CHAPTER 8 Internal Control and Cash

Objective 1: Define internal control

A. Internal control is the organizational plan and all the related measures that an entity adopts to 1. 2. 3. 4. !. '. Safeguard assets, Encourage employees to follow company policy, Promote operational efficiency, and Ensure accurate, relia le accounting records.

"anagement has primary responsi ility for the financial statements. E#hi it $%1 diagrams the shield that internal controls pro&ide for an organization. (he Sarbanes-Oxley Act re)uires pu lic companies to maintain a system of internal control and issue an internal control report.

Objective 2: Describe good internal control procedures

A. Competent, rel able, and eth cal personnel*Attract top%)uality employees, train them well, and super&ise them. !. Ass !nment o" respons b l t es*Each employee is assigned certain responsi ilities '. Separat on o" d#t es$+i&iding responsi ilities for transactions limits the chances for fraud and promotes accuracy of the accounting records. Separation of duties may e di&ided into two parts, 1. 2. Separat on o" operat ons "rom acco#nt n!*(he entire accounting function should e completely separate from operating departments. Separat on o" c#stody o" assets "rom acco#nt n!*Accountants should not ha&e access to assets, and those that ha&e access to assets -such as the cashier. should not ha&e access to the accounting records.

+. Internal and external a#d ts*/nternal and e#ternal auditors identify wea0nesses in internal control.

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1. Internal a#d tors are employees. 2. External a#d tors are employed y accounting firms that are hired y a usiness to e#amine the financial statements. 3. An a#d t is an e#amination of the company1s system of internal control, the accounting system and the financial statements.

E. %oc#ments *!usiness documents should e prenum ered to call attention to a missing document. 2. Electron c de& ces *Accounting systems are relying on the computer to perform asic functions3 and therefore, programmers ecome the focus for internal controls. !usinesses use other electronic de&ices to help protect assets and control operations, such as in&entory sensors. 4. Other controls$!usinesses often use controls to protect assets such as " reproo" &a#lts 'to protect documents., b#r!lar alarms -to protect property., po nt-o"-sale term nals -to protect cash.. 1. ( del ty bonds insure the company against theft y an employee. 2. )andatory &acat ons and *ob rotat on enhances morale and helps 0eep employees honest. 5. e-Commerce creates some new ris0s such as protection confidential information. 1. Some pitfalls include, a. . Stolen cred t-card num ers that can e used y unauthorized people. Comp#ter & r#ses -that reproduce themsel&es. and Tro*an horses -that do not reproduce. are &icious programs that can destroy or alter data and6or infect files. 5ac0ers can mpersonate legitimate usinesses on the we and solicit confidential data from unsuspecting people.

c. 2.

(wo standard techni)ues are used to secure e%commerce data. a. Encrypt on rearranges te#t messages y some mathematical process so that the message cannot e read y anyone who does not 0now the process. ( re+alls limit access to a local networ0 y loc0ing intruders.

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(here are some l m tat ons of internal control procedures. 1. 2. /nternal control systems can e thwarted y coll#s on etween two or more people wor0ing together to defraud the firm. An o&erly comple# internal control system may e inefficient.

7.

(he ban, acco#nt is a control de&ice ecause an0s ha&e esta lished practices for safeguarding cash. 1. !an0s pro&ide depositors with detailed records of cash transactions. (hese records include, a. . c. A s !nat#re card, to ensure that only an authorized person has access to the account. %epos t t c,ets, to maintain a record of amounts deposited. Chec,s, to maintain a record of monies withdrawn from the an0. 'hec0s include the date of the chec0, the name of the payee -the party to whom the chec0 is paid., and the signature of the maker -the party that signs the chec0.. -E#hi it $%3 shows a chec0 drawn on a an0 with a remittance advice, an optional attachment that tells the payee the reason for the payment.. -an, statements, to show the monthly acti&ity in an account. -E#hi it $% 4 is an e#ample of a an0 statement.. 1. 2. Canceled chec,s, chec0s that ha&e cleared the an0, are usually included in the an0 statement. Electron c "#nds trans"ers 'E(T. are paperless transactions that transfer cash to or from a an0 account. (he an0 statement lists E2( transactions.

d.

2.

(he ban, reconc l at on e#plains the differences etween the an0 statement alance and the general ledger alance of cash. -E#hi it $%8 illustrates the 'ash account in the general ledger.. a. Items recorded by the company are listed elow. Each of these are ad9ustments to the an0 statement alance. 1. %epos ts n trans t$"oney that has een deposited y the company ut not yet recorded y the an0.

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2. O#tstand n! chec,s$'hec0s that ha&e een issued y the company ut not yet paid y the an0. . Items recorded by the ban, ut not yet recorded y the company are listed elow. Each of these are ad9ustments to the book balance of cash. 1. -an, collect ons*"oney collected y the an0 on ehalf of its customers. Some companies use a loc,-box system where customers ma0e payments directly to the an0 to reduce theft.

2. E(T*(he an0 statement may include E2(1s that the company has not yet recorded. 3. Ser& ce char!es*2ees that the an0 charges for certain ser&ices and are not 0nown y the depositor until the an0 statement is recei&ed. 4. Interest re&en#e earned on the chec, n! acco#nt$(he amount of interest earned may not e 0nown until the an0 statement is recei&ed. 8. /ons#"" c ent "#nds chec,s '/S(.*:S2 chec0s recei&ed from customers and returned to the payee3 they are sometimes included in the an0 statement. ;. Chec, pr nt n! char!e$A fee that the an0 charges for printing chec0s. c. Errors may e made y either the an0 or the company.

