1. ©2008 Pearson Prentice Hall. All rights reserved. 4-1 Internal Control & Cash Chapter 4

2. ©2008 Pearson Prentice Hall. All rights reserved. 4-2 Internal Control - Objectives Safeguard assets Encourage employees to follow company policy Promote operational efficiency Ensure accurate, reliable accounting records Comply with legal requirements

3. ©2008 Pearson Prentice Hall. All rights reserved. 4-3 Sarbanes-Oxley Act (SOX) Accounting scandals shook the public’s confidence in the accounting profession  Enron and WorldCom overstated profits  Auditors Arthur Anderson went out of business In response, Congress passed SOX  Established new provisions for how large corporations are audited

4. ©2008 Pearson Prentice Hall. All rights reserved. 4-4 Learning Objective 1 Set up an internal control system

5. ©2008 Pearson Prentice Hall. All rights reserved. 4-5 Control Environment Tone set “at the top” Top management should set good example for employees Information System Provides accurate information to keep track of assets and measure income Risk assessment Identify risks in the business environment Control Procedures Ensure goals are achieved Monitoring of Controls Auditors make sure controls are working

6. ©2008 Pearson Prentice Hall. All rights reserved. 4-6 Internal Control Procedures Competent, reliable and ethical employees  Staff should be trained and fairly rewarded for its work Assignment of Responsibilities  Job descriptions should be clear Separation of Duties  Operations from accounting  Custody of assets from accounting

7. ©2008 Pearson Prentice Hall. All rights reserved. 4-7 Internal Control Procedures Audits  Internal or External Documents Electronic Devices Other controls  Fireproof vaults for important documents  Bonds on employees who handle cash  Mandatory vacations and job rotation

8. ©2008 Pearson Prentice Hall. All rights reserved. 4-8 Internal Controls for E-Commerce Risks of online business  Stolen credit cards  Computer viruses  Phishing Security measures  Encryption  Firewalls

9. ©2008 Pearson Prentice Hall. All rights reserved. 4-9 Limitations of Internal Control Collusion  Two people working together can circumvent system Cost  Company must weigh the benefits of controls with the cost

10. ©2008 Pearson Prentice Hall. All rights reserved. 4-10 Bank Account as Control Keeping cash in a bank account safeguards the asset Bank account documents provide controls  Signature card  Deposit tickets  Checks  Bank Statements  Electronic Funds Transfer (EFT)

11. ©2008 Pearson Prentice Hall. All rights reserved. 4-11 Learning Objective 2 Prepare and use a bank reconciliation as a control device

12. ©2008 Pearson Prentice Hall. All rights reserved. 4-12 Bank Reconciliation Process to update cash account Book Balance Cash account in General Ledger Bank Balance Cash amount according to bank statement Amounts don’t equal due to time lags in recording transactions

13. ©2008 Pearson Prentice Hall. All rights reserved. 4-13 Bank balance Add: Deposits in transit Subtract: Outstanding checks Add or Subtract: Bank errors Equals: Adjusted Cash Balance Book balance Subtract: EFT payments, service charges, NSF checks Add: Bank collections & Interest revenue Add or Subtract: Book errors Equals: Adjusted Cash Balance Preparing a Bank Reconciliation

14. ©2008 Pearson Prentice Hall. All rights reserved. 4-14 E4-20 Bank Balance, May 31$595 Plus: deposit in transit$1,788 Less: outstanding checks($603) Adjusted Cash Balance$1,780

15. ©2008 Pearson Prentice Hall. All rights reserved. 4-15 E4-20 Book Balance, May 31$1,882 Plus: Rent collection$300 Less: Service charge($12) Less: NSF checks($120) Less: Printed checks($9) Less: Error ____________ _ Adjusted Cash Balance$1,780 What would be the amount of the error? Subtract the actual amount of the deposit from the amount recorded

16. ©2008 Pearson Prentice Hall. All rights reserved. 4-16 Entries from Reconciliation All items on the book side require a journal entry  All items added will result in a debit to cash  All items subtracted will result in a credit to cash After entries are posted  Cash Balance in Ledger = Adjusted Cash Balance on Reconciliation

17. ©2008 Pearson Prentice Hall. All rights reserved. 4-17 E4-21 JOURNAL DateAccountsDebitCredit 31-MayCash$300 Rent revenue $300 Miscellaneous Expense$21 Cash ($9 +$12) $21

18. ©2008 Pearson Prentice Hall. All rights reserved. 4-18 E4-21 JOURNAL DateAccountsDebitCredit 31-May_____________________$120 Cash $120 Salary Expense$261 Cash $261 What account is debited for NSF checks?

