978-0077633059 Chapter 6 Lecture Note Part 1

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CHAPTER 6
CASH AND INTERNAL CONTROL
Related Assignment Materials
Student Learning Objectives Questions
Quick
Studies* Exercises* Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Define internal control and its
purpose and principles.
1, 2, 3, 4, 6 6-1, 6-11 6-1, 6-2 6-1 6-3, 6-5, 6-6
6-7, 6-8
C2. Define cash and cash
equivalents and explain how to
report them.
7, 10,11, 12,
13
6-2 6-3 6-1, 6-9
Analytical objectives:
A1 Compute days' sales uncollected
ratio and use it to assess
liquidity.
6-8 6-12 6-1, 6-2, 6-9
Procedural objectives:
P1. Apply internal control to cash
receipts and disbursements.
9 6-3, 6-11 6-4, 6-7 6-5, 6-7
P2. Explain and record petty cash
fund transactions.
8 6-4 6-5, 6-6 6-2, 6-3
P3. Prepare a bank reconciliation. 6-5, 6-6, 6-7 6-8, 6-9,
6-10, 6-11
6-4, 6-5
P4A. Describe the voucher system to
control cash disbursements.
(Appendix 6A)
6-9 6-13
P5A. Apply the net method to
control purchase discounts.
(Appendix 6B)
5 6-10 6-14 6-4
*See additional information on next page that pertains to these quick studies, exercises and problems.
6-1
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Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. Problems 6-4A and 6-5A can be
completed using Excel. Problem 6-2A and 6-5A, and the Serial Problem can be completed with Sage 50
Software. Problem 6-2A can be completed with QuickBooks.
Connect reproduces assignments online, in static or algorithmic mode, which allows instructors to
monitor, promote, and assess student learning. It can be used for practice, homework, or exams.
Synopsis of Chapter Revisions
Dandelion Chocolate: NEW opener with new entrepreneurial assignment
New learning notes added to bank reconciliation
New chart for timing differences for bank reconciliation
Updated receivables analysis using Hasbro and Mattel
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Chapter Outline Notes
I. Internal Control
A. Purpose of Internal Control
An internal control system consists of policies and procedures
managers use to:
1. Protect assets.
2. Ensure reliable accounting.
3. Promote efficient operations.
4. Urge adherence to company policies.
B. Sarbanes Oxley Act (SOX)
Section 404 of SOX requires the managers and auditors of
companies whose stock is traded on an exchange (called public
companies) to document and certify the system of internal
controls.
C. Principles of Internal Control:
1. Establish responsibilities.
2. Maintain adequate records.
3. Insure assets and bond key employees.
4. Separate recordkeeping from custody of assets.
5. Divide responsibility for related transactions.
6. Apply technological controls.
7. Perform regular and independent reviews.
The Committee of Sponsoring Organizations (COSO) provides a
1. Reduces processing errors.
2 Allows more extensive testing of records.
3. Limits hard copy evidence of processing steps but can
electronically store additional evidence.
4. Requires that crucial separation of responsibilities be carefully
distributed among fewer employees.
5. Increased e-commerce increases risks of credit card theft,
computer viruses and online impersonation.
E. Limitations of Internal Control
1. Human Element
a. Error: negligence, fatigue, misjudgment, r confusion
b. Fraud: opportunity, pressure, rationalization
2. Cost-benefit principle—the costs of internal controls must not
exceed their benefits.
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Chapter Outline Notes
II. Control of Cash—Basic guidelines for control of cash and cash
equivalents include: handling of cash must be separate from
recordkeeping of cash, cash receipts are promptly deposited in bank,
and disbursements of cash are by check.
A. Cash, Cash Equivalents, and Liquidity
1. Liquidity refers to a company's ability to pay for its near term
obligations.
2. Cash includes currency and coins, deposits in bank and
checking accounts (called demand deposits), many savings
accounts (called time deposits), and items that are acceptable
for deposit in those accounts (customers checks, cashier
checks, certified checks, and money orders).
3. Cash equivalent (examples; short-term U.S. Treasury bills and
money market funds) are short-term, highly liquid investment
assets meeting two criteria:
a. Readily convertible to a known cash amount.
b. Sufficiently close to their maturity date so that market
value is not sensitive to interest rate changes.
Note: Only investments purchased within three months of
their maturity dates usually satisfy these criteria.
B. Cash Management
1. Goals of Cash Management
a. Plan cash receipts to meet cash payments when due
b. Keep minimum level of cash necessary to operate.
2. Effective cash management principles:
a. Encourage collection of receivables
b. Delay payment of liabilities until last possible day allowed
c. Keep only necessary levels of assets
d. Plan expenditures
e. Invest excess cash
C. Control of Cash Receipts
Procedures for protecting cash received over-the-counter and by
mail:
1. Apply internal control principles.
2. Record cash shortages and overages in an income statement
account called Cash Over and Short.
