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Internal Control and

Managing Cash

Chapter 4

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Set up an effective

system of internal control.

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Internal Control

It is the organizational plan and all the

related measures that an entity adopts.

Safeguard assets.

Promote operational efficiency.

Encourage Adherence to company policies.

Ensure Accurate and reliable accounting records.

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Components of an

Effective System

Competent, reliable, and ethical personnel

Assignment of responsibilitiesAuthorization

Recording

Custody

Separation of duties

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Separation of the Authorization of transactions

from the Recording of transactions

from the Custody of assets

Separation of Duties

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Internal and External Audits

An auditis an examination by an outside party

of the companys financial statements,

accounting systems, and internal controls.

An internal auditoris an employee of the business.

An external auditoris an independent auditor.

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Documents and Records

Business documents and records include:

invoices (bills)

paid checks

accounting journals

accounting ledgers

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Electronic and Computer Controls

Businesses use electronic devices to safeguard assets.

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The Onion Model of E-Commerce

System Security

Sensitive

Hardware,

Software,

and Data

Encryption

Firewalls

Intrusion detection devices

Incident response procedures

Audits by external specialists

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Encryption

It is the transformation of data by a mathematicalprocess into a form that is unreadable by anyone

who does not have the secret decryption key.

Clear

message

Encryption

Encoded

message

Clear

message

Decryption

Same key

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Firewall

It is a technique that limits access to hardware,software, or data to persons within a network.

Inquirers

Customers

Hackers

Firewall 1

Inquirers

Customers

Firewall 2

Customers

Firewall 3

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Other Controls

Fireproof vaults

Burglar alarms

Point of sale terminals

Frequent bank deposits

Mandatory vacations Job rotation

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The Limitations of

Internal Control

Systems designed to thwart one persons

fraud can be beaten by two or more

employees working together

colluding to defraud the firm.

A system of internal control that is too

complex can be inefficient.

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Use a bank reconciliation

as a control device.

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The Bank Reconciliation

There are two records of a businesss cash:

the companys cash account

on its own books, and

the bank statement, which shows the

actual amount of cash in the bank.

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Two common items that cause differences

between the bank balance and the book balance.

1. Items recorded by the company but not yet

recorded by the bank:

Deposits in transit

Outstanding checks

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2. Items on a bank statement and not

recorded by the business:

Bank collections Electronic funds transfers

Service charge

Interest revenue earned on account NSF checks

Errors

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Bank Reconciliation Illustrated

The bank statement of Business Research, Inc.,

shows a balance of $5,931.51 on January 31.The company Cash account on the

books has a balance of $3,294.21.

The following reconciling itemsexplain why the two balances differ:

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The Bank Reconciliation Illustrated

1. The January 30 deposit of $1,591.63

does not appear on the bank statement.

2. The bank erroneously charged to theaccount a $100 check (No. 656) not

written by Business Research Associates.

3. Five company checks issued late inJanuary and recorded in the journal

have not been paid by the bank.

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Check No. Date Amount

337 Jan. 27 $ 286.00

338 28 319.47

339 28 83.00

340 29 203.14

341 30 458.53Total $1,350.14

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4. The bank received $904.03 by EFT

on behalf of Business Research, Inc.

5. The bank collected on behalf of the

company a note receivable, $2,114

(including interest revenue of $214).

6. The bank statement shows interestrevenue of $28.01.

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7. Check number 333 for $150 paid to Brown Company

on account was recorded as a cash payment of $510.

8. The bank service charge for the month was $14.25.

9. The bank statement shows an NSF check for $52.

10. Business Research pays insurance expense by

EFT and has not recorded this $361 payment.

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Balance perbank, January 31 $5,931.51

Add deposit in transit 1,591.63Check erroneously charged 100.00

$7,623.14

Less outstanding checks 1,350.14

Adjusted bank balance $6,273.00


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Balance perbooks, January 31 $3,294.21

Add: ETF receipt of rent revenue 904.03

Collection of note receivable 2,114.00

Interest revenue earned 28.01

Correction of book error 360.00

$6,700.25

Less: Service charge $ 14.25NSF check 52.00

Payment of insurance expense 361.00 427.25

Adjusted book balance $6,273.00


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Apply internal controls

to cash receipts and

cash payments.

