Chapter 6

Reporting and Analyzing

Cash and Internal Controls

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Conceptual Learning Objectives

C1: Define internal control and identify its
purpose and principles
C2: Define cash and cash equivalents
and explain how to report them
C3: Identify control features of banking
activities

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Analytical Learning Objectives

A1: Compute the days sales uncollected
ratio and use it to assess liquidity.

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Procedural Learning Objectives

P1: Apply internal control to cash receipts and
disbursements.
P2: Explain and record petty cash fund
transactions.
P3: Prepare a bank reconciliation.
P4: Appendix 6A: Describe the voucher system
to control cash disbursements.
P5: Appendix 6B: Apply the net method to
control purchase discounts.
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Purpose of Internal Control

C1

Policies
Policies and
and procedures
procedures managers
managers use
use to:
to:
1.
Protect
1.
Protect assets.
assets.
2.
Ensure
2.
Ensure reliable
reliable accounting.
accounting.
3.
Promote
3.
Promote efficient
efficient operations.
operations.
4.
Urge
4.
Urge adherence
adherence to
to company
company policies.
policies.

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C1

Principles of Internal Control

1.
1.

Establish
Establish responsibilities.
responsibilities.

2.
2.

Maintain
Maintain adequate
adequate records.
records.

3.
3.

Insure
Insure assets
assets and
and bond
bond key
key employees.
employees.

4.
4.

Separate
Separate recordkeeping
recordkeeping from
from custody
custody
of
of assets.
assets.

5.
5.

Divide
Divide responsibility
responsibility for
for related
related transactions.
transactions.

6.
6.

Apply
Apply technological
technological controls.
controls.

7.
7.

Perform
Perform regular
regular and
and independent
independent reviews.
reviews.

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Technology and Internal Control

C1

Reduced
Processing
Errors

More
Extensive Testing
of Records

Limited
Evidence of
Processing

Crucial
Separation of
Duties
Increased
e-commerce

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C1

Limitations of Internal Control

Human Error

Human Fraud

Negligence
Fatigue
Misjudgment
Confusion

Intent to
defeat internal
controls for
personal gain

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C1

Limitations of Internal Control

The costs of internal controls
must not exceed their benefits.

Benefits

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Costs
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Control of Cash

C2

An effective system of internal control that

protects cash and cash equivalents should meet
three basic guidelines:
Handling cash is
separated from
recordkeeping of
cash.

Cash receipts are

promptly deposited
in a bank.

Cash disbursements
are made by check.
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Cash, Cash Equivalents, and

Liquidity

C2

Cash
Currency, coins and amounts on deposit in bank
accounts, checking accounts, and some savings
accounts. Also includes items such as customer

checks, cashier checks, certified checks, and money

orders.

Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
interest rate changes.
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Cash, Cash Equivalents, and

Liquidity

C2

Liquidity
How easily an asset can be converted into
cash to be used to pay for services or
obligations.

Inventory
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Cash
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Control of Cash Receipts

P1

Cash Receipts By Mail

Over-the-Counter
Cash Receipts

Cash register with

locked-in record of
transactions.
Compare cash
register record with
cash reported.

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Two people open the

mail.

Money to cashiers
office.

List to accounting
dept.

Copy of list filed.

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Control of Cash Disbursements

P1

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All
All expenditures
expenditures should
should be
be made
made by
by check.
check.
The
The only
only exception
exception is
is for
for small
small payments
payments
from
from petty
petty cash.
cash.
Separate
Separate authorization
authorization for
for check
check signing
signing
and
and recordkeeping
recordkeeping duties.
duties.
Use
Use aa voucher
voucher system.
system.

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P4

Voucher System of Control

A
A voucher
voucher system establishes
establishes
procedures
procedures for:
for:

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Verifying,
Verifying, approving
approving and
and recording
recording
obligations
obligations for
for eventual
eventual cash
cash disbursements.
disbursements.

Issuing
Issuing checks
checks for
for payment
payment of
of verified,
verified,
approved
approved and
and recorded
recorded obligations.
obligations.

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Voucher System of Control

P4

Sender
Sender
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting

Receiver
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition

Supplier (Vendor)
Cashier
Accounting, Requesting
& Purchasing
Accounting
Supplier, Requesting,
Receiving & Accounting
Purchasing and
Accounting

Voucher
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P2

Petty Cash System of Control

Small payments required in most
companies for items such as postage,
courier fees, repairs and supplies.

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P2

Operating a Petty Cash Fund

Petty Cash

Company
Cashier

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Petty
Cashier

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P2

Operating a Petty Cash Fund

Petty Cash

Company
Cashier

Petty
Cashier

May 1

Accountant
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Petty cash
Cash

400
400

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P2

Operating a Petty Cash Fund

Petty Cash

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Petty
Cashier

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P2

Operating a Petty Cash Fund

A petty cash fund

is used only for
business
expenses.

