UNIT FOUR

INTERNAL CONTROL OVER CASH

Cash is the most liquid of all assets. It consists coins, currency, checks, and money on
hand or in bank .Generally, anything that the bank accepts for deposit at its face value is
said to be cash. Cash is an asset that is readily convertible into any other type of assets; it
is highly concealed and transported; and it is highly desired. Because of these
characteristics, cash is the asset most susceptible to improper diversion and use.
Moreover, because of the large volume of cash transactions, various errors may occur in
executing and recording cash transactions.
For proper safeguarding of cash and to assure the accuracy of the accounting records for
cash, effective internal control over cash is essential. Internal control is a system designed
to safeguard the assets of a business and to help in ensuring the accuracy and reliability of
the accounting records.
Internal control over cash
Internal control is a system designed to safeguard the assets of a business and to ensure
the accuracy and reliability of the accounting records. The accounting system should be
organized and operated in the manner that the work of one person is checked by another,
with minimum duplication of effort.
Cash is the most precious and most easily stolen asset of the business. It can easily be
transferred, is most likely to be diverted and used improperly. In addition, many
transactions either directly or indirectly affect the receipts or payments of cash.
Therefore, it is necessary that all the money received from sale of goods or services must
be protected to make it available for payment of expenses, and other obligations. In
addition, there must also be control over payments so that none of the firm’s cash is spent
without proper authorization or supervision.

Internal Control over Cash Receipts

Since cash can easily be lost or stolen, management must use special care in safeguarding
its receipts. Management and the accountant must set up a system for the internal control
of cash receipts. One important control procedure is promptly depositing the daily cash
receipts in the bank. Another important control procedure is to divide the duties of
receiving, recording, and depositing cash among different persons.
The following preventive measures may be used to safeguard cash receipts.
1. One person should receive cash, whether it is delivered by mail or in person (over
the counter). After making a record of the receipts, this person should hand the
cash over to another person for deposit in the bank.
2. All daily cash receipts should be deposited in the bank promptly.
3. A person other than the one who receives the cash or the one who deposits it in
the bank should make the entries for cash receipts in the firm’s accounting
records.
4. At the end of each month, a person other than the three mentioned above should
obtain the bank statement directly from the bank and should prepare bank
reconciliation.

1
Internal Control over Cash Payments
The control procedures for cash receipts are only one part of a well-designed system of
internal control. There must also be control over cash payments to ensure that none of the
firm’s cash is spent without proper authorization or supervision.
Internal control over cash payments may be achieved by adopting certain policies and by
planning work assignments. The following are some of the means to enhance internal
control over cash payments.
1. All payments should be made by check, except for minor payments for which
petty cash fund should be established.
2. No check should be issued before a proper approval and authorization of the
payment.
3. Only experienced and responsible personnel should approve bills.
4. The one who does not authorizes, Signs and mails checks, should keep the records
of payments.

Bank Account as a Tool for Controlling Cash

One of the major devices for maintaining control over cash is the use of a bank account.
An efficient controlling system requires the deposit of all cash receipts in the bank and all
payments by checks drawn on the bank or from special cash funds. When a business
strictly follows the system of depositing all cash receipts in a bank and paying all of its
obligations by drawing a check on the bank, there will be double records for cash: one
maintained by the business (depositor) and the other by the bank.
The forms used by a business in connection with a bank account are the following:
Signature Card: - when a business opens an account in a bank, the person authorized to
sign checks for the firm to make payments will provide his signature to the bank. At the
time an account is opened, the bank will assign an identifying number to the firm’s
account and the authorized person to sign checks drawn on the account will sign on a
signature card. The card is used by the bank to determine the validity of the signature on
checks presented to it for payment. The signature card serves as a contract between the
depositor and the bank. It authorizes the bank to make payments from funds in the
depositor’s account on checks that have the authorized signature.
Deposit Slip/Ticket: – A form, called a deposit slip, or a deposit ticket, must be prepared
for each bank deposit. These forms are provided to the depositor by the bank in which the
account is maintained and are usually preprinted with the assigned account number. The
depositor on the deposit slip lists the details of each deposit and it will be stamped or
initialed by the bank’s teller and given to the depositor as a receipt. The stamped deposit
slip gives the depositor written proof of the date and the total amount of the deposit.
Check: - A check is a written order signed by the depositor or other authorized person
(the drawer) instructing the bank (the drawee) to pay a specific sum of money to the
person designated (the payee). There are three parties to a check. The “drawer,’’ the one
who signs the check; the “drawee,’’ the bank on which the check is drawn;’’ and the
“payee,’’ the one to whom the payment is made.

