dfa5048_chapter 3_internal control and cash

7/28/2019 DFA5048_Chapter 3_Internal Control and Cash

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Chapter8-1

Chapter 8

Internal Control

and Cash

Accounting Principles, Ninth Edition


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Chapter8-2

1. Define internal control.2. Identify the principles of internal control.

3. Explain the applications of internal control principlesto cash receipts.

4. Explain the applications of internal control principlesto 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.

Study Objectives


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Chapter8-3

Internal control

Principles ofinternal control

Limitations

Cash equivalents

Restricted cash

Compensatingbalances

Making deposits

Writing checks

Bank statements

Reconciling thebank account

Electronic fundstransfer (EFT)system

Cash receiptscontrols

Cashdisbursementscontrols

Internal Control Cash ControlsControl

Features: Use ofa Bank

Reporting Cash

Internal Control and Cash


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Chapter8-4

Methods and measures adopted to:

1. Safeguard assets.

2. Enhance accuracy and reliability of accountingrecords.

3. Increase efficiency of operations, and

4. Ensure compliance with laws and regulations.

Internal Control

SO 1 Define internal control.

Internal Control


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Chapter8-5

Internal control systems have five primary components

1. A control environment

Integrity values and unethical activity

2. Risk assessment Risk factors to business

3. Control activities

Through policies and procedures

4. Information and communication

Through internal control system

5. Monitoring

Periodically

Internal Control

SO 1 Define internal control.

Internal Control


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Chapter8-6

Measures vary with

managements assessment of the risks faced.

size and nature of the company.

SO 2 Identify the principles of internal control.

Principles of Internal Control Activities

Fraud and Internal Control

Six principles of controls activities:

1. Establishment of responsibility2. Segregation of duties3. Documentation procedures4. Physical controls5. Independent internal verification6. Human resource controls


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Chapter8-7 SO 2 Identify the principles of internal control.

1. ESTABLISHMENT OF RESPONSIBILITY

Control is most effective when only one person is responsible

for a given task (e.g.: employees passcodes).2. SEGREGATON OF DUTIES

Related duties, including physical custody and recordkeeping, should be assigned to different individuals.

3. DOCUMENTATION PROCEDURES

Companies should use prenumbered documents for alldocuments should be accounted for.




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3. PHYSICAL CONTROLS Illustration 8-2




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4. INDEPENDENTINTERNAL VERIFICATION

1. Verify recordsperiodically or on asurprise basis.

2. Records verified by anemployee who is

independent.

3. Discrepancies andexceptions reportedto management.


Illustration 8-3



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5.HUMAN RESOURCE CONTROLS

1. Bond employees who handle

cash (obtain insuranceprotection against theft byemployees).

2. Rotate employees duties andrequire vacations.

3. Conduct background checks.




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Limitations of Internal Control1. Costs should not exceed benefit.

Costs of establishing control procedures should not exceed theirexpected benefits

2. Human element.A good system can become ineffective through employee fatigue,carelessness, or indifference.

Collusion may result - two or more individuals work together to getaround prescribed controls may significantly impair the

effectiveness of a system.

3. Size of the business.

E.g.: Small business find it difficult to segregate duties or toprovide for independent internal verification



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Chapter8-12

Cash Receipts Controls

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

Independent InternalVerification

Supervisors count cashreceipts daily;

treasurer comparestotal receipts to bankdeposits daily

Establishment ofResponsibility

Only designatedpersonnel are

authorized to handlecash receipts(cashiers)

Segregation of Duties

Different individuals

receive cash, recordcash receipts, and hold

the cash

DocumentationProcedures

Use remittanceadvice (mail

receipts), cashregister tapes, anddeposit slips

Physical,Mechanical, and

Electronic ControlsStore cash in safes

and bank vaults; limitaccess to storageareas; use cash

registers

Human ResourceControls

Bond personnel whohandle cash; requireemployees to take

vacations; deposit allcash in bank dailyIllustration 8-4

Cash Controls


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Chapter8-13

Cash Controls Cash Receipts

Cashconsists of coins, currency, checks, moneyorders, 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



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Chapter8-14


Control Procedures:Only designated personnel should be authorizedto handle or have access to cash receipts.

