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CHAPTER 8

Internal Control and Cash Principles


Accounting Principles, Eighth Edition
Chapter 8-1

Study Objectives
1. Define internal control. 2. Identify the principles of internal control.

3. Explain the applications of internal control principles to cash receipts.


4. Explain the applications of internal control principles to cash disbursements. 5. Describe the operation of a petty cash fund. 6. Indicate the control features of a bank account.

7. Prepare a bank reconciliation.


8. Explain the reporting of cash.
Chapter 8-2

Internal Control and Cash

Internal Control
The SarbanesOxley Act Principles Limitations

Cash Controls
Control over cash receipts Control over cash disbursements

Use of a Bank

Reporting Cash
Cash equivalents Restricted cash Compensating balances

Making deposits Writing checks Bank statements Reconciling the bank account

Chapter 8-3

Internal Control
Methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting records. Reduce risk of: a. Errors (unintentional) b. Irregularities (intentional)
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control.
Chapter 8-4

LO 1 Define internal control.

Internal Control

The Sarbanes-Oxley Act


Companies must develop principles of control over financial reporting. continually verify that controls are working. Independent auditors must attest to the level of internal control. SOX created the Public Company Accounting Oversight Board (PCAOB).
Chapter 8-5

LO 1 Define internal control.

Internal Control

Principles of Internal Control


Measures vary with size and nature of the business. managements control philosophy.

Illustration 8-1

Chapter 8-6

LO 2 Identify the principles of internal control.

Internal Control

Principles of Internal Control


ESTABLISHMENT OF RESPONSIBILITY Control is most effective when only one person is responsible for a given task. SEGREGATION OF DUTIES DOCUMENTATION PROCEDURES Companies should use prenumbered documents and all documents should be accounted for.
Chapter 8-7

LO 2 Identify the principles of internal control.

Internal Control

Principles of Internal Control


PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS

Physical

Mechanical and Electronic


Chapter 8-8

LO 2 Identify the principles of internal control.

Internal Control

Principles of Internal Control


INDEPENDENT INTERNAL VERIFICATION
1. Records periodically verified by an employee who is independent.
2. Discrepancies reported to management.

OTHER CONTROLS
1. Bond employees. 2. Rotate employees duties and require vacations. 3. Conduct background checks.
Chapter 8-9

LO 2 Identify the principles of internal control.

Internal Control

Limitations of Internal Control


Costs should not exceed benefit.

Human element.
Size of the business.

Chapter 8-10

LO 2 Identify the principles of internal control.

Cash Controls

Discussion Question
Q8-8. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control.

See notes page for discussion


Chapter 8-11

LO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls

Internal Control over Cash Receipts


Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips Physical, Mechanical, and Electronic Controls Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Other Controls Bond personnel who handle cash; require employees to take vacations; deposit all cash in bank daily

Store cash in safes and bank vaults; limit access to storage areas; use cash registers

Chapter 8-12

LO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls

Discussion Question
Q8-3. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why?

See notes page for discussion


Chapter 8-13

LO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls
Cash consists of coins, currency, checks, money orders, and money on hand or on deposit in a bank. Cash receipts come from: cash sales

collections on account from customers


receipt of interest, rent, and dividends investments by owners

bank loans
proceeds from the sale of noncurrent assets
Chapter 8-14

LO 3 Explain the applications of internal control principles to cash receipts.

Over-the-Counter Receipts
Sales Department
Illustration 8-7

Cashiers Department

Prepare daily summary


Prepare deposit slip

Cashier ring up sales


Supervisor 1. reads register totals 2. makes cash counts 3. prepares cash count sheets
Chapter 8-15

(deposit)

Bank

LO 3 Explain the applications of internal control principles to cash receipts.

(verification)

Treasurer Accounting
(record)

Mail Receipts
Control Procedures:
Mail receipts should be opened by two people, a list prepared, and each check endorsed.
Copy of the list, along with the checks and remittance advices, sent to cashiers department. Cashier adds the checks to the over-the-counter receipts and prepares a daily cash summary and makes the daily bank deposit.

Copy of list sent to treasurers office for comparison with total shown on daily cash summary.
Chapter 8-16

LO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls

Review Question
Permitting only designated personnel to handle cash receipts
is an application of the principle of:

a. segregation of duties.
b. establishment of responsibility. c. independent check. d. other controls.
Chapter 8-17

LO 3 Explain the applications of internal control principles to cash receipts.

Cash Controls

Internal Control over Cash Disbursements


Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash.
Applications:

Voucher system
Electronic funds transfers (EFT) system Petty cash fund
Chapter 8-18

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Internal Control over Cash Disbursements


Establishment of Responsibility Only designated personnel are authorized to sign checks (treasurer)
Segregation of Duties Different individuals approve and make payments; check signers do not record disbursements

Documentation Procedures Use prenumbered checks and account for them in sequence; each check must have an approved invoice
Other Controls Stamp invoices PAID

Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly
Physical, Mechanical, and Electronic Controls Store blank checks in safes, with limited access; print check amounts by machine in indelible ink

Chapter 8-19

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Discussion Question
Q8-14. Joe Griswold Companys internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls.
See notes page for discussion
Chapter 8-20

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Review Question
The use of prenumbered checks in disbursing cash is an application of the principle of:
a. establishment of responsibility.

b. segregation of duties.
c. physical, mechanical, and electronic controls. d. documentation procedures.

Chapter 8-21

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Internal Control over Cash Disbursements


Voucher System
Network of approvals, by authorized individuals, to ensure all disbursements by check are proper. A voucher is an authorization form prepared for each expenditure.

Chapter 8-22

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Internal Control over Cash Disbursements


Electronic Funds Transfers (EFT)
Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations.

