusting Entries from Bank Reconciliation Only amounts shown on the book portion of the reconciliation require an adjusting entry. 

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-40 Recording Adjusting Entries from Bank Reconciliation  Only amounts shown on the book portion of the reconciliation require an adjusting entry.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-41 After posting the reconciling entries the cash account looks like this... Adjusted balance on July 31. Recording Adjusting Entries from Bank Reconciliation

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-42 Days’ Sales Uncollected Days’ Sales Uncollected Accounts Receivable Net Sales × 365= How much time is likely to pass before we receive cash receipts from credit sales. How much time is likely to pass before we receive cash receipts from credit sales.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 6-43 End of Chapter 6