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Chapter 7

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Chapter 7

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  1. Chapter 7 Internal Control and Cash

  2. Objectives of the Chapter • 1. Introduce the internal control to safeguard assets and to produce reliable accounting records. • 2. Internal control for the most liquid asset – cash. Internal Control and Managing Cash

  3. The Sarbanes-Oxley Act (SOX) and the Internal Control • Under SOX, companies must develop sound internal control for financial reporting. • Mangers need to document and assess the effectiveness of the internal control. • Managers’ assessment on the internal control needs to be attested by outsider auditors. • Outsider auditors would also make their evaluation on the effectiveness of companies’ internal control.

  4. Internal Control • An organizational plan to (source: Financial Accounting by Harrison and Horngren (H & H)) • 1. Safeguard assets (i.e., cash, inventory, etc.); • 2. Encourage employees’ adherence to company policies; • 3. Promote operational efficiency; and • 4. Ensure accurate and reliable accounting records.

  5. Internal Control (contd.) • The plan includes(source: Financial Accounting by H & H) • 1. To have competent, reliable and ethical personnel; • 2. Assignment of responsibilities (see Exhibit on p6 for an organizational chart of a corp.). • Each employee is assigned certain responsibilities; and • 3. Proper authorization: Any deviation from standard policy requires a proper authorization.

  6. External Auditing Board of Directors Audit Committee President Senior Vice President Vice President, Finance and Accounting Vice President, Production Vice President, Marketing Other Vice Presidents Treasurer Controller Collections and Credits Cash Management General Accounting Taxes Internal Auditing Investor Relations Banking Relations Budgeting Systems Organizational Chart of a Corporation (source: H&H) Internal Control and Managing Cash 6

  7. Internal Control (contd.) • 4. Separation of duties: this procedure can reduce the chances for fraud and promote the accuracy of accounting records. The procedure may include: • a. separation of operation from accounting, • b. separation the custody of assets from accounting, • c. separation of the authorization of transactions from the custody of related assets, • d. separation of duties within the accounting function. The plan includes: Internal Control and Managing Cash

  8. Internal Control (contd.) • 5. Internal and external audits. • 6. Documents and records. • 7. Electronic and corporate control. • 8. Other controls. • The limitations of internal control: human element and the size of a company. The plan includes: Internal Control and Managing Cash

  9. Internal Control for Cash • Cash is the most liquid asset and is easy to steal. Therefore, most companies use internal control to safeguard their cash. Internal Control and Managing Cash

  10. Internal Control of Cash (Contd.) • 1. Immediate deposit of cash to bank accounts. • 2. Cash payments by checks except for small amount (paid by petty cash fund). • 3. Separation of duties. • 4. Prepare bank account reconciliation. Internal Control and Managing Cash

  11. The Voucher System in Cash Disbursement • A system to ensure all payments by checks are proper. • The system involves a network of approvals by authorized individuals. • It starts with a voucher (an authorization form for an expenditure (i.e., a purchase)). • All cash disbursements require a voucher (except for those from petty cash fund).

  12. The Voucher System (contd.) • Upon the receipt of vendor’s invoice and the goods, an accountant records the purchase and accounts payable. • The company issues and sends a check to the vendor before the required payment date ( treasurers are normally authorized to sign checks). • The paid voucher is sent to the accounting department for recording. Internal Control and Managing Cash

  13. Petty Cash Fund • Establishing a petty cash fund on 3/1: • Petty Cash 500 • Cash 500 • Making Payments from the fund: • Petty cash fund is used for the payments of small expenditures of the office (i.e., office drinks, office supplies, stamps, etc.) • The payments require petty cash receipts.

