Chapter 6 Accounting

Bank account purpose

A bank account is a record set up by a bank for a customer. It permits a customer to deposit money for safekeeping and helps control withdrawals.

Check involves 3 parties

A check involves three parties: a maker who signs the check, a payee who is the recipient, and a bank (or payer) on which the check is drawn. Sometimes, a check is accompanied with an optional remittance advice that explains the payment. When a remittance advice is unavailable, the memo line is often used for a brief explanation.

Journal entries for each item reflected in an adjustment 1st entry

A journal entry is required for each item reflected as an adjustment to the cash balance per books. Each of these journal entries will require either a debit or credit to the cash account. The first entry records the proceeds of its note receivable collected by the bank less the expense of having the bank perform that service. The second entry records interest credited to its account by the bank. The third entry records expenses for the check printing charge. The fourth entry records the NSF check that is returned as uncollectible. The $20 check was originally received from T. Woods in payment of his account and then deposited. The bank charged $10 for handling the NSF check and deducted $30 total from VideoBuster's account. This means the entry must reverse the effects of the original entry made when the check was received and must record (add) the $10 bank fee. After each of these journal entries are recorded and posted, the company's Cash account balance will be $1,845.

Reliable voucher sys follows

A reliable voucher system follows standard procedures for every transaction.

What is a voucher system?

A voucher system is a set of procedures and approvals designed to control cash disbursements and the acceptance of obligations.

Voucher system and control over cash begins when_____ What are 2 key factors associated with this?

A voucher system's control over cash disbursements begins when a company incurs an obligation that will result in payment of cash. A key factor in this system is that only approved departments and individuals are authorized to incur such obligations. Another key factor is that procedures for purchasing, receiving, and paying for merchandise are divided among several departments (or individuals). These departments include the one requesting the purchase, the purchasing department, the receiving department, and the accounting department.

All internal control policies and procedures have limitations that usually arise from 2 things

All internal control policies and procedures have limitations that usually arise from either (1) the human element or (2) the cost-benefit principle.

Internal controls sys consists of what that do what? (4)

An internal control system consists of the policies and procedures managers use to: Protect assets Ensure reliable accounting Promote efficient operations Uphold company policies

apply technological controls

Apply Technological Controls Cash registers, check protectors, time clocks, and personal identification scanners are examples of devices that can improve internal control. Technology often improves the effectiveness of controls. A cash register with a locked-in tape or electronic file makes a record of each cash sale. A check protector perforates the amount of a check into its face and makes it difficult to alter the amount. A time clock registers the exact time an employee both arrives at and departs from the job. Mechanical change and currency counters quickly and accurately count amounts, and personal scanners limit access to only authorized individuals. Each of these and other technological controls are an effective part of many internal control systems.

cash over and short account usually has a ______

Because customers are more likely to dispute being shortchanged than being given too much change, the Cash Over and Short account usually has a debit balance at the end of an accounting period. That balance is then reported on the income statement as part of selling, general and administrative expenses.

Cancelled checks and how they show

Canceled checks are checks the bank has paid and deducted from the customer's account during the period. In the past, bank statements included the depositor's canceled checks. Now, most banks provide online access to showing canceled checks electronically via online access to accounts.

Definition of forms of cash

Cash includes currency and coins along with the amounts on deposit in bank accounts, checking accounts (called demand deposits), and many savings accounts (called time deposits). Cash also includes items that are acceptable for deposit in these accounts such as customer checks, cashier's checks, certified checks, and money orders.

cash receipts arises from ____ Int control of cash receipts ensures that

Cash receipts can arise from transactions such as cash sales, collections of customer accounts, receipts of interest earned, bank loans, sales of assets, and owner investments. Internal control of cash receipts ensures that cash received is properly recorded and deposited.

Control of Cash Disbursements is important why?

Control of cash disbursements is especially important because most large thefts occur from payment of fictitious invoices.

Control of Cash Receipts thru the mail

Control of cash receipts that arrive through the mail starts with the person who opens the mail. Preferably, two people are assigned the task of, and are present for, opening the mail. A theft of cash receipts by mail requires collusion between these two employees.

