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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

Reduced Processing

Errors

More Extensive Testing

of Records

Limited Evidence of Processing

Crucial Separation of

Duties

Increased E-Commerce

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LIMITATIONS OF INTERNAL CONTROL Human Error

Negligence Fatigue

Misjudgment Confusion

Human Fraud

Intent to defeat internal

controls for personal 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.

Costs Benefits

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CONTROL OF CASH An effective system of internal control that

protects cash and cash equivalents should meet three basic guidelines:

Handling cash is separated from recordkeeping for

cash. Cash

disbursements are made by

check.

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Cash receipts are promptly

deposited in a bank.

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CASH, CASH EQUIVALENTS, AND LIQUIDITY

Cash Currency, 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 Equivalents Short-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 applying the 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 P1

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 SHORT Sometimes 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 MAIL P1

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 CONTROL P1

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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

Company Cashier

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Accountant

Petty Cashier

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Petty Cash

Petty Cashier

OPERATING A PETTY CASH FUND P2

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Delivery

Petty Cashier

A petty cash fund is used only for

business expenses.

OPERATING A PETTY CASH FUND P2

Supplies Services Transportation-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 Cashier

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Delivery Supplies Services Transportation-in

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Company Cashier

$71.30

To reimburse petty cash fund Petty

Cashier

OPERATING A PETTY CASH FUND P2

Accountant

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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 RECONCILIATION P3

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 P3

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 P3

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 P3

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 P3

Only the items reconciling the book balance require adjustment.

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GLOBAL VIEW

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

IFRS.

Banking Activities as Controls There 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 Procedures The 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 before we 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

Invoice Voucher

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APPENDIX 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