Financial Accounting

1
Chapter 9Internal Controland Cash
2
In this chapter
Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet
Current Assets Cash Chapter 9, 19 Chapter 9, 19 Chapter 9, 19 10000 Current Liabilities Accounts Payable 5000 5000
Accounts Receivable Accounts Receivable 20000 20000 Wages Payable 25000 25000 25000 25000
Notes Receivable Notes Receivable 15000 15000 Utilities Payable 2000 2000 2000 2000
Marketable Securities Marketable Securities 25000 25000 Long-Term Debt
Inventory Inventory 120000 120000 Notes Payable 20000 20000 20000 20000
Capital Assets Capital Assets Bonds Payable 600000 600000 600000 600000
Equipment Equipment 250000 250000 Owners Equity
Buildings Buildings 500000 500000 Common Stock 300000 300000 300000
Goodwill Goodwill 60000 60000 Retained Earnings 48000 48000 48000 48000
Total Assets Total Assets 1000000 1000000 Total Liabilities OE 1000000 1000000 1000000 1000000 1000000
3
Internal Control Systems

• All policies and procedures used to
• Protect assets
• Ensure reliable accounting
• Promote efficient operations
• Encourage adherence to company policies
• The primary purpose of internal control systems
  is to help extend the control an owner/manager
  has over the above items
• The bigger a company gets, the less hands on
  control managers have and so the greater the need
  for controlling systems to safeguard assets

4
Principles of Internal Control

• Ensure transactions and activities are authorized
• Maintain records
• Using pre-printed forms and filing procedures
  help to track the processes that run under the
  forms
• Insure assets
• Passes the risk of loss to a party willing to
  bear the loss (for a premium)
• Separate record keeping from custody of assets
• Risk of loss or theft gets reduced when the
  person having control over assets knows there is
  another person maintaining records
• Separate duties
• Dividing responsibilities for related
  transactions as a safety check

5
Principles of Internal Control

• Apply technological controls
• Use a cash register with a tape record, use time
  cards to track hourly wage earners activities
• Computerized control systems can provide more
  security with less paper trail and less auditing
  effort but still pose challenges
• Separating duties is even more critical the more
  technologically advanced the accounting system
• Perform internal and external audits
• Regularly reviewing the records helps to ensure
  any issues are reconciled within a short period
  of time and also tunes the auditor to look for
  common errors or patterns

6
Limitations of Internal Control

• The more active people are in the internal
  control process, the more likely human error and
  human fraud can play as a factor
• Human error results from fatigue, negligence,
  confusion or training issues
• Human fraud is intentionally malicious activity
  designed to defeat a control system
• Management can influence these by conveying a
  commitment and following through with processes
  that exercise control

7
Limitations of Internal Control

• Cost-benefit
• Its important to note that all quality assurance
  processes add no discernable value to the product
  or process (they prevent further loss).
• Internal control is the same
• Companies then should manage the investment they
  make in internal controls with respect to the
  return they expect to get from the effort

8
Cash

• Cash is probably one of the most important assets
  an organization can have.
• Cash includes currency, coins, and amounts on
  deposit in bank accounts. It also includes
  customers cheques, cashiers cheques, certified
  cheques, money orders, EFT deposits
• Basically anything that is cash or a cash
  equivalent
• Liquidity refers to how easily an asset can be
  converted into cash for paying obligations
• Cash is the most fluid of assets and so can be
  easily hidden and moved. Special precautions
  should be in place to secure cash. The control
  mechanisms outlined earlier are applicable

9
Petty Cash

• Most organizations put most of their cash in bank
  accounts so that it can earn interest but also
  that it is securely stored.
• For many organizations, this means that all
  payments can be made by cheque. These invoke a
  highly tuned and specialized tracking system run
  by banks to secure the funds controlled by
  cheques.
• But many small expenses are too small to pay by
  cheque (the cost/inconvenience of paying by
  cheque becomes too large)
• Petty Cash is a small store of cash used to pay
  small incidental costs (courier fees, repairs,
  supplies)

10
Petty Cash

• A Petty Cash fund has its own periodic cycle that
  can be used to control the small amount of funds
  on hand
• It starts by establishing the petty cash fund
• This establishes the petty cash fund. Now that
  it is established, it is no longer debited or
  credited, unless the owner wishes to increase it
  or decrease it

Date Account Titles and explanation PR Debit Credit
Apr 1 Petty Cash 100
Cash 100
11
Petty Cash

• Now that Petty Cash is established, the Petty
  Cashier can use cash to pay small expenses.
• Whenever an expense is paid directly out of petty
  cash a receipt is issued to record the purpose of
  the cash disbursement.
• At the end of the period (month), all receipts
  are collected and examined to determine how
  various expense and asset accounts should be
  debited.
• Exhibit 9.2 shows the Petty Cash Payments Report
  that summarizes the periods use of Petty Cash
• Note the calculation of over/short.
• The figures in this table are used to record
  journal entries

