CHAPTER SEVEN

ACCOUNTING FOR CASH

CASH

• Includes:– Currency, coins, and checking accounts– Checks received from customers– Money orders – Bank cashier’s checks

• Because cash plays such a central role in operating a business, it must be carefully managed and controlled.

INTERNAL CONTROL

• A set of procedures designed to:

–Safeguard an organization’s assets from• Employee theft, robbery, unauthorized use

–Enhance the accuracy and reliability of accounting records by reducing

• Risk of errors and irregularities

PRINCIPLES OF INTERNAL CONTROL

Establishment of responsibility: 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

5

Documentation procedures: Documents provide evidence that

transactions and events have occurred

PRINCIPLES OF INTERNAL CONTROL

PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS

Independent Internal VerificationIndependent Internal Verification

8

• Bonding of employees who handle cash

• Rotating employee’s duties and requiring employees to take vacations

Independent Internal VerificationIndependent Internal Verification

9

Limitations of Internal Controls

• Cost/Benefit - cost of establishing procedure should not exceed expected benefit

• Human element - fatigue, carelessness, indifference

• Collusion - two or more individuals who work together to get around controls

• Size of business

INTERNAL CONTROL

• Other Good internal control for cash transactions:

– All cash received should be deposited DAILY in a bank.

– All disbursements, except for payments from petty cash, should be made by CHECK.

MAKING DEPOSITS

• Deposit Ticket is a form showing– A detailed listing of items being deposited– Currency, coins, and checks are listed separately.– Each check should be identified by its ABA

number.• American Bankers Association number

• Found in upper right hand corner of check

• Also shown in MICR code on the lower left side of front of each check

• ABA number is used to sort and route checks.

MAKING DEPOSITS

• Endorsements--each check being deposited must be endorsed by the depositor.– Blank endorsement--the depositor simply signs

the back of the check.• Check becomes payable to any bearer.

– Restrictive endorsement--depositor adds words such as “For deposit,” “Pay to any bank,” or “Pay to Mary Adams only.”

WRITING CHECKS

• Check is a document ordering a bank to pay cash from a depositor’s account.

• Three parties to every check:– Drawer--the depositor who orders the bank to

pay the cash – Drawee--the bank on which the check is drawn– Payee--the person being paid the cash

• Business checks often have a check stub.

BANK STATEMENT

• Includes:– The balance at the BEGINNING of the period– Deposits and other amounts ADDED during the

period– Checks and other amounts SUBTRACTED

during the period– The balance at the END of the period

BANK STATEMENT

• Sent with bank statement– Canceled checks, “imaged” sheets of check

faces, or a listing of checks– Any other forms representing items added to or

subtracted from the account

EXAMPLE

Bank statement shows a balance of $4,350. But the general ledger account has a balance of $3,800. We need to prepare a

BANK RECONCILIATION.

Mary Adams Consulting Bank Reconciliation

October 31, 2009

Heading includes:Name of Company

Bank ReconciliationDate

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Reconciliation begins with balance according to the

bank statement.

$4,350

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Reconciling items are listedas additions or subtractions

from the bank balance.

$4,350Add:

Deduct:

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Once all reconciling itemsare listed, the

“Adjusted Bank Balance” is computed.

$4,350Add:

Deduct:

Adjusted Bank Balance

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Now the reconciliation turns to adjusting the BOOK balance.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31 $3,800

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Additions and subtractions will be made to the

book balance.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

“Adjusted book balance” is computed.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted Book Balance

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

We say it is “reconciled” when the Adjusted BANK and Adjusted BOOK

balances agree.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted Book Balance

REASONS FOR DIFFERENCES

• Outstanding checks– Checks that have not been presented to the bank

for payment

• Deposits in transit– Deposits that have not reached the bank or been

recorded by the bank before the statement is prepared

• Service charges– E.g., check printing and processing, account fees

REASONS continued

• Collections– Made by the bank on behalf of the depositor

• Not sufficient funds (NSF) checks– Checks deposited but not paid because drawer

did not have sufficient funds

• Errors– Made by bank or by the depositor in recording

cash transactions

BANK RECONCILIATION

THREE STEPS:

STEP #1

Identify deposits in transit and related errors.Compare bank statement with:Last month’s deposits in transit

• They should all be on the bank statement.Deposits listed in the accounting records

•If not found on the bank statement, the deposit is considered a deposit in transit.