Different individuals should:

1. receive cash

2. record cash receipt transactions

3. have custody of cash



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Chapter8-15


Documents should include:

1. Remittance advices

2. Cash register tapes

3. Deposit slipsCash should be stored in safes and bank vaults

Access to storage areas should be limited to authorizedpersonnel

Cash registers should be used in executing over-the-counter receipts



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Chapter8-16


Daily cash counts and daily comparisons of total receipts.

All personnel who handle cash receipts should be bondedand required to take vacations.

Control of over-the-counter receipts is centered on cash

registers that are visible to customers.



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Chapter8-17




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Chapter8-18

Over-the-Counter

Receipts


Illustration 8-4


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Chapter8-19

Mail Receipts

Control Procedures:Mail receipts should be opened by two people, a listprepared, and each check endorsed.

Copy of the list, along with the checks andremittance advices, sent to cashiers department.

Cashier adds the checks to the over-the-counterreceipts 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.



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Chapter8-20

Cash Controls Cash Disbursement

SO 4 Explain the applications of internalcontrol principles to cash disbursements.

Cash Disbursements Controls

Generally, internal control over cash disbursementsis more effective when companies pay by check,

rather than by cash.

Applications:

1. Voucher system

2. Petty cash fund


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Chapter8-21




Only specified individuals should be authorized tosign checks.

Different departments or individuals should beassigned the duties of approving an item forpayment and paying it.Prenumbered checks should be used and each checkshould be supported by an approved invoice or otherdocument.


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Chapter8-22




Blank checks should be stored in a safe.

1. Access should be restricted toauthorized personnel.

2. A check writer machine should be used

to imprint the amount on the check inindelible ink.


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Chapter8-23




Each check should be compared with the approvedinvoice before it is issued.

Following payment, the approved invoice should bestamped PAID.


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Chapter8-24




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Chapter8-25


Independent InternalVerification

Compare checks toinvoices; reconcile bank

statement monthly

Establishment ofResponsibility

Only designatedpersonnel are

authorized to signchecks (treasurer) and

approve vendors

Segregation of Duties

Different individualsapprove and makepayments; check

signers do not recorddisbursements

DocumentationProcedures

Use prenumberedchecks; checks must

have an approved

invoice; requireemployees to use

corporate credit cardsfor reimbursable

expenses

Physical ControlsStore blank checks in

safes, with limitedaccess; print check

amounts by machine inindelible ink

Illustration 8-6Cash Disbursements Controls

Human ResourceControls

Bond personnelwho handle cash;

require employeesto take vacations;

conduct backgroundchecks


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Chapter8-26

Voucher System

Network of approvals, by authorized

individuals, to ensure all disbursements bycheck are proper.

A voucheris an authorization form prepared

for each expenditure.Vouchers are recorded in a journal called thevoucher register.





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Chapter8-27

Review

Match each of the following principles of internal control with the

Appropriate description below.A. Establishment of responsibilityB. Segregation of dutiesC. Documentation proceduresD. Physical, mechanical, and electronic controls

E. Independent internal verificationF. Other controls

_____ 1.Involves the review, comparison, and reconciliation of dataprepared by other employees.

_____ 2.Provide evidence that transactions and events have occurred.

_____ 3.Includes the authorization and approval of transactions._____ 4.Rotating employees' duties and requiring employees to take

vacations._____ 5.Related activities should be assigned to different individuals._____ 6.Using garment sensors to deter theft.


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Chapter8-28

Review Solutions

1. E 3. A 5. B2. C 4. F 6. D


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Chapter8-29

Petty Cash Fund- Used to pay small amounts.Involves:

1. establishing the fund,

2. making payments from the fund, and

3. replenishing the fund.


SO 5 Describe the operation of a petty cash fund.

Replenishing the petty cash fund means the petty cash custodian requestsand receives cash from the companys regular checking account in order tohave the cash on hand equal to the amount reported in the general ledgeraccount, Petty Cash.

http://blog.accountingcoach.com/replenish-petty-cash/
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Chapter8-30

Petty Cash vs. Cash


Petty CashPetty cash is a small amount ofdiscretionary funds in the formof cash used for expenditures whereit is not sensible to make anydisbursement by check, because ofthe inconvenience and costs ofwriting, signing and then cashing thecheck.

People use them when they want touse it other than a cheque because

cheques have a surcharge attached,so petty cash vouchers can be usedfor small office needs.