2
The Bank Statement
Once a month, the bank sends each depositor, a statement of the deposits received and the
checks paid. The bank statement shows the balance at the beginning of the period, checks
withdrawn and other debits (deductions by the bank) made by the bank on the depositor’s
bank account, deposits and other credits (additions by the bank), and the balance at the
end of the period.
Bank Reconciliation
Dear Learners, since the bank and depositor maintain independent records of the
depositor’s checking account, it may seem that the balance as per the two will always
agree, but they are not likely to be equal on any specific date, hence the process of
bringing the two balances to one is called bank reconciliation.
The lack of agreement between the two balances is due to:
 Time lag of one party in recording the transaction.
 Error by either party in recording the transaction.
Some checks may have been written and entered in the firm’s journal but they may not
have been paid by the bank and charged to the depositor's account before the end of the
month .A deposit recorded in the firm’s journal may have reached the bank too late to be
included in the bank statement for the current month. The bank might have deducted
service charges or other items that have not yet been entered on the depositors’ record.

Bank reconciliation procedures

A company's general ledger account cash contains a record of transactions (checks
written, receipts from customers, etc.) that involve its checking account. The bank also
creates a record of the company's checking account when it processes the company's
checks, deposits, service charges, and other items. Soon after the ends of each month, the
bank usually mails a bank statement to the company. The bank statement lists the
activity in the bank account during the recent month as well as the balance in the bank
account. When the company receives its bank statement, the company should verify that
the amounts on the bank statement are consistent or compatible with the amounts in the
company's cash account in its general ledger and vice versa. This process of confirming
the amounts is referred to as reconciling the bank statement. The benefit of reconciling
the bank statement is to know the amount of cash reported by the company (company's
books) is consistent with the amount of cash shown in the bank's records.
As most companies write hundreds of checks each month and make many deposits,
reconciling the amounts on the company's books with the amounts on the bank statement
can be time consuming. The process is complicated because some items appear in the
company's cash account in one month, but appear on the bank statement in a different
month.
For example, checks written near the end of August are deducted immediately on the
company's books, but those checks will likely clear the bank account in early September.
On the other hand, sometimes the bank decreases the company's bank account without
informing the company of the amount. For example, a bank service charge might be
deducted on the bank statement on August 31, but the company will not know the amount
until the company receives the debit memorandum for such deduction together with the
bank statement in early September.

3
From these two examples, you can understand why there is likely be a difference of cash
balance of bank statement vs. cash balance in the company's books. It is also possible
(perhaps likely) that neither balance is the true balance. Both balances may need
adjustment in order to report the true amount of cash.
After you adjust the balance per bank statement and the balance per books to the true
balance, it is said you have reconciled the bank statement. Most accountants would
simply say that you have done the bank reconciliation.
Steps in Reconciliation Process
Step 1. Adjusting the Balance per Bank
The bank reconciliation process is demonstrated by several steps. The first step is to
adjust the balance on the bank statement to the true, adjusted, or corrected balance. The
items necessary for this step are listed in the following schedule:
Step 1. Balance per Bank Statement on Aug 31. 2006
Adjustments:
Add: Deposits in transit
Deduct: Outstanding checks
Add or Deduct: Bank errors
Adjusted/Corrected Balance per Bank
Deposits in transit are deposits already sent to the bank and recorded by the company,
but are not yet recorded by the bank. For example, a retail store deposits its cash receipts
of August 31 into the bank's night depository at 10:00 p.m. on August 31. The bank will
process this deposit on the morning of September 1. This is a deposit in transit as of
August 31 (the bank statement date).
Since deposits in transit are already included in the company's cash account, there is no
need to adjust the company's records. However, deposits in transit are not yet appeared on
bank statement. Therefore, they need to be listed on the bank reconciliation as an increase
to the balance per bank statement in order to report the true amount of cash. A helpful
rule of thumb is "put it where it isn't." A deposit in transit is on the company's book, but it
is not on the bank statement. Put it where it is not: as an adjustment to the balance on the
bank statement.
Outstanding checks are checks that have been written and recorded in the company's
cash account, but have not yet cleared the bank. Checks written during the last few days
of the month plus a few older checks is likely to be among the outstanding checks.
As all checks that have been written are immediately recorded in the company's cash
account, there is no need to adjust the company's records for the outstanding checks.
However, the outstanding checks have not yet reached the bank and the bank statement.
Therefore, outstanding checks are listed on the bank reconciliation as a decrease in the
balance per bank.
Recall the helpful tip "put it where it isn't." An outstanding check is on the company's
book, but it is not on the bank statement. Put it where it is not: as an adjustment to the
balance on the bank statement.
Bank errors are mistakes made by the bank. Bank errors could include the bank
recording an incorrect amount, entering an amount that does not belong on a company's
bank statement, or omitting an amount from a company's bank statement. The company

