ACG 2021ACG 2021Financial AccountingFinancial Accounting

Internal Control and Cash

Learning ObjectivesLearning Objectives

• Understand Internal Control

• Use a bank reconciliation as a control device

• Account for Petty Cash

• Use a budget to manage cash

Internal ControlInternal Control

Internal control is an organizational planplan and related measures that an entity adopts to reach various GoalsGoals:

– Safeguard assets– Encourage adherence to company policies– Promote operational efficiency– Ensure accurate and reliable accounting

records

Failures of Internal ControlFailures of Internal Control

• Enron• WorldCom• Others• Led to Congress Passing Sarbanes-

Oxley Act– Address Public Concerns over failed

• Audits of Public Companies• Internal Controls at Public Companies

Bank Accounts as ControlsBank Accounts as Controls

• All cash should be deposited into a bank account daily.

• To draw money from the account, a check is written

• Three parties to a check:– maker – signs the check– payee – to whom the check is written– bank – on which the check is drawn

• Remittance advice is an optional attachment that gives the reason for the payment.

Cash Control DefinitionsCash Control Definitions

• Monthly bank statements are sent to the account holder and should be reconciled.– to check (a financial account) against another for

accuracy (Webster Online Dictionary)

• Electronic fund transfer (EFT) is the electronic transfer of cash. No check is written.– Payments on behalf of account holder.– Deposits made from customers to account holder.

• Bank statements include both physical checks and EFT payments as well as other transactions on the account.

Bank ReconciliationBank Reconciliation

• Comparison of:– Two independently maintained records of a business’s cash

• The company’s Cash account (T-Account, the book balance)• The bank statement

• Differences between the two records generally arise because of timing differences.– Deposits were made but after the bank statement was

printed and mailed.– Checks were written but have not cleared the bank when the

bank statement was printed mailed.

• Reconciliations ensure that the two records agree.

Bank ReconciliationBank Reconciliation

Items for reconciliation:

• Items RECORDED by the company but not yet recorded by the bank:– Deposits in transit– Outstanding checks

Bank ReconciliationBank Reconciliation

Items for reconciliation:• Items recorded by the bank BUT NOT YET recorded

by the company. – Bank collections

• deposits received directly by the bank from customers– Electronic funds transfers

• Both payments and deposits– Service charges and the cost of printed checks– Interest revenue earned on checking account– Nonsufficient funds (NSF) checks

• These are checks deposited from a business’ customers that don’t have sufficient funds

– So they ‘bounce’

• Errors by the company or the bank

Bank ReconciliationBank Reconciliation

• The adjusted bank balance must equal the adjusted books balance– Book Balance = Ending Cash Account

• This is how we ensure Control over Cash

Reconciling ItemsReconciling Items

Bank Balance• Add deposits in transit• Subtract outstanding

checks• Add or subtract

corrections of bank errors, as appropriate

Book Balance• Add bank collection

items, interest revenue, and EFT receipts

• Subtract service charges, NSF checks, and EFT payments

• Add or subtract corrections of book errors, as appropriate.

Bank ReconciliationBank Reconciliation

• Journal entries are only made for:– Adjustments to Book Balance

• Bank collection items, interest revenue, and EFT receipts

• Service charges, NSF checks, and EFT payments

• Errors made by the company– (bank errors do not require journal entries on the

company’s books).

Bank Reconciliation Bank Reconciliation IllustratedIllustrated

Business Research, Inc., shows a balance on its bank statement of $5,931.51 on January 31. The company Cash account has a balance of $3,294.21.

1. The January 30 deposit of $1,591.63 does not appear on the bank statement.

2. The bank erroneously charged to the account a $100 check (No. 656) written by Business Research Associates.

3. Five company checks, totaling $1,350.14, issued late in January and recorded in the journal have not been paid by the bank.

4. The bank received $904.03 by EFT on behalf of Business Research, Inc.

5. The bank collected on behalf of the company a note receivable, $2,114 (including interest revenue of $214).

6. The bank statement shows interest revenue of $28.01.

Bank Reconciliation Bank Reconciliation IllustratedIllustrated

7. Check number 333 for $150 paid to Brown Company on account was recorded as a cash payment of $510.

8. The bank service charge for the month was $14.25.9. The bank statement shows an NSF check for $52.10. Business Research pays insurance expense by EFT and

has not recorded this $361 payment.

Bank ReconciliationBank ReconciliationBusiness Research, Inc.

Bank Reconciliation January 31, 20X6

Bank Balance, January 31 $5,931.51 Add: 1. Deposit of January 30 in transit 1,591.63 2. Correction of bank error – Research Associates check 656 erroneously charged against company account 100.00 7,623.14 Less: Outstanding Checks No. 337 $286.00 No. 338 319.47 No. 339 83.00 No. 340 203.14 No. 341 458.53 (1,350.14) Adjusted bank balance $6,273.00

Books Balance, January 31 $3,294.21 Add: 4. EFT receipt of rent revenue 904.03 5. Bank Collection of note receivable including interest revenue of $214 2,114.00 6. Interest revenue earned on bank balance 28.01 7. Correction of book error – overstated amount of check no. 333 360.00 6,700.25 Less: 8. Service charge $14.25 9. NSF check 52.00

10. EFT payment of insurance expense 361.00 (427.25) Adjusted book balance $6,273.00

Journal Entries from Journal Entries from ReconciliationReconciliation

(4) Cash 904.03Rent Revenue 904.03

Receipt of monthly rent

(5) Cash 2,114.00Notes Receivable 1,900.00

Note receivable collected by the bank

Interest Revenue 214.00

(6) Cash 28.01Interest Revenue 28.01

Interest earned on bank balance

Journal Entries from Journal Entries from ReconciliationReconciliation

(7) Cash 360.00Accounts Payable 360.00

Correction of check no. 333

(8) Miscellaneous Expense 14.25Cash 14.25

Bank Service Charge

(9) Accounts Receivable 52.00Cash 52.00

NSF customer check returned by bank

(10) Insurance Expense 361.00Cash 361.00

Payment of monthly insurance

ACG 2021ACG 2021Financial AccountingFinancial Accounting

Petty Cash

Cash Budgets, and

Cash on the Balance Sheet

Petty CashPetty Cash

• Petty cash fund is to pay for minor expenses.• Fund is opened with a particular amount of cash.• A custodian issues cash when needed and places all petty cash

tickets and receipts in the box with the remaining cash.• The sum of the remaining cash and petty cash tickets should equal

the amount established for the fund.• Petty cash is an example of an imprest fund.

• Beginning Cash + Added Cash – Receipts = Ending Cash

Added Cash

Petty Cash

Beg Bal Receipts

End Bal

Petty Cash Journal EntriesPetty Cash Journal Entries

Petty Cash 500.00Cash 500.00

To establish Petty Cash Fund

Postage Expense 70.00Office Supplies Expense 180.00Miscellaneous Expense 125.00

Cash 375.00To Reimburse the petty cash fund

Cash BudgetsCash Budgets

• Budget – a financial plan• Cash budget

– plans cash receipts and cash paymentsBeginning cashPlus: Expected ReceiptsLess: Expected PaymentsEquals: Expected Ending cash

• Allows mangers to know in advance whether they will likely need to borrow money.

Reporting Cash on the Reporting Cash on the Balance SheetBalance Sheet

• Cash and Cash Equivalents– liquid assets such as time deposits and certificates

of deposit

• Restricted cash must be disclosed separately.– Collateral– Other non-Operating uses

• Compensating balances are not included as cash.– Minimum cash balance required for loan

End of Chapter 4End of Chapter 4