CHAPTER 6

ACCOUNTING FOR CASH AND INTERNAL CONTROLS

Cash is a medium of exchange that a bank accepts for a deposit. Cash includes, Coins, Currency( paper
money), saving account, Bank draft and money order.
Purpose of Internal Controls:
Internal controls are a system of policies and procedures used by companies to safeguard assets and
ensure that transactions are recorded properly and in a timely manner.
Principles of Internal Control:
 Establish responsibilities
 Maintain adequate records
 Insure assets and key bond employees
 Separation of recordkeeping from custody of assets
 Divide responsibility for related transactions
 Apply technological controls
 Perform regular and independent reviews
Bank Reconciliation:
 Identifies and explains the differences or reconciling items between the cash balance in the depositor’s
general ledger and the cash balance according to the bank’s records.
 Reconciling items are transactions which have been recorded by either the depositor or the bank, but
not both, AND transactions which were not properly recorded by the depositor and/or the bank.
 Adjusting entries are recorded by the depositor for all reconciling items on the depositor’s side of the
bank reconciliation. If the adjusting entries are not recorded, these items will continue to appear on the
reconciliation if subsequent months until the adjusting entries have been made.
Petty Cash Account:
 Imprest account (balance does not fluctuate as cash is spent or replenished)
 Account is used to pay for minor expenses.
 Account is debited when it is created or the balance is increased and credited when the balance is
decreased.
Voucher System:
 a set of control procedures designed to ensure the cash disbursements have been properly approved and
are supported by the appropriate documents.
Bank Reconciliation
The balance according to the bank statement and the balance according to the depositor’s records must be
adjusted on the reconciliation properly determine the cash balance that should be in the general ledger.
Both the bank balance and the ledger balance are adjusted for items not previously recorded as follows:
Bank Balance Ledger Balance
Add: Deposits in Transit Add: Notes collected by the bank
Deduct: Outstanding Checks Deduct: Service Charges
Errors may be add or deducted NSF checks Errors
Errors may be add or deducted
** All adjustments to the ledger balance MUST be journalized in order for the cash account in the ledger
to agree with the adjusted cash balance.
Example #1
The cash account for Ace Co. on August 31, 2004, indicated a balance of $9,420. The bank statement
indicated a balance of $12,785 on August 31, 2004. The following reconciling items were discovered.
a) Checks outstanding totaled $6,240.
b) A deposit of $5,375, representing cash receipts of August 31, had been made too late to appear on the
bank statement.
c) A check for $240 had been incorrectly charged by the bank as $420.
d) A check for $658 returned with the statement had been recorded by Ace as $568. The check was for
the payment of an obligation to Cahill Co. on account.
e) The bank had collected for Ace $2,800 on a note left for collection.
The face of the note was $2,000.
f) Bank service charges for August amounted to $30.
Required: Prepare the bank reconciliation and journalize the necessary entries.
Cash balance according to bank statement $12,785
Add: Deposit of August 30 not recorded by bank $5,375
Bank error 180 5,555
$18,340
Deduct: Outstanding checks 6,240
Adjusted balance $12,100

Cash balance according to depositor’s records $9,420

Add: Proceeds of note and interest collected by bank 2,800
12,220
Deduct: Error in recording check $90
Bank service charges 30 120
Adjusted balance $12,100

Journal entries
Cash 2,800
Notes Receivable 2,000
Interest Revenue 800
A/P-Cahill Co. 90
Misc. Adm. Expense 30
Cash 120

Petty Cash

A Petty Cash fund is used to provide small amounts of cash for common expenditures for which the
company does not write a check or purchase on account. The petty cash account always has an entry to
establish the fund and perhaps a subsequent entry to increase or decrease the fund’s balance.
Replenishment entries are not recorded using the petty cash account. Any differences between the total of
the receipts for funds expended and the amount necessary to replenish the fund balance are debited or
credited to the Cash Short and over account.
The replenishment entry can be prepared in three steps:
 Debit each expense account for the amount spent from the receipt
 Credit Cash for the difference between the imprest balance and actual cash
Remaining in the fund
 If the entry does not balance debit or credit the difference to Cash Over and Short as appropriate
In June, the Filbert Company established a petty cash account with a $200 balance.
During June, the following expenditures were made from petty cash: supplies $95,
FEDEX bills $42, and miscellaneous other receipts $38. When counted, there was $25
of cash remaining in the petty cash fund. Journalize the entries for June.

