978-0078025754 Chapter 6 Lecture Note

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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.
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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
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 principlethe costs of internal controls must not
exceed their benefits.
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Chapter Outline
Notes
II. Control of CashBasic 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
the owner, who has authority to sign checks.
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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. Reimbursementdebit 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.).
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Chapter Outline
Notes
IV Global ViewCompares 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 SystemAppendix 6A
Important documents of a voucher system of control include:
A. Purchase Requisitionlists the merchandise needed and requests
that it be purchased.
B. Purchase Orderused by purchasing department to place an order
with a vendor (seller or supplier).
C. Invoicean 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 reportused by receiving department to verify that
goods conform to purchase order.
E. Invoice Approvalused by accounting department to verify all
necessary documents related to a purchase are assembled and
approve payment of the related invoice.
F. Vouchercan be a folder used to hold all documents related to a
given transaction and authorizes its recording.
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Chapter Outline
Notes
VI. Controls of Purchases DiscountsAppendix 6B
A. Recording inventory purchases using net method provides
more control than gross method.
B. Gross method in a perpetual inventory systemrecords
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 systemrecords
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.
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VISUAL #6-1
BANK RECONCILIATION
Reasons for discrepancies between
bank statement balance and checkbook
balance: Handle as follows:
Unrecorded deposits Add to Bank Balance
Outstanding checks Deduct from Bank Balance
Bank service charges Deduct from Book Balance
Debit memos Deduct from Book Balance
Credit memos Add to Book Balance
NSF checks Deduct from Book Balance
Interest Add to Book Balance
Errors Must analyze individually
(bank errors affect bank
balance and book errors
affect book balance)
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Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
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Alternate Demonstration Problem
Chapter 6
The Betsy Dough Company wants to prepare a bank reconciliation for the
month of June. When the bank statement for the month of June arrives
from the bank, the following steps are performed:
1. The deposits to the bank account, as recorded on the bank statement,
are compared to the deposit slips retained by the company. It is noted
that the last deposit, of $400, occurred after banking hours on the day of
the bank statement and therefore has not been recorded by the bank on
this bank statement.
2. Checks returned with the bank statement are compared to the checks
written and listed in checkbook. This comparison shows that there are
checks outstanding amounting to $1,456.
3. The ending balances on the statement and in the company’s books are
determined. The ending bank statement balance is exactly $10,129
whereas the books show $9,000.
4. Other information contained on the bank statement, not previously
known to the company, is determined. This includes the following: (a) a
note of $180 plus $20 interest from a customer for a total of $200 has
been collected by the bank and credited to our account; (b) a check
from Frank Ony for $120 previously deposited by us has been returned
for lack of sufficient funds; (c) the bank has charged us $25 for its
services (this includes a $10 fee for the NSF check). The $10 fee for the
NSF check will be charged to the customer.
5. A bank reconciliation is prepared; it does not balance! The difference is
$18, so a transposition error is looked for (whenever the difference is a
multiple of 9, there is a very good chance that there has been an
inadvertent exchange of two digits (for example, writing 29 when it
should have been 92). An error is found. Check number 141 was written
for $235 for Advertising Expense and cleared the bank for $235, but was
recorded in the company records as $253.
Required:
Prepare a bank reconciliation for the Betsy Dough Company at June 30,
20XX.
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Solution: Alternate Demonstration Problem
Chapter 6
BETSY DOUGH COMPANY
Bank Reconciliation
June 30, 20XX
Bank Statement
Bank statement balance .............................................
$10,129
Add:
Deposit of June 30 ............................................
400
10,529
Deduct:
Outstanding checks ..........................................
1,456
$ 9,073
Depositor’s Books
Book balance of cash .................................................
$ 9,000
Add:
Proceeds of customer note collected
by bank ...............................................................
200
Error in recording Check No. 141 ....................
18
Deduct:
NSF check from Frank Ony ..............................
$ 120
Bank service charges .......................................
25
145
$ 9,073
Adjusting entries Based on the Bank Reconciliation (made by depositor)
Cash………………………………………………………………. 218
Notes Receivable …………………………………………. 180
Interest Revenue ……………………………………….. 20
Advertising Expense ……………………………………… 18
Accounts Receivable F. Ony ……………………………….. 130
Miscellaneous Expense ………………………………………... 15
Cash 145
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