internal control and managing cash chapter 4. set up an effective system of internal control
TRANSCRIPT
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Internal Control and
Managing Cash
Chapter 4
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Set up an effective
system of internal control.
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Internal Control
It is the organizational plan and all therelated measures that an entity adopts.
Safeguard assets.
Promote operational efficiency.
Encourage Adherence to company policies.
Ensure Accurate and reliable accounting records.
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Components of anEffective System
Competent, reliable, and ethical personnelCompetent, reliable, and ethical personnel
Assignment of responsibilitiesAuthorization
RecordingCustody
Assignment of responsibilitiesAuthorization
RecordingCustody
Separation of dutiesSeparation of duties
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Separation of the Authorization of transactions
from the Recording of transactions
from the Custody of assets
Separation of the Authorization of transactions
from the Recording of transactions
from the Custody of assets
Separation of Duties
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Internal and External Audits
An audit is an examination by an outside partyof the company’s financial statements,
accounting systems, and internal controls.
An audit is an examination by an outside partyof the company’s financial statements,
accounting systems, and internal controls.
An internal auditor is an employee of the business.An internal auditor is an employee of the business.
An external auditor is an independent auditor.An external auditor is an independent auditor.
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Documents and Records
Business documents and records include:
invoices (bills)
paid checks
accounting journals
accounting ledgers
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Electronic and Computer Controls
Businesses use electronic devices to safeguard assets.
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The Onion Model of E-Commerce System Security
SensitiveHardware,Software,and Data
Encryption
Firewalls
Intrusion detection devices
Incident response procedures
Audits by external specialists
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Encryption
It is the transformation of data by a mathematicalprocess into a form that is unreadable by anyone
who does not have the secret decryption key.
Clear message
Encryption
Encoded message
Clear message
Decryption
Same key
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Firewall
It is a technique that limits access to hardware,software, or data to persons within a network.
Inquirers
Customers
Hackers
Firewall 1
Inquirers
Customers
Firewall 2
Customers
Firewall 3
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Other Controls
– Fireproof vaults– Burglar alarms– Point of sale terminals– Frequent bank deposits– Mandatory vacations– Job rotation
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The Limitations ofInternal Control
Systems designed to thwart one person’sfraud can be beaten by two or more
employees working together –colluding – to defraud the firm.
A system of internal control that is toocomplex can be inefficient.
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Use a bank reconciliation
as a control device.
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The Bank Reconciliation
There are two records of a business’s cash:
the company’s cash accounton its own books, and…
the bank statement, which shows theactual amount of cash in the bank.
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The Bank Reconciliation
Two common items that cause differencesbetween the bank balance and the book balance.
1. Items recorded by the company but not yet recorded by the bank: – Deposits in transit – Outstanding checks
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The Bank Reconciliation
2. Items on a bank statement and not recorded by the business: – Bank collections – Electronic funds transfers – Service charge – Interest revenue earned on account – NSF checks – Errors
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Bank Reconciliation Illustrated
The bank statement of Business Research, Inc.,shows a balance of $5,931.51 on January 31.
The company Cash account on thebooks has a balance of $3,294.21.
The following reconciling itemsexplain why the two balances differ:
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The Bank Reconciliation Illustrated
1. The January 30 deposit of $1,591.63 does not appear on the bank statement.
2. The bank erroneously charged to the account a $100 check (No. 656) not written by Business Research Associates.
3. Five company checks issued late in January and recorded in the journal have not been paid by the bank.
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The Bank Reconciliation Illustrated
Check No. Date Amount 337 Jan. 27 $ 286.00338 28 319.47339 28 83.00340 29 203.14341 30 458.53
Total $1,350.14
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The Bank Reconciliation Illustrated
4. The bank received $904.03 by EFT on behalf of Business Research, Inc.
5. The bank collected on behalf of the company a note receivable, $2,114 (including interest revenue of $214).
6. The bank statement shows interest revenue of $28.01.
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The Bank Reconciliation Illustrated
7. Check number 333 for $150 paid to Brown Company on account was recorded as a cash payment of $510.
8. The bank service charge for the month was $14.25.
9. The bank statement shows an NSF check for $52.
10. Business Research pays insurance expense by EFT and has not recorded this $361 payment.
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Balance per bank, January 31 $5,931.51Add deposit in transit 1,591.63Check erroneously charged 100.00
$7,623.14Less outstanding checks –1,350.14Adjusted bank balance $6,273.00
The Bank Reconciliation Illustrated
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Balance per books, January 31 $3,294.21Add: ETF receipt of rent revenue 904.03Collection of note receivable 2,114.00Interest revenue earned 28.01Correction of book error 360.00
$6,700.25Less: Service charge $ 14.25NSF check 52.00Payment of insurance expense 361.00 – 427.25Adjusted book balance $6,273.00
The Bank Reconciliation Illustrated
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Apply internal controls
to cash receipts and
cash payments.
