ACCOUNTING
PRINCIPLES
SIXTH CANADIAN EDITION
Chapter 7
Internal Control and Cash
Prepared by:
Debbie Musil
Kwantlen Polytechnic University
Internal Control and Cash
• Internal control
– Fraud
– Internal controls and activities
– Limitations of internal control
• Cash controls
– Internal controls over cash receipts and
payments
• Using a bank
– Using and reconciling a bank account
• Reporting cash
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CHAPTER 7:
Internal Control and Cash
LEARNING OBJECTIVES:
1. Explain the activities that help prevent fraud and
achieve internal control.
2. Apply control activities to cash receipts.
3. Apply control activities to cash payments,
including petty cash.
4. Describe the control features of a bank account
and prepare a bank reconciliation.
5. Report cash on the balance sheet.
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Fraud
• An intentional dishonest act
• Results in personal financial benefit by:
– Misappropriating (stealing) assets, or
– Misstating financial statements
• Three factors that contribute to fraud:
– Opportunity to commit fraud
– Financial pressure
– Rationalization (justify their actions)
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Internal Control
• Related methods and measures that management
designs and implements to help achieve:
– Reliable financial reporting
– Effective and efficient operations
– Compliance with laws and regulations
• Effective internal control systems have five basic
components:
–
–
–
–
–
Control environment
Risk assessment
Control activities
Information and communication
Monitoring
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Internal Control Systems
• Control environment
– Create a culture that values clear rules
and expects everyone to follow the rules
• Risk assessment
– Identify and analyze factors that create
risk, and determine how to manage
• Control activities
– Design policies and procedures to
address the risks faced by the company
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Internal Control Systems 2
• Information and communication
– Identify, collect and communicate
relevant information to appropriate
parties
• Monitoring
– Identifying and reporting problems to
appropriate levels where action can be
taken
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Control Activities
• Establishment of responsibility
– Make specific employees responsible for
specific tasks, including authorization
• Segregation of duties
– Duties are divided in a manner that
eliminates the ability to commit a fraud
and cover it up
• Documentation procedures
– Rules covering the handling and control
of documents (such as pre-numbering)
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Control Activities 2
• Physical and IT controls
– Over access to and use of assets and records
• Independent checks of performance
– Reviews of records and performance by
independent employees or external parties
• Human resource controls
– Bonding, rotation of duties, requiring vacations,
background checks
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Limitations of Internal
Control
• Reasonable assurance: cost of internal
control should not be more than expected
benefit
• Human element: fatigue, carelessness,
indifference, lack of training
• Collusion: two or more employees working
together to overcome segregation control
• Size of business: effective controls are
more difficult in smaller organizations
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CHAPTER 7:
Internal Control and Cash
LEARNING OBJECTIVES:
1. Explain the activities that help prevent fraud and
achieve internal control.
2. Apply control activities to cash receipts.
3. Apply control activities to cash payments,
including petty cash.
4. Describe the control features of a bank account
and prepare a bank reconciliation.
5. Report cash on the balance sheet.
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11
Cash Controls
• Effective control over cash is essential to:
– Safeguard cash
– Ensure the accuracy of accounting records
• Types of cash receipts:
–
–
–
–
Over-the-counter
Bank debit and credit card transactions
Mail-in receipts
Receipts via electronic funds transfer (EFT)
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Control Over Cash Receipts
• Responsibility:
– Only designated personnel are
authorized to handle cash receipts
• Segregation of duties:
– Different individuals receive and record
cash receipts, have custody of cash
• Documentation procedures:
– Use remittance advices, cash register
tapes, deposit slips
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Control Over Cash Receipts 2
• Physical controls:
– Store cash in safes and bank vaults
– Limit access
– Use cash registers
– Deposit cash daily
• Independent checks of performance:
– Daily cash counts and comparisons of
receipts
• Human resource controls:
– Bonding; require vacations
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Debit Card Transactions
• Sales using debit cards are considered
cash transactions
– Retailer receives cash directly into bank
account at some regular interval (e.g. daily)
– Proceeds received are net of transaction fees
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Bank Credit Card Transactions
• Sales using bank credit cards are also
considered cash transactions
– Retailer receives cash directly into bank
account
– Proceeds received are net of transaction fees
• Fees are generally higher than debit card fees
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Mail-in and Electronic
Receipts
• Mail-in receipts:
– Open mail in presence of two clerks
– Remittance slips sent to Accounting
independently of cash
• Electronic receipts:
– On-line banking: cash transferred from
customer’s bank account to company’s bank
account
– Company journalizes from its bank statement
– Pre-authorized payments: company initiates
payment and automatically journalizes
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CHAPTER 7:
Internal Control and Cash
LEARNING OBJECTIVES:
1. Explain the activities that help prevent fraud and
achieve internal control.
