UNIT 3: INTERNAL CONTROL OVER CASH

Contents
3.0 Aims and Objectives
3.1 Introduction
3.2 Nature of Cash
3.3 Internal Control Objectives for Cash Receipts
3.4 Internal Control Over Cash Disbursements
3.5 Segregation of Duties
3.6 Limitation of Internal Control Over Cash
3.7 Summary
3.8 Glossary
3.9 Answers to Check Your Progress Exercise
3.10 Model Examination Questions

3.0. AIMS AND OBJECTIVE

After studying this unit, you should be able to:

 describe the nature of cash
 explain the nature of the cash receipts and disbursement cycles.
 identify and explain the fundamental internal controls over cash, receipts, and
disbursements
 describe the Auditors objectives for the audit of cash.

3.1 INTRODUCTION

This unit tries to describe the nature of cash, in general; the nature of cash receipts and
disbursements separately; and tries to Identify and explain the fundamental internal controls
over cash receipts and disbursements. Moreover, it tries to describe the auditor’s objectives
for the audit of cash –finally, some of the weakness of internal control over cash is presented.
This unit helps the students to understand and describe the internal control over cash receipts
and disbursements in relation to the important documents and records used to control cash
transactions.

18
3.2 NATURE OF CASH

The item cash reported in the financial statements represents currency on hand and cash on
deposit in Bank accounts, including certificate of deposit, time deposits, and saving accounts.
Certain “cash equivalents” are combined with cash for presentation in the financial
statements. FASB statement of financial accounting standards No 95, statement of cash
flow”, defines cash equivalents as short – term, highly liquid investments that are readily
convertible to cash or so near to their maturity that there is little risk of change in their value.
examples of such type include, Treasury bills, commercial paper and money market funds.

Cash is affected in one or another, by all of the entity’s transaction cycles. Although the main
source of cash is revenue, other sources of cash include (1) the sale of property, plant, and
equipment and (2) the proceeds from issuing large – term debt or capital stock - the main
source of disbursements are the purchasing and payroll.

(i) Types of Bank accounts – the entity’s management must be concerned with the
control and safekeeping of cash. The use of different types of bank accounts keeps
in controlling the entity’s cash. The following types of Bank accounts all usually
used.
(ii) General cash account – It is the principle cash account for most entity’s the major
source of cash receipts for this account is the Revenue cycle, and the major sources
of cash disbursements are the purchasing and payroll cycles.
- Impress cash account contains a stipulated amount of money, and the account
is used for limited purposes. This account is usually used for disbursing of payroll
checks and the account contains a minimum balance.
- Branch accounts-companies that operate with multiple branches located in
multiply Locations may maintain separate accounts at local banks. This provides each
branch with ability to pay local expenses. The Branch submits periodic cash reports to
head quarters, and the branch account receives check or transfer from general cash
account.

19
3.3 INTERNAL CONTROL OBJECTIVES FOR CASH RECEIPTS TRANSACTIONS

There are seven detailed internal control over cash objectives that internal control over cash
receipts transactions must meet to prevent errors in journals and ledgers, as well as to prevent
International misstatements (frauds) the internal control over cash receipts must be sufficient
to provide reasonable assurance that.
i) Recorded transactions are valid (validity)
ii) Transactions are properly authorized (authority)
iii) Existing transactions are recorded (completeness)
iv) Transactions are properly valued (valuation)
v) Transactions are properly classified (classifications)
vi) Transactions are recorded at proper time (timeliness)
vii) Transactions are properly included in subsidiary ledger and correctly summarized
(posting and summarizations).

Internal control objective, (validity) prevents the possible misstatements of cash receipts. That
is cash receipts may be recorded but may not be received or deposited. The completeness
control objective helps to prevent misstatement of receipts such as cash receipts may be stolen
or lost before recording. The timeliness internal control objective prevents cash receipts
misstatements such as cash receipts may be recorded in the wrong period. Authorization
objective prevent, cash miss statements such as cash discounts may not be properly taken.
The valuation objective prevents cash receipts misstatements, like, cash Receipts may be
recorded as incorrect amount. The classification control objective of cash receipts may
prevent misstatements like cash receipts may be recorded in wrong financial statement
account. The posting and summarization objective prevent misstatement such as cash receipts
may be posted to wrong customer account, cash receipts may not be properly posted to
general ledger accounts.

20
3.4. INTERNAL CONTROL OVER CASH DISBURSEMENTS.

The Internal objectives for cash disbursements can be summarized as follows.

