Chapter 8

Differences between the company and bank balance may arise because of....

1. A delay either by the company or bank in recording transactions 2. The bank has debited or credited the company's account for transactions that the company will not know about until the bank statement is received. 3. Errors, such as incorrect posting, made by either the company or the bank.

The following types of credit or debit memo entries are found on a bank statement. What do they mean? 1. EC: 2. NSF: 3. SC: 4. ACH: 5. MS:

1. Error correction to correct bank error 2. Not sufficient funds check 3. Service charge 4. Automated clearing house entry for EFT 5. Miscellaneous item such as a collection of a note receivable on behalf of the company or receipt of a loan by the company from the bank.

How many control procedures are there?

5

Bank statement

A summary of all transactions that are usually mailed each month to the company (depositor) or made available online.

Warning signs of internal control problems with regard to people

Abrupt change in lifestyle (without winning the lottery) Close social relationships with suppliers Refusing to take vacation Frequent borrowing from other employees Excessive use of alcohol or drugs.

Recording Cash Short and Over account in the Income Statement

At the end of the accounting period, a debit balance in Cash Short and Over is included in miscellaneous expense Alternatively, a credit balance is included in the Other Revenue Section

Some of the control advantages of using bank accounts are:

Bank accounts reduce the amount of cash on hand. Bank accounts provide an independent recording of cash transactions. Reconciling the balance of the cash account in the company's records with the cash balance according to the bank is an important control. Use the bank accounts facilitates the transfer of funds using EFT systems

Compensating balance

Banks may require depositors to maintain minimum cash balances in their bank accounts.

A bank statement shows the

Beginning balance Additions Deductions Ending balance

Flow of the three factors influencing a company's control environment

CEO>Organizational Structure>EMPLOYEES> Personnel policies>Management's philosophy and operating style>CEO etc.

List the affected account, the amounts of the transaction, and whether it is a debit/credit for the following scenario: The actual cash received from cash sales totaled $35, 668 and the amount indicated by the cash register total for cash sales for May 3 was $35,690. The cash receipts, sales, and shortage would be recorded as follows.

Cash (Debit (-)) 35, 668 Cash Short and Over (Debit (-)) 22 Sales (Credit (+)) 35,690

Journaize incorrect check amount:

Cash (Debit +) Accounts Receivable (Credit +)

What are the five control procedures?

Competent personnel, rotating, duties, and mandatory vacations Separating responsibilities for related operations Separating operations, custody of assets, and accounting Proofs and security measures

Electronic Funds Transfers (EFT) advantages

Cost less than receiving cash payments through the mail Enhance internal controls over cash, since the cash is received directly by the bank without any employees handling the cash Reduce late payments from customers and speed up the processing of cash receipts.

In the bank's records, the company's account has a _____ balance.

Credit

What are the two main sources from which businesses normally receive cash?

Customers purchasing products or services Customers making payments on account

Instances where a bank makes credit entries (issues credit memos)

Deposits made by EFT Collections of notes receivable for the company Proceeds for a loan made to the company by the bank Interest earned on the company's account Correction (if any) to bank errors

Cash short and over account

Differences between cash on hand and amount of cash sales that result in salespersons making errors in giving change for customer or ringing up cash sales.

Where are compensating balances recorded?

Disclosed in notes to the financial statements

Recording Cash Short and Over accounts in the journal

If there is a cash shortage, the Cash Short and Over account is debited for the shortage. If there is a cash overage, the Cash Short and Over account is credited for the overage.

Employee fraud

Intentional act of deceiving an employer for personal gain.

Remittance advice

Invoices designed so a business's customers return a portion a portion of the invoice to identify how to apply the money order or cash received in the mail

Control environment

Overall attitude of management and employees about the importance of controls

Journalize bank debit memo for service charges:

Miscellaneous Expense (Debit +) Cash (Credit -)

Warning signs of internal control problems from the accounting system

Missing documentation or gaps in transaction numbers (could mean documents are being used for fraudulent transactions) An unusual increase in customer refunds (refunds my be phony). Differences between daily cash receipts and bank deposits (could mean receipts are being pocketed before being deposited). Sudden increase in slow payments (employee may be pocketing the payments). Backlog in recording transactions (possibly an attempt to delay detection of fraud).

Three factors influencing a company's control environment?

Organizational structure Personnel policies Management's philosophy and operating style

Control of cash payments should provide reasonable assurance that:

Payments are made for only authorized transactions Cash is used effectively and efficiently. For example, controls should ensure that all available purchase discounts are taken.

Instances where a bank makes debit entries (issues debit memos).

Payments made by EFT Service charges Customer checks returned for not sufficient funds Correction (if any) of bank erros

What are the five elements of internal control?

Risk assessment Control procedures Monitoring Information & Communication Management

Sarbanes-Oxley Act is also known as

Sarbanes-Oxley

Voucher system

Set of procedures for authorizing and recording liabilities and cash payments. I may be either manual or computerized.

Petty Cash Fund

Special cash fund that is used to pay for small amounts for items such as postage, office supplies, or minor repairs

Cash Equivalents

Temporary excess cash that is invested in highly liquid investments in order to earn interest. Cash equivalents are the mentioned investments.

Internal control

The procedures and processes used by a company to: safeguard its assets, process information accurately, ensure compliance with laws and regulations.

(T/F) A compensating balance is often required by the bank as part of a loan agreement or line of credit.

True

(T/F) Any item that is added to or deducted from a company's book balance in reconciliation needs to be recorded with a journal entry in the company's books.

True

(T/F) Banks usually maintain a record of all checking accounts transactions.

