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Chapter 8: Internal Control and Cash Highlights - Coggle Diagram
Chapter 8: Internal Control and Cash Highlights
Internal Control
Principles of Internal Control
Authorization of Transactions and Activities
All transactions and activities should be analyzed and approved by the complimentary individuals or departments.
Ex. An approval of the construction budget for a certain renovation which requires a certain type of payment.
Ex. A fixed price list of all shop items is an authorized list for the sales staff.
Control is effective when one person is responsible for a certain task.
Ex. If one person handles the cash register box at Sephora and there is a shortage of $100, it makes it easier to determine who is responsible for the shortage whereas if there were 3-4 people working in shifts, then it would be harder to find out who was responsible for the missing amount.
Segregation of duties
States that all related activities should be assigned to different individuals in order to reduce the number of errors and irregularities when the related activities are handled solely.
Purchase Ex. An employee can placed an order with friends/suppliers who offer bribery, he/she can only do a cursory count and inspection rather than thoroughly checking (leading to poor quality merchandise) or a payment can be authorized without it being properly checked, which can also be fake.
Sales Ex. an employee could charge false prices in order to gain extra commission, ship the product to themselves and lastly, understate the amount being billed to a friend or relative
The records and physical custody of an asset should always be handled by separate people. The accountant should only handle the records and the custodian of the asset should only handle the asset count.
With this principle, the chances of misplacing or robbing the asset is unlikely. The work of both employees should help differentiate the reliability of both of their work.
Documentation procedures
Provides evidence of the occurrence of the transaction and events
Cash register tapes is a form of documentation that records the sale and the amount of cash received.
Shipping documents indicate that the goods have been shipped.
Sales invoice shows that the customer has been billed for the goods he/she has purchased.
Signatures indicate responsibility of the goods being identified.
Documentation procedure
Documents should be pre-numbered and accounted for in order to prevent cloned and non-existing transactions.
Source documents for accounting entries are forwarded to the accounting department to ensure that all transaction are recorded on time.
All the above procedures relate to the accuracy of reliability in the accounting records.
Documentation should take place once the transaction has occurred.
Safeguarding assets and records
Physical controls are firstly for the safeguarding of assets, whereas mechanical and electronic controls are for safeguarding and the accuracy and reliability of the accounting records.
Program Controls
Built into computer systems to help prevent intentional or unintentional errors and unauthorized access.
May require passwords or random correctly answered personal questions before the system access is allowed
Independent verifications
Internal
Independent internal verification is beneficial when accounting records are compared with existing assets.
Generally done by internal auditors (employees who evaluate the effectiveness of the internal control system).
Periodically review activities of departments and individuals to ensure regularities and suggest improvements
If these auditors do not exist in very small companies, the boss is usually responsible for all the irregularities and manages the work of an internal auditor and other incompatible functions such as authorization and access to assets.
External
Generally done by external auditors (professional accountants hired by the company to report if the company's financial statements fairly present its financial position and their results of operations), who are independent to the company.
Involves review, comparison and reconciliation of data.
Maximum benefits
Verification should be done periodically or on a sudden basis to ensure that errors are not hidden beforehand.
Verification should always be done by someone who is responsible for the information being verified.
Any sort of inconsistencies and exceptions should be immediately reported to the management so that the correct actions can be taken.
Other controls
Bonding of employees who handle cash.
Involves gaining insurance protection against misuse of assets by unlawful employees.
The company screens all individuals prior to adding them to the policy (rejecting potential risks).
The bonded employees are informed that the insurance company will take strict actions against all offenders.
Rotating employees duties and requiring employees to take vacations.
Stops employees from any offence since they cannot hide their guilty actions.
Bank embezzlements often use this method to find the culprit (required vacations or by switching positions).
Limitations of Internal Control
Cost/benefit
The concept of reasonable assurance believes that the cost of control procedures should not exceed their expected benefit. Examples Include, putting threatening signs ("We have the right of inspection" and sensor tags on clothing) for shoplifters instead of having security guard checks at the doors.
