Principles of financial accounting 12e by needles crosson chapter 08

CHAPTER

8

Cash and Internal Control

Principles of
Accounting
12e
Needles
Powers
Crosson
©human/iStockphoto


Concepts Underlying Internal Control
 Inte rnal c o ntro l is the process that
establishes the reliability of the accounting
records and financial statements and ensures
that the company’s assets are protected.
– Taking a phys ic al inve nto ry facilitates control
over merchandise inventory.
 This process involves an actual count of all merchandise
on hand.
 A physical inventory must be taken under both the
periodic and perpetual inventory systems.
 Merchandisers usually take a physical inventory after
the close of business on the last day of their fiscal year.

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Components of Internal Control
(slide 1 of 2)

 An effective system of internal control has
five interrelated components.
– Co ntro l e nviro nme nt—created by
management’s overall attitude, awareness, and
actions. It encompasses:





a company’s ethics, philosophy, and operating style
organizational structure
method of assigning authority and responsibility
personnel policies and practices

– Ris k as s e s s me nt—involves identifying areas in
which risks of loss of assets or inaccuracies in
accounting records are high.
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Components of Internal Control
(slide 2 of 2)

– Co ntro l ac tivitie s —the policies and procedures
management puts in place to see that its

directives are carried out
– Info rmatio n and c o mmunic atio n—pertains to
the way the accounting system gathers and treats
information about the company’s transactions and
how it communicates individual responsibilities
within the system.
– Mo nito ring —management’s regular assessment
of the quality of internal control, including periodic
review of compliance with all policies and
procedure
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Control Activities
(slide 1 of 2)

 The goal of control activities is to safeguard a
company’s assets and ensure the reliability of
the accounting records. Standard controls
include:
– Autho rizatio n—the approval of certain
transactions and activities
– Recording Transactions—To establish
accountability for assets, all transactions should
be recorded.
– Documents and records—Well-designed
documents help ensure that transactions are
properly recorded.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Control Activities
(slide 2 of 2)

– Pe rio dic inde pe nde nt ve rific atio n—someone
other than the people responsible for the accounting
records and assets should periodically check the
records against the assets.
– S e paratio n o f dutie s —no one person should
authorize transactions, handle assets, and keep
records of assets.
– Sound personnel practices—including adequate
supervision; rotation of key people among different
jobs; insistence that employees take vacations; and
bonding of personnel who handle cash or inventory.
 Bo nding is the process of checking an
employee’s background and insuring the
company against theft by that person.

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Internal Control and Achieving Control
Objectives
 A system of internal control for merchandising
activities can achieve important objectives:
– Prevent losses of cash and inventory.
– Ensure that records of transactions and account
balances are accurate.
– Keep enough inventory on hand to sell to

customers without overstocking merchandise.
– Keep sufficient cash on hand to pay for purchases
in time to receive discounts.
– Keep credit losses as low as possible by making
credit sales only to customers who are likely to
pay on time.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Internal Control over
Merchandising Transactions (slide 1 of 2)
 Maintaining control is especially difficult for a
merchandiser because management must
not only establish controls for cash sales,
receipts, purchases, and cash payments, but
also protect its inventory.
 Most firms use the following procedures:
– Separate the functions of authorization,
recordkeeping, and custodianship of cash.
– Limit the number of people who have access to
cash, and designate who those people are.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Internal Control over
Merchandising Transactions (slide 2 of 2)
– Bond all employees who have access to cash.
– Keep the amount of cash on hand to a minimum
by using banking facilities as much as possible.

