Financial Accounting, 3e
Weygandt, Kieso, & Kimmel
Prepared by
Gregory K. Lowry
Mercer University
Marianne Bradford
The University of Tennessee
John Wiley & Sons, Inc.
CHAPTER 8
INTERNAL CONTROL AND CASH
After studying this chapter, you should be able to:
1 Define internal control.
2 Identify the principles of internal control.
3 Explain the applications of internal control principles to
cash receipts.
4 Describe the applications of internal control principles
to cash disbursements.
5 Explain the operation of a petty cash fund.
6 Indicate the control features of a bank account.
7 Prepare a bank reconciliation.
8 Explain the reporting of cash.
PREVIEW OF CHAPTER 8
INTERNAL CONTROL
AND CASH
Internal Control

Principles

Limitations
Cash Controls


Control over cash
receipts
Control over cash
disbursements
Use of a Bank

Making deposits

Writing checks

Bank statements

Reconciling the
bank account
Reporting Cash
INTERNAL CONTROL
Internal control consists of the plan of
organization and all the related methods
and measures adopted within a business
in order to:
1 safeguard its assets and
2 enhance the accuracy
and reliability of its
accounting records.
ILLUSTRATION 8-1
PRINCIPLES OF INTERNAL CONTROL
 Establishment of
responsibility
 Segregation of duties
 Documentation
procedures
 Physical, mechanical,
and electronic controls
 Independent internal
verification
 Other controls
PRINCIPLES OF
INTERNAL CONTROL
 Establishment of responsibility: control is
most effective when only one person is
responsible for a given task.
 Segregation of duties: the work of one
employee should provide a reliable
basis for evaluating the work of
another employee.
 Documentation procedures: documents
should provide evidence that transactions and
events have occurred.
PRINCIPLES OF
INTERNAL CONTROL
 Physical, mechanical, and electronic controls:
relate primarily to the safeguarding of assets
and enhancing accuracy and reliability of the
accounting records.
 Independent internal verification: the
review, comparison, and reconciliation
of information from two sources.
 Other controls: bonding of employees who
handle cash, rotating employee’s duties, and
requiring employees to take vacations.
ILLUSTRATION 8-2
PHYSICAL CONTROLS
 Safes, vaults, and safety deposit boxes for
cash and business papers
 Locked warehouses and storage cabinets
for inventories and records
 Computer facilities with pass key access
ILLUSTRATION 8-2
MECHANICAL AND ELECTRONIC
CONTROLS
 Alarms to prevent break-ins
 Television monitors and garment sensors
to deter theft
 Time clocks for recording time worked
INDEPENDENT INTERNAL
VERIFICATION
To obtain maximum benefit from independent
internal verification:
1 The verification should be made
periodically or on a surprise basis.
2 The verification should be done by an
employee who is independent of the
personnel responsible for the information.
3 Discrepancies and exceptions should be
reported to a management level that can
take appropriate corrective action.
INDEPENDENT INTERNAL
VERIFICATION
 Independent internal verification is often
assigned to internal auditors.
 Internal auditors evaluate the effectiveness
of the company’s system of internal
control on a continuous basis.
 Internal auditing is a professional activity
within a company, often
with direct access to
the board of directors.
ILLUSTRATION 8-3
COMPARISON OF SEGREGATION OF DUTIES PRINCIPLE
WITH INDEPENDENT INTERNAL VERIFICATION PRINCIPLE
Segregation
of Duties
Assistant Cashier B
Accounting Employee A
Maintains cash balances
per books
Maintains custody of
cash on hand
Makes monthly comparisons: reports any unreconcilable differences to treasurer
Independent Internal Verification
Assistant Treasurer A
LIMITATIONS OF
INTERNAL CONTROL
 Costs of establishing control procedures
should not exceed their expected benefits
according to the concept of reasonable
assurance.
 The human element is also an important factor
in every system of internal control. A good system
can become ineffective through employee fatigue,
carelessness, or indifference.
 Collusion may result when two or more
individuals work together to get around
prescribed controls and may significantly
impair the effectiveness of a system.
CASH
 Cash includes coins, currency,
checks, money orders, and money on
hand or on deposit at a bank or
similar depository.
 Internal control over cash is
imperative in order to
safeguard cash and assure
the accuracy of the
accounting records for cash.
INTERNAL CONTROL
OVER CASH RECEIPTS
 Only designated personnel should be
authorized to handle or have access to cash
receipts.
 Different individuals should:
1 receive cash
2 record cash receipt transactions
3 have custody of cash
INTERNAL CONTROL
