Chapter 4

Cash and Internal Controls

Conceptual Learning Objectives

C1: Define internal control and identify its
purpose and principles.
C2: Define cash and cash equivalents
and explain how to report them.

6-2

Analytical Learning Objectives

A1: Compute the days sales uncollected
ratio and use it to assess liquidity.

6-3

Procedural Learning Objectives

P1: Apply internal control to cash receipts
and disbursements.
P2: Explain and record petty cash fund
transactions.
P3: Prepare a bank reconciliation.
P4: Appendix 6A Describe the use of
documentation and verification to
control cash disbursements (see text for
details).
P5: Appendix 6B Apply the net method to
control purchase discounts (see text for
details).
6-4

C1

Purpose of Internal Control

Managers use policies and procedures to:
1.
1.
2.
2.
3.
3.
4.
4.

Protect assets.
Ensure reliable accounting.
Promote efficient operations.
Urge adherence to company policies.

6-5

The Sarbanes-Oxley Act

C1

The Sarbanes-Oxley Act, also known as SOX, requires

management and auditors of publicly held companies
to adhere to or perform specific requirements, such as ::
1.
1. Evaluation of internal controls.
2.
2. Oversight of the auditors work by the Public
Company Accounting Oversight Board (PCAOB).
3.
3. Restriction on consulting services performed by
auditors.
4.
4. Term limits on person leading the audit.
5.
5.

Harsh penalties for violators, including prison time

with severe fines.
6-6

Principles of Internal Control

C1

Establish responsibilities.

Maintain adequate records.

Insure assets and bond key employees.

Separate recordkeeping from custody

of assets.

Divide responsibility for related transactions.

Apply technological controls.

Perform regular and independent reviews.

6-7

Technology and Internal Control

Reduces
Processing
Errors

Allows More
Extensive Testing
of Records

Limits
Evidence of
Processing

Makes Crucial
Separation of
Duties
Difficult
Increases
E-commerce
6-8

C1

Limitations of Internal Control

Human Error

Human Fraud

Negligence
Fatigue
Misjudgment
Confusion

Intent to
defeat internal
controls for
personal gain
6-9

C1

Limitations of Internal Control

The costs of internal controls
must not exceed their benefits.

Benefits

Costs

6-10

C2

Control of Cash
An effective system of internal controls that
protects cash and cash equivalents should meet
three basic guidelines:
Handling cash is
separate from
recordkeeping of
cash.

Cash receipts are

promptly
deposited in a
bank.

Cash
disbursements are
made by check.
6-11

C2

Cash, Cash Equivalents, and

Liquidity
Liquidity
How easily an asset can be converted into
cash to be used to pay for services or
obligations.

Inventory

Cash
6-12

C2

Cash, Cash Equivalents, and

Liquidity
CASH

Currency, coins, amounts on deposit in bank

accounts, checking accounts, and many
savings accounts. Also includes items such as
customer checks, cashiers checks, certified
checks, and money orders.

Cash Equivalents
Short-term, highly liquid investments that are:
1.
1. Readily convertible to a known cash amount.
2.
2. Close to maturity (due) date and not sensitive
to interest rate changes.
6-13

Cash Management Principles

C2

When companies fail, one of the most

common causes is their inability to
manage cash. The goals of cash
management are twofold:

Plan cash receipts to meet cash

payments when due.
Keep the minimum level of
cash necessary to operate.
6-14

Control of Cash Receipts

P1

Over-the-Counter
Cash Receipts

Cash register with

locked-in record of
transactions.
Compare cash
register record with
cash reported.

Cash Receipts by Mail

Two people open the

mail.

Money to cashiers
office.

List to accounting
dept.

Copy of list filed.

6-15

Control of Cash Disbursements

P1

All
All expenditures
expenditures should
should be
be made
made by
by check.
check.
The
The only
only exception
exception is
is for
for small
small payments
payments
from
from petty
petty cash.
cash.
Separate
Separate authorization
authorization for
for check
check signing
signing
and
and recordkeeping
recordkeeping duties.
duties.
Use
Use aa voucher
voucher system.
system.

6-16

Voucher System of Control

P1

A
A voucher
voucher system
system establishes
establishes
procedures
procedures for:
for:

Verifying,
Verifying, approving,
approving, and
and recording
recording
obligations
obligations for
for eventual
eventual cash
cash
disbursements.
disbursements.
Issuing
Issuing checks
checks for
for payment
payment of
of verified,
verified,
approved,
approved, and
and recorded
recorded obligations.
obligations.

6-17

P1

Voucher System of Control

Sender
Sender
Cashier
Accounting
Receiving

Supplier (Vendor)
Purchasing
Requesting

Receiver
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition

Supplier (Vendor)
Cashier
Accounting; Requesting
& Purchasing
Accounting
Supplier; Requesting,
Receiving, and Accounting

Purchasing and
Accounting

Voucher
6-18

P2

Petty Cash System of Control

Small payments required in most
companies for items such as
postage, courier fees, minor
repairs, and low-cost supplies.

