Chapter 6
Internal Control and Accounting for Cash
General Comments for Chapter 6
Most students find the concepts in this chapter less difficult than those in the two previous
chapters. Begin the discussion of internal controls with a question about a practice familiar
to your students. For example, ask why a movie theater uses one person to sell tickets and
another to collect them as patrons enter the theater. Couldn’t the theater save money by us–
ing one employee to both sell and collect the tickets? Such a question leads into discussing
separation of duties. Similarly, you may ask why a department store requires two clerks to
sign a receipt for returned merchandise, or why some convenience stores post a sign by the
cash register offering each customer a cash reward if the cashier fails to give the customer a
receipt. After a brief introduction most students can grasp the internal control concepts by
reading the chapter. Recent news events provide a rich source of material to support your
discussion of independent audits. Demonstration Problems in the chapter of the Instructor’s
6-2
IV. Use Demonstration Problem 6-2 to reinforce bank reconciliation procedures.
This problem requires determining the amount of the unadjusted book balance in the
cash account. It provides sufficient information for students to determine the true
cash balance starting from the unadjusted bank balance. Students must realize that
the true cash balance is the same whether it is determined from the perspective of the
unadjusted bank or the unadjusted book balance. Once students understand this point,
they can determine the unadjusted book balance by working backwards from the true
cash balance.
V. Explain the use of a petty cash fund. The textbook illustrates recording the replen-
ishment of the petty cash fund in a nontraditional format. The text recognizes petty
cash expenses by debiting the various expense accounts and crediting the petty cash
account. Then the petty cash account is debited and the cash account is credited.
The traditional approach offsets the credit and debit to petty cash and uses a single
entry that debits expense accounts and credits the cash account. Although this ap-
proach leads to the same end result, it skips some logical steps, thereby confusing
students. To the extent possible, the textbook avoids shortcut recording procedures.
The objective is to teach students to understand accounting rather than to record
transactions as efficiently as possible. If you want to emphasize speed, record the en-
try as the text does first, then demonstrate how to improve efficiency since certain
debits and credits offset each other.
Use Demonstration Problem 6-3 to introduce accounting for petty cash funds. Have
students record the effects of petty cash transactions in the horizontal financial state-
ments model. Once students have seen how petty cash transactions affect financial
statements, have them record the events in general journal form. Demonstrate that
“Cash Short and Over” is usually an expense account, though conceivably it could be
a revenue account. Furthermore, note that while cash short and over is recorded sepa-
rately in the general journal, it is part of total expenses in the horizontal financial
statements model. This offers an opportunity to point out that detailed data main-
tained for managerial purposes are frequently summarized when presented in pub-
lished financial statements.
VI. Discuss the content of financial statements, the value of the footnotes and man-
agement discussion and analysis information, and the purpose and content of an
audit report. Recent news events provide a rich source of topics for this discussion.
Many students believe an audit report is confirmation that the financial statements are
accurate. Point out what an audit report does and does not tell the readers of financial
statements.
VII. Time considerations and homework assignments. Allot approximately one hour of
class time to cover Chapter 6. Exercises 6-8 A and B and 6-9A and B as well as
Problems 6-18 A and B are similar to Demonstration Problems 6-1 and 6-2. Problem
6-24A or B provides follow-up for Demonstration Problem 7-3.
6-3
Demonstration Problem 6-1 – Bank Reconciliation
The bank statement for Greenbrier Furniture Stores showed a balance of $63,289 as of No-
vember 30. The unadjusted balance in the general ledger cash account at November 30 was
$59,345. An examination of the bank statement disclosed the following information.
1. Outstanding checks totaled $24,598.
2. The bank had issued a $157 credit memo for interest deposited into Greenbrier’s ac-
count.
3. The bank had deducted a total of $469 for two non-sufficient funds (NSF) checks.
4. The bank statement enclosures included a debit memo for $36 the bank had deducted
from Greenbrier’s account to pay for new checks.
5. Deposits in transit were $19,060.
6. The bank had mistakenly deducted from Greenbrier’s account a $1,246 check drawn on
the Greenbay Company.