12
Petty Cash

• You can see how the report translates into a
  journal entry to record the petty cash
  disbursements into the books
• All expenses are debited (increased)
• The cash shortage is considered an expense and
  so is also debited so that cash can be used to
  replenish all the expenses plus the shortage.
• Note how the Petty Cash account itself is not
  touched here. It is as if the Cash account
  reaches over top of the Petty Cash account to
  cover the expenses
• In the second journal entry, you can see how the
  Petty Cash account is increased. The Petty Cash
  account is also debited (similar to when it was
  opened) and that much more cash is added to the
  Cash credit line

13
Mid-chapter Demo Problem

• Lets try out the Mid-chapter Demo problem
• Establish the Castillo Companys petty cash fund
• Record transactions and replenish the fund
• Use a Petty Cash Payments Report to understand
  how the cash has flowed out of the account
• Independent of the second item, reduce Petty Cash
  by 100

14
Banking Activities

• Mentioned earlier, banking activities serve to
  secure funds.
• This is done by storing funds in banks, but also
  by leveraging their detailed reporting system
• Bank Account a record set up by a bank for a
  customer permitting that customer to deposit and
  withdraw funds through deposits and cheques.
• Signature cards are used to authorize various
  people to sign company cheques
• Bank deposits the act of delivering cash or
  equivalents to the bank. The bank will issue a
  deposit slip as proof of deposit to the account.

15
Banking Activities

• Cheques documents written by the bank account
  customer and given to their vendors or suppliers.
  
• By presenting the cheque to the bank, the vendor
  claims the funds.
• The cheque authorizes the bank to distribute the
  funds to the vendor
• Electronic Funds Transfer (EFT) - this is a new
  fangled way of transferring money between
  business partners.
• Far cheaper than writing and mailing cheques,
  plus it occurs instantly

16
Banking Activities

• Credit Cards Paying by credit card is
  convenient for customers, which helps to spark
  sales
• Allowing payment by credit card allows
  organizations to make sales where they otherwise
  may not
• Shifts the burden of collecting on credit sales
  to a credit card company
• The credit card company manages this assumed
  burden and associated expenses by charging the
  organization a small credit card transaction fee
• Sometimes credit card companies also charge the
  credit card user with fees
• The book distinguishes between a credit card and
  a bank credit card
• The difference is the timing in payment to the
  retailer

17
Banking Activities

• Debit Cards these cards allow funds to be
  directly transferred between the customers
  account and the organizations account.
• Again, the bank does charge a fee for this
  service to the retailer and also sometimes to the
  customer

18
Bank Statements

• Bank Statements are usually a monthly report
  mailed to the business owner (accounting
  department), which summarizes the transactions on
  the bank account for the stated period (Exhibit
  9.5)
• Notice that Deposits are called Credits and
  Cheques are called debits
• In our books, deposits are increases in cash and
  so are debits and cheques decrease cash accounts
  and so credit those accounts
• The difference is that these statements are
  reported from the banks perspective.
• A companys bank account is a liability on the
  books of a bank

19
Bank Reconciliation

• Bank reconciliation is a method used to control
  and confirm the cash accounts.
• Because of the fluid/liquid nature of cash, this
  process is extremely critical
• In a big company, bank records may rarely match
  the company records for the bank account there
  is just too much going on.
• Reconciliation helps to explain and reconcile the
  differences which can be caused mostly by timing
  differences.

20
Bank Reconciliation

• Causes for differences between company and bank
  account records
• Unrecorded funds These are deposits made and
  recorded in the books by the company but not yet
  by the bank (say, overnight deposits)
• Outstanding cheques cheques are recorded as
  cash outlays by the company, but have not yet
  been cashed by the supplier
• Collections or interest earned The bank may
  offer interest on savings accounts and so may
  issue interest payments to the bank account
  holder. These are recorded in the bank account
  statement unknown to the company.
• Deductions for service fees similarly, banks
  will deduct for services fees directly from the
  bank account without informing the company.
• Errors made by both the bank and the company

21
Reconciling a Bank Statement

• First, note the ending date/period for the
  statement
• Note the beginning and ending balances
• Compare all deposits on the bank statement with
  those recorded by the accounting records.
  Identify discrepancies and determine which is
  correct
• Compare cancelled cheques received with those
  recorded on the bank statement and with those
  recorded in the books
• Identify outstanding cheques between the books
  and the bank account
• Inspect all additions due to customer payments,
  interest earned, collections
• Inspect all deductions due to service fees, NSF
  cheques, etc

22
Reconciling a Bank Statement

• Lets walk through the bank reconciliation
  exercise on page 456 to understand how the
  company reconciles its books with its bank
  accounts
• Build a reconciliation report (which looks like
  Exhibit 9.9, but for the next month) to summarize
  the reconciliation
• Prepare adjusting entries for any action that was
  outstanding

23
Exercises

• Try Exercise 9-6
• Establish the Petty Cash account
• Prepare the Petty Cash Payments Report
• Complete the journal entries to replenish the
  account and record expenses

24
Exercises

• Try Exercise 9-7. For all 3 pieces of this
  exercise
• Establish the Petty Cash account
• Prepare the Petty Cash Payments Report
• Complete the journal entries to replenish the
  account and record expenses

25
Exercise

• Try Problem 9-4A, 9-5A, 9-8A
• Chapter 10