What do bank statements usually include

Different banks use different formats for their bank statements. A bank statement typically includes: a summary of changes in the account; paid checks along with other debits are listed; as well as deposits and credits to the account.

divide responsibility for related transactions

Divide Responsibility for Related Transactions Good internal control divides responsibility for a transaction or a series of related transactions between two or more individuals or departments. This is to ensure that the work of one individual acts as a check on the other. This principle, often called separation of duties, is not a call for duplication of work. Each employee or department should perform unduplicated effort. Assigning responsibility for two or more of these tasks to one party (rather than two or more parties) might increase mistakes and perhaps fraud.

Bank deposits and how they work

Each bank deposit is supported by a deposit ticket, which lists items such as currency, coins, and checks deposited along with their corresponding dollar amounts. The bank gives the customer a copy of the deposit ticket or a deposit receipt as proof of the deposit.

All about EFTs

Electronic funds transfer (EFT) is the electronic transfer of cash from one party to another. No paper documents are necessary. Banks simply transfer cash from one account to another with a journal entry. Companies are increasingly using EFT because of convenience and low cost. We now commonly see items such as payroll, rent, utilities, insurance, and interest payments handled by EFT. A bank statement is sometimes a depositor's only notice of an EFT.

Principles of Internal Control (7)

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.

examples of cash equivalents

Examples of cash equivalents are short-term investments in assets such as U.S. Treasury bills and money market funds. Most companies combine cash equivalents with cash as a single item on the balance sheet.

More examples of what is on bank statements

Examples of other deductions on a bank statement include service charges and fees, checks deposited that are uncollectible, and withdrawals through automated teller machines (ATMs). (Most company checking accounts do not allow ATM withdrawals because of the company's desire to make all disbursements by check.) The bank typically notifies the depositor of each deduction to the depositor's account with a debit memorandum. A debit memorandum indicates that the bank has debited, or reduced, the depositor's account balance. (Recall that the depositor's account is a liability on the bank's books and debits are used to decrease liability accounts.) Examples of other transactions that increase the depositor's account include amounts the bank collects on behalf of the depositor and interest paid on the depositor's account. The bank typically notifies the depositor of each increase with a credit memoranda. (Again, recall that the depositor's account is a liability on the bank's books and credits are used to increase liability accounts.)

Human fraud is driven by the triple-threat of fraud:

Human fraud is driven by the triple threat of fraud: Opportunity—Refers to internal control weaknesses in a business. Pressure—Refers to financial, family, society, and other stresses to succeed. Rationalization—Refers to employees justifying their fraudulent behavior. Whenever two or more of these threats exist, the threat of fraud increases greatly!

Insure Assets and Bond Key Employees

Insure Assets and Bond Key Employees Good internal control means that assets are adequately insured against casualty and that employees handling large amounts of cash and easily transferable assets are bonded. An employee is bonded when a company purchases an insurance policy, or a bond, against losses from theft by that employee. Bonding reduces the risk of loss. It also discourages theft because bonded employees know an independent bonding company will be involved when theft is uncovered and is unlikely to be sympathetic with an employee involved in theft.

Liquidity and Liquid Assets

Liquidity refers to a company's ability to pay for its near-term obligations. Cash and similar assets are called liquid assets because they can be readily used to settle such obligations. A company needs liquid assets to effectively operate.

maintain adequate records

Maintain Adequate Records Good recordkeeping is part of an internal control system. It helps protect assets and ensures that employees use prescribed procedures. Reliable records are also a source of information that managers use to monitor company activities. When detailed records of equipment are kept, for instance, items are unlikely to be lost or stolen without detection. Similarly, transactions are less likely to be entered in wrong accounts if a chart of accounts is set up and carefully used. Many preprinted forms and internal documents are also designed for use in a good internal control system. When sales slips are properly designed, for instance, sales personnel can record needed information efficiently with less chance of errors or delays to customers. When sales slips are prenumbered and controlled, each one issued is the responsibility of one salesperson, preventing the salesperson from pocketing cash by making a sale and destroying the sales slip. Computerized point-of-sale systems achieve the same control results.

Who uses internal controls?

Managers use an internal control system to monitor and control business activities.