  14. Petty Cash Fund (Contd.) • Replenishing the fund on 3/31: • Postage expense 50 • Freight-out 120 • Office supplies 70 • Cash over and short 5 • Cash 245 • Note: the petty cash receipts indicated the payments in March including postage exp. $50, freight charges, $120, and office supplies, $70. The cash balance of the fund on 3/31 amounted to $255

  15. Bank Reconciliation • A. Causes of differences between the cash balances of bank and book. • B. Adjusting procedures Internal Control and Managing Cash

  16. A. Causes of Differences • 1. Errors made by banks or companies. • 2. Outstanding checks. • 3. Deposit in transit. • 4. Some transaction recorded by banks, but not recorded by companies (i.e., service charge, interest earned, collections of notes...). • 5. NSF check. Internal Control and Managing Cash

  17. A. Causes of Differences (Contd.) • 6. Checks deposited but returned for reasons other than NSF (I.e., unauthorized signature, check has been altered,etc.). • 7. Cash received, recorded, but not yet deposited (if adjusted to cash balance, this item needed to be considered). Internal Control and Managing Cash

  18. Adjusting Procedures Bank Balance Book Balance + Deposit in transit + Interest earned * + Cash received, recorded, + Notes collected * but not deposited +- EFT* - Outstanding checks - Service charge * + - Errors made by banks - NSF checks - Checks deposited but returned to payee by bank for reasons other than NSF + - Errors made by companies Adjusted Cash Balance Adjusted Cash Balance * Journal Entries Required Internal Control and Managing Cash

  19. Example • From the following information for D.K, prepare a bank reconciliation and any journal entries needed to adjust the cash account as of 8/31/x1 • 1. August 31, 20x1, cash balance per book, $8,000. • 2. August 31, 20x1, balance per bank, $7,500. • 3. Deposit in transit as of 8/31/x1, $2,000. Internal Control and Managing Cash

  20. Example (contd.) • 4. Checks outstanding as of 8/31/x1, $1,000. • 5. The bank improperly recorded a $650 deposit $560. • *6. Bank service charges, $100. (Not yet recorded by D.K.) • *7. Interest earned, $90. (Not yet recorded by D.K.) • * Journal entry required Internal Control and Managing Cash

  21. Example (contd.) • *8. Notes collected by bank, $400. (Not yet recorded by D.K.) • *9. NSF check, $100 (payment of an account receivable) • *10. A check of $300 payable to Energy Express Company for delivery charges was mistakenly recorded in the book at $600. • * Journal entry required Internal Control and Managing Cash

  22. Example (contd.) • * Journal entries are required by D.K.as follows: • 6. Miscellaneous Expense 100 • Cash 100 • 7. Cash 90 • Interest Revenue 90 • 8. Cash 400 • Notes Receivable 400 Internal Control and Managing Cash

  23. Example (contd.) • 9. Accounts Receivable 100 • Cash 100 • 10. Cash 300 • Delivery Exp. 300 Internal Control and Managing Cash

  24. Example (contd.) • Bank Balance (8/31/98) $7,500 • + Deposit In Transit 2,000 • - Checks Outstanding (1,000) • + Error Made by Bank 90 • Adjusted Cash Balance $8,590 • Book Balance (8/31/98) $8,000 • - Bank Service charge (100) • + Interest Earned 90 • + Notes Collected 400 • - NSF Checks (100) • +- Error made by the company 300 • Adjusted Cash Balance $8,590 Internal Control and Managing Cash

  25. Cash Management • 1. To maintain sufficient cash on hand for day-to-day operation and for payment of current liabilities. • 2. To prevent large amount of idle cash on hand. • 3. To speed the collection of cash from sale, by offering sales discounts: Internal Control and Managing Cash

  26. Cash Management (contd.) • 8/4 A/R, 2/10, n/30 50,000 • Sales Revenue 50,000 • 8/10 Cash 49,000 • Sales Discount 1,000 • A/R 50,000 • Also, Subsidiary ledger accounts are maintained for accounts receivable (see p26 for an example). Internal Control and Managing Cash

  27. Accounts Receivable Records Accounts Receivable General Ledger Subsidiary Ledger Cash Walmart Bal. 9,000 Bal. 1,800 Accounts Receivable Target Bal. 3,800 Bal. 1,300 Toys “R” US Bal. 700 Total 3,800

  28. Reporting Cash on the Balance Sheet (B/S) • Usually reported on the B/S as follows: • Current Assets: 20x2 20x1 • Cash and Cash Equivalents xxxx xxxx • Cash Equivalents: highly liquid investments with insignificant interest rate risk and with original maturities of three months or less (i.e., commercial papers, U.S. Treasury bills, money market fund, etc.) Internal Control and Managing Cash