Accounting Chapter 6

Cash Management

A common reason companies fail is inability to manage cash. Companies must plan both cash receipts and cash payments. Goals of cash management are to 1. Plan cash receipts to meet cash payments when due. 2. Keep a minimum level of cash necessary to operate. The treasurer is responsible for cash management. Effective cash management involves applying the following cash management strategies. Encourage collection of receivables. The quicker customers and others pay the company, the quicker it can use the money. Some companies offer discounts for quicker payments. *Delay payment of liabilities. The more delayed a company is in paying others, the more time it has to use the money. Companies regularly wait to pay bills until the last day allowed. *Keep only necessary assets. Acquiring expensive and rarely used assets can cause cash shortages. Some companies lease warehouses or rent equipment to avoid large up-front payments. *Plan expenditures. Companies must look at seasonal and business cycles to plan expenditures when money is available. *Invest excess cash. Excess cash earns no return and should be invested in productive assets like factories. *Excess cash from seasonal cycles can be placed in a short-term investment for interest.

Book Balance Adjustments: −Bank fees and NSF checks

A company sometimes deposits another party's check that is uncollectible. This check is called a nonsufficient funds (NSF) check. The bank initially increases the depositor's account for the check. When the check is uncollectible, the bank reduces the depositor's account for that check. The bank may charge the depositor a fee for processing an uncollectible check. Other bank charges include printing new checks and service fees.

4. Separate Recordkeeping from Custody of Assets

A person who controls or has access to an asset must not have access to 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.

Bank Balance Adjustments: ±Bank errors

Any errors made by the bank are accounted for in the reconciliation. To find errors, we (a) compare deposits on the bank statement with deposits in the accounting records and (b) compare canceled checks on the bank statement with checks recorded in the accounting records.

Book Balance Adjustments: ±Book errors

Any errors made by the depositor in the company books are accounted for in the reconciliation. To find errors, we use the same procedures described in the "Bank errors" section above.

3. Insure Assets and Bond Key Employees

Assets should be insured against losses, and employees handling lots of cash and easily transferable assets should be bonded. An employee is bonded when a company purchases an insurance policy, or a bond, against theft by that employee. Bonding discourages theft because bonded employees know the bonding company will pursue reported theft.

Liquidity

Availability of resources to meet short-term cash requirements.

Bank statement

Bank report on the depositor's beginning and ending cash balances, and a listing of its changes, for a period.

Book Balance Adjustments: +Interest earned and unrecorded cash receipts

Banks sometimes collect notes for depositors. Banks also receive electronic funds transfers to the depositor's account. When a bank collects an item, it is added to the depositor's account, less any service fee. The bank statement also includes any interest earned.

Canceled checks

Canceled checks are checks the bank has paid and deducted from the customer's account. We say such checks cleared the bank.

6. Apply Technological Controls

Cash registers, time clocks, and ID scanners are examples of devices that can improve internal control. A cash register with a locked-in tape or electronic file makes a record of each cash sale. A time clock records the exact hours worked by an employee. ID scanners limit access to authorized individuals.

Bank Balance Adjustments: +Deposits in transit

Deposits in transit are deposits made and recorded in the depositor's books but not yet listed on the bank statement. For example, companies can make deposits (in the night depository) after the bank is closed. If such a deposit occurred on a bank statement date, it would not appear on this period's statement. The bank would record such a deposit on the next business day, and it would appear on the next period's bank statement. Deposits mailed to the bank near the end of a period also can be in transit and not listed on the bank statement.

Check

Document signed by a depositor instructing the bank to pay a specified amount to a designated recipient.

Remittance advice

Explains the reason for payment

2. Maintain Adequate Records

Good recordkeeping helps protect assets and helps managers monitor company activities. When there are detailed records of equipment, for example, 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 used. Preprinted forms are also part of good internal control. When sales slips are properly designed, employees can record information efficiently with fewer errors. When sales slips are prenumbered, each slip is the responsibility of one salesperson, preventing the salesperson from stealing cash by making a sale and destroying the sales slip. Computerized point-of-sale systems achieve the same control results.

Cash

Includes currency, coins, and amounts on deposit in bank checking or savings accounts.

Signature card

Includes the signature of each person authorized to sign checks on the bank account.

Cash Over and Short

Income statement account used to record cash overages and cash shortages arising from errors in cash receipts or payments.

Internal controls

Internal controls or internal control system All policies and procedures used to protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies.

Sarbanes-Oxley Act (SOX)

Legislation that created the Public Company Accounting Oversight Board, regulates analyst conflicts, imposes corporate governance requirements, enhances accounting and control disclosures, impacts insider transactions and executive loans, establishes new types of criminal conduct, and expands penalties for violations of federal securities laws.

Deposit ticket

Lists items such as currency, coins, and checks deposited and their corresponding dollar amounts.

Bank Balance Adjustments: −Outstanding checks

Outstanding checks are checks written by the depositor, subtracted on the depositor's books, and sent to the payees but not yet turned in for payment at the bank statement date.

Principles of internal control

Principles prescribing management to establish responsibility, maintain records, insure assets, separate recordkeeping from custody of assets, divide responsibility for related transactions, apply technological controls, and perform reviews. 1. Establish responsibilities. 2. Maintain adequate records. 3. Insure assets and bond key employees. 4. Separate recordkeeping from custody of assets. 5. Divide responsibility for related transactions. 6. Apply technological controls. 7. Perform regular and independent reviews.

7. Perform Regular and Independent Reviews

Regular reviews of internal controls help ensure that procedures are followed. These reviews are preferably done by auditors not directly involved in the activities. Auditors evaluate the efficiency and effectiveness of internal controls. Many companies pay for audits by independent auditors. These auditors test the company's financial records and evaluate the effectiveness of internal controls.

Bank reconciliation

Report that explains the difference between the book (company) balance of cash and the cash balance reported on the bank statement, for purposes of computing the adjusted cash balance. The balance of a checking account on the bank statement rarely equals the depositor's book balance (from its records). This is due to information that one party has that the other does not. We must therefore verify the accuracy of both the depositor's records and the bank's records. To do this, we prepare a bank reconciliation to explain differences between the checking account balance in the depositor's records and the balance on the bank statement. The person preparing the bank reconciliation should not be responsible for processing cash receipts, managing checks, or maintaining cash records. The following explains bank and book adjustments.

Liquid assets

Resources such as cash that are easily converted into other assets or used to pay for goods, services, or liabilities.

1. Establish Responsibilities

Responsibility for a task should be clearly established and assigned to one person. When a problem occurs in a company where responsibility is not established, determining who is at fault is difficult. For example, if two salesclerks share the same cash register and cash is missing, neither clerk can be held accountable. To prevent this problem, a company can use separate cash drawers for each clerk.

5. Divide Responsibility for Related Transactions

Responsibility for a transaction should be divided between two or more individuals or departments. This ensures the work of one person acts as a check on the other to prevent fraud and errors. This principle, called separation of duties, does not mean duplication of work. For example, when a company orders inventory, the task should be split among several employees. One employee submits a request to purchase inventory, a second employee approves the request, a third employee makes the payment, and a fourth employee records the transaction.

Cash equivalents

Short-term investment assets that are readily convertible to a known cash amount or sufficiently close to their maturity date (usually within 90 days) so that market value is not sensitive to interest rate changes.

Petty cash

Small amount of cash in a fund to pay minor expenses; accounted for using an imprest system. *It is established to pay for small payments like low-cost supplies and shipping fees, etc. *It is an asset reported on the balance sheet.

Electronic funds transfer (EFT)

Use of electronic communication to transfer cash from one party to another.