CH 7 Internal control and cash

Joseph Lane, who receives cash from customers, conspires with Terry Baxter, who posts the collections to customer Accounts Receivable, to falsify records so they can take the cash for themselves. This is an example of:

Collusion

Bank reconciliation:

Compares and explains the difference between cash on the company's books and the bank's records.

5 Components of Internal Control

Control procedures Risk assessment Information system Monitoring of controls Environment

Cash ratio:

Helps determine a company's ability to meet its short-term obligations.

Cash equivalents

Highly liquid investments that can be converted into cash in three months or less.

Account number:

Identifies the account upon which the payment is drawn.

Routing number:

Identifies the bank upon which the payment is drawn.

Payee:

Individual or business to whom the check is paid.

Internal controls

Plan and measures designed to: 1. Safeguard assets 2. encourage employees to follow company policies 3. Promote operational efficiency 4. Ensure accurate, reliable accounting records

What does a receipt of cash over the counter in a store involve?

Point-of-sale terminal (cash register).

The Sarbanes-Oxley Act

Prohibits auditors of public companies from performing certain consulting services for those companies.

Committee of Sponsoring Organizations (COSO)

Provides thought leadership related to enterprise risk management, internal control, and fraud deterrence.

What is the 1st SOX provision?

Public companies must issue an internal control report. An auditor must evaluate internal controls.

Encription

Rearranging plain text messages by a mathematical process - the main way of achieving security in e-commerce.

The document that accompanies a payment to explain the reason for the payment is a:

Remittance advice

Sarbanes-Oxley Act (SOX)

Requires companies to review internal control and take responsibility for the accuracy and completeness of their financial reports.

What are the primary objectives that internal control is designed to accomplish?

Safeguard assets. Promote operational efficiency. Ensure accurate, reliable records.

Public company

Sells its stock to the general public. Are required by the U.S. Congress to maintain a system of internal controls.

Recording credit card sales net method:

Sells merchandise inventory to a customer for $3,000 on Aug. 15. the customer pays with a third-party credit card. The card processor assesses a 4% fee and deposits the net amount.

Recording credit card sales gross method:

Sold to a customer for $3,000 on Aug. 15. The customer pays with a third-party credit card. The processor uses the gross method.

What is the 4th SOX provision?

Stiff penalties await violators - 25 years in prison for securities fraud and 20 years for an executive making false sword statements.

What is the 2nd SOX provision?

The Public Company Accounting Oversight Board (PCAOB), oversees the work of auditors of public companies.

Canceled checks

The physical or scanned copies of the maker's cashed (paid) checks.

What is the 2nd step included for a check received by mail?

The treasurer has the cashier deposit the checks in the bank. The cashier receives a deposit receipt.

What are internal controls judged upon?

Their cost versus benefit. The stricter the internal controls, the higher the cost.

Why did congress pass the SOX act?

To address public concerns about various accounting scandals.

What is the key responsibility of a business manager?

To control operations.

Collusion

Two or more people working together to circumvent internal controls and defraud a company.

Petty cash

Used as an in-office source of cash for small immediate purchases.

Signature card:

a card that shows each authorized person's signature for a bank account.

Check

a document that instructs a bank to pay the designated person or business a specified amount of money.

Electronic Data Interchange (EDI)

a streamlined process that bypasses paper documents altogether. Computers of customers communicate directly with the computers of suppliers to automate routine business transactions.

Cash ratio equation:

cash ratio = (cash + cash equivalents)/ total current liabilities

Lock-box system

customers send their checks to a post office box that belongs to a bank. A bank employee empties the box daily and records the deposits into the company's bank account.

Bank statement

reports the activity in a customer's account.

Petty cash ticket

serves as authorization for payment.

Outstanding checks decrease...

the bank side of the reconciliation.

Audits

~Internal audits are performed by employees of the company. ~External audits are performed by independent auditors (not employees).

RT Company's Cash account shows an ending balance of $1,850. The bank statement shows a $52 service charge and an NSF check for $280. Other records indicate that a $240 deposit is in transit, and outstanding checks total $535. What is RT's adjusted cash balance?

$1,850 Book balance −$52 Service charge −$280 NSF check = $1,518 adjusted book balance

Recording for a processor collecting a 4% fee (gross method).

Collecting a 4% fee at the end of the month on merchandise sold to a customer for $3,000

The three ways a payment by check provides internal controls:

1. A check provides a record of the payment. 2. A check requires a signature by an authorized official. 3. Supporting evidence is reviewed prior to signing the check.

