Chapter 9
Internal Control
and Cash
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
In this chapter…
Balance Sheet
Current Assets
Cash
Chapter
9, 19
Current Liabilities
10000
Accounts Payable
Accounts Receivable
20000
Wages Payable
Notes Receivable
15000
Utilities Payable
Marketable Securities
25000 Long-Term Debt
Inventory
120000
Capital Assets
Bonds Payable
600000
Buildings
500000
Total Assets
2000
20000
250000 Owner’s Equity
60000
25000
Notes Payable
Equipment
Goodwill
5000
Common Stock
300000
Retained Earnings
48000
1000000 Total Liabilities + OE
1000000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Internal Control Systems
• All policies and procedures used to:
–
–
–
–
Protect assets
Ensure reliable accounting
Promote efficient operations
Encourage adherence to company policies
• The primary purpose of internal control systems is to help
extend the control an owner/manager has over the above
items
• The bigger a company gets, the less hands on control
managers have and so the greater the need for controlling
systems to safeguard assets
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Principles of Internal Control
• Ensure transactions and activities are authorized
• Maintain records
– Using pre-printed forms and filing procedures help to track the processes
that run under the forms
• Insure assets
– Passes the risk of loss to a party willing to bear the loss (for a premium)
• Separate record keeping from custody of assets
– Risk of loss or theft gets reduced when the person having control over
assets knows there is another person maintaining records
• Separate duties
– Dividing responsibilities for related transactions as a safety check
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Principles of Internal Control
• Apply technological controls
– Use a cash register with a tape record, use time cards to track
hourly wage earners’ activities
– Computerized control systems can provide more security with less
paper trail and less auditing effort but still pose challenges
• Separating duties is even more critical the more technologically
advanced the accounting system
• Perform internal and external audits
– Regularly reviewing the records helps to ensure any issues are
reconciled within a short period of time and also tunes the auditor
to look for common errors or patterns
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Limitations of Internal Control
• The more active people are in the internal control process,
the more likely human error and human fraud can play as a
factor
• Human error results from fatigue, negligence, confusion or
training issues
• Human fraud is intentionally malicious activity designed to
defeat a control system
• Management can influence these by conveying a
commitment and following through with processes that
exercise control
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Limitations of Internal Control
• Cost-benefit
– Its important to note that all quality assurance processes add no
discernable value to the product or process (they prevent further
loss).
– Internal control is the same
– Companies then should manage the investment they make in
internal controls with respect to the return they expect to get from
the effort
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Cash
• Cash is probably one of the most important assets an
organization can have.
• Cash – includes currency, coins, and amounts on deposit in
bank accounts. It also includes customers’ cheques,
cashiers cheques, certified cheques, money orders, EFT
deposits
– Basically anything that is cash or a cash equivalent
• Liquidity refers to how easily an asset can be converted
into cash for paying obligations
• Cash is the most fluid of assets and so can be easily hidden
and moved. Special precautions should be in place to
secure cash. The control mechanisms outlined earlier are
applicable
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Petty Cash
• Most organizations put most of their cash in bank accounts
so that it can earn interest – but also that it is securely
stored.
• For many organizations, this means that all payments can
be made by cheque. These invoke a highly tuned and
specialized tracking system run by banks to secure the
funds controlled by cheques.
• But many small expenses are too small to pay by cheque
(the cost/inconvenience of paying by cheque becomes too
large)
• Petty Cash is a small store of cash used to pay small
incidental costs (courier fees, repairs, supplies)
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Petty Cash
• A Petty Cash fund has its own periodic cycle that can be
used to control the small amount of funds on hand
• It starts by establishing the petty cash fund:
Date
Account Titles and explanation
Apr 1
Petty Cash
PR
Debit
Credit
100
Cash
100
• This establishes the petty cash fund. Now that it is
established, it is no longer debited or credited, unless the
owner wishes to increase it or decrease it
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Petty Cash
• Now that Petty Cash is established, the Petty Cashier can
use cash to pay small expenses.
• Whenever an expense is paid directly out of petty cash a
receipt is issued to record the purpose of the cash
disbursement.
• At the end of the period (month), all receipts are collected
and examined to determine how various expense and asset
accounts should be debited.
• Exhibit 9.2 shows the Petty Cash Payments Report that
summarizes the period’s use of Petty Cash
– Note the calculation of over/short.
• The figures in this table are used to record journal entries
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Petty Cash
• You can see how the report translates into a journal entry
to record the petty cash disbursements into the books
– All expenses are debited (increased)
– The cash shortage is considered an “expense” and so is also
debited so that cash can be used to replenish all the expenses plus
the shortage.
