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Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
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Chapter 7
Internal Control and Cash
After studying Chapter 7, you should be able to: Identify the principles of internal control.
Explain the application of internal control to cash
receipts.
Explain the application of internal control to cash
disbursements.
Chapter 7
Internal Control and Cash
After studying Chapter 7, you should be able to: Explain the reporting of cash.
Discuss the basic principles of cash management. Identify the primary elements of a cash budget. Identify and interpret measures that evaluate the
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Internal Control
consists of...
all the related methods and measures
adopted within a business to:
safeguard its assets;
enhance accuracy and reliability of accounting
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Establishment of
Responsibility
Control is most effective when only
one person is responsible for a
Segregation of Duties
Responsibility of related activities
should be assigned to different individuals.
Responsibility of keeping the records
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Segregation of Duties
•Responsibility for related activities should be assigned to different individuals
•Responsibility for keeping records for an asset should be separate from the physical custody of the asset
Documentation
Provide evidence that
transactions and
events occurred:
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Documentation Procedures
Documents should be pre-numbered
All documents should be accounted for Sources documents should be promptly
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Independent Internal
Verification
Involves review, comparison, and reconciliation of data prepared by employees
•Verification should be made periodically or on surprise basis
•Verification should be done by employee who is independent of the personnel
responsible for the information
Independent Internal
Verification
Involves review, comparison, and reconciliation of
data prepared by employees.
Verification should be made periodically or on
surprise basis.
Verification should be done by employee who is
independent of the personnel responsible for the information.
Discrepancies and exceptions should be reported
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Independent Internal
Other Controls
Bonding of employees who handle cash
Cash consists of...
coins currency checks
Cash consists of...
coins
currency checks
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Cash is the most desirable
asset...
because it is readily
Limitations of Internal Controls
Cost/Benefit - cost of establishing
procedure should not exceed expected benefit
Human element - fatigue, carelessness, indifference
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Internal Control
Over Cash Disbursements
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Electronic Funds
Transfer (EFT)
An approach to transfer funds among
parties without paper (deposit tickets, checks, etc.)
EFT uses wire, telephone,telegraph or
Petty Cash Fund
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Petty Cash Fund
Use of a Bank...
is good internal control.
minimizes the amount of cash that must be kept
on hand.
provides a double record of all bank transactions
one by the business one by the bank
a company can safeguard its cash by using a
27 Bank Statement shows •check & other debits •deposits & other credits •daily cash balance Bank Statement
Company Balance and Bank Balance of Cash Usually Differ Because...
Time lags that prevent one of the parties from recording the
transaction in the same period.
Days pass between the time a check is written and dated and
date it is paid by the bank.
A day may pass between the time receipts are recorded by
the company and the time they are recorded by the bank.
A time lag may occur when the bank mails a debit or credit
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Reconciliation Procedure
reconcile balance per books and
balance per bank to their adjusted or correct balances
the reconciliation should be prepared
Terms
Deposits in transit - deposits recorded by the
depositor that have not been recorded by the bank.
Outstanding Checks - checks issued and
recorded by the company that have not been paid by the bank.
NSF Check - a check that is not paid by the bank
because of insufficient funds in the customer’s bank account.
Bank Reconciliation Procedures
$ Per Bank Statement -outstanding checks +deposits
+/- bank errors
correct cash amount
$ Per Books -NSF Checks
-check printing or other service charge +notes collected by bank
W.A. Laird Company
Bank Reconciliation April 30, 1998
Cash balance per bank statement 15,907.45
Add: Deposits in transit 2,201.40
18,108.85 Less: Outstanding checks
No. 453 3,000.00
No. 457 1,401.30
No. 460 1,502.70 5,904.00
Adjusted cash balance per bank 12,204.85
Cash balance per books 11,589.45
Add: Collection of N/R for $ 1000 plus interest
earned $50, less collection fee $ 15 1,035.00
Error on recording check No. 443 36.00 1,071.00 12,660.45
Less: NSF check 425.60
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Each reconciling item in determining the adjusted balance per books must be journalized and posted.
W.A. Laird Company
Bank Reconciliation April 30, 1998
Cash balance per bank statement 15,907.45
Add: Deposits in transit 2,201.40
18,108.85 Less: Outstanding checks
No. 453 3,000.00
No. 457 1,401.30
No. 460 1,502.70 5,904.00
Adjusted cash balance per bank 12,204.85
Cash balance per books 11,589.45
Add: Collection of N/R for $ 1000 plus interest
earned $50, less collection fee $ 15 1,035.00
Error on recording check No. 443 36.00 1,071.00 12,660.45
Less: NSF check 425.60
Apr 30 Cash 1,035.00 Miscellaneous Expense 15.00
Notes Receivable 1,000.00 Interest Revenue 50.00 Apr 30 Cash 36.00
Accounts Payable 36.00 Apr 30 Accounts Receivable-Baron 425.60
Cash 425.60
Apr 30 Miscellaneous Expense 30.00
Cash 30.00
Reporting Cash
Cash is recorded in both the balance sheet and
the statement of cash flows.
The balance sheet shows the amount of cash
available at a given point in time.
The statement of cash flows shows the
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Cash Equivalents
Readily convertible to known amount of cash
So near maturity that market value is
relatively insensitive to changes in interest rates
Examples:
Treasury bills
Commercial paper
Restricted Cash...
Is cash that is not
available for general use.
Is set aside for special
purpose.
If not to be used within
Operating Cycle of a
Merchandising Company…is
the average time it takes to
go from cash to cash in
producing revenues.
Five Principles of Cash
Management
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Reporting Cash
Cash on hand, cash in banks, and petty
cash are often combined and reported as cash.
Cash is the most liquid asset and listed
Cash Budget
Cash is vital.
Planning the company's
cash needs is a key business activity.
Cash budget shows the
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Cash Budget
The cash budget contains :
Cash receipts section;
Cash Receipts Section
includes expected receipts from the
company's principal source(s) of revenue, such as cash sales and collections from
customers on credit sales
also shows anticipated receipts of interest
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Cash Disbursements Section
shows expected payments for direct
materials, direct labor, manufacturing overhead, and selling and
administrative expenses.
includes projected payments for income
Financing Section
Shows expected borrowings and the
repayment of the borrowed funds
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Adequacy Of Cash
Net cash provided by operating
Liquidity - the ability of a company to pay
obligations that are expected to come due within the next year.
Current Cash Debt Coverage Ratio
-indicates whether a company can pay off
its current liabilities from current
operations.
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Solvency - the ability of a company to pay interest as it comes due and to repay the face
value of debt at maturity
Cash Debt Coverage Ratio -indicates
whether a company can pay off its total
liabilities from current operations
Net Cash Provided by Operating Activities
Additional Tools Used to Measure
the Adequacy of Cash
Two additional tools used to measure the adequacy of cash are:
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Ratio of Cash to
Daily Cash Expenses
Computes the number of days of cash
expenses the cash on hand can cover
Average daily cash expenses can be
approximated by subtracting
depreciation (a noncash expense) from total expenses and dividing by 365
Ratio of Cash to
Daily Cash Expenses
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Free Cash Flow
Free cash flow is the amount of discretionary cash flow a company has for:
purchasing additional investments
paying its debt
adding to its liquidity
Net cash provided by operating activities $250,000
Less: Capital expenditures $80,000 Dividends paid 50,000
130,000
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