Cash and Internal Controls

1. Chapter 08 Cash and Internal Controls

2. Policies and procedures managers use to: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies. Internal Control System C1

3. Sarbanes-Oxley Act (SOX) C1 The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal controls. Sen. Paul Sarbanes (D-MD) Rep. Mike Oxley (R-OH) Section 404 of SOX requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting.

4. Internal control principles common to all companies: Establish responsibilities. Maintain adequate records. Insure assets and bond key employees. Separate recordkeeping from custody of assets. Divide responsibility for related transactions. Apply technological controls. Perform regular and independent reviews. Principles of Internal Control C1

5. Technology and Internal Control C1 Reduced Processing Errors More Extensive Testing of Records Crucial Separation of Duties Limited Evidence of Processing Increased E-Commerce

6. Human Fraud Human Error Negligence Fatigue Misjudgment Confusion Intent to defeat internal controls for personal gain Limitations of Internal Control C1 Human fraud triple-threat: Opportunity, Pressure, and Rationalization.

7. Limitations of Internal Control C1 The costs of internal controls must not exceed their benefits. Benefits Costs

8. Control of Cash C2 An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cashis separated from recordkeeping for cash. Cash receiptsare promptly deposited in a bank. Cash disbursements are made by check.

9. Cash, Cash Equivalents,and Liquidity C2 Cash and similar assets are called liquid assets because they can be readily used to settle such obligations. • 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 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.

10. Cash Management C2 The goals of cash management are twofold: Plan cash receipts to meet cash payments when due. 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.

11. 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.

12. Cash Over and Short P1 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. 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:

13. Cash Receipts by Mail P1 Preferably, two people are assigned the task of opening the mail. The cashier deposits the money in a bank. The recordkeeper records the amounts received in the accounting records. Mailroom Cashier Recordkeeper

14. Control of Cash Disbursements P1 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. Control of cash disbursements is especially important as most large thefts occur from payment of fictitious invoices.

15. 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 P1

16. Voucher System of Control P1

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

18. Petty Cash Operating a Petty Cash Fund P2 CompanyCashier Petty Cashier Accountant

19. Petty Cash Operating a Petty Cash Fund P2 Petty Cashier

20. Delivery Operating a Petty Cash Fund P2 A petty cash fund is used only for business expenses. Petty Cashier Transportation-in Services Supplies

21. Delivery Operating a Petty Cash Fund P2 Petty Cashier Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Transportation-in Services Supplies

22. Operating a Petty Cash Fund P2 $71.30 To reimburse petty cash fund Company Cashier Petty Cashier Accountant

23. Basic Bank Services Signature Cards Bank Accounts Deposit Tickets Checks Electronic Funds Transfer Bank Statements

24. Usually once a month, the bank sends each depositor a bank statement showing the activity in the account. Bank Statement C2

25. 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.

26. 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 Cash Balance per Book + Deposits in Transit + Collections & Interest - Outstanding Checks - Uncollectible items +/- Errors +/- Errors = Adjusted Cash Balance Adjusted Cash Balance Adjusting entries are recorded for the reconciling items on the book side of the reconciliation.

27. Illustration of a Bank Reconciliation P3 We follow nine steps in preparing the bank reconciliation. Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance

28. 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

29. 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.

30. Illustration of a Bank Reconciliation P3 Only the items reconciling the book balance require adjustment.

31. Global View Internal Control Purposes, Principles and Procedures The purposes and principles of internal control systems are fundamentally the same across the globe. 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.

32. Days’ Sales Uncollected Accounts Receivable Net Sales $612,000,000 $4,022,000,000 56 days = = × 365 × 365 Days’ Sales Uncollected A1 Indicates how much time is likely to pass before we receive cash receipts from credit sales.

33. Appendix 8A: Documentation and Verification P4 Purchase Requisition Purchase Order Invoice Voucher Receiving Report

34. Appendix 8B: Control of Purchase Discounts P5 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.

35. END OF CHAPTER 08