Internal Control and Cash

Internal Control and Cash
Chapter 7 Copyright ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
Learning Objectives Define internal control and describe the components of internal control and control procedures Apply internal controls to cash receipts Apply internal controls to cash payments Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Learning Objectives Explain and journalize petty cash transactions Demonstrate the use of a bank account as a control device and prepare a bank reconciliation and related journal entries Use the cash ratio to evaluate business performance Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

What Is Internal Control?
Safeguard assets Encourage employees to follow company policies Promote operational efficiency Ensure accurate, reliable accounting records Internal Control is an organizational plan and the related measures designed to accomplish the following: Internal Control, when structured properly, allows a company to operate efficiently and effectively without the burden of improper or inaccurate information. The objectives of internal control establish a goal. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Components of Internal Control CRIME
Control procedures Risk assessment Information system Monitoring of controls Environment Under the Sarbanes-Oxley Act of 2002, Internal control reports are required for publicly traded companies. The Public Company Accounting Oversight Board was created. Stiff penalties were established for financial statement fraud. By addressing the key components of an internal control system, the goals of internal control are more easily achieved. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Internal Control Procedures
Competent reliable and ethical personnel Assignment of responsibilities Separation of Duties Audits Documents Electronic devices E-Commerce Firewalls, Encryption, Passwords, and Digital Signatures Other Controls Fireproof vaults Alarms Job rotation There are many ways that control can be maintained. Control, according to the Committee of Sponsoring Organizations, inevitably involves people. Therefore, a good control system must have, at its core, competent and reliable personnel. In order to track control breakdowns, responsibilities must be assigned throughout the organization. In addition, some of those duties, must be separated in a way that requires more than one person to carry a transaction to its finality. Other controls include the use of audits to determine the degree to which the control system is working. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! The Sarbanes-Oxley Act, passed in 2002, is a comprehensive set of rules that govern the relationship of management and the external audit firm. Among its components is a requirement that companies review their internal control structure. Management is required to take responsibility for both the effectiveness of the internal control system and the accuracy and completeness of their financial reports. Failure to fulfill that responsibility can lead to both fines and prison time. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

©2014 Pearson Education, Inc. publishing as Prentice Hall
>TRY IT! Internal Control is defined as an organizational plan and all the related measures adopted by an entity to safeguard assets, encourage employees to follow company policies, promote operational efficiency, and ensure accurate and reliable accounting records. ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Encryption involves the rearranging of plain-text messages by a mathematical process. Given that all electronic communication, once launched into a network, is deemed to be permanent, it is recommended that all network communication, including and all files that reside on the network, be encrypted in a manner that prevents it being read by an unintended third party. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! In most medium-sized and large organizations, responsibilities must be divided among employees so that it takes more than one person to finalize a transaction. For example, the person who approves invoices for payment should not be the same person who writes or signs the checks. In small companies, separation of duties can be difficult to accomplish. In such cases, other compensating controls should be in place. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! The internal audit function in any organization has, as its primary mission, ensuring that the company’s employees are complying with company policies. In order to accomplish this task, the internal audit function should occupy an organizational status of internal independence, reporting directly to the company president and/or the board of directors. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Apply internal controls to cash receipts
Learning Objective 2 Apply internal controls to cash receipts Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Internal Controls for Cash Receipts
