Introductory Accounting B

1. Introductory Accounting B B11-A291 / B11-A027 Mark Binder, CA Chapter 9

2. Learning Objectives Define, explain the purpose and identify the principles of internal control Define cash and explain how it is reported Apply internal control to cash Explain and record petty cash fund transactions Identify control features of banking activities Prepare a bank reconciliation

3. Internal Control In small organizations have an active owner manager who can oversee operations. Owner / manager has personal contact with all staff. Has physical custody of all assets. Owner / manager acts as a control mechanism.

4. Internal Control This approach is not practical in large organizations. Large organizations must rely on the system of internal control. The procedures that control businesses are the internal control procedures. These procedures protect company from waste, fraud and theft.

5. Internal Control Good internal control also promotes managerial effectiveness and efficiency. Internal control systems will: Protect assets. Ensure reliable accounting. Promote efficient operations. Urge adherence to company policies.

6. Internal Control Internal control procedures vary from company to company There are general principles which most adhere to:

7. 7 Principles of Internal Control Establish Responsibilities Maintain adequate records Insure assets and bond employees Separate record keeping from custody of assets Divide responsibilities for related transactions Apply technological controls Perform regular independent reviews

8. Establish Responsibilities Make a specific employee responsible for a particular task. No clear line of responsibility difficult to determine cause of problem and prevent it in the future. Also difficult to award credit.

9. Maintain Adequate Records If no adequate records difficult to know how to record transactions or how to correct if error occurs. May be unable to take corrective action. Use of preprinted forms helps. Ensures all transactions are accounted for.

10. Insure Assets and Bond Employees Proper insurance is a wise precaution. Bonded employees used when dealing with cash. The employee is bonded, if cash is missing the bonding company will make up the shortfall. Discourages theft in sensitive positions.

11. Separate Record Keeping and Custody Over Assets Fundamental principle of internal control. Much more difficult to have theft. For theft two employees would have to work together, called collusion. Example: Employee responsible for inventory does not have access to inventory records.

12. Divide Responsibility for Related Transactions Similar activities are kept separate. Example: placing orders separate from checking on goods received. Reduces fraud. Also improves accuracy of information as information is checked by another.

13. Apply Technological Controls Adding machines, cash registers, automatic payroll and time clocks. Difficult to manipulate reducing the chance of fraud. Also improves accuracy.

14. Perform Regular and Independent Reviews Even well designed systems fail. Large numbers of transactions or management can override system. Independent reviews should be done to ensure compliance with policy. Use Internal Audit. Internal Audit should report to the board.

15. Technology and Internal Control Computers are used in maintaining internal control. Use Computer Aided Audit Techniques. Sometimes necessary when no intermediate results are generated. Always need good internal control.

16. Internal Control for Cash Duties should be separate so that those who are responsible for cash do not keep the records. All cash deposits should be deposited intact daily. All cash payments made by cheque.

17. Internal Control for Cash Divide responsibilities to improve accuracy and reduce likelihood of fraud. Daily deposits done increases accuracy, improves cash flow and reduces likelihood of fraud. Paying by cheque serves as a good control mechanism, as it establishes a good document trail.

18. Internal Control for Cash Usually when recording cash sales use a cash register. This is good segregation of duties. The cashiers have access to cash but not the accounting records. Most cash registers use a ‘Z’ total to determine the total of all sales. This can be reconciled to cash.

19. Internal Control for Cash Small differences in cash registers are usually recorded to the account cash / over short. Dr: Cash $1000.10. Cr: Sales $1,001.10. Dr: Cash over / short $1.00.

20. Cash Received in the Mail Posses special problems. Often use two people to open the mail. Listing of cash is prepared and sent to accounting department. Cash is then sent to cashier. Unrecorded amounts will be discovered when payments go missing – segregation of duties.

21. Cash Disbursements Cheques require someone with signing authority to sign cheque. In small organizations this is usually the owner / manager. A voucher system limits who can generate obligations.

22. Cash Disbursements A request is forwarded to the department manager. The department manager then sign the requisition. The purchasing department then receives request and initiates a purchase. Usually a receiving report confirms goods were received in good condition.

23. Cash Disbursements When the cheque is produced it is then forwarded for signature. When the signatory reviews the documentation it will clearly indicate that the purchase was approved by the appropriate manager.

24. Petty Cash Due to the security around producing cheques many organizations maintain a small amount of cash for minor expenses. Usually the cash is kept in a secure location. When someone want to purchase something they request of the petty cashier an appropriate amount of money.

25. Petty Cash After purchase the receipt, with any change is then returned to the petty cashier. When the fund becomes depleted the petty cashier will replenish the fund.

26. Petty Cash To create a petty cash fund the journal entry is: Dr: Petty Cash $75 Cr: Cash $75

27. Petty Cash After some time the petty cash fund is low. The petty cashier will add up the receipts and create the following journal entry. Dr: Misc expense $46.50. Dr: Transportation in $15.05. Dr: Delivery expense $5.00. Dr: Office supplies $4.75. Cr: Cash $71.30.