(i) Validity - It refers that segregation of duties must be made to check

possible misstatements such as cash disbursement recorded may not be made
(occurred).
(ii) Completeness – It refers that all transactions of the given period which
are made or occurred must be included or recorded in records. How ever there night be
cash disbursements made or occurred but mot recorded or included. Auditors have to
check numerical sequence of cheeks, daily cash disbursements reconciled to postings to
accounts payable subsidiary records.
(iii) Timeliness – It refers that all disbursement transactions must be
recorded in proper time then, the internal control objective helps to prevent cash
disbursements not to be recorded in a wrong period. In control procedure, there would
be daily reconciliation of checks issued with postings to cash disbursements journal and
accounts payable subsidiary records.
(iv) Authorization – It refers that there must be appropriate authorization
of disbursement transactions by concerned personnel. Control procedure to insure this
objective is segregation of duties; checks must be prepared only after all source
documents have been independently approved.
(v) Valuation – It refers that cash disbursements must be properly
determined. The balances of cash disbursements must be determined accurately. There
might be incorrect amount of cash disbursed and recorded in journal, there fore, there
must be a control procedure to check this misstatement. Daily cash disbursements report
must be reconciled to checks issued; vendor statements must be reconciled to accounts
payable records, and independently reviewed, monthly bank statements must be
reconciled and independently reviewed.
(vi) Classification - The cash disbursements must be properly classified to
in accord dance with chart of accounts. There fore, there might be cash disbursements
charged to wrong account. The control procedure includes that there must be well –

21
 prepared chart of accounts, independent approval and review of general ledger account
on voucher packet.
(vii) Posting and summarization – It refers that all cash disbursement
transactions must be posted and summarized. There might be cash disbursement posted
to the wrong vendor accounts, or cash disbursements journal may not be summarized
properly or not properly posted to general ledger accounts. Then, there must be
reconciled and independently reviewed, monthly cash disbursements journal agreed
must agree to general ledger postings, Accounts payable subsidiary records must be
reconciled to general ledger control account.

3.5. SEGREGATION OF DUTIES

Segregation of duties with regard to control over cash includes the following types. The
custody (possessing), recording, and Authorization of cash should be separated. That is, the
same person should not be entrusted to perform the two or three activities. The reason is that
if the custody and record keeping are done by the same person, that person can steal money
and they change the ledger to conceal the theft. If cashier has custody, the bookkeeper makes
entries, and the finance head authorizes payments, this is good segregation of duty regarding
to petty cash. If the Bank account is reconciled by one who does not have access to cash, then
it is good segregation of duties regarding to cash in Bank the store keeper should not fill our
receiving reports to control Inventory. The person who authorizes salary for new employee
should not be the one paying the salary. The receiving of cash, depositing of the cash in the
Bank, recording of cash and general ledger should be segregated. Cash payment preparation,
authorizing of cash payment, cash payment, (disbursing), and recording of cash payments in
cash disbursement journal and general ledger such as Account payable ledger and cash control
ledger should be segregated; that is each activity should be performed by different persons.

3.6. LIMITATIONS (WEAKNESS) OF INTERNAL CONTROL OVER CASH

Weak internal control procedures would create opportunity for fraud or defalcation /theft/ of
cash. The most common defalcation techniques of cash are:

22
a. Withholding of cash receipts – proceeds form cash sales are withheld at point of
sales recording and receiving of cash. For example, a cash register clerk can fail to
register sales or under register amounts, and pocketing full or partial amounts, If the
customer does not wait for his receipts and changes, or check amounts charged,
registered, and paid.
b. Lapping - refers to cash collection on account from credit customer may be
postponed (delayed). This is usually practiced as temporary borrowing, but in the long
run they lead to cover up by more elaborate means. This is possible if a single person
is responsible to receive cash from charge customers and keep records for accounts
receivable at the same time.
c. Sales discount – cash can be abstracted from sales discount not taken by customers.
i.e when customers pay the full amount, only amount net of discount are recorded to
customers and the difference would be pocketed by recording it to discount account.
d. Writing off bad debts – Accounts Receivable could be written off as bad debts when
actually customers remittance is pocketed.
e. Fictions Accounts Receivable – Goods could be taken for private use or stolen by
charging fictions customers and writing off as bad debts later on.
f. Check – kiting – It refers to transferring of check from one back to another when
business has two bank accounts say in bank X and Y check is written to withdraw an
account from bank X account balance, and deposited into Bank Y account. Because of
lag (delay) of time for clearance, the amount deposited in bank Y is immediately
reflected, but is not reflected as deduction (withdrawal) from Bank X account soon,
Consequently such technique is practiced by casher to cover up cash shortage which
an auditor might uncover.
g. Window – Dressing – Cash Shortage or cash position could be improved by holding
the cash book open /unclosed) beyond the closing date to include subsequent cash
receipts.
h. Others includes as, cashier payable to self, check payable to others, petty cash
vouchers.

