Chapter

8

Cash and Internal Control
Chapter 8-1

Study Objectives
1. Define fraud and internal control. 2. Identify the principles of internal control.

3. Explain the applications of internal control principles to cash receipts.
4. Explain the applications of internal control principles to cash disbursements. 5. Describe the operation of a petty cash fund. 6. Indicate the control features of a bank account.

7. Prepare a bank reconciliation.
8. Explain the reporting of cash.
Chapter 8-2

Fraud, Internal Control, and Cash

Fraud and Internal Control

Cash Controls

Control Features: Use of a Bank
Making deposits

Reporting Cash

Fraud

The SarbanesOxley Act
Internal control Principles of internal control

Cash receipts controls Cash disbursements controls

Cash equivalents

Writing checks
Bank statements Reconciling the bank account Electronic funds transfer (EFT) system

Restricted cash
Compensating balances

Limitations

Chapter 8-3

Fraud and Internal Control
Fraud
Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.

Illustration 8-1

Why does fraud occur?

Chapter 8-4

SO 1 Define fraud and internal control.

Chapter 8-5

Fraud and Internal Control

The Sarbanes-Oxley Act
Companies must develop principles of control over financial reporting. continually verify that controls are working. Independent auditors must attest to the adequacy of internal control. SOX created the Public Company Accounting Oversight Board (PCAOB).
Chapter 8-6

SO 1 Define fraud and internal control.

Fraud and Internal Control
Internal Control
Methods and measures adopted to:
1. Safeguard assets. 2. Enhance accuracy and reliability of accounting records. 3. Increase efficiency of operations, and 4. Ensure compliance with laws and regulations.
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control.
Chapter 8-7

SO 1 Define fraud and internal control.

Fraud and Internal Control
Internal Control
Internal control systems have five primary components
1. A control environment 2. Risk assessment

3. Control activities
4. Information and communication 5. Monitoring

Chapter 8-8

SO 1 Define fraud and internal control.

Fraud and Internal Control
Principles of Internal Control Activities
Measures vary with
management’s assessment of the risks faced. size and nature of the company.
Six principles of controls activities:

     
Chapter 8-9

Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls
SO 2 Identify the principles of internal control.

Fraud and Internal Control
Principles of Internal Control Activities
ESTABLISHMENT OF RESPONSIBILITY Control is most effective when only one person is responsible for a given task. SEGREGATON OF DUTIES Related duties, including physical custody and record keeping, should be assigned to different individuals. DOCUMENTATION PROCEDURES Companies should use prenumbered documents for all documents should be accounted for.
Chapter 8-10

SO 2 Identify the principles of internal control.

Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
Illustration 8-2

Chapter 8-11

SO 2 Identify the principles of internal control.

Fraud and Internal Control
Principles of Internal Control Activities
INDEPENDENT INTERNAL VERIFICATION 1. Verify records periodically or on a surprise basis. 2. Records verified by an employee who is independent.
3. Discrepancies reported
Illustration 8-3

to management.

Chapter 8-12

SO 2 Identify the principles of internal control.

Fraud and Internal Control
Principles of Internal Control Activities
HUMAN RESOURCE CONTROLS 1. Bond employees. 2. Rotate employees’ duties and require vacations. 3. Conduct background checks.

Chapter 8-13

SO 2 Identify the principles of internal control.

Chapter 8-14

Fraud and Internal Control
Limitations of Internal Control
Costs should not exceed benefit.

Human element.
Size of the business.

Chapter 8-15

SO 2 Identify the principles of internal control.

Cash Controls
Cash Receipts Controls
Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash
Illustration 8-4 Chapter 8-16

Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips Physical, Mechanical, and Electronic Controls

Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Human Resource Controls Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily

Store cash in safes and bank vaults; limit access to storage areas; use cash registers

SO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Discussion Question
Q8-6. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why?

See notes page for discussion
Chapter 8-17

SO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Discussion Question
Q8-11. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control.

See notes page for discussion
Chapter 8-18

SO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Cash consists of coins, currency, checks, money orders, and money on hand or on deposit in a bank. Cash receipts come from: cash sales

collections on account from customers
receipt of interest, rent, and dividends investments by owners

bank loans
proceeds from the sale of noncurrent assets
Chapter 8-19

SO 3 Explain the applications of internal control principles to cash receipts.

Over-theCounter Receipts

Illustration 8-4

Chapter 8-20

SO 3 Explain the applications of internal control principles to cash receipts.

Mail Receipts
Control Procedures:
Mail receipts should be opened by two people, a list prepared, and each check endorsed.
Copy of the list, along with the checks and remittance advices, sent to cashier’s department. Cashier adds the checks to the over-the-counter receipts and prepares a daily cash summary and makes the daily bank deposit. Copy of list sent to treasurer’s office for comparison with total shown on daily cash summary.
Chapter 8-21

SO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Review Question
Permitting only designated personnel to handle cash receipts is an application of the principle of:
a. segregation of duties.

b. establishment of responsibility.
c. independent check. d. Human resource controls.

Chapter 8-22

SO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Cash Disbursements Controls
Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash. Applications:

Voucher system
Petty cash fund

Chapter 8-23

SO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls
Cash Disbursements Controls
Establishment of Responsibility Only designated personnel are authorized to sign checks (treasurer) and approve vendors
Segregation of Duties Different individuals approve and make payments; check signers do not record disbursements
Chapter 8-24 Illustration 8-6

Documentation Procedures Use prenumbered checks; checks must have an approved invoice; require employees to use corporate credit cards for reimbursable expenses Physical Controls

Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly
Human Resource Controls Bond personnel who handle cash; require employees to take vacations; conduct background checks

Store blank checks in safes, with limited access; print check amounts by machine in indelible ink

Cash Controls
Discussion Question
Q8-17 Joe Griswold Company’s internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls.