To illustrate a shortage

On the other hand, if a cash register's record shows $625 but the count of cash in the register is $621, the entry to record cash sales and its shortage debits the Cash account for $621, debits Cash Over and Short for $4, the amount of the shortage, and credits Sales for $625.

How do you control cash disbursements

One key to controlling cash disbursements is to require all expenditures to be made by check. Another key is to deny access to the accounting records to anyone other than the owner who has the authority to sign checks. A small business owner often signs checks and knows from personal contact that the items being paid for are actually received.

A bank reconciliation has two parts.

One part starts with the bank balance, makes adjustments for timing differences and errors, and arrives at an adjusted bank balance.

Usually, the ending cash balance on the bank statement does not agree with the ending cash balance in the company's Cash account because of timing differences and errors. The most common causes of differences are:

Outstanding checks—Checks written by the company and recorded in the company's books that have not yet been paid (or cleared) by the bank are referred to as outstanding checks. They are identified by comparing the list of canceled checks on the bank statement with the record of checks maintained by the company. Deposits in transit—Deposits sent to the bank by the company and recorded in the company's books that have not yet been recorded by the bank are referred to as deposits in transit. They are determined by comparing the deposits listed on the bank statement with the company deposit records. Deductions for uncollectible items and for services—Sometimes, a company has deposited a check from a customer that could not be collected. That is, the bank processed the check through banking channels to the customer's bank, but the customer's account did not have sufficient funds to cover the check. As a result, after marking it NSF (for non-sufficient funds), the customer's bank returned the check to the company's bank, which then charged it back to the company's account. The bank would have initially credited the depositor's account for the amount of the check. When the bank learns the check is uncollectible, it debits (reduces) the depositor's account for the amount of that check. The bank might also charge the depositor a fee for processing an uncollectible check. Other possible bank charges to a depositor's account include printing new checks and service fees. Additions for collections and for interest—Banks sometimes act as collection agents for their depositors by collecting notes and other items. When a bank collects an item, it is added to the depositor's account, less any service fee. The bank also sends a credit memorandum to notify the depositor of the transaction. The bank statement might also include a credit for any interest earned. Errors—Both banks and depositors can make errors. Bank errors might not be discovered until the depositor prepares the bank reconciliation. Also, depositor errors are sometimes discovered when the bank balance is reconciled. Errors are identified by comparing deposits on the bank statement with deposits in the accounting records and comparing canceled checks on the bank statement with checks recorded in the accounting records.

perform regular and independent reviews

Perform Regular and Independent Reviews Changes in personnel, stress of time pressures, and technological advances present opportunities for shortcuts and lapses. To counter these factors, regular reviews of internal control systems are needed to ensure that procedures are followed. These reviews are preferably done by internal auditors not directly involved in the activities. Their impartial perspective encourages an evaluation of the efficiency as well as the effectiveness of the internal control system. Many companies also pay for audits by independent, external auditors. These external auditors test the company's financial records to give an opinion as to whether its financial statements are presented fairly. Before external auditors decide on how much testing is needed, they evaluate the effectiveness of the internal control system. This evaluation is often helpful to a client.

Estab Responsibility

Proper internal control means that responsibility for a task is clearly established and assigned to one person. When a problem occurs in a company where responsibility is not identified, determining who is at fault is difficult. For instance, if two sales clerks share the same cash register and there is a cash shortage, neither clerk can be held accountable. To prevent this problem, one clerk might be given responsibility for handling all cash sales. Alternately, a company can use a register with separate cash drawers for each clerk. Do you remember waiting at a retail counter during a shift change while employees swap cash drawers? Now you know why!

Flow of record keeping dealing with cash and its separation from its recordkeeping

Proper internal control prescribes that custody over cash should be separate from its recordkeeping. For over-the-counter cash receipts, this separation begins with the cash sale. The clerk who has access to cash in the register should not have access to its locked-in record. At the end of the clerk's work period, the clerk should count the cash in the register, record the amount, and turn over the cash and a record of its amount to the company cashier. The cashier, like the clerk, has access to the cash but should not have access to accounting records (or the register tape or file locked inside the register A third employee, often a supervisor, compares the record of total register transactions (or the register tape or file) with the cash receipts reported by the cashier. This record is the basis for a journal entry recording over-the-counter cash receipts. The clerk and the cashier have access to cash but not to the accounting records. The third employee has access to the records for cash but not to the actual cash. None of them can make a mistake or divert cash without the difference being revealed when the cash sheets are compared to the register sheets.

