CHAPTER 8

Internal Control and

Cash Principles
Accounting Principles, Eighth Edition
Chapter
8-1

Study
Study Objectives
Objectives
1.

Define internal control.

2.

Identify the principles of internal control.

3.

Explain the applications of internal control principles

to cash receipts.

4.

Explain the applications of internal control principles

to cash disbursements.

5.

Describe the operation of a petty cash fund.

6.

Indicate the control features of a bank account.

7.

Prepare a bank reconciliation.

8.

Explain the reporting of cash.

Chapter
8-2

Internal
Internal Control
Control and
and Cash
Cash

Internal
Control
The SarbanesOxley Act
Principles
Limitations

Chapter
8-3

Cash
Controls
Control over
cash receipts
Control over
cash
disbursements

Use of a Bank
Making
deposits
Writing checks
Bank
statements
Reconciling the
bank account

Reporting
Cash
Cash
equivalents
Restricted
cash
Compensating
balances

Internal
Internal Control
Control
Methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records. Reduce risk of:
a. Errors (unintentional)
b. Irregularities (intentional)
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations
are required to maintain an adequate system of internal control.
Chapter
8-4

LO 1 Define internal control.

Internal
Internal Control
Control

The Sarbanes-Oxley Act

Companies must
develop principles of control over financial
reporting.
continually verify that controls are working.
Independent auditors must attest to the level of
internal control.
SOX created the Public Company Accounting
Oversight Board (PCAOB).
Chapter
8-5

LO 1 Define internal control.

Internal
Internal Control
Control

Principles of Internal Control

Illustration 8-1

Measures vary with

size and nature of
the business.
managements control
philosophy.

Chapter
8-6

LO 2 Identify the principles of internal control.

Internal
Internal Control
Control

Principles of Internal Control

ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is
responsible for a given task.
SEGREGATION OF DUTIES
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents and all
documents should be accounted for.
Chapter
8-7

LO 2 Identify the principles of internal control.

Internal
Internal Control
Control

Principles of Internal Control

PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS

Physical

Mechanical
and
Electronic
Chapter
8-8

LO 2 Identify the principles of internal control.

Internal
Internal Control
Control

Principles of Internal Control

INDEPENDENT INTERNAL VERIFICATION
1. Records periodically verified by an employee who is
independent.
2. Discrepancies reported to management.

OTHER CONTROLS
1. Bond employees.
2. Rotate employees duties and require vacations.
3. Conduct background checks.
Chapter
8-9

LO 2 Identify the principles of internal control.

Internal
Internal Control
Control

Limitations of Internal Control

Costs should not exceed benefit.
Human element.
Size of the business.

Chapter
8-10

LO 2 Identify the principles of internal control.

Cash
Cash Controls
Controls
Discussion Question

Q8-8. The management of Sewell Company asks

you, as the company accountant, to explain (a)
the concept of reasonable assurance in internal
control and (b) the importance of the human
factor in internal control.

See notes page for discussion

Chapter
8-11

LO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Controls
Controls

Internal Control over Cash Receipts

Establishment of
Responsibility

Documentation
Procedures

Independent Internal
Verification

Only designated
personnel are
authorized to handle
cash receipts
(cashiers)

Use remittance
advice (mail
receipts), cash
register tapes, and
deposit slips

Supervisors count cash

receipts daily;
treasurer compares
total receipts to bank
deposits daily

Segregation of Duties

Physical,
Mechanical, and
Electronic Controls

Other Controls

Different individuals
receive cash, record
cash receipts, and hold
the cash

Chapter
8-12

Store cash in safes

and bank vaults; limit
access to storage
areas; use cash
registers

Bond personnel who

handle cash; require
employees to take
vacations; deposit all
cash in bank daily

LO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Controls
Controls
Discussion Question

Q8-3. At the corner grocery store, all sales

clerks make change out of one cash register
drawer. Is this a violation of internal control?
Why?

See notes page for discussion

Chapter
8-13

LO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Controls
Controls
Cash consists of coins, currency, checks, money
orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets
Chapter
8-14

LO 3 Explain the applications of internal control principles to cash receipts.

Over-the-Counter
Over-the-Counter Receipts
Receipts

Cashiers Department

Sales Department
Illustration 8-7

Prepare daily summary

Prepare deposit slip
Cashier ring up sales
Supervisor
1. reads register totals
2. makes cash counts
3. prepares cash count
sheets
Chapter
8-15

Bank

Treasurer Accounting

(deposit) (verification)
(record)
LO 3 Explain the applications of internal control principles to cash receipts.

