7 Internal Control Cash

Learning Objectives
1 Definition of cash

2 Apply internal control principles to cash.

3 Identify the control features of a bank account.

4 Do Exercises

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LEARNING
OBJECTIVE
1 Definition and features of cash

Definition of cash
 Cash consists of coins, currency (paper money), checks,
money orders, and money on hand or on deposit in a
bank or similar depository.
 Companies report cash in two different statements: the
balance sheet and the statement of cash flows. The
balance sheet reports the amount of cash available at a
given point in time. The statement of cash flows shows
the sources and uses of cash during a period of time.

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LEARNING
OBJECTIVE
1 Definition and features of cash

Features of cash
 Cash is the one asset that is readily convertible into other
type of asset. It is easily concealed and transported, and
highly desired => Cash is the asset most susceptible to
fraudulent activates
 Because of the large volume of cash transactions,
numerous errors may occur in executing and
recording them

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LEARNING Apply internal control principles to
2
OBJECTIVE cash.

Cash Receipt Controls

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 Cash Receipt Controls

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 Cash Controls

OVER-THE-
COUNTER
RECEIPTS
Important internal
control principle—
segregation of record-
keeping from physical
custody.

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 Cash Receipt Controls

MAIL RECEIPTS
 Mail receipts should be opened by two mail clerks, a list
prepared, and each check endorsed “For Deposit Only.”
 Each mail clerk signs the list to establish responsibility for
the data.
 Original copy of the list, along with the checks, is sent to
the cashier’s department.
 Copy of the list is sent to the accounting department for
recording. Clerks also keep a copy.

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 Cash Receipt Controls

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. other controls.

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 Cash Disbursement Controls

Generally, internal control over cash disbursements is more

effective when companies pay by check or electronic funds
transfer (EFT) rather than by cash.

One exception is payments for incidental amounts that are

paid out of petty cash.

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 Cash Disbursement

Illustration:
Application of internal
control principles to cash
disbursements

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 Cash Disbursement Controls

Illustration 8-6
Application of internal
control principles to cash
disbursements

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 Cash Disbursement Controls

Question
The use of prenumbered checks in disbursing cash is an
application of the principle of:

a. segregation of duties.

b. establishment of responsibility.

c. physical, mechanical, and electronic controls.

d. documentation procedures.

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 Cash Disbursement Controls

VOUCHER SYSTEM CONTROLS

 A network of approvals by authorized individuals, acting
independently, to ensure all disbursements by check are
proper.

 A voucher is an authorization form prepared for each

expenditure in a voucher system.

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 Petty Cash Fund

Petty Cash Fund - Used to pay small amounts.

Involves:
1. establishing the fund,
2. making payments from the
fund, and
3. replenishing the fund.

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 Ethics Insight
How Employees Steal
Occupational fraud is using your own occupation for personal gain through
the misuse or misapplication of the company’s resources or assets. This
type of fraud is one of three types:
1. Asset misappropriation, such as theft of cash on hand, fraudulent
disbursements, false refunds, ghost employees, personal purchases,
and fictitious employees. This fraud is the most common but the least
costly.
2. Corruption, such as bribery, illegal gratuities, and economic extortion.
This fraud generally falls in the middle between asset misappropriation
and financial statement fraud as regards frequency and cost.
3. Financial statement fraud, such as fictitious revenues, concealed
liabilities and expenses, improper disclosures, and improper asset
values. This fraud occurs less frequently than other types of fraud but it
is the most costly.
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 Ethics Insight
How Employees Steal
The graph below shows the frequency and the median loss for each type of
occupational fraud.

Source: 2014 Report to the Nations on Occupational Fraud and Abuse, Association of
Certified Fraud Examiners, pp. 10–12.

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 LEARNING Identify the control features of a bank
3
OBJECTIVE account.

The use of a bank contributes significantly to good

internal control over cash.
 Minimizes the amount of currency on hand.
 Creates a double record of bank transactions.
 Bank reconciliation.
Helpful Hint
Essentially, the bank
statement is a copy of the
bank’s records sent to the
customer (or available
online) for review.