Solution #2:
Petty Cash 200
Cash 200 To establish the fund

Supplies 95 to replenish the fund and record all the expenses paid for in cash.
Delivery Expense 42
Misc. Adm. Expense 38
Cash 175

If it was in the case of voucher system

Petty cash 200
Account payable 200 for petty cash establishment

Account payable 200

Petty cash 200

Supplies 95
Delivery Expense 42
Misc. Adm. Expense 38
A/P 175

A/P 175

Cash at bank 175

The Cash Over and Short account has two purposes:

 It will be debited or credited for the difference between the total of the receipts and the cash required to
replenish the petty cash account. If there are missing receipts, the account is debited and if there is too
much cash in the account, the account is credited.
 It is used to record shortages or overages in the cash register. The cash in the drawer represents a debit
to cash. The cash register tape represents the credit to sales. If there is a shortage, it is debited Cash Short
and Over. If there is an overage, it is credited Cash Short and Over.
Example #3:
In July, the Filbert Company made the following expenditures from petty cash: repairs
$85, FEDEX bills $60 and postage $13. When counted, there was $40 of cash remaining in the petty cash
fund. Journalize the entries for July.
Solution #3:
Supplies 85
Delivery Expense 60 from receipts
Misc. Adm. Expense 13
Cash Over and Short 2 160 – 85 – 60 – 13 = 2
Cash 160
The bank account

It is one of the major devices for maintaining control over cash. To get the most benefit from the bank
account, all cash received must be deposited in the bank and all payments must be made by checks drawn
on the bank or from special cash funds. When such system is strictly followed, there is a double record of
cash, one maintained by the business and the other by the bank. In some cases a bank may require a
business to maintain a minimum cash balance called compensating balance. This requirement is
generally imposed by the bank as a part of a loan agreement or line of credit (an amount the bank is
willing to lend).

Forms used in a bank account

A) Signature card: At the time account is opened, an identifying number is assigned to the account
which is used for verification. The depositor will sign on. It is a written check.

B) Deposit ticket (slip): Used by the business as a receipt to record the cash deposit. A copy is given by
the bank to the depositor.

C) Check: is a written document signed by the depositor, ordering the bank to pay a sum of money to an
individual or business entity (to the order of a designated person). Three parties involved in a check:

1) Maker (drawer): The one who signs the check.

2) Payer (drawee): the bank on which the check is drawn.
3) Payee: the one (party) to whom payment is made. Is the one (party) to whose order the check is
drawn.
Make check payee check Bank

Money
The Voucher System:-

A Voucher system is made up of records, methods, and procedures used in proving and recording
liabilities and in making and recording cash payments. A voucher systems uses (1) Vouchers, (2) a
voucher register, (3) a file for unpaid voucher (unpaid voucher file), 4) a check register, and (5) a file for
paid vouchers (paid voucher file.

Voucher means any document that serves as proof of authority to pay cash, such as an invoice approved
for payment or as evidence that cash has been paid, such as a canceled check. A voucher is a special form
on which is recorded relevant data about a liability and the details of its payment. The basic idea of this
system is that every transaction that will result in cash disbursement must be verified, approved in
writing, and recorded before a check is issued. A voucher is a written authorization from prepared for
each expenditure. The following steps are invoiced under the voucher system

1- preparation of a voucher
2- approval of the voucher
3- recording the voucher
4- filing the unpaid voucher
5- paying the voucher
CHAPTER 7
ACCOUNTING FOR RECEIVABLES
Accounts Receivable:
 Result from sales on account (credit sales), not cash sales.
 May also result from credit card sales if there is a delay between when sale is made and when
the cash is received from the credit card company.

