0. Acct 2210: Internal Control and Accounting for Cash
Chapter 6
Acct 2210: Internal Control and Accounting for Cash
In this chapter we will look at the importance of good internal controls for achieving enterprise objectives and accounting for cash.
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin

1. Identify the key elements of a strong system of internal control.
LO 1
Identify the key elements of a strong system of internal control.
Learning Objective 1: Identify the key elements of a strong system of internal control.
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2. Internal Controls
Internal Controls (policies/procedures to provide assurance that enterprise objectives are accomplished)
(1)
Accounting controls designed to safeguard company assets and ensure reliable accounting records
(2) Administrative controls for evaluating performance and assessing compliance with company policies and public laws
The policies and procedures used to provide reasonable assurance that the objectives of an enterprise will be accomplished are called internal controls. Internal controls can be divided into two categories: (1) accounting controls are designed to safeguard company assets and ensure reliable accounting records; and (2) administrative controls are concerned with evaluating performance and assessing the degree of compliance with company policies and public laws.
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3. The Nine (9) Features of Internal Control (pg 315-317)
Separation of Duties
Quality of Employees
Bonded Employees
Required Absences
Procedures Manual
Authority and Responsibility
Prenumbered Documents
Physical Control
Performance Evaluations
Here is a listing of the 9 major internal control features that we will discuss in detail on the following screens.
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4. 1) Separation of Duties
When duties are separated, the work of one employee can act as a check on the work of another employee. The likelihood of fraud or theft is greatly reduced.
It is important that a company implement a plan to separate duties. We do not want one person to be able to order an item, pay for it, and have it under his or her control. When we separate duties we are asking one employee to serve as a check on the work of another employee or group of employees. Effective separation of duties reduces the likelihood of fraud or theft by employees.
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5. 2) Quality of Employees
The ability of cross-trained employees to substitute for one another prevents disruptions in the workplace. Job rotation may help relieve boredom and increase productivity.
It is desirable to cross-train employees. By doing so, one employee can step in and do the work of another in cases of illness, vacation, or extended leave. Cross-training helps minimize disruption in the workplace and often increases productivity of all workers.
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6. 3) Bonded Employees
A fidelity bond provides insurance that protects a company from loss caused by employee dishonesty. To become bonded, an employee’s background is investigated.
Any employee working with cash, accounts receivable, inventory, and similar assets needs to be placed under a fidelity bond. Bonding provides insurance against theft or dishonesty on the part of a bonded employee. Obviously, to be bonded, the employee must go through an extensive background check. The ability to be bonded can be made a precondition of employment.
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7. 4) Required Absences
An employee may be able to cover up fraudulent activities if they are always present at work. All employees should be required to take regular vacations and their duties should be rotated periodically.
All employees should be required to take annual vacations. While they are away from work, a cross-trained employee will fill in and complete the work of the absent employee. If the employee on vacation is involved in any activity that is not in the best interest of the company, the cross-trained employee should be able to discover the problem and bring it to management’s attention.
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8. 5) Procedures Manual
Accounting and other important procedures should be written in a procedures manual. Periodically,
management should conduct an investigation to see that required procedures are actually being followed.
Large- and medium-size companies should have a formal set of policies and procedures that all employees are expected to follow. The policies and procedures should be in writing and made available to all employees in the organization. Management should request that the internal audit staff investigate whether the policies and procedures are being followed by members of the organization.
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9. 6) Authority and Responsibility
General authority applies to all member of the organization. For example, all employees are required to fly coach and purchase airline tickets from a specific vendor.
Specific authority applies only to a specific position within the organization. For example, all checks must be cosigned by the Controller and Treasurer.
Policies and procedures can be general or specific. General policies apply to all employees. For example, it may be company policy that all air travel be booked at “coach” fare and that tickets be purchased from an authorized vendor.
Specific policies apply to a single individual or a small group of employees. For example, it may be company policy that all checks require two signatures. One of the signers should be in the accounting function to attest to accounting policies being followed, and the other should be from the treasury department. The Treasurer has ultimate authority and responsibility for the management of cash.
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10. 7) Prenumbered Documents.
Prenumbered forms are used for all important documents such as checks, purchase orders, receiving reports, and invoices. The use of prenumbered forms helps keep track of all forms issued during a particular period.
You probably use prenumbered checks. You may become concerned when you are missing a check number. For example, you wrote and recorded check number 101 and 103, but cannot locate check 102.
