Chapter 6 Accounting Systems, Internal Controls, and Cash Financial and Managerial Accounting 8th Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of 1 NVTech Inc. Objectives 1. Define an accounting system and describe its implementation. 2. List the three objectives of internal control, and define and give examples of the five elements of internal control. 3. Describe the nature of cash and the importance of internal control over cash. 4. Summarize basic procedures for achieving internal control over cash receipts. 2 Objectives 5. Summarize basic procedures for achieving internal control over cash payments, including the use of a voucher system. 6. Describe the nature of a bank account and it sue in controlling cash. 7. Prepare a bank reconciliation and journalize any necessary entries. 8. Account for small cash transactions using a petty cash fund. 9. Summarize how cash is presented on the balance sheet. 10. Compute and interpret the ratio of cash to current liabilities. 3 Analysis Basic Accounting System Design Implementation 4 Objectives of Internal Control To provide reasonable assurance that: 1. assets are safeguarded and used for business purposes. 2. business information is accurate. 3. employees comply with laws and regulations. 5 Elements of Internal Control 1. 2. 3. 4. 5. Control environment Risk assessment Control procedures Monitoring Information and communication 6 1. Control environment Management philosophy and operating style influences the control environment. 7 2. Risk assessment Once risks are identified, they can be analyzed to estimate their significance, to assess their likelihood of occurring, and to determine actions that will minimize them. 8 3. Control Procedures - a Competent Personnel Rotating Duties Mandatory Vacations Separating Responsibilities for Related Operations Separating Operations, Custody of Assets, and Accounting Proofs and Security Measures 9 3. Control Procedures - b Otherwise,Responsibilities the following Separating for Related abuses areOperations possible: 1. Orders may be placed on the basis of friendship with a supplier, rather than on price, quality, and other objective factors. 2. The quantity and quality of supplies received may not be verified, thus causing payment for supplies not received or poor-quality supplies. 3. Supplies may be stolen by the employee. 4. The validity and accuracy of invoices may be verified carelessly. 10 3. Control Procedures - c Competent Personnel Rotating Duties Mandatory Vacations Separating Responsibilities for Related Operations Separating Operations, Custody of Assets, and Accounting Proofs and Security Measures 11 3. Control Procedures - d Custody of Assets Independent check Independent check Operations Accounting Independent check 12 Clues to Potential Problems Warning signs with regard to people: 1. Abrupt changes in lifestyle. 2. Close social relationships with suppliers. 3. Refusing to take a vacation. 4. Frequent borrowing from other employees. 5. Excessive use of alcohol or drugs. 13 Clues to Potential Problems Warning signs from the accounting system: 1. Missing documents or gaps in transaction numbers. 2. An unusual increase in customer refunds. 3. Differences between daily cash receipts and bank deposits. 4. Sudden increase in slow payments. 5. Backlog in recording transactions. 14 Control Over Cash Receipts Many companies need several cash accounts to account for different cash categories and funds. Most companies have multiple bank accounts. The title for each bank account should be: Cash in Bank—(Name of Bank) Preventive controls protect cash from theft and misuse of cash. Detective controls are designed to detect theft or misuse of cash and are also preventive in nature. 15 Retailers’ Sources of Cash Cash Receipts CASHIER’S DEPARTMENT Register records ACCOUNTING DEPARTMENT Remittance advices Mail Receipts 16 Retailers’ Sources of Cash CASHIER’S DEPARTMENT ACCOUNTING DEPARTMENT 1 Deposit ticket Deposit receipt Bank 17 Controlling Cash Received from Cash Sales 19 Cash 3 142 00 Cash Short and Over Sales 8 00 3 150 00 To record cash sales and actual cash on hand. Cash sales for March 19 totaled $3,150.00 per the cash register tape. After removing the change fund, only $3,142.00 was on hand. 18 Controlling Cash Received in the Mail Most companies’ invoices are designed so that customers return a portion of the invoice, call a remittance advice. 19 Controlling Cash Received in the Mail 1. The employee who opens the mail should initially compare the amount received with the amount on the remittance advice. 2. The employee opening the mail stamps checks and money orders “For Deposit Only” in the bank account of the business. 3. All cash is sent to the Cashier’s Department where checks and money orders are combined with receipts from cash sales and a bank deposit ticket is prepared. 20 Controlling Cash Received in the Mail 4. The remittance advices and their summary totals are delivered to the Accounting Department where a clerk prepares the records of the transactions and posts them to the customer account. 5. The stamped duplicate copy of the deposit ticket is returned to the Accounting Department where a clerk compares the receipt with the total amount that should have been deposited. 21 Internal Control of Cash Payments 1. Cash controls must provide assurance that payments are made for only authorized transactions. 2. Cash controls should ensure that cash is used efficiently. 3. A voucher system provides assurance that what is being paid for was properly ordered, received, and billed by the supplier. 22 A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. Basic Features of the Voucher System 23 Basic Features of the Voucher System A voucher system normally uses vouchers. The system normally has a file for unpaid vouchers and a file for paid vouchers. Usually prepared by the Accounting Department after all necessary supporting documents are received (purchase order, supplier’s invoice, and a receiving report). In preparing the voucher, the accounts payable clerk verifies the quantity, price, and mathematical accuracy of the supporting documents and files the paid voucher. 