Required
a. Reconcile the balance shown on the bank statement with the unadjusted balance of the
company’s cash account.
b. Prepare the general journal entries necessary to adjust the cash balance per books to the
true cash balance.
c. What is the book balance in Greenbrier’s cash account after the adjusting entries have
been posted to the ledger accounts?
6-4
Demonstration Problem 6-2 Bank Reconciliation
The bank statement for Broom Company showed a $200 bank balance at the end of the
month. A comparison of Broom Company’s bank statement and accounting records dis-
closed a $40 deposit in transit and $55 of outstanding checks at month-end. The bank state-
ment enclosures included a $5 NSF check and a credit memo for $10 of interest.
Required
a. Determine the unadjusted book balance in the cash account.
b. Prepare the general journal entries necessary to adjust the cash balance per books to the
true cash balance.
c. What is the book balance in Broom’s cash account after the adjusting entries have been
posted to the ledger accounts?
Demonstration Problem 6-3
Establish and Account for Petty Cash Fund
Sharp Appliance Repair Company engaged in the following events.
1. Sharp earned $1,000 of cash service revenue.
2. Sharp established a $500 petty cash fund.
3. The petty cash custodian reimbursed an employee $12 for a delivery charge the employ-
ee paid on an overnight letter to an attorney.
4. Sharp replenished the petty cash fund when it contained the following: $25 of currency
and coin; receipts for delivery charges, $50; receipts for office supplies, $230; an in-
voice for a minor repair, $180.
Required
a. Record each event using the horizontal financial statements model.
b. Prepare general journal entries to record the events.
6-5
Demonstration Problem 6-1 Solution, part a. Bank Reconciliation
Greenbrier Furniture Stores
Bank Reconciliation
November 30
Unadjusted bank balance
$63,289
Unadjusted book balance
$59,345
Add:
Add:
Deposits in transit
19,060
Credit memo for interest
157
Bank error, Greenbay check
1,246
Subtract:
Subtract:
Outstanding checks
(24,598)
NSF checks
(469)
Charge for checks
(36)
True cash balance
$58,997
True cash balance
$58,997
Demonstration Problem 6-1 Solution, part b. Adjusting Entries
Account Titles
Debit
Credit
1
Cash
157
Interest Revenue
157
2
Accounts Receivable
469
Bank Service Charge Expense
36
Cash
505
Demonstration Problem 6-1 Solution, part c.
Determine Cash Balance
The balance in the cash account after the adjusting entries have been posted to the ledger ac-
counts is $58,997. The adjusting entries update the books so they reflect the amount of cash
owned by the company as of the date of the bank statement (the true cash balance).
6-6
Demonstration Problem 6-2 Solution, part a. Bank Reconciliation
Broom Company
Bank Reconciliation
Unadjusted bank balance
$200
Unadjusted book balance
$180
Add:
Add:
Deposits in transit
40
Credit memo for interest
10
Subtract:
Subtract:
Outstanding checks
(55)
NSF check
(5)
True cash balance
X = $185
True cash balance
X = $185
Compute the answer as follows: First, determine the true cash balance using the bank bal-
ance, deposits in transit, and outstanding checks. Using the true cash balance, work back-
wards to determine the unadjusted book balance.
Demonstration Problem 6-2 Solution, part b. Adjusting Entries
Date
Account Titles
Debit
Credit
1
Cash
10
Interest Revenue
10
2
Accounts Receivable
5
Cash
5
Demonstration Problem 6-2 Solution, part c.
Determine Cash Balance
The balance in the cash account after the adjusting entries have been posted to the ledger ac-
counts is $185. The adjusting entries update the books so they reflect the amount of cash
owned by the company as of the date of the bank statement (the true cash balance).
6-7
Demonstration Problem 6-3 Solution, part a. Statements Model
Event
Assets
=
Liabilities
+
Equity
Revenue
–
Expense
=
Net Income
Cash Flow
Cash
+
Petty
Cash
=
Ret.
Earn.
