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ACCT 2101 – Introduction to Financial Accounting
Chapter 6 – Reporting and Analyzing Cash and Internal Control
Internal Control
• Purpose of Internal Control
o A properly designed internal control system is a key part of system design, analysis, and
performance.
o Internal controls do not provide guarantees, but they lower the company's risk of loss.
o Internal control system consists of all policies and procedures managers use to:
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▪
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o Sarbanes-Oxley Act requires manager and auditors of public companies to document
and certify that company's system of internal controls.
Section 404 requires that managers document and assess the effectiveness of
all internal control processes that can impact financial reporting.
• Principles of Internal Control
o Internal control procedures increase the reliability and accuracy of accounting records.
o The principles of internal control are to:
▪ Establish responsibilities
▪ Maintain adequate records
▪ Insure assets and bond key employees
▪ Separate recordkeeping from custody of assets
▪ Divide responsibility for related transactions
▪ Apply technology controls
▪ Perform regular and independent reviews
• Technology and Internal Control
o Technology provides rapid access to large quantities of data.
• Limitations of Internal Control
o Internal control policies and procedures are applied by people; the human element
creates several potential limitations:
▪ Human error - resulting from negligence, fatigue, misjudgment, or confusion.
▪ Human fraud - involves intent by people to defeat internal controls.
o Cost-benefit constraint - the cost of internal controls must not exceed their benefits.
Control of Cash
• Basic guidelines for control of cash include:
o Handling of cash must be separate from recordkeeping of cash.
o Cash receipts are promptly deposited in a bank.
o Disbursements of cash are made by pre-numbered checks.
• Cash, Cash Equivalents, and Liquidity
o liquidity - a company's ability to pay for its near-term obligations.
▪ Cash and similar assets are called liquid assets because they can be readily used
to settle such obligation.
o Cash - includes currency and other items that are payable on demand.
o Cash equivalents - short-term, highly liquid investment assets meeting two criteria.
▪ Readily convertible to a known cash amount. Ex. (money market funds, treasury
bills and commercial papers
▪ Sufficiently close to their maturity date so that their market value is not
sensitive to interest rate changes.
• Only investments purchased within three months of their maturity
dates usually satisfy these criteria.
• Cash Management
o The goals of cash management are twofold:
▪ Plan cash receipts to meet cash payments when due.
▪ Keep the minimum level of cash necessary to operate.
• Control of Cash Receipts
o Over-the-counter cash receipts
▪ Record on a cash register at the time of each sale.