CashCash refers to money in the physicalform of currency, suchas banknotes and coins.In bookkeeping and finance, "cash"refers to current assets comprising

currency or currency equivalents thatcan be accessed immediately or near-immediately (as in the case of moneymarket accounts).Cash is seen either as a reserve forpayments, in case of a structural or

incidental negative cash flow or as away to avoid a downturn on financialmarkets.

http://en.wikipedia.org/wiki/Petty_cash http://en.wikipedia.org/wiki/Cash
http://en.wikipedia.org/wiki/Petty_cashhttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Petty_cash


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Chapter8-31

Petty Cash Fund

Accounting entries are required when:

1. The fund is established

2. The fund is replenished

3. The amount of the fund is changed





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Chapter8-32

Established Fund

Two essential steps in establishing a pettycash fund are:

1. appointing a petty cash custodian whowill be responsible for the fund, and

2. determining the size of the fund.




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Chapter8-33

Illustration: If Laird Company decides to establish a $100fund on March 1, the journal entry is:



Petty cash 100Mar. 1

Cash 100


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Chapter8-34

Replenishing Fund

When the money in the petty cash fund reaches aminimum level, the fund is replenished.

The request for reimbursement is initiated by thepetty cash custodian.

The petty cash custodian prepares a schedule ofthe payments that have been made and sendsthe schedule, with supporting documentation,to the treasurers office.




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Chapter8-35

Illustration: Assume that on March 15 Lairds petty cashcustodian requests a check for $87. The fund contains $13cash and petty cash receipts for postage $44, freight-out $38,and miscellaneous expenses $5. The general journal entry to

record the check is:



Postage expense 44Mar. 15

Cash 87

Freight-out 38

Miscellaneous expense 5


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Chapter8-36

Illustration: Occasionally, the company may need to recognizea cash shortage or overage. Assume that Lairds petty cash

custodian has only $12 in cash in the fund plus the receipts aslisted. The request for reimbursement would, therefore, be for

$88, and Laird would make the following entry:



Postage expense 44Mar. 15

Cash 88

Freight-out 38

Miscellaneous expense 5Cash over and short 1


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Chapter8-37

Review

The petty cash fund of $200 for Walsh Company appeared as

Follows on December 31, 2005:Cash $95.60Petty cash vouchersFreight in $19.40Postage 40.00

Balloons for a special occasion 18.00Meals 25.00

Instructions1. Briefly describe when the petty cash fund should be replenished.

Because there is cash on hand, is there a need to replenish thefund at year end on December 31? Explain.2. Prepare in general journal form the entry to replenish the fund.3. On December 31, the office manager gives instructions to

increase the petty cash fund by $100. Make the appropriatejournal entry.


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Chapter8-38

Review Solutions

1. Petty cash should be replenished on a periodic basis orwhen the cash is low. It must be replenished on thebalance sheet date so that the expenses represented bythe petty cash vouchers can be recorded in the properaccounting period.

2. Freight-in 19.40Postage Expense 40.00Miscellaneous Expense 18.00Meals Expense 25.00Cash Over and Short 2.00

Cash 104.40

3. Petty Cash 100.00Cash 100.00


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Chapter8-39

Review

On October 1, 2005, Foster Company establishes an *imprest pettycash fund by issuing a check for $150 to Jill Nott, the custodian ofthe petty cash fund. On October 31, 2005, Jill Nott submitted thefollowing paid petty cash receipts for replenishment of the pettycash fund when there is $7 cash in the fund:

Freight-in $25Office Supplies Expense 35Entertainment of Clients 60Postage Expense 20

InstructionsPrepare the journal entries required to establish the petty cashfund on October 1 and the replenishment of the fund on October31.


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Chapter8-40

Review Solutions

Oct. 1 Petty Cash 150Cash 150(To establish a petty cash fund)

31 Cash Over and Short 3Freight-in 25Office Supplies Expense 35Entertainment Expense 60Postage Expense 20

Cash 143(To record expenses for October andto replenish the petty cash fund)


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Chapter8-41

Review

Imprest system on petty cash Imprest system is a form of financial accounting system.

The most common imprest system is the pettycash system.

The base characteristic of an imprest system is that afixed amount is reserved, which will be replenished at theend of a period or when the circumstances request it.

