Lecture Principles of financial accouting - Chapter 8: Cash and internal controls

After completing this chapter you should be able to: Define internal control and identify its purpose and principles, define cash and cash equivalents and explain how to report them, compute the days’ sales uncollected ratio and use it to assess liquidity.

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 Winston Kwok, Ph.D., CPA

McGraw­Hill/Irwin         Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.

Chapter 8

Cash and Internal Controls

Internal Control System

Policies and procedures managers use to:

 Protect assets.

 Ensure reliable accounting.

 Promote efficient operations.

 Urge adherence to company policies

C1

Principles of Internal Control

Internal control principles common to all companies:

1 Establish responsibilities.

2 Maintain adequate records.

3 Insure assets and bond key employees.

4 Separate recordkeeping from custody of assets.

5 Divide responsibility for related transactions.

6 Apply technological controls.

7 Perform regular and independent reviews.

C1

Technology and Internal Control

Reduced Processing

of Records

More Extensive Testing

of Records

Limited Evidence of

Processing

Limited Evidence of

Processing

Crucial Separation of

Duties

Crucial Separation of

Duties

Increased E-Commerce

Increased E-Commerce

C1

Limitations of Internal ControlHuman Error

Negligence Fatigue Misjudgment Confusion

Human Fraud

Intent to defeat internal controls for personal gain

C1

Human fraud triple-threat:

Opportunity, Pressure, and Rationalization.

Limitations of Internal Control

The costs of internal controls must not exceed their benefits.

The costs of internal controls must not exceed their benefits.

Costs

Benefits

C1

Control of Cash

An effective system of internal control that protects cash and cash equivalents should meet

three basic guidelines:

An effective system of internal control that protects cash and cash equivalents should meet

three basic guidelines:

Cash disbursements are made by check.

C2

Cash receipts are promptly deposited in a

bank.

Cash receipts are promptly deposited in a

bank.

Cash, Cash Equivalents,

and Liquidity

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.

C2

Cash and similar assets are called liquid assets because

they can be readily used to settle such obligations.

Cash Management

The goals of cash management are twofold:

1 Plan cash receipts to meet cash payments when due.

2 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.

C2

Over-the-Counter Cash Receipts

P1

This graphic illustrates that none of the people

involved can make a mistake or divert cash without the difference being revealed

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

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

Cash Receipts by Mail

Recordkeeper

The recordkeeper records the amounts received in the accounting records.

Control of Cash Disbursements

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.

P1

Control of cash disbursements is

especially important as most large thefts occur from payment

of fictitious invoices.

Voucher System of Control

A voucher system establishes procedures

for:

1 Verifying, approving, and recording

obligations for eventual cash disbursements.

2 Issuing checks for payment of verified,

approved, and recorded obligations.

A voucher system establishes procedures

for:

1 Verifying, approving, and recording

obligations for eventual cash disbursements.

2 Issuing checks for payment of verified,

approved, and recorded obligations.

P1

Voucher System of Control

P1

Petty Cash System of Control

Small payments required in most companies

for items such as postage, courier fees,

repairs, and supplies.

Small payments required in most companies

for items such as postage, courier fees,

repairs, and supplies.

P2

Operating a Petty Cash Fund

Petty Cash

Company Cashier

P2

Accountant

Petty Cashier

Petty Cash

Petty Cashier

Operating a Petty Cash Fund

P2

Petty Cashier

A petty cash fund is

used only for business expenses.

A petty cash fund is

used only for business expenses.

Operating a Petty Cash Fund

P2

Supplies Services

Transportation-in

Operating a Petty Cash Fund

Petty cash receipts

with either no signature

or a forged signature

usually indicate misuse

of petty cash.

Petty cash receipts

with either no signature

or a forged signature

usually indicate misuse

of petty cash.

Petty Cashier

P2

Delivery Supplies

Services Transportation-in

Company

Cashier

$71.30

To reimburse petty cash fund Petty

Cashier

Operating a Petty Cash Fund

P2

Accountant

Basic Bank Services

Bank Accounts Signature CardsSignature Cards Deposit Tickets

Funds Transfer

Electronic Funds Transfer StatementsBank

Bank Statements

Bank Statement

Usually once

a month, the bank sends

each depositor a

bank statement showing the activity in the account.

C2

Bank Reconciliation

A bank reconciliation is prepared periodically to explain

the difference between cash reported on the bank

statement and the cash balance on company’s books.

P3

Bank Reconciliation

P3

The balance of a checking account reported on

the bank statement rarely equals the balance in

the depositor’s accounting records

Cash Balance per Bank

+ Deposits in Transit

- Outstanding Checks

+/- Errors Adjusted Cash Balance

Cash Balance per Book + Collections & Interest

- Uncollectible items

+/- Errors Adjusted Cash Balance

Adjusting entries are recorded for the reconciling items on

the book side of the reconciliation

=

Illustration of a Bank Reconciliation

We follow nine steps in preparing the

bank reconciliation

Illustration of a Bank Reconciliation

P3

We follow nine steps in preparing the

bank reconciliation

Cash Balance per Book

+ Collections & Interest

- Uncollectible items

+/- Errors Adjusted Cash Balance

Illustration of a Bank Reconciliation

P3

We follow nine steps in preparing the

bank reconciliation

Adjusting entries are recorded for the reconciling

items on the book side of the reconciliation

Illustration of a Bank Reconciliation

P3

Only the items reconciling the book balance

require adjustment

DAYS’ SALES UNCOLLECTED

Days’

Sales Uncollected

Accounts Receivable

Net Sales × 365

=

Indicates how much time is likely to pass before

we receive cash receipts from credit sales.

Indicates how much time is likely to pass before

we receive cash receipts from credit sales.

A1

56 days $612,000,000

$4,022,000,000 × 365

=

account is recorded and brought to management’s

attention.

END OF CHAPTER 8