CHAPTER 8

INTERNAL CONTROL AND CASH

After studying this chapter, you should be able to:
1 Define 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.
 INTERNAL CONTROL
STUDY OBJECTIVE 1

Internal Control
1. Safeguards an organization’s assets
2. Enhances the accuracy and
reliability of accounting records
PRINCIPLES OF INTERNAL
CONTROL
STUDY OBJECTIVE 2
 PRINCIPLES OF
INTERNAL CONTROL

• Establishment of responsibility:
• most effective when only one person is responsible
for a given task
• Segregation of duties:
• the work of one employee should provide a
reliable basis for evaluating the work of
another employee
• Documentation procedures:
• documents provide evidence that transactions and
events have occurred
 PRINCIPLES OF
INTERNAL CONTROL

• Physical, mechanical, and electronic controls:

safeguarding of assets and enhancing accuracy and
reliability of the accounting records.
• Independent internal verification:
the review, comparison, and reconciliation of
information from two sources.
• Other controls:
bonding of employees who handle cash, rotating
employee’s duties, and requiring employees to take
vacations.
 PHYSICAL, MECHANICAL,
AND ELECTRONIC CONTROLS
 Locked warehouses and storage cabinets for
inventories and records
 Safes, vaults, and safety deposit boxes for
cash and business papers
 Time clocks for recording time worked
 Computer facilities with pass key access
 Alarms to prevent break-ins
 CC TV monitors and garment sensors to
deter theft
PHYSICAL, MECHANICAL, AND
ELECTRONIC CONTROLS
 INDEPENDENT INTERNAL
VERIFICATION
Maximum benefit
Independent internal verification:

1 Made on periodic or surprise basis

2 Should be done by someonewho is
independent of the employee responsible for
the information
3 Report discrepancies and exceptions to a
management level that can take appropriate
corrective action
COMPARISON OF SEGREGATION OF DUTIES
PRINCIPLE WITH INDEPENDENT INTERNAL
VERIFICATION PRINCIPLE
LIMITATIONS OF INTERNAL
CONTROL
 Costs of establishing control procedures
should not exceed their expected benefits
 The human element is an important factor in every
system of internal control.
• A good system can become ineffective through
employee fatigue, carelessness, or indifference.
 Collusion may result.
• Two or more individuals work together to get around
prescribed controls and may significantly impair the
effectiveness of a system.
 CONTROL OVER CASH
RECEIPTS
STUDY OBJECTIVE 3

• Only designated personnel should be

authorized to handle or have access to cash
receipts.
• Different individuals should:
1 receive cash
2 record cash receipt transactions
3 have custody of cash
 CONTROL OVER
CASH RECEIPTS

• Documents should include:

1 Remittance advices
2 Cash register tapes
3 Deposit slips
• Cash should be stored in safes and bank vaults
• Access to storage areas should be limited to
authorized personnel
• Cash registers should be used in executing
over-the-counter receipts
 CONTROL OVER
CASH RECEIPTS

• Daily cash counts and daily comparisons of total receipts.

• All personnel who handle cash receipts should be bonded
and required to take vacations.
• Control of over-the-counter receipts is centered on cash
registers that are visible to customers.
 CONTROL OVER CASH
DISBURSEMENTS
STUDY OBJECTIVE 4

• Payments are made by check rather

than by cash, except for petty cash
transactions.
• Only specified individuals should
be authorized to sign checks.
• Different departments or individuals
should be assigned the duties of approving
an item for payment and paying it.
 CONTROL OVER CASH
DISBURSEMENTS
 Prenumbered checks should be used and
each check should be supported by an
approved invoice or other document.
 Blank checks should be stored in a safe.
1 Access should be restricted to authorized
personnel.
2 A check writer machine should be used
to imprint the amount on the check in
indelible ink.
 CONTROL OVER CASH
DISBURSEMENTS

 Each check should be compared with the

approved invoice before it is issued.
 Following payment, the approved invoice
should be stamped “PAID”.

a i d
P
 VOUCHER SYSTEM

 The voucher system

 Is often used to enhance the internal control over
cash disbursements.
Is an extensive network of approvals by
authorized individuals acting independently to
ensure that all disbursements by check are
proper.
 A voucher is an authorization form prepared
for each expenditure.
 Vouchers are recorded in a journal called the
voucher register.
 PETTY CASH FUND
STUDY OBJECTIVE 5

 A petty cash fund is used to pay relatively small

amounts
 Operation of the fund, often called an imprest
system, involves:
1 Establishing the fund
2 Making payments from the fund
3 Replenishing the fund
 Accounting entries are required when:
1 The fund is established
2 The fund is replenished
3 The amount of the fund is changed
 ESTABLISHING THE FUND

• Two essential steps in establishing a petty

cash fund are:
1 appointing a petty cash custodian who
will be responsible for the fund and
2 determining the size of the fund.
• Ordinarily, the amount is expected to cover
anticipated disbursements for a 3 to 4 week
period.
ESTABLISHING THE FUND

100
100

When the fund is established, a check payable to the

petty cash custodian is issued for the stipulated amount.
 REPLENISHING THE
FUND
 When the money in the petty cash fund
reaches a minimum level, the fund is replenished.
 The request for reimbursement is initiated by the
petty cash custodian.
 The petty cash custodian prepares a schedule of
the payments that have been made and sends the
schedule, with supporting documentation, to the
treasurer’s office.
 REPLENISHING THE
FUND