28. Petty Cash In this example the amount of all receipts was $71.30. The fund was also short in cash of exactly $71.30. Occasionally, because receipts disappear or improper change is given the total of receipts will not equal the amount missing from the fund.

29. Petty Cash If the total of all receipts was $20. Petty Cash is usually $50. Since there is a receipt for $20 the balance in petty cash should be $30. If the balance in the fund is $27 this would imply $3 is missing.

30. Petty Cash In such a case the journal entry would be: Dr: Office supplies $20 Dr: Cash over / short $3 Cr: Cash $23. With the additional $23 + $27 in the fund = $50. Usually the fund is always maintained at that level.

31. Bank Reconciliation This is probably the piece of information you are most likely to be using immediately. Bank reconciliations are a basic control mechanism that virtually all companies use.

32. Bank Reconciliation Basic Premise: Compare the balance of the bank in the general ledger (book) to the bank statement received from the bank. Account for the differences between the two sources of information.

33. Bank Reconciliation - Layout Bank Statement Balance Reconciling items Adjusted balance agrees to adjusted book balance Balance of Bank per G/L (Book) Reconciling items Adjusted book balance agrees to adjusted bank statement balance

34. Reconciling Items - Bank There are only two types of reconciling items that will affect the bank balance: Outstanding Cheques Outstanding Deposits

35. Outstanding Cheques Outstanding cheques are cheques that have been written but for whatever reason have not cleared the bank yet. These cheques have been included in the G/L (book) but not in the bank statement These cheques should be subtracted from the bank statement balance.

36. Outstanding Deposits Outstanding cheques are extremely common. Outstanding deposits are not quite as common. They refer to deposits made, and recorded in the G/L (book) but have not cleared the bank. Usually this is deposits made after month end that relate to the prior month.

37. Outstanding Deposits Many companies use a night depository for their cash deposits. Usually these deposits are recorded on the next business day. So deposits on Friday the 31st will not be recorded until the 1st of the following month on the bank statement. The same is true of deposits done on the 31st after 3 p.m. Outstanding deposits are added to the bank statement balance.

38. Bank Reconciliation - Layout Bank Statement Balance. Add: Outstanding deposits. Less: Outstanding Cheques. Adjusted balance agrees to adjusted book balance. Balance of Bank per G/L (Book) Reconciling items Adjusted book balance agrees to adjusted bank statement balance

39. Adjustments to the Book (G/L) We have now made all the adjustments to the bank. The only adjustments ever made to the bank are for outstanding cheques and outstanding deposits. All other adjustments are to the Book.

40. Adjustments to the Book We need to account for all items that have affected the bank balance which we have not yet recorded in the G/L (Book). These include: Interest earned Interest charged Service charges Debit memoranda for NSF cheques Credit memoranda for collections of notes payable

41. Interest earned Occasionally on bank accounts interest is earned. The precise amount is usually not known so it is recorded at the end of the month from the bank statement. It is an addition to the book.

42. Interest Charged Frequently, companies have lines of credit arranged with the bank. This allows the bank account to go negative. When this occurs interest is charged. The precise amount is usually not known till the end of the month. This is subtracted from the book balance.

43. Service Charges All financial institutions charge service charges for a variety of services. The exact amount of these charges is usually not known until the end of the month. These are subtracted from the book balance.

44. Debit Memoranda The bank will often issue debit memoranda for any reductions in the bank balance. Usually these are not issued for service charges or interest as these are standard. Less usual is debit memoranda for NSF charges. An NSF charge is a charge for a cheque which has insufficient funds to support it.

45. Debit Memoranda These are subtracted from the book balance. Other debit memoranda could also be issued for the printing of cheques. These would also be subtracted from the book balance.

46. Credit Memoranda Occasionally banks act as a collection service on notes receivable. Usually, when the note is collected the bank will mail a credit memoranda to the company. Generally, the company does not record the credit memoranda until the bank statement arrives.

47. Credit Memoranda When the note is collected the bank will usually charge a fee for this service. Our text book wants this recorded as one item. In practice you usually record this as two items. One, the collection of the note receivable is added to the book balance. Two, the service charge is subtracted from the bank balance.

48. Errors Occasionally, amounts are recorded in the General Ledger which are in error. The effect on the bank reconciliation depends on the error itself. Example: The error was to record cheque 123 for $35. The actual cheque, which was correct was for $53.

49. Errors In this case our G/L has recorded cheque 123 for $35. The bank has the cheque recorded as $53. Our G/L (book) has under recorded the expense. Therefore we need to subtract an additional $18 from the book.

50. Errors Example: Deposit for $990 was recorded in the book as $909. In this case we have under recorded a deposit. We need to add $81 (990 – 909) to the book balance.

51. Bank Reconciliation - Layout Bank Statement Balance. Add: Outstanding deposits. Less: Outstanding Cheques. Adjusted balance agrees to adjusted book balance. Balance of Bank per G/L (Book) Add: interest earned notes receivable error (if applicable) Less: interest charged Service charges NSF charges error (if applicable) Adjusted book balance agrees to adjusted bank statement balance