OVER CASH RECEIPTS
 Documents should include:
1 remittance advices
2 cash register tapes
3 deposit slips
 Cash should be stored in safes and bank vaults
 Access to storage areas should be limited to
authorized personnel
 Cash registers should be used in executing
over-the-counter receipts
INTERNAL CONTROL
OVER CASH RECEIPTS
 Daily cash counts and daily comparisons
of total receipts.
 All personnel who handle cash
receipts should be bonded and
required to take vacations.
 Control of over-the-counter
receipts is centered on cash
registers that are visible to customers.
INTERNAL CONTROL OVER
CASH DISBURSEMENTS
 Payments are made by check rather
than by cash, except for petty cash
transactions.
 Only specified individuals should
be authorized to sign checks.
 Different departments or individuals
should be assigned the duties of approving
an item for payment and paying it.
INTERNAL CONTROL OVER
CASH DISBURSEMENTS
 Prenumbered checks should be used and
each check should be supported by an
approved invoice or other
document.
 Blank checks should be stored
in a safe.
1 Access should be restricted to
authorized personnel.
2 A check writer machine should be used
to imprint the amount on the check in
indelible ink.
INTERNAL CONTROL OVER
CASH DISBURSEMENTS
 Each check should be compared with
the approved invoice before it is issued.
 Following payment, the approved
invoice should be stamped PAID.
ELECTRONIC
FUNDS TRANSFER
 Processing checks is expensive; therefore, new
methods are being developed to transfer funds
among parties without the use of paper.
 Electronic Funds Transfer (EFT)
is a disbursement system that uses
wire, telephone, telegraph, or
computer to send cash from one
location to another.
 Regular payments such as those for
house, car, and utilities are frequently
made by EFT.
PETTY CASH FUND
 A petty cash fund is used to pay relatively small
amounts.
 Operation of the fund, often called an imprest
system, involves:
1 establishing the fund,
2 making payments from the fund, and
3 replenishing the fund.
 Accounting entries are required when:
1 the fund is established,
2 the fund is replenished, and
3 the amount of the fund is changed.
ESTABLISHING THE FUND
 2 essential steps in establishing a petty
cash fund are
1 appointing a petty cash custodian who
will be responsible for the fund and
2 determining the size of the fund.
 Ordinarily, the amount is expected to
cover anticipated disbursements for a
3-week to 4-week period.
ESTABLISHING THE FUND
GENERAL JOURNAL
Date
Mar. 1
Account Titles and Explanation
Petty Cash
Cash
(To establish a petty cash fund)
Debit
Credit
100
100
Laird Company decides to establish a $100 fund on
March 1. When the fund is established, a check payable
to the petty cash custodian is issued for the stipulated
amount.
REPLENISHING THE FUND
 When the money in the petty cash fund
reaches a minimum level, the fund is
replenished.
 The request for reimbursement is initiated
by the petty cash custodian.
 The petty cash custodian prepares a
schedule of the payments that have been
made and sends the schedule, with
supporting documentation, to the
treasurer’s office.
REPLENISHING THE FUND
GENERAL JOURNAL
Date
Mar. 15
Account Titles and Explanation
Postage Expense
Freight-in
Miscellaneous Expense
Cash
(To replenish petty cash fund)
Debit Credit
44
38
5
87
On March 15 the petty cash custodian requests a check for
$87. The fund contains $13 cash and petty cash receipts for
postage $44, freight-in $38, and miscellaneous expenses, $5.
REPLENISHING THE FUND
GENERAL JOURNAL
Date
Mar. 15
Account Titles and Explanation
Postage Expense
Freight-in
Miscellaneous Expense
Cash Over and Short
Cash
(To replenish petty cash fund)
Debit Credit
44
38
5
1
88
On March 15 the petty cash custodian requests a check for
$88. The fund contains $12 cash and petty cash receipts for
postage $44, freight-in $38, and miscellaneous expenses, $5.
USE OF A BANK
 The use of a bank minimizes the amount of
currency that must be kept on hand and
contributes significantly to good internal
control over cash.
 A company can safeguard its cash by
using a bank as a depository and
clearing house for checks received
and checks written.
 New depositors are required to sign a
signature card when opening a checking account.
WRITING CHECKS
 A check is a written order signed by the
depositor directing the bank to pay a specified
sum of money to a designated recipient.
 Three parties to a check are:
1 Maker (drawer) issues the check
2 Bank (payer) on which check is drawn
3 Payee to whom check is payable
BANK STATEMENTS
W. A. LAIRD COMPANY
ACCOUNT
STATEMENT
A bank statement shows:
1 checks paid and other
debits charged against
the account
2 deposits and other
credits made to the
account
