CHAPTER: 1

Cash
and
Internal Control
OUTLINE:
Cash and Cash Equivalents
Control Over Cash
Cash Management
Reading a Bank Statement
The Bank Reconciliation
The Need for Adjustments to the Records
Establishing a Petty Cash Fund
An Introduction to Internal Control
The Sarbanes-Oxley Act of 2002
The Control Environment
The Accounting System
Internal Control Procedures
Computerized Business Documents and Internal Control
CASH
“Regardless of the form it takes, cash reported on a balance
sheet must be readily available to pay debts.”
Coin and Currency
Checking, Saving accounts
Undeposited, Cashier and certified checks

Cashier Check: A check written by a financial institution, usually a bank, on its own funds.
Certified Checks: Check for which the issuing bank guarantees availability of cash in the
holder’s account
CASH
EQUIVALENTS
“An investment that is readily convertible to a known amount of cash and has
an original maturity to the investor of three months or less.”

Readily convertible to cash

Original maturity to investor of three months or less

Examples
Commercial paper: Securities issued by large corporations to obtain funds to meet short term obligations….
not more than 270 days
Treasury bills: a short dated government security, yielding no interest at a discount on its redemption price
Certain money market funds: A mutual fund that invests solely in cash and cash equivalent securities.
CASH MANAGEMENT
 Collection and disbursement of cash
 Maintenance of Liquidity
 Investment of surplus cash or raising the cash from outside for financing the deficit.

Guard against theft and other abuses

Neither too little nor too much cash on hand
Tools

Cash budgets
Cash flows statement
Bank Reconciliations
Petty cash funds
BANK STATEMENT
Two Fundamental Principles of Internal Control
1. All cash receipts be deposited intact daily.
2. All cash payments should be made by check.

Bank Statement: A detailed list, provided by the bank, of all activity for
a particular account during the month.

Cash Account: A company's general ledger account. Cash contains a

record of the transactions (checks written, receipts from customers,
etc.) that involve its checking account.
BANK RECONCILIATION
A form used by the accountant to reconcile or resolve any differences
between the balance shown on the bank statement for a particular
account with the balance shown in the accounting records.

Objectives:
To determine the actual cash balance
To find error and fraud
BANK RECONCILIATION
 Bank Statement
 Cash Account
 Canceled check
 Outstanding check
 Deposits
 Deposit in transit
 Not Sufficient Fund (NSF) Check
 Credit memoranda
 Debit memoranda
 Service Charge
 Customer note and interest
 Interest Earned
REASONS FOR DISAGREEMENT BETWEEN
BANK STATEMENT AND CASH BOOK BALANCE
1. Items recorded on Cash Book and not on Bank Statement
Outstanding Checks
Deposit in Transit

2. Items recorded on Bank Statement and not on Cash Book

Bank Collections
Service Charges
Bank Interest
Non Sufficient Fund (NSF) Checks

3. Errors made on recording on Cash Book and Bank Statement

BANK RECONCILIATION - STEPS
1. Trace deposits listed on the bank statement to the books. Prepare a
list of the deposits in transit.
2. Trace any checks recorded on the books but not listed on the bank
statement. Prepare a list of the outstanding checks.
3. List all items, other than deposits, shown as additions on the bank
statement. Prepare a list of credit memoranda.
4. List all amounts, shown as subtractions on the bank statement.
Prepare a list of debit memoranda.
5. Identify any errors made by the bank or by the company in recording
the various cash transactions.
6. Use the information collected in steps 1 through 5 to prepare a bank
reconciliation.
BANK RECONCILIATION – STEP 1

Trace deposits listed on the bank statement to

the books. Identify the deposits in transit. Add to
the bank balance.

Deposits in transit: Late period deposits

not yet reflected on bank statement
EXAMPLE OF
RECONCILIATION
Bank Statement Adjustments: Deposits

Balance per statement, June 30 $3,308.59

Add: Deposit in transit 642.30
BANK RECONCILIATION – STEP 2

Trace checks cleared by the bank to the books.

Identify outstanding checks. Subtract from the
bank balance.

