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Chapter 08 - Cash and Internal Control
CHAPTER 8
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 8-1, 8-11 8-1, 8-2 8-1 8-3, 8-5, 8-6
8-7, 8-8
C2. Define cash and cash
equivalents and explain how to
report them.
7, 10,11, 12,
13
8-2 8-3 8-1, 8-9
Analytical objectives:
A1 Compute days' sales uncollected
ratio and use it to assess
liquidity.
8-8 8-12 8-1, 8-2, 8-9
Procedural objectives:
P1. Apply internal control to cash
receipts and disbursements.
9 8-3, 8-11 8-4, 8-7 8-5, 8-7
P2. Explain and record petty cash
fund transactions.
8 8-4 8-5, 8-6 8-2, 8-3
P3. Prepare a bank reconciliation. 8-5, 8-6, 8-7 8-8, 8-9,
8-10, 8-11
8-4, 8-5
P4A. Describe the voucher system to
control cash disbursements.
(Appendix 8A)
8-9 8-13
P5A. Apply the net method to
5 8-10 8-14 8-4
8-1
Chapter 08 - Cash and Internal Control
Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. Problems 8-4A and 8-5A can be
completed using Excel. Problem 8-2A and 8-5A, and the Serial Problem can be completed with Sage
50 Software. Problem 8-2A 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
8-2
Chapter 08 - Cash and Internal Control
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
framework for how these principles improve the quality of
financial reporting.
D. Technology and Internal Control
Technology provides quick access to databases and information.
Examples of how technology impacts internal control:
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.
8-3
Education.
Chapter 08 - Cash and Internal Control
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
3. Cash equivalent (examples; short-term U.S. Treasury bills and
money market funds) are short-term, highly liquid investment
assets meeting two criteria:
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
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
the owner, who has authority to sign checks.
8-4
Chapter 08 - Cash and Internal Control
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
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:
3. Steps in preparing the bank reconciliation:
8-5
Education.
Chapter 08 - Cash and Internal Control
a. Identify the bank balance of the cash account (balance per
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.).
8-6
Chapter 08 - Cash and Internal Control
Chapter Outline Notes
IV Global View—Compares U.S. GAAP to IFRS
internal control.
IV. Decision Analysis—Days' 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 8A
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
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.
8-7
Chapter 08 - Cash and Internal Control
Chapter Outline Notes
VI. Controls of Purchases Discounts—Appendix 8B
A. Recording inventory purchases using net method provides
more control than gross method.
B. Gross method in a perpetual inventory system—records
the purchase (debit inventory, credit accounts payable) at
the gross amount and later reduces the inventory account
by the amount of the discount if invoice is paid within the
discount period. If the invoice is not paid within the
discount period the inventory account is not affected.
C. Net method in a perpetual inventory system—records
purchases (debit inventory, credit accounts payable) at net
amount and later records Discount Lost and increases
accounts payable if the invoice not paid within discount
period.
D. Discount Lost is an expense account and is brought to
management’s attention so they can seek to identify the
reason for discounts lost such as oversight, carelessness or
unfavorable terms.
E. Periodic inventory system differs from perpetual (under
either method) in that increases to inventory are recorded
in Purchases account and decreases to inventory for the
discount are recorded in Purchases Discount.
8-8
