1. ACCOUNTING PRINCIPLES SIXTH CANADIAN EDITION Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 7 Internal Control and Cash

2. Internal control –Fraud –Internal controls and activities –Limitations of internal control Cash controls –Internal controls over cash receipts and payments Using a bank –Using and reconciling a bank account Reporting cash Copyright John Wiley & Sons Canada, Ltd. 2

3. LEARNING OBJECTIVES: CHAPTER 7: Internal Control and Cash Copyright John Wiley & Sons Canada, Ltd. 3 1.Explain the activities that help prevent fraud and achieve internal control. 2.Apply control activities to cash receipts. 3.Apply control activities to cash payments, including petty cash. 4.Describe the control features of a bank account and prepare a bank reconciliation. 5.Report cash on the balance sheet.

4. Fraud An intentional dishonest act Results in personal financial benefit by: –Misappropriating (stealing) assets, or –Misstating financial statements Three factors that contribute to fraud: –Opportunity to commit fraud –Financial pressure –Rationalization (justify their actions) 4 Copyright John Wiley & Sons Canada, Ltd.

5. Internal Control Related methods and measures that management designs and implements to help achieve: –Reliable financial reporting –Effective and efficient operations –Compliance with laws and regulations Effective internal control systems have five basic components: –Control environment –Risk assessment –Control activities –Information and communication –Monitoring Copyright John Wiley & Sons Canada, Ltd. 5

6. Internal Control Systems Control environment –Create a culture that values clear rules and expects everyone to follow the rules Risk assessment –Identify and analyze factors that create risk, and determine how to manage Control activities –Design policies and procedures to address the risks faced by the company Copyright John Wiley & Sons Canada, Ltd. 6

7. Internal Control Systems 2 Information and communication –Identify, collect and communicate relevant information to appropriate parties Monitoring –Identifying and reporting problems to appropriate levels where action can be taken Copyright John Wiley & Sons Canada, Ltd. 7

8. Control Activities Establishment of responsibility –Make specific employees responsible for specific tasks, including authorization Segregation of duties –Duties are divided in a manner that eliminates the ability to commit a fraud and cover it up Documentation procedures –Rules covering the handling and control of documents (such as pre-numbering) Copyright John Wiley & Sons Canada, Ltd. 8

9. Control Activities 2 Physical and IT controls –Over access to and use of assets and records Independent checks of performance –Reviews of records and performance by independent employees or external parties Human resource controls –Bonding, rotation of duties, requiring vacations, background checks Copyright John Wiley & Sons Canada, Ltd. 9

10. Limitations of Internal Control Reasonable assurance: cost of internal control should not be more than expected benefit Human element: fatigue, carelessness, indifference, lack of training Collusion: two or more employees working together to overcome segregation control Size of business: effective controls are more difficult in smaller organizations Copyright John Wiley & Sons Canada, Ltd. 10

11. LEARNING OBJECTIVES: CHAPTER 7: Internal Control and Cash Copyright John Wiley & Sons Canada, Ltd. 11 1.Explain the activities that help prevent fraud and achieve internal control. 2.Apply control activities to cash receipts. 3.Apply control activities to cash payments, including petty cash. 4.Describe the control features of a bank account and prepare a bank reconciliation. 5.Report cash on the balance sheet.

12. Cash Controls Effective control over cash is essential to: –Safeguard cash –Ensure the accuracy of accounting records Types of cash receipts: –Over-the-counter –Bank debit and credit card transactions –Mail-in receipts –Receipts via electronic funds transfer (EFT) Copyright John Wiley & Sons Canada, Ltd. 12

13. Control Over Cash Receipts Responsibility: –Only designated personnel are authorized to handle cash receipts Segregation of duties: –Different individuals receive and record cash receipts, have custody of cash Documentation procedures: –Use remittance advices, cash register tapes, deposit slips Copyright John Wiley & Sons Canada, Ltd. 13

14. Control Over Cash Receipts 2 Physical controls: –Store cash in safes and bank vaults –Limit access –Use cash registers –Deposit cash daily Independent checks of performance: –Daily cash counts and comparisons of receipts Human resource controls: –Bonding; require vacations Copyright John Wiley & Sons Canada, Ltd. 14

15. Debit Card Transactions Sales using debit cards are considered cash transactions –Retailer receives cash directly into bank account at some regular interval (e.g. daily) –Proceeds received are net of transaction fees Copyright John Wiley & Sons Canada, Ltd. 15

16. Bank Credit Card Transactions Sales using bank credit cards are also considered cash transactions –Retailer receives cash directly into bank account –Proceeds received are net of transaction fees Fees are generally higher than debit card fees Copyright John Wiley & Sons Canada, Ltd. 16

17. Mail-in and Electronic Receipts Mail-in receipts: –Open mail in presence of two clerks –Remittance slips sent to Accounting independently of cash Electronic receipts: –On-line banking: cash transferred from customer’s bank account to company’s bank account –Company journalizes from its bank statement –Pre-authorized payments: company initiates payment and automatically journalizes Copyright John Wiley & Sons Canada, Ltd. 17

18. LEARNING OBJECTIVES: CHAPTER 7: Internal Control and Cash Copyright John Wiley & Sons Canada, Ltd. 18 1.Explain the activities that help prevent fraud and achieve internal control. 2.Apply control activities to cash receipts. 3.Apply control activities to cash payments, including petty cash. 4.Describe the control features of a bank account and prepare a bank reconciliation. 5.Report cash on the balance sheet.

