Chapter 8: Internal Control and Cash

Bank Accounts

A major reason businesses use these is for internal control. Control advantages: -reduce amount of cash on hand. -provide an independent recording of cash transactions (reconciling the balance of the cash account in company's records worth the cash balance according to bank is important control). -facilitates the transfer of funds by EFT systems.

Compensating balance

A requirement by some banks requiring depositors to maintain minimum cash balances in their bank accounts. -often required by bank as part of a loan agreement or line of credit (pre approved amount the bank is willing to lend to a customer upon request).

Voucher system

A set of procedures for authorizing and recording liabilities and cash payments. It can be either manual or computerized. Voucher: any document that serves as a proof of authority to pay cash or issue an EFT. -for the purchase of goods, a voucher is supported by the suppliers invoice, a purchase order, and a receiving report.

Journal entries after Bank Reconciliation

After the steps have been completed for the Bank Reconciliation, the companies records need to be updated. -the Bank section does not require any updates (although bank should be informed of any errors). -companies records do require updates for the company section. PowerNetworking examples attached

Risk assessment

All businesses face risks such as changes in customer requirements, competitive threats, regulatory changes, and changes in economic factors. -management should identify the risks, analyze their significance, assess their likelihood of occurring, and take the necessary actions to minimize them.

cash short and over account

An account which has recorded errors in cash sales or errors in making change causing the amount of actual cash on hand to differ from the beginning amount of cash plus the cash sales for the day. Example: cash register total for cash sales for May 3 totaled $35,690. The cash receipts from cash sales totaled $35,668. -recorded as debit to Cash and Cash Short and Over accounts. -credit to sales. Recording this account in the books: In Journal: -if there is a cash shortage, this account is debited for shortage. -if there is a cash overage, this account is credited for the overage. In income statement: -at end of accounting period, debit balance of this account is included in "miscellaneous expenses". -alternatively, credit balance is included in the "Other Revenue" section.

bank reconciliation

An analysis of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger. -the adjusted cash balance determined in the bank reconciliation is reported on the balance sheet. Usually divided into 2 sections: 1. Bank Section: begins with the cash balance according to the bank statement and ends with the adjusted balance. 2. Company section: begins with the cash balance according to the company's records and ends with the adjusted balance. (The adjusted balance from bank and company sections must be equal).

Cash received from cash sales

An important control to protect cash received in over-the-counter sales is a cash register. -salesperson may make errors in making change or ringing up cash sales, thus the amount of cash on hand may differ from the amount of cash sales (record in cash short and over account)

Bank statement

Banks usually maintain a record of all checking account transactions. A summary of all transactions is mailed, usually monthly, to the company (depositor) or made available online. Shows: beginning balance, additions, deductions, and ending balance. Banks POV: -the company's checking account balance is a liability in the banks records, thus the company's account has a credit balance. -credit memo entry on the bank statement will increase (credit) the companies account. -debit memo entry on bank statement will decrease (debit) the company's account. Banks makes credit entries (Credit memos) for following: -deposits made by EFT. -collections of notes receivable for the company. -proceeds for a loan made to the company by the bank. -interest earned in the company's account. -corrections of bank errors. Banks makes debit entries (debit memos) for following: -payments made by EFT. -services charges. -customer checks returned for not sufficient funds (NSF checks). -corrections of bank errors.

Cash paid by EFT

Cash can also be paid by EFT systems. Attached image includes examples.

Special purpose funds

Cash funds often used by companies for special needs, such as payroll or travel expenses. -established and controlled in similar manner to petty cash fund.

Reporting Cash in Financial Statements

Cash is normally listed in the Current Assets Section of the Balance Sheet (usually presented as 1 single cash amount by combining bank and cash fund accounts). Cash Equivalents: -a company may have temporary excess in cash, which is normally invested in cash equivalents. -companies that invest in cash equivalents usually report Cash and Cash Equivalents as one amount on the balance sheet (AS SEEN IN ATTACHMENT). Compensating Balance: -banks may require depositors to maintain compensating balance which is disclosed in notes to the financial statements.