Outstanding checks: Checks written but not

yet presented to bank
EXAMPLE OF RECONCILIATION
Bank Statement Adjustments: Checks Outstanding
Balance per statement, June 30 $3,308.59
Add: Depositper
Balance in transit
statement, June 30 642.30$3,308.59
Deduct:
Add: Outstanding
Deposit Check
in transit 642.30
No. 496
Deduct: $ 79.89
Outstanding checks:
No.No.
501496 213.20$ 79.89
No.No.
502501 424.75 213.20 (717.84)
Adjusted balance,
No. 502 June 30424.75 $3,233.05
(717.84)
Adjusted balance, June 30 $3,233.05
BANK RECONCILIATION – STEP 3

List all other additions (credit memoranda) shown

on the bank statement. Add to the book balance.

Credit memoranda: Interest earned, customer notes

collected, etc.
EXAMPLE OF
RECONCILIATION
Cash Account Adjustments: Credit Memoranda

Balance per books, June 30 $2,895.82

Add: Customer note collected $500.00
Interest on customer note 50.00
Interest earned during June 15.45
Error in recording check 498 54.00 619.45
BANK RECONCILIATION – STEP 4

List all other subtractions (debit memoranda)

shown on the bank statement. Subtract from
the book balance.

Debit memoranda:
NSF checks, service charges, etc.
EXAMPLE OF
RECONCILIATION
Cash Account Adjustments: Debit Memoranda
Balance per books, June 30 $2,895.82
Add: Customer note collected $500.00
Interest on customer note 50.00
Interest earned during June 15.45
Error in recording check 498 54.00 619.45

Deduct: NSF check $245.72

Collection fee on note 16.50
Service charge for lockbox 20.00 (282.22)
Adjusted balance, June 30 $3,233.05
BANK RECONCILIATION – STEP 5

Identify errors made by the bank or the

company in recording the transactions during
the period.
BANK RECONCILIATION – STEP 6
Use the information collected in steps 1 through 5 to prepare the bank
reconciliation.

Bank Reconciliation
Adjusted
Balance per bank $$$ balances
: for book
Adjusted balance $$$ and bank
must
Balance per books $$$ agree
:
Adjusted balance $$$
EXAMPLE OF RECONCILIATION
Bank Statement Adjustments
Balance per statement, June 30 $3,308.59
Adjusted balance, June 30 $3,233.05

Cash Account Adjustments

Balance per books, June 30 $2,895.82
Adjusted balance, June 30 $3,233.05
BANK RECONCILIATION
ADJUSTING ENTRIES

Bank Reconciliation

Balance per bank $$$

: Book
Adjusted balance $$$ adjustments
are the basis
Balance per books $$$ for
: adjusting
Adjusted balance $$$ entries
 …… Company
Bank Reconciliation Statement
31 Month, Year

Balance per bank statement XXX

Add; Deposit in Transit XXX
Bank Error XXX XXX
Less; Outstanding Checks XXX
Bank Error XXX (XXX)
Adjusted Balance XXX

Balance per book XXX

Add; Customer note collected XXX
Interest on Customer note XXX
Interest earned XXX
Error on recording on book XXX XXX
Less; Bank Charge XXX
NSF Check XXX
Service Charge XXX
Error on recording on book XXX (XXX)
Adjusted Balance XXX
BOARD QUESTION
The cash account for Viaduct Systems at March 31, 2003 indicated a balance of
$17,474.35. The bank statement indicated a balance of $23,391.40 on March 31, 2003.
Comparing the bank statement and the accompanying cancelled checks and
memorandum with the records reveals the following:
  

a. Checks outstanding totaled $5,010.80.

b. A deposit of $3,215.50 representing receipts of March 31 had been made too late
to appear on the bank statement.
c. The bank had collected $3,600 on a note left for collection. The face value of a
note was $3,000.
d. A check for $1,050 returned with the statement had been incorrectly recorded by
Viaduct Systems as $1,500. The check was for the payment of an obligation to
Bates Co. for the purchase of office supplies on account.
e. A check drawn for $878 had been incorrectly charged by the bank as $788.
f. Bank service charges for March amounted to $18.25.
 
