internal control, managing cash, and making ethical judgments

7 - 1©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber

Internal Control, Managing Cash,

and Making Ethical JudgmentsChapter

7


Define internal control.

Objective 1


Internal Control

What is internal control? It is the organizational plan and all the related

measures that an entity adopts to…– safeguard assets,– encourage adherence to company policies,– promote operational efficiency, and...– ensure accurate and reliable accounting

records.


Operational ControlsOperational Controls

Financial Reporting ControlsFinancial Reporting Controls

Internal Control


Identify the characteristics

of an effective systemof internal control.

Objective 2


Establishing an Effective System of Internal Control

Characteristics of an effective internal control system include:

1 Competent, reliable, and ethical personnel2 Assignment of responsibilities3 Proper authorization4 Separation of duties


Separation of operations from accountingSeparation of operations from accounting

Separation of the custody of assets from accountingSeparation of the custody of assets from accounting

Separation of the authorization of transactionsfrom the custody of related assets

Separation of the authorization of transactionsfrom the custody of related assets

Separation of duties within the accounting functionSeparation of duties within the accounting function

Separation of Duties


Stolen credit card numbersStolen credit card numbers

Computer virus and Trojan horsesComputer virus and Trojan horses

Impersonation of companiesImpersonation of companies

Internal Controls for e-Commerce



What is an encryption? It is the primary method of achieving

confidentiality in e-commerce. Plain-text messages are rearranged by some

mathematical process. The encrypted message cannot be read by

anyone who does not know the process.



The Internet Corporate IntranetFirewallFirewall

Network Computers


The Limitations ofInternal Control

Most internal control measures can be circumvented or overcome.

Collusion is when two or more employees work as a team with the purpose to defraud the firm.


The Bank Account as aControl Device

Documents used to control a bank account include:

– signature card– deposit ticket– check– bank statement– bank reconciliation


The Bank Reconciliation

What are two records of a business’s cash?1 Cash account in the business’s own general

ledger.2 The bank statement which tells the actual

amount of cash the business has in the bank.



Items recorded by a company not on the bank statement:

– deposit in transit– outstanding checks



Items on a bank statement and not recorded by the business:

– bank collections– bank fees– interest earned on account– NSF checks


The Paths That Two Checks Take (Good Check)

akerwrites check

to payee.

akerwrites check

to payee.Payee

deposits checkin bank.

Payeedeposits check

in bank.Payee’s bank

sends check tomaker’s bank.

Payee’s banksends check tomaker’s bank.

Maker’s bankpays the check.Maker’s bank

pays the check.


The Paths That Two Checks Take (NFS Check)

Maker’s bankbalance is notsufficient to

pay the check.

Maker’s bankbalance is notsufficient to

pay the check.Maker’s banksends theworthless

check back topayee’s bank.

Maker’s banksends theworthless

check back topayee’s bank. Payee’s bank

decreases payee’sbalance.

Payee’s bankdecreases payee’s

balance.

Payee holdsworthless

check.

Payee holdsworthless

check.


Prepare a bank reconciliationand the related journal

entries.

Objective 3


The Bank Reconciliation Example

At the beginning of July, Sahita, Inc. received the June’s bank statement.

It indicated the following: The bank balance was $63,275. The bank had collected a note receivable

from one of Sahita’s customers in the amount of $1,325.



The bank paid the electric bill of $1,500. There was a $200 check returned for NSF. Interest earned on the account was $265. Bank service charges were $12.



Sahita’s books indicates a cash balance of $66,647.

A deposit of $11,250 was mailed to the bank on June 30.

Checks issued in June for $8,000 have not yet been paid by the bank.


Balance per bank, June 30 $63,275

Add deposit in transit 11,250$74,525

Less outstanding check 8,000Adjusted bank balance $66,525

Balance per bank, June 30 $63,275

Add deposit in transit 11,250$74,525

Less outstanding check 8,000Adjusted bank balance $66,525



Balance per books, June 30 $66,647Add: Note receivablecollected by the bank 1,325Interest income 265

$68,237Less: Payment of electric bill 1,500NSF check 200Service charge 12Adjusted book balance $ 66,525

Balance per books, June 30 $66,647Add: Note receivablecollected by the bank 1,325Interest income 265

$68,237Less: Payment of electric bill 1,500NSF check 200Service charge 12Adjusted book balance $ 66,525