Almost all documents used in business are prenumbered. Prenumbered documents include invoices, purchase orders, sales orders, receipts, and many others. Next time someone gives you a receipt, notice that it has a number printed on it. The use of prenumbered documents helps us control and track all forms issued during the accounting period.
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11. 8) Physical Control
All companies should maintain adequate physical control over valuable assets that may be misappropriated. For example, inventory should be properly stored in a secure location. Serial numbers should be placed on all valuable assets to assist in a physical count of these assets.
Every company should have established policies to physically control and protect its valuable assets. Assets such as cash, inventory, and certain types of equipment can be misappropriated by employees for personal gain. Inventory should be stored in a secure location and be under the control of a warehouse manager. We should place identifying numbers on all valuable physical assets that may be subject to misappropriation. Not only is this a good idea for a company, it is an excellent idea for your personal life. If you have recorded serial numbers from your television, DVD player, computer and other assets, you will be able to assist police in case of a robbery.
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12. 9) Performance Evaluation
Internal controls should include independent verification of employee performance.
For example, someone other than the person who has control over inventory should take a physical count of inventory.
Internal and external audits serve as independent verification of performance.
Each employee should be subject to a performance evaluation at least annually. More frequent evaluations increase the effectiveness of the internal controls related to the employee’s job.
Internal and external audits serve as independent verification of performance.
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13. Internal Control Limitations!
Internal controls can be circumvented by collusion among employees. Two or more employees working together can hide embezzlement by covering for each other. No system can completely prevent fraud.
Regardless of how good a company’s internal control system may be, it can always be circumvented by collusion among two or more employees. When employees collude, they are able to cover for each other and make the embezzlement difficult to find. In recent years we have seen collusion at the highest levels of management. The intent of most of these plans was to make the company’s financial position look stronger than it actually was. Top management gained from the appreciation in the value of the company’s stock. Most of these managers had significant stock options as part of their compensation plan.
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14. Identify special internal controls for cash.
LO 2
Identify special internal controls for cash.
Learning Objective 2: Identify special internal controls for cash.
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15. Accounting for Cash Controlling Cash
Up to date signature card should be maintained.
Cash receipts should be recorded immediately upon receipt and deposited intact daily.
Controlling Cash
A monthly bank reconciliation should be prepared by an independent party.
A deposit ticket should be used for all deposits.
Part I Cash is the asset most susceptible to misappropriation, so we need special controls over cash. To begin, all cash receipts should be recorded immediately and deposited intact daily. The only exception is for cash needed for cash registers or petty cash funds.
Part II Prenumbered deposit tickets should be used for all deposits. The deposit tickets should be maintained for as long as necessary.
Part III All cash disbursements, with the exception of petty cash, should be made by prenumbered checks. It is a very good policy to have two check signers.
Part IV All bank accounts should be reconciled each month by an independent party. That party is the internal auditor in large organizations. As a result of the reconciliation, adjusting entries are usually required to have the general ledger account show the true cash balance.
Part V
We must make certain that all current employees who are authorized to sign checks have signed the bank authorized signature card.
Cash payments should be made by prenumbered check.
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16. Prepare a bank reconciliation.
LO 3
Prepare a bank reconciliation.
Learning Objective 3: Prepare a bank reconciliation.
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17. Reconciling the Bank Statement
The bank reconciliation reports on the differences between the balance on the bank statement and the balance in the general ledger cash account. The reconciliation results in the true cash balance that will appear on the balance sheet.
Part I As you know from your personal finances, the bank reconciliation explains the difference between the cash balance shown on your bank statement and the cash balance in the general ledger cash account. In your case, the general ledger is your checkbook. We should be able to reconcile the bank statement to the true cash balance and the cash account to the same true cash balance.
Part II Common adjustments to the cash balance shown on the bank statement are deposits in transit and checks that are outstanding at the end of the period. We always add the deposits in transit to the bank balance and deduct any checks outstanding.
Part III Some common adjustments to the general ledger cash account include amounts collected for use by the bank and interest earned on our checking account. Both of these amounts will be added to the general ledger cash balance. Any bank service charge and non-sufficient funds checks are subtracted. A non-sufficient funds check is one that we deposited in our checking account but the maker of the check did not have sufficient cash to cover it. Sometimes we refer to these as “bounced” checks.
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18. Reconciling the Bank Statement
If an error is found on the bank statement, an adjustment for it is made to the unadjusted bank balance to determine the “true” cash balance. Any error or change made on our books requires an adjusting journal entry to correct.