19. Control Over Cash Payments Made by cheque, EFT or petty cash Establish responsibility: –Only designated individuals can sign cheques Segregation of duties: –Different people approve and make payments Documentation procedures: –Use pre-numbered cheques and account for numerical continuity –Supported by approved invoice or similar Copyright John Wiley & Sons Canada, Ltd. 19

20. Control Over Cash Payments 2 Physical and IT controls: –Secure blank cheques and restrict access –Print cheques electronically or use writer Independent checks of performance: –Compare cheques to invoices –Reconcile bank statement regularly Human resources: –Hire bonded personnel Copyright John Wiley & Sons Canada, Ltd. 20

21. Petty Cash Fund Used to pay small amounts To establish a petty cash fund: –Appoint a custodian who is responsible for it –Determine the appropriate size of the fund Copyright John Wiley & Sons Canada, Ltd. 21

22. Petty Cash Fund 2 Making payments from the fund: –Usually limited in size and type of transaction –Documented on a pre-numbered receipt –No accounting entry when payment is made Replenishing the fund: –Done when fund reaches some set minimum –Custodian prepares a summary of payments, supported by receipts and other documents –Reviewed and approved independently –Used as a basis for accounting entry Copyright John Wiley & Sons Canada, Ltd. 22

23. Petty Cash Fund 3 Cash shortage or overage –Recognized when fund replenished –Becomes an expense or revenue Fund can be increased (if not large enough) or decreased (if too large) when replenished Copyright John Wiley & Sons Canada, Ltd. 23

24. LEARNING OBJECTIVES: CHAPTER 7: Internal Control and Cash Copyright John Wiley & Sons Canada, Ltd. 24 1.Explain the activities that help prevent fraud and achieve internal control. 2.Apply control activities to cash receipts. 3.Apply control activities to cash payments, including petty cash. 4.Describe the control features of a bank account and prepare a bank reconciliation. 5.Report cash on the balance sheet.

25. Use of a Bank Account Strengthens internal controls over cash –Minimizes the amount of cash on hand –A clearing house for receipts and cheques –Provides a double record of cash transactions Bank deposits and cheques –Duplicate deposits slips are stamped by bank –Cheques usually require two authorized signatures Bank reconciliation compares bank’s balance with company’s balance and explains any differences Copyright John Wiley & Sons Canada, Ltd. 25

26. Bank Statement Copyright John Wiley & Sons Canada, Ltd. 26

27. Reconciling the Bank Account Bank balance almost never agrees to depositor’s balance –Due to time lags and errors in recording transactions The two balances must be reconciled –Called preparing a bank reconciliation –Done by an employee who has no responsibilities related to cash Balance per books and per bank are both reconciled to their adjusted (correct) balance Copyright John Wiley & Sons Canada, Ltd. 27

28. Reconciling Items per Bank Balance per bank +Deposits in transit –Deposits recorded by depositor that have not been recorded by bank -Outstanding cheques –Cheques issued & recorded by company that have not been presented to bank ±Bank errors =Adjusted cash balance per bank Copyright John Wiley & Sons Canada, Ltd. 28

29. Reconciling Items per Books Balance per books +Credit memoranda –Amounts credited to company by bank, such as interest earned, EFT deposits, etc. -Debit memoranda –Charges levied by bank against depositor’s account – service charges, NSF charges, etc. ±Company errors =Adjusted cash balance per books Copyright John Wiley & Sons Canada, Ltd. 29

30. Entries from Bank Reconciliation Each reconciling item required to calculate adjusted cash balance per books must be journalized –To ensure that these are accounted for by company Each reconciling item required to calculate adjusted cash balance per bank is NOT journalized –Will be recorded by bank when received Copyright John Wiley & Sons Canada, Ltd. 30

31. LEARNING OBJECTIVES: CHAPTER 7: Internal Control and Cash Copyright John Wiley & Sons Canada, Ltd. 31 1.Explain the activities that help prevent fraud and achieve internal control. 2.Apply control activities to cash receipts. 3.Apply control activities to cash payments, including petty cash. 4.Describe the control features of a bank account and prepare a bank reconciliation. 5.Report cash on the balance sheet.

32. Reporting Cash Cash on the balance sheet includes: –Coins, currency, cheques, money on deposit –Bank debit and credit card transactions –Cash equivalents: investments with a term of three months or less that are easily sold Listed first on the balance sheet, as it is the most liquid Bank overdrafts are reported as a liability Restricted cash is reported separately Copyright John Wiley & Sons Canada, Ltd. 32

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