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Chapter 04 - Cash and Internal Controls
4-1
Chapter 4
Cash and Internal Controls
INSTRUCTOR’S MANUAL
Authors’ Perspectives
Chapter 4 introduces students to the basics of internal controls. To help students relate to the
PART A: Internal Controls
LO4-2 Identify the components, responsibilities, and limitations of internal control.
Internal controls – Part A begins with a discussion of occupational fraud and accounting
scandals. In some instances, managers have acted unethically in reporting their companies’
PART B: Cash
LO4-3 Define cash and cash equivalents.
LO4-4 Understand controls over cash receipts and cash disbursements.
Cash controls – The discussion of general internal controls in Part A moves to a discussion of
specific cash controls in Part B. One reason for the focus on cash is that cash is the most liquid of
a company’s assets and therefore may be the asset most in need of internal control. In addition,
since most students are familiar with cash, the different forms of cash payments (checks, debit
Chapter 04 - Cash and Internal Controls
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cards, and credit cards), and bank statements, relating internal controls to cash topics makes the
concept of internal controls easier to grasp.
Common Mistake: The term debit card can cause some confusion for someone in the first
accounting course. Throughout this course, we refer to an increase in cash as a debit to cash.
Bank reconciliation – We can present the bank reconciliation as a specific example of an
internal control, rather than a formal financial statement to be issued to the public.
• Illustration 4-10 focuses on cash collections in the company records versus the bank
statement. By pointing out the red circled amounts, we make it easy to see why the two
balances can differ and why a reconciliation is needed.
PART C: Statement of Cash Flows
LO4-7 Identify the major inflows and outflows of cash.
Reporting of cash – Given the focus on internal controls related to cash in Part B, Part C then
provides a discussion of how cash is reported to those outside the company. Part C briefly
mentions that cash is reported as an asset in the balance sheet, but the discussion primarily
and financing cash flows.
Chapter 04 - Cash and Internal Controls
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ANALYSIS
LO4-8 Demonstrate the link between cash reported in the balance sheet and cash
reported in the statement of cash flows.
Cash Analysis – The final section of the chapter involves cash analysis by first showing how the
statement of cash flows reconciles the balance of cash shown in consecutive balance sheets. It’s
Self-Study Materials
■ Let’s Review—Bank reconciliation (p. 195).
■ Let’s Review—Types of cash flow (p. 200).
Chapter 04 - Cash and Internal Controls
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Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
LO4-1 Discuss the impact of accounting scandals and the passage of the Sarbanes-Oxley
Act.
The accounting scandals in the early 2000s prompted passage of the Sarbanes-Oxley Act (SOX).
LO4-2 Identify the components, responsibilities, and limitations of internal control.
Internal control refers to a company’s plan to improve the accuracy and reliability of accounting
LO4-3 Define cash and cash equivalents.
Cash includes coins and currency, checks received, and balances in savings and checking
LO4-4 Understand controls over cash receipts and cash disbursements.
Because cash is the asset of a company most susceptible to employee fraud, controls over cash
LO4-5 Reconcile a bank statement.
In a bank reconciliation, we reconcile the bank’s cash balance for (1) cash transactions already
Chapter 04 - Cash and Internal Controls
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LO4-6 Account for employee purchases.
To make purchases on behalf of the company, some employees are allowed to use debit cards
LO4-7 Identify the major inflows and outflows of cash.
The statement of cash flows reports all cash activities for the period. Operating activities include
Analysis
LO4-8 Demonstrate the link between cash reported in the balance sheet and cash reported
in the statement of cash flows.