Proper int control prescribes that ______ with regard to OTC cash receipts

Proper internal control prescribes that responsibilities be established and adequate records be maintained. With regards to over-the-counter cash receipts, sales to customers should be recorded on a cash register at the time of each sale. To help ensure that correct amounts are entered, each register should be located so customers can read the amounts entered and clerks should be required to give the customer a receipt for each sale. The design of each cash register should provide a permanent, locked-in record of each transaction.

Walk through of a whole bank reconciliation

Recall that a bank reconciliation has two parts. The "bank" part starts with the bank balance, makes adjustments for timing differences and errors, and arrives at an adjusted bank balance. Recall that the adjustments here are items that the bank doesn't know about yet. Also, recall that, except for bank errors (which must be individually analyzed), each of these items should be added or deducted based on what the bank will do when it processes the item. Step 1—Identify the bank statement balance of the cash account (balance per bank). VideoBuster's bank balance is $2,050. Step 2—Identify and list any unrecorded deposits and any bank errors understating the bank balance. Add them to the bank balance. VideoBuster's $145 deposit placed in the bank's night depository on October 31 is not recorded on its bank statement. Step 3—Identify and list any outstanding checks and any bank errors overstating the bank balance. Deduct them from the bank balance. VideoBuster's comparison of canceled checks with its books shows two checks outstanding: No. 124 for $150 and No. 126 for $200. Step 4—Compute the adjusted bank balance. The adjusted bank balance is $1,845. No journal entries are required for the items reflected as adjustments to the cash balance per bank statement. These items are already recorded on the company's books. The "book" part of the bank reconciliation starts with the book balance, makes adjustments for timing differences and errors, and arrives at an adjusted book balance. Again, think of the adjustments to the cash balance per books as the items that the company didn't know about until the bank statement was received. Except for book errors (which must be individually analyzed), each of these items should be added or deducted based on what the bank did when it processed the item. Step 5—Identify the company's book balance of the cash account (balance per book). VideoBuster's book balance is $1,404.58. Step 6—Identify and list any unrecorded credit memoranda from the bank, any interest earned, and errors understating the book balance. Add them to the book balance. VideoBuster's bank statement includes a credit memorandum showing the bank collected a note receivable for the company on October 23. The note's proceeds of $500 (minus a $15 collection fee) are credited to the company's account. VideoBuster's bank statement also shows a credit of $8.42 for interest earned on the average cash balance. There was no prior notification of this item, and it is not yet recorded. Step 7—Identify and list any unrecorded debit memoranda from the bank, any service charges, and errors overstating the book balance. Deduct them from the book balance. Debits on VideoBuster's bank statement that are not yet recorded include (a) a $23 charge for check printing and (b) an NSF check for $20 plus a related $10 processing fee. (The NSF check is dated October 16 and was included in the book balance.) Step 8—Compute the adjusted book balance. The adjusted book balance is $1,845. Step 9—Verify that the two adjusted balances from steps 4 and 8 are equal.

Technology impact on internal controls (5)

Reduced Processing Errors—Technologically advanced systems reduce, but do not eliminate, errors in processing information. Less human involvement can cause data entry errors to go undiscovered. Moreover, errors in software can produce consistent but inaccurate processing of transactions. More Extensive Testing of Records—A review of electronic records can include broader testing when information is easily accessible. Limited Evidence of Processing—Many data processing steps are increasingly done by computer. As a result, fewer hard-copy items of documentary evidence are available for review and, yet, technologically advanced systems can provide new evidence. Separation of Duties—A company with a smaller workforce risks losing separation of duties. For instance, the person who designs and programs the information system should not operate it. The company must also separate control over programs and files from the activities related to cash receipts and disbursements. Increased E-Commerce—Most companies have some e-commerce transactions. All such transactions involve at least three risks (1) Credit card number theft is a risk of using, transmitting, and storing such data online. (2) Computer viruses are malicious programs that attach themselves to innocent files for purposes of infecting and harming other files and programs. (3) Impersonation online can result in charges of sales to bogus accounts, purchases of inappropriate materials, and the unknowing giving up of confidential information to hackers.

