1. Internal Control and Cash
Chapter 10
Internal Control and Cash

2. 7-1
Internal control is broadly defined as the procedures and processes used by a company to safeguard its assets, process information accurately, and ensure compliance with laws and regulations.

3. 10-1 Principles of Internal Control
Establishment of responsibility
Segregation of duties
Documentation procedures
Physical, mechanical, and electronic controls
Independent internal verification
Other controls

4. 7-2 Objectives of Internal Control
Objectives of Internal Control
7-2
To provide reasonable assurance that:
assets are safeguarded and used for business purposes,
business information is accurate, and
employees comply with laws and regulations.

5. 7-2
Employee fraud is the intentional act of deceiving an employer for personal gain.

6. 7-2
Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are—
the control environment,
risk assessment,
control procedures,
monitoring, and
information and communication.

7. Control Environment
7-2
A business’s control environment is the overall attitude of management and employees about the importance of controls.

8. Management’s philosophy and operating style
Factors That Influence the Control Environment
7-2
Management’s philosophy and operating style
The business’s organizational structure
Personnel policies

9. Limitations of Internal Control
Human Error
Negligence
Fatigue
Misjudgment
Confusion
Human Fraud
Intent to
defeat internal
controls for
personal gain
Any internal control system has limitations. Because humans are involved in the internal control system, our negligence, fatigue, misjudgment, and confusion can negatively impact the goals of the system. Also, an internal control system can be circumvented by individuals who desire to commit fraud and who are willing to work together to do so.

10. Limitations of Internal Control
The costs of internal controls
must not exceed their benefits.
We also must keep in mind that the costs of internal controls must not exceed their benefits. A department store could drastically cut shoplifting losses by having an armed guard escort each customer while in the store. Obviously, the cost of this internal control exceeds the benefit, not to mention the impact it would have on customer morale.
Benefits
Costs

11. 10-2 Application of Internal Control to Cash Receipts
Establishment of Responsibility
Only designated personnel are authorized to handle cash receipts (cashiers)
Physical, Mechanical, and Electronic Controls
Store cash in safes and bank vaults; limit access to storage areas; use cash registers
Segregation of Duties
Different individuals receive cash, record cash receipts, and hold the cash
Independent Internal Verification
Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily
Documentation Procedures
Use remittance advice (mail receipts), cash register tapes, and deposit slips
Other Controls
Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily

12. 10-3 Application of Internal Control to Cash Disbursements
Establishment of Responsibility
Only designated personnel authorized to sign checks (treasurer)
Physical, Mechanical, and Electronic Controls
Store blank checks in safes, with limited access; print check amounts by machine in indelible ink
Segregation of Duties
Different individuals approve and make payments; check signers do not record disbursements
Independent Internal Verification
Compare checks to invoices; reconcile bank statement monthly
Documentation Procedures
Use prenumbered checks and account for them in sequence; each check must have approved invoice
Other Controls
Stamp invoices PAID

13. Control of Cash C2
An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines:
Handling cash is separated from recordkeeping of cash.
Cash receipts are promptly deposited in a bank.
Control of cash focuses on three areas.
One, those who handle cash should be separate from those who keep records of cash.
Two, cash receipts should be deposited daily in the bank.
Three, cash disbursements should be made by check.
Cash disbursements are made by check.

14. 7-7
Companies that have invested excess cash in cash equivalents usually report cash and cash equivalents as one amount on the balance sheet.

15. Control of Cash Receipts
Control of Cash Receipts 28

16. Electronic Funds Transfers
7-3
Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills.

17. 7-3 Control of Cash Payments—The Voucher System
Control of Cash Payments—The Voucher System
7-3
A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized.
A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer.

18. Voucher System of ControlP4
Sender
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting
Cashier
Accounting, Requesting & Purchasing
Accounting
Supplier (Vendor)
Purchasing and
Supplier, Requesting, Receiving & Accounting
Voucher
In a voucher system, a purchase requisition initiates the process for a purchase. If approved, the purchase requisition triggers the issuance of a purchase order. An invoice is received from the vendor once a purchase is made. A receiving report indicates that we actually received the goods. The invoice approval indicates that we ordered the goods, we received the goods we ordered, and that we were billed for the goods we ordered and received. The invoice approval triggers the check preparation for a valid purchase.
Copies of all of these documents are kept as supporting documentation for the disbursement in the voucher file.

19. Use of Bank Accounts
7-4
A major reason that businesses use bank accounts is for control purposes.
Why open a bank account?(3:06)

20. 7-4
Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions.

21. Bank Statement
7-4
A summary received from the bank of all checking account transaction is called a bank statement.

22. EC — Error correction to correct bank error.
7-4
Typical credit or debit memorandum entries found on the bank statement:
EC — Error correction to correct bank error.
NSF — Not sufficient funds check.
SC — Service charge.
ACH — Automated Clearing House entry for electronic funds transfer.
MS — Miscellaneous items.

23. Power Networking’s Records and Bank Statement
The company should determine the reason for difference in these two amounts.

24. 7-5
A bank reconciliation is an analysis of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger in order to determine the adjusted cash balance.

25. 7-5
Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation.

26. 7-6
It is usually not practical for a business to write checks to pay small amounts. Thus, it is desirable to control such payments by using a special cash fund, called a petty cash fund.