Objective 3: Prepare a bank reconciliation and the related journal entries

A. (he following ad9ustments are made to the balance per ban,0 -E#hi it $%; is an e#ample of a an0 reconciliation.. -alance per ban, Add2 %epos ts n trans t 3ess2 O#tstand n! chec,s Ad*#sted ban, balance 11 11 11 '11. 11

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(he following ad9ustments are made to the balance per boo,s0 -alance per boo,s Add2 E(T rece pt -an, collect on Interest re&en#e 3ess2Ser& ce char!e /S( E(T payment Other ban, char!es Ad*#sted boo, balance 11 11 11 11 11 11 11 11 11 11 11

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Errors that are made y the an0 are ad9ustments to the alance per an0. Errors that are made on the oo0s are ad9ustments to the alance per oo0s. Errors may e either added or su tracted. Ad*#st n! *o#rnal entr es are re)uired for e&ery ad9ustment to the oo01s alance and are illustrated elow, 1. -an, collect on2 'ash :otes =ecei&a le /nterest =e&enue 2. Interest re&en#e2 'ash /nterest =e&enue 3. Ser& ce char!e2 "iscellaneous E#pense 'ash 4. /S( chec,2 Account =ecei&a le 'ash 8. << << << << << << << << <<

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E(T$an E2( can e used for &arious transactions. (he account, other than 'ash, that is in&ol&ed will depend on the situation. Rece pt 'ash >arious Accounts << << Payment >arious Accounts 'ash << <<

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An ad9usting entry for errors is made only when the error affects the oo0 side of the reconciliation.

O+ners and mana!ers of small usinesses do not ha&e the lu#ury of separation of duties. (he an0 reconciliation can e used to help control cash.

Objective 4: Apply internal controls to cash receipts

A. Internal control o&er cash rece pts ensures that all cash is deposited and that the accounting records are correct. E#hi it $%$ illustrates a cash receipt o&er the counter in a department store. Point%of%sale terminals -cash registers. can pro&ide control for cash rece pts o&er the co#nter0 1. A receipt should e issued for each sale recorded y the register. 2. (he cash drawer should open only when the cler0 enters an amount so that all transactions will e recorded on the register tape. 3. (he cashier should deposit the cash, with the register tape eing sent to the accounting department. '. +. 1. (he remittance ad&ices are forwarded to the accounting department and the chec0s are forwarded to the treasurer. 2. 3. (he controller then compares the an0 deposit amount from the treasurer, and the de it to 'ash from the accounting department. "any companies use a loc0% o# system to separate cash duties and esta lish control o&er receipts. 'ustomers send their chec0s directly to the an0 and therefore, company personnel ne&er handle incoming cash. A mailroom employee who compares the amount of the chec0 with the remittance ad&ice should handle cash rece &ed n the ma l. See E#hi it $%?.

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Objective : Apply internal controls to cash pay!ents

A. !. '. Internal control o&er cash payments is at least as important as controlling cash receipts. Chec,s are an important control ecause a chec0 acts as a source document and re)uires an authorized signature. (he p#rchas n! and payment process, illustrated in E#hi it $%1@, re)uires the following steps. 1. 2. 3. 4. (he company sends a p#rchase order to the supplier. (he supplier fills the order, ships the goods, and mails an n&o ce to the purchaser. Ahen the goods arri&e, a rece & n! report is prepared. (he accounting department com ines all the documents, chec0s them for accuracy, and forwards this payment pac,et -E#hi it $%1@. to the appropriate officer for appro&al and payment. !efore payment, the documents should e compared to ensure that the usiness pays cash only for the goods ordered and recei&ed.

8. +.

A &o#cher is a document authorizing a cash dis ursement -E#hi it $%12.. 1. (he payee, due date, terms, description, and in&oice amount are all found on the &oucher, as well as places for recording the account de ited, date paid, and chec0 num er. (he &oucher is prepared y the accounting department after all the documents ha&e een compared. (he &oucher pro&ides e&idence that supports a cash dis ursement.

2.

E.

Esta lishing a petty cash "#nd allows control o&er payments too small to pay y chec0. 1. (he following controls should e esta lished o&er the petty cash fund. a. . c. +esignate an employee to administer the fund. Beep a specific amount on hand -an mprest system.. Support all fund payments with a petty cash tic0et.

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d. 2.

=eplenish the fund through normal cash payment procedures.

(he entry to esta lish the fund is, Petty 'ash << 'ash in !an0 <<

3. 4.

A petty cash t c,et is prepared li0e the one illustrated in E#hi it $%13 whene&er a dis ursement is made from petty cash. :o 9ournal entry is made at this time. Ahen the fund is replenished, all petty cash payments are recorded in a summary entry such as the one illustrated elow, Cffice Supplies Postage E#pense << +eli&ery E#pense << 'ash in !an0 << <<

2.

'ash and 'ash E)ui&alents is the first current asset listed on the alance sheet of most companies. 1. Cash e4# &alents are li)uid assets such as time deposits and certificates of deposit. 2. =estricted cash, such as compensat n! balances, should not e reported as a current asset if the company does not e#pect to spend the cash within a year or the operating cycle, if longer than a year.

Objective ": #ake business ethical judg!ents

A. !. Darge companies ha&e a code o" eth cs designed to encourage employees to act ethically. Accountants who are mem ers of the A/'PA must also a ide y the A$%PA %ode of Professional &thics. Accountants who are mem ers of the /"A must also a ide y the 'tandards of &thical %onduct for #anage!ent Accountants.

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