CHAPTER Cash and Internal Control Principles of Accounting 12e Needles Powers Crosson ©human/iStockphoto Concepts Underlying Internal Control  Inte rnal c o ntro l is the process that establishes the reliability of the accounting records and financial statements and ensures that the company’s assets are protected – Taking a phys ic al inve nto ry facilitates control over merchandise inventory  This process involves an actual count of all merchandise on hand  A physical inventory must be taken under both the periodic and perpetual inventory systems  Merchandisers usually take a physical inventory after the close of business on the last day of their fiscal year ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Components of Internal Control (slide of 2)  An effective system of internal control has five interrelated components – Co ntro l e nviro nme nt—created by management’s overall attitude, awareness, and actions It encompasses:     a company’s ethics, philosophy, and operating style organizational structure method of assigning authority and responsibility personnel policies and practices – Ris k as s e s s me nt—involves identifying areas in which risks of loss of assets or inaccuracies in accounting records are high ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Components of Internal Control (slide of 2) – Co ntro l ac tivitie s —the policies and procedures management puts in place to see that its directives are carried out – Info rmatio n and c o mmunic atio n—pertains to the way the accounting system gathers and treats information about the company’s transactions and how it communicates individual responsibilities within the system – Mo nito ring —management’s regular assessment of the quality of internal control, including periodic review of compliance with all policies and procedure ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Control Activities (slide of 2)  The goal of control activities is to safeguard a company’s assets and ensure the reliability of the accounting records Standard controls include: – Autho rizatio n—the approval of certain transactions and activities – Recording Transactions—To establish accountability for assets, all transactions should be recorded – Documents and records—Well-designed documents help ensure that transactions are properly recorded ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Control Activities (slide of 2) – Pe rio dic inde pe nde nt ve rific atio n—someone other than the people responsible for the accounting records and assets should periodically check the records against the assets – S e paratio n o f dutie s —no one person should authorize transactions, handle assets, and keep records of assets – Sound personnel practices—including adequate supervision; rotation of key people among different jobs; insistence that employees take vacations; and bonding of personnel who handle cash or inventory  Bo nding is the process of checking an employee’s background and insuring the company against theft by that person ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Internal Control and Achieving Control Objectives  A system of internal control for merchandising activities can achieve important objectives: – Prevent losses of cash and inventory – Ensure that records of transactions and account balances are accurate – Keep enough inventory on hand to sell to customers without overstocking merchandise – Keep sufficient cash on hand to pay for purchases in time to receive discounts – Keep credit losses as low as possible by making credit sales only to customers who are likely to pay on time ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Internal Control over Merchandising Transactions (slide of 2)  Maintaining control is especially difficult for a merchandiser because management must not only establish controls for cash sales, receipts, purchases, and cash payments, but also protect its inventory  Most firms use the following procedures: – Separate the functions of authorization, recordkeeping, and custodianship of cash – Limit the number of people who have access to cash, and designate who those people are ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Internal Control over Merchandising Transactions (slide of 2) – Bond all employees who have access to cash – Keep the amount of cash on hand to a minimum by using banking facilities as much as possible – Physically protect cash on hand by using cash registers, cashiers’ cages, and safes – Record and deposit all cash receipts promptly, and make payments by check rather than by currency – Have a person who does not handle or record cash make unannounced audits of the cash on hand – Have a person who does not authorize, handle, or ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Control of Purchases and Cash Disbursements  To avoid theft, cash payments should be made only after they have been specifically authorized and supported by documents that establish the validity and amount of the claims  A company should also separate the duties involved in purchasing goods and services and the duties involved in paying for them ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Cash Equivalents  Management may decide to invest excess cash in short-term interest-bearing accounts or certificates of deposit (CDs) at banks and other financial institutions, in government securities (such as U.S Treasury notes), or in other securities  If these investments have a term of 90 days or less when they are purchased, they are called c as h e quivale nts because the funds revert to cash so quickly they are treated as cash on the balance sheet ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Cash Control Methods (slide of 2)  In addition to internal control of cash transactions, other ways of controlling cash include: – Impre s s s ys te ms —systems, such as pe tty cas h funds , used by a company for small expenditures and cash advances and restored to a fixed amount periodically – Banking services—which include:  Safe depositories for cash  Negotiable instruments and other valuable business documents, such as stocks and bonds  Checking accounts  Collection and payment of certain types of debt ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Cash Control Methods (slide of 2)  Exchange of foreign currencies  Ele c tro nic funds trans fe r—a method of conducting business transactions in which a company electronically transfers cash from its bank to another company’s bank  Automated teller machine (ATM) and debit card transactions—When purchases are made using a debit card, the amount of the purchase is deducted directly from the buyer’s bank account – Bank re c o nc iliatio ns —the process of accounting for the difference between the balance on a company’s bank statement and the balance in its Cash account ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Bank Reconciliations (slide of 2)  The following transactions commonly appear in a company’s records but not on its bank statement: - Outs tanding c he c ks —checks that a company has issued and recorded but that not yet appear on its bank statement - De po s its in trans it—deposits a company has sent to its bank but that the bank did not receive in time to enter on the bank statement ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Bank Reconciliations (slide of 2)  Transactions that may appear on the bank statement but not in the company’s records include: - Service charges—fees for the use of a checking account - NS F (no ns uffic ie nt funds ) c he c ks —An NSF check is a check that a company has deposited but that is not paid when the bank presents it to the issuer’s bank - Miscellaneous debits and credits—including fees charged for other services, such as stopping payment on checks, printing checks, and collections on promissory notes - Interest income—interest paid on a company’s average balance Accounts that pay interest are sometimes called NOW or money market accounts ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Petty Cash Funds  It is sometimes necessary to make small payments of cash for postage stamps, shipping charges due, or minor purchases of office supplies – For situations in which it is inconvenient to pay by check, most companies set up a pe tty c as h fund using an imprest system, in which the fund is established for a fixed amount  A voucher documents each cash payment made from the fund  The fund is periodically reimbursed, based on the vouchers, by the exact amount necessary to restore its original cash balance ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Making Disbursements from the Petty Cash Fund  The custodian of the petty cash fund should prepare a pe tty c as h vo uc he r, or written authorization, for each expenditure, as shown below The person who receives the payment signs the voucher ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Management’s Responsibility for Internal Control  Management is responsible for establishing a satisfactory system of internal controls – This means that management must:  safeguard the firm’s assets  ensure reliability of its accounting records  see that its employees comply with all legal requirements and operate the firm to the best advantage of its owners – The Sarbanes-Oxley Act requires that the chief executive officer, the chief financial officer, and the auditors of a public company fully document and certify the company’s system of internal controls ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Independent Accountant’s Audit of Internal Control  Although privately owned companies usually are not required to have an independent certified public accountant audit their financial statements, many companies choose to so These companies are also not required to have their internal control systems audited  Public companies, on the other hand, are required to not only have an independent audit of their financial statements, but also to have an audit of their internal control ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part  ... (slide of 2)  The goal of control activities is to safeguard a company’s assets and ensure the reliability of the accounting records Standard controls include: – Autho rizatio n—the approval of. .. the firm to the best advantage of its owners – The Sarbanes-Oxley Act requires that the chief executive officer, the chief financial officer, and the auditors of a public company fully document... (slide of 2) – Bond all employees who have access to cash – Keep the amount of cash on hand to a minimum by using banking facilities as much as possible – Physically protect cash on hand by using