Chapter 6 Terms Defined- Internal Controls

● Internal Control System

○ Protect Assets

○ Ensure relaible accounting

○ Prmote efficient operations

○ Urge adhrenece to company policies

● Sarbanes Oxley Act- requires mangers and auditors of companies whose stcok is
traded on ana exchange to documents and certify the system of internal
controls

● Principles of Internal Controls

○ Establish Reposibilities

○ Maintian adequate records

○ Insure asstes and bond key employees

○ Separate recordkeeping from custody of assets

○ Divideresposnibilties for related transactions

○ Apply technological controls

○ Perfrom rrgular and independent reviews

● Establish Repsonsibiloties:

○ Responsibility for a task is clearly established and assigned to one person

● Maintianing Adequate records:

○ Reliable records help manager monitor a company’s transactions

properly

● Insure asstes and bond key employees

○ An employee is bonded whena company purchases an insurance policy or

a bond, against losses from theft by that employee

○ Bonding reduces the risk of loss

● Separate recordkeeping from custody of assets

○ A person who controls or has access to an asset must not keep that
asset’s accounting records

○ In order to collude, agree in secret to commit a fraud, two or more

people must agree to collude

● Divideresposnibilties for related transactions

○ Divides responbilirty for a transaction between two or more individuals

or departments.

■ This is to ensure that the work of one idnividula acts as a check

for the other.

○ Separation of duties- not a dupoliaction of work

● Apply technological controls

○ Technological devices can improve the effectiveness of internal controls

● Internal control limitatations

○ Human element

■ Human error- human messes up an accounting record

■ Human fraud- intent by people to defeat internal controls

○ Cost-benefit principle

■ Cost of internal controls must not exceed its benefits

● Cash- necessary asset to all companies

○ Cash eqiavlensts-

○ Most liquid of all assets

○ Easily hidden and moved

● Eeffective system of interna; controls to handel cash

○ Handling cash is separate from recordkeeping of cash

○ Cash recipts are promtlydeposited in the bank

 ○ Cash dipersments are made by check

● Liquideity- companies abailtiy to pay for its near term obligations

○ Liquid assets- cash and similar assets used to readility settle a companies
obligations.

● Cash- currency with amounts on deposit in banking accounts, checking accounts

(demand accounts), and savings accounts (time accounts).

● Cash equivalents has two requirements

○ Readily convertible into a known cash amount

○ Suffeincently close to their due date so that market value is not

sensitive to interst rate changes.

● Cah management

○ Plan cash recripts to meet cash payments when due

○ Keep a minimum level of cash necessary to operate

● Effective cash management

○ Encourage collection of recievables

○ Delay payment of liabilities

○ Keep only necessary levels of assets

■ Just-in-time inventory scheme- meaning they plan inventory to be

aviaible at the same time orders are filled

○ Plan expenditures

○ Invest excess cash

● Control of cash reciprts- cash recived is properly recorded and deposited

○ Over-the-counter- should be recorded on a cash registerat the time of

each sale.

■ Cash Over and Short account- income statement account

recording the income effects of cash overages and cash shortages
 ■ Cash register’s record shows 550, bu the cash count in the register
shows 555

Cash 555

Cash Over and Short 5

Sales 550

● Cash register’s record shows 625, but cash count in the register is 621

Cash 621

Cash Over and Short 4

Sales 625

○ Cash Over and short account usually has a debit balance at the end of
an accounting period

■ Debit balnce represents an expense

● Reprted as either miscellaneous expenses or miscellaneous

revenues

● Cash reciprts by mail

○ Person opening the mail enters a list of money recived

○ First copy is snet to the cahsier

○ Second copy sent to the recordkeepre in the accounting area

○ Third copy is keep by the clerk who opens the mail

○ Cahier depsoits money in the bank, recordkeepre record amounts

recived in accounting records

○ Excpetion to this internal control is employee collusion

● Cash disbursements

○ Voucher system of control- set of procedures and approvals deisgned

to control cash disbursements and the acceptance of obligations

■ Verifying, approving, and recrding obligations for eventual cash

disbursements
 ■ Issuing checks for payement or verified, approved, and recorded
obligations

■ Voucher- an internal document used to accumulate information

to control cash disbursements and to ensure that a transacation
is properly recorded.

