Financial Accounting: Tools for Business Decision Making, 2nd Ed.

1. ELS Prepared by: Ellen L. Sweatt Georgia Perimeter College Financial Accounting:Tools for Business Decision Making, 2nd Ed. Kimmel, Weygandt, Kieso

2. Internal Control and Chapter 7 Cash

3. Chapter 7Internal Control and Cash After studying Chapter 7, you should be able to: • Identify the principles of internal control. • Explain the application of internal control to cash receipts. • Explain the application of internal control to cash disbursements. • Prepare a bank reconciliation.

4. Chapter 7Internal Control and Cash After studying Chapter 7, you should be able to: • Explain the reporting of cash. • Discuss the basic principles of cash management. • Identify the primary elements of a cash budget. • Identify and interpret measures that evaluate the adequacy of cash.

5. Internal Control consists of... all the related methods and measures adopted within a business to: • safeguard its assets; • enhance accuracy and reliability of accounting of its accounting records.

6. Illustration 7-1

7. Establishment of Responsibility Control is most effective when only one person is responsible for a given task.

8. Segregation of Duties • Responsibility for related activities should be assigned to different individuals • Responsibility for keeping records for an asset should be separate from the physical custody of the asset Accountability for Assets

9. Documentation • Provide evidence that transactions and events occurred: • Shipping documents • Sales invoices

10. Documentation Procedures • Documents should be pre-numbered • All documents should be accounted for • Sources documents should be promptly forwarded to accounting department

11. Physical, Mechanical and Electronic Controls Illustration 7-3

12. Independent Internal Verification • Involves review, comparison, and reconciliation of data prepared by employees • Verification should be made periodically or on surprise basis • Verification should be done by employee who is independent of the personnel responsible for the information • Discrepancies and exceptions should be reported to management

13. Independent Internal Verification Illustration 7-4

14. Other Controls • Bonding of employees who handle cash • Rotating employee’s duties and requiring employees to take vacations

15. Limitations of Internal Controls • Cost/Benefit - cost of establishing procedure should not exceed expected benefit • Human element - fatigue, carelessness, indifference • Collusion - two or more individuals who work together to get around controls • Size of business

16. Cash consists of... • coins • currency • checks • money orders • money on hand • deposits in bank

17. Cash is the most desirable asset... because it is readily convertible into any other asset.

18. Internal Control Over Cash Receipts Page 297 in book Illustration 7-5

19. Internal Control Over Cash Disbursements Illustration 7-6

20. Electronic Funds Transfer (EFT) • An approach to transfer funds among parties without paper (deposit tickets, checks, etc.) • EFT uses wire, telephone,telegraph or computer to transfer from one location to another

21. Petty Cash Fund is a cash fund used to pay relatively small amounts

22. Use of a Bank... • is good internal control. • minimizes the amount of cash that must be kept on hand. • provides a double record of all bank transactions • one by the business • one by the bank • helps a company safeguard its cash by using a bank as a depository and clearinghouse for checks received and written.

23. Illustration7-7 Bank Statement - a copy of the bank’s records sent to the customer for periodic review. Apri l 30, 2001 • Bank Statement shows • check & other debits • deposits & other credits • daily cash balance

24. Company Balance and Bank Balance of Cash Usually Differ Because... • Time lags that prevent one of the parties from recording the transaction in the same period. • Days pass between the time a check is written and dated and date it is paid by the bank. • A day may pass between the time receipts are recorded by the company and the time they are recorded by the bank. • A time lag may occur when the bank mails a debit or credit memo to the company. • Errors by either party in recording transactions.

