Internal Control and Cash

CHAPTER

7

Internal ControlInternal Control

• The related methods and measures adopted The related methods and measures adopted within a business to:within a business to:– Optimize the use of resourcesOptimize the use of resources

– Prevent and detect errors and irregularitiesPrevent and detect errors and irregularities

– Safeguard assetsSafeguard assets

– Maintain reliable control systemsMaintain reliable control systems

Establishment of ResponsibilityEstablishment of Responsibility

• Control is most effective Control is most effective when only one person is when only one person is responsible for a given taskresponsible for a given task

Segregation of DutiesSegregation of Duties

• RRelated activities should be assigned to different elated activities should be assigned to different individualsindividuals

• Separate Separate record record keepingkeeping from physical custody from physical custody of theof the assetasset

DocumentationDocumentation

• Provide evidence that transactions and Provide evidence that transactions and events occurredevents occurred– Shipping documentsShipping documents

– Sales invoicesSales invoices

• Documents should be pre-numberedDocuments should be pre-numbered and and accounted foraccounted for

Physical ControlsPhysical Controls

Illustration 7-2

Independent Internal VerificationIndependent Internal Verification

• Comparison, reconciliation, and review of Comparison, reconciliation, and review of data prepared by employeesdata prepared by employees– Periodically or on a random basisPeriodically or on a random basis– Done by employee who is independent of the Done by employee who is independent of the

personnel responsible for the informationpersonnel responsible for the information– Discrepancies and exceptions should be Discrepancies and exceptions should be

reported to managementreported to management

Limitations of Internal ControlLimitations of Internal Control

• Cost / Cost / benefitbenefit• Human element Human element • Collusion Collusion • Size of businessSize of business

CashCash

• CoinsCoins• CurrencyCurrency• ChequesCheques• MoneyMoney orders orders• MoneyMoney on hand on hand• DepositsDeposits in bank in bank

• Readily convertible into any other assetReadily convertible into any other asset• High value in small bulkHigh value in small bulk• Non-control of owner identification (serial Non-control of owner identification (serial

numbers)numbers)

CashCash

BankBank

• Minimizes cash that must be kept Minimizes cash that must be kept on handon hand

• Provides a double record of Provides a double record of transactionstransactions– OneOne by the business by the business– OneOne by the bank by the bank

• Safeguards cash by using a bank Safeguards cash by using a bank as a depository and clearinghouse as a depository and clearinghouse for cheques received and writtenfor cheques received and written

Bank Statement •Copy of bank’s Copy of bank’s records sent to the records sent to the customer for periodic customer for periodic reviewreview

•SShows cheque and hows cheque and other debits deposits, other debits deposits, other credits and theother credits and thedaily cash balancedaily cash balance

Illustration 7-6

TermsTerms

• Deposits in transitDeposits in transit– DepositsDeposits recorded by the depositor that have recorded by the depositor that have

not yet been recorded by the banknot yet been recorded by the bank• Outstanding chequesOutstanding cheques

– ChequesCheques written (written (issuedissued)) and recorded by a and recorded by a company but that have not yet been company but that have not yet been presented presented to/to/paid by the bankpaid by the bank

• Adjusted balanceAdjusted balance– Reconciled or Reconciled or correct cash balancecorrect cash balance

TermsTerms

• Debit memorandaDebit memoranda– Charges against depositor’s account [e.g. Charges against depositor’s account [e.g.

service charges, RC (returned) / NSF service charges, RC (returned) / NSF (insufficient funds) cheques](insufficient funds) cheques]

• Credit memorandaCredit memoranda– Amounts that increase depositor’s account Amounts that increase depositor’s account

(e.g., interest earned)(e.g., interest earned)

Understanding Debits and CreditsUnderstanding Debits and Credits

BankBank(Your Cash (Your Cash

Account is a Account is a Liability)Liability)

BooksBooks(Cash is an (Cash is an

Asset)Asset)

ChequeCheque Debit Debit (decrease)(decrease)

Credit Credit (decrease)(decrease)

DepositDeposit Credit Credit (increase)(increase)

Debit Debit (increase)(increase)

Differences Between Company Differences Between Company Balance and Bank BalanceBalance and Bank Balance

• Time lagsTime lags– The period after a The period after a cheque is written and dated cheque is written and dated

but not yet but not yet presented to nor presented to nor paid by the bankpaid by the bank– The period between receipts being recorded The period between receipts being recorded

by the company and by the company and time receipts being time receipts being recorded by the recorded by the bankbank

– TimeTime lag lagss occur when the bank mails debit or occur when the bank mails debit or credit memocredit memoss to the company to the company

• ErrorsErrors by either party in recording by either party in recording transacttransactionsions

Bank ReconciliationBank Reconciliation

• This reconciles the balance in the company’s This reconciles the balance in the company’s bank account with the cash balance in the bank account with the cash balance in the general ledgergeneral ledger

Reporting CashReporting Cash

• Cash on hand, cash in banks, Cash on hand, cash in banks, cash equivalents, cash equivalents, and petty and petty cash are often combined and cash are often combined and reported as cashreported as cash

• Cash is recorded in both the Cash is recorded in both the balance sheet and the cash balance sheet and the cash flow statementflow statement

• Cash is the most liquid asset Cash is the most liquid asset and is listed first in the current and is listed first in the current asset section of the balance asset section of the balance sheetsheet

Cash EquivalentsCash Equivalents

• Readily convertible to known amount of cashReadily convertible to known amount of cash• So near maturity that market value is So near maturity that market value is

relatively insensitive to changes in interest relatively insensitive to changes in interest ratesrates

• ExamplesExamples– Treasury billsTreasury bills– Commercial paperCommercial paper– Money market fundsMoney market funds

Restricted CashRestricted Cash

• CCash that is not available for ash that is not available for general use; general use; set aside for set aside for special purposesspecial purposes

• If it is not to be used within the If it is not to be used within the next year, report as noncurrent next year, report as noncurrent assetasset

• For example, a bank may For example, a bank may require a borrower to have a require a borrower to have a compensating balance—compensating balance—minimum cash balanceminimum cash balance

Five Principles of Cash ManagementIllustration 7-10

Cash BudgetingCash Budgeting

• PlanningPlanning a a company's company's cash needs is a key cash needs is a key business activitybusiness activity

• Cash budget shows Cash budget shows anticipated cash flows anticipated cash flows over a one-to twoover a one-to two--year year periodperiod

Cash BudgetCash Budget

• Cash receipts sectionCash receipts section• Cash disbursements Cash disbursements

sectionsection• Financing sectionFinancing section