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 Making Bank Deposits
Illustration 8-8
Authorized
employee should
make deposit.

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 Writing Checks

Written order signed by depositor directing bank to pay a

specified sum of money to a designated recipient.

Maker

Payee

Payer

Illustration 8-9
Check

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 Bank Statements

DEBIT
MEMORANDUM
 Bank service charge.
 NSF (not sufficient
funds).

CREDIT
MEMORANDUM
 Collect notes
receivable.
 Interest earned.
Illustration 8-10
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LO 3
 Bank Statements

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.

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 Reconciling the Bank Account

Reconcile balance per books and balance per bank to their

“correct” or “true” balance.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks. Time Lags
3. Bank memoranda.
4. Errors.

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 Reconciling the Bank Account

RECONCILIATION PROCEDURES Illustration

Bank reconciliation
adjustments

+ 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

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 RECONCILIATION PROCEDURES

(Illustration 8-10)

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 RECONCILIATION PROCEDURES

Illustration: Prepare a bank reconciliation at April 30.

Cash balance per bank statement $15,907.45

Deposit in transit 2,201.40
Outstanding checks (5,904.00)
Adjusted cash balance per bank $12,204.85

Cash balance per books $11,589.45

Error in check No. 443 36.00
NSF check (425.60)
Bank service charge (30.00)
Collection of notes receivable 1,035.00
Adjusted cash balance per books $12,204.85

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 Reconciling the Bank Account

ENTRIES FROM BANK RECONCILIATION

COLLECTION OF NOTE RECEIVABLE: Assuming interest of
$50 has not been accrued and collection fee is charged to
Miscellaneous Expense, the entry is:

Apr. 30 Cash 1,035.00

Miscellaneous Expense 15.00
Notes Receivable 1,000.00
Interest Revenue 50.00

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 ENTRIES FROM BANK RECONCILIATION

BOOK ERROR: The cash disbursements journal shows that

check no. 443 was a payment on account to Andrea Company, a
supplier. The correcting entry is:

Apr. 30 Cash 36.00

Accounts Payable 36.00

NSF CHECK: As indicated earlier, an NSF check becomes an

account receivable to the depositor. The entry is:

Apr. 30 Accounts Receivable 425.60

Cash 425.60
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 ENTRIES FROM BANK RECONCILIATION

BANK SERVICE CHARGES: Depositors debit check printing

charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:

Apr. 30 Miscellaneous Expense 30.00

Cash 30.00

Illustration 8-13

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 Reconciling the Bank Account

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.

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 Electronic Funds Transfer (EFT) System

 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.

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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 1: The following control procedures are used at Torres

Company for over-the-counter cash receipts.
1. To minimize the risk of robbery, cash in excess of $100 is stored in
an unlocked attaché case in the stock room until it is deposited in the
bank.
2. All over-the-counter receipts are processed by three clerks who use
a cash register with a single cash drawer.
3. The company accountant makes the bank deposit and then records
the day’s receipts.
4. At the end of each day, the total receipts are counted by the cashier
on duty and reconciled to the cash register total.
Instructions
(a) For each procedure, explain the weakness in internal control, and
identify the control principle that is violated.
(b) For each weakness, suggest a change in procedure that will result
in good internal control.
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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 1: Answer

Procedures Weakness Principle Recommended Change

1 Cash is not adequately Physical Cash should be stored in

Protected from theft. controls. a safe until it is
deposited
in bank.

2 Inability to establish Establishment A cashier office

Responsibility for cash of responsibility supervisor should count
with a specific clerk. cash.

3 The accountant Segregation The cashier’s department

should not of duties. should make the
handle cash. deposits.

4 Cash is not Independent A cashier office

independently Internal verification. supervisor should count
counted. cash.

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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 2: The following control procedures are used in Mendy

Lang’s Boutique Shoppe for cash disbursements.
1. The company accountant prepares the bank reconciliation and
reports any discrepancies to the owner.
2. The store manager personally approves all payments before
signing and issuing checks.
3. Each week, 100 company checks are left in an unmarked envelope
on a shelf behind the cash register.
4. After payment, bills are fi led in a paid invoice folder.
5. The company checks are unnumbered.
Instructions
(a) For each procedure, explain the weakness in internal control, and
identify the internal control principle that is violated.
(b) For each weakness, suggest a change in the procedure that will
result in good internal control.