The control cycle for cash receipts involves several different controls. The controls start in the mail room where a mail room employee opens the mail. Most companies ask for checks, instead of cash. The employee records the checks received and forwards them to the Treasurer for deposit in the bank. At the same time, a remittance advice (a listing of the checks and amounts received) is sent to the Accounting Department. A mail room employee opens all mail and records the checks on a remittance advice. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Treasurer deposits the cash and checks in the bank with a deposit slip. A copy of the deposit slip is validated by the bank and then forwarded to the Controller. The Treasurer is responsible for depositing the checks, documented with a deposit receipt. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Accounting Department records the amounts from the remittance advice in the books. And forwards a copy to the Controller. The remittance advice goes the Accounting Department where is it recorded. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Controller now has a copy of the deposit amount showing the amount that was deposited in the bank and a copy of the remittance advice that shows how much was recorded in the books. The two amounts must match. The Controller’s office matches the remittance advice and the deposit receipt. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information concerning how companies control cash received by mail. The ________ opens the mail and sends customer checks to the treasurer. The _______ deposits the customer checks in the bank. The ________ uses the remittance advices to record the journal entries for cash receipts. The ________ compares the bank deposit to the journal entry for cash receipts. Fill in the blanks of the four statements below. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information concerning how companies control cash received by mail. The mail room employee opens the mail and sends customer checks to the treasurer. The _______ deposits the customer checks in the bank. The ________ uses the remittance advices to record the journal entries for cash receipts. The ________ compares the bank deposit to the journal entry for cash receipts. The mail is opened by the mail room employee who the cash and checks to the Treasurer. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information concerning how companies control cash received by mail. The mail room employee opens the mail and sends customer checks to the treasurer. The cashier deposits the customer checks in the bank. The ________ uses the remittance advices to record the journal entries for cash receipts. The ________ compares the bank deposit to the journal entry for cash receipts. The cashier, who works in the Treasurer’s office, deposits the cash and checks in the bank. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information concerning how companies control cash received by mail. The mail room employee opens the mail and sends customer checks to the treasurer. The cashier deposits the customer checks in the bank. The accounting dept. uses the remittance advices to record the journal entries for cash receipts. The ________ compares the bank deposit to the journal entry for cash receipts. The accounting department uses the remittance advices to record the cash receipts in the journal. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information concerning how companies control cash received by mail. The mail room employee opens the mail and sends customer checks to the treasurer. The cashier deposits the customer checks in the bank. The accounting dept. uses the remittance advices to record the journal entries for cash receipts. The controller compares the bank deposit to the journal entry for cash receipts. The controller compares the bank deposit slip to the journal entry. The amounts should match. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Apply internal controls to cash payments
Learning Objective 3 Apply internal controls to cash payments Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Controls over Cash Payments
Cash payments also have controls that support each other and insure proper disbursement of cash. First, a purchase order is prepared and sent to the vendor. Second, the inventory is sent by the vendor to the company. At the same time, a copy of the invoice is sent to the company. When the inventory is received, it is counted and compared to the original purchase order to insure that what was received matches what was originally ordered. A copy of the receiving report is then sent to the accounting department, where is it matched against the invoice. If the amounts match, the invoice is authorized for payment and a check is sent to the vendor. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Bills are only approved for payment by the accounting department when all the documents related to the transaction are matched together. Each of the documents in the process are prepared in multiple copies. For example, the purchase order has at least three copies. One stays in the originating department. One copy goes to the vendor. The third copy is sent to the receiving department to be matched against the packing list that comes with the delivered inventory. Only when the system is able to match all three documents (purchase order, receiving report, and invoice) is the invoice authorized for payment. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

A payment voucher authorizes a check to be sent to the vendor. When the invoice is authorized for payment, a voucher is prepared that goes to the cashier. The cashier prepares the check for payment based on the voucher. However, the cashier is not allowed to send the checks until they are signed by the appropriate officers in the company. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information. The vendor ships the inventory and sends a(n) ____________back to the purchaser. After approving all documents, the purchaser sends a(n) _______ to the vendor. When ordering merchandise inventory, the purchaser sends a(n) _________ to the vendor. The purchaser receives the inventory and prepares a(n) _________________. Fill in the missing information. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information. The vendor ships the inventory and sends a(n) invoice back to the purchaser. After approving all documents, the purchaser sends a(n) _______ to the vendor. When ordering merchandise inventory, the purchaser sends a(n) _________ to the vendor. The purchaser receives the inventory and prepares a(n) _________________. Invoices are sent by the vendor to the company. The invoice and shipment are based on the purchase order. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information. The vendor ships the inventory and sends a(n) invoice back to the purchaser. After approving all documents, the purchaser sends a(n) check to the vendor. When ordering merchandise inventory, the purchaser sends a(n) _________ to the vendor. The purchaser receives the inventory and prepares a(n) _________________. Only after the purchase order, receiving report, and invoice are matched is the invoice authorized for payment. In many companies, the vendor must also be matched against a list of approved vendors. Only then is the check sent to the vendor. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information. The vendor ships the inventory and sends a(n) invoice back to the purchaser. After approving all documents, the purchaser sends a(n) check to the vendor. When ordering merchandise inventory, the purchaser sends a(n) purchase order to the vendor. The purchaser receives the inventory and prepares a(n) _________________. When a department or office needs to order goods, a purchase order is prepared to be sent to the vendor. In some cases, the purchase order must be approved before being sent. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Fill in the missing information. The vendor ships the inventory and sends a(n) invoice back to the purchaser. After approving all documents, the purchaser sends a(n) check to the vendor. When ordering merchandise inventory, the purchaser sends a(n) purchase order to the vendor. The purchaser receives the inventory and prepares a(n) receiving report. When the inventory is received, the packing list is matched against the purchase order. If they match, the receiving report is sent to accounting to be matched against the invoice. If the packing list does not match the purchase order, then an exception report is generated that must be addressed by the purchaser and the vendor. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Explain and journalize petty cash transactions
Learning Objective 4 Explain and journalize petty cash transactions Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Petty Cash Used as an in-office source of cash for small immediate purchases. Often the responsibility of a designated employee. No cash is removed unless a corresponding receipt is placed in the “box.” Uses for Petty Cash Office donuts Cleaning supplies Sympathy flowers Entertaining clients Public transportation Tips for service providers Petty Cash is a common asset in many offices. Essentially, it is a small amount of cash that is maintained physically on site for every day expenses or small emergencies. In a single-office operation, the issue of petty cash may not be material. However, in a company that has tens of thousands of employees, organized into hundreds or thousands of separate offices or departments, each having its own petty cash, the amount of physical cash can become significant. The immense size of the cash amounts that comprise all of the separate petty cash amounts spread throughout the company requires effective controls be put in place. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Setting Up Petty Cash A check is written for an authorized amount to fund the Petty Cash Fund. After the check is cashed, the cash is physically placed in the Petty Cash Fund. To set up the petty cash fund, a journal entry is prepared that shows a credit to Cash and a debit to the Petty Cash Fund. A check is written and cashed at the bank. The cash is then placed in the custody of a responsible employee who must administer the fund. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Replenishing Petty Cash
As the petty cash is used, it must be replaced either with petty cash disbursement tickets or with the actual receipts. At any given time, the amount of actual cash in the petty cash fund and the receipts and tickets in the fund should total to the original authorized amount of the fund. In some circumstances, there are small amounts that are not accounted for. A check is written for $82 to replenish the fund. The receipts (tickets) are used to prepare an entry to record the related expenses. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Accounting for Petty Cash
At the end of the period, the petty cash fund is replenished. A journal entry is prepared that records each of the receipts and tickets in the fund. Any unexplained cash discrepancies are recorded in an account called Cash Over & Short. A check is written for the expended amounts and the cash is put back into the fund, returning it to its original balance. When cash is missing, the “Cash Short & Over” is used to record the unaccounted for amount. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Learning Objective 5 Demonstrate the use of a bank account as a control device and prepare a bank reconciliation and related journal entries Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Bank Account as a Control Device
During the 1960’s, Frank Abagnale passed $2.8 million of forged checks in over 26 different countries by exploiting weak controls over bank accounts. Signature Card Deposit Ticket Check Bank Statement Electronic Funds Transfers Bank Reconciliation Most of the company’s cash is kept in bank accounts. The bank statements can be used as additional controls to keep proper control over the company’s most liquid and vulnerable asset—Cash. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

