Chapter 06 – Reporting and Analyzing Cash and Internal Controls
Chapter 06
Reporting and Analyzing Cash and Internal Controls
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
(A &B set)**
Beyond the
Numbers
Conceptual objectives:
C1. Define internal control and
identify its purpose and
principles.
1, 2, 3, 4, 5, 6
6-1, 6-10,6–11
6-1, 6-3
6-1
EC, TTN,
TIA, ED,
HTR
C2. Define cash and cash
equivalents and explain how to
report them.
7, 10, 11, 12,
13
6-2
6-4
RIA, GD
Analytical objectives:
A1 Compute the days’ sales
uncollected ratio and
use it to assess liquidity.
6-8
6-12
RIA, CA, GD
Procedural objectives:
P1. Apply internal control
to cash receipts and
disbursements.
6-3, 6-11
6-2, 6-8
TTN, ED
P2. Explain and record
petty cash fund transactions.
8
6-5
6-5, 6-6
6-2, 6-3
P3. Prepare a bank reconciliation.
9
6-4, 6-6, 6-7
6-7, 6-9, 6-10,
6-11
6-4, 6-5
P4. Describe the use of
documentation and verification
to control cash disbursements.
(Appendix 6A)
6-9
6-13
P5. Apply the net method to control
purchase discounts
(Appendix 6B)
6-10
6-14
CIP
* Assignment materials that can be completed by students using:
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-2
Synopsis of Chapter Revisions
• Google: NEW opener with new entrepreneurial assignment
• Expanded presentation of ‘Hacker’s Guide’
• New discussion of the lock box and its purpose
• New data on sources of fraud complaints
• New evidence on methods to override controls
• New visual on document to bond (insure) an employee
• New example of MLB controls, or lack thereof
PowerPoint® Slides
Chapter Learning Objective
PowerPoint® Slides
C1
3-8
C2
9-12
P1
13-16, 26
P2
17-25
P3
27-34
A1
35
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-3
Chapter Outline
Notes
I. Internal Control
A. Purpose of Internal Control.
A properly designed internal control system is a key part of system
design, analysis, and performance. Internal controls do not
provide guarantees, but they lower the company’s risk of loss.
B. Internal control system consists all policies and procedures
managers use to:
1. Protect assets.
2. Ensure reliable accounting.
3. Promote efficient operations.
4. Urge adherence to company policies.
C. Sarbanes-Oxley Act (SOX) 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. Auditors must evaluate internal
controls and are limited as to consulting services provided. The
PCAOB is an oversight board. There are harsh penalties for
violations.
D. Principles of Internal Control
Certain fundamental internal control principles apply to all
companies. Internal control procedures increase the reliability and
accuracy of accounting records. Framework is provided by the
Committee of Sponsoring Organizations (COSO).
principles of internal control are to:
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.
E. Technology and Internal Control
Technology provides rapid access to large quantities of data.
Examples of technological impacts on internal control:
1. Reduced processing errors.
2 More extensive testing of records.
3. Limited evidence of processing.
4. Crucial separation of duties.
5. Increased E-Commerce.
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-4
Chapter Outline
Notes
F. Limitations of Internal Control
1. Internal control policies and procedures are applied by people;
the human element creates several potential limitations:
a. Human error—resulting from negligence, fatigue,
misjudgment, or confusion.
b. Human fraud—involves intent by people to defeat internal
controls, such as management override, for personal gain.
Human fraud is driven by the triple threat of fraud;
opportunity, pressure and rationalization.
2. Cost-benefit principle—the costs of internal controls must not
exceed their benefits.
II. Control of Cash
Basic guidelines for control of cash include: handling of cash must be
separate from recordkeeping of cash, cash receipts are promptly
deposited in a bank, and disbursements of cash are made by check.
A. Cash, Cash Equivalents, and Liquidity
1. Liquidity refers to 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 obligations.
2. Cash includes currency and coins, deposits in bank and
checking accounts, many savings accounts, and items that are
acceptable for deposit in those accounts.
3. Cash equivalents are short-term, highly liquid investment
assets meeting two criteria. (Note: only investments purchased
within three months of their maturity dates usually satisfy
these criteria.)
a. Readily convertible to a known cash amount.
b. Sufficiently close to their maturity date so that their
market value is not sensitive to interest rate changes.
B. Cash management
1. Companies must plan both cash receipts and cash payments.
The goals of cash management are to plan cash receipts to meet
cash payments when due and to keep the minimum level of
cash necessary to operate.
2. Effective cash management involves the following principles:
a. Encourage collection of receivables.
b. Delay payment of liabilities.
c. Keep only necessary levels of assets.
d. Plan expenditures.
e. Invest excess cash.