4
should notify the bank of its errors. Depending on the error, the correction could increase
or decrease the balance shown on the bank statement. (Since the company did not make
the error, the company's records are not affected).
Step 2. Adjusting the Balance per Books
The second step of the bank reconciliation is to adjust the balance in the company's cash
account so that it is the true, adjusted, or corrected balance. Examples of the items
involved are shown in the following schedule:
Step 2. Balance per Books on Aug, 31 2006
Adjustments:
Add: Notes collected by the bank
Deduct: Bank service charges
Deduct: NSF checks & fees
Add or Deduct: Errors in company's cash account
Adjusted/Corrected Balance per Books

Bank service charges are fees deducted from the bank statement for the bank's
processing activities related to the checking account (accepting deposits, posting checks,
mailing the bank statement, etc.) Other types of bank service charges include the fee
charged when a company overdraws its checking account and the bank fee for processing
a stop payment order on a company's check. The bank might deduct these charges or fees
on the bank statement without notifying the company. When that occurs, the company
usually learns of the amounts only after receiving its bank statement.
Since the bank service charges have already been deducted on the bank statement, there
is no adjustment to the balance per bank statement. However, the service charges will
have to be entered as an adjustment to the company's book. The company's cash account
needs to be decreased by the amount of the service charges.
Recall the helpful tip "put it where it isn't." A bank service charge is already listed on the
bank statement, but it is not on the company's books. Put it where it is not: as an
adjustment to the cash account on the company's book.

An NSF check is a check that was not honored by the bank of the person or company
writing the check because that account did not have a sufficient balance. As a result, the
check is returned without being honored or paid. (NSF is the acronym for not sufficient
funds and the bank describes the returned check as a return item. Others refer to the NSF
check as a "rubber check" because the check "bounced" back from the bank on which it
was written.) When the NSF check comes back to the bank in which it was deposited, the
bank will decrease the checking account of the company that had deposited the check.
The amount charged will be the amount of the check plus a bank fee.

Since the NSF check and the related bank fee have already been deducted on the bank
statement, there is no need to adjust the balance per the bank. However, if the company
has not yet decreased its cash account balance for the returned check and the bank fee,
the company must decrease the balance per books in order to reconcile.

5
Check printing charges occur when a company arranges for its bank to handle the
reordering of its checks. The cost of the printed checks will automatically be deducted
from the company's checking account.
Since the check printing charges have already been deducted on the bank statement,
there is no adjustment to the balance per bank. However, the check printing charges need
to be adjusted to the company book. They will be a deduction to company's Cash
account.
Interest earned will appear on the bank statement when a bank gives a company interest
on its account balances. The amount is added to the checking account balance and is
automatically on the bank statement. Hence, there is no need to adjust the balance per the
bank statement. However, the amount of interest earned will increase the balance in the
company's cash account on its books. Recall "put it where it isn't." Interest earned on the
current account in the bank is on the bank statement, but it is not on the company's books.
Put it where it is not: as an adjustment to the cash account on the company's book.
Notes Receivables are assets of a company. When notes come due, the company might
ask its bank to collect the note receivable. For this service, the bank will charge a fee. The
bank increases the company's checking account for the amount it collected (principal plus
interest) and will decrease the account by the collection fee it charges. Since these
amounts are already on the bank statement, the company must be certain that the amounts
appear on the company's book in its cash account.

Recall the tip "put it where it isn't." The amounts collected by the bank and the bank's
fees are on the bank statement, but they are not on the company's book. Put them where
they are not: as adjustments to the cash account on the company's book.
Errors in the company's cash account result from the company entering an incorrect
amount, entering a transaction that does not belong in the account, or omitting a
transaction that should be in the account. Since the company made these errors, the
correction of the error will be either an increase or a decrease to the balance in the cash
account on the company's books.

Step 3. Comparing the Adjusted Balances

Dear learners, after adjusting the balance per bank (step 1) and the balance per book (step
2), the two adjusted amounts should be equal. If they are not equal, you must repeat the
process until the balances are identical.
The balances should be the true, correct amount of cash as of the date of the bank
reconciliation.

Step 4. Preparing Journal Entries

Journal entries must be prepared for the adjustments to the balance per book (step 2).
Adjustments to increase the cash balance require a journal entry that debits cash account
and credits another account. Adjustments to decrease the cash balance require a credit to
cash and a debit to another account.
Example:
a. On February 28, the V. Trading received a bank statement. The cash balance as
per bank statement was Br. 29,517.72. On the other hand, the firms’ cash ledger
has got balance of Br. 28, 243.15 on the same date.

6
 b. A total debit memorandum was Br .39 of which Br. 25 is NSF check and Br. 14 is
for bank service charge.
c. In verifying the canceled checks, it was found that a Br. 100 check was charged
by mistake to the account of the V. Trading on February 28 and included in the
canceled checks.
d. Outstanding checks were identified and listed as follows:
 Check No. 117, Br.127.56
 Check No. 118, Br.101.01
 Check No. 120, Br.375.00
e. Deposits in transit total Br. 220
f. Note and interest collected by bank Br 1,030.00

Bank reconciliation for V. trading will be prepared as follow:

V. Trading
Bank Reconciliation
February 28, 19X1
Balance on bank statement……………………………………………..Br. 29, 517.72
Add: Deposit in transit……………………………Br. 220
Bank error ……………………………… 100 320____
29,837.72
Deduct: Outstanding checks:
No 117, Feb. 27………………………Br. 127.56
No. 118, Feb.28 ……………………. 101.01
No. 120, Feb 28 ………………….. 375 603.57
Adjusted cash Balance…………………………………………………Br. 29,234.15

Balance as per depositor……………………………………………… Br 28, 243.75

Add Note and interest collected by bank ……………………………… 1,030.00
Br. 29,273.15
Deduct: Bank service charge ………………….. Br…14
NSF check………………………………. 25 39.00
Adjusted cash Balance………………………………………………… Br. 29,234.15

Preparing the journal entries

The last step is passing the journal entries for all data adjusted on cash balance as per
book. In other words, items in the second section of the bank reconciliation require
entries on the book of depositor to correct the cash account balance. The data used for
adjustment are those in the bank reconciliation section that begins with the balance as per
book. All information adjusted on the book balance in the reconciliation should be
recorded in the firm’s ledger.

The entries for V. Trading, based on the bank reconciliation above, are as follows:

Feb. 28 Cash in Bank…………………….1030

7
 Notes Receivable………………………….1000
Interest income ………………………………30
(To record collection of receivable and interest by bank on behalf the V.Trading)

Feb. 28 Miscellaneous expense…………………..14

Cash in Ban……………………….14
(To record bank service charge)

Feb. 28 Account receivable……………….25

Cash in Bank………………………..25
(To record NSF check)

After these entries are posted, the cash account balance will be Br. 29,234.15, the same
figure as the adjusted balance on the bank reconciliation. This is the amount of cash
available for use as of Feb.28 for preparation of balance sheet on the same day.

The Petty Cash Funds

Although payments should be made through check after proper authorization has been
given for the payment, sometimes it is not practical to make every payment through
writing checks. There are times when small expenditures must be made in cash. In most
businesses, there is a frequent need for the payment of relatively small amounts, such as
for postage due, transportation charges, or purchase of urgently needed supplies at a
nearby retail store. Payment by check in such cases would result in delay, displeasure and
higher cost. Therefore, most businesses find it convenient to pay such small expenses in
cash. The small amount of cash kept o hand for such minor expenditures is called petty
cash.
In establishing a petty cash fund, the first step is to estimate the amount of cash for such
relatively small disbursements.The initial fund would be created by issuing a check for
the estimated amount. Usually Br.100 would be sufficient for most small business needs;
however, larger businesses may have several thousand birr in the funds available as petty
cash. The entry for this initial fund would be to debit petty cash fund account and credit
cash in bank account.
The second step is making the payments from the petty cash fund. The payment to be
made from the petty cash fund is usually limited to a predetermined minimum such as Br.
100. This means those payments, which are greater than Br. 100 will not be paid from the
petty cash fund. As expenditures are made, the custodian of the fund will reimburse
employees and secure a petty cash voucher in return. At any given time the total of cash
on hand plus reimbursed vouchers must equal the original fund, if not, there is cash short
or over.
Finally, When the amount of money in the petty cash fund is reduced, the fund is
replenished (restored to its established balance).

Example:
Assume that W Company has established petty cash fund of Br. 300 on May 1of the
current year. At the end of the month, the petty cash vouchers revealed the following
expenditures:

8
  Office supplies………………….. ………… ..Br. 47.50.
 Postage………….. ………. ………………… 22
 Store supplies…………………….. ………… 35
 Delivery, expense………………….. …………. 62
 Daily newspaper (miscellaneous expense)....... 87.7
Total……………………………………… Br. 245.2
To record the establishment and replenishment of the petty cash fund, the entries would
be as follows:
May 1. Petty Cash…………………………………… 300
Cash in Bank……………………………………. 300
(To record establishment of petty cash fund)

May 30. Office Supplies……………..Br. 47.50

Postage ……………………….. 22
Store Supplies………………….. 35
Delivery Expense……………… .62
Miscellanies Expense………….. 87.7
Cash in Bank 245.2
(To record the payment from the petty cash and replenishment of the petty cash fund).

It should be noted that the only entry in the petty cash fund account is the initial debit (the
debit made when the petty cash is established). Unless at some other time the standard
amount of the fund (Br. 300 in this case) is increased or decreased, no entry is made in
the Petty Cash account. The expenditures from the petty cash fund are recorded in the
accounts only when the fund is replenished.