Human element
Good system can become ineffective due to employee fatigue, carelessness or lack of interest. Moreover, unlawful employees (receiving clerk) may add random numbers or false amounts for assets being received.
Collusion
When multiple employees work together, the effectiveness of the system lowers. Employees may collaborate to understate cash receipts and gain more commission, which ruins the purpose of segregation of duties.
Size of business
Small businesses may not have enough staff to segregate duties between employees, which may lead to more errors. Therefore, external verification is key. Computer systems (point of sales) help in the accuracy of sales since the transaction is recorded as soon as the transaction occurs.
Objectives
Optimize the use of resources to reduce inefficiencies and waste.
Prevent and detect errors and irregularities in the accounting process.
Safeguard assets from theft, robbery and unauthorized use.
Maintain reliable control systems to enhance the accuracy and reliability of accounting records.
Internal control procedures demanded after the Canada Business Corporations Act was federally established, which are followed to enhance the business organizations security by fulfilling the following objectives:
Cash Controls
Internal Control over Cash Receipts
Over the Counter Receipts
Cash registers that are visible to customers.
Check out lines or department cash registers, show the amount to the customer which prevents extra unlawful commission.
Customer receives change and receipt, which are expected to be rechecked.
Cash register tape.
Locked into register, removed when shift is done.
Shows all registered receipts accounted for.
Accumulates the daily transactions and totals at the end of the day, which is compared to the amount of cash in the register.
Reported on a cash count sheet that is signed by both the cashier and the supervisor/manager to show responsibility of the all transactions accounted for.
Given to head cashier.
Prepares a daily cash summary
Shows total cash received and the amount of cash and money on account.
Send copies to the accounting department (cash receipts journal) and comptroller's office for later comparison with the daily bank deposit.
Prepares deposit slip and makes bank deposit (should be equal to the amounts on book).
Fundamentally occurs when all cash receipts are deposited daily, intact into the bank account.
Significant numbers are deposited in person by an authorized employee.
A duplicate deposit slip is then given to the company comptroller who compares the daily cash summary with the amount deposited
Mail Receipts
Result from billings and credit sales (commonly received by businesses)
Number of cheques received through the mail daily by a national retailer such as Sears.
Should be opened in front of 2 mail clerks.
Usually in the form of cheques.
Accompanied with remittance advice, stating the purpose of the cheque.
Often a part of the bill the customer tears off and returns.
For deposit only using a company stamp.
Restrictive endorsement: reduces likelihood of the cheque being diverted to personal use.
Banks will not give cash to an individual who follows restrictive endorsement.
List of duplicate cheques (showing the name of the issuer, purpose of payment and the amount of the cheque) should be signed by the email clerk.
The original copy, along with the cheques and remittance advices are sent to the cash department in case any sort of over the counter receipts needs to be added when the daily cash summary and bank deposit are being prepared.
Copy is sent to accounting department for cross checking.
Debit cash and credit accounts receivables/sales.
Sources
Cash sales
Collections on account
Receipt of interest
Dividends
Rents
Investments
Bank loans
Proceeds for the sale of capital assets
Internal Control over Cash Disbursements
Petty Cash Fund
Cash fund used to pay small amounts generally utilized on an imprest system.
Establishing the Fund
Debit Petty Cash and Credit Cash
Cheque payable is issued to the petty cash custodian for the amount required to pay small bills such as postage, couriers and taxis.
No additional entries are required to be made unless the amount has been changed.
Covers a 3-4 week period.
Making Payments from the Fund
All payments from the fund should be documented on a pre-numbered petty cash receipt.
If a freight bill or invoice has been issued for this payment, it should be attached to the receipt.
Receipts are kept in the petty cash box until the fund need to e replenished.
Sum of the funds = Established Total
Replenishing the fund
When the accounting impacts of each payment are recognized.
When the cash and receipts in the petty cash do not equal the amount established in the petty cash fund, a cash shortage or overage is recognized.
Ex. If a fund contained $13 of cash and the custodian only had $12, the Cash Over and Short would be debited and vice versa for an overage.
Occurs at the end of the accounting period.
