ACCT 100

Chapter 7

Internal Control and Cash

Internal Control and Managing Cash 2

Objectives of the Chapter

1. Introduce the internal control to safeguard assets and to produce reliable accounting records.

2. Internal control for the most liquid asset – cash.

The Sarbanes-Oxley Act (SOX) and the Internal ControlUnder SOX, companies must develop sound internal control for financial reporting.

Mangers need to document and assess the effectiveness of the internal control.

Managers’ assessment on the internal control needs to be attested by outsider auditors.

Outsider auditors would also make their evaluation on the effectiveness of companies’ internal control.

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Internal Control An organizational plan to (source:

Financial Accounting by Harrison and Horngren (H & H))

1. Safeguard assets (i.e., cash, inventory, etc.);

2. Encourage employees’ adherence to company policies;

3. Promote operational efficiency; and

4. Ensure accurate and reliable accounting records.

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Internal Control (contd.)

The plan includes(source: Financial Accounting by H & H)

1. To have competent, reliable and ethical personnel;

2. Assignment of responsibilities (see Exhibit on p6 for an organizational chart of a corp.).Each employee is assigned certain responsibilities; and

3. Proper authorization: Any deviation from standard policy requires a proper authorization.

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Board ofDirectorsBoard ofDirectors

PresidentPresident

SeniorVice President

SeniorVice President

Vice President,Marketing

Vice President,Marketing

Vice President,Production

Vice President,Production

Vice President,Finance andAccounting

Vice President,Finance andAccounting

OtherVice Presidents

OtherVice Presidents

AuditCommittee

AuditCommittee

ExternalAuditing

ExternalAuditing

ControllerController

GeneralAccountingGeneral

Accounting TaxesTaxes InternalAuditingInternalAuditing

BudgetingBudgeting SystemsSystems

TreasurerTreasurer

Collections and Credits

Collections and Credits

CashManagement

CashManagement

InvestorRelationsInvestor

RelationsBanking

RelationsBanking

Relations

Organizational Chart of a Corporation (source: H&H)

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Internal Control (contd.)

4. Separation of duties: this procedure can reduce the chances for fraud and promote the accuracy of accounting records. The procedure may include:a. separation of operation from accounting,b. separation the custody of assets from accounting,c. separation of the authorization of transactions from

the custody of related assets,d. separation of duties within the accounting function.

The plan includes:

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Internal Control (contd.)

5. Internal and external audits.

6. Documents and records.

7. Electronic and corporate control.

8. Other controls.

The limitations of internal control: human element and the size of a company.

The plan includes:

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Internal Control for Cash

Cash is the most liquid asset and is easy to steal. Therefore, most companies use internal control to safeguard their cash.

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Internal Control of Cash (Contd.)

1. Immediate deposit of cash to bank accounts.

2. Cash payments by checks except for small amount (paid by petty cash fund).

3. Separation of duties.

4. Prepare bank account reconciliation.

The Voucher System in Cash Disbursements A system to ensure all payments made by

checks are proper. The system involves a network of

approvals by authorized individuals. All cash disbursements require a voucher

(except for those from petty cash fund).

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The Voucher System (contd.) Purchase Order: a document issued by a

buyer to a seller, specifying the products and the agreed prices for products the seller will provided to the buyer.

Invoice (Bill): a document issued by a vendor to the buyer upon the delivery of products indicating the quantity of products delivered and agreed prices for products

Voucher: A document representing an intent to pay a vendor.

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The Voucher System (contd.) Upon the receipt of vendor’s invoice (and

the products), an employee in accounts payable will match the invoice with the purchase order.

With a successful match, the employee will record the purchase and accounts payable.

A voucher will be produced and filed.

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The Voucher System (contd.) Upon the approval (i.e., by a controller), a

check will be issued (i.e., by a treasurer) and sent to the vendor before the required payment date.

The paid voucher is sent to the accounting department for recording.

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Petty Cash Fund

Establishing a petty cash fund on 3/1:

Petty Cash 500

Cash 500

Making Payments from the fund:

Petty cash fund is used for the payments of small expenditures of the office (i.e., office drinks, office supplies, stamps, etc.)

The payments require petty cash receipts.