$ amounts for deposits in the accounting records

•If they differ, the error needs to be corrected.

STEP #1 EXAMPLE

A deposit in the accounting records of $635, dated October 31, had not been received by the bank.

DEPOSITIN

TRANSIT

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

DEPOSITS IN TRANSIT areadded to the bank balance.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

STEP #2

Identify outstanding checks and related errors.Compare canceled checks with bank statement and accounting records:• If they differ, error needs to be corrected.

STEP #2 EXAMPLE

Check # 862 payable to XYZ Telephone Company was written for $46.25 but was entered on the check stub and on the books as $64.25.

$18.00 ERROR

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

$18.00 is added back tothe book balance.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

STEP #2

Identify outstanding checks and related errors.Compare canceled checks with bank statement and accounting records:

Check mark the stub or accounting records to indicate check has cleared. Checks written but not cleared are OUTSTANDING CHECKS.

•Subtracted from the bank balance on the reconciliation

If they differ, the error needs to be corrected.

STEP #2 EXAMPLE

Check numbers 890, 892, and 893 do not appear on the bank statement.

OUTSTANDINGCHECKS

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31

Outstanding checksare deducted fromthe bank balance.

$4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

STEP #3

Identify additional reconciling items.Compare any additions and deductions on the bank statement that are not deposits or checks with the accounting records.Items ADDED to the account by the bank are CREDIT MEMOS.Items DEDUCTED from the account by the bank are DEBIT MEMOS.

STEP #3 EXAMPLE

Mary used an ATM machine to make a withdrawal from her account of $200 for personal use. However, she forgot to record this withdrawal on the books.

Deduct $200from the

book balance.

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200

STEP #3 EXAMPLE

The bank returned an NSF check of $350 written by one of Mary’s clients.

Deduct $350from the

book balance.

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200NSF check 350

STEP #3 EXAMPLE

The bank deducted $10 from Mary’s account for service charges.

Deduct $10from the

book balance.

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200NSF check 350Bank service charge 10

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200NSF check 350Bank service charge 10

The Bank section of thereconciliation is totaled.

$4,985

$3,258

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200NSF check 350Bank service charge 10

Then the Booksection is totaled.

$4,985

$3,258

$3,818

$560$3,258

EXAMPLE

We now know that the actual amount of cash is $3,258. But the General Ledger Cash account still shows $3,800.

JOURNAL ENTRIESNEEDED

BANK RECONCILIATIONJOURNAL ENTRIES

• Only two kinds of items appearing on a bank reconciliation require journal entries:– Errors in the books– Bank additions and deductions that do not

already appear in the accounting records

• ALL items in the BOOK section of the reconciliation

Mary Adams Consulting Bank Reconciliation

October 31, 2009Bank statement balance, October 31 $4,350Add:

Deduct:

Adjusted Bank BalanceBook balance, October 31Add:

Deduct:

$3,800

Adjusted book balance

Deposit in transit $635

Error on check #862 18

Outstanding checksNo. 890No. 892No. 893

$598334795 1,727

Unrecorded ATM withdrawal $200NSF check 350Bank service charge 10

These 4 items will require journal entries.

$4,985

$3,258

$3,818

$560$3,258

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash1

2

3

4

5

6

7

8

9

10

11

When check #862 was written, the Cash account was credited for $18.00 more

than the check amount of $46.25.

This entry puts $18.00 backin the Cash account.

18 00Oct. 31

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash1

2

3

4

5

6

7

8

9

10

11

Telephone Expense

18 00

18 00

Error on Check #862

Oct. 31

Telephone Expense was originallydebited for $64.25. This was $18.00 more than the actual telephone bill of $46.25.

This entry removes the extra $18.00.

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash1

2

3

4

5

6

7

8

9

10

11

Since the ATM withdrawal wasfor “personal expenses,”

Drawing should be debited.

Telephone Expense

18 00

18 00Error on Check #862

M.A., Drawing 200 00

Oct. 31

31

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash1

2

3

4

5

6

7

8

9

10

11

The $200 withdrawal was never recorded.