Cash received in the mail

Cash is received in the mail when customers pay their bills. This cash is usually in the form of checks and money orders. -Most companies design their invoices so that customers return a portion of the invoice, called a remittance advice, with their payment. This document may be used to control cash received in the mail (allows comparison of amount initially recorded and amount received).

Cash received by EFT

Cash may be received from customers through electronic funds transfer (EFT). For example, customers may authorize automatic EFTs from their checking accounts to pay monthly bills. Companies encourage using EFT for following reasons: -cost less than receiving cash payments via mail. -enhance internal controls over cash (since ash is received directly by bank without employee handling cash). -reduce late payments from customers and speed up the processing of cash receipts.

Credit or debit memo entry types

Credit or debit memo entry types that are found on a bank statement: EC: error correction to correct bank errors. NSF: not sufficient funds check. -customer checks that were initially deposited but were not paid by the customers bank due to insufficient funds so the bank issues a debit memo. SC: service charge. -debit memo from bank on bank statement. ACH: automated clearing house entry for electronic funds transfer. -can be either debit or credit. MS: miscellaneous items (ex. Collection of notes receivable or receipt loan by the company from the bank).

Cash

Includes coins, currency (paper money), checks, and money orders. -money on deposit with a bank or other financial institute that is available for withdrawal is also considered cash. -asset most likely to be stolen or used improperly in a business

Information and Communication

Information about the control environment, risk assessment, control procedures, and monitoring is used by management for guiding operations and ensuring compliance with reporting, legal, and regulatory requirements. -management also uses external information to assess events and conditions that impact decision making and external reporting. Essential element of internal control.

Monitoring

Monitoring the internal control system is used to locate weaknesses and improve controls. -often includes observing employee behavior and the accounting system for indicators of control problems. Warning signs are in attached image.

Sabarnes-Oxley Act

Often referred to Sabarnes-Oxley, this act applies only to companies whos stock is traded in public exchanges (Publicly held companies). Purpose: to foster public confidence and trust in the financial reporting of companies. -designed to prevent fraud, theft, and financial scandals. Requires companies to: -maintain effective internal controls over the recording of transactions and the preparing of financial statements (internal controls deter fraud and prevent misleading). -report effectiveness of the companies internal controls (required to be filed with companies annual 10-K report with the Securities and Exchange Commission).

ratio of cash to monthly cash expenses

Ratio that helps assess how long a company can continue to operate without additional financing or generating positive cash flows from operations. -helpful for start up companies or companies in distress (both of which generally report losses and negative cash flow from operations). Computed: ____ __ ___ __ ___ ___ ______ = cash as of year end ➗ monthly cash expenses -the cash, including any cash equivalents, is taken from the balance sheet at year end. -The monthly cash expenses, cash burn, are estimated from operating activities section of statement of cash flows as follows: Monthly Cash Expenses = negative cash flow from operations ➗ 12

Cash equivalents

Short-term, highly liquid investments that can be readily converted to a specific amount of cash and which are relatively insensitive to interest rate changes. Examples: -US treasury bills. -Notes issued by major corporations (commercial paper). -money market funds.

Preparing a Bank Reconciliation: Bank Section

Step 1: Enter the Cash Balance according to the bank from the ending cash balance in the bank statement. Step 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 in the preceding periods reconciliation and with the current periods deposits (ex. Deposits in transit at the end of the period). Step 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 periods reconciliation and with recorded check (ex. Outstanding checks at end of period). Step 4: Determine the Adjusted Balance by adding step 2 and deducting step 3. END OF BANK SECTION, now move onto Company Section in next slide.

Preparing a Bank Reconciliation: Company Section

Step 5: Enter the Cash Balance according to the company from the ending cash balance in the ledger. Step 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 (ex. Notes receivable and interest that the bank collected). Step 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 (ex. Customer NSF checks and bank service charges). Step 8: Determine the Adjusted Balance by adding step 6 and deducting step 7.