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Controlling and Managing Cash
Internal control over cash receipts ensuresthat all cash receipts are deposited in the
bank and no collections are lost.
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Over the Counter Receipts
The point-of-sale terminal (cash register) offerscontrol over the cash received in a store.
The point-of-sale terminal (cash register) offerscontrol over the cash received in a store.
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Mail Receipts
All incoming mail should be openedby a mailroom employee.
All incoming mail should be openedby a mailroom employee.
This person should compare the checkreceived with the remittance advice.
This person should compare the checkreceived with the remittance advice.
The mailroom clerk keeps a runningtotal of cash receipts for the day.
The mailroom clerk keeps a runningtotal of cash receipts for the day.
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Mail Receipts
Many companies use a lock-box system.Many companies use a lock-box system.
Customers send checks directly to anaddress that is essentially a bank account.
Customers send checks directly to anaddress that is essentially a bank account.
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Element ofInternal Control
Internal Controls overCash Receipts
Competent, reliable,ethical personnel
Carefully screen andtrain employees.
Proper authorizationOnly designated employees cangrant exceptions for customers.
Internal ControlsOver Cash Receipts
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Internal ControlsOver Cash Receipts
Internal: management policiesExternal: control over cash receipts
Internal andexternal audits
Electronic andcomputer controls
Match receipts with remittancesand bank deposit ticket daily.
Employees who handle cash do nothave access to accounting records.
Separation of duties
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Internal Control: Payments Purchasing Process
Purchase order Purchasingdepartment Supplier
Invoice (bill) Supplier Accountingdepartment
Receiving report Receivingdepartment
Accountingdepartment
Disbursementpacket
Accountingdepartment
Officer whosigns the check
Purchase request(requisition)
Salesdepartment
Purchasingdepartment
Business Document Prepared by Sent to
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Internal Control: Payments Disbursement Packet
Purchase Request
Purchase Order
Receiving Report
Invoice
Disbursement Packet
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Element ofInternal Control
Internal Controls overCash Payments
Competent, reliable,ethical personnel
Payments entrusted to high levelemployees and the treasurer.
Proper authorizationLarge expenditures must be
authorized by top management.
Internal ControlsOver Cash Payments
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Internal ControlsOver Cash Payments
Internal: management policiesExternal: control over cash payments
Internal andexternal audits
Electronic andcomputer controls
Computer programmers do notoperate the computers.
Employees who handle checks haveno access to accounting records.
Separation of duties
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Use a budget to
manage cash.
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Using a Budget to Manage Cash
A budget is a financial plan thathelps coordinate business activities.
A cash budget helps a company,or an individual, manage cash byplanning the receipt and payment
of cash during a future period.
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Cash Budget Example
1. Cash balance, February1, 20x2 $ 202.6
Estimated cash receipts: 2. Collections from customers 2,858.3 3. Interest and dividends on investments 6.2 4. Sale of store fixtures 4.9
$3,072.0Estimated cash payments: 5. Purchases of inventory $1,906.2 6. Operating expenses 561.0 7. Expansion of existing stores 206.4 8. Opening of new stores 344.6 9. Payment of long-term debt 148.710. Payment of dividends 219.0 3,385.911. Net cash position at January 31, 20x3 (111.3)12. Budgeted / Desired cash balance, January 31, 20x3 200.013. Additional cash needed to meet desired 1/31/x3 balance $ 311.3
Cash Budget For the Year Ended January 31, 20x3 (In millions)
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Reporting Cash onthe Balance Sheet
Companies usually combine all cash amountsinto a single total called “Cash and Cash
Equivalents” on the balance sheet.
Cash equivalents include liquid assets…
Time deposits Certificates of deposit
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Reporting Cash onthe Balance Sheet
America Online, Inc.Consolidated Balance Sheet
December 31 Excerpts
AssetsCurrent assets:
Cash and cash equivalents $2,610Short-term investments 886Accounts receivable 464
(In Millions) 2000
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Weigh ethical judgment in
business.
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Ethics and Accounting
Most large companies have a code of ethicsdesigned to encourage ethical and
responsible behavior by employees.
Accountants have additionalincentives to behave ethically.
AICPA Code of Professional Conduct
Standards of Ethical Conductfor Management Accountants
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Ethics and Accounting
Conflict of Interest
EnronCorporation
A. Fastow, CEO
OutsidePartnershipA. Fastow,Principal
Business
transactions
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End of Chapter 4