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employees from attempting any thefts because they will not be able to
INTERNAL CONTROL AND CASH permanently conceal their improper actions.
(2) Staff should be adequately trained for the duties they are assigned
INTERNAL CONTROL and understand the importance of internal controls and their
Internal Control – consist of the plan of organization and all the related implementation.
methods and measures adopted within a business to (1) safeguard its (3) Staff wages and salaries should be commensurate with the duties
assets from employee theft, robbery and unauthorized use and (2) performed. If this is not the case, staff may feel aggrieved and
enhance the accuracy and reliability of its accounting records and consider engaging in fraudulent activities to transfer wealth from the
financial statements. This is done by reducing the risk of errors business to themselves.
(unintentional mistakes) and irregularities (intentional mistakes and LIMITATIONS OF INTERNAL CONTROL
misinterpretations) in the accounting process. o A business’s system of internal control is generally designed
Internal Control – measures vary with the size and nature of the to provide reasonable assurance that assets are properly
business and with management’s control philosophy. safeguarded and that the accounting records are reliable. The
Business follow specific control principles. There are six principle listed: concept of reasonable assurance rests on the premise that the
1. Establishment of responsibility costs of establishing control procedures should not exceed their
o An essential characteristic of internal control is the expected benefit.
assignment of responsibility to specific employees. o The human element is an important factor in every system
o Control is the most effective when only one person is of internal control.
responsible for given task. o The size of the business also may impose limitations on
o Establishing responsibility includes the authorization and internal control.
approval of transactions.
2. Segregation of duties CASH CONTROL
o Also called Separation of functions or Division of work. Cash is the beginning of a business’s operating cycle, it is also
o Segregation of duties is indispensable in a system of internal usually the starting point for its system of internal control.
control. Cash is the one asset that is readily convertible into any other type of
o There are two common application of this principle: asset.
(1) Related activities should be assigned to different Cash is the asset most susceptible to improper division and use.
individuals. Cash consists of coins, currency, cheques, money orders and money
(2) Establishing the accountability (keeping the records) on hand or on deposit in a bank or similar depository.
for an asset should be separate from the physical Postage stamps are prepaid expense. (cheques payable in the future)
custody of that asset. Postdated cheques are accounts receivable. (cheques payable in the
↓ future)
(The custodian is the entity holding the assets for safekeeping, Internal control over cash receipts
meaning protecting the assets from theft or loss. This is usually a
large bank or investment firm that has a good reputation and
o Cash receipts come from a variety of sources: cash sales;
strong security measures in place.) collections on accounts from customers; the receipt of interest,
3. Documentation procedures rent, and dividends; investments by owners; bank loans; and
o Documents provide evidence that transactions and events proceeds from the sale of non-current assets.
have occurred. o Control of over-the-counter-receipts in retail businesses is
o Several procedures should be established for documents: centered on cash registers that are visible to customers.
(1) First, whenever possible, documents should be o Mail receipts – resulting from billings and credit sales are
prenumbered, and all documents should be another way cash is received by businesses.
accounted for. Prenumbering helps to prevent a Internal control over cash payments (cash disbursement)
transaction from being recorded more than once. o Cash may be disbursed for a variety of reasons: to pay
It also helps to prevent the transactions from not expenses and liabilities or to purchase assets.
being recorded. o Internal control over cash payments is more effective when
(2) Second, documents that are source documents for payments are made by cheque or electronic transfer, rather than
accounting entries should be promptly forwarded cash.
to the accounting department. This control o Voucher system is a network approvals by authorized
measure helps to ensure timely recording the individuals acting independently to ensure that all payments by
transaction and contributes directly to the a cheque are proper.
accuracy and reliability of the accounting records. o Voucher is an authorization form prepared for each
(3) Third, multiple copies of documents should have expenditure.
different colors o Vouchers are required for all types of cash payments except
4. Physical, mechanical, and electronic controls those form petty cash.
o Physical controls relate primarily to the safeguarding of o The voucher system involves two journal entries: (1) to issue
assets (such as safes, vaults and safety deposit boxes for cash, the voucher – the voucher must be recorded in the journal
cash equivalents and business papers and locked warehouses called a voucher register and (2) to pay the voucher – the
and storage cabinets for inventories and records). voucher is stamped ‘paid’, and the paid voucher is sent to the
o Mechanical and electronic controls also safeguard assets; accounting department for recording in a journal called the
some enhance the accuracy and reliability of the accounting cash payment journal.
