1. Internal Control and Cash
Chapter 7
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2. 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.

3. Components of Internal Control
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.

4. 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.

5. Risk Assessment Risk Assessment
Examples: Foods may prove harmful, planes may crash, companies face bankruptcy
When facing difficulties, management is tempted to falsify financial statements
Greater the risk, the more controls that are needed
A company must assess its risks. For example, Kraft Foods faces the risk that its food products may harm people; American Airlines planes may crash; Sony faces copyright infringement risks; and all companies face the risk of bankruptcy. Companies facing difficulties are tempted to falsify the financial statements to make themselves look better than they really are.

6. Information System Information is critical
Decision makers need accurate information
Controls in place to:
Prevent unauthorized access to accounting systems
Insure adequate approvals for transactions
As we have seen, the information system is critical. Decision makers need accurate information to keep track of assets and measure profits and losses. Controls must be in place within the information system to ensure that only authorized users have access to various parts of the accounting information system. Additionally, controls are needed to insure that adequate approvals for recorded transactions are in place.

7. Monitoring of Controls
Hire auditors to monitor controls
Internal Auditors
Employees of the company
Check for company policy adherence
Determines if legal requirements are followed
External Auditors
Not employees
Completely independent of the business
Monitor controls on financial statement presentations
Suggest improvements
Companies hire auditors to monitor their controls. Internal auditors are employees of the business who ensure that employees are following company policies and that operations are running efficiently. These internal auditors also determine whether the company is following legal requirements that monitor internal controls to safeguard assets.
External auditors are outside accountants that are completely independent of the business. They monitor the controls to ensure that the financial statements are presented fairly in accordance with GAAP and they suggest improvements to help the business.

8. Control Environment Control Environment
The “tone at the top” of the business
Starts with the C.E.O. and top managers
Behave honorably to set examples
Demonstrate importance of internal control
Control procedures are the procedures designed to ensure that the business’s goals are achieved.
The control environment is the “tone at the top” of the business. It starts with the owner or C.E.O. and the top managers. They must behave honorably to set a good example for company employees. Each must demonstrate the importance of internal controls if he or she expects the employees to take the controls seriously. Former executives of Enron and WorldCom failed to establish a good control environment and are in prison as a result.

9. 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.

10. Internal Controls for Cash Receipts
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.

11. Internal Controls for Cash Receipts
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.

12. Internal Controls for Cash Receipts
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.

13. 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.
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14. Controls over Cash Payments
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.

15. Controls over Cash Payments
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.

16. 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.

17. 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.

18. 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.

19. 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.

20. Bank Account as a Control Device
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.

21. 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.

22. 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.

23. 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.

24. 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.

25. Exhibit 7-8 Bank Reconciliation
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.

26. Exhibit 7-8 Bank Reconciliation
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.

27. Exhibit 7-8 Bank Reconciliation
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.

28. >TRY IT! Added to the bank balance Subtracted from the bank balance
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.

29. 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

30. >TRY IT! Added to the bank balance Subtracted from the bank balance
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.

31. >TRY IT! Added to the bank balance Subtracted from the bank balance
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.

32. >TRY IT! Added to the bank balance Subtracted from the bank balance
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.

33. >TRY IT! Added to the bank balance Subtracted from the bank balance
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.

34. Use the cash ratio to evaluate business performance

35. Cash Ratio
The cash ratio is used as a measure of a company’s ability to quickly pay it current liabilities.
The cash ratio is used as a measure of a company’s ability to quickly pay it current liabilities.

36. Kohl’s

37. Eastman Chemical

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Walmart
Cash Ratio = 7,281/69, = .1049
©2014 Pearson Education, Inc. Publishing as Prentice Hall