Book balance - ALWAYS

1. Add bank collections, interest revenue, and EFT receipts. 2. Subtract service charges, NSF checks, and EFT payments. 3. Add or subtract corrections of book errors.

Bank balance - ALWAYS

1. Add deposit in transit. 2. Subtract outstanding checks. 3. Add or subtract corrections of bank errors.

The book side of the reconciliation includes:

1. Credit memorandums (bank collections) are cash receipts the bank has received and recorded but the company has not recorded on its books. 2. Service charge, often referred to as a debit memorandum. 3. Interest revenue on a checking account. 4. Non-sufficient funds (NSF) checks are received from customers for paying of services rendered or merchandise sold that have turned out to be worthless. 5. Book errors that either incorrectly increase or decrease the cash balance in the company's general ledger.

The bank side of the reconciliation includes:

1. Deposits in transit that are recorded by the company but not yet by its bank. 2. Outstanding checks that are issued by the company and recorded on its books but not yet paid by its bank. 3. Bank errors that either incorrectly increase or decrease the bank balance.

The controller or the treasurer should examine the payment packet to prove:

1. It received the goods ordered. 2. It is paying only for the goods received and authorized. 3. It is paying the correct amount.

Characteristics of EFT's:

1. Many bills are paid with EFT. 2. EFT is less expensive than mailing a check. 3. Debit card transactions and direct deposits are EFTs.

Ways a bank account can be used as a control device:

1. Signature card 2. Deposit ticket 3. Check

Deposit ticket:

A bank form that is completed by the customer and shows the amount of each deposit.

Firewall

A device that blocks nonmembers out of a network.

Evaluated Receipts Settlement (ERS)

A procedure that compresses the payment approval process into a single step by comparing the receiving report to the purchase order.

Internal control report

A report by management describing its responsibility for and the adequacy of internal controls over financial reporting.

Electronic funds transfer (EFT)

A system that transfers cash by electronic communication rather than by paper documents.

Imprest system

A way to account for petty cash by maintaining a constant balance in the petty cash account. At any time, cash plus petty cash tickets must total the amount allocated to the petty cash fund.

Separating the custody of assets from accounting

Accountants must not handle cash and cashiers must not handle accounting.

What is the 3rd SOX provision?

Accounting firms are not allowed to audit a public company and also certain consulting services for the same client.

Separating operations from accounting

Accounting should be completely different from the operating departments, such as sales and production.

What is the 1st step included for a check received by mail?

All incoming mail is opened my a mailroom employee. The mailroom then sends all customer checks to the treasurer and all remittance advices to the accounting department.

Remittance advice

An optional attachment to a check that tells the business the reason for the payment.

Smith automotive parts had the following select financial data as of December 31, 2018 Cash $15,000 Cash Equivalents $3,000 Total current assets 40,000 Total Current liabilities 30,000 What is Smith's cash ratio?

Cash ratio = (Cash + Cash equivalents) / Total current liabilities = ($15,000 + 3,000) / $30,000 = 0.60

The petty cash fund had an initial balance of $125. It currently has $15 and petty cash tickets totaling $85 for office supplies. The entry to replenish the fund would contain a:

Debit to Cash Short & Over for $25.

Thompson Corporation has a sale in the amount of $10,000. The customer pays by credit card. The credit card processor charges 3% and uses the gross method. The journal entry to record the transaction on the date of sale would include a

Debit to Cash for $10,000

Timing differences:

Differences between cash on the company's books and the bank's records because of a time lag in recording transactions.

Seperation of Duties

Dividing responsibility between two or more people to limit fraud and promote accuracy of accounting records

Internal auditor

Employee from the business that ensures that employees are following policies, the business meets all legal requirements, and operations are running smoothly.

A firewall

Limits access into a local computer network.

What are some uses for petty cash?

Office donuts. Cleaning supplies. Sympathy flowers. Entertaining clients. Public transportation. Tips for service providers.

External auditor

Outside accountant, evaluates the controls to ensure that the financial statements are presented fairly in accordance with the GAAP.

Maker:

Party who issues the check.

Replenishing the Petty Cash Fund To replenish the petty cash fund, the company writes a check, payable to Petty Cash, for $82 to bring the cash on hand up to $200.

~When cash is missing, the Cash Short & Over account is used to record the unaccounted for amount. ~The Petty Cash account is used in a journal entry only when the fund is started or when its amount is increased or decreased. ~When replenishing the fund, the company debits either the associated expense incurred or the asset purchased with the funds.