1. Cash and Internal Controls
Chapter 6
Cash and Internal Controls
In this chapter, we will learn more about cash, internal controls, petty cash, and bank reconciliations.

2. INTERNAL CONTROL SELF– STUDY MATERIALS
C1: Define internal control and identify its purpose and principles.
C2: Define cash and cash equivalents and explain how to report them.
C3: Identify control features of banking activities.
P1: Apply internal control to cash receipts and disbursements.
-VOUCHER System of control
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3. Analytical Learning Objectives
SELF-STUDY
A1: Compute the days’ sales uncollected ratio and use it to assess liquidity.
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4. Procedural Learning Objectives
IN-CLASS:
P2: Explain and record petty cash fund transactions.
P3: Prepare a bank reconciliation.
NOT COVERED:
P4: Appendix 6A: Describe the use of documentation and verification to control cash disbursements.
P5: Appendix 6B: Apply the net method to control purchase discounts
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5. Voucher System of ControlP4
A voucher system establishes procedures for:
Verifying, approving and recording obligations for eventual cash disbursements.
Issuing checks for payment of verified, approved and recorded obligations.
A voucher system establishes procedures that help to verify, approve and properly record cash disbursements.
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6. Voucher System of ControlP4
Sender
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
SALES Requesting
Cashier
Accounting, Requesting & Purchasing
Accounting
Supplier (Vendor)
Purchasing and
Supplier, Requesting, Receiving & Accounting
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.
Voucher
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7. Purpose of Internal Control
Policies and procedures managers use to:
Protect assets.
Ensure reliable accounting.
Promote efficient operations.
Urge adherence to company policies.
An internal control system is a collection of policies and procedures that protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies.
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8. The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, also known as SOX, requires management and auditors of publicly held companies to adhere to or perform specific requirements, such as:
Evaluation of internal controls.
Auditor’s work is overseen by the Public Company Accounting Oversight Board (PCAOB).
Restriction on consulting services performed by auditors.
Term limits on person leading the audit.
Harsh penalties for violators, including prison time with severe fines.
The Sarbanex-Oxley Act was a revolutionary piece of legislation that dramatically changed the way audits are planned and conducted. This act, also known as SOX, requires that managers and auditors of companies whose stock is traded on an exchange (called public companies) document and certify the company’s system of internal controls. There are some specific requirements which are shown in the slide above. This act requires that auditors evaluate internal controls and issue an internal control report. Secondly, the act requires a public oversight body. It also restricts what consulting services auditors can provide to the client. In addition, the act places term limits on the person leading the audit. Finally, the act imposes harsh penalties, including prison time and harsh fines for those that violate the terms of the act.
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9. Principles of Internal Control
Establish responsibilities.
Maintain adequate records.
Insure assets and bond key employees.
Separate recordkeeping from custody of assets.
Divide responsibility for related transactions.
Apply technological controls.
Perform regular and independent reviews.
Principles of internal control include:
Establish responsibilities.
Maintain adequate records.
Insure assets and bond key employees.
Separate recordkeeping from custody of assets.
Divide responsibility for related transactions.
Apply technological controls.
Perform regular and independent reviews.
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10. Technology and Internal Control
Reduced
Processing
Errors
More
Extensive Testing
of Records
Crucial
Separation of
Duties
Limited
Evidence of
Processing
The use of technology has an impact on internal controls. Technology can help reduce processing errors and allow more extensive testing of records. However, it can also limit evidence of processing because of the lack of a paper trail. Because more work can be performed by one person, it can also create situations that cause a lack of separation of duties. Technology has encouraged the growth of e-commerce, which has greatly enhanced the need for strong internal controls.
Increased
e-commerce
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11. 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.
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12. 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
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13. Cash and Cash Equivalents
Currency, coins and amounts on deposit in bank accounts: checking accounts, and many savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders.
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
US Treasury Bills & Notes: 3-month maturity.
3-month CDs and Money Market Funds
On a balance sheet, cash is combined with cash equivalents. Cash includes currency, coins and amounts on deposit in bank accounts, checking accounts, and savings accounts. Cash equivalents include short-term, highly liquid investments that are easily converted into a known cash amount and that are close to maturity and are not sensitive to interest rate changes.
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14. Cash & Cash Equivalents
On Dec. 31, 2010, ABC Co's total CASH COUNT =$1,000,000
The following items are included in the CASH COUNT:
Petty cash funds=$12,000,
Customers Checks =$3,000,
Coins =$1,000 and
Stamps =$100.
The following items are not included in cash count:
-Three-month CD: $10,000
-Two-month Treasury Note (Bill): $7,000
Required:
Prepare the Current Assets Section of the Balance Sheet