– Note how the Petty Cash account itself is not touched here. It is as
if the Cash account “reaches over top” of the Petty Cash account to
cover the expenses
– In the second journal entry, you can see how the Petty Cash
account is increased. The Petty Cash account is also debited
(similar to when it was opened) and that much more cash is added
to the Cash credit line
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Mid-chapter Demo Problem
• Lets try out the Mid-chapter Demo problem
– Establish the Castillo Company’s petty cash fund
– Record transactions and replenish the fund
• Use a Petty Cash Payments Report to understand how the cash has
flowed out of the account
– Independent of the second item, reduce Petty Cash by $100
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Banking Activities
• Mentioned earlier, banking activities serve to secure funds.
– This is done by storing funds in banks, but also by leveraging their
detailed reporting system
• Bank Account – a record set up by a bank for a customer
permitting that customer to deposit and withdraw funds
through deposits and cheques.
– Signature cards are used to authorize various people to sign
company cheques
• Bank deposits – the act of delivering cash or equivalents to
the bank. The bank will issue a deposit slip as proof of
deposit to the account.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Banking Activities
• Cheques – documents written by the bank account
customer and given to their vendors or suppliers.
– By presenting the cheque to the bank, the vendor claims the funds.
– The cheque authorizes the bank to distribute the funds to the
vendor
• Electronic Funds Transfer (EFT) - this is a new fangled
way of transferring money between business partners.
– Far cheaper than writing and mailing cheques, plus it occurs
instantly
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Banking Activities
• Credit Cards – Paying by credit card is convenient for
customers, which helps to spark sales
– Allowing payment by credit card allows organizations to make sales
where they otherwise may not
– Shifts the burden of collecting on credit sales to a credit card company
– The credit card company manages this assumed burden and associated
expenses by charging the organization a small credit card transaction
fee
– Sometimes credit card companies also charge the credit card user with
fees
• The book distinguishes between a credit card and a bank
credit card
– The difference is the timing in payment to the retailer
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Banking Activities
• Debit Cards – these cards allow funds to be directly
transferred between the customer’s account and the
organization’s account.
– Again, the bank does charge a fee for this service to the retailer and
also sometimes to the customer
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Bank Statements
• Bank Statements are usually a monthly report mailed to the
business owner (accounting department), which
summarizes the transactions on the bank account for the
stated period (Exhibit 9.5)
– Notice that Deposits are called Credits and Cheques are called
debits
– In our books, deposits are increases in cash and so are debits and
cheques decrease cash accounts and so credit those accounts
– The difference is that these statements are reported from the bank’s
perspective.
• A company’s bank account is a liability on the books of a bank
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Bank Reconciliation
• Bank reconciliation is a method used to control and
confirm the cash accounts.
– Because of the fluid/liquid nature of cash, this process is extremely
critical
• In a big company, bank records may rarely match the
company records for the bank account – there is just too
much going on.
• Reconciliation helps to explain and reconcile the
differences which can be caused mostly by timing
differences….
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Bank Reconciliation
• Causes for differences between company and bank account
records:
– Unrecorded funds – These are deposits made and recorded in the
books by the company but not yet by the bank (say, overnight
deposits)
– Outstanding cheques – cheques are recorded as cash outlays by the
company, but have not yet been cashed by the supplier
– Collections or interest earned – The bank may offer interest on
savings accounts and so may issue interest payments to the bank
account holder. These are recorded in the bank account statement
unknown to the company.
– Deductions for service fees – similarly, banks will deduct for
services fees directly from the bank account without informing the
company.
– Errors – made by both the bank and the company
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Reconciling a Bank Statement
• First, note the ending date/period for the statement
• Note the beginning and ending balances
• Compare all deposits on the bank statement with those
recorded by the accounting records. Identify discrepancies
and determine which is correct
• Compare cancelled cheques received with those recorded on
the bank statement and with those recorded in the books
– Identify outstanding cheques between the books and the bank account
• Inspect all additions due to customer payments, interest
earned, collections
• Inspect all deductions due to service fees, NSF cheques, etc
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Reconciling a Bank Statement
• Lets walk through the bank reconciliation exercise on page
456 to understand how the company reconciles its books
with its bank accounts
– Build a reconciliation report (which looks like Exhibit 9.9, but for
the next month) to summarize the reconciliation
– Prepare adjusting entries for any action that was outstanding
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Exercises
• Try Exercise 9-6
– Establish the Petty Cash account
– Prepare the Petty Cash Payments Report
– Complete the journal entries to replenish the account and record
expenses
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Exercises
• Try Exercise 9-7. For all 3 pieces of this exercise:
– Establish the Petty Cash account
– Prepare the Petty Cash Payments Report
– Complete the journal entries to replenish the account and record
expenses
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Exercise
• Try Problem 9-4A, 9-5A, 9-8A
• Chapter 10
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD