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Chapter 4 Internal Control and Cash

Internal Control
Internal control is the organizational plan and related measures that an entity adopts to:

Safeguard assets Encourage adherence to company policies Promote operational efficiency Ensure accurate and reliable accounting records

Sarbanes-Oxley Act (SOX)

Created Public Company Accounting Oversight Board. Prohibits accounting firms from both auditing financial statements of a firm and providing certain consulting services for the same client. Requires periodic rotation of lead auditors. Requires public companies to issue internal control reports and the outside auditor to evaluate the clients internal controls. Provides stiff penalties for violators.

Internal Control Systems


Good internal control systems require: Competent, reliable, ethical personnel Assignment of responsibilities Proper authorization Supervision of employees Separation of duties

separation of operations from accounting separation of the custody of assets from accounting

Internal and external audits Documents and records Electronic and computer controls

E-Commerce

Audits by external specialists Incident response procedures Intrusion detection devices

Onion model of system security

Firewalls
Encryption

Sensitive Hardware, Software, and Data

E-Commerce

Encryption is the transformation of data by a mathematical process into a form that is unreadable by those without a key. Firewall limits access to hardware, software, or data to persons within a network. Intrusion detection identifies unauthorized entries to the system. Incident response procedures apprehend hackers and remove them from the system. External audits (WebTrust, SysTrust, CPA firms, etc.) test e-commerce systems.

Other Controls

Fireproof vaults Burglar alarms Point-of-sale terminals Fidelity bonds on cashiers and others who have access to cash Mandatory vacations Job rotation

Bank Accounts as Controls


All cash should be deposited into a bank account daily. To draw money from the account, a check is written Three parties to a check:

maker signs the check payee to whom the check is written bank on which the check is drawn

Remittance advice is an optional attachment that gives the reason for the payment.

Bank Accounts as Controls

Monthly bank statements are sent to the account holder and should be reconciled. Electronic fund transfer (EFT) is the electronic transfer of cash. No check is written. Bank statements include both physical checks and EFT payments as well as other transactions on the account.

Bank Reconciliation

Two independently maintained records of a businesss cash


The companys Cash account The bank statement

Differences between the two records generally arise because of timing differences. Reconciliations ensure that the two records agree.

Bank Reconciliation
Items for reconciliation: Items recorded by the company but not yet recorded by the bank:

Deposits in transit Outstanding checks

Bank Reconciliation
Items for reconciliation: Items recorded by the bank but not yet recorded by the company.

Bank direct collections Electronic funds transfers not known by Company Service charges and the cost of printed checks Interest revenue earned on checking account Non-sufficient funds (NSF) checks

Errors by the company or the bank

Bank Reconciliation

The adjusted bank balance must equal the adjusted books balance.

Reconciling Items
Bank Balance

Book Balance

Add deposits in transit Subtract outstanding checks Add or subtract corrections of bank errors, as appropriate

Add bank direct collection items, interest revenue, and EFT receipts Subtract service charges, NSF checks, and EFT payments Add or subtract corrections of book errors, as appropriate.

Bank Reconciliation

Journal entries are only made for:

Bank direct collection items, interest revenue, and EFT receipts Service charges, NSF checks, and EFT payments Errors made by the company (bank errors do not require journal entries on the companys books).

Bank Reconciliation
Business Research, Inc. Bank Reconciliation January 31, 20X6

Bank
Balance, January 31 Add: 1. Deposit of January 30 in transit 2. Correction of bank error Research Associates check 656 erroneously charged against company account $5,931.51

Books
Balance, January 31 $3,294.21 Add: 4. EFT receipt of rent revenue 904.03 5. Bank Collection of note receivable including interest revenue of $214 2,114.00 6. Interest revenue earned on bank balance 28.01 7. Correction of book error overstated amount of check no. 333 360.00 6,700.25 Less: 8. Service charge $14.25 9. NSF check 52.00 10. EFT payment of insurance expense 361.00 (427.25) Adjusted book balance $6,273.00

1,591.63

100.00 7,623.14

Less: Outstanding Checks No. 337 $286.00 No. 338 319.47 No. 339 83.00 No. 340 203.14 No. 341 458.53 Adjusted bank balance

(1,350.14) $6,273.00

Journal Entries from Reconciliation


(4) Cash Rent Revenue Receipt of monthly rent 904.03 904.03

(5)

Cash 2,114.00 Notes Receivable 1,900.00 Interest Revenue 214.00 Note receivable collected by the bank Cash Interest Revenue Interest earned on bank balance 28.01 28.01

(6)

Journal Entries from Reconciliation


(7) Cash Accounts Payable Correction of check no. 333 Miscellaneous Expense Cash Bank Service Charge Accounts Receivable Cash 360.00

360.00
14.25

(8)

14.25
52.00 52.00

(9)

NSF customer check returned by bank


(10) Insurance Expense Cash Payment of monthly insurance 361.00 361.00

Controlling Cash Receipts

Over-the-counter receipts

Point of sale terminal Lockbox Checks removed and totaled in mailroom. Remittance advice to accounts receivable, checks to Treasurer for deposit. Controller compares:

Mail Receipts

control total from mail room bank deposit amount from cashier debit to cash from accounting department

Controlling Cash Payments

Payment by check

Purchase requisition (request) Purchase order authorizes an order purchase order, invoice, and receiving report

Payment packet matches


Payment packet should be cancelled to ensure that the invoice is not paid twice.

Petty Cash

Petty cash fund is to pay for minor expenses. Fund is opened with a particular amount of cash. A custodian issues cash when needed and places all petty cash tickets and receipts in the box with the remaining cash. The sum of the remaining cash and petty cash tickets should equal the amount established for the fund. Petty cash is an example of an imprest fund.

Cash Budgets

Budget a financial plan Cash budget plans cash receipts and cash payments
Beginning cash Plus: Expected Receipts Less: Expected Payments Equals: Expected Ending cash

Allows mangers to know in advance whether they will likely need to borrow money.

Reporting Cash

Cash and Cash Equivalents

liquid assets such as time deposits and certificates of deposit

Restricted cash must be disclosed separately. Compensating balances are not included as cash.

Ethics

Corporate and Professional Codes of Ethics

Corporate Codes of Conduct AICPA Code of Professional Conduct IMA Standards of Ethical Conduct for Management Accountants Conflicts of interest

Ethical Issue