1
1,000
+
0
=
0
+
1,000
1,000
–
0
=
1,000
1,000 OA
2
(500)
+
500
=
0
+
0
0
–
0
=
0
0
3
-0-
+
0
=
0
+
0
0
–
0
=
0
0
4
(475)
+
0
=
0
+
(475)
0
–
475
=
(475)
(475) OA
Totals
25
+
500
=
0
+
525
1,000
–
475
=
525
525 NC
Demonstration Problem 6-3 Solution, part b. Journal Entries
Date
Account Titles
Debit
Credit
1
Cash
1,000
Service Revenue
1,000
2
Petty Cash
500
Cash
500
3
No entry
4
Delivery Expense
50
Office Supplies
230
Repairs Expense
180
Cash Short and Over
15
Petty Cash
475
Petty Cash
475
Cash
475
Alternatively, Event No. 4 can be recorded without the offsetting $475 credit to Petty Cash
and the $475 debit to Petty Cash. The two entries can be combined as follows:
Date
Account Titles
Debit
Credit
4
Delivery Expense
50
Office Supplies
230
Repairs Expense
180
Cash Short and Over
15
Cash
475
6-8
Demonstration Problem 6-1 Workpaper, part a. Bank Reconciliation
Greenbrier Furniture Stores
Bank Reconciliation
November 30
Unadjusted bank balance
$
Unadjusted book balance
$
Add:
Add:
Deposits in transit
Credit memo for interest
Bank error, Greenbay check
Subtract:
Subtract:
Outstanding checks
NSF checks
Charge for checks
True cash balance
$ 58,997
True cash balance
$58,997
Demonstration Problem 6-1 Workpaper, part b. Adjusting Entries
Account Titles
Debit
Credit
1
2
Demonstration Problem 6-1 Workpaper, part c.
Determine Cash Balance
The balance in the cash account after the adjusting entries have been posted to the ledger ac-
counts is $_____________.
6-9
Demonstration Problem 6-2 Workpaper, part a. Bank Reconciliation
Broom Company
Bank Reconciliation
Unadjusted bank balance
$
Unadjusted book balance
$ ?
Add:
Add:
Deposits in transit
Credit memo for interest
Subtract:
Subtract:
Outstanding checks
NSF check
True cash balance
X = $
True cash balance
X = $
Demonstration Problem 6-2 Workpaper, part b. Adjusting Entries
Account Titles
Debit
Credit
1
2
Demonstration Problem 6-2 Workpaper, part c.
Determine Cash Balance
The balance in the cash account after the adjusting entries have been posted to the ledger ac-
counts is $_______________.
6-10
Demonstration Problem 6-3 Workpaper, part a. Statements Model
Event
Assets
=
Liabilities
+
Equity
Revenue
–
Expense
=
Net Income
Cash Flow
Cash
+
Petty
Cash
=
Ret.
Earn.
1
+
=
+
–
=
2
+
=
+
–
=
3
+
=
+
–
=
4
+
=
+
–
=
Totals
25
+
500
=
0
+
525
1,000
–
475
=
525
525 NC
Demonstration Problem 6-3 Workpaper, part b. Journal Entries
Account Titles
Debit
Credit
1
2
3
4
Alternatively, Event No. 4 can be recorded without the offsetting $475 credit to Petty Cash
and the $475 debit to Petty Cash. The two entries can be combined as follows:
Account Titles
Debit
Credit
4
6-11
Quiz Questions for Chapter 6
1. Hannah Porter is an accounting clerk for a large department store. Her husband owns an office supply
business. Hannah paid her husband’s business for supplies the department store never received. Which of
the following practices would allow Hannah to perpetuate this scam?
a. Requiring a single person to approve disbursements, sign checks, and reconcile the checking ac-
count.
b. Keeping prenumbered checks under lock and key.
c. Requiring one employee to approve supporting documents and a different employee to sign checks.
d. Marking supporting documents “paid” when checks are signed.
2. Debit memos issued by a bank for service charges on a company’s checking account would
a. increase the bank’s liabilities.
b. increase the customer’s liabilities.
c. decrease the customer’s liabilities.
d. decrease the bank’s liabilities.
3. RST’s bank statement included an NSF check that one of its customers had written to pay its account re-
ceivable. How would recording the NSF check affect RST’s accounting equation?
a. Increase assets / decrease liabilities.
b. Decrease assets / increase liabilities.
c. Have no effect on total assets, liabilities, or equities.
d. Increase liabilities / decrease equities.