This replenishment is not credited on the imprest account,but from another source.

When a sufficient amount is used, the imprest account will

never be credited again.

As such, it can be seen as apermanent debt.


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Chapter8-42

Review

Petty cash imprest system allows only to replenishthe spending. So, if you start the month with100 in your petty

cash float and spend90 of that cash in the month,an amount of90 will be then placed in your pettycash float to bring the balance of your petty cashfloat back to100.

The replenishment is credited to the primary cashaccount and the debits will go to the respectiveexpense accounts, based on the petty cash receipts.

Source: http://en.wikipedia.org/wiki/Imprest_system
http://en.wikipedia.org/wiki/Imprest_systemhttp://en.wikipedia.org/wiki/Imprest_system


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Chapter8-43

Contributes to good internal control over cash.Minimizes the amount of currency on hand.

Creates a double record of bank transactions.

Bank reconciliation.

Control Features: Use of a Bank

SO 6 Indicate the control features of a bank account.


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Chapter8-44

A check is a written order signed by thedepositor directing the bank to pay aspecified sum of money to a designated

recipient.Three parties to a check are:

1. Maker (drawer) issues the check

2. Bank (payer) on which check is drawn

3. Payee to whom check is payable




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Chapter8-45

Making Bank DepositsAuthorized employeeshould make deposit.


Bank CodeNumbers

Front Side Reverse Side

Illustration 8-8



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Chapter

8-46

Writing ChecksWritten order signed by depositor directing bank to paya specified sum of money to a designated recipient.


Maker

Payee

Illustration 8-9

Payer



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Chapter

8-47

Bank Statement shows:

Checks paid and other debits chargedagainst the account

Deposits and other credits made to theaccount

Account balance after each daystransactions




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Chapter

8-48

Memorandum:Bank debit memorandum

Indicate charges against the depositors

account. Example: ATM service chargesBank credit memorandum

Indicate amounts that will increase the

depositors account. Example: interest incomeon account balance




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Chapter

8-49

Bank StatementsDebit Memorandum

Bank service charge

NSF (not sufficientfunds)


Illustration 8-10

Credit Memorandum

Collect notesreceivable.

Interest earned.



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Chapter

8-50 SO 7 Prepare a bank reconciliation.


Reconciliation

Necessary as the balance per bank and balanceper books are seldom in agreement due to timelags and errors.

Bank Reconciliation

Should be prepared by an employee who has noother responsibilities pertaining to cash.


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Chapter

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Reconciling the Bank Account

SO 7 Prepare a bank reconciliation.

Reconcile balance per books and balance per bank totheir adjusted (corrected) cash balances.

Reconciling Items:1. Deposits in transit.

2. Outstanding checks.

3. Errors.

4. Bank memoranda.



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Chapter

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Reconciliation Procedures


+ Deposit in Transit

- Outstanding Checks

+- Bank Errors

+ Notes collected by bank

- NSF (bounced) checks

- Check printing or otherservice charges

+- Company Errors

CORRECT BALANCE CORRECT BALANCE

Illustration 8-11



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Chapter

8-53




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Chapter

8-54

Illustration: The bank statement for Laird Company (Illustration8-10), shows a balance per bank of $15,907.45 on April 30, 2010.On this date the balance of cash per books is $11,589.45. Usingthe four reconciliation steps, Laird determines the followingreconciling items.



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Chapter

8-55

Illustration: a) Prepare a bank reconciliation at April 30.


Cash balance per bank statement $15,907.45

Add: Deposit in transit 2,201.40

Less: Outstanding checks (5,904.00)

Adjusted cash balance per bank $12,204.85

Cash balance per books $11,589.45

Collection of notes + interest - fee 1,035.00

Add: Error in recording check no. 443 36.00

Less: NSF check (425.60)

Bank service charge (30.00)

Adjusted cash balance per books $12,204.85


Illustration 8-12


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Chapter

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The company records each reconciling item used to determinethe adjusted cash balance per books.