6-19

P2

Operating a Petty Cash

Fund
Petty Cash

Company
Cashier

Petty
Cashier

May 1

Petty cash
Cash

400
400

Accountant
6-20

P2

Operating
a
Petty
Cash
Fund
Operating a Petty Cash Fund

Petty Cash

Petty
Cashier

6-21

P2

Operating a Petty Cash Fund

Operating a Petty Cash Fund

A petty cash
fund is used only
for business
expenses.

Petty
Cashier

39
Stamps
$45

Courier
$80
6-22

P2

Operating
a
Petty
Cash
Fund
Operating a Petty Cash Fund
Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.

Petty
Cashier

Receipts

39
Stamps
$45

Courier
$80
6-23

P2

Operating a Petty Cash Fund

Operating a Petty Cash Fund

Receipts

$125
Company
Cashier

To reimburse
petty cash fund

Petty
Cashier

Use
Use aa Cash
Cash
Over
Over and
and Short
Short
account
account if
if needed.
needed.

Accountant
6-24

P2

Petty Cash Example

Tension Co. maintains a petty cash fund of $400.
The following summary information was taken from
petty cash receipts for July:
Travel expenses
$79.30
Customer business lunches
Express mail postage 55.00
Office supplies expense
Total
$260.28

93.42
32.48

Lets look at replenishing the fund if the balance on

July 31 was $137.80.

6-25

Petty Cash Example

P2

What
What amount
amount of
of cash
cash will
will be
be
required
required to
to replenish
replenish the
the petty
petty
cash
cash fund?
fund?
a.
a.
b.
b.
c.
c.
d.
d.

$260.20
$260.20
$262.20
$262.20
$139.80
$139.80
$137.80
$137.80

Lets prepare the journal entry to replenish the

petty cash fund.
6-26

Petty Cash Example

P2

Journal entry to replenish the petty cash fund

Expense
Expense
account
account
6-27

P1

Banking Activities as Controls

Bank Accounts

Checks

Signature Cards

Deposit Tickets

Electronic
Funds
Transfer

Bank
Statements
6-28

P3

Bank Reconciliation
A
A bank
bank reconciliation
reconciliation is
is prepared
prepared regularly
regularly to
to explain
explain the
the
difference
difference between
between cash
cash reported
reported on
on the
the bank
bank statement
statement and
and the
the
cash
cash balance
balance on
on companys
companys books.
books.

Why are the

balances different?

6-29

Reconciling Items

P3

(How to account for debit and credit memoranda)

Bank
Bank Statement
Statement Balance
Balance

Add:
Add:

Deposits
Deposits in
in transit.
transit.
Deduct:
Deduct:
Outstanding
Outstanding
checks
checks
Add
Add or
or Deduct:
Deduct:
Bank
Bank errors.
errors.

Book
Book Balance
Balance
Add:
Add: Collections
Collections
made
made by
by the
the bank.
bank.
Add:
Add: Interest
Interest earned
earned
on
on checking
checking account.
account.
Deduct:
Deduct: Non-sufficient
Non-sufficient
funds
funds check
check (NSF).
(NSF).
Deduct:
Deduct: Bank
Bank service
service
charge.
charge.
Add
Add or
or Deduct:
Deduct:
Book
Book errors.
errors.
6-30

P3

Bank Reconciliation
Two sections:
1.
1. Reconcile
Reconcile bank
bank statement
statement balance
balance to
to

the
the adjusted
adjusted bank
bank balance.
balance.
2.
2. Reconcile
Reconcile book
book balance
balance to
to the
the adjusted
adjusted
book
book balance.
balance.

The adjusted balances should be equal.

6-31

P3

Bank Reconciliation Example

Lets
Lets prepare
prepare aa July
July 31
31 bank
bank statement
statement for
for
the
the Simmons
Simmons Company.
Company.

The
The July
July 31
31 bank
bank statement
statement indicated
indicated aa
balance
balance of
of $9,610.
$9,610.
The
The Cash
Cash general
general ledger
ledger account
account on
on that
that
date
date shows
shows aa balance
balance of
of $7,430.
$7,430.
Additional
Additional information
information necessary
necessary for
for the
the
reconciliation
reconciliation is
is shown
shown on
on the
the next
next slide.
slide.
6-32

P3

Bank Reconciliation Example

1.

Outstanding checks totaled $2,417.

2.

A $500 check mailed to the bank for deposit had not

reached the bank at the statement date.

3.

The bank returned a customers NSF check for $225

received as payment on account receivable.

4.

The bank statement showed $30 interest earned during

July.

5.

Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.

6.

A $486 deposit by Acme Company was erroneously

credited to our account by the bank.
6-33

P3

Bank Reconciliation Example

6-34

P3

Adjusting Entries from a

Bank Reconciliation
Only amounts shown on the book portion
of the reconciliation require an adjusting
entry.

6-35

P3

Adjusting Entries from a

Bank Reconciliation
After posting the reconciling entries, the cash account
in the general ledger looks like this:

Adjusted
Adjusted balance
balance on
on July
July 31.
31.
6-36

A1

Days Sales Uncollected

How
How much
much time
time is
is likely
likely to
to pass
pass before
before
we
we receive
receive cash
cash receipts
receipts from
from credit
credit sales?
sales?
Days
=
sales
uncollected

Accounts receivable
Net sales

365

6-37

End of Chapter 6

6-38