15. Cash, Cash Equivalents, and Liquidity
How easily an asset can be converted into cash to be used to pay for services or obligations.
Liquidity refers to how easily an asset can be converted into cash to be used to pay for services and obligations.
Inventory
Cash
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16. Cash Management Principles
When companies fail, one of the most common causes is their inability to manage cash. The goals of cash management are twofold:
Plan cash receipts to meet cash payments when due.
Keep the minimum level of cash necessary to operate.
When companies fail, one of the most common causes is their inability to manage cash. Companies must plan both cash receipts and cash payments. The goals of cash management are twofold: One, plan cash receipts to meet cash payments when due, and two, keep the minimum level of cash needed to operate. In addition, basic cash management principles should be applied by the person responsible for cash management. These principles include the quick collection of receivables, the delaying of payment of liabilities, the planning of expenditures, and the investment of excess cash.
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17. Control of Cash C1
An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines:
Handling cash is separate 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.
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18. Control of Cash Receipts
Cash Receipts By Mail
Two people open the mail.
Money to cashier’s office => Bank
List to accounting dept => Record
Copy of list filed.
Cash Receipts by mail
Require four (4) people
Over-the-Counter Cash Receipts
Cash register with locked-in record of transactions.
Compare cash register record with cash reported.
Because cash is the most liquid asset, it is the most susceptible to theft. As a result, the controls over cash receipts are important.
A cash register’s listing of cash transactions can be compared to actual cash in the register to determine if cash in the register is correct.
When cash is received by mail, have two people present when opening the mail to deter theft. The cash is sent to the cashier, a list of who paid the cash is sent to the accounting department, and a copy of the list is filed.
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19. Control of Cash DisbursementsP1
All expenditures should be made by check. The only exception is for small payments from petty cash.
Separate authorization for check signing and recordkeeping duties.
Use a voucher system.
Requiring all disbursements to be made by check is a common internal control policy. Other controls include the separation of the following duties: authorization for the disbursement, check signing, and recordkeeping. Use of a voucher system also provides a good control over disbursements. Let’s look at the voucher system described on the next slide.
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20. Control of Cash Disbursements
To safeguard against theft: -require all expenditures be made by check (except for small payments made from petty cash fund); and -deny access to the accounting records to anyone, other than the owner, who has authority to sign checks.