– Physically protect cash on hand by using cash
registers, cashiers’ cages, and safes.
– Record and deposit all cash receipts promptly,
and make payments by check rather than by
currency.
– Have a person who does not handle or record
cash make unannounced audits of the cash on
hand.
– Have a person who does not authorize, handle, or

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Control of Purchases and
Cash Disbursements
 To avoid theft, cash payments should be
made only after they have been specifically
authorized and supported by documents that
establish the validity and amount of the
claims.
 A company should also separate the duties
involved in purchasing goods and services
and the duties involved in paying for them.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Cash Equivalents
 Management may decide to invest excess
cash in short-term interest-bearing accounts

or certificates of deposit (CDs) at banks and
other financial institutions, in government
securities (such as U.S. Treasury notes), or
in other securities.
 If these investments have a term of 90 days
or less when they are purchased, they are
called c as h e quivale nts because the funds
revert to cash so quickly they are treated as
cash on the balance sheet.
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Cash Control Methods
(slide 1 of 2)

 In addition to internal control of cash transactions,
other ways of controlling cash include:
– Impre s s s ys te ms —systems, such as pe tty cas h
funds , used by a company for small expenditures
and cash advances and restored to a fixed
amount periodically
– Banking services—which include:
 Safe depositories for cash
 Negotiable instruments and other valuable business
documents, such as stocks and bonds
 Checking accounts
 Collection and payment of certain types of debt
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Control Methods
(slide 2 of 2)

 Exchange of foreign currencies
 Ele c tro nic funds trans fe r—a method of conducting
business transactions in which a company electronically
transfers cash from its bank to another company’s bank
 Automated teller machine (ATM) and debit card
transactions—When purchases are made using a debit
card, the amount of the purchase is deducted directly
from the buyer’s bank account.

– Bank re c o nc iliatio ns —the process of accounting
for the difference between the balance on a
company’s bank statement and the balance in its
Cash account.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Bank Reconciliations
(slide 1 of 2)

 The following transactions commonly
appear in a company’s records but not on
its bank statement:
- Outs tanding c he c ks —checks that a
company has issued and recorded but
that do not yet appear on its bank
statement

- De po s its in trans it—deposits a
company has sent to its bank but that
the bank did not receive in time to enter
on the bank statement
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Bank Reconciliations
(slide 2 of 2)

 Transactions that may appear on the bank
statement but not in the company’s records
include:
- Service charges—fees for the use of a checking account
- NS F (no ns uffic ie nt funds ) c he c ks —An NSF check is
a check that a company has deposited but that is not
paid when the bank presents it to the issuer’s bank.
- Miscellaneous debits and credits—including fees
charged for other services, such as stopping payment
on checks, printing checks, and collections on
promissory notes
- Interest income—interest paid on a company’s average
balance. Accounts that pay interest are sometimes
called NOW or money market accounts.
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Petty Cash Funds
 It is sometimes necessary to make small
payments of cash for postage stamps,

shipping charges due, or minor purchases of
office supplies.
– For situations in which it is inconvenient to pay by
check, most companies set up a pe tty c as h fund
using an imprest system, in which the fund is
established for a fixed amount.
 A voucher documents each cash payment made from
the fund.
 The fund is periodically reimbursed, based on the
vouchers, by the exact amount necessary to restore its
original cash balance.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Making Disbursements from the
Petty Cash Fund
 The custodian of the petty cash fund should
prepare a pe tty c as h vo uc he r, or written
authorization, for each expenditure, as
shown below. The person who receives the
payment signs the voucher.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Management’s Responsibility for
Internal Control
 Management is responsible for establishing a
satisfactory system of internal controls.
– This means that management must:

 safeguard the firm’s assets.
 ensure reliability of its accounting records.
 see that its employees comply with all legal
requirements and operate the firm to the best advantage
of its owners.

– The Sarbanes-Oxley Act requires that the chief
executive officer, the chief financial officer, and
the auditors of a public company fully document
and certify the company’s system of internal
controls.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Independent Accountant’s Audit of
Internal Control
 Although privately owned companies usually
are not required to have an independent
certified public accountant audit their
financial statements, many companies
choose to do so. These companies are also
not required to have their internal control
systems audited.
 Public companies, on the other hand, are
required to not only have an independent
audit of their financial statements, but also to
have an audit of their internal control.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.