records (such as alarms to prevent break-ins and time clocks o Electronic Funds Transfer (EFT) – payment systems that use
or computer logins for recording time worked.) wire, telephone, or the internet to transfer cash from one
5. Independent internal verification location to another.
o Most internal control systems provide for independent o EFT was developed to transfer funds among parties without
internal verification. the use of paper (cheques, deposit tickets, and etc.).
o This principle involves the review, comparison and
reconciliation of data prepared by other employees. Internal control over cash
o To obtain maximum benefit from independent internal Internal control over cash payments
verification: receipts
(1) the verification should be made periodically or on a
Establishment of responsibility Establishment of responsibility
surprise basis *receipts* *cheque*
(2) the verification should be done by someone who is Only designated personnel are Only designated personnel are
independent of the employee responsible for the authorized to handle cash receipts authorized to sign cheques (finance
(cashiers). officer).
information
(3) discrepancies and exceptions should be reported to
management level that can take appropriate corrective
Segregation of duties Segregation of duties
action
o Independent internal verification is especially useful in Different individuals receive cash, Different individuals approve and
comparing recorded accountability with existing assets. record cash receipts and hold the make payments; cheque signers do
cash. not record payments.
o Internal auditors are employees who evaluate on a
continuous basis the effectiveness of the entity’s system of
internal control. They periodically review the activities of Documentation procedures Documentation procedures
departments and individuals to determine whether prescribed
internal controls are being followed. Use remittance advice (mail Use prenumbered cheques and
receipts), cash register tapes and account for them in sequence; each
6. Other controls deposit slips. cheque must have an approved
invoice.
Other control measures include the following.
(1) Employees’ duties should be rotated and they should be required Physical, mechanical, electronic Physical, mechanical, electronic
to take annual leave. These measures are designed to deter control control
Use of a bank account facilitates the control of cash because it
Store cash in safes and bank vaults; Store blank cheques in safes, with creates a double record of all bank transactions – one by the business
limit access to storage areas; use cash limited access; print cheque amounts
registers. by machine in indelible ink.
and the other by the bank.
Making bank deposits
Independent internal verification Independent internal verification
o Bank deposits should be made by an authorized employee. Each
deposit must be documented by a deposit slip (ticket).
Supervisors count cash receipts Compare cheques to invoices; o Deposit slips are prepared in duplicate. The original is retained
daily; finance officer compares total reconcile bank statement monthly. by the bank; the duplicate, machine stamped by the bank to
receipts to bank deposits daily. establish its authenticity, is retained by the depositor.
Writing cheques
Independent internal verification Other controls o Cheque is a written order signed by the depositor directing the
bank to pay a specified sum of money to a designated recipient.
Require employees to take annual Stamp invoices PAID.
leave; deposit all cash in bank daily. o There are three parties to a cheque: (1) the drawer who issues the
cheque; (2) the bank or the payer on which the cheque is drawn;
(3) the payee to whom the cheque is payable.
PETTY CASH FUND – is a cash fund used to pay relatively small o A cheque is a negotiable instrument that can be transferred to
amounts but still maintain satisfactory control. another party by endorsement.
The operation of a petty cash fund, often called an imprest system,
involves three steps: (1) establishing fund, (2) making payment from the Bank Statement
fund, and (3) replenishing the fund. o Bank statement shows the depositor’s bank transactions and
*imprest means an advance of money for a designated purpose* balances.
o It shows (1) cheques paid and other debits and transfers that
1. ESTABLISHING THE FUND
reduce the balance in the depositor’s account, (2) deposits and
Two essential steps in establishing a petty cash fund are (1) appointing
other credits and transfers that increase the balance in the
a petty cash custodian who will be responsible for the fund and (2)
depositor’s account and (3) the account balance after each day’s
determining the size of the fund.
transactions.
If Dance Ezy Lts decides to establish a $100 fund on March 1, the
o A paid cheque is sometimes referred to as a cancelled cheque.
entry journal form is:
Mar. 1 Petty Cash 100
Direct debits
Cash 100 • Banks charge a monthly fee for their services called
(To establish a petty cash bank fee. The bank fee is only charged when the
fund)
average, monthly balance in a cheque account falls
No additional entries will be made to the Petty Cash account unless below a specified amount.
management changes the stipulated amount of the fund. For example, if • A direct debit explaining the fee is included with the
Dance Ezy decides on July 1 to increase the size of the fund to $250, it bank statement and noted on the statement.
would debit Petty Cash $150 and credit Cash $150.