21. Petty Cash System of Control
Small payments required in most companies for items such as postage, courier fees, repairs and supplies.
Sometimes, a quick disbursement is needed to be made for an immediate need. Trying to go through all of the approval processes needed to have a check prepared is too time consuming and would take too long. Companies usually keep a petty cash amount on hand to use for small, immediate needs.
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22. Operating a Petty Cash Fund
Company Cashier
Petty Cashier
The accountant makes an entry to debit Petty Cash and credit Cash for the amount of the check.
Accountant
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23. Operating a Petty Cash Fund
Petty Cashier
Petty Cash
The petty cashier takes the check to the bank and cashes it. The cash is brought back and placed in a secure location.
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24. Operating a Petty Cash Fund
A petty cash fund is used only for business expenses.
Petty Cashier
As petty cash is needed, the petty cashier supplies the cash for the purchases.
Courier
$80
39¢
Stamps
$45
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25. Operating a Petty Cash Fund
Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash.
Receipts
Petty Cashier
Receipts supporting the petty cash disbursements are given to the petty cashier.
Courier
$80
39¢
Stamps
$45
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26. Operating a Petty Cash Fund
Receipts
$125
To reimburse
petty cash fund
Company Cashier
Petty Cashier
When the petty cash fund is low, the petty cashier takes the receipts to the company cashier and requests a check in that amount to replenish the petty cash fund.
When the check is issued, the accountant makes an entry to debit the expenses or assets indicated on the receipts and credits cash.
Let’s look at a petty cash example.
Use a Cash
Over and Short
account if needed.
Accountant
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27. Operating a Petty Cash Fund
Sometimes, the petty cash receipts plus the cash remaining will not total to the fund balance.
i. A shortage is recorded as an expense in the reimbursing entry with a debit to the Cash Over and Short account.
ii. An overage is recorded with a credit to the Cash Over and Short account in the reimbursing entry.

28. Petty Cash Example P2
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 $260.20
Let’s look at replenishing the fund if the
Cash Balance on July 31 was $
Tension Company maintains a petty cash fund of four hundred dollars. The receipts for the month of July include:
Seventy-nine dollars and thirty cents for travel expenses
Ninety-three dollars and forty-two cents for business lunches
Fifty-five dollars for postage, and
Thirty-two dollars and forty-eight cents for office supplies.
On July thirty first, the fund has a balance of one hundred thirty-seven dollars and eighty cents.
Let’s look at how to replenish the fund.
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29. Petty Cash Example P2
What amount of cash will be required to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
What amount of cash will be required to replenish the petty cash fund?
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30. Let’s prepare the journal entry to replenish the petty cash fund.
Petty Cash Example P2
What amount of cash will be required to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
Tension Company will need two hundred sixty-two dollars and twenty cents to replenish the fund up to its original balance of four hundred dollars.
Now, let’s look at the journal entry to replenish the petty cash fund.
Let’s prepare the journal entry to replenish the petty cash fund.
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31. Petty Cash Example Journal entry to replenish petty cash fund P2
Tension Company would debit each expense account for the amount on the receipts. Cash would be credited for the amount needed to replenish the fund to four hundred dollars.
In this example, Tension Company had a cash shortage in the petty cash fund of two dollars. This means that a receipt was lost, an error was made, or a theft occurred. Management monitors the balance in the Cash Over and Short account to determine if there is a problem with cash shortages or overages.
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32. Quick Study 4
Exercise 5
Exercise 6

33. Banking Activities as Controls
Bank Accounts
Signature Cards
Deposit Tickets
Banks offer certain protections for your cash. For example, use of a bank account is a more secure place for your cash than a safe at the office. Signature cards are used so the bank knows whose signature is approved for use on checks. Deposit tickets provide support for deposits to your account. Checks provide authorization for disbursements from your account. Electronic funds transfers limit the number of people who have their hands on the cash and so it reduces theft and fraud. Bank statements are provided so customers can reconcile their accounts in a timely manner and notice any unusual or unauthorized activity.
Checks
Electronic Funds Transfer
Bank Statements
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34. Bank Activities A check involves three parties:
A bank account is a record set up by a bank for a customer. All persons authorized to write checks, sign a signature card.
Each bank deposit is supported by a deposit ticket.
Electronic Funds Transfer (EFT) is the electronic communication transfer of cash from one party to another.
To withdraw money, depositors use a check.
A check involves three parties:
Maker: Who signs the check;
Payee: The recipient; Bank (Payer): On which the check is drawn

35. Bank Statement
Once a month, the bank sends each depositor a bank statement showing activities of a bank account.
A bank statement includes, at least, the following:
Beginning cash balance per bank;
Check & other debits decreasing the balance;
Deposits & other credits increasing the balance;
Ending cash balance per bank.