■ When a company recives a monthly bill, it should reveiew and

verify charges, prepare a voucher, and insert the bill.

○ Petty cash disbursements- small payments required for items such as

postage, courier fees, minor repairs and low-cost supplies.

■ Designates advance money to establish the petty cash fund,

withdraw from the fund, and reiumburse the fund.

■ Each disbrursemnt reduces cash,a nd increases the amount of

recupts in the petty cash box

■ Estbalishing a petty cash fund

Petty Cash 75

Cash 75

● After a petty cash fund is established, the account is not debited or credited
again unless the amount of the fund is changed.

● Reimbursing a petty cash fund

Miscellaneous expense 2

Mercahndise inventory 2

Delivery Expense 2

Office Supply expense 2

Cash 8

● Increasing or decresing a petty cash fund form 75 to 100

Petty Cash 25

Cash 25

● Decrease fund from 75 to 50

 Cash 25

Petty Cash 25

● Petty chaier fails to get a receipt ofor payment or overpays for the petty cahs
amount due, to reimnburse petty cash fund

Misecllaneous Expense 178

Cash Over and Short 7

Cash 185

● Bank Account is a record set up by a bank for a customer

○ Signature card- bank employees use to verify signatures on checks

○ Deposit ticket- lists items such as currency, coins, and checks

deposited along with their corresponding dollar amounts.

○ To withdraw money, a depositor can use a check, which is a document

signed by the depositor instructing the bank to pay a specified amount
of money to a designated recipient.

○ Check involes three parties : maker who signs the check, payee who
recives the check, and a bank on which the check is drawn.

○ Elstronic Funds Transfer (EFT0- electronic transfer of acsh from one

party to another.

○ Bank statement- shows activity on an account

○ Depotors account is a liability on the banls records

■ When a depositor increase their bank account, the bank records

it as a credit to that liability account

■ Debit memorandums form the bank produce credits to the

dpostors books, and credit memorandums from the bank
produce debits to the depositors books.

○ Cancled checks are checks the bank has paid and deducted from the
customer;s account during the period.

○ Bank notifies depostir with a debit memorandum when the bank

reduces the balance.
 ○ Bank reconciliation- rport explaining any differences between the
checking account balance according to the depositor’s records and the
balance reported on the bank statement.

■ Outstanding cjecks- chjecks written by the depositor, deducted

from the depostir’s recored, and sent to the payees, but not yet
recived by the bank for payment at the bank statement due.

■ Depost in transit- depostotrs made and recored by the depositor

but not yet reocred on the bank statement.

■ Deductions for uncollectible items and for services- deopits

sometimes deposits another party’s check that is uncollectablie.
They are called non-sufficent(NSF) checks.

■ Additions for collections and for interest- Banks sometimes act

as collection agents for their depositors by collecting notes and
other items.

■ Errors- both abnks and depositoera make errors

● Adjusting entries for bank reconciliation

○ It is important to rmember that only items reconciling the book

balance require adjustment

○ Collection note

Cash 485

Collection Expense 15

Notes Recievable 500

● Interest credited to an account by a bank

Cash 8.42

Interest Revenue 8.42

● Check printing charges

Miscellaneous Expense 23

Cash 23

● NSF chack
 Accounts Recievable – T. woods 30

Cash 30

● Day’s Sales Uncollected Ratio- how quickly a company can convert its
accounts receivable into cash

○ We use this to estimate how much time is likely to pass before

the current amount of account recievables is recived in cash.

Day’s Sales Uncollected = Accounts Reciveable x 365

Net Sales

The less time money is tied up in recievables often translates into increased
profitablity