Sarbanes-Oxley Act (SOX) requires what?

Sarbanes-Oxley Act (SOX) requires the managers and auditors of companies whose stock is traded on an exchange (called public companies) to document and certify the system of internal controls.

separate record keeping from custody of assets

Separate Recordkeeping from Custody of Assets A person who controls or has access to an asset must not keep that asset's accounting records. This principle reduces the risk of theft or waste of an asset because the person with control over it knows that another person keeps its records. Also, a recordkeeper who does not have access to the asset has no reason to falsify records. This means that to steal an asset and hide the theft from the records, two or more people must collude—or agree in secret to commit the fraud.

Controls over cash should meet three basic guidelines:

Separate the handling of cash from the recordkeeping of cash. This guideline applies separation of duties to minimize errors and fraud. When duties are separated, two or more people must collude to steal cash and conceal this action in the accounting records. Promptly deposit cash receipts in a bank. This guideline uses immediate (say, daily) deposits of all cash receipts to produce a timely independent record of the cash received. It also reduces the likelihood of cash theft (or loss) and the risk that an employee could personally use the money before depositing it. Make cash disbursements by check (or electronic funds transfer, ETF). This guideline uses payments by check to develop an independent bank record of cash disbursements. It also reduces the risk of cash theft (or loss).

4 specific SOX requirements

Some of the specific requirements of SOX include: Executives and boards of directors must install effective internal controls. Auditors must evaluate internal controls. Auditors' work overseen by the Public Company Accounting Oversight Board (PCAOB). Violators receive harsh penalties — up to 25 years in prison with severe fines.

Cash over short account and how it is reported

Sometimes errors in making change are discovered from differences between the cash in a cash register and the record of the amount of cash receipts. Although a clerk is careful, one or more customers can be given too much or too little change. This means that at the end of a work period, the cash in a cash register might not equal the record of cash receipts. This difference is reported in the Cash Over and Short account.

Preparing a Bank Reconciliation (steps 1-9)

Step 1. Identify the bank statement balance (balance per bank). Step 2. Identify and add unrecorded deposits and bank errors understating the bank balance. Add them to the bank balance. Step 3. Identify and deduct outstanding checks and bank errors overstating the bank balance from the bank balance. Step 4. Compute the adjusted bank balance. Step 5. Identify the company's book balance (balance per book). Step 6. Identify and add unrecorded credit memoranda, interest earned, and errors understating the book balance to the book balance. Step 7. Identify and deduct unrecorded debit memoranda, service charges, and errors overstating the book balance and deduct them from the book balance. Step 8. Compute the adjusted book balance. Step 9. Verify that the two adjusted balances are equal. If the two adjusted balances from steps 4 and 8 are equal, then they are reconciled. If not, go back and check for accuracy and any missing data.

role of cashier recordkeeper

The cashier deposits the money in a bank and the recordkeeper records the amounts received in the accounting records. Later, when the bank balance is reconciled (or compared to) with the Cash records in the ledger, errors or acts of fraud by the mail clerks, the cashier, or the recordkeeper will be revealed.

Where is each copy sent

The first copy is sent with the money to the cashier. A second copy is sent to the recordkeeper in the accounting area. A third copy is kept by the clerk(s) who opened the mail.

Internal control policies and procedures are applied by people. This human element creates several potential limitations that can be categorized in two ways.

The first is human error. Human error can occur from carelessness, misjudgment, or confusion. The second category is human fraud. Human fraud involves intent by people to defeat internal controls, such as management override, for personal gain. The human element highlights the importance of establishing an internal control environment to convey management's commitment to internal control policies and procedures

2nd major limitation on internal controls is the ______

The second major limitation on internal control is the cost-benefit principle, which dictates that the costs of internal controls must not exceed their benefits. Analysis of costs and benefits must consider all factors, including the impact on morale. Managers must establish internal control policies and procedures with a net benefit to the company.