Both the bank and our accounting department can make errors that go undetected until we prepare the bank reconciliation. These errors always need to be analyzed and corrected. All reconciling items that appear on the general ledger cash side of our reconciliation require an adjustment to our books. The adjustments change the general ledger balance to the true cash balance.
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19. Bank Reconciliation More Information
Green Shades Resorts, Inc. is preparing the bank reconciliation for the month of September.
The Sept 30th balance on the bank statement is $3,516.45, and the Cash general ledger balance on this date is $3,
There was a deposit in transit in the amount of $
The bank erroneously deducted a $25 check drawn on the books of Green Valley Resorts from our account.
At September 30th three checks are outstanding. Check 639 dated 9/18 for $13.75; Check 646 dated 9/20 for $29.00; and Check 672 dated 9/27 for $
On the next two screens we present information relating to the bank reconciliation for Green Shades Resorts for the month of September. You may choose to either print these screens or jot down the information.
More Information
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20. Let’s prepare the bank reconciliation
During the month of September the bank collected an account receivable for us in the amount of $
A check actually written for $36.45 for utilities expense was erroneously recorded in our records by the bookkeeper as $63.45.
The bank assessed a service charge of $8.40 for September.
We deposited a NSF check in the amount of $
Here is the remainder of the information for Green Shades Resorts.
Let’s prepare the bank reconciliation
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21. Bank Reconciliation
Deposits in transit are added to the unadjusted bank balance since these were not included by the bank.
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22. Bank Reconciliation
The check drawn on Grand Valley Resorts should not have been deducted from GSRI’s bank balance and is added back here.
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23. Bank Reconciliation
The outstanding checks have not yet reached the bank and should be deducted from the unadjusted bank balance.
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24. Bank Reconciliation
After making these adjustments to the bank statement balance, we arrive at the true cash balance on September 30th. Next let’s adjust the book balance. Our books do not reflect the receivable collected by the bank and it is added back here.
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25. Bank Reconciliation
Our books show an amount of $63.45 deducted for check number 633 while the true amount was $ Therefore the difference of $27.00 must be added back.
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26. Bank Reconciliation
We deduct the bank service charge of $8.40. The NSF check did not clear the bank. We recorded it as a deposit in our books but the bank was unable to obtain the funds from the maker so the check was returned. We deduct all NSF checks from the unadjusted book balance.
Notice that the true cash balance on the bank side of the reconciliation and on the book side are the same. We have been able to explain all of the differences between the bank account balance and the balance on our books.
We must prepare adjusting entries for all items on the book portion of the reconciliation. After we prepare the adjustments, the general ledger balance will be equal to $4, Let’s make the adjusting entries now.
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27. Adjusting the Books (Only)
Every reconciling item that appears on the unadjusted book balance section requires a journal entry to adjust the general ledger cash balance to the true cash balance.
Part I First, let’s group together all adjustments that will increase our cash account. You may want to look back at the reconciliation before we go on.
Part II The first adjusting entry is to debit, or increase, Cash for $967, and credit Accounts Receivable for the amount collected by the bank on our behalf and credit Utilities Expense for our bookkeeping error. Now let’s look at all the adjustments that will reduce our Cash account.
Part III We begin by debiting Bank Service Charge Expense for $8.40, and Accounts Receivable for the amount of the NSF check. We credit, or reduce, Cash for the total of $ After all these adjustments are posted, the balance in our Cash account is the true cash balance.
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28. Cash Short and Over
When using a cash register, employees sometimes make mistakes in collecting cash or making change for customers. If the cash register does not reconcile by a small amount at the end of the day, we use an account called Cash Short and Over to force a balance.
Assume a cash register was to have a balance of $500, but contained only $499 at the end of the day.
Part I An account called Cash Short and Over is used to balance cash registers at the end of the day. It is not uncommon for employees to make mistakes in collecting cash or making change. The mistake may be in the favor of the customer or the company. The amounts involved should be small.
Part II One cash register is supposed to have a balance of $500 at the end of the day. On the day in question, the balance is $499. To balance the register we debit the Cash account for $499, debit Cash Short and Over of $1, and credit Sales for $500.
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29. Describe the auditor’s role in financial reporting.
LO 5
Describe the auditor’s role in financial reporting.
Learning Objective 5: Describe the auditor’s role in financial reporting.
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30. Certified Public Accountants
The Financial Analyst
How can a financial analyst know that a company really did follow GAAP?
Audits
CPAs
Certified Public Accountants
Part I
How can a financial analyst know that a company really did follow generally accepted accounting principles?