3 account balance after
each day’s transactions
Statement Date/Credit
77 WEST CENTRAL AVENUE
Line Closing Date
MIDLAND, MICHIGAN 48654
April 30, 1996
457923
ACCOUNT NUMBER
Deposits and Credits
Balance
Last Statement
No.
Total Amount
13,256.90
20
34,805.10
CHECKS AND DEBITS
Date No. Amount
Checks and Debits
Balance
Total Amount
This Statement
32,154.55
15,907.45
26
DEPOSITS AND
CREDITS
DAILY BALANCE
Date
Amount Date Amount
4-2
435
644.95
4-5
436 3,260.00
4-4
437 1,185.79
4-3
438
776.65
4-8
439 1,781.70
4-7
440 1,487.90
4-8
441 2,420.00
4-11
442 1,585.60
4-12
443 1,226.00
=================
4-29
NSF
425.60
4-29
459 1,080.30
4-30
DM
30.00
4-30
461
620.15
4-2
4,276.85
4-3
2,137.50
4-5
1,350.47
4-7
982.46
4-8
1,320.28
4-9 CM 1,036.00
4-11
2,720.00
4-12
757.41
4-13
1,218.56
==============
4-27
1,545.57
4-29
2,929.45
4-30
2,128.60
Symbols:
CM
Credit Memo
EC
Error Correction
NSF
DM
Debit Memo
INT
Interest Earned
SC
4-2
16,888.80
4-3
18,249.65
4-4
17,063.86
4-5
15,154.33
4-7
14,648.89
4-8
11,767.47
4-9
12,802.47
4-11
13,936.87
4-12
13,468.28
=============
4-27
13,005.45
4-29
14,429.00
4-30
15,907.45
Not Sufficient Funds
Service Charge
Reconcile Your
Account Promptly
MEMORANDA
 Bank debit memoranda indicate
charges against the depositor’s
account.
Example: ATM service charges
 Bank credit memoranda indicate
amounts that will increase the
depositor’s account.
Example: interest income on
account balance
RECONCILING THE
BANK ACCOUNT
 Reconciliation is necessary because
the balance per bank and balance per
books are seldom in agreement due
to time lags and errors.
 A bank reconciliation should be
prepared by an employee who
has no other responsibilities
pertaining to cash.
RECONCILING THE
BANK ACCOUNT
 Steps in preparing a bank reconciliation:
1 Determine deposits in transit
2 Determine outstanding checks
3 Note any errors discovered
4 Trace bank memoranda to the records
 Each reconciling item used in determining
the adjusted cash balance per books should
be recorded by the depositor
ILLUSTRATION 8-13
BANK RECONCILIATON
LAIRD COMPANY
Bank Reconciliation
April 30, 2001
Cash balance per bank statement
Add: Deposits in transit
Less: Outstanding checks
No. 453
No. 457
No. 460
Adjusted cash balance per bank
Adjusted cash balance per books
$ 15,907.45
2,201.40
18,108.85
The bank statement for
the Laird Company
shows a balance per
bank of $15,907.45 on
April 30, 2001.
Cash balance per books
Add: Collection of note receivable, $1,000 plus interest earned
$50, less collection fee $15
Error in recording check No. 443
Less: NSF check
Bank service charge
On this date the
balance of cash per
books is $11,589.45.
$ 3,000.00
1,401.30
1,502.70
5,904.00
$ 12,204.85
$ 12,204.85
$ 11,589.45
$ 1,035.00
36.00
425.60
30.00
1,071.00
12,660.45
455.60
ENTRIES FROM BANK
RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Cash
Miscellaneous Expense
Notes Receivable
Interest Revenue
(To record collection of notes
receivable by bank)
Debit Credit
1,035.00
15.00
1,000.00
50.00
Collection of Note Receivable This entry involves four
accounts. Interest of $50 has not been accrued and the
collection fee is charged to Miscellaneous Expense.
ENTRIES FROM BANK
RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Cash
Accounts Payable — Andrea
Company
(To correct error in recording
check No. 443)
Debit
Credit
36.00
36.00
Book Error An examination of the cash disbursements
journal shows that check No. 443 was a payment on
account to Andrea Company, a supplier. The check, with
a correct amount of $1,226.00, was recorded at $1,262.00.
ENTRIES FROM BANK
RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Accounts Receivable — J. R. Baron
Cash
(To record NSF check)
Debit Credit
425.60
425.60
NSF Check An NSF check becomes an
accounts receivable to the depositor.
ENTRIES FROM BANK
RECONCILIATION
GENERAL JOURNAL
Date
Apr. 30
Account Titles and Explanation
Miscellaneous Expense
Cash
(To record charge for printing
company checks)
Debit
Credit
30.00
30.00
Bank Service Charges Check printing charges (DM) and
other bank service charges (SC) are debited to Miscellaneous
Expense because they are usually nominal in amount.
REPORTING CASH
 Cash reported on the Balance Sheet
includes:
1 Cash on Hand
2 Cash in banks
3 Petty Cash
 Cash is listed first in the balance sheet
under the title cash and cash
equivalents because it is the most liquid
asset.
CASH EQUIVALENTS
 Cash equivalents are highly liquid
investments with maturities of 3
months or less when purchased
that can be converted into a
specific amount of cash.
 Examples include money market
funds, bank certificates of deposit,
and U.S. Treasury bills and notes.
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CHAPTER 8
INTERNAL CONTROL AND CASH