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Controlling and Managing Cash

Internal control over cash receipts ensures

that all cash receipts are deposited in the

bank and no collections are lost.

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Over the Counter Receipts

The point-of-sale terminal (cash register) offers

control over the cash received in a store.

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Mail Receipts

All incoming mail should be opened

by a mailroom employee.

This person should compare the check

received with the remittance advice.

The mailroom clerk keeps a running

total of cash receipts for the day.

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Mail Receipts

Many companies use a lock-box system.

Customers send checks directly to an

address that is essentially a bank account.

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Element ofInternal Control

Internal Controls overCash Receipts

Competent, reliable,

ethical personnel

Carefully screen and

train employees.

Proper authorization

Only designated employees can

grant exceptions for customers.

Internal Controls

Over Cash Receipts

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Internal Controls

Over Cash Receipts

Internal: management policies

External: control over cash receipts

Internal and

external audits

Electronic andcomputer controls

Match receipts with remittancesand bank deposit ticket daily.

Employees who handle cash do not

have access to accounting records.Separation of duties

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Internal Control: Payments

Purchasing Process

Purchase order Purchasingdepartment

Supplier

Invoice (bill) SupplierAccountingdepartment

Receiving report Receivingdepartment Accountingdepartment

Disbursementpacket

Accountingdepartment

Officer whosigns the check

Purchase request(requisition)

Salesdepartment

Purchasingdepartment

Business Document Prepared by Sent to

l l

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Internal Control: Payments

Disbursement Packet

Purchase Request

Purchase Order

Receiving ReportInvoice

Disbursement Packet

l C l

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Element ofInternal Control

Internal Controls overCash Payments

Competent, reliable,

ethical personnel

Payments entrusted to high level

employees and the treasurer.

Proper authorization

Large expenditures must be

authorized by top management.

Internal Controls

Over Cash Payments

I l C l

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Internal Controls

Over Cash Payments

Internal: management policies

External: control over cash payments

Internal and

external audits

Electronic andcomputer controls

Computer programmers do notoperate the computers.

Employees who handle checks have

no access to accounting records.Separation of duties

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Use a budget to

manage cash.

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Using a Budget to Manage Cash

A budgetis a financial plan that

helps coordinate business activities.

A cash budget helps a company,

or an individual, manage cash byplanning the receipt and payment

of cash during a future period.

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Cash Budget Example

1. Cash balance, February1, 20x2 $ 202.6

Estimated cash receipts:2. Collections from customers 2,858.33. Interest and dividends on investments 6.24. Sale of store fixtures 4.9

$3,072.0Estimated cash payments:

5. Purchases of inventory $1,906.26. Operating expenses 561.07. Expansion of existing stores 206.48. Opening of new stores 344.6

9. Payment of long-term debt 148.710. Payment of dividends 219.0 3,385.911. Net cash position at January 31, 20x3 (111.3)12. Budgeted / Desired cash balance, January 31, 20x3 200.013. Additional cash needed to meet desired 1/31/x3 balance $ 311.3

Cash Budget For the Year Ended January 31, 20x3 (In millions)

R ti C h

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Reporting Cash on

the Balance Sheet

Companies usually combine all cash amounts

into a single total called Cash and Cash

Equivalents on the balance sheet.

Cash equivalents include liquid assets

Time deposits Certificates of deposit

R ti C h

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Reporting Cash on

the Balance Sheet

America Online, Inc.Consolidated Balance Sheet

December 31 Excerpts

AssetsCurrent assets:

Cash and cash equivalents $2,610Short-term investments 886Accounts receivable 464

(In Millions) 2000

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Weigh ethical judgment in

business.

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Ethics and Accounting

Most large companies have a code of ethics

designed to encourage ethical and

responsible behavior by employees.Accountants have additional

incentives to behave ethically.

AICPA Code of Professional ConductStandards of Ethical Conduct

for Management Accountants

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Ethics and Accounting

Conflict of Interest

Enron

Corporation

A. Fastow, CEO

Outside

Partnership

A. Fastow,

Principal

Business

transactions

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End of Chapter 4