When a check is prepared, it will have a remittance advice, sometimes called a check voucher, that shows the pertinent information about the check. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Bank Reconciliation Deposits in Transits Outstanding Checks Bank Collections Electronic Funds Transfers Service Charges Interest Nonsufficient Funds Checks A mathematical explanation of the difference between two numbers. With a bank reconciliation, there is often a difference between the bank statement balance and the general ledger cash balance. Often the bank balance on a given date and the balance on the books on the same date differ. There are often very good explanations for the difference, such as checks that the company has written (and deducted from its books) but which have not cleared the bank. To explain the difference between the two unequal balances, a bank reconciliation is prepared. Some activities have been conducted by the business, but there is a time delay between the transaction and when the bank learns the information. These activities include deposits in transit and outstanding checks. There are also activities that happen at the bank that the business does not learn about until they receive the periodic bank statement. These activities include amounts collected by the bank, electronic funds transfers, bank service charges, interest that is earned by the company or that is owed by the company, and nonsufficient funds checks. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Reconciliation Process Part A
Start with the Bank Balance at the end of the period + Add Deposits-in-Transit (DIT) Cash you have collected from customers, but which has not yet been deposited - Deduct Outstanding Checks (O/S Checks) Include ALL uncleared checks, even from previous periods Adjust for bank errors = Adjusted Bank Balance A normal reconciliation includes two parts. Part A starts with the bank balance and adjusts the balance for deposits in transit and for outstanding checks. Deposits in transit are added to the bank balance. Outstanding checks are deducted from the bank balance. In some cases the bank statement indicates errors made by the bank. Those errors must be added to or subtracted from the bank balance in order to arrive at the adjusted bank balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Reconciliation Process Part B
Start with the Book Balance at the end of the period + Add Bank Collections, Interest Revenue, and EFT Receipts (Cash receipts not already on the books) Deduct Services Charges, NSF Checks, and EFT Payments (Cash payments not already on the books) Adjust for book errors = Adjusted Bank Balance Part B of the bank reconciliation starts with the book balance. The bank statement should be analyzed. Any amounts that the bank added to the account during the period should be added to the book balance. Any amounts that are subtracted by the bank should be subtracted from the book balance. Again any errors in the books must be included with Part B of the reconciliation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exhibit 7-8 Bank Reconciliation
Bank April 30, 2015 = $12,720 Book April 30, 2015 = $20,850 Deposits in transit for April = $9,000 Outstanding Checks for April = $2,000 EFT receipt from customer = $100 Interest revenue on bank account = $30 Bank service charge = $20 EFT payment of water bill = $40 NSF Check = $1,200 Examine the information and then prepare the appropriate bank reconciliation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Part A, Bank, starts with the bank balance of $12,720 and adds deposits in transit of $9,000 and subtracts the outstanding check of $2,000. The adjust balance is $19,720. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Part B, Book, starts with the book balance of $20,850. The bank statement showed that the bank collected $100 from a customer and that the bank added interest to our account in the amount of $30. These amounts are added to the book balance. The bank statement also shows a service charge of $20, and ETF payment of a water bill for $40, and a nonsufficient funds check of $1,200. These amounts are subtracted from the book balance. The adjusted balance is $19,720. More importantly, the amounts from Part A and Part B are equal, indicating that the reconciliation was properly prepared. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Prepare a journal entry for each item on the Book side of the reconciliation Finally, a journal entry is prepared for all the adjusting items on Part B of the reconciliation. Anything added to the reconciliation will be credited. Anything subtracted from the reconciliation will be debited. The difference will be either a debit or a credit to cash to make the journal entry balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check Match each action with the appropriate reconciliation item. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check The interest revenue is added to the book balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check The NSF check will be subtracted from the book balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check The Deposit in transit should be added to the bank balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check The service charge will be subtracted from the book balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! For each of the following items, determine whether the item would be Added to the bank balance Subtracted from the bank balance Added to the book balance Subtracted from the book balance Interest revenue earned NSF check Deposit in transit Service charge Outstanding check The outstanding check will be subtracted from the bank balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

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