internal control & cash

Internal Control and CashChapter 4

Describe fraud and its impact

•Intentional misrepresentation of facts•Causes injury or damage to another party•Large problem that increases each year

Types of Fraud

Fraud Triangle

Motive

RationalizationOpportunity

Explain the objectives and components of internal control

Internal Control

•Primary way fraud and errors are: ▫Prevented▫Detected or▫Corrected

•Management and Board of Directors implement a:▫Plan of organization ▫System of procedures

Objectives of Internal Control

Sarbanes-Oxley Act (SOX)

•Federal law requiring public companies to have system of internal controls ▫Auditors examine controls and issue

reports on reliability•Provisions:

▫Require internal control report by companies

▫Create Public Company Accounting Oversight Board

▫Limit non-audit services of auditing firms▫Penalize violators

Shield of Internal Control

Internal Controls

Inefficiency

Company assets

Control Procedures

Monitoring

Information System

Control Environment

Risk Assessment

Components of Internal Control

Control Environment

•Tone at the top▫Starts with owner(s) and top managers

acting ethically•Key ingredient

▫Corporate code of ethics

Risk Assessment

•Identify business risks•Establish procedures to deal with risks

Information System and Control Procedures•Information System

▫How accounting information enters and exits company

▫System must capture, process, and report transactions accurately

•Control procedures▫Built-in control environment and

information system▫How companies meet five objectives of

internal control

Monitoring Controls

•Prohibit one employee or a group from processing a transaction completely

•Program controls into computerized system

•Hired auditors to monitor controls▫Internal – monitor from the inside to

safeguard assets▫External – test from the outside to ensure

accounting records are accurate

Internal Control Procedures

•Smart Hiring Practices•Separation of Duties

▫Asset handling▫Record keeping▫Transaction approval

•Comparison and Compliance Monitoring▫Operating and cash budgets▫Audits▫Manual or computer checks

Internal Control Procedures

•Adequate Records▫Hard copy or electronic

•Limited Access▫Assets by custodians▫Records by accounting department

•Proper Approvals▫The larger the transaction, the more

specific approval

•Smart hiring practices and segregation of duties

•Comparisons and compliance monitoring•Adequate records•Limited access •Proper approvals

Information Technology (IT)

•Accounting systems rely on more than ever before

•Examples:▫Electronic sensors▫Barcode scanning

•Basic attributes of internal control do not change▫Procedures to implement are different

•Use of computers can greatly improve speed and accuracy

Safeguard Controls

Internal Controls for E-Commerce•Pitfalls of e-commerce

▫Stolen credit card numbers▫Computer viruses and Trojan Horses▫Phishing expeditions

•Security measures▫Encryption▫Firewalls

Costs and Benefits of Internal Control•Ways good internal control can be

circumvented▫Collusion▫Management override▫Fatigue & negligence

•The stricter the internal control, the more it costs▫The benefits should outweigh the costs

Design and use a bank reconciliation

Bank Account as Control Device

Bank Account Documents

•Signature card▫Protects against forgery

•Deposit ticket▫Proof of transaction

•Check▫Maker – signs the check▫Payee – to whom the check is paid▫Bank – where funds are drawn

Bank Statement

•Reports:▫Cash receipts▫Cash payments

•Electronic Funds Transfer (EFT)▫Make payments by

electronic communication

Bank Reconciliation

•Two records of a business’s cash▫The Cash account in the general ledger▫The bank statement

•Amounts are usually different▫Time lags in recording transactions

•Bank reconciliation explains differences

Bank Side of the Reconciliation

•Deposits in transit•Outstanding checks•Bank errors

Book Side of the Reconciliation

•Bank collections•Electronic funds transfers (EFT)•Service charges•Interest revenue•Nonsufficient funds (NSF) checks•Cost of printed checks•Book errors

Exercise 4-21A

Bank: Books:

Balance, November 30

$570 Balance, November 30

$1,780

Add: Add:

Deposit in transit 1,765 EFT rent collection 335

Service charges (18)

Less: NSF checks (120)

Outstanding checks (601) Correction of error (243)