23
Check Your Progress Exercise

(1) Which of the following is relevant to the auditors objectives in audit of cash.
A. Evaluating internal control over cash transaction.
B. Substantiate the existence of recorded cash.
C. Establish the completeness of recorded cash.
D. To determine that the client has right to recorded cash.
E. All of the above F. None
(2) An auditor would consider a cashier job description to contain compatible
duties if the casher receives remittance from the mail room and also prepares:
A. the prelisting of individual checks. C. the daily deposit slip.
B. the monthly bank reconciliation. D. remittance advice.
(3) Cash receipts from sales on account have been misappropriated. Which of the
following acts would conceal this defecation and be least likely to be detected by an
auditor?
A. understating the sales journal
B. over stating the accounts receivable control
C. overstating the accounts receivable subsidiary ledger
D. understating the cash receipts journal
(4) One of the following internal controls would be most likely to detect the
lapping of collections from customers?
A. Independent internal verification of dates of entry in the cash receipts journal with
dates of daily cash summaries.
B. Authorization of write – off of uncollectible accounts by a supervisor independent
of the credit approval function.
C. Segregation of duties between receiving cash and posting the accounts receivable
ledger.
D. Supervisory comparison of the daily cash summary with the sum of the cash
receipts journal entries.

24
3.7 SUMMARY

This unit described the fundamental internal control over cash receipts and disbursements. It
also explained how the auditors design tests of controls for cash. To summarize:
1. Since cash generally has high degree of inherent risk, more audit time is devoted to the
audit of the account than is indicated by its dollar amount.
2. Internal control over cash receipts should provide assurance that all cash received is
reported promptly and accurately, control over cash sales is strongest when two or
more employees participate in each transactions, or when collections are controlled by
a cash register.
3. Internal control over cash disbursements is best achieved when all payments are made
by cheek or well – controlled electronic fund transfers except for minor payments.
4. The cash value and liquid nature of many investments makes the separation of the
authorization, custody, and record – keeping functions’.

3.8 GLOSSARY

1. Window dressing – Action taken by the client. Shortly connect it before the balance
sheet date to improve the financial picture presented in the financial statements.
2. Voucher – A document authorizing a cash disbursement. A voucher usually provides
space for employees performing various approval functions to initial. (The term voucher
may also be applied to the group of documents that support a cash disbursement.
3. Kiting – manipulations causing an amount of cash to be included simultaneously in
the balance of two or more bank accounts. Kiting schemes are based on the fleet period
the time necessary for a check deposited in one bank to clear two bank while it was
drawn.

3.9 ANSWER TO CHECK YOU PROGRESS

1. A 2. C 3. D 4. A

25
3.10 MODEL EXAMINATION QUESTIONS

1. Which of the following is the most effective control procedures to detect vouchers
prepared for the payment of goods that were not received?
A. Counting of goods upon receipt in storeroom.
B. Matching of purchase order, receiving report, and vendor in voice for each
voucher in accounts payable department.
C. Comparison of goods received with goods reqisioned in receiving department.
D. Verification of vouchers for accuracy and payroll in internal audit Department.
2. Which of the following procedures in cash disbursement cycle should not be
performed by the accounts payable department?
A. Cancellation of supporting documents after payment.
B. Comparison of the vendor invoice with the receiving report.
C. Verification of the mathematical accuracy of the vendor invoice
3. For Effective internal control purpose, which of the following individuals should be
responsible for mailing signed checks?
A. Receptionist B. Treasurer
C. Accounts Payable clerk. D. Payroll clerk
4. In museum, opened to public visiting assume that two clerks are assigned at entrance
to collect admission fees. What possible internal control should be installed to prevent
cash misuse?
A. The admission fee collectors should deposit daily collections.
B. The treasurer and the clerk should deposit the cash.
C. Cashier is responsible to receive daily cash collections and deposit the cash.
D. The cash collection should be based on cash receiving in voice.
5. Which of the following is an internal control procedures that would prevent paid
vouchers from being presented for payment for the second time?
A. Vouchers should be prepared by individuals who are net responsible for signing
checks
B. Vouchers should be approved by responsible official.
C. The person signing checks should compare the check with vouchers supporting do
comments.

26
D. All of the above

27