Balance per books$66,525

Balance per books$66,525

Balance per bank$66,525

Balance per bank$66,525

Equal amountsEqual amounts


Record Reconciling Items

June 30, 200xCash 1,325

Notes Receivable 1,325 Notes collected by the bank

June 30, 200xCash 1,325

Notes Receivable 1,325 Notes collected by the bank

June 30, 200xCash 265

Interest Income 265 Interest earned on bank balance

June 30, 200xCash 265

Interest Income 265 Interest earned on bank balance



June 30, 200xUtilities Expense 1,500

Cash 1,500Monthly electricity expense

June 30, 200xUtilities Expense 1,500

Cash 1,500Monthly electricity expense

June 30, 200xAccounts Receivable – NSF 200

Cash 200NSF check returned by bank

June 30, 200xAccounts Receivable – NSF 200

Cash 200NSF check returned by bank



June 30, 200xBank Service Fees 12

Cash 12

Bank service charges

June 30, 200xBank Service Fees 12

Cash 12

Bank service charges


Apply internal controls

to cash receipts.

Objective 4


Cash ReceiptsOver the Counter

The terminal should be positioned so that customers can see the amount the cashier enters into the cash register.

The cash drawer should open only when the sales clerk enters an amount on the keypad.

The roll of tape locked inside the machine records each sale and cash transaction.



Pricing merchandise at “uneven” amounts means that the clerk has to open the cash drawer.

This requires entering the amount of the sale on the keypad and so onto the register tape.



At the end of the day, the cashier deposits the cash in the bank.

The tape goes to accounting.


Cash Receipts by Mail

All incoming mail should be opened by a mailroom employee.

This person should compare the check received with the remittance advice.

Cash receipts should be given to the cashier. The mailroom employee forwards the

remittance advice to accounting.


Cash Receipts by Mail

Many companies use a lock-box system. Customers send their checks directly to an

address that is a bank account. Company personnel do not handle the cash.


Cash 24,980 Cash Short and Over 20 Sales Revenue 25,000 Daily cash sales

Cash 24,980 Cash Short and Over 20 Sales Revenue 25,000 Daily cash sales

Cash Short and Over

Assume that the cash register tapes indicate sales revenue of $25,000.

However, the cash received was $24,980. What entry would record the day’s sales?


Apply internal controls

to cash payments.

Objective 5


Control OverApproval of Payments

Purchase Request

Purchase Order

Invoice

Receiving Report

Disbursement Packet


Control OverApproval of Payments

The accounting department...– combines all of these documents,– checks them for accuracy, and...– forwards this disbursement packet to

designated officers for approval and payment.


Controlling Petty Cash Payments

On June 15, Sahita Inc. manager decided to establish a $250 petty cash fund.

What is the entry?

June 15, 200xPetty Cash 250

Cash in Bank 250To open the petty cash fund

June 15, 200xPetty Cash 250

Cash in Bank 250To open the petty cash fund



Jose is the petty cash custodian responsible for the fund.

On June 20, he purchased supplies in the amount of $70.

For each disbursement, he prepares a petty cash ticket.

At all times the amount of cash in the petty cash fund plus the petty cash tickets must equal $250.



Jose also spent $20 for delivery charges and $60 for coffee and other miscellaneous expenses.

What is the journal entry to record the replenishment of the fund?


June 30, 200xSupplies 70Delivery Expense 20Miscellaneous Expense 60

Cash in Bank 150To replenish the petty cash fund

June 30, 200xSupplies 70Delivery Expense 20Miscellaneous Expense 60

Cash in Bank 150To replenish the petty cash fund



Using a budget to

manage cash.

Objective 6


Cash Budget Example

On June 1, the cash balance of Clara’s Boutique amounted to $20,000.

She expected collections during the month to be $100,000.

Clara budgeted $110,000 cash payments during the month.

She would like to keep a $20,000 balance at all times.

How much money must she borrow?


Cash Budget Example

Beginning balance $ 20,000 Budgeted collections 100,000 Cash available $120,000 Less budgeted payments 110,000 Cash balance $ 10,000 She needs to borrow $10,000.


Cash Budget Example

Not included in the budgeted collections is a $73,400 sale to a store in Rio de Janeiro.

She expects to collect this amount in July. Assume the exchange rate is 3.67 reals per

dollar. How much does she expect to collect? 73,400 reals ÷ 3.67 = $20,000


Make ethical judgments

in business.

Objective 7


Ethics and Accounting

Code ofConduct

88%

Companies

—

0.75 —

0.50 —

0.25 —

0.00


Professional Code of Ethics

Accountants are held to very high standards of conduct.

There is no compromising. Would you hire an accountant who is

“almost always” honest? Internal controls rely upon basic honesty

and integrity.


End of Chapter 7