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Chapter 6

Chapter 6. Cash and Internal Controls. INTERNAL CONTROL SELF– STUDY MATERIALS. C1: Define internal control and identify its purpose and principles. C2: Define cash and cash equivalents and explain how to report them. C3: Identify control features of banking activities.

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Chapter 6

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  1. Chapter 6 Cash and Internal Controls

  2. INTERNAL CONTROL SELF– STUDY MATERIALS C1: Define internal control and identify its purpose and principles. C2: Define cash and cash equivalents and explain how to report them. C3: Identify control features of banking activities. P1: Apply internal control to cash receipts and disbursements. -VOUCHER System of control 6-2

  3. Analytical Learning Objectives SELF-STUDY A1: Compute the days’ sales uncollected ratio and use it to assess liquidity. 6-3

  4. Procedural Learning Objectives IN-CLASS: P2: Explain and record petty cash fund transactions. P3: Prepare a bank reconciliation. NOT COVERED: P4:Appendix 6A: Describe the use of documentation and verification to control cash disbursements. P5: Appendix 6B: Apply the net method to control purchase discounts 6-4

  5. A voucher system establishes procedures for: Verifying, approving and recording obligations for eventual cash disbursements. Issuing checks for payment of verified, approved and recorded obligations. Voucher System of Control P4 6-5

  6. Check Cashier Supplier (Vendor) Invoice Approval Accounting Cashier Accounting, Requesting& Purchasing Receiving Report Receiving Invoice Supplier (Vendor) Accounting Supplier, Requesting, Receiving & Accounting Purchase Order Purchasing Purchase Requisition Purchasing and Accounting SALES Requesting Voucher Voucher System of Control P4 Sender Receiver 6-6

  7. Policies and procedures managers use to: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies. Purpose of Internal Control C 1 6-7

  8. The Sarbanes-Oxley Act, also known as SOX, requires management and auditors of publicly held companies to adhere to or perform specific requirements, such as: Evaluation of internal controls. Auditor’s work is overseen by the Public Company Accounting Oversight Board (PCAOB). Restriction on consulting services performed by auditors. Term limits on person leading the audit. Harsh penalties for violators, including prison time with severe fines. The Sarbanes-Oxley Act C 1 6-8

  9. Establish responsibilities. Maintain adequate records. Insure assets and bond key employees. Separate recordkeeping from custodyof assets. Divide responsibility for related transactions. Apply technological controls. Perform regular and independent reviews. Principles of Internal Control C1 6-9

  10. Technology and Internal Control C 1 Reduced Processing Errors More Extensive Testing of Records Crucial Separation of Duties Limited Evidence of Processing Increased e-commerce 6-10

  11. Human Fraud Human Error Negligence Fatigue Misjudgment Confusion Intent to defeat internal controls for personal gain Limitations of Internal Control C 1 6-11

  12. Limitations of Internal Control C 1 The costs of internal controls must not exceed their benefits. Benefits Costs 6-12

  13. Cash Currency, coins and amounts on deposit in bank accounts: checking accounts, and many savings accounts. Also includes items such as customer checks,cashier checks, certified checks, and money orders. Cash and Cash Equivalents • Cash Equivalents • Short-term, highly liquid investments that are: • Readily convertible to a known cash amount. • Close to maturity date and not sensitive to interest rate changes • US Treasury Bills & Notes: 3-month maturity. • 3-month CDs and Money Market Funds 6-13

  14. Cash & Cash Equivalents On Dec. 31, 2010, ABC Co's total CASH COUNT =$1,000,000 The following items are included in the CASH COUNT: • Petty cash funds=$12,000, • Customers Checks =$3,000, • Coins =$1,000 and • Stamps =$100. The following items are not included in cash count: • -Three-month CD: $10,000 • -Two-month Treasury Note (Bill): $7,000 Required: Prepare the Current Assets Section of the Balance Sheet

  15. Liquidity How easily an asset can be converted into cash to be used to pay for services or obligations. Cash, Cash Equivalents, and Liquidity C 2 Inventory Cash 6-15

  16. Cash Management Principles C2 When companies fail, one of the most common causes is their inability to manage cash.The goals of cash management are twofold: • Plan cash receipts to meet cash payments when due. • Keep the minimum level of cash necessary to operate. 6-16

  17. Control of Cash C1 An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cash is separate from recordkeeping of cash. Cash receipts are promptly deposited in a bank. Cash disbursements are made by check. 6-17

  18. Over-the-Counter Cash Receipts Cash register with locked-in record of transactions. Compare cash register record with cash reported. Cash Receipts By Mail Two people open the mail. Money to cashier’s office => Bank List to accounting dept => Record Copy of list filed. Cash Receipts by mail Require four (4) people Control of Cash Receipts P1 6-18

  19. Control of Cash Disbursements P1 • All expenditures should be made by check. The only exception is for small payments from petty cash. • Separate authorization for check signing and recordkeeping duties. • Use a voucher system. 6-19

  20. Control of Cash Disbursements To safeguard against theft:-require all expenditures be made by check (except for small payments made from petty cash fund); and -deny access to the accounting records to anyone,other than the owner, who has authority to sign checks.

