Chapter 7
Define internal control

Organizational plan and all the related measures to:
Safeguard
assets
Encourage
employees to
follow company
policies
Ensure accurate,
reliable
accounting
records
Promote
operational
efficiency
Copyright (c) 2009 Prentice Hall. All rights reserved.
3
Explain the Sarbanes-Oxley Act


Congress passed SOX after the Enron and
WorldCom scandals
Provisions include:
◦ Public companies must issue an internal control report
◦ Created Public Company Accounting Oversight Board
 Oversees work of auditors of public companies
◦ Accounting firms may not both audit and provide
consulting services to the same company
◦ Stiff penalties for violators
 20 – 25 years in prison
Copyright (c) 2009 Prentice Hall. All rights reserved.
5
List and describe the components of internal
control and control procedures
Monitoring of controls
 Information System
 Control procedures
 Control Environment
 Risk Assessment

MICER
Acronym to remember
five components
Copyright (c) 2009 Prentice Hall. All rights reserved.
7

Competent, reliable and ethical personnel
◦ Trained and supervised

Assignment of responsibilities
◦ Each employee has clearly defined responsibilities

Separation of duties
◦ Operations separate from accounting
◦ Custody of assets separate from accounting

Audits
◦ Accounting records should be examined regularly

Documents
◦ Invoices should be pre-numbered
Copyright (c) 2009 Prentice Hall. All rights reserved.
8

Electronic Devices
◦ Inventory sensors

Other controls
◦
◦
◦
◦
Alarms and security cameras
Loss-prevention specialists
Bonding employees
Mandatory vacations
Copyright (c) 2009 Prentice Hall. All rights reserved.
9
Explain control procedures unique to e-commerce

Risks
◦ Stolen credit card numbers and passwords
◦ Computer viruses and Trojans
◦ Phishing

Security measures
◦ Encryption
◦ Firewalls
Copyright (c) 2009 Prentice Hall. All rights reserved.
11

Collusion:
◦ Two or more employees work together to defraud the
company

Cost:
◦ The stricter the internal control, the greater the cost
Copyright (c) 2009 Prentice Hall. All rights reserved.
12
Apply internal controls to cash receipts





Receipt is issued for each transaction
Cash drawer opens when a transaction is
entered
At the end of a shift, manager proves cash by
comparing cash in drawer with machine’s record
of sales
At least once a day, cashier deposits cash in
bank
Register tape sent to accounting
department
Copyright (c) 2009 Prentice Hall. All rights reserved.
14


Beginning Balance
Add: Deposits
Less: Withdrawals
----------------------------------Ending Balance
Question: Does the Ending Balance equal what
we count out the balance to be?
◦ In case of the bank statement, we must first adjust the
bank statement to reflect
 Deposits in transit
 Outstanding Checks (ones that haven’t been cashed)
Copyright (c) 2009 Prentice Hall. All
rights reserved.
15





Key: Separate accounting records (posting the
credit to Accounts Receivable and other
accounts from posting the debit to cash)
Incoming mail opened by a mailroom employee
Customer checks sent to treasurer and cashier
deposits money in bank
Remittance advice sent to accounting for journal
entries
Controller compares records of
◦ The day’s bank deposit amount from treasurer
◦ The debit to Cash made by the accounting department
(which will have to tie to the credit to Accounts
Receivable)
Copyright (c) 2009 Prentice Hall. All rights reserved.
16
Apply internal controls to cash payments



Important internal control
Check provides record of payment
Must be signed by an authorized official who
reviews documents supporting the payment
◦ This separates the actual writing of the check from the
accounting records of it
Copyright (c) 2009 Prentice Hall. All rights reserved.
18
Document
Action
Purchase order
Company requests
goods from supplier
Invoice
Supplier sends
goods
(will be received by accounting department)
Receiving report
(will be initiated in shipping)
Check
Company receives
goods
Company pays for
goods
Copyright (c) 2009 Prentice Hall. All rights reserved.
19


The documents that record the transaction are
SEPARATED from the goods involved in the
transaction
Employees must collude to defraud the company
Copyright (c) 2009 Prentice Hall. All
rights reserved.
20
Describe ethical business issues related to
accounting




Analyzing right from wrong
Most companies have a code of ethics
Accountants held to higher standard
Ethical decision making
◦
◦
◦
◦
Define the situation
Specify alternatives
Identify consequences
Make the decision
Copyright (c) 2009 Prentice Hall. All rights reserved.
22


Do you think that Enron executives felt they had
“crossed the line” or did they look down one day to
discover they had finally stepped over it.
Favorite movie to watch for “ethics” is the
Rainmaker
◦ Ethics of purpose, ethics of procedure
◦ Ethics of purpose, no ethics of procedure (the end,
justifies the means)
◦ No ethics of purpose, ethics of procedure (harming
people but doing it within the law)
◦ No ethics of purpose and no ethics of procedure

