CH 07

Internal Control, Managing Cash, and Making Ethical Judgments Chapter 7
2002 Prentice Hall, Inc.
Business Publishing
Accounting, 5/E
Horngren/Harrison/Bamber
7-1
Objective 1
Define internal control.
Business Publishing
Accounting, 5/E
7-2
Internal Control
What is internal control? It is the organizational plan and all the related measures that an entity adopts to safeguard assets, encourage adherence to company policies, promote operational efficiency, and... ensure accurate and reliable accounting records.
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7-3
Internal Control
Operational Controls
Financial Reporting Controls
Business Publishing
Accounting, 5/E
7-4
Objective 2
Identify the characteristics of an effective system of internal control.
Business Publishing
Accounting, 5/E
7-5
Establishing an Effective System of Internal Control
2
3 4
Characteristics of an effective internal control system include: Competent, reliable, and ethical personnel Assignment of responsibilities Proper authorization Separation of duties
Business Publishing
Accounting, 5/E
7-6
Separation of Duties
Separation of operations from accounting
Separation of the custody of assets from accounting Separation of the authorization of transactions from the custody of related assets Separation of duties within the accounting function
Internal Controls for e-Commerce

Stolen credit card numbers
Computer virus and Trojan horses Impersonation of companies
Business Publishing
Accounting, 5/E
7-8

What is an encryption? It is the primary method of achieving confidentiality in e-commerce. Plain-text messages are rearranged by some mathematical process. The encrypted message cannot be read by anyone who does not know the process.

The Internet
Network Computers
Firewall
Corporate Intranet
Business Publishing
Accounting, 5/E
7 - 10
The Limitations of Internal Control

Most internal control measures can be circumvented or overcome. Collusion is when two or more employees work as a team with the purpose to defraud the firm.
Business Publishing
Accounting, 5/E
7 - 11
The Bank Account as a Control Device

Documents used to control a bank account include: signature card deposit ticket check bank statement bank reconciliation
Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7 - 12
The Bank Reconciliation

1
What are two records of a businesss cash? Cash account in the businesss own general ledger. The bank statement which tells the actual amount of cash the business has in the bank.
Business Publishing
Accounting, 5/E
7 - 13

Items recorded by a company not on the bank statement: deposit in transit outstanding checks
Business Publishing
Accounting, 5/E
7 - 14

Items on a bank statement and not recorded by the business: bank collections bank fees interest earned on account NSF checks
Business Publishing
Accounting, 5/E
7 - 15
The Paths That Two Checks Take (Good Check)

Maker writes check to payee.
Makers bank pays the check. Payee deposits check in bank.
Payees bank sends check to makers bank.

2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E
7 - 16
The Paths That Two Checks Take (NFS Check)

Makers bank balance is not sufficient to pay the check. Payee holds worthless check.
Makers bank sends the worthless check back to payees bank.
Payees bank decreases payees balance.

Accounting, 5/E
Business Publishing
7 - 17
Objective 3
Prepare a bank reconciliation and the related journal entries.
Business Publishing
Accounting, 5/E
7 - 18
The Bank Reconciliation Example

At the beginning of July, Sahita, Inc. received the Junes bank statement. It indicated the following: The bank balance was $63,275. The bank had collected a note receivable from one of Sahitas customers in the amount of $1,325.
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7 - 19

The bank paid the electric bill of $1,500. There was a $200 check returned for NSF. Interest earned on the account was $265. Bank service charges were $12.
Business Publishing
Accounting, 5/E
7 - 20

Sahitas books indicates a cash balance of $66,647. A deposit of $11,250 was mailed to the bank on June 30. Checks issued in June for $8,000 have not yet been paid by the bank.
Business Publishing
Accounting, 5/E
7 - 21

Balance per bank, June 30 Add deposit in transit Less outstanding check Adjusted bank balance $63,275 11,250 $74,525 8,000 $66,525
Business Publishing
Accounting, 5/E
7 - 22

Balance per books, June 30 Add: Note receivable collected by the bank Interest income Less: Payment of electric bill NSF check Service charge Adjusted book balance
$66,647 1,325 265 $68,237 1,500 200 12 $ 66,525

Horngren/Harrison/Bamber 7 - 23

Balance per books $66,525 Balance per bank $66,525
Equal amounts
Business Publishing
Accounting, 5/E
7 - 24
Record Reconciling Items

June 30, 200x Cash 1,325 Notes Receivable Notes collected by the bank
1,325
June 30, 200x Cash 265 Interest Income 265 Interest earned on bank balance

June 30, 200x Utilities Expense Cash Monthly electricity expense June 30, 200x Accounts Receivable NSF Cash NSF check returned by bank
1,500
1,500
200
200
June 30, 200x Bank Service Fees Cash Bank service charges
12
12
Business Publishing
Accounting, 5/E
7 - 27
Objective 4
Apply internal controls to cash receipts.
Business Publishing
Accounting, 5/E
7 - 28
Cash Receipts Over the Counter

The terminal should be positioned so that customers can see the amount the cashier enters into the cash register. The cash drawer should open only when the sales clerk enters an amount on the keypad. The roll of tape locked inside the machine records each sale and cash transaction.