Accounting for Uncollectible Accounts:

 Not all sales on account result in cash being collected from the customer.
 Account receivable that are not collected result in an operating expense.
 the matching principle requires that this expense be recorded in the period of sale, not the
period when the account is determined to be uncollectible.
 The Allowance Method is GAAP and fulfills the matching principle.
 The Direct Write-off Method is not GAAP and may not be used unless the expense closely
approximates the expense under the Allowance Method.

Determining the Amount of Uncollectible Receivables and Bad Debt Expense:

The Percent of Sales Method
Uses credit sales for the period to estimate bad debt expense for the period. Sometimes referred
to as the income statement method.
The Percent of Receivables Method
Analyses the balance in Accounts Receivable to estimate the balance in the Allowance for
Uncollectible Accounts at the end of the period. Sometimes referred to as the balance sheet
method.
Accounts Receivable on the Balance Sheet:
Allowance account is deducted from Accounts Receivable to determine Net
Realizable Value.
Notes Receivable:
Notes Receivable may be accepted by the seller in payment for a sale or to replace an account
receivable from a prior sale.
 Notes bear interest for their term which is paid at the end of the term, the maturity date.
 Interest rates are typically stated as a percent per annum, that is, as a yearly or annual rate.
 Interest revenue is earned as time passes, regardless of whether payment has been received.
 Interest revenue for outstanding notes receivable is typically accrued at the end of the year,
although it may be accrued at the end of a quarter or month.
 If the note is not paid or dishonored at maturity, the amount of the principal and interest is
debited to accounts receivable because it is still payable to the seller by the buyer. Another note
may also be accepted by the buyer in place of the account receivable
Allowance Method
The Allowance Method takes its name from the Allowance for Uncollectible Account which is
used to properly value accounts receivable until the uncollectible account receivable can be
written-off.
The Allowance Method debits bad debt expense in the period when the sale is recorded and
credits a contra-asset account, Allowance for Uncollectible Accounts.
Uncollectible Accounts Expense xxx
Allowance for Uncollectible Accounts xxx
In the period in which a specific account is determined to be uncollectible, the Allowance is
debited and Accounts Receivable is credited.
Allowance for Uncollectible Accounts xxx
Accounts Receivable xxx
Uncollectible Accounts Expense is reported on the Income Statement. The Allowance for
Uncollectible (Doubtful) Accounts is a contra asset account and is reported on the Balance Sheet
as a deduction from Accounts Receivable. The result is called Net Realizable Value:
Current Assets:
Accounts Receivable 25,000
Less allowance for doubtful accounts 3,000
Net Realizable Value 22,000
Sometimes a customer will pay the accounts receivable after it was written off.
Recording the receipt of cash is always a two-step process: first, the account receivable is
reinstated (added back into the general ledger) and second, the cash is recorded and accounts
receivable is reduced for the payment.
To reinstate the accounts receivable:
Accounts Receivable xxx
Allowance for Uncollectible Accounts xxx
To apply the cash received:
Cash xxx
Accounts Receivable xxx

Example #1: Journalize the following transactions.

2011 12/31 estimated that $8,000 of accounts receivable would become uncollectible.
2012 1/05 Wrote-off the $600 balance owed by Jane Camp and the $400 balance owed by
Friends, Inc.
2012 3/18 reinstated the account of Jane Camp that had been written off as Uncollectible
Solution #1
Uncollectible Accounts Expense 8,000
Allowance for Uncollectible Accounts 8,000

Allowance for Uncollectible Accounts 1,000

Accounts Receivable-Camp 600
Accounts Receivable-Friends 400

Accounts Receivable-Camp 600

Allowance for Uncollectible Accounts 600
Cash 600
Accounts Receivable-Camp 600

Methods for Estimating the Uncollectible Amount

In the period of sale, the customer that eventually will not pay the amount that will not be paid
and the period in which the customer’s account will become uncollectible cannot be determined.
Therefore, the uncollectible accounts expense must be estimated at the end of each accounting
period.

