Chapter 8

Cash and Internal

Control

Chapter
8-1
 Study Objectives

1. Define fraud and internal control.

2. Identify the principles of internal control.
3. Explain the applications of internal control principles
to cash receipts.
4. Explain the applications of internal control principles
to cash disbursements.
5. Describe the operation of a petty cash fund.
6. Indicate the control features of a bank account.
7. Prepare a bank reconciliation.
8. Explain the reporting of cash.
Chapter
8-2
 Fraud, Internal Control, and Cash

Control
Fraud and
Cash Controls Features: Use of Reporting Cash
Internal Control
a Bank

Fraud Cash receipts Making deposits Cash equivalents

The Sarbanes- controls Writing checks Restricted cash
Oxley Act Cash Bank statements Compensating
Internal control disbursements balances
Reconciling the
controls
Principles of bank account
internal control Electronic funds
Limitations transfer (EFT)
system

Chapter
8-3
 Fraud and Internal Control

Fraud
Dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer.

Illustration 8-1

Why does
fraud occur?

Chapter
8-4 SO 1 Define fraud and internal control.
Chapter
8-5
 Fraud and Internal Control

The Sarbanes-Oxley Act

Companies must
develop principles of control over financial
reporting.
continually verify that controls are working.

Independent auditors must attest to the adequacy

of internal control.
SOX created the Public Company Accounting
Oversight Board (PCAOB).
Chapter
8-6 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Internal Control
Methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records.
3. Increase efficiency of operations, and
4. Ensure compliance with laws and regulations.

Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations

are required to maintain an adequate system of internal control.
Chapter
8-7 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Internal Control
Internal control systems have five primary components
1. A control environment
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring

Chapter
8-8 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

Measures vary with
management’s assessment of the risks faced.
size and nature of the company.

Six principles of controls activities:

 Establishment of responsibility
 Segregation of duties
 Documentation procedures
 Physical controls
 Independent internal verification
 Human resource controls
Chapter
8-9 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible
for a given task.
SEGREGATON OF DUTIES
Related duties, including physical custody and record
keeping, should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents for all
documents should be accounted for.
Chapter
8-10 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

PHYSICAL CONTROLS Illustration 8-2

Chapter
8-11 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

Illustration 8-3
INDEPENDENT INTERNAL
VERIFICATION
1. Verify records
periodically or on a
surprise basis.
2. Records verified by an
employee who is
independent.
3. Discrepancies reported
to management.

Chapter
8-12 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

HUMAN RESOURCE CONTROLS
1. Bond employees.
2. Rotate employees’ duties and
require vacations.
3. Conduct background checks.

Chapter
8-13 SO 2 Identify the principles of internal control.
Chapter
8-14
 Fraud and Internal Control

Limitations of Internal Control

Costs should not exceed benefit.
Human element.
Size of the business.

Chapter
8-15 SO 2 Identify the principles of internal control.
 Cash Controls
Cash Receipts Controls
Establishment of Documentation Independent Internal
Responsibility Procedures Verification
Only designated Use remittance Supervisors count cash
personnel are advice (mail receipts daily;
authorized to handle receipts), cash treasurer compares
cash receipts register tapes, and total receipts to bank
(cashiers) deposit slips deposits daily

Segregation of Duties Physical, Human Resource

Different individuals Mechanical, and Controls
receive cash, record Electronic Controls Bond personnel who
cash receipts, and hold Store cash in safes handle cash; require
the cash and bank vaults; limit employees to take
access to storage vacations; deposit all
Illustration 8-4 areas; use cash cash in bank daily
registers
Chapter
8-16 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Discussion Question
Q8-6. At the corner grocery store, all sales clerks
make change out of one cash register drawer. Is this
a violation of internal control? Why?

See notes page for discussion

Chapter
8-17 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Discussion Question
Q8-11. The management of Sewell Company asks
you, as the company accountant, to explain (a) the
concept of reasonable assurance in internal control
and (b) the importance of the human factor in
internal control.