24 Bank Accounts: Their Nature and Use as a Control Over Cash A bank reconciliation is a listing of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger. A summary received from the bank of all account transaction is called a statement of account. 25 Reasons for Differences Between Depositor’s Records and the Bank Statement Outstanding checks Deposits in transit Service charges Collections Not-sufficient-funds (NSF) checks Errors 26 Steps in a Bank Reconciliation 1. Compare each deposit listed on the bank statement with unrecorded deposits appearing on the preceding period’s reconciliation and with deposit receipts. Add deposits not recorded by the bank to the balance according to the bank statement. 2. Compare paid checks with outstanding checks appearing on the preceding period’s reconciliation and with recorded checks. Deduct checks outstanding that have been paid by the bank from the balance according to the bank statement. 27 Steps in a Bank Reconciliation 3. Compare bank credit memorandums to entries in the journal. Add credit memorandums that have not been recorded to the balance according to the depositor’s records. 4. Compare bank debit memorandums to entries recording cash payments. Deduct debit memorandums that have not been recorded from the balance according to the depositor’s records. 5. List any errors discovered during the preceding steps.28 BANK Bank’s books Beginning balance $3,359.78 Depositor’s records Beginning balance $2,549.99 Power Network prepares to reconcile the monthly bank statement as of July 31, 2006 29 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 Depositor’s records Beginning balance $2,549.99 816.20 $4,175.98 A deposit of $816.20 did not appear on the bank statement. 30 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Depositor’s records Beginning balance Add note and interest collected by bank $2,549.99 408.00 $2,957.99 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking 31 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Depositor’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 deposit of $637.02 did not appear ThreeAchecks that were written during the on appear the bankon statement. period did not the bank statement: #812, $1,061; #878, $435.39, #883, $48.60. 32 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Depositor’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check returned because of insufficient funds $300.00 The bank returned an NSF check from one of the firm’s customers, Thomas Ivey, in the amount of $300. This was a payment on account. 33 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Depositor’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 The bank service charges totaled $18.00. 34 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Depositor’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327.00 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26. 35 BANK Bank’s books Beginning balance Add deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Adjusted balance $2,630.99 Depositor’s records Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327 Adjusted balance $2,630.99 36 Now, if desired, we can prepare a formal statement for Power Networking. 37 Power Networking Bank Reconciliation July 31, 2006 Balance per bank statement Add: Deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct: Outstanding checks No. 812 No. 878 No. 883 Adjusted balance $1,061.00 435.39 48.60 Balance per depositor’s records Add: Note and interest collected by bank Deduct: NSF check (Thomas Ivey) returned Bank service charges Error in recording Check No. 879 Adjusted balance 1,544.99 $2,630.99 $2,549.99 408.00 $2,957.99 $300.00 18.00 9.00 327.00 $2,630.99 38 Journal entries must be prepared for those items that affected the depositor’s side of the reconciliation. 39 Power Networking Bank Reconciliation July 31, 2006 Balance per bank statement Add: Deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct: Outstanding checks No. 812 No. 878 No. 883 Adjusted balance $1,061.00 435.39 48.60 Balance per depositor’s records Add: Note and interest collected by bank Deduct: NSF check (Thomas Ivey) returned Bank service charges Error in recording Check No. 879 Adjusted balance 1,544.99 $2,630.99 $2,549.99 408.00 $2,957.99 $300.00 18.00 9.00 327.00 $2,630.99 40 Entries Related to a Bank Reconciliation July 31 Cash Notes Receivable Interest Receivable Note collected by bank. 408 00 400 00 8 00 41 Power Networking Bank Reconciliation July 31, 2006 Balance per bank statement Add: Deposit not recorded by bank $3,359.78 816.20 $4,175.98 Deduct: Outstanding checks No. 812 No. 878 No. 883 Adjusted balance $1,061.00 435.39 48.60 Balance per depositor’s records Add: Note and interest collected by bank Deduct: NSF check (Thomas Ivey) returned Bank service charges Error in recording Check No. 879 Adjusted balance 1,544.99 $2,630.99 $2,549.99 408.00 $2,957.99 $300.00 18.00 9.00 327.00 $2,630.99 42 Entries Related to a Bank Reconciliation July 31 Cash 408 00 Notes Receivable 400 00 Interest Receivable Note collected by bank. 30 Accounts Receivable—Thomas Ivey Miscellaneous Administrative Exp. Accounts Payable—Taylor Co. Cash NSF check, bank service charges, and error in recording Check no. 879. 8 00 300 00 18 00 9 00 327 00 43 Petty Cash 44 On August 1, issued Check No. 511 for $100 to established a petty cash fund. Aug. 1 Petty Cash Cash 100 00 100 00 Established petty cash fund. 45 At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, $28, postage (office supplies), $22; store supplies, $35, and miscellaneous administrative items, $3. Aug. 31 Office Supplies Store Supplies Miscellaneous Administrative Exp. Cash Replenished petty cash fund. 50 00 35 00 3 00 88 00 46 Financial Analysis and Interpretation Solvency is the ability of a business to meet its financial obligations (debts) as they are due. Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities. This ability is normally assessed by examining balance sheet relationships. 47 Financial Analysis and Interpretation Doomsday Ratio Laettner Co. Oakley Co. A. Cash and equivalents B. Current liabilities Doomsday ratio A / B $100,000 $ 120,000 400,000 1,500,000 0.25 0.08 Use: To indicate thethese company’s ability to How are ratios used? meet creditors obligations in the worst case assumption that should the business cease to exist. THE END 48