Chapter 6

1. © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. Chapter 6 Accounting Systems, Internal Controls, and Cash Financial and Managerial Accounting 8th Edition Warren Reeve Fess

2. Objectives 1.Define an accounting system and describe its implementation. 2.List the three objectives of internal control, and define and give examples of the five elements of internal control. 3.Describe the nature of cash and the importance of internal control over cash. 4.Summarize basic procedures for achieving internal control over cash receipts.

3. Objectives 5.Summarize basic procedures for achieving internal control over cash payments, including the use of a voucher system. 6.Describe the nature of a bank account and it sue in controlling cash. 7.Prepare a bank reconciliation and journalize any necessary entries. Account for small cash transactions using a petty cash fund. 9.Summarize how cash is presented on the balance sheet. 10.Compute and interpret the ratio of cash to current liabilities.

4. FEEDBACK Design Implementation Analysis Basic Accounting System

5. Objectives of Internal Control To provide reasonable assurance that: 1. assets are safeguarded and used for business purposes. 2. business information is accurate. 3. employees comply with laws and regulations.

6. Elements of Internal Control 1. Control environment 2. Risk assessment 3. Control procedures 4. Monitoring 5. Information and communication

7. 1. Control environment Management philosophy and operating style influences the control environment.

8. 2. Risk assessment Once risks are identified, they can be analyzed to estimate their significance, to assess their likelihood of occurring, and to determine actions that will minimize them.

9. 3. Control Procedures - a • Competent Personnel • Rotating Duties • Mandatory Vacations • Separating Responsibilities for Related Operations • Separating Operations, Custody of Assets, and Accounting • Proofs and Security Measures

10. 3. Control Procedures - b Separating Responsibilities for Related Operations Otherwise, the following abuses are possible: 1. Orders may be placed on the basis of friendship with a supplier, rather than on price, quality, and other objective factors. 2. The quantity and quality of supplies received may not be verified, thus causing payment for supplies not received or poor-quality supplies. 3. Supplies may be stolen by the employee. 4. The validity and accuracy of invoices may be verified carelessly.

11. 3. Control Procedures - c • Competent Personnel • Rotating Duties • Mandatory Vacations • Separating Responsibilities for Related Operations • Separating Operations, Custody of Assets, and Accounting • Proofs and Security Measures

12. 3. Control Procedures - d Independent check Independent check Independent check Custody of Assets Operations Accounting

13. Clues to Potential Problems Warning signs with regard to people: 1. Abrupt changes in lifestyle. 2. Close social relationships with suppliers. 3. Refusing to take a vacation. 4. Frequent borrowing from other employees. 5. Excessive use of alcohol or drugs.

14. Clues to Potential Problems Warning signs from the accounting system: 1. Missing documents or gaps in transaction numbers. 2. An unusual increase in customer refunds. 3. Differences between daily cash receipts and bank deposits. 4. Sudden increase in slow payments. 5. Backlog in recording transactions.

15. Control Over Cash Receipts • Many companies need several cash accounts to account for different cash categories and funds. • Most companies have multiple bank accounts. The title for each bank account should be: Cash in Bank—(Name of Bank) • Preventive controlsprotect cash from theft and misuse of cash. • Detective controlsare designed to detect theft or misuse of cash and are also preventive in nature.

16. Mail Receipts Retailers’ Sources of Cash Register records Cash Receipts CASHIER’S DEPARTMENT ACCOUNTINGDEPARTMENT Remittance advices

17. Deposit receipt Deposit ticket Bank Retailers’ Sources of Cash CASHIER’S DEPARTMENT ACCOUNTINGDEPARTMENT 1

18. Controlling Cash Received from Cash Sales 19 Cash 3 142 00 Cash Short and Over 8 00 Sales 3 150 00 To record cash sales and actual cash on hand. Cash sales for March 19 totaled $3,150.00 per the cash register tape. After removing the change fund, only $3,142.00 was on hand.

19. Controlling Cash Received in the Mail Most companies’ invoices are designed so that customers return a portion of the invoice, call a remittance advice.

20. Controlling Cash Received in the Mail 1.The employee who opens the mail should initially compare the amount received with the amount on the remittance advice. 2.The employee opening the mail stamps checks and money orders “For Deposit Only” in the bank account of the business. 3.All cash is sent to the Cashier’s Department where checks and money orders are combined with receipts from cash sales and a bank deposit ticket is prepared.

21. Controlling Cash Received in the Mail 4.The remittance advices and their summary totals are delivered to the Accounting Department where a clerk prepares the records of the transactions and posts them to the customer account. 5. The stamped duplicate copy of the deposit ticket is returned to the Accounting Department where a clerk compares the receipt with the total amount that should have been deposited.

22. Internal Control of Cash Payments 1. Cash controls must provide assurance that payments are made for only authorized transactions. 2. Cash controls should ensure that cash is usedefficiently. 3. A voucher system provides assurance that what is being paid for was properly ordered, received, and billed by the supplier.

23. A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. Basic Features of the Voucher System

24. Basic Features of the Voucher System • A voucher system normally uses vouchers. • The system normally has a file for unpaid vouchers and a file for paid vouchers. • Usually prepared by the Accounting Department after all necessary supporting documents are received (purchase order, supplier’s invoice, and a receiving report). • In preparing the voucher, the accounts payable clerk verifies the quantity, price, and mathematical accuracy of the supporting documents and files the paid voucher.

25. Bank Accounts: Their Nature and Use as a Control Over Cash A bank reconciliation is a listing of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger. A summary received from the bank of all account transaction is called a statement of account.