37. Bank Reconciliation P3
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? *
Anyone who has a bank account should prepare a bank reconciliation on a regular basis. If you do not, you are “banking” that the bank and you will not make any errors. And remember, humans are involved on both sides so the chances are likely that an error will occur. A bank reconciliation will identify any errors that need to be corrected by you or the bank.
Why are the balances different on the bank statement and on the Cash account? Because of timing differences. Let’s look at how to prepare a bank reconciliation in more detail.
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38. Bank Statement Balance
Reconciling Items
Book Balance
Add: Collections made by the bank.
Add: Interest earned on checking account. =>CM
Deduct: Nonsufficient funds check (NSF).
Deduct: Bank service charge =>DM
Add or Deduct: Book errors
Adjusted Book Balance.
Bank Statement Balance
Add:
Deposits in transit.
Deduct: Outstanding Checks
Add or Deduct: Bank errors.
Adjusted Bank Balance
There are two sides to a bank reconciliation. On the bank’s side, we will start with the balance on the bank statement and adjust it for outstanding checks, deposits in transit, and errors made by the bank.
On the book’s side, we will start with the Cash balance in the ledger and adjust it for customer checks that were drawn on accounts that were nonsufficient, bank service charges, interest earned, collections made by the bank on our behalf, and errors we made.
Examples of collections made by the bank on our behalf would be when the bank acts as a collection medium for customer payments or when the bank collects a note receivable for us from a customer.
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39. Reconciling Items
Identify and list any unrecorded Debit Memoranda (DM) from the bank for NSF Checks, service charges, and errors over­stating the book balance. => Deduct them from the book balance. Identify and list any unrecorded Credit Memoranda (CM) from the bank for interest, collections, and errors under­stating the book balance. => Add them to the book balance.

40. Bank Reconciliation Two sections:P3
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.
When we prepare a bank reconciliation, there are two sections. In one section, we reconcile the bank statement balance to an adjusted bank balance. In the other section, we reconcile the book balance to an adjusted book balance. The adjusted balances in both sections should be equal.
Now, let’s look at an example of a bank reconciliation.
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41. 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.
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.
On July thirty first, Simmons Company’s bank statement listed a balance of nine thousand six hundred ten dollars. Their Cash account had a balance on that date of seven thousand four hundred thirty dollars.
Additional information necessary for the reconciliation is shown on the next screen.
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42. Bank Reconciliation Example
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.
Take a minute and read over these six items before proceeding. As you read the items, determine if they are a bank reconciling item or a book reconciling item. We will discuss each one on the next slide.
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43. Bank Reconciliation Example
Take a minute and read over these six items before proceeding. As you read the items, determine if they are a bank reconciling item or a book reconciling item. We will discuss each one on the next slide.
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44. Recording Adjusting Entries from a Bank ReconciliationP3
Only amounts shown on the book portion of the reconciliation require an adjusting entry.
We only make entries for the items on the book side of the reconciliation. First, we debit Cash and credit Interest Revenue for the amount of the revenue earned. Second, we debit Supplies Expense and Accounts Receivable and credit Cash. The debit to Supplies Expense is to correct the error we made earlier. The debit to Accounts Receivable creates an account for the amount of the nonsufficient fund check the customer gave us. This debit to accounts receivable indicates that the customer has not satisfied his account.
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45. Recording Adjusting Entries from a Bank ReconciliationP3
After posting the reconciling entries the cash account looks like this:
After posting these entries, the balance in the Cash account is adjusted to the balance on the bank reconciliation of seven thousand two hundred seven dollars.
Adjusted balance on July 31.
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46. Quick Study 6
Exercise 7
Exercise 9 & 10

47. Days’ Sales Uncollected
How much time is likely to pass before
we receive cash receipts from credit sales.
Days’
Sales
Uncollected
Accounts Receivable
Net Sales
× 365 =
The Days’ Sales Uncollected ratio indicates how much time is likely to pass before we receive cash receipts from credit sales. It is calculated as Accounts Receivable divided by Net Sales times three hundred sixty-five.
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