Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso, Trenholm KIMMEL Prepared by: Barbara Trenholm University of New Brunswick

Chapter 7 Internal Control and Cash PowerPoint Slides After studying Chapter 7, you should be able to: Identify the principles of internal control. Explain the applications of internal control to cash receipts. Explain the applications of internal control to cash disbursements. Prepare a bank reconciliation. 1

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

Internal Control The related methods and measures adopted within a business to Optimize the use of resources Prevent and detect errors and irregularities Safeguard assets Maintain reliable control systems

Illustration 7-1

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

Segregation of Duties Related activities should be assigned to different individuals Separate recordkeeping from physical custody of the asset

Documentation Provide evidence that transactions and events occurred Shipping documents Sales invoices Documents should be prenumbered and accounted for

Physical, Mechanical and Electronic Controls Illustration 7-2

Independent Internal Verification Review, comparison, and reconciliation of data prepared by employees Periodically or on surprise basis Done by employee who is independent of the personnel responsible for the information Discrepancies and exceptions should be reported to management

Limitations of Internal Control Cost/benefit Human element Collusion Size of business

Cash Coins Currency Cheques Money orders Money on hand Deposits in bank

Cash Readily convertible into any other asset High value in small bulk Non-control of owner identification (serial numbers)

Internal Control Over Cash Receipts Illustration 7-4

Internal Control Over Cash Disbursements Illustration 7-5

Petty Cash Imprest (of fixed size) cash fund used to pay relatively small amounts

Petty Cash Fund (Appendix) Operation of the petty cash fund involves 1 Establishing fund 2 Making payments from fund 3 Replenishing fund Accounting entries are required when 1 Fund is established 2 Fund is replenished 3 Amount of fund is changed

Bank Minimizes cash that must be kept on hand PowerPoint Slides Bank Minimizes cash that must be kept on hand Provides a double record of transactions One by the business One by the bank Safeguards cash by using a bank as a depository and clearinghouse for cheques received and written 24

copy of bank’s records sent to the customer for periodic review Bank statement - copy of bank’s records sent to the customer for periodic review Illustration7-6 Bank statement shows cheque & other debits deposits & other credits daily cash balance

Differences Between Company Balance and Bank Balance PowerPoint Slides Differences Between Company Balance and Bank Balance Time lags Time cheque is written and dated and date presented to and paid by the bank Time receipts recorded by company and time receipts recorded by bank Time lags occur when the bank mails debit or credit memos to the company Errors by either party in recording transactions 27

Terms Deposits in transit Outstanding cheques Adjusted balance PowerPoint Slides Terms Deposits in transit Deposits recorded by depositor that have not been recorded by bank Outstanding cheques Cheques written (issued) and recorded by company that have not been presented to/paid by bank Adjusted balance Reconciled or correct cash balance 29

Terms Debit memoranda Credit memoranda Charges against depositor’s account (e.g. service charges, RC (returned)/NSF (insufficient funds) cheques) Credit memoranda Amounts that increase depositor’s account (e.g., interest earned)

-cheque printing or other service charges +notes collected by bank Illustration 7-7 Bank Reconciliation Procedures $ Per Bank Statement -outstanding cheques +deposits in transit +/- bank errors = correct cash amount $ Per Books -NSF cheques -cheque printing or other service charges +notes collected by bank +/- book errors

Reconciling Journal Entries Books Each reconciling item in determining the adjusted balance per books MUST be journalized and posted Bank Do NOT journalize any entries on bank side

PowerPoint Slides Reporting Cash Cash on hand, cash in banks, cash equivalents, and petty cash are often combined and reported as cash Cash is recorded in both the balance sheet and the statement of cash flows Cash is the most liquid asset and listed first in the current asset section of the balance sheet 39

Cash Equivalents Readily convertible to known amount of cash So near maturity that market value is relatively insensitive to changes in interest rates Examples Treasury bills Commercial paper Money market funds

Restricted Cash Cash not available for general use Set aside for special purpose If not to be used within next year, report as noncurrent asset

Five Principles of Cash Management PowerPoint Slides Five Principles of Cash Management Illustration 7-12 33

Cash Budget Planning company's cash needs is a key business activity PowerPoint Slides Cash Budget Planning company's cash needs is a key business activity Cash budget shows anticipated cash flows, over a 1 to 2 year period 42

Cash Budget Cash receipts section Cash disbursements section PowerPoint Slides Cash Budget Cash receipts section Cash disbursements section Financing section 43

Assessing Cash Adequacy PowerPoint Slides Assessing Cash Adequacy Cash to daily cash expenses ratio Free cash flow 50

Cash to Daily Cash Expenses Ratio PowerPoint Slides Cash to Daily Cash Expenses Ratio Cash to daily cash expenses ratio = Cash and cash equivalents Average daily cash expenses* * Subtract amortization from total expenses. Divide by 365 days Measures the number of days of cash expenses that cash on hand can cover 51

Free Cash Flow Free cash flow is amount of discretionary cash flow a company has for Purchasing additional investments Reducing debt Adding liquidity Cash provided by operating activities - Capital expenditures - Dividends paid = Free cash flow

Decision Checkpoints Does the company have adequate cash to meet its daily needs? Does the company have any discretionary cash available? Cash to daily cash expenses ratio Free cash flow

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