26. Reasons for Differences Between Depositor’s Records and the Bank Statement • Outstanding checks • Deposits in transit • Service charges • Collections • Not-sufficient-funds (NSF) checks • Errors

27. Steps in a Bank Reconciliation 1. Compare each deposit listed on the bank statement with unrecorded deposits appearing on the preceding period’s reconciliation and with deposit receipts. Add deposits not recorded by the bank to the balance according to the bank statement. 2. Compare paid checks with outstanding checks appearing on the preceding period’s reconciliation and with recorded checks. Deduct checks outstanding that have been paid by the bank from the balance according to the bank statement.

28. Steps in a Bank Reconciliation 3. Compare bank credit memorandums to entries in the journal. Add credit memorandums that have not been recorded to the balance according to the depositor’s records. 4. Compare bank debit memorandums to entries recording cash payments. Deduct debit memorandums that have not been recorded from the balance according to the depositor’s records. 5. List any errors discovered during the preceding steps.

29. BANK Depositor’s records Bank’s books Beginning balance $2,549.99 Beginning balance $3,359.78 Power Network prepares to reconcile the monthly bank statement as of July 31, 2006

30. BANK Depositor’s records Bank’s books Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 $4,175.98 A deposit of $816.20 did not appear on the bank statement.

31. BANK Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 $4,175.98 Depositor’s records Bank’s books Beginning balance $2,549.99 Add note and interest collected by bank 408.00 $2,957.99 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking

32. BANK Depositor’s records Bank’s books Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Three checks that were written during the period did not appear on the bank statement: #812, $1,061; #878, $435.39, #883, $48.60. A deposit of $637.02 did not appear on the bank statement.

33. BANK Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Depositor’s records Bank’s books Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check returned because of insufficient funds $300.00 The bank returned an NSF check from one of the firm’s customers, Thomas Ivey, in the amount of $300. This was a payment on account.

34. BANK Depositor’s records Bank’s books Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 The bank service charges totaled $18.00.

35. BANK Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 Depositor’s records Bank’s books Error recording Check No. 879 9.00 327.00 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

36. BANK Depositor’s records Bank’s books Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check return because of insufficient funds $300.00 Bank service charges 18.00 Error recording Check No. 879 9.00 327 Adjusted balance $2,630.99 Adjusted balance $2,630.99

37. Now, if desired, we can prepare a formal statement for Power Networking.

38. Power NetworkingBank ReconciliationJuly 31, 2006 Balance per bank statement $3,359.78 Add: Deposit not recorded by bank 816.20 $4,175.98 Deduct: Outstanding checks No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Adjusted balance $2,630.99 Balance per depositor’s records $2,549.99 Add: Note and interest collected by bank 408.00 $2,957.99 Deduct: NSF check (Thomas Ivey) returned $300.00 Bank service charges 18.00 Error in recording Check No. 879 9.00 327.00 Adjusted balance $2,630.99

39. Journal entries must be prepared for those items that affected the depositor’s side of the reconciliation.

40. Power NetworkingBank ReconciliationJuly 31, 2006 Balance per bank statement $3,359.78 Add: Deposit not recorded by bank 816.20 $4,175.98 Deduct: Outstanding checks No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Adjusted balance $2,630.99 Balance per depositor’s records $2,549.99 Add: Note and interest collected by bank 408.00 $2,957.99 Deduct: NSF check (Thomas Ivey) returned $300.00 Bank service charges 18.00 Error in recording Check No. 879 9.00 327.00 Adjusted balance $2,630.99

41. Entries Related to a Bank Reconciliation July 31 Cash 408 00 Notes Receivable 400 00 Interest Receivable8 00 Note collected by bank.

42. Power NetworkingBank ReconciliationJuly 31, 2006 Balance per bank statement $3,359.78 Add: Deposit not recorded by bank 816.20 $4,175.98 Deduct: Outstanding checks No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Adjusted balance $2,630.99 Balance per depositor’s records $2,549.99 Add: Note and interest collected by bank 408.00 $2,957.99 Deduct: NSF check (Thomas Ivey) returned $300.00 Bank service charges 18.00 Error in recording Check No. 879 9.00 327.00 Adjusted balance $2,630.99

43. July 31 Cash 408 00 Notes Receivable 400 00 Interest Receivable8 00 Note collected by bank. Entries Related to a Bank Reconciliation 30 Accounts Receivable—Thomas Ivey 300 00 Miscellaneous Administrative Exp. 18 00 Accounts Payable—Taylor Co. 9 00 Cash 327 00 NSF check, bank service charges, and error in recording Check no. 879.

44. Petty Cash

45. On August 1, issued Check No. 511 for $100 to established a petty cash fund. Aug. 1 Petty Cash 100 00 Cash 100 00 Established petty cash fund.

46. At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, $28, postage (office supplies), $22; store supplies, $35, and miscellaneous administrative items, $3. Aug. 31 Office Supplies 50 00 Store Supplies 35 00 Miscellaneous Administrative Exp. 3 00 Cash 88 00 Replenished petty cash fund.

47. Financial Analysis and Interpretation Solvency is the ability of a business to meet its financial obligations (debts) as they are due. Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its currentandnoncurrent liabilities. This ability is normally assessed by examining balance sheetrelationships.

48. Financial Analysis and Interpretation Doomsday Ratio Laettner Co. Oakley Co. A. Cash and equivalents $100,000 $ 120,000 B. Current liabilities 400,000 1,500,000 Doomsday ratio A / B 0.25 0.08 Use: To indicate the company’s ability to meet creditors obligations in the worst case assumption that should the business cease to exist. How are these ratios used? THE END