Chapter 6

Cash and Internal Control

Cash

Cash: Readily available to pay debts

Various forms of cash: Coin and currency on hand Cash on deposit in the form of checking and savings

accounts Undeposited, cashier, and certified checks

LO 1

Cash Equivalents

Investment readily convertible to known amount of cash Maturity—three months or less

Example: Commercial paper Treasury bills issued by the federal government Money market funds

Six-month bank certificate of deposit would not be a cash equivalent

Exhibit 6.1—Cash and Cash Equivalents on the Balance Sheet and the Statement of Cash Flows

Cash Management

Tools of cash management: Cash flows statement Cash budgets Bank reconciliations Petty cash funds

LO 2

Reading a Bank Statement

Bank statement : a detailed list, provided by the bank, of all activity for a particular account during the month.

Outstanding check : check written by a company but not yet presented to the bank for payment

Deposit in transit : deposit recorded on the books but not yet reflected on the bank statement

Bank Reconciliation

Reconcile or resolve any differences between balance on the bank statement with balance shown in the accounting records

Steps used in preparing a bank reconciliation:1. Prepare a list of the deposits in transit2. Prepare a list of the outstanding checks3. Prepare a list of credit memoranda4. Prepare a list of debit memoranda5. Identify any errors

Credit Memoranda and Debit Memoranda

Credit memoranda Additions on a bank statement for such items as

interest paid on the account and notes collected by the bank for the customer

Debit memoranda Deductions on a bank statement for items such as

NSF checks and various service charges

Step 1: Prepare a list of the deposits in transit

Trace deposits listed on the bank statement to the books

Identify the deposits in transit Any deposits recorded on the books but not yet

shown on the bank statement Add to the bank balance

Step 2: Prepare a List of the Outstanding Checks

Arrange the canceled checks in numerical order Trace each of them to the books

Any checks recorded on the books but not yet listed on the bank statement are outstanding

Subtract from the bank balance

Step 3: Prepare a List of Credit Memoranda

List all items, other than deposits, shown as additions on the bank statement Interest paid by the bank Amounts collected by the bank for the customer

For these items, bank increases, or credits, its liability to the company on its own books

Step 4: Prepare a List of Debit Memoranda

List all amounts, other than canceled checks, shown as subtractions on the bank statement NSF checks Service charges

A liability is created on the books of the bank when a company deposits money in a bank

Bank reduces the amount of its liability for these various items and debits the liability on its own books

Step 5: Identify any Errors

Identify any errors made by the bank or by the company in recording cash transactions

Bank Reconciliation

Bank Reconciliation

Balance per bank $$$

Adjusted balance $$$

Balance per books $$$

Adjusted balance $$$

Example 6.2—Preparing a Bank Reconciliation

Need for Adjustments to the Records

Book adjustments are basis for

adjusting entries

Petty Cash fund

Money kept on hand for making minor disbursements rather than by writing checks

Periodically, the fund is replenished When fund is replenished, an adjustment is

made to record its replenishment and to recognize the various expenses incurred

Internal Control System

Policies and procedures necessary to ensure: Safeguarding of an entity’s assets Reliability of accounting records Accomplishment of overall company objectives

LO 3

Sarbanes-Oxley Act of 2002—SOX

An act of Congress in 2002 Intended to bring reform to corporate

accountability and stewardship in the wake of a number of major corporate scandals

Sarbanes-Oxley Act of 2002—SOX (continued)

Internal control report: a report required by Section 404 of the Sarbanes-Oxley Act Maintain an adequate internal control structure Assesses effectiveness of internal control structure

Outside auditors must issue report on company’s internal control

Sarbanes-Oxley Act of 2002—SOX (continued)

Public Company Accounting Oversight Board (PCAOB): five-member body created by SOX Set auditing standards in the United States

Board of directors: consists of key officers of a corporation and outside members responsible for general oversight of the affairs of the entity

Audit committee: a subset of the board of directors Provides direct contact between the stockholders

and the independent accounting firm

The Control Environment

Factors that influence internal control: Management’s competence and operating style Personnel policies and practices Board of directors, particularly audit committee

The Accounting System

Methods and records used to accurately report entity’s transactions and maintain accountability for assets and liabilities

Use of a journal is an integral part of all accounting systems

Can be completely manual, fully computerized, or a mixture of both

Internal Control Procedures

Administrative controls: Procedures concerned with efficient operation of

the business and adherence to managerial policies Accounting controls:

Procedures concerned with safeguarding the assets or the reliability of the financial statements

LO 4

Internal Control System

Important internal control procedures: Proper authorizations Segregation of duties Independent verification Safeguarding of assets and records Independent review and appraisal Design and use of business documents

Internal audit staff

Department responsible for monitoring and evaluating the internal control system

Business Documents

Crucial link between economic transactions entered into by an entity and the accounting record of those events

Often called source documents Key feature:

Sequential numbering system Multiple copies

Limitations on Internal Control

Not totally foolproof Does not ensure prevention of collusion Maintenance of controls can be costly

Small businesses cannot afford Human errors can weaken the system

Misunderstood instructions, carelessness, fatigue, and distraction can lead to errors

Computerized Business Documents and Internal Control

All cash receipts should be deposited intact in the bank on a daily basis Intact means that no disbursements should be made

from the cash received from customers All cash disbursements should be made by

check

LO 5

Control over Cash Receipts

Most merchandisers receive checks and currency from customers in two ways Cash received over the counter from cash sales Cash received in the mail from credit sales

Cash discrepancies Discrepancies occur occasionally due to theft by

dishonest employees and to human error

Role of Computerized Business Documents in Controlling Cash Disbursements

Purchase Requisition A form a department uses to initiate a request to

order merchandise Purchase order

A form sent by the purchasing department to the supplier

Exhibit 6.5—Document Flow for the Purchasing Function

Exhibit 6.6—Purchase Requisition

Exhibit 6.7—Computer-Generated Purchase Order

Exhibit 6.8—Invoice

A form sent by the seller to the buyer as evidence of a sale

Exhibit 6.9—Computer-Generated Receiving Report

Blind Receiving Report

A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier

Exhibit 6.10—Invoice Approval Form

A form the accounting department uses before making payment to document the accuracy of all information about a purchase

Exhibit 6.11—Check with Remittance Advice

A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier

End of Chapter 6