As accountants, we are asked often to “lie with
numbers”
Copyright (c) 2009 Prentice Hall. All
rights reserved.
23
Demonstrate the use of a bank account as a
control device
Signature
card
Deposit
ticket
Bank
statement
Check
Bank
reconciliation
Copyright (c) 2009 Prentice Hall. All rights reserved.
25
Prepare a bank reconciliation and the related
journal entries

Cash account in
general ledger

Bank statement
Usually show different balances
Timing differences due to time lag in
recording transactions
A bank reconciliation is prepared to
explain these differences
Copyright (c) 2009 Prentice Hall. All rights reserved.
27

We have to FIRST figure out the correct balance
for cash in the bank account
◦ It is NOT the bank’s balance
 Does not show deposits in transit
 Does not show outstanding checks
◦ It is NOT the general ledger balance
 Does not show unrecorded deposits
 Does not show unrecorded withdrawals
 Service charges

Reconciling petty cash fund is easier
◦ we can count the balance in the drawer and reconcile to
it
Copyright (c) 2009 Prentice Hall. All
rights reserved.
28

See separate handouts
Copyright (c) 2009 Prentice Hall. All
rights reserved.
29
Explain and journalize petty cash transactions


Cash fund kept on hand to pay for small
expenditures
Controls needed: (Separate custody of asset from
accounting)
◦ Designate a custodian of petty cash fund
◦ Keep a specific amount of cash on hand
◦ All fund payments are supported with a petty cash ticket
which shows
 the amount taken out of the drawer,
 who took it, and
 reason for the withdrawal (so we know what account needs
to be debited)
]
Copyright (c) 2009 Prentice Hall. All rights reserved.
31



At ANY time, we can count the cash and the petty
cash tickets and these should total up to the
amount established for the petty cash fund
Key: It works like an inventory account
Beginning Balance
Add: Deposits (There are NONE)
Less: Withdrawals
----------------------------------Ending Balance (if this doesn’t count to the amount in the petty
cash drawer, we have “shrinkage” which we call “cash over & short”
Copyright (c) 2009 Prentice Hall. All
rights reserved.
32


Check written for designated amount and cashed
Journal entry:
General Journal
Page 8
Date
May
Account Titles and Description
1 Petty cash
PR
Dr.
Cr.
$$$
Cash
$$$
Copyright (c) 2009 Prentice Hall. All rights reserved.
33
A numbered ticket is prepared for each expenditure
Petty Cash Ticket No. 15
May 2, 2009
Date: _________________
Paid to: _______________
Foster’s Office Supply
For: ___________________
Office Supplies
$8.00
Amount: ________________
Sharon Kahl
Approved by: ___________
Carol Miller
Payment received by: ___________
Debit Account No.: _________
Supplies Expense – Account No. 615
Copyright (c) 2009 Prentice Hall. All rights reserved.
34
Petty Cash Ticket No. 15
Date: _________________
May 2, 2007
Paid to: _______________
Foster’s Office Supply
For: ___________________
Office Supplies
$8.00
Amount: ________________
Sharon Kahl
Approved by: ____________
Carol Miller
Payment received by: _____________
Debit Account No.: _________
615
Copyright (c) 2009 Prentice Hall. All rights reserved.
35


Maintaining petty cash at its designated balance
Money in petty cash plus the receipts should
always equal designated balance
Petty
cash
balance
Copyright (c) 2009 Prentice Hall. All rights reserved.
36


Total amounts on petty cash tickets
Add to cash remaining in fund
◦ Should equal petty cash fund balance
◦ If it doesn’t, missing amount is Cash short and over



Journal entry prepared to record expenditures
A new check is cashed to replenish fund to its
original balance
Cash is placed in petty cash box
Copyright (c) 2009 Prentice Hall. All rights reserved.
37



Account used whenever a cash fund is short or
over
May have either a debit or credit balance
Reported as expense or revenue depending on
ending balance
Copyright (c) 2009 Prentice Hall. All rights reserved.
38
General Journal
Page 8
Date
Account Titles and Description
Aug 31 Office supplies
Delivery expense
Cash short & over
Cash
PR
Dr.
Cr.
60
30
8
82
Replenish petty cash fund
Copyright (c) 2009 Prentice Hall. All rights reserved.
39


The check we write for $82 is written for “cash”
which we cash at the bank and then put the $82
cash in the petty cash drawer.
The check will carry a “memo” line “to replenish
petty cash”
Copyright (c) 2009 Prentice Hall. All
rights reserved.
40
#1
The imprest system requires that the petty cash box
contains cash and receipts that total the amount of the
imprest balance. This clearly identifies the amount of
cash for which the custodian is responsible, and that is
the system’s main internal control feature.
General Journal
#2
Date
Account Titles and Description PR
Dec 1 Petty cash
Cash
Dr.
Cr.
$150
$150
Copyright (c) 2009 Prentice Hall. All rights reserved.
41
General Journal
Date
Account Titles and Description
Dec 31 Office supplies
PR
Dr.
Cr.
111
Delivery expense
30
Cash
136
Cash short & over
Copyright (c) 2009 Prentice Hall. All rights reserved.
5
42