Required: Prepare a bank reconciliation statement for Viaduct Systems
(21,506.1)
REVIEW PROBLEM
The following information is available for McCarthy Corp. on June 30, 2012:
a. The balance in cash as reported on the June 30, 2012, bank statement is $5,654.98.
b. McCarthy made a deposit of $865 on June 30 that is not included on the bank statement.
c. A comparison between the canceled checks returned with the bank statement and McCarthy’s
records indicated that two checks had not yet been returned to the bank for payment. The amounts of
the two checks were $236.77 and $116.80.
d. The cash account on the company’s books reported a balance on June 30 of $4,165.66
e. McCarthy rents some excess storage space in one of its warehouses, and the tenant pays in monthly
rent directly to the bank for deposit in McCarthy’s account. The bank statement indicates that a deposit
of $1,500 was made during the month of June.
f. Interest earned on the checking account and added to McCarthy’s account during June was $11.75
g. Bank service charges were $15 for the month of June as reported on the bank statement.
h. A comparison between the checks returned with the bank statement and the company’s revealed that
a check written by the company in the amount of $56 was recorded by the company erroneously as a
check for $560.
Required: Prepare a bank reconciliation for the month of June in good form.
(Adjusted Balance: 6,166.41)
BANK RECONCILIATION
ADJUSTING ENTRIES
A number of adjustments to its records are needed to
change the balance of the cash account.

The additions and deductions to the cash account on

the books should be the basis for the adjustments.

To record bank reconciliation adjustments.

ADJUSTING ENTRIES
Bank Service Charge
Bank Service Charge XXX
Cash XXX
To record bank service charge

NSF Check
Accounts Receivable XXX
Cash XXX
To record NSF check return

Interest Earned
Cash XXX
Interest Revenue XXX
To record interest revenue

Notes Receivable and Interest revenue

Cash XXX
Notes Receivable XXX
Interest Revenue XXX
To record collection of Notes and Interest by Bank
BANK RECONCILIATION
Mickey’s Marathon Sports
Bank Reconciliation
June 30, 2012
Balance per books, June 30 $2,895.82

Add: Customer note collected $500.00

Interest on customer note 50.00
Interest earned during June 15.45
Error in recording check 498 54.00 619.45

Deduct: NSF check $245.72

Collection fee on note 16.50
Service charge for lockbox 20.00 (282.22)

Adjusted balance, June 30 $3,233.05

PROBLEM 6-1 BANK RECONCILIATION
The following information is available to assist you in preparing a bank reconciliation for Calico Corners on May 31,
2008:
a. The balance on the May 31, 2008, bank statement is $8,432.11.
b. Not included on the bank statement is a $1,250 deposit made by Calico Corners late on May 31.
c. A comparison between the canceled checks returned with the bank statement and the company records indicated that the
following checks are outstanding at May 31:
No. 123 $ 23.40
No. 127 145.00
No. 128 210.80
No. 130 67.32
d. The Cash account on the company’s books shows a balance of $9,965.34.
e. The bank acts as a collection agency for interest earned on some municipal bonds held by Calico Corners. The May
bank statement indicates interest of $465.00 earned during the month.
f. Interest earned on the checking account and added to Calico Corners’ account during May was $54.60. Miscellaneous
bank service charges amounted to $50.00.
g. A customer’s NSF check in the amount of $166.00 was returned with the May bank statement.
h. A comparison between the deposits listed on the bank statement and the company’s books revealed that a customer’s
check in the amount of $123.45 was recorded on the books during May but was never added to the company’s account.
The bank erroneously added the check to the account of Calico Closet, which has an account at the same bank.
i. The comparison of deposits per the bank statement with those per the books revealed that another customer’s check in
the amount of $101.10 was correctly added to the company’s account. In recording the check on the company’s books,
however, the accountant erroneously increased the Cash account to $1,011.00.
Required
1. Prepare a bank reconciliation in good form. ( Adjusted Balance: USD 9,359.04)
 PETTY CASH
 Petty cash or the petty cash fund is a small amount of cash on
hand used for paying expenses too small to merit writing a check.