19. ©2008 Pearson Prentice Hall. All rights reserved. 4-19 Learning Objective 3 Apply internal controls to cash receipts and cash payments

20. ©2008 Pearson Prentice Hall. All rights reserved. 4-20 Internal Control over Cash Receipts Over the counter Cash register record transactions Receipts issued to customer Manager compares cash in drawer to cash register record Receipts deposited at least daily By mail Checks and remittance advice separated Checks sent to treasurer for deposit Remittance advice sent to accounting to record Bank deposit slip compared with debit to cash

21. ©2008 Pearson Prentice Hall. All rights reserved. 4-21 Internal Control Over Cash Payments Payment by check  Provides record of payment  Must be signed by authorized official  Official should study evidence supporting payment

22. ©2008 Pearson Prentice Hall. All rights reserved. 4-22 Documents Used to Control Purchases Purchase order  Prepared by purchasing company to place order Invoice  Prepared by selling company to list items sent and to request payment Receiving report  Prepared by purchasing company to show that goods were received

23. ©2008 Pearson Prentice Hall. All rights reserved. 4-23 Payment packet Receiving Report Invoice Purchase Order Documents should agree before payment is made

24. ©2008 Pearson Prentice Hall. All rights reserved. 4-24 Separation of Duties Responsibilities should be split:  Purchasing goods  Receiving goods  Approving and paying for goods

25. ©2008 Pearson Prentice Hall. All rights reserved. 4-25 Petty Cash Small amount of cash kept on hand for incidental purchases Fund is established at a set amount Custodian of fund prepares ticket that lists each item purchased Tickets plus remaining cash should equal fund balance

26. ©2008 Pearson Prentice Hall. All rights reserved. 4-26 Learning Objective 4 Use a budget to manage your cash

27. ©2008 Pearson Prentice Hall. All rights reserved. 4-27 Budget Financial plan that helps coordinate business activities A cash budget helps a company manage cash by planning receipts and payments

28. ©2008 Pearson Prentice Hall. All rights reserved. 4-28 CASH BUDGET Beginning cash balance Plus: Budgeted Cash Receipts Minus: Budgeted Cash payments Equals: Expected ending cash balance Compare ending balance to minimum needed If excess, invest If shortfall, borrow

29. ©2008 Pearson Prentice Hall. All rights reserved. 4-29 E4-24 Cash Budget 20X8 Beginning cash balance$81 Budgeted cash receipts: Cash collections from customers$11,284 Sale of equipment115$11,399

30. ©2008 Pearson Prentice Hall. All rights reserved. 4-30 E4-24 Budgeted cash payments: Costs of services and products$6,166 Operating expenses2,543 Purchase of new equipment1,825 Debt payments597 Dividend payment338$11,469 Expected cash balance$11

31. ©2008 Pearson Prentice Hall. All rights reserved. 4-31 E4-24 Expected Cash Balance = $11 Company’s Minimum Cash Balance = $75 Expected Borrowing = ________ What amount of borrowing would get the company to its minimum?

32. ©2008 Pearson Prentice Hall. All rights reserved. 4-32 Learning Objective 5 Make ethical business judgments

33. ©2008 Pearson Prentice Hall. All rights reserved. 4-33 Codes of Ethics Most companies have a code of ethics Owners and managers must set an ethical tone as well The accounting profession is expected to maintain higher standards  AICPA Code of Professional Conduct  Standards of Ethical Conduct for Management Accountants

34. ©2008 Pearson Prentice Hall. All rights reserved. 4-34 Ethical Issues in Accounting Pressure often exists for managers to reach earnings or stock price goals Earnings can be manipulated by  Understating expenses  Overstating revenues Use Framework for Making Ethical Judgments

35. ©2008 Pearson Prentice Hall. All rights reserved. 4-35 Framework for Ethical Judgments Identify the ethical issue Specify the alternatives Assess the possible outcomes Make the decision

36. ©2008 Pearson Prentice Hall. All rights reserved. 4-36 End of Chapter Four