Chapter 8-23

LO 4 Explain the applications of internal control principles to cash disbursements.

Cash Controls

Internal Control over Cash Disbursements


Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund.

Chapter 8-24

LO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The fund was established on March 1 with a balance of $100. During March the following petty cash receipts were found in the petty cash box. Receipt
Date 3/5 7 9 11 14 No. 1 2 3 4 5 For Stamp inventory Freight-out Miscellaneous expense Travel expense Miscellaneous expense Amount $ 39 21 6 24 5

The fund was replenished on March 15 when the fund contained $3 in cash. On March 20, the amount in the fund was increased to $150. Instructions: Journalize the entries in March that pertain to the operation of the petty cash fund.
Chapter 8-25

LO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 The fund was established on March 1 with a balance of $100 March 1 Petty cash Cash 100 100

Chapter 8-26

LO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 The fund was replenished on March 15 when the fund contained $3 in cash. March 15 Postage expense Freight-out Miscellaneous expense Travel expense 39 21 11 24

Cash over Short Cash

2
97

Chapter 8-27

LO 5 Describe the operation of a petty cash fund.

Cash Controls
E8-8 On March 20, the amount in the fund was increased to $150. March 20 Petty cash Cash 50 50

Chapter 8-28

LO 5 Describe the operation of a petty cash fund.

Use of a Bank
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions. Bank reconciliation.

Chapter 8-29

LO 6 Indicate the control features of a bank account.

Use of a Bank
Making Bank Deposits
Authorized employee should make deposit.
Illustration 8-10

Bank Code Numbers

Front Side
Chapter 8-30

Reverse Side
LO 6 Indicate the control features of a bank account.

Use of a Bank
Writing Checks
Illustration 8-11

Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient.
Maker Payee Payer

Chapter 8-31

LO 6 Indicate the control features of a bank account.

Use of a Bank
Bank Statements
Debit Memorandum
Bank service charge NSF (not sufficient funds)
Illustration 8-12

Credit Memorandum
Collect notes receivable.

Interest earned.
Chapter 8-32

LO 6 Indicate the control features of a bank account.

Use of a Bank

Review Question
The control features of a bank account do not include:
a. having bank auditors verify the correctness of the bank balance per books. b. minimizing the amount of cash that must be kept on hand. c. providing a double record of all bank transactions. d. safeguarding cash by using a bank as a depository.
Chapter 8-33

LO 6 Indicate the control features of a bank account.

Use of a Bank
Reconciling the Bank Account
Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks. 3. Errors. 4. Bank memoranda.
Chapter 8-34

LO 7 Prepare a bank reconciliation.

Use of a Bank
Reconciliation Procedures
Illustration 8-13

+ Deposit in Transit Outstanding Checks

+ Notes collected by bank NSF (bounced) checks Check printing or other service charges

+- Bank Errors

+- Book Errors CORRECT BALANCE


Chapter 8-35

CORRECT BALANCE
LO 7 Prepare a bank reconciliation.

Use of a Bank
E8-11 The following information pertains to Family Video Company.
1.

Cash balance per bank, July 31, $7,263.

2.
3. 4. 5.

Cash balance per books, July 31, $7,284.


July bank service charge not recorded by the depositor $28. Deposits in transit, July 31, $1,500. Bank collected $900 note for Family in July, plus interest $36, less fee $20.The collection has not been recorded by Family, and no interest has been accrued. Outstanding checks, July 31, $591.

6.

Instructions a) Prepare a bank reconciliation at July 31. b) Journalize the adjusting entries at July 31 on the books of Family Video Company.
Chapter 8-36

LO 7 Prepare a bank reconciliation.

Use of a Bank
E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement
Add: Deposit in transit Less: Outstanding checks Adjusted cash balance per bank $7,288 1,500 (591) $8,172 $7,284 900 36 (28) (20) $8,172
LO 7 Prepare a bank reconciliation.

Cash balance per books


Add: Collection of notes receivable Collection of interest Less: Bank service charge Note collection fee Adjusted cash balance per books
Chapter 8-37

Use of a Bank
E8-11 b) Journalize the adjusting entries at July 31 on the books of Family Video Company. Dr. Cr. July 31 Cash 788 Bank charge expense 28 Miscellaneous expense Notes receivable 20 900

Interest revenue
Note: Adjusting journal entry includes only the adjustments to the cash balance per books.
Chapter 8-38

36

LO 7 Prepare a bank reconciliation.

Use of a Bank

Review Question
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:
a. outstanding checks. b. deposit in transit. c. a bank error.

d. bank service charges.

Chapter 8-39

LO 7 Prepare a bank reconciliation.

Reporting Cash
Most liquid asset, listed first in current assets section of balance sheet.
Illustration 8-16

Cash equivalents

Restricted cash
Compensating balances
Chapter 8-40

LO 8 Explain the reporting of cash.

Use of a Bank

Review Question
Which of the following statements correctly describes the reporting of cash?
a. Cash cannot be combined with cash equivalents.

b. Restricted cash funds may be combined with Cash.


c. Cash is listed first in the current assets section. d. Restricted cash funds cannot be reported as a current asset.
Chapter 8-41

LO 7 Prepare a bank reconciliation.

Recording Process

Discussion Question
Q2-19. Jim Benes is confused about how accounting information flows through the accounting system. He believes the flow of information is as follows.
a. Debits and credits posted to the ledger.

b. Business transaction occurs.


c. Information entered in the journal. d. Financial statements are prepared. e. Trial balance is prepared.

Is Jim correct? If not, indicate to Jim the proper flow of the information. See notes page for discussion
Chapter 8-42

LO 7 Prepare a trial balance and explain its purposes.

Copyright
Copyright 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Chapter 8-43

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