Mail
Mail Receipts
Receipts
Control Procedures:
Mail receipts should be opened by two people, a
list prepared, and each check endorsed.
Copy of the list, along with the checks and
remittance advices, sent to cashiers department.
Cashier adds the checks to the over-the-counter
receipts and prepares a daily cash summary and
makes the daily bank deposit.
Copy of list sent to treasurers office for
comparison with total shown on daily cash
summary.
Chapter
8-16

LO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Controls
Controls
Review Question

Permitting only designated personnel to handle

cash receipts
is an application of the principle of:
a. segregation of duties.
b. establishment of responsibility.
c. independent check.
d. other controls.
Chapter
8-17

LO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Controls
Controls

Internal Control over Cash Disbursements

Generally, internal control over cash
disbursements is more effective when
companies pay by check, rather than by cash.
Applications:
Voucher system
Electronic funds transfers (EFT) system
Petty cash fund
Chapter
8-18

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls

Internal Control over Cash Disbursements

Establishment of
Responsibility

Documentation
Procedures

Independent Internal
Verification

Only designated
personnel are
authorized to sign
checks (treasurer)

Use prenumbered
checks and account
for them in
sequence; each check
must have an
approved invoice

Compare checks to
invoices; reconcile bank
statement monthly

Other Controls

Store blank checks in

safes, with limited
access; print check
amounts by machine in
indelible ink

Segregation of Duties
Different individuals
approve and make
payments; check
signers do not record
disbursements

Chapter
8-19

Stamp invoices
PAID

Physical, Mechanical,
and Electronic
Controls

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls
Discussion Question

Q8-14. Joe Griswold Companys internal

controls over cash disbursements provide for
the treasurer to sign checks imprinted by a
checkwriting machine in indelible ink after
comparing the check with the approved invoice.
Identify the internal control principles that are
present in these controls.
See notes page for discussion
Chapter
8-20

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls
Review Question

The use of prenumbered checks in disbursing

cash is an application of the principle of:
a. establishment of responsibility.
b. segregation of duties.
c. physical, mechanical, and electronic controls.
d. documentation procedures.

Chapter
8-21

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls

Internal Control over Cash Disbursements

Voucher System
Network of approvals, by authorized
individuals, to ensure all disbursements by
check are proper.
A voucher is an authorization form prepared
for each expenditure.

Chapter
8-22

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls

Internal Control over Cash Disbursements

Electronic Funds Transfers (EFT)
Disbursement systems that uses wire,
telephone, or computers to transfer cash
balances between locations.

Chapter
8-23

LO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Controls
Controls

Internal Control over Cash Disbursements

Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,
2. making payments from the fund, and
3. replenishing the fund.

Chapter
8-24

LO 5 Describe the operation of a petty cash fund.

Cash
Cash Controls
Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The
fund was established on March 1 with a balance of $100. During
March the following petty cash receipts were found in the petty cash
box.
Receipt
Date

No.

For

3/5

Stamp inventory

Freight-out

Miscellaneous expense

11

Travel expense

14

Miscellaneous expense

Amount
$

39
21
6
24
5

The fund was replenished on March 15 when the fund contained $3 in

cash. On March 20, the amount in the fund was increased to $150.
Instructions: Journalize the entries in March that pertain to the
operation of the petty cash fund.
Chapter
8-25

LO 5 Describe the operation of a petty cash fund.

Cash
Cash Controls
Controls
E8-8 The fund was established on March 1 with a
balance of $100
March 1

Chapter
8-26

Petty cash
Cash

100
100

LO 5 Describe the operation of a petty cash fund.

Cash
Cash Controls
Controls
E8-8 The fund was replenished on March 15 when the
fund contained $3 in cash.
March 15

Chapter
8-27

Postage expense
Freight-out

39
21

Miscellaneous expense
Travel expense
Cash over Short
Cash

11
24
2
97

LO 5 Describe the operation of a petty cash fund.

Cash
Cash Controls
Controls
E8-8 On March 20, the amount in the fund was
increased to $150.
March 20

Chapter
8-28

Petty cash
Cash

50
50

LO 5 Describe the operation of a petty cash fund.

Use
Use of
of aa Bank
Bank
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.

Chapter
8-29

LO 6 Indicate the control features of a bank account.

Use
Use of
of aa Bank
Bank
Making Bank Deposits
Authorized employee
should make deposit.

Front Side
Chapter
8-30

Illustration 8-10

Bank Code
Numbers

Reverse Side
LO 6 Indicate the control features of a bank account.