 There might be a petty cash drawer or box in each department for

larger corporations.

 A petty cash fund can be used for office supplies, cards for
customers, flowers, paying for a catered lunch for employees, or
reimbursing employees for expenses.
PETTY CASH

Journalize
A check is written
establishment of
fund

Disbursement
with proper
documentation

Fund replenished
PETTY CASH TRANSACTIONS
Steps in setting up and maintaining a petty cash
fund:
 Write and cash a check for lump sum amount and entrust
money to petty cash custodian
 Make journal entry to record establishment of the fund
 Make disbursement from fund with proper documentation
 Periodically replenish fund by writing and cashing check
in the amount necessary to bring fund back to original
balance
 Record the replenishment and recognize the expenses
 JOURNAL ENTRIES FOR A PETTY CASH FUND

1. Establishment of petty cash fund

Petty Cash Fund XXX
Cash XXX
To record establishment of petty cash fund.

2. Replenishment of petty cash fund

Expenses Account Head XXX
Cash over and short XXX
Cash XXX
Cash over and short XXX
To record replenishment of petty cash fund.
 EXERCISE 6-5 PETTY CASH FUND
On Janary 2, 2012, Carson Car Rentals decided to set up a petty cash fund. The
treasurer established the fund by writing and cashing a $300 check and placing
the coin and currency in a locked petty cash drawer. Earl Paxton was designated
as the custodian for the fund. During January, the following receipts were given
to Paxton in exchange for cash from the fund:
U.S. Post Office (stamps) 76.00
Speedy Delivery Service 45.30
Cake N Cookies (Party for retiring employees) 65.40
Office Supply Supertore (paper, pencils) 36.00
A count of the cash in the drawer on January 31 revealed a balance of $74.10.
The treasurer wrote and cashed a check on the same day to restore the fund to
its original balance of $300.
Required:
Prepare the necessary journal entries, with explanations, for January. Assume
that all stamps and office supplies were used during the month.
 Types of Fraud
FRAUD Assets Misappropriation
Corruption
Financial Misstatement

1.Pressure
Significant Liabilities
Support sick relatives
College loan, Home loan
Expensive Habits
Earning Comparatively less than friends

2. Opportunity 3. Rationalization (Justification)

Weak Internal Control Never felt they are actually a criminal
No separation of duties Everyone does it
Ineffective monitoring of management It’s the culture
No other way to mange the problem
INTERNAL CONTROL SYSTEM
 Consists of the policies and procedures necessary
to ensure:
 The safeguarding of an entity’s assets
 The reliability of its accounting records
 The accomplishment of its overall objectives
OBJECTIVES OF INTERNAL CONTROLS
Internal controls are policies and procedures designed to ensure:

 Accurate and reliable financial reports are prepared

 Protect (safeguard) assets and records from theft, damage and

unauthorized access

 Laws, regulations, contracts and company policies are followed

SARBANES-OXLEY ACT
OF 2002 (SOX)
Act of Congress intended to bring reform
to corporate accountability and stewardship
in response to corporate scandals.

Questionable accounting practices by companies

such as Enron and WorldCom.

Protect shareholders, employees and the public from

accounting errors and fraudulent financial practices.
SARBANES-OXLEY ACT OF 2002 (SOX)
Section 404 requires the annual report to include internal
control report in which management is required to:

 State its responsibility to establish and maintain an adequate

internal control structure and procedures for financial reporting.
(States management’s responsibility for its system of internal control)

 Assess the effectiveness of its internal control structure and

procedures for financial reporting.
(Indicate that management believes internal control over financial reporting is effective)

Another important provision in SOX

 The company’s outside auditors must issue a report on their
assessment of the company’s internal control.
COMPONENTS OF
INTERNAL CONTROL

Control
Environment

Accounting Internal
System Control
Procedures
 THE CONTROL ENVIRONMENT
The control environment is concerned with the actions,
policies, and procedures that reflect the overall attitude of the
top management, directors, and owners of an entity about
internal control and its importance.

