Cash and Internal Controls

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 08

CASH AND INTERNAL CONTROLS

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INTERNAL CONTROL SYSTEM

Policies and procedures managers use to: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies.

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SARBANES-OXLEY ACT (SOX)

The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal

controls.

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Section 404 of SOX requires that managers document and assess the effectiveness of all internal control processes that

can impact financial reporting.

Sen. Paul Sarbanes(D-MD)

Rep. Mike Oxley(R-OH)

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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.

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TECHNOLOGY AND INTERNAL CONTROL

ReducedProcessing

Errors

MoreExtensive Testing

of Records

LimitedEvidence ofProcessing

CrucialSeparation of

Duties

Increased E-Commerce

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LIMITATIONS OF INTERNAL CONTROL

Human Error

NegligenceFatigue

MisjudgmentConfusion

Human Fraud

Intent todefeat internal

controls forpersonal gain

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Human fraud triple-threat: Opportunity, Pressure, and Rationalization.

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LIMITATIONS OF INTERNAL CONTROL

The costs of internal controls must not exceed their benefits.

CostsBenefits

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CONTROL OF CASHAn effective system of internal control that

protects cash and cash equivalents should meet three basic guidelines:

Handling cashis separated from recordkeeping for

cash.Cash

disbursements are made by

check.

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Cash receiptsare promptly

deposited in a bank.

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CASH, CASH EQUIVALENTS,AND LIQUIDITY

CashCurrency, 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 EquivalentsShort-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.

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Cash and similar assets are called liquid assets because they can be readily used to settle such obligations.

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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 applyingthe following cash management principles: Encourage collection of receivables. Delay payment of liabilities. Keep only necessary levels of assets. Plan expenditures. Invest excess cash.

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OVER-THE-COUNTER CASH RECEIPTS

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This graphic illustrates that none of the people involved can make a mistake or divert cash

without the difference being revealed.

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CASH OVER AND SHORTSometimes errors in making change are discovered from differences between the cash in the cash register and the

record of the amount of cash receipts.

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If a cash register’s record shows $550 but the count of cash in the register is $555, we would prepare the following journal

entry:

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CASH RECEIPTS BY MAILP1

Mailroom

Preferably, two people are

assigned the task of opening

the mail.

Cashier

The cashier deposits the money in a

bank.

Recordkeeper

The recordkeeper records the

amounts received in the

accounting records.

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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.

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Control of cash disbursements is especially important as most

large thefts occur from payment of fictitious invoices.

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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.

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VOUCHER SYSTEM OF CONTROLP1

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PETTY CASH SYSTEM OF CONTROL

Small payments required in most companies for items such as postage, courier fees,

repairs, and supplies.

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OPERATING A PETTY CASH FUND

Petty Cash

CompanyCompanyCashierCashier

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AccountantAccountant

Petty Petty CashierCashier

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Petty Cash

Petty Petty CashierCashier

OPERATING A PETTY CASH FUNDP2

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Delivery

Petty Petty CashierCashier

A petty cash fund is used only for

business expenses.

OPERATING A PETTY CASH FUNDP2

SuppliesServicesTransportation-in

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OPERATING A PETTY CASH FUND

Petty cash receipts with either no signature or a forged signature

usually indicate misuse of petty cash.

Petty Petty CashierCashier

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DeliverySuppliesServicesTransportation-in

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Company Company CashierCashier

$71.30

To reimbursepetty cash fund Petty Petty

CashierCashier

OPERATING A PETTY CASH FUNDP2

AccountantAccountant

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BASIC BANK SERVICES

Bank Accounts Signature Cards Deposit Tickets

Checks Electronic Funds Transfer

Bank Statements

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BANK STATEMENT

Usually once a month, the bank sends

each depositor a

bank statement

showing the activity in the

account.

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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.

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BANK RECONCILIATIONP3

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.

=

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ILLUSTRATION OF A BANK RECONCILIATION

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Cash Balance per Bank

+ Deposits in Transit

- Outstanding Checks

+/- Errors

Adjusted Cash Balance

We follow nine steps in preparing the bank reconciliation.

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ILLUSTRATION OF A BANK RECONCILIATION

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We follow nine steps in preparing the bank reconciliation.

Cash Balance per Book

+ Collections & Interest

- Uncollectible items

+/- Errors

Adjusted Cash Balance

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ILLUSTRATION OF A BANK RECONCILIATION

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We follow nine steps in preparing the bank reconciliation.

Adjusting entries are recorded for the reconciling items on the book side of the reconciliation.

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ILLUSTRATION OF A BANK RECONCILIATION

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Only the items reconciling the book balance require adjustment.

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GLOBAL VIEW

Control of CashAccounting definitions for cash are similar for U.S. GAAP and

IFRS.

Banking Activities as ControlsThere is a global demand for banking services, bank statements,

and bank reconciliations. To the extent feasible, companies utilize banking services as part of their effective control procedures.

Internal Control Purposes, Principles and ProceduresThe purposes and principles of internal control systems are

fundamentally the same across the globe.

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DAYS’ SALES UNCOLLECTED

Days’Sales

Uncollected

Accounts Receivable Net Sales × 365=

Indicates how much time is likely to pass beforewe receive cash receipts from credit sales.

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56 days $612,000,000$4,022,000,000 × 365=

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APPENDIX 8A: DOCUMENTATION AND

VERIFICATION

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Receiving Report

Purchase Requisition

Purchase Order

InvoiceVoucher

8 - 34APPENDIX 8B: CONTROL OF PURCHASE

DISCOUNTS

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The net method gives management an advantage in controlling and monitoring cash payments involving

purchase discounts.

When purchases are recorded at net amounts, a Discounts Lost expense account is recorded and

brought to management’s attention.

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END OF CHAPTER 08