Cash and Internal Control

LU 1
Key Issues to be discussed

What are the forms of cash found and reported on a company balance
sheet?
What techniques do companies use to control cash?
Why are internal controls important?
What are some basic internal control procedures?

Chapter 6, Slide #1

Issues to be discussed

Why are checks and invoices sequentially numbered?

Why do you receive a cash register receipt at a departmental store?
Would the person writing the checks prepare the bank reconciliation?
Why or why not?
Why internal control over cash disbursements would be more effective
when payments are made by check rather than by cash?
Why would a business use a petty cash fund? In what instances would
the petty cash fund be used? Develop a system of internal control for
petty cash.
Which statement, the balance sheet or the statement of cash flows,
provides the user with more information about cash?

Chapter 6, Slide #2

What Constitutes Cash?

Classification as cash indicates that an item is readily available to pay

debts.
Coin and currency, Checking, savings, and money market accounts
Undeposited, cashier, and certified checks
Cash equivalents are readily convertible to known amount of cash
original maturity to the investor of less than three months
treasury bills, commercial paper, money market funds
Both cash and cash equivalents included as cash on statement of cash
flows

Chapter 6, Slide #3

Cash Management
Necessary to ensure company has neither
too little nor too much cash on hand
Tools
Cash flows statement
Bank reconciliations
Petty cash funds

Chapter 6, Slide #4

Control Over Cash

Cash management is necessary to guarantee that neither too much nor too little cash
is on hand.
Internal control over cash is needed to guard against theft and other abuses of cash
Cash alone does not earn anything, but must be invested
Too much cash could make company a takeover target
A bank statement details all activity in an account each month
Canceled checks: an outstanding check was written but not yet presented for
payment, and therefore is not on statement
Deposits: on companys records, a deposit in transit was made in the last day or two
of the month, doesnt show up on statement
NSF check (Not Sufficient Funds) was deposited, but bank could not collect, and
deducted from balance
Service charge
Customer note and interest: bank acts as collection agent for company, takes
payments directly
Interest earned

Chapter 6, Slide #5

Bank Reconciliation Statement

A bank reconciliation should be prepared as soon as the statement is received,

by someone independent of custody, record-keeping, and authorization
Trace deposits listed on bank statement to books, list deposits in transit
Trace canceled checks on bank statement to books, list outstanding checks
List credit memoranda (the bank credits or increases its liability to the company
on its books): items credited on banks books to company for interest or
collections from customers
List debit memoranda (the bank debits or reduces the liability to the company on
its books): NSF checks, service charges
Identify errors by bank or company
Reconcile book balance and bank balance to adjusted balance using above items
Prepare any necessary journal entries using items above that are adjustments to
balance on books

Chapter 6, Slide #6

Establishing a Petty Cash Fund

The petty cash fund is an exception to the all expenditures by

check rule, for minor amounts.
A check is written for a lump-sum amount and cashed
Custodian of cash is given to one individual (petty cash custodian)
Minor disbursements are reimbursed from it when receipts are
presented
Replenish periodically by totaling receipts and writing a check to bring
the cash in the fund back to its original amount

Chapter 6, Slide #7

The Control Environment

The success of an internal control system depends on the
operating style of management and the competency of the
people responsible for the system
Personnel policies and practices are important components
of the internal control system
The effectiveness of the internal control system also
depends on the board of directors and audit committee

Chapter 6, Slide #8

Internal Control Procedures

Proper Authorizations
Segregation of Duties
Independent Verification
Safeguarding Assets and Records
Independent Review and Appraisal
The Design and Use of Business Documents

Chapter 6, Slide #9

Bank Statements
Cash balance, beginning of period

Deposits
Customer notes and

interest collected by
bank
Interest earned

Canceled checks
NSF checks
Service charges

= Cash balance, end of period

Chapter 6, Slide #10

Bank Reconciliation Step 1

Trace deposits listed on the bank statement
to the books. Identify the deposits in transit.
Add to the bank balance.
Deposits in transit:
Late period deposits
not yet reflected on
bank statement
Chapter 6, Slide #11

Example of Reconciliation
Bank Statement Adjustments: Deposits
Balance per statement, June 30
Add: Deposit in transit

Chapter 6, Slide #12

NRs.3,308.59
642.30

Bank Reconciliation Step

2
Trace checks cleared by the bank to the
books. Identify outstanding checks.
Subtract from the bank balance.
Outstanding checks: Checks written but not
yet presented to bank

Chapter 6, Slide #13

Example of Reconciliation
Bank Statement Adjustments: Checks Outstanding
Balance per statement, June 30
Add:
Deposit in transit
Deduct: Outstanding checks:
No. 496
No. 501
No. 502
Adjusted balance, June 30

Chapter 6, Slide #14

$3,308.59
642.30
$ 79.89
213.20
424.75

(717.84)
$3,233.05

Bank Reconciliation Step 3

List all other additions (credit memoranda)
shown on the bank statement. Add to the
book balance.
Credit memoranda:
Interest earned,
customer notes collected,
etc.
Chapter 6, Slide #15

Example of Reconciliation
Cash Account Adjustments: Credit Memoranda
Balance per books, June 30
Add:
Customer note collected
Interest on customer note
Interest earned during June
Error in recording check 498

Chapter 6, Slide #16

Rs. 2,895.82
Rs. 500.00
50.00
15.45
54.00
619.45

Bank Reconciliation Step

4
List all other subtractions (debit
memoranda) shown on the bank statement.
Subtract from the book balance.
Debit memoranda: NSF checks, service
charges, etc.

Chapter 6, Slide #17

Example of Reconciliation
Cash Account Adjustments: Debit Memoranda
Balance per books, June 30
Add:
Customer note collected
Interest on customer note
Interest earned during June
Error in recording check 498
Deduct: NSF check
Collection fee on note
Service charge for lockbox
Adjusted balance, June 30
Chapter 6, Slide #18

Rs.2,895.82
Rs.500.00
50.00
15.45
54.00
Rs.245.72
16.50
20.00

619.45

(282.22)
Rs.3,233.05

Bank Reconciliation Step 5

Identify errors made by the bank or the
company in recording the transactions
during the period.

Chapter 6, Slide #19

Bank Reconciliation Step 6

Use the information collected in steps 1 through 5 to
prepare the bank reconciliation.
Bank Reconciliation
Balance per bank

NRs

Adjusted balance

NRs

Balance per books

NRs

Adjusted balance

NRs

Chapter 6, Slide #20

Adjusted
balances
for book
and bank
must
agree

Example of Reconciliation
Bank Statement Adjustments
Balance per statement, June 30 Rs.3,308.59
Adjusted balance, June 30
Rs.3,233.05

Cash Account Adjustments

Balance per books, June 30
Adjusted balance, June 30
Chapter 6, Slide #21

Rs. 2,895.82
Rs. 3,233.05

Bank Reconciliation Adjusting

Entries
Bank Reconciliation
Balance per bank
:
Adjusted balance
Balance per books
:
Adjusted balance
Chapter 6, Slide #22

NRs.
NRs.
NRs.
NRs.

Book
adjustments
are the basis
for
adjusting
entries

Bank Reconciliation Adjusting

Entries
Accounts Receivable
Collection Fee Expense
Rent ExpenseLockbox
Cash
Notes Receivable
Interest revenue
Supplies

245.72
16.50
20.00
337.23
500.00
65.45
54.00

To record bank reconciliation adjustments.

Chapter 6, Slide #23