Chapter Seven
Internal Control
and Accounting
for Cash
McGraw-Hill/Irwin
©The McGraw-Hill Companies, Inc. 2006
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
Separation of Duties
When duties are separated, the work of one
employee can act as a check on the work of
another employee. The likelihood of fraud or theft
is greatly reduced.
Quality of Employees
The ability of cross-trained employees to substitute
for one another prevents disruptions in the
workplace. Job rotation may help relieve boredom
and increase productivity.
Bonded Employees
A fidelity bond provides insurance that protects a
company from loss caused by employee
dishonesty. To become bonded, an employee’s
background is investigated.
Required Absences
An employee may be able to cover up
fraudulent activities if they are always present
at work. All employees should be required to
take regular vacations and their duties should
be rotated periodically.
Procedures Manual
Accounting and other important procedures should be
written in a procedures manual. Periodically,
management should conduct an investigation to see
that required procedures are actually being followed.
Authority and Responsibility
General authority applies to all member of the
organization. For example, all employees are required
to fly coach and purchase airline tickets from a
specific vendor.
Specific authority applies only to a specific position
within the organization. For example, all checks must
be cosigned by the Controller and Treasurer.
Prenumbered Documents.
Prenumbered forms are used for all important
documents such as checks, purchase orders, receiving
reports, and invoices. The use of prenumbered forms
helps keep track of all forms issued during a particular
period.
Physical Control
All companies should maintain adequate physical
control over valuable assets that may be
misappropriated. For example, inventory should be
properly stored in a secure location. Serial numbers
should be placed on all valuable assets to assist in a
physical count of these assets.
Performance Evaluation
•Internal controls should include independent verification
of employee performance.
•A physical inventory should be taken at least annually.
An independent reconciliation between the general
ledger balance and inventory should be compared to the
inventory count.
•Auditors should evaluate the effectiveness of the control
system.
Limitations
Internal controls can be circumvented by
collusion among employees. Two or more
employees working together can hide
embezzlement by covering for each other. No
system can prevent fraud.
Accounting for Cash
Cash receipts should
Up to date signature
card should be
maintained.
A monthly bank
reconciliation should
be prepared by an
independent party.
be recorded
immediately upon
receipt and deposited
intact daily.
Controlling
Cash
A deposit ticket
should be used for
all deposits.
Cash disbursements
should be made by
prenumbered check.
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
+ Deposits in transit
Deduct - Outstanding checks
Equals = True cash balance
Add
Adjustments to the Book Balance
Unadjusted book balance
Add + Accounts receivable collections
+
Deduct Deduct Equals =
Add
Interest earned
Bank service charges
Non-sufficient funds (NSF) check
True cash balance
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.
Bank Reconciliation
Matrix, Inc. is preparing the bank reconciliation for the
month of June.
1. The June 30th balance on the bank statement is
$4,892.56, and the Cash general ledger balance on this
date is $4,240.54.
2. There was a deposit in transit in the amount of $475.
3. The bank erroneously deducted a $200 check drawn on
the books of Matters, Inc. from our account.
4. At June 30th there were three checks outstanding. Check
1078 dated 6/28, for $372.33; Check 1080 dated 6/29,
for $402.41; and Check 1081 dated 6/30, for $66.89.
More Information
Bank Reconciliation
5. During the month of June the bank collected an account
receivable for us in the amount of $875.
6. A check actually written for $146.88 for supplies was
erroneously recorded in our records by the bookkeeper
as $173.88.
7. Matrix earned interest of $9.25 on its checking account.
8. The bank assessed a service charge of $12.75 for June
and we deposited a NSF check in the amount of
$413.11.
Let’s prepare the bank reconciliation
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted bank balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted bank balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted bank balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted bank balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted bank balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
Bank Reconciliation
Matrix, Inc.
Bank Reconciliation Statement
June 30, 2006
Unadjusted Bank Balance, June 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 1078 - June 28
372.33
Check No. 1080 - June 29
402.41
Check No. 1081 - June 30
66.89
True Cash balance, June 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 4,892.56
475.00
200.00
(841.63)
$ 4,725.93
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
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
Interest revenue
Bank service charge expense
Accounts receivable
Cash
Debit
911.25
Credit
875.00
27.00
9.25
12.75
413.11
425.86
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
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.
Using Petty Cash Funds
Establishing a $500 petty cash fund.
Account Title
Petty cash
Cash
Debit
500.00
Credit
500.00
Petty cashier takes
the check to the
bank and gets $500
cash for the fund.
Treasurer prepares
a $500 check
payable to the petty
cashier.
Using Petty Cash Funds
During the month the petty cashier paid out $217
for FedEx deliveries, $34.50 for late-working
employee meals, $27 for cab fare to the airport for a
salesperson, and $187.60 for office postage stamps.
The petty cashier asked for and received a receipt
for each disbursement made this month. The fund is
getting low on cash so the petty cashier requests
that the fund be replenished.
Using Petty Cash Funds
Here is an analysis of the impact of the reimbursement.
Assets
= Liab.
(466.10) = NA
+ Equity
Rev.
–
Exp.
+
NA
–
466.10 =
(466.10)
= Net Inc.
(466.10)
Cash Flow
(466.10) OA
The journal entry to record the reimbursement would be:
Account Title
Delivery Expense
Employee Meal Expense
Taxi Expense
Postage Expense
Cash
Debit
217.00
34.50
27.00
187.60
Credit
466.10
Using Petty Cash Funds
Petty cashier takes
the check to the
bank and gets
$466.10 cash for
the fund.
Treasurer prepares
a $466.10 check
payable to the petty
cashier.
The fund is now returned to its $500 balance.
Current Versus Noncurrent
Current assets are expected to be converted to cash or
consumed within one year or an operating cycle,
whichever is longer. Current assets include:
•Cash
•Marketable Securities
•Accounts Receivable
•Short-Term Notes Receivable
•Interest Receivable
•Inventory
•Supplies
•Prepaids
Current Versus Noncurrent
Current liabilities are due within one year or an
operating cycle, whichever is longer. Current liabilities
include:
•Accounts Payable
•Short-Term Notes Payable
•Wages Payable
•Taxes Payable
•Interest Payable
Limbaugh Company
Classified Balance Sheet
As of December 31, 2006
Assets
Current Assets
Cash
Accounts Receivable
Inventory
Prepaid Rent
Total Current Assets
Property, Plant, and Equipment
Office Equipment
$ 80,000
Less: Accumulted Depreciation
(25,000)
Building
340,000
Less: Accumulted Depreciation
(40,000)
Land
Total Property, Plant, and Equipment
Total Assets
$
20,000
35,000
230,000
3,600
$
288,600
55,000
300,000
120,000
$
475,000
763,600
$
193,800
Liabilities and Stockholders' Equity
Current Liabilities
Accounts Payable
Notes Payable
Salaries Payable
Unearned Revenue
Total Current Liabilities
Long-Term Liabilities
Notes Payable
Total Liabilities
Stockholders' Equity
Common Stock
Retained Earnings
Total Liabilities and Stockholders' Equity
$
32,000
120,000
32,000
9,800
100,000
293,800
200,000
269,800
$
469,800
763,600
Classified
Balance
Sheet
Current Ratio
Current Asset
Current
=
Current Liabilities
Ratio
For Limbaugh Company the current ratio is:
Current
=
Ratio
$288,600
= 1.49:1
$193,800
End of Chapter Seven