See notes page for discussion

Chapter
8-18 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Cash consists of coins, currency, checks, money

orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets

Chapter
8-19 SO 3 Explain the applications of internal control principles to cash receipts.
 Over-the-
Counter
Receipts

Illustration 8-4

Chapter
8-20 SO 3 Explain the applications of internal control principles to cash receipts.
 Mail Receipts

Control Procedures:
Mail receipts should be opened by two people, a list
prepared, and each check endorsed.

Copy of the list, along with the checks and

remittance advices, sent to cashier’s department.

Cashier adds the checks to the over-the-counter

receipts and prepares a daily cash summary and
makes the daily bank deposit.

Copy of list sent to treasurer’s office for

comparison with total shown on daily cash summary.
Chapter
8-21 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Review Question
Permitting only designated personnel to handle
cash receipts is an application of the principle of:
a. segregation of duties.
b. establishment of responsibility.
c. independent check.
d. Human resource controls.

Chapter
8-22 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Cash Disbursements Controls

Generally, internal control over cash disbursements
is more effective when companies pay by check,
rather than by cash.
Applications:
Voucher system
Petty cash fund

Chapter SO 4 Explain the applications of internal

8-23
control principles to cash disbursements.
 Cash Controls

Cash Disbursements Controls Illustration 8-6

Documentation
Establishment of Procedures Independent Internal
Responsibility Use prenumbered Verification
Only designated checks; checks must Compare checks to
personnel are have an approved invoices; reconcile bank
authorized to sign invoice; require statement monthly
checks (treasurer) and employees to use
approve vendors corporate credit cards
Human Resource
for reimbursable
Controls
Segregation of Duties expenses
Bond personnel
Different individuals who handle cash;
Physical Controls require employees
approve and make
payments; check Store blank checks in to take vacations;
signers do not record safes, with limited conduct background
disbursements access; print check checks
amounts by machine in
Chapter
indelible ink
8-24
 Cash Controls

Discussion Question
Q8-17 Joe Griswold Company’s internal controls over
cash disbursements provide for the treasurer to sign
checks imprinted by a checkwriting machine in indelible
ink after comparing the check with the approved invoice.
Identify the internal control principles that are present
in these controls.

See notes page for discussion

Chapter SO 4 Explain the applications of internal

8-25
control principles to cash disbursements.
 Cash Controls

Review Question
The use of prenumbered checks in disbursing
cash is an application of the principle of:
a. establishment of responsibility.
b. segregation of duties.
c. physical, mechanical, and electronic controls.
d. documentation procedures.

Chapter SO 4 Explain the applications of internal

8-26
control principles to cash disbursements.
 Cash Controls

Cash Disbursements Controls

Voucher System
Network of approvals, by authorized
individuals, to ensure all disbursements by
check are proper.
A voucher is an authorization form prepared
for each expenditure.

Chapter SO 4 Explain the applications of internal

8-27
control principles to cash disbursements.
 Cash Controls

Cash Disbursements Controls

Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,

2. making payments from the fund, and

3. replenishing the fund.

Chapter
8-28 SO 5 Describe the operation of a petty cash fund.
 Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The
fund was established on March 1 with a balance of $100. During
March the following petty cash receipts were found in the petty cash
box.
March 5 Stamp inventory $39
March 7 Freight-out 21
March 9 Miscellaneous expense 6
March 11 Travel expense 24
March 14 Miscellaneous expense 5
The fund was replenished on March 15 when the fund contained $3 in
cash. On March 20, the amount in the fund was increased to $150.
Instructions: Journalize the entries in March that pertain to the
operation of the petty cash fund.

Chapter
8-29 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

E8-8 The fund was established on March 1 with a

balance of $100.

March 1 Petty cash 100

Cash 100

Chapter
8-30 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

E8-8 The fund was replenished on March 15 when the

fund contained $3 in cash.

March 15 Postage expense 39

Freight-out 21
Miscellaneous expense 11
Travel expense 24
Cash over and short 2
Cash 97

Chapter
8-31 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

E8-8 On March 20, the amount in the fund was

increased to $150.

March 20 Petty cash 50

Cash 50

Chapter
8-32 SO 5 Describe the operation of a petty cash fund.
 Control Features: Use of a Bank

Contributes to good internal control over cash.

Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.

Chapter
8-33 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank
Illustration 8-8
Making Bank Deposits
Authorized employee Bank Code
Numbers
should make deposit.

Reverse Side
Front Side
Chapter
8-34 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank

Writing Checks Illustration 8-9

Written order signed by depositor directing bank to pay

a specified sum of money to a designated recipient.

Maker

Payee

Payer

Chapter
8-35 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank
Illustration 8-10
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)

Credit Memorandum
Collect notes
receivable.
Interest earned.

Chapter
8-36 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank

Review Question
The control features of a bank account do not
include:
a. having bank auditors verify the correctness of
the bank balance per books.
b. minimizing the amount of cash that must be kept
on hand.
c. providing a double record of all bank
transactions.
d. safeguarding cash by using a bank as a
depository.
Chapter
8-37 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank

Reconciling the Bank Account

Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.

2. Outstanding checks.

3. Errors.

4. Bank memoranda.

Chapter
8-38 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank
Reconciliation Procedures
Illustration 8-11

+ Deposit in Transit + Notes collected by bank

- Outstanding Checks - NSF (bounced) checks
+- Bank Errors - Check printing or other
service charges
+- Company Errors
CORRECT BALANCE CORRECT BALANCE

Chapter
8-39 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank
E8-11 The following information pertains to Family Video Company.
1. Cash balance per bank, July 31, $7,263.
2. Cash balance per books, July 31, $7,284.
3. July bank service charge not recorded by the depositor $28.
4. Deposits in transit, July 31, $1,500.
5. Bank collected $900 note for Family in July, plus interest $36,
less fee $20.The collection has not been recorded by Family, and
no interest has been accrued.
6. Outstanding checks, July 31, $591.
Instructions
a) Prepare a bank reconciliation at July 31.
b) Journalize the adjusting entries at July 31 on the books of Family
Video Company.
Chapter
8-40 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

E8-11 a) Prepare a bank reconciliation at July 31.

Cash balance per bank statement $7,263
Add: Deposit in transit 1,500
Less: Outstanding checks (591)
Adjusted cash balance per bank $8,172

Cash balance per books $7,284

Add: Collection of notes receivable 900
Collection of interest 36
Less: Bank service charge (28)
Note collection fee (20)
Adjusted cash balance per books $8,172

Chapter
8-41 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

E8-11 b) Journalize the adjusting entries at July 31 on

the books of Family Video Company. Dr. Cr.
July 31 Miscellaneous expense 28
Cash 28
July 31 Cash 916
Miscellaneous expense 20
Interest revenue 36
Notes receivable 900
Note: Adjusting journal entry includes only the
adjustments to the cash balance per books.

Chapter
8-42 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

Review Question
The reconciling item in a bank reconciliation that
will result in an adjusting entry by the depositor
is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.

Chapter
8-43 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

Electronic Funds Transfers (EFT)

Disbursement systems that uses wire,
telephone, or computers to transfer cash
balances between locations.
EFT transfers normally result in better
internal control since no cash or checks are
handled by company employees.

Chapter
8-44 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

Discussion Question
Q8-23. Lori Figgs is confused about the lack of
agreement between the cash balance per books and the
balance per the bank. Explain the causes for the lack of
agreement to Lori, and give an example of each cause.

See notes page for discussion

Chapter
8-45 SO 7 Prepare a bank reconciliation.
 Reporting Cash
Cash consists of coins, currency (paper money), checks,
money orders, and money on hand or on deposit in a bank
or similar depository.
Illustration 8-14

Cash equivalents
Restricted cash
Compensating balances
Chapter
8-46 SO 8 Explain the reporting of cash.
 Reporting Cash

Review Question
Which of the following statements correctly
describes the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with
Cash.
c. Cash is listed first in the current assets
section.
d. Restricted cash funds cannot be reported as a
current asset.
Chapter
8-47 SO 8 Explain the reporting of cash.