Preparing a Bank Reconciliation: Verify Adjusted Balances are equal

Step 9: Verify that the adjusted balance is determined, and steps 4 and 8 or equal. -if the adjusted balances in steps 4 and 8 or unequal, search for any bank or company errors. -add or deduct the effects of any errors and verify that the adjusted balances are equal.

Elements of internal control

The 3 objectives (listed in previous slide) can be achieved by applying following 5 elements of internal control Elements: 1. Control environment. 2. Risk assessment. 3. Control procedures. 4. Monitoring. 5. Information and communication.

Bank statement as control over cash

The bank statement is a company's primary control that company uses over cash. -company uses bank statement by comparing the company's recording of the cash transactions to those recorded by the bank. The cash balance shown in the bank statement is usually different from the company's cash balance. Differences may arise because: -delay by either company or bank in recording transactions. -bank has debited or credited the company's account for transactions that company will not know about until the bank statement is received. -errors, such as incorrect posting, made by either bank or company.

Control of cash payments

The 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. Includes: -voucher system -cash paid by EFT

Employee fraud

The intentional act of deceiving an employer for personal gain. -serious concern of internal control is preventing this.

Control environment

The overall attitude of management and employees about the importance of controls. The 3 following factors influence a companies _____ ______: 1. Managements philosophy and operating style (relates to whether management emphasizes the importance of internal control). 2. The company's organizational structure (framework for planning and controlling operations). 3. The company's personnel policies (involve hiring, training, evaluation, compensation, and promotion of employees).

Internal control

The procedures and processes used by companies to: -safeguard its assets. -process information accurately. -ensure compliance with laws and regulations. Limitations: can only provide reasonable assurance for safeguarding assets, processing accurate information, and complying with laws and regulations due to following factors. -human elements of controls. -cost-benefit considerations.

Control of cash receipts

To protect cash from theft and misuse, a business must control cash from the time it is received until it is deposited in a bank. Business normally receive cash from 2 main sources: 1. Customers purchasing products/services. 2. Customers making payments on account. Includes: -cash received from cash sales -cash received in the mail -cash received by EFT

Petty Cash Fund

a cash fund used to pay relatively small amounts, used instead of writing a check for each small amount paid for things such as postage, office supplies, etc. -ASSET acct with Dr balance. -only time it is credited is when the fund is eliminated or decreased. -only time it is debited is when the fund is established or increased. Establishing fund: estimate the amount of payments needed from the fund during a period (replenished periodically, when depleted, or when reaches a minimum amount). journal entry to establish fund: -Dr to Petty Cash -Cr to Cash. Replenishing: replenish periodically or when you reach minimum balance. Journal entry: -Dr accounts summarized by petty cash receipts -Cr Cash for amount needed to replenish. -if there is more left in the fund then beginning balance less receipts then Cr Cash Over and Short account. -if there is less on hand then beginning balance less receipts then Dr Cash Over and Short. Example: the Petty Cash account was established at $500. The ending balance is $30. The Petty Cash Receipts add up to $467. -the amount to replenish petty cash fund does not equal the total of petty cash receipts. -difference is debited to Cash Short and Over account. Attached is journal entry to replenish the petty cash fund.

Securities and Exchange Commission (SEC)

monitors the stock market and enforces laws regulating the sale of stocks and bonds.

Control procedures

provide reasonable assurance that business goals will be achieved, including the prevention of fraud. Include the following: -competent personnel, rotating duties, and mandatory vacations: companies require competent employees that are able to perform the duties required. -separating responsibilities for related operations: responsibility for related operations should be divided among 2+ people (decreasing possibility of errors or fraud). -separating operations, custody of assets, and accounting: these should be separated, in this way the accounting records serve as an independent check on the operating managers and employees who have custody of assets. -proofs and security measures: used to safeguard assets and ensure reliable accounting data.