Chapter Six

Internal Control and Accounting for Cash

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Features of Internal Control

1. 2. 3. 4. 5. 6. 7. 8. 9. Separation of Duties Quality of Employees Bonded Employees Required Absences Procedures Manual Authority and Responsibility Prenumbered Documents Physical Control Performance Evaluations
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Accounting for Cash

Up to date signature card should be maintained. be recorded immediately upon receipt and deposited intact daily.

Cash receipts should

A monthly bank reconciliation should be prepared by an independent party.

Controlling Cash

A deposit ticket should be used for all deposits.

Cash payments should

be made by prenumbered check.

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Reconciling the Bank Statement

The bank reconciliation reports on the differences between the balance on the bank statement and the balance in the general ledger cash account. The reconciliation results in the true cash balance that will appear on the balance sheet.
Adjustment to the Bank Balance Unadjusted bank balance
Adjustments to the Book Balance Unadjusted book balance Add + Accounts receivable collections

+ Deposits in transit Deduct - Outstanding checks Equals = True cash balance

Add

+ Deduct Deduct Equals =

Add

Interest earned Bank service charges Non-sufficient funds (NSF) check True cash balance

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Reconciling the Bank Statement

If an error is found on the bank statement, an adjustment for it is made to the unadjusted bank balance to determine the true cash balance. An error made on our books requires an adjusting journal entry to correct.

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Bank Reconciliation
Green Shades Resorts, Inc. is preparing the bank reconciliation for the month of September. 1. The Sept 30th balance on the bank statement is $3,516.45, and the Cash general ledger balance on this date is $3,361.22 .

2. There was a deposit in transit in the amount of $724.11.

3. The bank erroneously deducted a $25 check drawn on the books of Green Valley Resorts from our account.

4. At September 30th three checks are outstanding. Check 639 dated 9/18 for $13.75; Check 646 dated 9/20 for $29.00; and Check 672 dated 9/27 for $192.50 . More Information
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Bank Reconciliation
5. During the month of September the bank collected an account receivable for us in the amount of $940.00 . 6. A check actually written for $36.45 for supplies was erroneously recorded in our records by the bookkeeper as $63.45.

7. The bank assessed a service charge of $8.40 for September.

8. We deposited a NSF check in the amount of $289.51 .

Lets prepare the bank reconciliation

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Bank Reconciliation
Green Shades Resorts, Inc. Bank Reconciliation Statement September 30, 2011 Unadjusted Bank Balance, September 30 $ 3,516.45 Add: Deposits in transit 724.11 Bank error: Check drawn on GVRI charged to GSRI 25.00 Less: Outstanding checks Check No. 639 - September 18 13.75 Check No. 646 - September 20 29.00 Check No. 672 - September 27 192.50 (235.25) True Cash balance, September 30 $ 4,030.31 Unadjusted Book Balance, September 30 Add: Receivable collected by bank Error: Check 633 recorded as 63.45 not 36.45 Less: Bank service charge NSF Check True Cash balance, September 30 $ 3,361.22 940.00 27.00 (8.40) (289.51) $ 4,030.31

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Adjusting the Books

Every reconciling item that appears on the unadjusted book balance section requires a journal entry to adjust the general ledger cash balance to the true cash balance.
Account Title Cash Accounts Receivable Supplies Expense Bank service charge expense Accounts receivable Cash Debit 967.00 Credit 940.00 27.00 8.40 289.51 297.91

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Cash Short and Over

When using a cash register, employees sometimes make mistakes in collecting cash or making change for customers. If the cash register does not reconcile by a small amount at the end of the day, we use an account called cash short and over to force a balance.
Assume a cash register was to have a balance of $500, but contained only $499 at the end of the day.
Account Title Cash Cash short and over Sales Debit 499.00 1.00 Credit

500.00

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Using Petty Cash Funds

A petty cash fund is used to make small expenditures that cannot wait for the formal checkwriting process. The fund is operated on an imprest basis. This means that when the fund gets low on cash it is replenished. The petty cashier is always responsible for the cash in the fund. This is an excellent internal control.

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Using Petty Cash Funds

Record expenses paid from the petty cash fund.
Account Title Misc. Expense Cash Debit 216.00 Credit 216.00

Petty cashier takes the check to the bank and gets $216.00 cash for the fund.

Treasurer prepares a $216.00 check payable to the petty cashier.

The fund is now returned to its $300 balance.

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The Financial Analyst

How can a financial analyst know that a company really did follow GAAP?

Certified Public Accountants

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Materiality and Financial Audits

Auditors do not guarantee that financial statements are absolutely correctonly that they are materially correct.

Material Item An error, or other reporting problem, that would influence the decision of an average prudent investor.
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Types of Audit Opinions

Unqualified Adverse

Qualified

Disclaimer
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