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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 2: Answer
Procedures Weakness Principle Recommended Change

1 The bank reconciliation Independent Someone with no other cash

is not independently internal responsibilities should
prepared. verification. prepare the bank
reconciliation.

2 The approval and Segregation The store manager should

payment of bills is done of duties. approve bills for payment
by the same individual. and the treasurer should
sign
and issue checks.

3 Checks are not stored in Physical Checks should be stored in

a secure area. controls. a safe or locked file drawer.

4 After payment, Documentation Bills should be stamped

bills are simply procedures. PAID before being placed
filed in a folder. in the folder.

5 Checks are not Documentation Checks should be

prenumbered. procedures. prenumbered and
subsequently accounted for.
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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 3: At Martinez Company, checks are not prenumbered

because both the purchasing agent and the treasurer are authorized
to issue checks. Each signer has access to unissued checks kept in
an unlocked file cabinet. The purchasing agent pays all bills pertaining
to goods purchased for resale. Prior to payment, the purchasing agent
determines that the goods have been received and verifies the
mathematical accuracy of the vendor’s invoice. After payment, the
invoice is filed by vendor name and the purchasing agent records the
payment in the cash disbursements journal. The treasurer pays all
other bills following approval by authorized employees. After payment,
the treasurer stamps all bills “paid,” files them by payment date, and
records the checks in the cash disbursements journal. Martinez
Company maintains one checking account that is reconciled by the
treasurer.
Instructions
(a) List the weaknesses in internal control over cash disbursements.
(b) Identify improvements for correcting these weaknesses.
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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 3: Answer
(a) Weaknesses (b) Suggested Improvement

1 Checks are not prenumbered. Use prenumbered checks.

2 The purchasing agent signs Only the treasurer’s department

checks. personnel should sign checks.

3 Unissued checks are stored in Unissued checks should be stored

unlocked file cabinet. in a locked file cabinet with access
restricted to authorized personnel

4 After payment, bills are simply Bills should be stamped PAID

filed in a folder. before being placed in the folder

5 After payment, the invoice is The invoice should be stamped

filed. PAID.

6 The purchasing agent records Only accounting department

payments in cash personnel should record cash
disbursements journal. disbursements.

7 The treasurer records the Same as answer to No. 6 above.

checks in cash disbursements
journal.

8 The treasurer reconciles the An internal auditor should

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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 3: Answer
I have reviewed your cash disbursements system and suggest that
you make the following improvements:
1. Danner Company should use prenumbered checks. These should
be stored in a locked file cabinet or safe with access restricted to
authorized personnel.
2. The purchasing department should approve bills for payment. The
treasurer’s department should prepare and sign the checks. The
invoices should be stamped paid so that they cannot be paid twice.
3. Only the accounting department personnel should record cash
disbursements.
4. An internal auditor should reconcile the bank statement.
If you have any questions about implementing these suggestions,
please contact me.

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 LEARNING
OBJECTIVE
4 Do Exercises

Exercise 4: Listed below are five procedures followed by Eikenberry

Company.
1. Several individuals operate the cash register using the same
register drawer.
2. A monthly bank reconciliation is prepared by someone who has no
other cash responsibilities.
3. Joe Cockrell writes checks and also records cash payment journal
entries.
4. One individual orders inventory, while a different individual
authorizes payments.
5. Unnumbered sales invoices from credit sales are forwarded to the
accounting department every four weeks for recording.
Instructions:
Indicate whether each procedure is an example of good internal
control or of weak internal control. If it is an example of good internal
control, indicate which internal control principle is being followed. If it
is an example of weak internal control, indicate which
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internal control principle is violated.
 Exercise 4
Answer:

IC good or weak? Related internal control principle

1 Weak Establishment of Responsibility

2 Good Independent Internal Verification
3 Weak Segregation of Duties
4 Good Segregation of Duties
5 Weak Documentation Procedures

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