• Separate direct debits may also appear on the statement
2. MAKING PAYMENTS FROM THE FUND for other bank services such as the cost of printing
No accounting entry is made to record a payment at the time it is made cheques, traveler’s cheques, and transferring funds to
from petty cash. It is considered unnecessary to do so. Instead, the
other locations.
accounting effects of each payment are recognized when the funds
replenished. • A direct debit is also used by the bank when a deposited
cheque from a customer ‘bounces’ because of
3. REPLENISHING THE FUND
insufficient funds. The cheque is marked as a
When the money in the petty cash fund reaches a minimum level, the
fund is replenished. The individual prepares a request for dishonoured cheque (not sufficient funds) by the
reimbursement is initiated by the petty cash custodian. This individual customer’s bank and is returned to the depositor’s bank.
prepares a schedule (or summary) of the payments that have been made Direct credits
and sends the schedule, supported by petty cash receipts and other • A depositor may ask the bank to collect its notes
documentation, to the finance office. receivable.
To illustrate, assume that on March 15 the petty cash custodian • Many bank offer interest on cheque accounts. The
requests a cheque for $87. The fund contains $13 cash and petty cash interest earned will be indicated on the bank statement
receipts for postage $44, stationery $38, and miscellaneous expenses by a direct credit entry.
$5. The general journal entry to record the cheque is: Transfer
Mar. Postage Expense 44 • Transfer from the account appears as a debit on the
15 Stationery 38 bank statement with identification as to who the funds
Miscellaneous Expense 5
Cash 87 have been transferred to.
(To replenish petty cash fund) *When a person transfers money from their bank account to another person's
account, it is recorded as a debit entry on their bank statement. This means
Cash decrease by $87 ($100 – current count of $13). Note that the Petty Cash that the balance of their account decreases by the amount of the transfer.*
account is not affected by the reimbursement entry. Replenishment changes the • A transfer to the account appears as a credit entry on
composition of the fund by replacing the petty cash receipts with cash. It does the bank statement with identification as to who has
not change the balance in the fund. transferred the funds.
Assume in the preceding example that the custodian had only $12 in cash in *When a person receives money from another person's bank account, it is
recorded as a credit entry on their bank statement. This means that the balance
the fund plus the receipts as listed. The request for reimbursement would,
of their account increases by the amount of the transfer.*
therefore, have been for $88. The following entry would be made:
Mar. Postage Expense 44 Reconciling the bank account
15 Stationery 38 o The process the make the balance per books agree with the
Miscellaneous Expense 5
Cash Over and Short 1 balance per bank is called reconciling the bank account.
Cash 88 o Time lags – prevent parties from recording the transactions in
(To replenish petty cash fund)
the same period.
o Steps in the reconciliation procedure
If the custodian had $14 in cash, the reimbursement request would have been for
1. Outstanding deposits – deposits recorded by the depositor
$86 and Cash Over and Short is reported in the income statement as an other
expense. A credit balance in the account is reported as other income. Cash
that have not been recorded by the bank. They are added to
Over and Short is closed to Profit and Loss Summary at the end of the year. the balance per bank.
2. Unpresented cheques – issued cheques recorded by the
Internal control over petty cash fund is strengthened by (1) having a
business that have not been presented by the recipient to the
supervisor make surprise counts of the fund to ascertain whether the
bank for payment represent. They are deducted from the
paid vouchers and fund cash equal the imprest amount and (2)
balance per the bank.
cancelling or mutilating the paid vouchers so they cannot be *Note: Outstanding deposits and Unpresented cheques are reconciling
resubmitted for reimbursement. items because of time lags*
3. Errors – any errors discovered in the foregoing steps.
For example, if a paid cheque correctly written by the
USE OF A BANK ACCOUNT business for $195 was mistakenly recorded by the business
The use of a bank account contributes significantly to good internal for $159, the error is deducted from the balance per books.
control over cash. 4. Direct debits and credits – trace direct debits and credits to
the depositor’s records.