True

(T/F) Items related to a bank reconciliation will require a journal entry.

True

Bank reconciliation

an analysis of the items and amounts that result in the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger.

Cash received in the mail typically comes in the form of

checks and money orders

A line of credit is a _____ amount the ________ is willing to lend to a ______ upon request.

pre-approved; bank; customer

Control procedures

provide reasonable assurance that business goals will be achieved, including the prevention of fraud.

To protect cash from theft and misuse, a business must control cash from the time it is _______ until it is deposited in a _____.

received; bank

(T/F) The adjusted balance from bank and company sections do not necessarily need to be equal

False The adjusted balance from bank and company sections must be equal.

(T/F) The cash balance shown by a bank statement is usually the same as the company's cash balance

False The cash balance shown by a bank statement is usually different from the company's cash balance.

(T/F) The company's checking account balance in the bank records is an asset.

False The company's checking account balance in the bank records is a LIABILITY.

(T/F) Cash is the asset least likely to be stolen or used improperly in a business.

False cash is the asset most MOST likely to be stolen or used improperly in a business.

(T/F) It is usually not practical for a business to write checks to pay small amounts for such items as postage, office supplies, or minor repairs.

True

(T/F) Sarbanes-Oxley also requires companies and their independent accountants to report on the effectiveness of the company's internal controls.

True

(T/F) Whatever is reconciled on the company section will require journal entries to adjust the cash balance in the company's records to the reconciled balanced.

True

How many sections is a bank reconciliation usually divided into?

Two

Examples of cash equivalents

U.S. Treasury bills Notes issued by major corporations (referred to as commercial paper) Money market funds

Where are the reports on the effectiveness of the company's internal controls required to be filed?

With the company's annual 10-K report with the Securities and Exchange Commission.

Examples of cash being PAID by EFT systems

Withdrawal of cash from a bank account using an ATM machine Payment of wages or salaries (payroll check) by an employer directly to an employee's checking account Payment to a supplier or other vendor using EFT systems

Cash register is

an important control to protect cash received in over-the-counter sales

The adjusted cash balance determined in the bank reconciliation is reported on the ____ _____.

balance sheet

Cash includes

coins, currency (paper money), checks, and money orders Money on deposit with a bank or other financial institution that is available for withdrawals is also considered cash.

Because the bank statement is prepared from the bank's point of view, a ______ ______ entry on the bank statement indicates an increase (a _____) to the company's account.

credit memo; credit

A _____ _____ entry on the bank statement indicates a decrease (a _____) in the company's account

debit entry; debit

The three internal control objectives can be achieved by applying the ______ __ ______ _______.

elements of internal control

A serious concern of internal control is preventing __________ ______.

employee fraud

A major reason that businesses use bank accounts is for ____ _____.

internal control

For the purchase of goods, a ______ is supported by the supplier's ______, a _______ order, and a ______ report.

voucher; invoice; purchase; receiving

How to prepare a bank reconciliation Steps 1-4: Bank section

1. Enter the Cash balance according to bank from the ending cash balance according to the bank statement 2. Add deposits not recorded by the bank Identify deposits not recorded by the bank by comparing each deposit listed on the bank statement with unrecorded deposits appearing int eh preceding period's reconciliation and with the current period's deposits. 3. Deduct outstanding checks that have not been paid by the bank Identify outstanding checks by comparing paid checks with outstanding checks appearing on the preceding period's reconciliation and with recorded checks. Examples: Outstanding checks at the end of the period. 4. Determine the adjusted balance by adding Step 2 and deducting Step 3

What are the steps to creating and maintaining a petty cash fund?

1. Estimate the amount of payments needed from the fund during a period, such as a week or a month. 2. A check is written and cashed for this amount 3. The money obtained from cashing the check is then given to an employee., called the petty cash custodian, who disburses monies from the fund as needed. 4. The petty cash fund is normally replenished at periodic intervals, when it is depleted, or reaches a minimum amount. 5. When a petty cash fund is replenished, the accounts debited are determining by summarizing the petty cash receipts. A check is then written for this amount, payable to petty cash.

Objectives of Internal Controls

1. Safeguarded Assets 2. Accurate Information 3. Compliance with Laws and Regulations

What two sections are a bank reconciliation usually divided into?

1. The bank section begins with the cash balance according to the bank statement and ends with the adjusting balance. 2. The company section begins with the cash balance according to the company's records and ends with the adjusted balance.

How many elements of internal control are there?

5

How to prepare a bank reconciliation Step 5-9: Company Section

5. Enter the Cash balance according to company from the ending cash balance in the ledger. 6. Add credit memos that have not been recorded. Identify the bank credit memos that have not been recorded by comparing the bank statement credit memos to entries in the journal Examples: A not receivable and interest that the bank has collected for the company 7. Deduct debit memos that have not been recorded. Identify the bank debit memos that have not been recorded by comparing the bank statement debit memos to entries in the journal. Examples: Customers' not sufficient funds (NSF) checks, bank service charges 8. Determine the Adjusted balance by adding Step 6 and deducting Step 7. Verify that Adjusted Balances Are Equal 9. Verify that the adjusted balances determined in Steps 4 and 8 are equal. If the adjusted balances in Steps 4 and 8 are unequal, search for any bank or company errors. Add or deduct the effects of any errors and verify that the adjusted balances are equal.

Voucher

Any document that serves as a proof of authority to pay cash or issue and electronic funds transfer

Sarbanes-Oxley Act

Applies only to companies whose stock is traded on public exchanges Its purpose is to foster public confidence and trust in the financial reporting of companies.