Percentage of Sales Method

The Percent of Sales Method uses one income statement account, Sales, to estimate the change in
another income statement account, Bad Debt Expense, for the period. This is the amount of the
required adjusting entry. This method is typically used by businesses with a large number of
customers with relatively uniform accounts receivable balances.
The balance in the Allowance account is the balance in the ledger before adjustment plus the
adjusting entry for bad debt expense.
The bad debt expense for the period is calculated by multiplying the uncollectible percentage
times the credit sales in the period to determine the uncollectible accounts expense for the period.
This will be the amount of the adjusting entry.
Example #2: Uncollectible accounts expense is estimated at ¼ of 1% of net sales of $4,000,000
for the year. The current balance in Allowance for Doubtful Accounts is $300 credit. Determine
the following:
a) The uncollectible accounts expense for the year.
b) The adjusting entry to be made on December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.
Solution #2
1. 4,000,000 * .0025 = $10,000
2. Uncollectible Accounts Expense 10,000
Allowance for Uncollectible Accounts 10,000
3. $300 credit balance + 10,000 additional credit = $10,300 credit balance

Percent of Accounts Receivable Method

The Percent of Receivables Method uses the balance in one balance sheet account, Accounts
Receivable, to estimate the balance in another balance sheet account, Allowance for
Uncollectible Accounts, at the end of the period.
The adjusting entry for bad debt expense is the difference between the balance in the ledger for
the allowance account before adjustment and the estimated balance in the allowance account.
The current balance of accounts receivable is analyzed by use of an aging schedule to determine
the desired ending balance for the Allowance for Doubtful Accounts. The uncollectible accounts
expense for the period is determined based on the current (unadjusted) balance in the Allowance,
the desired ending balance in the Allowance account and any write-offs of uncollectible accounts
during the period.

Percentage of receivables method is a balance sheet approach to bad debts estimation. It

calculates bad debts as a percentage of ending accounts receivable. This is usually done using a
procedure called aging of accounts receivable.

Unlike the percentage of sales method, the percentage of receivables method does not directly
estimate bad debts expense. This method actually estimates the ending balance of allowance for
bad debts account. The estimated bad debts expense is then calculated as shown below:

Ending Balance of Allowance for Bad Debts A/C

− CR Balance in Allowance for Bad Debts; or
+ DR Balance in Allowance for Bad Debts
= Bad Debts Expense

Example #3: The balance of Allowance for Doubtful Accounts before adjustment at the end of
the period is $400 debit. Based on an analysis of Accounts Receivable, it was estimated that
$10,000 would become uncollectible.
Determine the following:
a) The uncollectible accounts expense (bad debts expenses) for the year.
b) The adjusting entry to be made of December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.
Solution #3
a) Uncollectible accounts expense = 400 + 10,000= 10,400

b) Uncollectible accounts expense 10,400

Allowance for doubtful accounts 10,400

c) 10,000
DIRECT WRITE-OFF METHOD

The Direct Write-off Method records uncollectible accounts expense in the period when the
customer’s account is determined to be uncollectible. The entry to write-off the account
receivable is
Uncollectible accounts expense xxx
Accounts receivable xxx
In the period when a specific account is determined to be uncollectible. The Direct
Write-off Method violates the matching principle because it does not match revenues and
expenses in the same period.