A business can safeguard its cash by using a bank account as a
Any unrecorded direct entries should be listed in the
depository and as a clearing house for cheques received and
appropriate section of the reconciliation schedule.
cheques written.
• Credit memos – refer to items representing deposit
Use of a bank account minimizes the amount of currency that must
credited by the bank to the account of the depositor
be kept on hand.
but not yet recorded by the depositor as cash
receipts.
(Examples: A note receivable and interest that the
bank has collected for the company.)
• Debit memos – refer to the items not representing
checks paid by the bank which are charged or
debited by the bank to the account of the depositor
but not yet recorded by the depositor as cash
disbursement.
(Examples: Customers’ not sufficient funds (NSF)
checks/Dishonoured checks; bank service charges.)
*The illustration and entries for Bank Reconciliation can be found on
pages 350 – 351 and 353 – 354.*
Reporting cash
o Cash equivalents is the term given to highly liquid investments that can
be converted into a specific amount of cash. (typically have maturities of
3 months or less when purchased)
*Cash equivalents are short-term investments or assets that are easily convertible into
cash, have a low risk of value fluctuation, and are highly liquid. Examples of cash
equivalents include money market funds, treasury bills, commercial papers, and
certificates of deposit.* ↓
o Cash equivalents include money market investments such as bank
certificates of deposit and Treasure bills and notes.
o A business may have cash that is restricted for a special purpose.
• Current asset – if the restricted cash is expected to be used within
the next year.
• Non-current asset – when the restricted funds will not be used in
that time.
o Bank overdraft – shown as a current liability in the statement of
financial position.
Classification of Receivables
The receivables that result from sales on account are normally
accounts receivable or notes receivable.
The term receivables includes all money claims against other entities,
including people, companies, and other organizations.
Receivables are usually a significant portion of the total current assets.
ACCOUNTS RECEIVABLE
The most common transaction creating a receivable is selling
merchandise or services on account (on credit).
The receivable is recorded as a debit to Accounts Receivable.
Accounts receivable are normally collected within a short period, such
as 30 or 60 days.
They are classified on the balance sheet as a current asset.
the beginning balance. It will have a debit balance if the
NOTES RECEIVABLE write offs exceed the beginning balance.
Notes receivable are amounts that customers owe for which a formal,
written instrument of credit has been issued. 2.
Notes are often used for credit periods of more than 60 days.
Notes may also be used to settle a customer’s account receivable.
Notes and accounts receivable that result from sales transactions are
sometimes called trade receivables.
OTHER RECEIVABLE
Other receivables include interest receivable, taxes receivable, and
receivables from officers or employees.
Other receivables are normally reported separately on the balance sheet.
If they are expected to be collected within one year, they are classified as
current assets. If collection is expected beyond one year, they are
classified as noncurrent assets.
Reported under the caption Investments.
Uncollectible Receivables
A major issue that has not yet been discussed is that some customers will
not pay their accounts. That is, some accounts receivable will be
uncollectible.
Companies may shift the risk of uncollectible receivables to other
companies. (For example, some retailers do not accept sales on account,
but will only accept cash or credit cards. Such policies shift the risk to
the credit card companies.)
Companies may also sell their receivables. This is often the case when a
company issues its own credit card.
Selling receivables is called factoring the receivables.
The buyer of the receivables is called a factor.
Regardless of how careful a company is in granting credit, some credit
sales will be uncollectible. The operating expense recorded from
uncollectible receivables is called bad debt expense, uncollectible
accounts expense, or doubtful accounts expense.
Some indications that an account may be uncollectible include the
following:
o The receivable is past due.
o The customer does not respond to the company’s attempts to
collect.
o The customer files for bankruptcy.
o The customer closes its business.
o The company cannot locate the customer.
If a customer doesn’t pay, a company may turn the account over to a
collection agency. After the collection agency attempts to collect
payment, any remaining balance in the account is considered worthless.
The two methods of accounting for uncollectible receivables are as
follows:
o Direct write-off method – records bad debt expense only when an
account is determined to be worthless.
o Allowance method – records bad debt expense by estimating
uncollectible accounts at the end of the accounting period.
are recorded as cash sales. In such cases, receivables are a small part of
the current assets and any bad debt expense is small. Examples of such
businesses are a restaurant, a convenience store, and a small retail store