Collection of Note Receivable: Assuming interest of $50 hasnot been accrued and collection fee is charged to

Miscellaneous Expense, the entry is:


Cash 1,035.00Apr. 30

Miscellaneous expense 15.00

Notes receivable 1,000.00Interest revenue 50.00



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Chapter

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Book Error: The cash disbursements journal shows thatcheck no. 443 was a payment on account to Andrea Company,a supplier. The correcting entry is:


Cash 36.00Apr. 30Accounts payable 36.00



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Chapter

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NSF Check: As indicated earlier, an NSF check becomes anaccount receivable to the depositor. The entry is:


Accounts receivable 425.60Apr. 30

Cash 425.60

Bank Service Charges: Depositors debit check printingcharges (DM) and other bank service charges (SC) to

Miscellaneous Expense. The entry is:

Miscellaneous 30.00Apr. 30

Cash 30.00



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Chapter

8-59

Review

Using the code letters below, indicate how each of the items listed would be handled inpreparing a bank reconciliation.

CodeA Add to cash balance per booksB Deduct from cash balance per booksC Add to cash balance per bankD Deduct from cash balance per bankE Does not affect the bank reconciliation

Items:1. Outstanding checks.2. Bank service charge.3. Check for $320 correctly written and paid by the bank but incorrectly

entered in the cash payments journal for $230.4. Deposit in transit.5. Bank returns deposited check marked NSF.

6. Bank collects notes receivable and interest for depositor.7. Bank debit memorandum for check printing fees.8. Petty cash custodian has $86 in paid petty cash vouchers that have not

been reimbursed.9. Bank charged a check against the company which should have been charged

to another company.10. A check for $236 was correctly paid by the bank but was incorrectly

entered in the cash payments journal for $263.


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Chapter

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Review Solutions

1. D 6. A

2. B 7. B

3. B 8. E

4. C 9. C

5. B 10. A


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Chapter

8-61

Review

Milner Boat Company's bank statement for the month of September showed a balance per bank of

$7,000. The company's Cash account in the general ledger had a balance of $5,459 at September30.Other information is as follows:(1) Cash receipts for September 30 recorded on the company's books were $5,200 but this

amount does not appear on the bank statement.(2) The bank statement shows a debit memorandum for $40 for check printing

charges.

(3) Check No. 119 payable to Kohl Company was recorded in the cash payments journal andcleared the bank for $248. A review of the accounts payable subsidiary ledger shows a $36credit balance in the account of Kohl Company and that the payment to them should havebeen for $284.

(4) The total amount of checks still outstanding at September 30 amounted to $6,000.(5) Check No. 138 was correctly written and paid by the bank for $409. The cash payment

journal reflects an entry for Check No. 138 as a debit to Accounts Payable and a credit toCash in Bank for $490.

(6) The bank returned an NSF check from a customer for $560.(7) The bank included a credit memorandum for $1,260 which represents collection of acustomer's note by the bank for the company; principal amount of the note was $1,200 andinterest was $60. Interest has not been accrued.

Instructions(a) Prepare a bank reconciliation for Milner Boat Company at September 30.(b) Prepare any adjusting entries necessary as a result of the bank reconciliation.


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Chapter

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Review Solutions

(a) MILNER BOAT COMPANY

Bank ReconciliationSeptember 30

Cash balance per bank $ 7,000Add: (1) Deposit in transit 5,200

12,200Less: (4) Outstanding checks 6,000

Adjusted cash balance per books $ 6,200

Cash balance per books $ 5,459Add: (5) Accounts Payable Error $ 81

(7) Collect $1,200 note and interest $60 1,260 1,341

6,800Less: (2) Check printing 40

(6) NSF Check 560 600Adjusted cash balance per books $ 6,200Note: Item (3) is not a reconciling item.


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Chapter

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Review Solutions

(b)

Sept. 30 Cash 81Accounts Payable 81

(To correct error in recording Check No. 138)

30 Cash 1,260Notes Receivable 1,200Interest Revenue 60

(To record collection of note receivable andinterest by the bank)

30 Miscellaneous Expense 40Cash 40

(To record check printing charges)

30 Accounts Receivable 560Cash 560

(To record NSF check)


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Chapter

8-64

Electronic Funds Transfers (EFT)

Disbursement systems that uses wire,telephone, or computers to transfer cash

balances between locations.EFT transfers normally result in betterinternal control since no cash or checks arehandled by company employees.




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Reporting Cash

Cash consists of coins, currency (paper money), checks,money orders, and money on hand or on deposit in a bankor similar depository.

Cash equivalentsRestricted cash

Compensating balances

Illustration 8-14