C. Control of Cash Receipts
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-5
Chapter Outline
Notes
Internal control of cash receipts ensures that cash is properly
recorded and deposited.
1. Over-the-counter cash receipts:
a. Record on a cash register at time of sale.
b. Separate custody from recordkeeping.
2. Cash Over and Short – sometimes errors in making change
are discovered from differences between the cash in a cash
register and the record of the amount of cash receipts.
a. Record any petty cash shortages/overages in the Cash
Over and Short account.
b. Entry to record cash sales with an overage: debit Cash,
credit Cash Over and Short, credit Sales.
c. Entry to record cash sales with a shortage: debit Cash,
debit Cash Over and Short, credit Sales.
d. Report balance of cash over and short account, an income
statement account; as part of miscellaneous expenses if it
has a debit balance or as part of miscellaneous revenues if
it has a credit balance.
3. Cash receipts by mail:
a. Preferably, two people should open the mail and prepare a
list of cash received; copies should be sent to cashier,
recordkeeper in accounting area, and clerks who open
mail.
b. The cashier deposits the money in a bank.
c. The recordkeeper records the amounts received in the
accounting records.
d. Bank account should be reconciled by another person (see
below).
D. Control of Cash Disbursements
To safeguard against theft—require all expenditures be made by
check (except for small payments made from petty cash fund) and
deny access to the accounting records to anyone, other than the
owner, who has authority to sign checks.
1. Cash budget shows projected cash receipts and
disbursements.
2. Lock box – customers can send payments directly to bank so
that handling of cash is minimized.
3. A voucher system is a set of procedures and approvals
designed to control cash disbursements and the acceptance of
obligations. The voucher system includes procedures for:
a. Verifying, approving, and recording obligations for
eventual cash disbursements.
b. Issuing checks for payment of verified, approved, and
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-6
Chapter Outline
Notes
recorded obligations.
c. Key factors in a voucher system:
i. Only approved departments and individuals are
authorized to incur such obligations.
ii. Several business documents (purchase requisition,
purchase order, invoice, receiving report, and check)
are accumulated in a voucher, which is an internal
document (or file) used to accumulate information to
control cash disbursements.
4. Use a petty cash system of control as follows:
a. Write and cash a check to establish petty cash fund. Entry
to record establishment: debit Petty Cash, credit Cash.
b. A petty cash fund is used to pay for small items such as
postage, courier fees, minor repairs, and low-cost supplies.
c. Assign a petty cashier (custodian) to account for the
amounts expended and keep receipts.
d. Entry to record reimbursement: debit the related expense
and/or asset accounts for the amounts paid for with petty
cash, credit Cash for the amount reimbursed to the petty
cash fund.
e. Entry to increase fund: debit petty cash and credit cash.
f. Entry to decrease fund: debit cash and credit petty cash.
g. Sometimes, the petty cash payments reported plus the cash
remaining will not total to the fund balance.
i. A shortage is recorded as an expense in the
reimbursing entry with a debit to the Cash Over and
Short account.
ii. An overage is recorded with a credit to the Cash Over
and Short account in the reimbursing entry.
III. Banking Activities as Controls
A. Basic Bank Services
Bank accounts permit depositing money for safeguarding and help
control withdrawals.
1. A bank account is a record set up by a bank for a customer. To
limit access, all persons authorized to write checks,
documents instructing the bank to pay a specified amount of
money to a designated recipient, sign a signature card. Each
bank deposit is supported by a deposit ticket.
2. Electronic Funds Transfer (EFT) is the electronic
communication transfer of cash from one party to another.
Chapter 06 – Reporting and Analyzing Cash and Internal Controls
6-7
Chapter Outline
Notes
B. Bank Statement
Once a month, the bank sends each depositor a bank statement
showing activities in the bank account.
C. Bank Reconciliation
1. A bank reconciliation is a report explaining any differences
between the checking account balance according to the
depositor’s records and the balance reported on the bank
statement.
2. The balance reported on the bank statement rarely equals the
balance in the depositor’s accounting records; this is usually
due to information that one party has that the other does not.
a. Outstanding checks.
b. Deposits in transit.
c. Deductions for uncollectible items and for services
d. Additions for collections and for interest.
e. Errors.
3. Steps in preparing the bank reconciliation:
a. Identify the bank statement balance of the cash account
(balance per bank).
b. Identify and list any unrecorded deposits 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, interest earned, and errors understating the book
balance. Add them to the book balance.
g. Identify and list any unrecorded debit memoranda from the
bank, service charges, and errors overstating 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 so, they are reconciled. If not, check for
mathematical accuracy and missing data to achieve
reconciliation.