$1,734 $1,734

Summary of Reconciling Items

BANK BALANCE - ALWAYS BOOK BALANCE - ALWAYS

Add deposits in transit Add bank collections, interest revenue, and EFT receipts

Subtract outstanding checks Subtract services charges, NSF checks, EFT payments

Add or subtract correction of bank errors

Add or subtract correction of book errors

Journalizing Bank Reconciliation Items•All items on the book side of the bank

reconciliation require journal entries•If the item is added to book side

▫Debit Cash•If the items is subtracted from the book

side▫Credit Cash

JOURNAL

Accounts and explanation Debit Credit

Interest Revenue

To record interest earned on the bank statement

Accounts Receivable

Account receivable collected by bank

Miscellaneous Expense

Bank service charges

Accounts Receivable

NSF check returned by bank

Evaluate internal controls over cash receipts and cash payments

Internal Control over Cash

•Cash is easy to steal•All transactions ultimately affect cash•Cash receipts should be deposited quickly•Companies can receive cash

▫Over the counter▫Through the mail

Cash Receipts over the Counter•Point-of-sale terminals provide control over

cash receipts▫Also record sale, cost of item sold, and

reduction to inventory•Customer issued a receipt as proof of

purchase•Sales associate turns in cash drawer at end

of shift▫Combined with other cash and deposited

•Accounting department reconciles sales per terminal to cash in drawer

Cash Receipts by MailMailroomMailroom

ChecksChecks Remittance advicesRemittance advices

Accounting DepartmentAccounting DepartmentTreasurerTreasurer

Debit to Cash

Deposit receipt

Bank Controller

Controls Over Payments by Check•Payment by check or EFT payment is an

important internal control▫Provides record of the payment▫Check must be signed by an authorized

official▫EFT must be approved by an authorized

official▫Should be supported by evidence payment

Cash Payments by Check

Receiving Report

InvoiceInvoice

Inventory

Purchase Order

Check or EFT

Company A

Company X

Internal Control for Purchasing

•Segregate the following duties:▫Purchasing ▫Receiving▫Approving and Paying

Payment PacketReceiving

Report

Invoice

Purchase Order

Petty Cash

•Small fund to make minor purchases•One employee is responsible for the

accounting▫Custodian

•Set amount of cash •Voucher prepared for each payment•Sum of fund plus paid voucher should

equal set amount▫Imprest system

Construct and use a cash budget

Budgeting

•Budget▫Financial plan to coordinate activities

•Cash budget▫Planning receipts and payments

•Steps:▫Start with beginning cash balance▫Add budgeted receipts and subtract budget

payments▫Equals expected cash balance▫Compare cash available to budgeted cash

balance

Expected Cash Balance

If expected cash is greater than

minimum needed

Invest excess

If expected cash is less than

minimum needed

Consider borrowin

Cash Budget

Beginning cash balance

Budgeted cash receipts:

Collections from customers

Dividends from investments

Sale of plant and equipment

Budgeted cash payments:

Purchases of inventory

Operating expenses

Purchase of long-term assets

Payment of dividends

Payment of long-term debt

Cash available (needed)

Budgeted cash balance, end of period

Cash available for investing or (new financing needed)

Exercise 4-25ACash Budget - Gale Communications Inc.

Beginning cash balance $78

Budgeted cash receipts:

Collections from customers 11,335

Sale of assets 157

11,570

Budgeted cash payments:

Cost of services and products

$6,169

Operating expense 2,553

Purchase of new equipment 1,822

Debt payments 578

Cash dividends 358 11,480

Cash available $90

Budgeted cash balance, end of period (78)

Cash available for investing $12

Exercise 4-25A (continued)

Reporting Cash on the Balance Sheet•All cash accounts combined into a single

total ▫Cash & Cash Equivalents

•Cash equivalents include▫Time deposits▫Certificates of deposit▫High grade government securities

Compensating Balances

•Cash balance should not include cash that is restricted in any way

•Company that borrows agrees to maintain a minimum cash balance▫Compensating balance agreement

internal control & cash

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