Who is responsible for cash management? Effective cash management involves applying the following cash management principles.

The treasurer of the company is responsible for cash management. Effective cash management involves applying the following cash management principles. Encourage collection of receivables. The more quickly customers and others pay the company, the more quickly that company can use the money. Delay payment of liabilities. The more delayed a company is in paying others, the more time it has to use the money. Some companies regularly wait to pay their bills until the last possible day allowed. Keep only necessary levels of assets. The less cash tied up in idle assets, the more cash to invest in productive assets. Plan expenditures. Cash should be spent only when it is available. Managers must consider seasonal and business cycles to plan expenditures. Invest excess cash. Excess cash earns no return and should be invested. Excess cash from seasonal cycles can be placed in a bank account or other short-term investment for income. Excess cash beyond what's needed for regular business should be invested in productive assets like factories and inventories.

Large businesses and cash disbursements

This arrangement is impossible in large businesses. Instead, internal control procedures must be substituted for personal contact. Such procedures are designed to assure the check signer that the obligations recorded are properly incurred and should be paid. Also, internal control over electronic procedures must be applied when cash disbursements are made electronically.

How does the voucher procedure work?

To coordinate and control the responsibilities of these departments, a company uses several different business documents. These documents are accumulated in a voucher, which is an internal document (or file) used to accumulate information to control cash disbursements and to ensure that a transaction is properly recorded. The process begins with a purchase requisition and concludes with a check drawn against cash.

To illustrate overage

To illustrate, if a cash register's record shows $550 but the count of cash in the register is $555, the entry to record cash sales and its overage debits the Cash account for $555, credits Cash Over and Short for $5, the amount of the overage, and credits Sales for $550.

How is the voucher sys illustrated

To illustrate, when a company receives an invoice, it should review and verify the charges, prepare a voucher (file), and insert the bill. This transaction is then recorded with a journal entry. If the amount is currently due, a check is issued. If not, the voucher is filed for payment on its due date.

cash equivalents and the criteria they must meet

To increase their return, many companies invest idle cash in cash equivalents. Cash equivalents are short-term, highly liquid investment assets meeting two criteria: Readily convertible to a known cash amount. Sufficiently close to their due date so that their market value is not sensitive to interest rate changes. Only investments purchased within three months of their due date usually satisfy these criteria.

To limit access to bank account

To limit access to a bank account, all persons authorized to write checks on the account must sign a signature card, which bank employees use to verify signatures on checks.

How is withdrawing from an account handeled

To withdraw money from an account, the depositor can use a check, which is a document signed by the depositor instructing the bank to pay a specified amount of money to a designated recipient.

All about bank statements and what they contain

Usually once a month, the bank sends each depositor a bank statement showing the activity in the account. A bank statement, which reflects the information in the bank's records, includes the beginning-of-period balance of the depositor's account, checks and other debits decreasing the account during the period, deposits and other credits increasing the account during the period, and the end-of-period balance of the depositor's account.

The voucher system of control establishes procedures for:

Verifying, approving, and recording obligations for eventual cash disbursement. Issuing checks for payment of verified, approved, and recorded obligations.

The goals of cash management are twofold:

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: Plan cash receipts to meet cash payments when due.. Keep a minimum level of cash necessary to operate.

When mail is opened what is the procedure

When the mail is opened, a list of money received should be prepared (in triplicate). This list should contain a record of each sender's name, the amount, and an explanation of why the money is sent.

Cash in a bank account is an ______ on the ______book's, the account is a _____ on the ______ ________ because

While the cash in the bank account is an asset on the depositor's books, the account is a liability on the bank's records because the bank owes that money to the depositor. As such, when the depositor increases the account balance, the bank records it with a credit to that liability account. When the depositor decreases the account balance, the bank records it with a debit to that liability account.

What is a bank reconciliation?

performed to verify the accuracy of both the bank statement and the cash accounts of a business. A bank reconciliation should be prepared each time a bank statement is received from the bank. This process also identifies any transactions or changes that need to be reflected on the company's books.