Petty
Cashier

39
Stamps
$45
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Courier
$80

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P2

Operating a Petty Cash Fund

Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.

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Receipts

Petty
Cashier

39
Stamps
$45

Courier
$80

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P2

Operating a Petty Cash Fund

Receipts

$125
Company
Cashier

To reimburse
petty cash fund

May 31

Use a Cash
Over and Short
account if needed.

Accountant
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Petty
Cashier
Postage expense
Delivery expense
Cash

45
80
125

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Petty Cash Example

P2

Tension Co. maintains a petty cash fund of $400. The

following summary information was taken from petty
cash vouchers for July:
Travel Expenses
$79.30
Customer Business Lunches
Express Mail Postage
55.00
Miscellaneous Office Supplies

93.42
32.48

Lets look at replenishing the fund if the balance on

July 31 was $137.80.
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P2

Petty Cash Example

What amount of cash will be required
to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80

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Petty Cash Example

P2

What
What amount
amount of
of cash
cash will
will be
be
required
required to
to replenish
replenish the
the petty
petty
cash
cash fund?
fund?
a.
a.
b.
b.
c.
c.
d.
d.

$260.20
$260.20
$262.20
$262.20
$139.80
$139.80
$137.80
$137.80

Lets prepare the journal entry to replenish the petty cash fund.

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Petty Cash Example

P2

Journal entry to replenish petty cash fund

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C3

Banking Activities as Controls

Bank Accounts

Checks
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Signature Cards

Deposit Tickets

Electronic
Funds
Transfer

Bank
Statements
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Bank Reconciliation

P3

A
A bank
bank reconciliation
reconciliation is
is prepared
prepared periodically
periodically to
to explain
explain the
the
difference
difference between
between cash
cash reported
reported on
on the
the bank
bank statement
statement and
and the
the
cash
cash balance
balance on
on companys
companys books.
books.

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Why are the

balances different?

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Reconciling Items

P3

Bank
Bank Statement
Statement Balance
Balance

Add:
Add:

Deposits
Deposits in
in transit.
transit.
Deduct:
Deduct:
Outstanding
Outstanding
Checks
Checks
Add
Add or
or Deduct:
Deduct:
Bank
Bank errors.
errors.

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Book
Book Balance
Balance
Add:
Add: Collections
Collections
made
made by
by the
the bank.
bank.
Add:
Add: Interest
Interest earned
earned
on
on checking
checking account.
account.
Deduct:
Deduct: Nonsufficient
Nonsufficient
funds
funds check
check (NSF).
(NSF).
Deduct:
Deduct: Bank
Bank service
service
charge.
charge.
Add
Add or
or Deduct:
Deduct:
Book
Book errors.
errors.
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Bank Reconciliation

P3

Two sections:
1.
1. Reconcile
Reconcile bank
bank statement
statement balance
balance to
to

the
the adjusted
adjusted bank
bank balance.
balance.
2.
2. Reconcile
Reconcile book
book balance
balance to
to the
the adjusted
adjusted
book
book balance.
balance.

The adjusted balances should be equal.

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P3

Bank Reconciliation Example

Lets
Lets prepare
prepare aa July
July 31
31 bank
bank reconciliation
reconciliation
statement
statement for
for the
the Simmons
Simmons Company.
Company.

The
The July
July 31
31 bank
bank statement
statement indicated
indicated aa
balance
balance of
of $9,610.
$9,610.
The
The cash
cash general
general ledger
ledger account
account on
on that
that
date
date shows
shows aa balance
balance of
of $7,430.
$7,430.
Additional
Additional information
information necessary
necessary for
for the
the
reconciliation
reconciliation is
is shown
shown on
on the
the next
next screen.
screen.

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P3

Bank Reconciliation Example

1.

Outstanding checks totaled $2,417.

2.

A $500 check mailed to the bank for deposit had not

reached the bank at the statement date.

3.

The bank returned a customers NSF check for $225

received as payment on account receivable.

4.

The bank statement showed $30 interest earned during

July.

5.

Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.

6.

A $486 deposit by Acme Company was erroneously

credited to our account by the bank.

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P3

Recording Adjusting Entries from

a Bank Reconciliation

P3

Only amounts shown on the book portion

of the reconciliation require an adjusting
entry.

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Recording Adjusting Entries from

a Bank Reconciliation

P3

After posting the reconciling entries the cash account

looks like this:

Adjusted
Adjusted balance
balance on
on July
July 31.
31.
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Days Sales Uncollected

A1

How
How much
much time
time is
is likely
likely to
to pass
pass before
before
we
we receive
receive cash
cash receipts
receipts from
from credit
credit sales.
sales.
Days
=
Sales
Uncollected

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Accounts Receivable
Net Sales

365

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End of Chapter 6

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