Use
Use of
of aa Bank
Bank
Writing Checks

Illustration 8-11

Written order signed by depositor directing bank to pay

a specified sum of money to a designated recipient.
Maker
Payee
Payer

Chapter
8-31

LO 6 Indicate the control features of a bank account.

Use
Use of
of aa Bank
Bank
Bank Statements

Illustration 8-12

Debit Memorandum
Bank service charge
NSF (not sufficient
funds)

Credit Memorandum
Collect notes
receivable.
Interest earned.
Chapter
8-32

LO 6 Indicate the control features of a bank account.

Use
Use of
of aa Bank
Bank
Review Question
The control features of a bank account do not include:

Chapter
8-33

a.

having bank auditors verify the correctness of

the bank balance per books.

b.

minimizing the amount of cash that must be kept

on hand.

c.

providing a double record of all bank transactions.

d.

safeguarding cash by using a bank as a depository.

LO 6 Indicate the control features of a bank account.

Use
Use of
of aa Bank
Bank
Reconciling the Bank Account
Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Errors.
4. Bank memoranda.
Chapter
8-34

LO 7 Prepare a bank reconciliation.

Use
Use of
of aa Bank
Bank
Reconciliation Procedures
Illustration 8-13

+ Deposit in Transit

+ Notes collected by bank

NSF (bounced) checks

Check printing or other

service charges

Outstanding Checks

+- Bank Errors

+- Book Errors
CORRECT BALANCE
Chapter
8-35

CORRECT BALANCE
LO 7 Prepare a bank reconciliation.

Use
Use of
of aa Bank
Bank
E8-11 The following information pertains to Family Video Company.
1.

Cash balance per bank, July 31, $7,263.

2.

Cash balance per books, July 31, $7,284.

3.

July bank service charge not recorded by the depositor $28.

4.

Deposits in transit, July 31, $1,500.

5.

Bank collected $900 note for Family in July, plus interest $36,
less fee $20.The collection has not been recorded by Family, and
no interest has been accrued.

6.

Outstanding checks, July 31, $591.

Instructions
a) Prepare a bank reconciliation at July 31.
b) Journalize the adjusting entries at July 31 on the books of Family
Video Company.

Chapter
8-36

LO 7 Prepare a bank reconciliation.

Use
Use of
of aa Bank
Bank
E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement
Add:
Deposit in transit
Less:
Outstanding checks
Adjusted cash balance per bank

Cash balance per books

Add:

Collection of notes receivable

Collection of interest
Less:
Bank service charge
Note collection fee
Adjusted cash balance per books
Chapter
8-37

$7,288
1,500
(591)
$8,172
$7,284
900
36
(28)
(20)
$8,172

LO 7 Prepare a bank reconciliation.

Use
Use of
of aa Bank
Bank
E8-11 b) Journalize the adjusting entries at July 31 on
the books of Family Video Company.
Dr.
Cr.
July 31
Cash
788
Bank charge expense
28
Miscellaneous expense
Notes receivable
Interest revenue

20
900
36

Note: Adjusting journal entry includes only the

adjustments to the cash balance per books.
Chapter
8-38

LO 7 Prepare a bank reconciliation.

Use
Use of
of aa Bank
Bank
Review Question

The reconciling item in a bank reconciliation that

will result in an adjusting entry by the depositor
is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
Chapter
8-39

LO 7 Prepare a bank reconciliation.

Reporting
Reporting Cash
Cash
Most liquid asset, listed first in current assets
section of balance sheet.
Illustration 8-16

Cash equivalents
Restricted cash
Compensating balances
Chapter
8-40

LO 8 Explain the reporting of cash.

Use
Use of
of aa Bank
Bank
Review Question

Which of the following statements correctly

describes the reporting of cash?

Chapter
8-41

a.

Cash cannot be combined with cash equivalents.

b.

Restricted cash funds may be combined with

Cash.

c.

Cash is listed first in the current assets

section.

d.

Restricted cash funds cannot be reported as a

current asset.
LO 7 Prepare a bank reconciliation.

Recording
Recording Process
Process
Discussion Question
Q2-19. Jim Benes is confused about how accounting
information flows through the accounting system. He
believes the flow of information is as follows.
a. Debits and credits posted to the ledger.
b. Business transaction occurs.
c. Information entered in the journal.
d. Financial statements are prepared.
e. Trial balance is prepared.

Is Jim correct? If not, indicate to Jim the proper flow

of the information.
Chapter
8-42

See notes page for discussion

LO 7 Prepare a trial balance and explain its purposes.

Copyright
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Chapter
8-43