Internal Control and Cash

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Chapter 6
Internal Control and Cash
Electronic Presentation by Douglas Cloud
Pepperdine University
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Learning Goals
1. Describe and illustrate the objectives and
elements of internal control. 2. Describe and
illustrate methods of preventing and detecting
employee fraud. 3. Describe and illustrate the
application of internal controls to
cash. 4. Describe the nature of a bank account
and its use in controlling cash.
After studying this chapter, you should be able
to
Continued
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Learning Goals
5. Describe and illustrate the use of a bank
reconciliation in controlling cash. 6. Describe
the accounting for special-purpose cash
funds. 7. Describe and illustrate the reporting
of cash and cash equivalents in the financial
statements. 8. Describe, illustrate, and
interpret the cash flow to net income ratio and
the cash to monthly cash expense ratio.
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Learning Goal
1
Describe and illustrate the objectives and
elements of internal control.
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Internal controls help business guide their
operations and prevent abuses.
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Objectives of Internal Control
1. Assets are safeguarded and used for business
purposes. 2. Business information is
accurate. 3. Employees comply with laws and
regulations.
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Control Environment
The control environment is the overall attitude
of management and employees about the importance
of controls.
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Risk Assessment
Risk includes

• Changes in customer requirements
• Competitive threats
• Changes in economic factors
• Employee violations of company policies and
  procedures

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Control Procedures
Control procedures are established to provide
reasonable assurance that business goals will be
achieved, including the prevention of fraud.
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Control Procedures

• Competent personnel
• Rotating duties
• Mandatory vacations
• Separating responsibilities for related
  operations
• Separate operations
• Custody of assets
• Accounting proofs
• Security measures
• Monitor the internal control system

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Security Measures
Locate the cash register near the door, so that
it is fully visible from outside the store.
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Security Measures
Have two employees work late hours.
Employ a security guard
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Security Measures
Deposit cash in bank daily before 5 p.m.
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Security Measures
Keep only small amounts of cash on hand after 5
p.m. by depositing excess cash in a store safe
that cant be opened by employees on duty.
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Security Measures
Install cameras and alarm systems.
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Warning Signs With Regard to People

1. Abrupt change in lifestyle.
2. Close social relationship with suppliers.
3. Refusing to take a vacation.
4. Frequent borrowing from other employees.
5. Excessive use of alcohol or drugs.

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Warning Signs From the Accounting System

1. Missing documents or gaps in transaction numbers.
2. An unusual increase in customer fraud.
3. Differences between daily cash receipts and bank
   deposits.
4. Sudden increase in slow payments.
5. Backlog in record transactions.

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Learning Goal
2
Describe and illustrate methods of preventing and
detecting employee fraud.
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Elements Common to Most Employee Fraud

• An employees perceived financial need

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Elements Common to Most Employee Fraud

• An opportunity to use a fraudulent scheme to
  satisfy the need

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Elements Common to Most Employee Fraud

• A rationalization that the fraud is justified

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Preventive Controls
The company assets should be controlled in such a
way that an employees ability to steal the
assets is limited.
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Preventive Controls
Proper authorization and approval procedures can
be effectively used to prevent employee fraud.
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Detective Controls

• Periodic reviews of the accounting records are
  useful in identifying unusual transactions or
  accounts for further investigation.
• Independent checks are useful in detecting
  employee fraud.
• Reconciliations are useful in detecting employee
  theft.

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Risk Factors Relating to Employee Fraud

• Lack of proper record keeping for assets
  susceptible to theft.
• Lack of proper segregation of duties.
• Lack of independent checks.

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Risk Factors Relating to Employee Fraud

• Lack of a proper system of authorization.
• Lack of proper physical safeguarding of assets
  susceptible to theft.
• Lack of timely and proper documentation for
  transactions.

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Risk Factors Relating to Employee Fraud

• Lack of a proper management oversight.
• Lack of proper screening procedures for employees
  in sensitive positions.
• Lack of mandatory vacations for employees in
  sensitive position.

