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CHAPTER REVIEW

Internal Control

1. (S.O. 1) Internal control consists of the plan of organization and all the related
methods and measures adopted within a business to (a) safeguard its assets a n d
(b) enhance the accuracy and reliability of its accounting records.

2. (S.O. 2) An essential characteristic of internal control is the establishment of re-


sponsibility to specific employees. Control is most effective when only one person
is responsible for a given task.

3. The rationale for segregation of duties is this: The work of one employee should,
without a duplication of effort, provide a reliable basis for evaluating the work of an-
other employee.

4. The responsibility for related transactions should be assigned to different individu-


als, and the responsibility for establishing the accountability for an asset should be
separate from the physical custody of that asset.

5. Documentation procedures provide evidence that transactions and events have


occurred.

6. Physical, mechanical, and electronic controls relate primarily to the safeguarding o f


assets and include such measures as safes for the storage of cash prior to deposit,
bank vaults for the deposit of cash, safety deposit boxes for the storage of impor -
tant business papers, fences around storage areas, and locked warehouses for in-
ventories.

7. Mechanical and electronic controls include electronic burglar alarms, television


monitors, sensors on garments, cash registers, time clocks and built-in hardware
controls.

8. Most systems of internal c ontrol provide for independent internal verification. This
principle involves the review, comparison, and reconciliation of data prepared b y
one or several employees.

9. In large companies, independent internal verification is often assigned to internal


auditors. Internal auditors are employees of the company who evaluate the effec-
tiveness of the company's system of internal control on a continuous basis.

10. Other control measures include bonding of employees who handle cash, rotating
employees' duties, and requiring employees to take vacations.

Limitations of Internal Control

11. The concept of reasonable assurance rests on the premise that the costs of estab-
lishing control procedures should not exceed their expected benefits.

12. The human element is also an important factor in every system of internal control. A
good system can become ineffective through employee fatigue, carelessness, o r
indifference.

13. Collusion may result when two or more individuals work together to get a r o u n d
prescribed controls and may significantly impair the effectiveness of a system.

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Cash

14. Cash consists of coins, currency (paper money), checks, money orders, and money
on hand or on deposit in a bank or similar depository. To safeguard cash and t o
assure the accuracy of the accounting records for cash, effective internal control
over cash is imperative.

Internal Control Over Cash Receipts

15. (S.O. 3) The application of internal control principles to cash receipts transactions
in-cludes: (1) only designated personnel should be authorized to handle or have
access to cash receipts; (2) different individuals should be assigned the duties o f
receiving cash, recording cash receipt transactions, and having custody of cash; (3)
documents should include remittance advices, cash register tapes, and deposit
slips; (4) cash should be stored in company safes and bank vaults, access to stor-
age areas should be limited to authorized personnel, and cash registers should be
used in executing over-the-counter receipts; (5) daily cash counts and daily c om-
parisons of total receipts should be made; and (6) all personnel who handle cash
receipts should be bonded and required to take vacations.

16. Control of over-the-counter receipts is centered on cash registers that are visible t o
customers.

Internal Control Over Cash Disbursements

17. (S.O. 4) Generally, internal control over cash disbursements is more effective w h e n
pay-ments are made by check rather than by cash, except for incidental amounts
that are paid out of petty cash.

18. The application of internal control principles to cash disbursements transactions


includes: (1) only specified individuals should be authorized to sign checks; (2) dif-
ferent departments or individuals should be assigned the duties of approving an
item for payment and paying it; (3) prenumbered checks should be used and each
check should be supported by an approved invoice or other document; (4) blank
checks should be stored in a safe and access should be restricted to authorized
personnel, and a check writer machine should be used to imprint the amount on the
check in indelible ink; (5) each check should be compared with the approved in-
voice before it is issued; and (6) following payment, the approved invoice (or form)
should be stamped PAID.

Voucher Syst em

19. A voucher system is often used to enhance the internal control over cash dis-
bursements. A voucher system is an extensive network of approvals by authorized
individuals acting independently to ensure that all disbursements by check are
proper. A voucher system includes the use of authorization forms called vouchers
which are recorded by the accounting department in the voucher register.

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Electronic Funds Transfer

20. Electronic Funds Transfer (EFT) is a disbursement system that uses wire, tele-
phone, telegraph or computer to send cash from one location to another.

Petty Cash Fund

21. (S.O. 5) A petty cash fund is a cash fund used to pay relatively small amounts.
a. The operation of the fund, often called an imprest system, involves (1) estab-
lishing the fund, (2) making payments from the fund, and (3) replenishing the
fund.
b. Accounting entries are required when (1) the fund is established, (2) the fund is
replenished, and (3) the amount of the fund is changed.

Use of a Bank

22. (S.O. 6) The use of a bank minimizes the amount of currency that must be kept o n
hand and therefore contributes significantly to good internal control over cash.

23. A check is a written order signed by the depositor directing the bank to pay a speci-
fied sum of money to a designated recipient. The three parties to a check are as fol-
lows:
a. The maker (or drawer) who issues the check.
b. The bank (or payer) on which the check is drawn.
c. The payee to whom the check is payable.

24. A bank statement shows (a) checks paid and other debits charged against the ac-
count, (b) deposits and other credits made to the account, and (c) the account bal-
ance after each day's transactions.

25. A bank debit memoranda is usually included with the bank statement to indicate
charges against the depositor's account such as a bank service charge, cost o f
printing checks, issuing traveler's checks, and when a previously deposited c us-
tomer's check "bounces" because of insufficient funds (NSF check).

26. A bank credit memoranda shows such items as the collection of a note receivable
for the depositor by the bank.

Reconciling the Bank Account

27. (S.O. 7) A reconciliation of a bank account is necessary because the balance per
bank and balance per books are seldom in agreement. The lack of agreement may
be the result of time lags and errors.

28. To obtain maximum benefit from a bank reconciliation, the reconciliation should be
prepared by an employee who has no other responsibilities pertaining to cash.

29. In reconciling the bank statement, it is customary to reconcile the balance per b o o k s
and balance per bank to their adjusted cash balances. The reconciliation schedule
consists of two sections. The steps in preparing a bank reconciliation are:

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a. Determine deposits in transit.
b. Determine outstanding checks.
c. Note any errors discovered.
d. Trace bank memoranda to the records.

30. Each reconciling item used in determining the adjusted cash balance per b o o k s
should be recorded by the depositor.

Reporting Cash

31. (S.O. 8) Cash on hand, cash in banks, and petty cash are often combined and r e-
ported simply as Cash. Because it is the most liquid asset, cash is listed first in the
current asset section of the balance sheet under the title "cash and cash equiva-
lents." Cash equivalents are highly liquid investments, with maturities of 3 m o n t h s
or less when purchased, that can be converted into a specific amount of cash. They
include money market funds, money market savings certificates, bank certificates o f
deposit, and U.S. Treasury bills and notes.

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