44
38
5
87

On March 15 the petty cash custodian requests a check for

$87. The fund contains $13 cash and petty cash receipts for
postage, $44, freight-out, $38, and miscellaneous expenses,
$5.
 REPLENISHING THE
FUND

44
38
5
1
88

On March 15 the petty cash custodian requests a check for

$88. The fund contains $12 cash and petty cash receipts for
postage, $44, freight-out, $38, and miscellaneous expenses,
$5.
 USE OF A BANK
STUDY OBJECTIVE 6

 The use of a bank minimizes the amount of

currency that must be kept on hand and
contributes significantly to good internal
control over cash.
 A company can safeguard
its cash by using a bank as
a depository and as a
clearing house for checks
received and checks written.
 WRITING CHECKS

 A check is a written order signed by the

depositor directing the bank to pay a specified
sum of money to a designated recipient.
 Three parties to a check are:
1 Maker (drawer) issues the check
2 Bank (payer) on which check is drawn
3 Payee to whom check is payable
WRITING CHECKS
 BANK STATEMENTS

A bank statement shows:

1 Checks paid and other debits charged against the
account
2 Deposits and other credits made to the account
3 Account balance after each day’s transactions
 MEMORANDA

 Bank debit memoranda

• Indicate charges against the
depositor’s account.
Example: ATM service charges
 Bank credit memoranda
• Indicate amounts that will increase
the depositor’s account.
Example: interest income on account
balance
 RECONCILING THE BANK
ACCOUNT
STUDY OBJECTIVE 7
 Reconciliation
• Necessary as the balance per bank and
balance per books are seldom in
agreement due to time lags and errors.
 A bank reconciliation
• Should be prepared by an employee
who has no other responsibilities
pertaining to cash.
 RECONCILING THE
BANK ACCOUNT

 Steps in preparing a bank reconciliation:

1 Determine deposits in transit
2 Determine outstanding checks
3 Note any errors discovered
4 Trace bank memoranda to the records
 Each reconciling item used in determining
the adjusted cash balance per books should
be recorded by the depositor.
BANK RECONCILIATION
 BANK RECONCILIATION

W. A. LAIRD COMPANY
Bank Reconciliation
April 30, 2022
Cash balance per bank statement The bank statement for $ 15,907.45
Add: Deposits in transit 2,201.40
the Laird Company
18,108.85
shows a balance per
Less: Outstanding checks
No. 453
bank of $15,907.45 on $ 3,000.00
No. 457 April 30, 2017. 1,401.30
No. 460
Adjusted cash balance per bank $ 12,204.85
1,502.70 5,904.00

Cash balance per books $ 11,589.45

Add: Collection of $1,000 note receivable plus interest earned
$50, less collection fee $15 $ 1,035.00
Error in recording check 443 36.00 1,071.00
On this date the
12,660.45
Less: NSF check balance of cash per 425.60
Bank service charge books is $11,589.45. 30.00 455.60
Adjusted cash balance per books $ 12,204.85
 ENTRIES FROM BANK
RECONCILIATION

1035
15
1000
50

Collection of Note Receivable: This entry involves four

accounts. Interest of $50 has not been accrued and the
collection fee is charged to Miscellaneous Expense.
 ENTRIES FROM BANK
RECONCILIATION

36
36

Book Error: An examination of the cash disbursements

journal shows that check No. 443 was a payment on
account to Andrea Company, a supplier. The check, with
a correct amount of $1,226.00, was recorded at $1,262.00.
ENTRIES FROM BANK
RECONCILIATION

425.60
425.60

NSF Check: An NSF check becomes

an accounts receivable to the
depositor.
 ENTRIES FROM BANK
RECONCILIATION

30
30

Bank Service Charges: Check printing charges (DM) and

other bank service charges (SC) are debited to Miscellaneous
Expense because they are usually nominal in amount.
 REPORTING CASH
STUDY OBJECTIVE 8

 Cash reported on the Balance Sheet

includes:
1 Cash on hand
2 Cash in banks
3 Petty cash
 Cash is listed first in the balance sheet
under the title cash and cash equivalents
because it is the most liquid asset.
 BRS: Practice
Problem: XYZ Company’s cash books show cash balance at Supreme Bank on September
30, 2022 is Tk. 20,502 but the bank statement shows an ending balance Tk. 22,190 on the
same date. An examination of XYZ’s accounting records and September bank statement
identified the following reconciling items:
•A deposit of Tk. 3,680 was mailed on September 30 but does not appear on the bank
statement.
•Cheques written in September but not charged to bank statement are:
•Check # 7327 Tk. 150
# 7348 Tk. 4,820
# 7349 Tk. 31
•XYZ company has not yet recorded the Tk. 600 of interest collected by the bank September
20 on a govt. bond held by the bank for XYZ.
•Bank service charges of Tk. 18 are not yet recorded on XYZ’s book.
•One of XYZ’s customer’s cheques for Tk. 220 was returned with the bank statement with
marked NSF. The bank treated this bad cheque as a disbursement.
•XYZ discovered that check # 7322, written in September for Tk. 131 in payment of an
account payable, had been incorrectly recorded in their books as Tk. 311.
•A cheque of ABC company for the amount of Tk. 175 that had been incorrectly charged to
XYZ Company accompanied the bank statement.
Requirement: Prepare a bank reconciliation statement for XYZ Company on September 30,
2022 and record necessary journals in XYZ book.