 Internal control is defined as the procedures and o External auditors evaluate and report

processes used by a company to: on internal control as part of their annual

1. Safeguard its assets. financial statement audit.
2. Process information accurately.
3. Ensure compliance with laws and regulations. 5. Information and communication – essential
element of internal control.
 Internal Control—Integrated Framework is the
standard by which companies design, analyze, and Limitations of Internal Control
evaluate internal control. 1. The human element of controls –
recognizes that controls are applied and
 Employee fraud is the intentional act of deceiving an used by humans.
employer for personal gain. 2. Cost-benefit considerations –
recognize that the cost of internal controls
 The three internal control objectives can be achieved should not exceed their benefits.
by applying the Five Elements of Internal Control set
forth by the Integrated Framework. 5 These elements Cash Controls Over Receipts and Payments
are as follows:
1. Control environment – overall attitude of  Cash includes coins, currency (paper money),
management and employees about the checks, and money orders.
importance of controls. Three factors
influencing a company’s control Control of Cash Receipts
environment are as follows:  Businesses normally receive cash from two main
o Management’s philosophy and sources:
operating style - relates to whether o Customers purchasing products or
management emphasizes the services
importance of internal controls. o Customers making payments on
o The company’s organizational account
structure – framework for planning and  Cash Received from Cash Sales – An important
controlling operations. control to protect cash received in over-the-
o The company’s personnel policies – counter sales is a cash register.
involve the hiring, training, evaluation,  Cash Received in the Mail – Cash is received in
compensation, and promotion of the mail when customers pay their bills. This cash
employees. is usually in the form of checks and money
2. Risk assessment orders. Most companies design their invoices so
3. Control procedures – provide reasonable that customers return a portion of the invoice,
assurance that business goals will be called a remittance advice, with their payment.
achieved, including the prevention of fraud.  Cash Received by EFT – Cash may also be
Control procedures, which constitute one of the received from customers through electronic funds
most important elements of internal control, transfer (EFT).
include the following:
o Competent personnel, rotating duties, Control of Cash Payments
and mandatory vacations
 The control of cash payments should provide
o Separating responsibilities for related
reasonable assurance that:
operations
o Payments are made for only authorized
o Separating operations, custody of
transactions.
assets, and accounting
o Cash is used effectively and efficiently.
o Proofs and security measures – used to
For example, controls should ensure
safeguard assets and ensure reliable
that all available purchase discounts are
accounting data.
taken.
4. Monitoring – locate weaknesses and improve
 Voucher system is a set of procedures for
controls. Includes observing employee
authorizing and recording liabilities and cash
behavior and the accounting system for
payments.
indicators of control problems.
o Internal auditors, who are independent  A voucher is any document that serves as proof
of operations, usually perform such of authority to pay cash or issue an electronic
evaluations. Internal auditors are also funds transfer.
responsible for day-to-day monitoring of  A voucher is normally prepared after all
controls. necessary supporting documents have been
received. For the purchase of goods, a voucher is
 supported by the supplier’s invoice, a purchase
order, and a receiving report.
 Cash Paid by EFT – Cash can also be paid by
electronic funds transfer (EFT) systems.

Bank Accounts
 Major reason that companies use bank accounts is
for internal control.
 Banks usually maintain a record of all checking
account transactions. A summary of all
transactions, called a bank statement, is mailed,
usually each month, to the company (depositor) or
made available online.
 Bank statement shows the beginning balance,
additions, deductions, and the ending balance.
 Bank makes credit entries (issues credit memos):
o Deposits made by electronic funds transfer
(EFT)
o Collections of notes receivable for the
company
o Proceeds for a loan made to the company by
the bank
o Interest earned on the company’s account
o Correction (if any) of bank errors
 Bank makes debit entries (issues debit memos):
o Payments made by electronic funds transfer
(EFT)
o Service charges
o Customer checks returned for not sufficient
funds
o Correction (if any) of bank errors
 ACH (Automated Clearing House) is a network for
clearing electronic funds transfers among individuals,
companies, and banks.

Bank Reconciliation
 Bank reconciliation is an analysis of the items and
amounts that result in the cash balance reported in
the bank statement to differ from the balance of the
cash account in the ledger.
 A company may temporarily have excess cash. In
such cases, the company normally invests in highly
liquid investments in order to earn interest. These
investments are called cash equivalents.
 Banks may require that companies maintain
minimum cash balances in their bank accounts.
Such a balance is called a compensating balance.
This is often required by the bank as part of a loan
agreement or line of credit.
 A line of credit is a preapproved amount the bank is
willing to lend to a customer upon request.
Compensating balance requirements are normally
disclosed in notes to the financial statements.
 Ratio of cash to monthly cash expenses is useful
for assessing how long a company can continue to
operate without: 1. Additional financing, or 2.
Generating positive cash flows from operations