1. Integrity and ethical values

2. Commitment to competence
3. Board of directors and audit committee
4. Management’s philosophy and operating style
5. Organizational structure
6. Assignment of authority and responsibility
7. Human resource policies and practices
THE ACCOUNTING SYSTEM

Methods and records used to report

transactions and maintain financial
information

 Can be manual, fully computerized, or a

combination of both
 Use of journals is an integral part of any system
 INTERNAL CONTROL PROCEDURES
Internal control procedures can be either administrative or accounting in
nature.
Administrative controls: Procedures concerned with efficient operation
of the business and adherence to managerial policies.
Accounting controls: Procedures concerned with safeguarding the
assets or the reliability of the financial statements.
Some of the most important internal control procedures
1. Proper authorizations

2. Segregation of duties

3. Independent verification

4. Safeguarding of assets and records

5. Independent review and appraisal

6. Design and use of business documents

PROPER AUTHORIZATIONS
Along with the authority comes responsibility
Purchasing department – order goods and service
Credit department – establish specific policies for granting credit
HR department – hire new employees

General authorizations
A cashier authorizes the sale of book in a bookstore

Specific authorizations
Bookstore manager’s approval may be required before a book can be
returned
SEGREGATION OF DUTIES
One employee is given the authority to prepare checks and to sign them.
Single employee is allowed to order inventory and receive it from the
suppliers.
Honest and never makes mistakes, nothing bad will happen.
Dishonest or makes errors, the company has to bear losses.
Not only do fraud but also hide it.

Internal Control – Physical custody of assets be separated from the

accounting for those assets.

Smaller businesses do not have adequate personnel to achieve complete

segregation of key functions.
INDEPENDENT VERIFICATION
One individual or department acts as a check on the work of another.

Examples:
Physical count of inventory
Bank Reconciliation by someone not responsible for either the physical
custody of cash or the cash records acts as an independent check on the
work of these parties.
SAFEGUARDING OF ASSETS AND RECORDS
Protect assets and accounting records from loss, theft, unauthorized use
etc.

 Secured storage areas with limited access are essential for the
safekeeping of inventory.

 Protection of accounting records against misuse.

 Access to a computerized accounting record to authorized persons

through personal identification number and a password.
INDEPENDENT REVIEW AND APPRAISAL
 Periodic review and appraisal of the accounting system and the
people operating it.

 The group primarily responsible are the internal audit staff.

 Provide management with periodic reports on the effectiveness of

the control system and the efficiency of operations

 Helps to ensure that the company’s policies and procedures are

followed.
THE DESIGN AND USE OF BUSINESS
DOCUMENTS
 Business documents are important link between economic
transactions entered into by an entity and the accounting record of
those events.

 Capture all relevant information about a transaction and assist in

proper recording and classification

 Source documents: Employee’s wages is the time card, a sale

include the sale order, the sale invoice and the related shipping
documents

 Are properly controlled: sequential numbering systems

LIMITATIONS ON INTERNAL
CONTROL
 No system is entirely foolproof
 Entity’s size affects the degree of control that it
can obtain
 Installation and maintenance of controls can be
costly: segregation of duties requires additional
staffs
 Cost VS benefit tradeoff
COMPUTERIZED BUSINESS
DOCUMENTS AND INTERNAL
CONTROL

 Cash receipts should be deposited intact in the

bank on a daily basis

 All cash disbursements should be made by check

CONTROL OVER CASH
RECEIPTS
 Cash received over the counter (e.g., cash sales)

 Cash received in the mail (e.g., credit sales)

CONTROLS OF CASH RECEIVED OVER
THE COUNTER

 Cash registers
 Locked-in cash register tape
 Prenumbered customer receipts

 Investigate recurring discrepancies

CONTROLS OVER CASH RECEIVED
IN THE MAIL
 Two employees open mail
 Prelist prepared
 Monthly customer statements
 DOCUMENT FLOW FOR
MERCHANDISE
Purchase Receiving
Requisition Report

Purchase Invoice
Order Approval

Purchase Check
Invoice Prepared
END OF CHAPTER 1