Chapter 08

CASH AND INTERNAL CONTROLS

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

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INTERNAL CONTROL SYSTEM

Policies and procedures managers use to: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies.

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SARBANES-OXLEY ACT (SOX)

The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal controls.

Sen. Paul Sarbanes (D-MD)

Rep. Mike Oxley (R-OH)

Section 404 of SOX requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting.

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PRINCIPLES OF INTERNAL CONTROL

Internal control principles common to all companies:
1. 2. 3. 4. 5. 6. 7. 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.

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TECHNOLOGY AND INTERNAL CONTROL

Reduced Processing Errors More Extensive Testing of Records

Limited Evidence of Processing Increased E-Commerce

Crucial Separation of Duties

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LIMITATIONS OF INTERNAL CONTROL Human Error Human Fraud

Negligence Fatigue Misjudgment Confusion

Intent to defeat internal controls for personal gain

Human fraud triple-threat: Opportunity, Pressure, and Rationalization.

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LIMITATIONS OF INTERNAL CONTROL

The costs of internal controls must not exceed their benefits.

Benefits Costs

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CONTROL OF CASH
An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines:
Handling cash is separated from recordkeeping for cash. Cash disbursements are made by check. Cash receipts are promptly deposited in a bank.

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CASH, CASH EQUIVALENTS, AND LIQUIDITY

Cash and similar assets are called liquid assets because they can be readily used to settle such obligations.
Cash Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders. Cash Equivalents Short-term, highly liquid investments that are: 1. Readily convertible to a known cash amount. 2. Close to maturity date and not sensitive to interest rate changes.

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CASH MANAGEMENT
The goals of cash management are twofold:
1. 2. Plan cash receipts to meet cash payments when due. Keep a minimum level of cash necessary to operate.

Effective cash management involves applying the following cash management principles:
Encourage collection of receivables. Delay payment of liabilities. Keep only necessary levels of assets. Plan expenditures. Invest excess cash.

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OVER-THE-COUNTER CASH RECEIPTS

This graphic illustrates that none of the people involved can make a mistake or divert cash without the difference being revealed.

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CASH OVER AND SHORT

Sometimes errors in making change are discovered from differences between the cash in the cash register and the record of the amount of cash receipts.

If a cash registers record shows $550 but the count of cash in the register is $555, we would prepare the following journal entry:

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CASH RECEIPTS BY MAIL

Preferably, two people are assigned the task of opening the mail. The cashier deposits the money in a bank. The recordkeeper records the amounts received in the accounting records.

Mailroom

Cashier

Recordkeeper

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CONTROL OF CASH DISBURSEMENTS

Control of cash disbursements is especially important as most large thefts occur from payment of fictitious invoices. Keys to Controlling Cash Disbursements Require all expenditures to be made by check. Limit access to checks except for those who have the authority to sign checks.

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VOUCHER SYSTEM OF CONTROL

A voucher system establishes procedures A voucher system establishes procedures for: for:
1. Verifying, approving, and recording 1. Verifying, approving, and recording obligations for eventual cash disbursements. obligations for eventual cash disbursements. 2. Issuing checks for payment of verified, 2. Issuing checks for payment of verified, approved, and recorded obligations. approved, and recorded obligations.

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VOUCHER SYSTEM OF CONTROL

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PETTY CASH SYSTEM OF CONTROL

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

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OPERATING A PETTY CASH FUND

Petty Cash

Company Cashier

Petty Cashier

Accountant

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OPERATING A PETTY CASH FUND

Petty Cashier
Petty Cash

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OPERATING A PETTY CASH FUND

A petty cash fund is used only for business expenses.

Petty Cashier

Transportation-in Services

Supplies

Delivery

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OPERATING A PETTY CASH FUND

Petty Cashier

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

Transportation-in Services

Supplies

Delivery

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OPERATING A PETTY CASH FUND

$71.30 Company Cashier

To reimburse petty cash fund

Petty Cashier

Accountant

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BASIC BANK SERVICES

Bank Accounts Signature Cards Deposit Tickets

Checks

Electronic Funds Transfer

Bank Statements

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BANK STATEMENT
Usually once a month, the bank sends each depositor a bank statement showing the activity in the account.

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BANK RECONCILIATION
A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on companys books.

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BANK RECONCILIATION
The balance of a checking account reported on the bank statement rarely equals the balance in the depositors accounting records. Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance Cash Balance per Book + Collections & Interest - Uncollectible items +/- Errors

Adjusting entries are recorded for the reconciling items on the book side of the reconciliation.

Adjusted Cash Balance

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ILLUSTRATION OF A BANK RECONCILIATION

We follow nine steps in preparing the bank reconciliation.
Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance

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ILLUSTRATION OF A BANK RECONCILIATION

We follow nine steps in preparing the bank reconciliation.
Cash Balance per Book + Collections & Interest - Uncollectible items +/- Errors Adjusted Cash Balance

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ILLUSTRATION OF A BANK RECONCILIATION

We follow nine steps in preparing the bank reconciliation.

Adjusting entries are recorded for the reconciling items on the book side of the reconciliation.

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ILLUSTRATION OF A BANK RECONCILIATION

Only the items reconciling the book balance require adjustment.

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GLOBAL VIEW
Internal Control Purposes, Principles and Procedures The purposes and principles of internal control systems are fundamentally the same across the globe. Control of Cash Accounting definitions for cash are similar for U.S. GAAP and IFRS.

Banking Activities as Controls There is a global demand for banking services, bank statements, and bank reconciliations. To the extent feasible, companies utilize banking services as part of their effective control procedures.

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DAYS SALES UNCOLLECTED

Indicates how much time is likely to pass before Indicates how much time is likely to pass before we receive cash receipts from credit sales. we receive cash receipts from credit sales.
Days = Sales Uncollected 56 days = Accounts Receivable Net Sales $612,000,000 $4,022,000,000 365

365

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APPENDIX 8A: DOCUMENTATION AND VERIFICATION

Purchase Requisition Purchase Order Invoice Receiving Report
Voucher

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APPENDIX 8B: CONTROL OF PURCHASE DISCOUNTS

The net method gives management an advantage in controlling and monitoring cash payments involving purchase discounts.

When purchases are recorded at net amounts, a Discounts Lost expense account is recorded and brought to managements attention.

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END OF CHAPTER 08