4. Bates Company’s unadjusted cash balance at the end of April was $28,700. Other relevant information is:
deposits in transit, $4,600; a credit memo in the bank statement for interest earned, $1,000; a check for
$100 incorrectly recorded as $110 by the company’s bookkeeper; a debit memo in the bank statement for
a $16 bank service charge; and outstanding checks, $4,200. The true cash balance on April 30 was
a. $29,700.
b. $29,694.
c. $29,074.
d. $29,100.
5. Arthur Company established a $250 petty cash fund. At the end of the accounting period there was $90 of
coins and currency in the fund, as well as expense vouchers of $150. Replenishing the petty cash fund
would
a. increase expenses by $160.
b. decrease equity by $150.
c. increase assets by $160.
d. decrease liabilities by $150.
6. What effect does reimbursing an employee from the petty cash fund have on the accounting equation?
a. No effect on assets, liabilities, or equities.
b. Decrease assets / decrease equities.
c. Decrease assets / increase liabilities.
d. Increase liabilities / decrease equities.
6-12
7. EFG Company’s bank statement reported an unadjusted bank account balance of $20,900 at the end of
February. Analyzing the February bank statement disclosed the following:
Credit memo for funds the bank had collected on a note receivable, $800
Deposits in transit, $1,420
Debit memo for service charge, $6.50
Outstanding checks, $750
NSF check, $310
The true cash balance at the end of February was
a. $21,260.00.
b. $22,053.50.
c. $22,370.00.
d. $21,570.00.
8. An outstanding certified check for $400 would require what adjustment to determine the true cash balance?
a. $400 subtracted from the unadjusted bank balance.
b. $400 subtracted from the unadjusted book balance.
c. $400 added to the unadjusted book balance.
d. No adjustments would be required to determine the true cash balance.
9. Which of the following is true?
a. Internal controls are unnecessary when key employees are bonded.
b. The practice of separating duties prevents an employee from both approving a refund and disbursing
the cash.
c. Experienced accounting clerks need not use prenumbered documents.
d. Administrative controls would limit access to physical assets but not to accounting records.
10. A company can protect itself from dishonest employees by obtaining
a. a signature card.
b. a certified check.
c. a fidelity bond.
d. an outstanding check.
11. The unadjusted bank balance on May 31 was $5,200. The unadjusted cash account balance was $4,790.
The following information was available:
Deposits in transit, $550
Credit memo, $600 of interest earned
Outstanding checks, $360
Certified check, $50
The true cash balance on May 31 was
a. $5,390.
b. $5,200.
c. $4,790.
d. none of the above.
12. ABC Company established a petty cash fund. Which of the following reflects how this event affects the
company’s financial statements?
Assets
=
Liab.
+
Equity
Rev.
–
Exp.
=
Net Inc.
Cash Flow
a.
+
+
NA
NA
+
–
NA
b.
+ –
NA
NA
NA
NA
NA
– OA
c.
+ –
NA
NA
NA
NA
NA
NA
d.
+
+
NA
NA
NA
NA
– OA
6-13
6-14
Quiz Answers
Question
Answer
1
A
2
D
3
C
4
B
5
A
6
A
7
D
8
D
9
B
10
C
11
A
12
C
Copyright © McGraw-Hill Education. Permission required for reproduction or display.
6-15
Summary Outline of a Lesson Plan for Chapter 6
I. Begin with an introduction about the nature and purpose of internal controls.
Offer a few familiar internal control examples.
II. Use Demonstration Problem 6-1 to show students how to prepare a bank recon-
ciliation. Discuss how bank reconciliations are a form of internal control.
III. Explain the adjusting entries needed to update the unadjusted book balance for
Demonstration Problem 6-1.
IV. Use Demonstration Problem 6-2 to reinforce bank reconciliation procedures.
V. Explain petty cash funds. Illustrate with Demonstration Problem 6-3.
VI. Discuss the content of financial statements, the value of the footnotes and man-
agement discussion and analysis information, and the purpose and content of an
audit report.
VII. Time considerations and homework assignments. Allot approximately one hour of
class time to cover Chapter 6. Exercises 6-8 A and B and 6-9 A and B as well as Problems 6-
18 A and B are similar to Demonstration Problems 6-1 and 6-2. Problem 6-24 A or B pro-
vides follow-up for Demonstration Problem 7-3.