Part II
Analysts and other users rely on audits conducted by certified public accountants. An audit is a detailed examination of a company’s financial statements and underlying accounting records. The primary roles of an independent auditor are:
Conducts a financial audit.
Assumes both legal and professional responsibilities to the public as well as to the company paying the auditor.
Determines if financial statements are materially correct rather than absolutely correct.
Presents conclusions in an audit report that includes an opinion as to whether the statements are prepared in conformity with generally accepted accounting principles.
Maintains professional confidentiality of client records. However, this does not exempt the auditor from legal obligations such as testifying in court.
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31. Materiality and Financial Audits
Auditors do not guarantee that financial statements are absolutely correct—only that they are materially correct.
“Material” Item
An error, or other reporting problem, that would influence the decision of an average prudent investor.
Part I
As mentioned in the primary roles of auditors on the previous slide, auditors do not guarantee that financial statements are absolutely correct—only that they are materially correct. The question then becomes “How big is material?”
The concept of materiality is very subjective. If Walmart inadvertently overstated its sales by $1,000,000, would this be material? In 2011, Walmart had approximately $419,000,000,000 of sales! A $1,000,000 error in sales at Walmart is like a $1 error in computing the pay of a person who makes $419,000 a year—not material at all!
Part II
An error, or other reporting problem, is material if knowing about it would influence the decision of an average prudent investor.
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32. Types of Audit Opinions
Unqualified
Adverse
Part I
Once an audit is complete, the auditors present their conclusions in a report that includes an audit opinion. If auditors are satisfied that the financial statements are “fair” they issue an unqualified audit report. An unqualified audit report indicates that the financial statements are useful and that creditors and investors can trust what is reported.
Part II
The most negative report an auditor can issue is an adverse opinion. An adverse opinion means that one or more departures from Generally Accepted Accounting Principles are so material the financial statements do not present a fair picture of the company’s status.
Part III
A qualified opinion falls between an unqualified and an adverse opinion. A qualified opinion means that for the most part, the company’s financial statements are in compliance with Generally Accepted Accounting Principles, but the auditors have reservations about something in the statements. The auditor’s report explains why the opinion is qualified.
Part IV
If an auditor is unable to perform the audit procedures necessary to determine whether the statements are prepared in accordance with Generally Accepted Accounting Principles, the auditor cannot issue an opinion on the financial statements. Instead, the auditor issues a disclaimer of audit opinion. A disclaimer is neither negative nor positive. It simply means that the auditor is unable to obtain enough information to confirm compliance with Generally Accepted Accounting Principles.
Qualified
Disclaimer
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33. Confidentiality
The confidentiality rules in the code of ethics for CPAs prohibits auditors from voluntarily disclosing information they have acquired as a result of their accountant-client relationships.
However, accountants may be required to testify in a court of law.
The confidentiality rules in the code of ethics for CPAs prohibits auditors from voluntarily disclosing information they have acquired as a result of their accountant-client relationships. However, accountants may be required to testify in a court of law. In general, federal law does not recognize an accountant-client privilege as it does with attorneys and clergy.
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34. The Securities and Exchange Commission (SEC)
The SEC is a government agency authorized to establish and enforce the accounting rules for public companies.
Public companies, have to follow the reporting rules of the SEC as well as GAAP.
The SEC is a government agency authorized to establish and enforce the accounting rules for public companies. Public companies, have to follow the reporting rules of the SEC as well as GAAP. SEC companies must file specific information directly with the SEC annually, quarterly, and in-between if required.
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35. Sarbanes-Oxley Act (SOX) of 2002
Prior to 2002, the SEC left much of the regulation and oversight of independent audits to the AICPA.
However, SOX established the PCAOB to enforce audit standards for SEC audits.
The SEC regulates audit standards as well as financial reporting. Prior to passage of the Sarbanes-Oxley Act in July 2002, the SEC left much of the regulation and oversight of independent auditors to the American Institute of Certified Public Accountants, a private professional organization. However, a key provision of Sarbanes-Oxley establishes the Public Company Accounting Oversight Board (PCAOB). This board assumes the primary responsibility for establishing and enforcing auditing standards for CPA firms that audit SEC companies. The board has five financially astute members, three of whom cannot be CPAs.
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36. End of Chapter Six
Internal control is one of those subjects that does not seem as important while you are a student as it is in the business world. Once you graduate, the company you work with will have extensive internal controls. It is crucial that you are aware of the controls and how they will impact your job.
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