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Learning Goal
3
Describe and illustrate the application of
internal controls to cash.
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What is Cash?
Cash includes coins, currency (paper money),
checks, money orders, and money on deposit that
is available for unrestricted withdrawal.
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Control of Cash Receipts
One of the most important controls to protect
cash received in over-the-counter sales is the
cash register.
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Control of Cash Receipts
After a cash register clerks cash has been
counted and recorded on a memorandum form, the
cash is then placed in a store safe until it can
be deposited in the bank.
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Control of Cash Receipts
The employee who opens the mail should initially
compare the amount of cash received with the
amount shown on the remittance advice.
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Control of Cash Receipts
The employee opening the mail normally also
stamps the checks and money orders For Deposit
Only in the bank account of the business.
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Control of Cash Receipts
When cash is deposited in the bank, the bank
cashier normally stamps a duplicate copy of the
deposit ticket. This bank receipt is returned to
the Accounting Department for comparison and
recording.
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Control of Cash Payments
A voucher system is a set of procedures for
authorizing and recording liabilities and cash
payments.
A voucher is any document that serves as proof of
authority to pay cash.
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Learning Goal
4
Describe the nature of a bank account and its use
in controlling cash.
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A summary of all checking account transactions,
called a bank statement, is mailed to the
depositor each month.
It shows the beginning balance, additions,
deductions, and the balance at the end of the
period.
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Businesses usually require that all cash receipts
be initially deposited in the bank account.
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Likewise, businesses usually use checks or bank
account transfers to make all cash payments.
Except very small ones.
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Learning Goal
5
Describe and illustrate the use of a bank
reconciliation in controlling cash.
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A bank reconciliation is a listing of the items
and amounts that cause the cash balance reported
in the bank statement
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to differ from the balance of the cash account
in the ledger.
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Steps in a Bank Reconciliation
1. Compare cash deposit listed on the bank
statement with unrecorded deposits appearing in
the preceding periods reconciliation and with
deposit receipts or other records of deposits.
Cash balance according to bank statement
Add deposits not on bank statement
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Steps in a Bank Reconciliation
2. Compare paid checks with outstanding checks
appearing on the preceding periods
reconciliation and with recorded checks.
Cash balance according to bank statement
Deduct outstanding checks No. 1512 xxx No.
1515 xxx No. 1521 xxxx
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Steps in a Bank Reconciliation
3. Compare bank credit memorandums to entries in
the journal.
Cash balance according to depositors record
Add note and interest collect by bank
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Steps in a Bank Reconciliation
4. Compare bank debit memorandums to entries
recording cash payments journal.
Cash balance according to depositors record
Deduct Check returned because of insufficient
funds Bank service charge
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Steps in a Bank Reconciliation
5. List any errors discovered during the
preceding steps.
Cash balance according to depositors record
Deduct Error in recording Check No. 1509
Assume that Check No. 1509 was written for 193
and recorded as 139.
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Typical Journal Entries
July 31 Cash 408 Notes Receivable 400 Interes
t Income 8
31 Accounts ReceivableIvey 300 Miscellane
ous Expense 18 Accounts PayableTaylor
Co. 9 Cash 327
Entries are based only on the information from
the depositors side of the reconciliation.
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Learning Goal
6
Describe the accounting for special-purpose cash
funds.
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It is usually not practical for a business to
write checks to pay small amounts, like postage.
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To control these small payments, a petty cash
fund is used. This is a small cash fund under
the control of a petty cashier.
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If a secretary needs a book of stamps, the
secretary signs a voucher that provides a
description and amount in exchange for the
necessary cash.
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The petty cashier places the voucher in a locked
drawer for later reconciliation and recording.
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Most businesses use a payroll bank account to pay
employees. This is known as a special-purpose
fund.
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Learning Goal
7
Describe and illustrate the reporting of cash and
cash equivalents in the financial statements.
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A company may have cash in excess of operating
needs. These funds are placed in highly liquid
investments and are called cash equivalents.
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Examples of Cash Equivalents

• Commercial paper
• Certificates of deposit
• U.S. government and agency securities
• Corporate notes and bonds
• Municipal securities

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Learning Goal
8
Describe, illustrate, and interpret the cash flow
to net income ratio and the cash to monthly cash
expense ratio.
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Ratio of Cash Flow to Net Income
Net cash flow from operations
From the statement of cash flows
151,250 83,725
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Ratio of Cash Flow to Net Income
From the income statement
151,250 83,725
Net income
Cash flow ratio 1.81
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Ratio of Cash to Monthly Cash Expenses
Cash at the end of the year
38,450 12,604
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Ratio of Cash to Monthly Cash Expenses
38,450 12,604
Net cash flow from operations per month
From the statement of cash flows
Ratio of cash to monthly expenses 3.05
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Chapter 6
The End
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