25. Reconciliation Procedure • reconcile balance per books and balance per bank to their adjusted or correct balances • the reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash

26. Terms • Deposits in transit - deposits recorded by the depositor that have not been recorded by the bank. • Outstanding Checks - checks issued and recorded by the company that have not been paid by the bank. • NSF Check - a check that is not paid by the bank because of insufficient funds in the customer’s bank account. • Adjusted balance - same as true cash balance, correct cash balance

27. Bank Reconciliation Procedures $ Per Bank Statement -outstanding checks +deposits +/- bank errors correct cash amount $ Per Books -NSF Checks -check printing or other service charge +notes collected by bank correct cash amount Illustration 7-8

28. Illustration 7-9 W.A. Laird CompanyBank ReconciliationApril 30, 2001 Cash balance per bank statement 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00 Adjusted cash balance per bank12,204.85 Cash balance per books 11,589.45 Add: Collection of N/R for $ 1000 plus interest earned $50, less collection fee $ 15 1,035.00 Error on recording check No. 443 36.001,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60 Adjusted cash balance per bank12,204.85

29. For Cash To Show the Correct Balance Each reconciling item in determining the adjusted balance per books must be journalized and posted.

30. Illustration 7-9 W.A. Laird CompanyBank ReconciliationApril 30, 2001 Cash balance per bank statement 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00 Adjusted cash balance per bank12,204.85 Cash balance per books 11,589.45 Add: Collection of N/R for $ 1000 plus interest earned $50, less collection fee $ 15 1,035.00 Error on recording check No. 443 36.001,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60 Adjusted cash balance per bank12,204.85

31. JOURNAL Apr 30 Cash 1,035.00 Miscellaneous Expense 15.00 Notes Receivable 1,000.00 Interest Revenue 50.00 Apr 30 Cash 36.00 Accounts Payable 36.00 Apr 30 Accounts Receivable-Baron 425.60 Cash 425.60 Apr 30 Miscellaneous Expense 30.00 Cash 30.00

32. Reporting Cash • Cash is recorded in both the balance sheet and the statement of cash flows. • The balance sheet shows the amount of cash available at a given point in time. • The statement of cash flows shows the sources and uses of cash during a period of time.

33. Cash Equivalents • Readily convertible to known amount of cash • So near maturity that market value is relatively insensitive to changes in interest rates • Examples: • Treasury bills • Commercial paper • Money Market Funds

34. Restricted Cash... • Is cash that is not available for general use. • Is set aside for special purpose. • If not to be used within next year, report as noncurrent asset.

35. Operating Cycle of a Merchandising Company…is the average time it takes to go from cash to cash in producing revenues. Illustration 7-12

36. Five Principles of Cash Management Illustration 7-13

37. Reporting Cash • Cash on hand, cash in banks, and petty cash are often combined and reported as cash. • Cash is the most liquid asset and listed first in the current asset section of the balance sheet.

38. Cash Budget • Cash is vital. • Planning the company's cash needs is a key business activity. • Cash budget shows the anticipated cash flows, over a 1 to 21-year period.

39. Cash Budget The cash budget contains : • Cash receipts section; • Cash disbursements section; • Financing section.

40. Cash Receipts Section • includes expected receipts from the company's principal source(s) of revenue, such as cash sales and collections from customers on credit sales • also shows anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock

41. Cash Disbursements Section • shows expected payments for direct materials, direct labor, manufacturing overhead, and selling and administrative expenses. • includes projected payments for income taxes, dividends, investments, and plant assets.

42. Financing Section shows... • expected borrowings • the repayment of the borrowings and interest

43. Two Tools to Measure the Adequacy of Cash • cash to daily cash expenses ratio; • free cash flow.

44. Cash to Daily Cash Expenses Ratio • Computes the number of days of cash expenses that cash on hand can cover • Average daily cash expenses can be approximated by subtracting depreciation (a noncash expense) from total expenses and dividing by 365 days

45. Illustration 7-16 Cash to Daily Cash Expenses Ratio Cash and cash equivalent Average daily cash expenses

46. Free cash flow is the amount of discretionary cash flow a company has for: purchasing additional investments reducing its debt adding to its liquidity Net cash provided by operations $250,000 Less: Capital expenditures $80,000 Cash Dividends 50,000 130,000 Free Cash Flow $120,000 Free Cash Flow Illustration 7-17