  21. Small payments required in most companies for items such as postage, courier fees, repairs and supplies. Petty Cash System of Control P2 6-21

  22. Petty Cash Operating a Petty Cash Fund P2 CompanyCashier Petty Cashier Accountant 6-22

  23. Petty Cash Operating a Petty Cash Fund P2 Petty Cashier 6-23

  24. 39¢ Stamps $45 Courier $80 Operating a Petty Cash Fund P2 A petty cash fund is used only for business expenses. Petty Cashier 6-24

  25. 39¢ Stamps $45 Courier $80 Operating a Petty Cash Fund P2 Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Receipts Petty Cashier 6-25

  26. Operating a Petty Cash Fund P2 Receipts $125 To reimburse petty cash fund Company Cashier Petty Cashier Use a Cash Over and Short account if needed. Accountant 6-26

  27. Operating a Petty Cash Fund Sometimes, the petty cash receipts plus the cash remaining will not total to the fund balance. i. A shortage is recorded as an expense in the reimbursing entry with a debit to the Cash Over and Short account. ii. An overage is recorded with a credit to theCash Over and Short account in the reimbursing entry.

  28. Petty Cash Example P2 Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses $79.30 Customer Business Lunches 93.42 Express Mail Postage 55.00 Miscellaneous Office Supplies 32.48$260.20 Let’s look at replenishing the fund if the Cash Balance on July 31 was $137.80. 6-28

  29. Petty Cash Example P2 What amount of cash will be required to replenish the petty cash fund? a. $260.20 b. $262.20 c. $139.80 d. $137.80 6-29

  30. Petty Cash Example P2 What amount of cash will be required to replenish the petty cash fund? a. $260.20 b. $262.20 c. $139.80 d. $137.80 Let’s prepare the journal entry to replenish the petty cash fund. 6-30

  31. Petty Cash Example P2 Journal entry to replenish petty cash fund 6-31

  32. Quick Study 4 Exercise 5 Exercise 6

  33. Banking Activities as Controls C 3 Signature Cards Bank Accounts Deposit Tickets Checks Electronic Funds Transfer Bank Statements 6-33

  34. Bank Activities A bank account is a record set up by a bank for a customer. All persons authorized to write checks, sign a signature card. Each bank deposit is supported by a deposit ticket. Electronic Funds Transfer (EFT) is the electronic communication transfer of cash from one party to another. To withdraw money, depositors use a check. A check involves three parties: Maker: Who signs the check; Payee: The recipient;Bank (Payer): On which the check is drawn

  35. Bank Statement Once a month, the bank sends each depositor a bank statementshowing activities of a bank account. A bank statement includes, at least, the following: Beginning cash balance per bank; Check & other debits decreasing the balance; Deposits & other credits increasing the balance; Ending cash balance per bank.

  36. Bank Reconciliation P3 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. Why are the balances different? * 6-37

  37. Bank Statement Balance Add: Deposits in transit. Deduct:Outstanding Checks Add or Deduct: Bank errors. Adjusted Bank Balance Book Balance Add: Collections made by the bank. Add: Interest earned on checking account. =>CM Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge =>DM Add or Deduct: Book errors Adjusted Book Balance. Reconciling Items 6-38

  38. Reconciling Items Identify and list any unrecorded Debit Memoranda (DM) from the bank for NSF Checks, service charges, and errors over­stating the book balance. => Deduct them from the book balance.Identify and list any unrecorded Credit Memoranda(CM) from the bank for interest, collections, and errorsunder­stating the book balance. => Add them to the book balance.

  39. Bank Reconciliation P3 Two sections: • Reconcile bank statement balance to the adjusted bank balance. • Reconcile book balance to the adjusted book balance. The adjusted balances should be equal. 6-40

  40. Bank Reconciliation Example P3 Let’s prepare a July 31 bank reconciliation statement for the Simmons Company. • The July 31 bank statement indicated a balance of $9,610. • The cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. 6-41

  41. Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. The bank returned a customer’s NSF check for $225 received as payment on account receivable. The bank statement showed $30 interest earned during July. Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank. Bank Reconciliation Example 6-42

  42. Bank Reconciliation Example P3 6-43

  43. Only amounts shown on the book portion of the reconciliationrequire an adjusting entry. Recording Adjusting Entries from a Bank Reconciliation P3 6-44

  44. After posting the reconciling entries the cash account looks like this: Recording Adjusting Entries from a Bank Reconciliation P3 Adjusted balance on July 31. 6-45

  45. Quick Study 6 Exercise 7 Exercise 9 & 10

  46. Days’ Sales Uncollected Accounts Receivable Net Sales = × 365 Days’ Sales Uncollected A1 How much time is likely to pass before we receive cash receipts from credit sales. 6-47

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