2. Apply control activities to cash receipts.
3. Apply control activities to cash payments,
including petty cash.
4. Describe the control features of a bank account
and prepare a bank reconciliation.
5. Report cash on the balance sheet.
Copyright John Wiley & Sons Canada, Ltd.
18
Control Over Cash Payments
• Made by cheque, EFT or petty cash
• Establish responsibility:
– Only designated individuals can sign cheques
• Segregation of duties:
– Different people approve and make payments
• Documentation procedures:
– Use pre-numbered cheques and account for
numerical continuity
– Supported by approved invoice or similar
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Control Over Cash
Payments 2
• Physical and IT controls:
– Secure blank cheques and restrict
access
– Print cheques electronically or use writer
• Independent checks of performance:
– Compare cheques to invoices
– Reconcile bank statement regularly
• Human resources:
– Hire bonded personnel
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Petty Cash Fund
• Used to pay small amounts
• To establish a petty cash fund:
– Appoint a custodian who is responsible for it
– Determine the appropriate size of the fund
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Petty Cash Fund 2
• Making payments from the fund:
– Usually limited in size and type of transaction
– Documented on a pre-numbered receipt
– No accounting entry when payment is made
• Replenishing the fund:
– Done when fund reaches some set minimum
– Custodian prepares a summary of payments,
supported by receipts and other documents
– Reviewed and approved independently
– Used as a basis for accounting entry
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Petty Cash Fund 3
• Cash shortage or overage
– Recognized when fund replenished
– Becomes an expense or revenue
• Fund can be increased (if not large enough) or
decreased (if too large) when replenished
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CHAPTER 7:
Internal Control and Cash
LEARNING OBJECTIVES:
1. Explain the activities that help prevent fraud and
achieve internal control.
2. Apply control activities to cash receipts.
3. Apply control activities to cash payments,
including petty cash.
4. Describe the control features of a bank account
and prepare a bank reconciliation.
5. Report cash on the balance sheet.
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Use of a Bank Account
• Strengthens internal controls over cash
– Minimizes the amount of cash on hand
– A clearing house for receipts and cheques
– Provides a double record of cash transactions
• Bank deposits and cheques
– Duplicate deposits slips are stamped by bank
– Cheques usually require two authorized
signatures
• Bank reconciliation compares bank’s
balance with company’s balance and
explains any differences
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Bank Statement
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Reconciling the Bank
Account
• Bank balance almost never agrees to
depositor’s balance
– Due to time lags and errors in recording
transactions
• The two balances must be reconciled
– Called preparing a bank reconciliation
– Done by an employee who has no
responsibilities related to cash
• Balance per books and per bank are both
reconciled to their adjusted (correct)
balance
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Reconciling Items per Bank
Balance per bank
+ Deposits in transit
– Deposits recorded by depositor that have
not been recorded by bank
- Outstanding cheques
– Cheques issued & recorded by company
that have not been presented to bank
± Bank errors
= Adjusted cash balance per bank
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Reconciling Items per Books
Balance per books
+ Credit memoranda
– Amounts credited to company by bank, such as
interest earned, EFT deposits, etc.
- Debit memoranda
– Charges levied by bank against depositor’s
account – service charges, NSF charges, etc.
± Company errors
= Adjusted cash balance per books
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Entries from Bank
Reconciliation
• Each reconciling item required to
calculate adjusted cash balance per
books must be journalized
– To ensure that these are accounted for
by company
• Each reconciling item required to
calculate adjusted cash balance per
bank is NOT journalized
– Will be recorded by bank when received
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CHAPTER 7:
Internal Control and Cash
LEARNING OBJECTIVES:
1. Explain the activities that help prevent fraud and
achieve internal control.
2. Apply control activities to cash receipts.
3. Apply control activities to cash payments,
including petty cash.
4. Describe the control features of a bank account
and prepare a bank reconciliation.
5. Report cash on the balance sheet.
Copyright John Wiley & Sons Canada, Ltd.
31
Reporting Cash
• Cash on the balance sheet includes:
– Coins, currency, cheques, money on deposit
– Bank debit and credit card transactions
– Cash equivalents: investments with a term of
three months or less that are easily sold
• Listed first on the balance sheet, as it is the
most liquid
• Bank overdrafts are reported as a liability
• Restricted cash is reported separately
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Copyright
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights
reserved. Reproduction or translation of this work beyond
that permitted by Access Copyright (the Canadian copyright
licensing agency) is unlawful. Requests for further
information should be addressed to the Permissions
Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and
not for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these files or programs or from the use
of the information contained herein.
Prepared by:
A. Davis, MSc, BComm, CA, CFE
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Canada, Ltd.
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