D. Control of Cash Disbursements
To safeguard against theft:
1. Require all expenditures be made by checks. (Exception—
small payments made from petty cash fund.)
2. Deny access to the accounting records to anyone, other than
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Chapter Outline Notes
3. Use a voucher system of control that establishes procedures
for:
a. verifying, approving and recording obligations for
eventual cash disbursement.
b. issuing checks for payment of verified, approved, and
recorded obligations.
(Documents in a voucher system are listed and explained in
appendix notes)
4. Use a petty cash system of control as follows:
a. Write and cash a check to establish petty cash fund.
Record as a debit to Petty Cash and credit to Cash.
(Use the Petty Cash account only when the fund is
established or size of fund is increased or decreased.)
b. Assigning a petty cashier (custodian) to account for
the amounts expended and to keep receipts.
c. Reimbursement—debit the expenses or other items
paid for with petty cash and credit Cash for the
amount reimbursed to the petty cash fund.
d. Record any petty cash shortages/overages.
III. Banking Activities as Controls
A. Basic Bank Services
Bank accounts permit depositing money for safeguarding and
helps control withdrawals. Electronic Funds Transfer (EFT) is an
electronic communication transfer of cash from one party to
another.
B. Bank Statement
Shows activities of a bank account and is used to prove the
accuracy of the depositor's cash records in preparing a bank
reconciliation.
1. Bank reconciliation –a report that explains (reconciles) the
difference between the balance of a checking account
according to the depositor's records and the balance reported
on the bank statement.
2. Factors causing the bank statement balance to differ from the
depositor's book balance are:
a. Outstanding checks.
b. Deposits in transit.
c. Deductions for uncollectible items and services
d. Additions for collections and interest.
e. Errors by either the bank or depositor
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Chapter Outline Notes
3. Steps in preparing the bank reconciliation:
a. Identify the bank balance of the cash account (balance per
bank).
b. Identify and list any unrecorded deposits (deposits in
transit) and any bank errors understating the bank balance.
Add them to the bank balance.
c. Identify and list any outstanding checks and any bank
errors overstating the bank balance. Deduct them from the
bank balance.
d. Compute the adjusted bank balance, also called corrected
or reconciled balance.
e. Identify the company's balance of the cash account
(balance per book).
f. Identify and list any unrecorded credit memoranda from
the bank, any interest earned, and errors that understated
the book balance. Add them to the book balance.
g. Identify and list any unrecorded debit memoranda from
the bank, service charges, and errors that overstated the
book balance. Deduct them from the book balance.
h. Compute the adjusted book balance, also called corrected
or reconciled balance.
i. Verify the two adjusted balances from steps d and h are
equal. If yes, they are reconciled. If not, check for
accuracy and missing data to achieve reconciliation.
4. Adjusting entries from a bank reconciliation
a. All reconciling additions to book balance are debits to
cash. Credit depends on reason for addition (Examples:
Credit Interest Income for interest on balance and Notes
Receivable when bank collected note).
b. All reconciling subtractions from book balance are credits
to cash. Debit depends on reason for subtraction.
(Examples: Debit Miscellaneous Expense for bank service
charge and Accounts Receivable/customer for NSF
checks.).
6-6
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Chapter Outline Notes
IV Global View—Compares U.S. GAAP to IFRS
A. Internal control purposes, principles and procedures are basically
the same across the globe.
B. The definitions of cash are similar for U.S. GAAP and IFRS.
C. There is a global demand for banking services, bank statements
and bank reconciliations and bank services are a part of effective
internal control.
IV. Decision AnalysisDays' Sales Uncollected
A. Also called days' sales in receivables.
B. Used to evaluate the liquidity of a company; estimates how
quickly a company will convert its accounts receivable into cash.
C. Calculated by dividing current balance of accounts receivable by
net sales and multiplying the result by 365.
V. Documents in a Voucher System—Appendix 6A
Important documents of a voucher system of control include:
A. Purchase Requisition—lists the merchandise needed and requests
that it be purchased.
B. Purchase Order—used by purchasing department to place an order
with a vendor (seller or supplier).
C. Invoice—an itemized statement of goods prepared by the vendor
(copy sent to buyer) listing the customer’s name, items sold, sales
prices, and terms of sale.
D. Receiving report—used by receiving department to verify that
goods conform to purchase order.
E. Invoice Approval—used by accounting department to verify all
necessary documents related to a purchase are assembled and
approve payment of the related invoice.
F. Voucher—can be a folder used to hold all documents related to a
given transaction and authorizes its recording.
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