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Petty Cash Fund (Contd.)

Replenishing the fund on 3/31:

Postage expense 50

Freight-out 120

Office supplies 70

Cash over and short 5

Cash 245Note: the petty cash receipts indicated the payments in March

including postage exp. $50, freight charges, $120, and office supplies, $70. The cash balance of the fund on 3/31 amounted to $255

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Internal Control and Managing Cash 17

Bank Reconciliation

A. Causes of differences between the cash balances of bank and book.

B. Adjusting procedures

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A. Causes of Differences

1. Errors made by banks or companies.2. Outstanding checks.3. Deposit in transit.4. Some transaction recorded by banks,

but not recorded by companies (i.e., service charge, interest earned, collections of notes...).

5. NSF check.

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A. Causes of Differences (Contd.)

6. Checks deposited but returned for reasons other than NSF (I.e., unauthorized signature, check has been altered,etc.).

7. Cash received, recorded, but not yet deposited (if adjusted to cash balance, this item needed to be considered).

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Bank Balance Book Balance

+ Deposit in transit + Interest earned *

+ Cash received, recorded, + Notes collected *

but not deposited +- EFT*- Outstanding checks - Service charge *

+ -Errors made by banks - NSF checks- Checks deposited

butreturned to payee

by bank for reasons

otherthan NSF

+ -Errors made by companies

Adjusted Cash Balance Adjusted Cash Balance

* Journal Entries Required

Adjusting Procedures

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Example

From the following information for D.K, prepare a bank reconciliation and any journal entries needed to adjust the cash account as of 8/31/x1

1. August 31, 20x1, cash balance per book, $8,000.

2. August 31, 20x1, balance per bank, $7,500.3. Deposit in transit as of 8/31/x1, $2,000.

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Example (contd.)

4. Checks outstanding as of 8/31/x1, $1,000.

5. The bank improperly recorded a $650 deposit $560.

*6. Bank service charges, $100. (Not yet recorded by D.K.)

*7. Interest earned, $90. (Not yet recorded by D.K.)

* Journal entry required

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Example (contd.)

*8. Notes collected by bank, $400. (Not yet recorded by D.K.)

*9. NSF check, $100 (payment of an account receivable)

*10. A check of $300 payable to Energy Express Company for delivery charges was mistakenly recorded in the book at $600.

* Journal entry required

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Example (contd.)

* Journal entries are required by D.K.as follows:

6. Miscellaneous Expense 100Cash 100

7. Cash 90Interest Revenue 90

8. Cash 400Notes Receivable 400

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Example (contd.)

9. Accounts Receivable 100Cash 100

10. Cash 300Delivery Exp. 300

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Example (contd.)

Bank Balance (8/31/98) $7,500 + Deposit In Transit 2,000 - Checks Outstanding (1,000)+ Error Made by Bank 90 Adjusted Cash Balance $8,590

Book Balance (8/31/98) $8,000 - Bank Service charge (100)+ Interest Earned 90 + Notes Collected 400 - NSF Checks (100)+- Error made by the company 300 Adjusted Cash Balance $8,590

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Cash Management

1. To maintain sufficient cash on hand for day-to-day operation and for payment of current liabilities.

2. To prevent large amount of idle cash on hand.

3. To speed the collection of cash from sale, by offering sales discounts:

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Cash Management (contd.)

8/4 A/R, 2/10, n/30 50,000

Sales Revenue 50,000

8/10 Cash 49,000

Sales Discount 1,000

A/R 50,000

Also, Subsidiary ledger accounts are maintained for accounts receivable (see p26 for an example).

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Accounts Receivable General Ledger Subsidiary Ledger

Cash WalmartBal. 9,000 Bal. 1,800

Accounts Receivable TargetBal. 3,800 Bal. 1,300

Toys “R” USBal. 700

Total 3,800

Accounts Receivable Records

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Reporting Cash on the Balance Sheet (B/S)

Usually reported on the B/S as follows:

Current Assets: 20x2 20x1

Cash and Cash Equivalents xxxxxxxx

Cash Equivalents: highly liquid investments with insignificant interest rate risk and with original maturities of three months or less (i.e., commercial papers, U.S. Treasury bills, money market fund, etc.)