Internal Control measures on Petty Cash Funds: 1) supervisors making surprise counts on the fund to ensure consistencies 2) cancelling paid receipts to ensure resubmissions do not occur.
Cash is handed out in order to pay expenses and liabilities or to purchase assets.
Effective when payments are made by cheque.
Applications to internal control procedures:
Safeguarding cash to ensure accuracy of the accounting records.
Cash: coins, currency (paper/virtual currency), cheques, money orders, travellers’ cheques, and money on deposit in a bank or similar depository.
1) If the bank accepts it for deposit, it is cash.
2) Postdated (due in future) cheques and Not Sufficient Funds cheques are accounts receivable.
3) Debit card transactions and credit card slips are cash but nonbank.
Reporting Cash
Using the Information in the Financial Statements
Management report
Purpose: to consider the management's responsibility of making internal control systems during the reporting process to ensure asset consistencies and protection.
Management works to strike a balance to manage cash as too little is insufficient to pay the bills and too much is an unproductive asset unless it is invested in other areas and can also speculate assumptions of not optimizing a company's return on assets.
Cash on hand + cash in banks + petty cash = Cash in balance sheet (not a formal equation, shown to emphasize the combination of these accounts).
Cash equivalents: liquid investments, which can be converted into certain amounts of cash and is typically combined with cash.
Maturities: 3 months or below from the time purchased
Ex. short term deposits, short term investments (treasury bills), money market funds and short term notes.
Bank overdraft: a cheque amount is more than what the bank account holds, which leads the company in a cash deficit position by the year end.
Short term loan from bank (overdraft in real life): Cash shows a credit balance in the general ledger (current liability).
Restricted cash
Ex. funds held on deposit for real estate purchases or a plant expansion fund for construction payments.
If it is expected to be used within one year, the amount is reported as a current asset, however, if it is to be used in the future, it should be reported as a non-current asset.
Compensating balances
In the process of making loans into depositors, banks generally require their borrowers to have a minimum cash balance in order to provide the bank support for the loan they are giving you.
Form of restricted cash, which are recorded as non-current assets.
Use of a Bank
Bank Deposits
Made by authorized employee (head cashier), which is documented by a deposit slip (original is kept by the banker and the copy is stamped for authority purposes and given to the depositor).
Direct deposits are generally made by ABMs or EFTs for which supporting documents arrive at the moth end along with the bank statement.
Electronic Funds Transfer (EFTs)
Cheques or deposits handled virtually.
Ex. Employers such as Sephora automatically transfer money to their employees (cashiers or sales people) through EFTs.
Utilities, rent, house payments are also commonly paid through EFTs.
Writing Cheques
Written order signed by the depositor that instructs the bank to pay a certain amount of money to a certain person or business.
Maker: issues the cheque.
Bank/Payer: which the cheque id drawn upon (Bank of Montreal).
Payee: whom the cheque is being delivered to.
All cheques must clearly state the purpose of their payment. Moreover, the cheque must reference the invoice that is being paid.
Businesses must also make sure to check their chequing account is balance at all times.
Bank Statements
Shows the depositor's bank transaction and balance.
Shows the cheques paid as well as the other debits that lowers the depositor's account balance.
Shows deposits and credits that increase the balance in the depositor's account.
The account balance after daily transactions.
Debit Memorandum
Bank service charge: bank charging monthly fee in return of using their services.
Can be issued for bank services such as the cost of printing cheques, issuing traveller's cheques, certifying cheques and transferring funds to other locations.
Used by bank when deposited cheques bounce due to insufficient funds. This leads to a Not Sufficient Funds or Returned Cheque from the customer's bank and returned to the depositor's bank.
NSF cheques normally create an accounts receivable and lead to a reduction cash in the bank account.
Credit Memorandum
When a depositor asks the bank to collect its notes receivables, which leads to a credit in the depositor's account
Sent with the statement to explain the entry.
Banks may offer interest on chequing accounts, which can be indicated as CM or IN on the bank statement.
Minimizes the monetary amount that must be kept on hand.