Pricing merchandise at uneven amounts means that the clerk has to open the cash drawer. This requires entering the amount of the sale on the keypad and so onto the register tape.
Business Publishing
Accounting, 5/E
7 - 30

At the end of the day, the cashier deposits the cash in the bank. The tape goes to accounting.
Business Publishing
Accounting, 5/E
7 - 31
Cash Receipts by Mail

All incoming mail should be opened by a mailroom employee. This person should compare the check received with the remittance advice. Cash receipts should be given to the cashier. The mailroom employee forwards the remittance advice to accounting.
Cash Receipts by Mail

Many companies use a lock-box system. Customers send their checks directly to an address that is a bank account. Company personnel do not handle the cash.
Business Publishing
Accounting, 5/E
7 - 33
Cash Short and Over

Assume that the cash register tapes indicate sales revenue of $25,000. However, the cash received was $24,980. What entry would record the days sales?
Cash Cash Short and Over Sales Revenue Daily cash sales
2002 Prentice Hall, Inc. Business Publishing
24,980 20
25,000
Accounting, 5/E
Objective 5
Apply internal controls to cash payments.
Business Publishing
Accounting, 5/E
7 - 35
Control Over Approval of Payments

Purchase Request Purchase Order Invoice
Receiving Report
Disbursement Packet
Business Publishing
Accounting, 5/E
7 - 36
Control Over Approval of Payments

The accounting department... combines all of these documents, checks them for accuracy, and... forwards this disbursement packet to designated officers for approval and payment.
Business Publishing
Accounting, 5/E
7 - 37
Controlling Petty Cash Payments

On June 15, Sahita Inc. manager decided to establish a $250 petty cash fund. What is the entry?
June 15, 200x Petty Cash 250 Cash in Bank To open the petty cash fund
250
7 - 38

Jose is the petty cash custodian responsible for the fund. On June 20, he purchased supplies in the amount of $70. For each disbursement, he prepares a petty cash ticket. At all times the amount of cash in the petty cash fund plus the petty cash tickets must equal $250.

Jose also spent $20 for delivery charges and $60 for coffee and other miscellaneous expenses. What is the journal entry to record the replenishment of the fund?
Business Publishing
Accounting, 5/E
7 - 40

June 30, 200x Supplies 70 Delivery Expense 20 Miscellaneous Expense 60 Cash in Bank To replenish the petty cash fund
150
Business Publishing
Accounting, 5/E
7 - 41
Objective 6
Using a budget to manage cash.
Business Publishing
Accounting, 5/E
7 - 42
Cash Budget Example

On June 1, the cash balance of Claras Boutique amounted to $20,000. She expected collections during the month to be $100,000. Clara budgeted $110,000 cash payments during the month. She would like to keep a $20,000 balance at all times. How much money must she borrow?
Cash Budget Example

Beginning balance $ 20,000 Budgeted collections 100,000 Cash available $120,000 Less budgeted payments 110,000 Cash balance $ 10,000 She needs to borrow $10,000.
Business Publishing
Accounting, 5/E
7 - 44
Cash Budget Example

Not included in the budgeted collections is a $73,400 sale to a store in Rio de Janeiro. She expects to collect this amount in July. Assume the exchange rate is 3.67 reals per dollar. How much does she expect to collect? 73,400 reals 3.67 = $20,000
Objective 7
Make ethical judgments in business.
Business Publishing
Accounting, 5/E
7 - 46
Ethics and Accounting

1.00 0.75
0.50
0.25 0.00
Code of Conduct 88%
Companies
Professional Code of Ethics

Accountants are held to very high standards of conduct. There is no compromising. Would you hire an accountant who is almost always honest? Internal controls rely upon basic honesty and integrity.
End of Chapter 7
Business Publishing
Accounting, 5/E
7 - 49

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Internal Control, Managing Cash, and Making Ethical Judgments Chapter 7

2002 Prentice Hall, Inc.

Define internal control.

2002 Prentice Hall, Inc.

Financial Reporting Controls

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

Establishing an Effective System of Internal Control

2002 Prentice Hall, Inc.

Internal Controls for e-Commerce

2002 Prentice Hall, Inc.

Internal Controls for e-Commerce

Internal Controls for e-Commerce

2002 Prentice Hall, Inc.

The Limitations of Internal Control

2002 Prentice Hall, Inc.

The Bank Account as a Control Device

2002 Prentice Hall, Inc.

The Bank Reconciliation

2002 Prentice Hall, Inc.

The Bank Reconciliation

2002 Prentice Hall, Inc.

The Bank Reconciliation

2002 Prentice Hall, Inc.

The Paths That Two Checks Take (Good Check)

Payees bank sends check to makers bank.

The Paths That Two Checks Take (NFS Check)

Makers bank sends the worthless check back to payees bank.

Payees bank decreases payees balance.

2002 Prentice Hall, Inc.

Prepare a bank reconciliation and the related journal entries.

2002 Prentice Hall, Inc.

The Bank Reconciliation Example

2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7 - 19

The Bank Reconciliation Example

2002 Prentice Hall, Inc.

The Bank Reconciliation Example

2002 Prentice Hall, Inc.

The Bank Reconciliation Example

2002 Prentice Hall, Inc.

The Bank Reconciliation Example

$66,647 1,325 265 $68,237 1,500 200 12 $ 66,525

The Bank Reconciliation Example

2002 Prentice Hall, Inc.

Record Reconciling Items

Record Reconciling Items

Record Reconciling Items

2002 Prentice Hall, Inc.

Apply internal controls to cash receipts.

2002 Prentice Hall, Inc.

Cash Receipts Over the Counter

2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7 - 29

Cash Receipts Over the Counter

2002 Prentice Hall, Inc.

Cash Receipts Over the Counter

2002 Prentice Hall, Inc.

Cash Receipts by Mail

2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 7 - 32

Cash Receipts by Mail

2002 Prentice Hall, Inc.

Cash Short and Over

Apply internal controls to cash payments.

2002 Prentice Hall, Inc.