This entry will remove the $200 from the Cash account.

Telephone Expense

18 00

18 00Error on Check #862

M.A., Drawing 200 00

Oct. 31

31

Cash 200 00

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash1

2

3

4

5

6

7

8

9

10

11

Telephone Expense

18 00

18 00Error on Check #862

M.A., Drawing 200 00

Oct. 31

31

Cash 200 00Unrecorded ATM withdrawal

GENERAL JOURNAL cont.

DATE DESCRIPTION PR DEBIT CREDIT

Accounts Receivable10

11

12

13

14

15

16

17

18

19

20

Cash

350 00

350 00NSF check

31

The amount of the bounced checkis placed into Accounts Receivable

and Cash is reduced.

GENERAL JOURNAL cont.

DATE DESCRIPTION PR DEBIT CREDIT

Accounts Receivable10

11

12

13

14

15

16

17

18

19

20

Cash

350 00

350 00NSF check

Miscellaneous Expense 10 00

31

31

Cash 10 00Bank service charge

Service charges are usually small.Often they are put into Misc. Expense.

PETTY CASH

• A fund set up to pay for small items with cash– Checks for very small amounts are cumbersome.

• To establish the fund:– Check is written to the petty cash custodian.– Check is cashed. – Money is placed into secure box/drawer.

• Custodian is the only person authorized to pay out petty cash.

EXAMPLE

Mary wants to establish a $50 Petty Cash fund to be used to make small purchases

CASH

$50 $50 is withdrawn (by check)from the Cash account.

EXAMPLE

Mary wants to establish a $50 Petty Cash fund to be used to make small purchases.

CASH

$50

Petty Cash is an ASSET account.

$50

PETTY CASH

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Petty Cash1

2

3

4

5

6

7

8

9

10

11

50 00Nov. 15

Cash 50 00

Establish Petty Cash fund

PETTY CASH VOUCHER

• A receipt prepared for every payment from Petty Cash

• Voucher includes:– Name of Payee– Purpose and amount of payment– Account to be charged (e.g., Postage Expense)– Signature of custodian and payee

PETTY CASH PAYMENTS RECORD

• Multi-column record that supplements the regular accounting records

• Provides record of each Petty Cash payment– Broken down by account

• E.g.: Travel/Entertainment Expense, Postage Exp., etc.

– Used to prepare Replenishment journal entry

REPLENISHING PETTY CASH

• Fund is replenished:– When funds run low, and– End of each accounting period

• Journal Entry is made:– Debiting the accounts charged (e.g., Postage

Expense)– Crediting Cash for amount needed to replenish

the fund – Petty Cash account is not debited or credited.

EXAMPLEAfter two weeks, Mary notices it contains the following vouchers and only $5.65 cash:

Voucher # 1 $15.00 for expenses incurred while on a business trip (Travel/Entertainment Expense)

Voucher # 2 $11.45 for express mailing a report to a client (Postage Expense)

Voucher # 3 $17.90 for oil change on company van (Vehicle Maintenance Expense)

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

1

2

3

4

5

6

7

8

9

10

11

15 00Nov. 30

11 45

Travel/Entertainment Exp.

Postage ExpenseVehicle Maintenance Exp. 17 90

Cash 44 35

Cash should be credited for the amount needed to restore the fund to its established amount.

$50.00 fund - $5.65 in box = $44.35 needed

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

1

2

3

4

5

6

7

8

9

10

11

15 00Nov. 30

11 45

Travel/Entertainment Exp.

Postage ExpenseVehicle Maintenance Exp. 17 90

Cash 44 35

Journal Entry balances!!!Vouchers (amounts debited)

equal the amount needed to

replenish the box (credit).

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

1

2

3

4

5

6

7

8

9

10

11

15 00Nov. 30

11 45

Travel/Entertainment Exp.

Postage ExpenseVehicle Maintenance Exp. 17 90

Cash 44 35

Replenishment of PC fund

CASH BUDGETING

Cash receipts section includes expected receipts from the company’s principal sources of revenue

Cash disbursements section includes expected payments for direct materials, direct labor, etc.

Financing section shows expected borrowings and their repayment