Chapter 04 - Cash and Internal Controls
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Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO4-1
Define occupational fraud
5
2
LO4-1
Explain internal control
5
and detective controls
9
LO4-2
Explain separation of duties
5
10
LO4-2
Identify responsibility for internal control
5
11
LO4-2
Recognize limitations of internal control
5
12
LO4-2
Define collusion
5
13
LO4-2
Describe likelihood of fraud by top-level employees
5
23
LO4-5
Describe timing differences in the cash balance
5
24
LO4-5
Make adjustments related to the bank reconciliation
5
25
LO4-6
Explain purchase cards and a petty cash fund
5
26
LO4-6
Describe managerial control over employee
purchases with credit cards and the petty cash fund
5
Chapter 04 - Cash and Internal Controls
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Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE4-1
LO4-1
Identify terms associated with the Sarbanes-Oxley
Act
5
BE4-2
LO4-2
Identify terms associated with components of
internal control
5
BE4-3
LO4-2
Define control activities associated with internal
control
5
BE4-11
LO4-5
Record adjustments to the company’s cash balance
5
BE4-12
LO4-5
Prepare a bank reconciliation
5
BE4-13
LO4-6
Record employee purchases
5
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E4-1
LO4-1
Answer true-or-false questions about occupational
fraud
15
E4-2
LO4-1
Answer true-or-false questions about the Sarbanes-
Oxley Act
15
Chapter 04 - Cash and Internal Controls
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E4-10
LO4-5
Calculate the balance of cash using a bank
reconciliation
10
E4-11
LO4-5
Calculate the balance of cash using a bank
reconciliation
10
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P4-1A
LO4-4
Discuss control procedures for cash receipts
15
P4-2A
LO4-5
Prepare the bank reconciliation and record cash
adjustments
25
P4-3A
LO4-5
Prepare the bank reconciliation and record cash
adjustments
30
Additional
Perspectives
Topic
Time
(Min.)
AP4-1
Continuing Problem: Great Adventures
45
AP4-2
Financial Analysis: American Eagle Outfitters, Inc.
40
Chapter 04 - Cash and Internal Controls
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Alternate Let’s Review
Problem #1
At the end of April, Classic Cinema’s accounting records show a cash balance of $5,240. The
April bank statement reports a cash balance of $6,700. The following information is gathered
from the bank statement and company records:
Required:
1. Prepare a bank reconciliation for the month of April.
2. Adjust the balance of cash in the company’s records.
Solution:
1.
Classic Cinema
Bank Reconciliation
April 30
Bank’s Cash Balance
Company’s Cash Balance
Per bank statement
$ 6,700
Per general ledger
$ 5,240
2.
April 30
Debit
Credit
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
260
Interest Revenue . . . . . . . . . . . . . . . .
80
Chapter 04 - Cash and Internal Controls
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Problem #2
A company reports in its current year each of the transactions listed below.
Required:
Indicate whether each transaction should be reported as an operating, investing, or financing cash
flow in the company’s statement of cash flows, and whether each is a cash inflow or outflow.
Transaction
Type of Cash Flow
Inflow or Outflow
1. Issue common stock for cash.
2. Receive cash from customers.
3. Sell equipment for cash.
4. Pay cash for advertising.
Solution:
Chapter 04 - Cash and Internal Controls
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Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, student can avoid making the same mistakes and gain a deeper
understanding of the chapter material.
Common Mistake
The term debit card can cause some confusion for someone in the first accounting course.
this confuse you.
Common Mistake
Notice that bank statements refer to an increase (or deposit) in the cash balance as a credit and a
decrease (or withdrawal) as a debit. This terminology is the opposite of that used in financial
Common Mistake
Students sometimes mistake an NSF check as a bad check written by the company instead of one
written to the company. When an NSF check occurs, the company has deposited a customer’s
Common Mistake
Some students try to update the Cash account for deposits outstanding, checks outstanding, or a
Chapter 04 - Cash and Internal Controls
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Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provide throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
Does the company
maintain adequate
internal controls?
Management’s discussion,
auditor’s opinion
If management or the auditor notes
any deficiencies in internal controls,
financial accounting information may
be unreliable.
Question
Accounting Information
Analysis & Decision
Is the company able to
Statement of cash flows
Cash flows generated from internal
Decision Maker’s Perspective
How Much Cash Is Enough?
Investors and creditors closely monitor the amount of cash a company holds. The company needs
enough cash, or enough other assets that can quickly be converted to cash, to pay obligations as
Chapter 04 - Cash and Internal Controls
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Ethical Dilemma
Suppose that you were sent to prison for a crime you did not commit. While in prison, the
warden learns that you have taken financial accounting and are really good at “keeping the
books.” In fact, you are so good at accounting that you offer to teach other inmates basic
financial skills that they’ll use someday after being released.
However, the warden plans to use his position of authority at the prison to steal money.
He uses prisoners as low-cost labor to do projects around town. Because other legitimate
companies cannot compete with these low costs, they bribe the warden not to bid on jobs. The
Key Issues
• Benefitting personally vs. seeing others abused
Option 1: Continue to falsify the accounting records
• You need to take care of yourself in prison. Prison life has a different set of rules.
Option 2: Discontinue falsifying the accounting records
• By falsifying documents, you are just as guilty as the person (warden) stealing the
money.