NOTES RECEIVABLE
A Promissory Note is a written promise to pay a specific dollar amount on demand or at a
specific time, usually with interest. If the note is paid according to the terms, the note is honored.
If the note is not paid as agreed according to the terms, the note is dishonored. If the note is
dishonored, the amount due including the interest earned and unpaid is recorded in accounts
receivable.
At the end of the accounting period, in order to comply with the matching principle, interest must
be accrued for the number of days between the most recent interest payment date and the end of
the accounting period using the calculation method shown above.
Example #4: On July 17, 2001, received a $12,000, 90-day, 10% notes on account from Adams
Co.
Determine:
A) Due date for the note
B) Interest earned during the term of the note
C) Maturity value of the note
Prepare journal entries whether:
D) The note is honored on the maturity date
E) The note is dishonored on the maturity date
Solution #4:
a) Due Date:
Term of the note = 90
Days remaining in July 31 – 17 = 14
Remaining term of the note 76
Days in August 31
Remaining term of the note 45
Days in September 30
Remaining term of the note 15
Since the remaining 15 days are less than the 31 days in October, the note is due on October 15
B) Interest:
Calculated as Principal X Rate X Time
$12,000 x .10 x 90 days/360 days = $300
Time is calculated as the term of the note divided by 360 days for the year.
Time is always based on a 360-day year.
C) Maturity Value:
Calculated as Principal + Interest
$12,000 + $300 = $12,300
D) Note is honored:
7/17 Notes receivable 12,000
Accounts receivable 12,000
10/15 Cash 12,300
Notes receivable 12,000
Interest receivable 300
E) Note is dishonored:
7/17 Notes receivable 12,000
Accounts receivable 12,000
10/15 Accounts receivable 12,300
Notes receivable 12,000
Interest receivable 300
The difference between the two entries for 10/15 is the account to be debited.

Discounting Note receivable

To get cash quickly, company’s (payees) sometimes sell their note receivable to another party
before the note matures. The payee endorses the note and hands it over to the note purchaser,
usually bank, which collects the maturity value of the note at maturity date. Selling a note
receivable by endorsing before maturity value is called discounting a Note receivable because
the payee of the note receivable lesses than its maturity value.

Important terms related to discounting of a Note

Proceeds: is the amount of the cash obtained from the bank by discounting a note.

Discount: is the difference between the amount of the holder of the note received from the bank
and the maturity value of the note (maturity value plus proceed). It is computed on the maturity
value of the note for the period of time the bank must hold the note i.e. the due date of transfer
and due date. The difference between the amount of the proceeds and the face values (carrying)
of the note is recorded by the payee as interest income or interest expense.

If proceeds exceeds principal = interest income

If principal exceeds proceeds = interest expense

Discount period: is the period (number of days) from the date of discounting the note to the date
of maturity. It is the period in which the bank holds the note (the period that lies between the
notes is discounted until it matures).

Steps in computing the proceeds

1) Determine the maturity value (maturity value= face value plus interest)
2) Determine discount period
3) Determine the discount amount(discount = mv x discount rate x discount period)
4) Determine the proceeds (proceeds = maturity value - discount)

Example, assume that a note a 90 day, 12% note receivable for $1800 dated November 8, is
discounted at the payee’s bank on December 3, at the rate of 14%. Required, calculate

1) Maturity value of the note (MV)

Face value of the note Nov 8……………………. $1800
Interest on note 90 days at 12% …………………….54
Maturity value of the note due Feb 6……………… $1,854
2) Discount period
Discount period December 3 to Feb 6……………65 days
3) Discount
Discount on maturity value = $1854 x 14% x 65/360 =$46.87
4) Proceeds = maturity value – discount = $1854- 46.87 = $1807.13

The excess of the proceeds from discounting the note $7.13($1807.13-1800) over its face value
$1800 is recorded as interest income. Therefore, the entry on December 3 is

December 3/ cash………………….1807.13
 Note receivable………………………………….1800

Interest income……………………………………..7.13

Assume also that if the discount rate is 20% instead of 14%

Discount = $1854 x 20% x 65/360 =$66.95

Proceed = $1854 – 66.95 = $1787.05

December 3/ cash………………..1787.05

Interest expense……….12.95

Note receivable……………………….1800