See notes page for discussion
Chapter 8-25

SO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Review Question
The use of prenumbered checks in disbursing cash is an application of the principle of:
a. establishment of responsibility.

b. segregation of duties.
c. physical, mechanical, and electronic controls. d. documentation procedures.

Chapter 8-26

SO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls
Cash Disbursements Controls
Voucher System
Network of approvals, by authorized individuals, to ensure all disbursements by check are proper. A voucher is an authorization form prepared for each expenditure.

Chapter 8-27

SO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls
Cash Disbursements Controls
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund.

Chapter 8-28

SO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The fund was established on March 1 with a balance of $100. During March the following petty cash receipts were found in the petty cash box.
March 5 March 7 March 9 March 11 March 14 Stamp inventory Freight-out Miscellaneous expense Travel expense Miscellaneous expense $39 21 6 24 5

The fund was replenished on March 15 when the fund contained $3 in cash. On March 20, the amount in the fund was increased to $150. Instructions: Journalize the entries in March that pertain to the operation of the petty cash fund.
Chapter 8-29

SO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 The fund was established on March 1 with a balance of $100. March 1 Petty cash Cash 100 100

Chapter 8-30

SO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 The fund was replenished on March 15 when the fund contained $3 in cash. March 15 Postage expense Freight-out Miscellaneous expense Travel expense 39 21 11 24

Cash over and short Cash

2
97

Chapter 8-31

SO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 On March 20, the amount in the fund was increased to $150. March 20 Petty cash Cash 50 50

Chapter 8-32

SO 5 Describe the operation of a petty cash fund.

Control Features: Use of a Bank
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions. Bank reconciliation.

Chapter 8-33

SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank
Making Bank Deposits
Authorized employee should make deposit.
Illustration 8-8

Bank Code Numbers

Front Side
Chapter 8-34

Reverse Side
SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank
Writing Checks
Illustration 8-9

Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient.
Maker Payee Payer

Chapter 8-35

SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank
Bank Statements
Debit Memorandum
Bank service charge NSF (not sufficient funds)
Illustration 8-10

Credit Memorandum
Collect notes receivable.

Interest earned.
Chapter 8-36

SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank

Review Question
The control features of a bank account do not include:
a. having bank auditors verify the correctness of the bank balance per books. b. minimizing the amount of cash that must be kept on hand. c. providing a double record of all bank transactions. d. safeguarding cash by using a bank as a depository.
Chapter 8-37

SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank
Reconciling the Bank Account
Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks. 3. Errors. 4. Bank memoranda.
Chapter 8-38

SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank
Reconciliation Procedures
Illustration 8-11

+ Deposit in Transit Outstanding Checks

+ Notes collected by bank NSF (bounced) checks Check printing or other service charges

+- Bank Errors

+- Company Errors CORRECT BALANCE
Chapter 8-39

CORRECT BALANCE
SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank
E8-11 The following information pertains to Family Video Company.
1.

Cash balance per bank, July 31, $7,263.

2.
3. 4. 5.

Cash balance per books, July 31, $7,284.
July bank service charge not recorded by the depositor $28. Deposits in transit, July 31, $1,500. Bank collected $900 note for Family in July, plus interest $36, less fee $20.The collection has not been recorded by Family, and no interest has been accrued. Outstanding checks, July 31, $591.

6.

Instructions a) Prepare a bank reconciliation at July 31. b) Journalize the adjusting entries at July 31 on the books of Family Video Company.
Chapter 8-40

SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank
E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement
Add: Deposit in transit Less: Outstanding checks Adjusted cash balance per bank $7,263 1,500 (591) $8,172 $7,284 900 36 (28) (20) $8,172
SO 7 Prepare a bank reconciliation.

Cash balance per books
Add: Collection of notes receivable Collection of interest Less: Bank service charge Note collection fee Adjusted cash balance per books
Chapter 8-41

Control Features: Use of a Bank
E8-11 b) Journalize the adjusting entries at July 31 on the books of Family Video Company. Dr. Cr. July 31 Miscellaneous expense 28 July 31 Cash Cash 916 28

Miscellaneous expense Interest revenue Notes receivable

20
36 900

Note: Adjusting journal entry includes only the adjustments to the cash balance per books.
Chapter 8-42

SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank

Review Question
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:
a. outstanding checks. b. deposit in transit. c. a bank error.

d. bank service charges.

Chapter 8-43

SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank
Electronic Funds Transfers (EFT)
Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations. EFT transfers normally result in better internal control since no cash or checks are handled by company employees.

Chapter 8-44

SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank
Discussion Question
Q8-23. Lori Figgs is confused about the lack of agreement between the cash balance per books and the balance per the bank. Explain the causes for the lack of agreement to Lori, and give an example of each cause.

See notes page for discussion
Chapter 8-45

SO 7 Prepare a bank reconciliation.

Reporting Cash
Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository.
Illustration 8-14

Cash equivalents Restricted cash Compensating balances
Chapter 8-46

SO 8 Explain the reporting of cash.

Reporting Cash

Review Question
Which of the following statements correctly describes the reporting of cash?
a. Cash cannot be combined with cash equivalents.

b. Restricted cash funds may be combined with Cash.
c. Cash is listed first in the current assets section. d. Restricted cash funds cannot be reported as a current asset.
Chapter 8-47

SO 8 Explain the reporting of cash.