Internal I. control
A. Purpose of internal control
1. Most companies must delegate responsibilities and rely on formal procedures rather
than personal contact in controlling business activities
2. Internal control system monitors and controls business activities
3. Functions
a) Protect assets
b) Ensure reliable accounting
c) Promote efficient operations
* Help managers plan operations
d) Urge adherence to company policies
* Prevent avoidable losses
* Monitor company and employee performance
B. Principles of internal control
1. Fundamental internal control principles apply to all companies
2. Establish responsibilities
a) Responsibility for a task is clearly established and assigned to one person
* Determine who is at fault
3. Maintain adequate records
a) Protects assets
* Less likely to be stolen
b) Ensures that employees use prescribed procedures
* Decreases the likelihood of errors
4. Insure assets and bond key employees
a) Assets are adequately incurred
b) An employee is bonded when a company purchases an insurance policy or a
bond against losses from theft by that employee
* Discourages theft because bonded employees know an independent
bonding company will be involved when theft is uncovered
c) Separates record keeping from custody of assets
* A person who controls or has access to an asset must not keep the
assets accounting records because this would make theft very easy
* Theft requires colluding of two or more employees
5. Divide responsibility for related transactions
a) The work of one individual acts to check the work of another
b) Separation of duties, not duplicated efforts
6. Apply technological controls
a) Technology improves the effectiveness of controls
* Electronic file records each cash sale
* Cash register records the exact time an employee arrives and departs
work
7. Perform regular and independent reviews
a) Ensure procedures are followed by evaluating efficiency and effectiveness
II. Technology and internal control
A. Technology allows us quicker access to databases and information
B. Improves managers abilities to monitor and control business activities
C. Reduces processing errors
1. Mathematical errors are nearly eliminated
2. With less human involvement errors go unnoticed
D. More extensive testing of records
1. Audit of electronic records includes more extensive testing because information is
easily and rapidly accessed
a) Can quickly analyze samples or even an entire database
E. Limited evidence of processing
1. Fewer hard copies
2. Allows the designing and operating of information systems
F. Crucial separation of duties
1. Yield some job eliminations or consolidations
G. Increased e-commerce
1. New risks
a) Credit card number theft
b) Compute viruses
c) Impersonation: charges of sales to bogus accounts, purchases of inappropriate
materials, unknowingly giving confidential information to hackers
III. Limits of internal control
A. Human
1. Error from negligence
2. Fraud from intentional desires to exploit company
a) Highlights the importance of establishing internal control environments
B. Cost benefit principle
1. Managers must establish internal control policies and procedures that render a net
benefit to the company
IV. Control of cash
A. Cash and cash equivalents = most liquid assets
B. Internal controls protect cash
1. Handling of cash is separate from recordkeeping of cash
2. Cash receipts are promptly deposited in a bank
3. Disbursements are made by check
V. Cash, cash equivalents and liquidity
A. Liquid assets: can be readily used to pay for its near term obligations
B. Cash: currency, coins, balance of bank account
C. Cash equivalents: checks, money orders
VI. Control of cash receipts
A. Ensures that cash received is properly recorded and deposited
B. Over the counter cash receipts
1. Recorded on a cash register at the time of each sale
a) Register provides a locked in record of each transaction
2. Custody of cash should be separate from its recording keeping body
3. Cash over and short
a) Difference between the cash in the register and the record amount of cash
b) Sources: errors in change
c) Overage
* Debit cash
* Credit cash over and short (equity)
d) Shortage
* Credit cash
* Debit cash over and short
e) Cash over and short account is considered a miscellaneous expense/
miscellaneous revenue
C. Cash receipts by mail
1. When cash receipts arrive through the mail
2. Two people are assigned to opening the mail
a) Generate a list of the monies received
* List goes to cashier (along with the money), recordkeeping and a copy
is kept by the clerks
VII. Control of cash disbursements
A. Largest incidents of theft occur from payment of fictitious invoices
B. Rules
1. All expenditures must be made by check
2. Only the owner has access to the accounting records and the authority to sign checks
3. Procedures for purchasing, receiving and paying are divided among several
departments
C. Voucher system of control
1. Voucher system: set of procedures and approvals designed to control cash
disbursements and the acceptance of obligations
2. Functions
a) Verifies obligations for eventual cash disbursement
b) Issues checks paying verified obligations
c) Vouchers coordinate actions of different departments
3. Voucher: an internal document used to accumulate information to control cash
disbursements and to ensure that a transaction is properly recorded
a) Issued for all purchases and expenditures
4. Process
a) Receive bill, verify prepare charges, a voucher, record journal entry, issue
check on day payment is due
D. Perry cash system of control
1. Used for petty cash disbursements
a) Spending on postage, minor repairs, low cost supplies
2. An imprest system: designates advance money to establish the fund, to withdrawal
from the fund and to reimburse the fund
3. Process
a) Estimate the amount of petty cash needed for the period
b) Check for this amount is drawn by the cashier
c) When money is taken from the petty cash fund a receipt is replaced
* Receipts + amount in fund = original amount in the fund
d) Petty cash cashier categorizes expenses from the petty cash account and
records them as expenses
c) Company cashier stamps these expense receipts as paid
4. Accounting
a) The establishment of a petty cash fund
* Debit to petty cash (asset)
* Credit to cash
* After the petty cash fund is established, the petty cash fund is not
debited or credited again unless the amount designated for the account is
changed
b) Payments from petty cash fund
* Debit expense accounts
c) Reimburse petty cash fund
* Credit cash
d) Increasing or decreasing petty cash fund
* Increase: debit petty cash, credit cash
* Decrease: credit petty cash, debit cash
e) Cash over and short: errors resulting in the petty cash report + cash remaining
in petty cash does not equal funds balance
* Shortage: expense, debit cash over and short
* Overage: credit cash over and short
5. If petty cash fund is not reimbursed, financial statements show overstated cash and
understated expenses
VIII. Banking activities as controls
A. Bank account, deposit and check
1. Bank account: a place to deposit money that has withdrawal controls ensuring that
only those on the signature card can write checks
a) Deposit ticket: record of deposits
2. Check: way to withdrawal money from an account
B. Electronic funds transfer
1. Electronic communication transfer of cash from one party to another
2. Recorded with a journal entry
3. Cash receipts are listed with deposits and other additions
C. Bank statement
1. Shows the activity in an account
a) Beginning period balance
b) Debits decreasing the account
c) Credits increasing the account
d) End of period balance
2. Accounting of a bank statement
a) Depositor's account is a liability on the bank's records
* When a depositor increases the account balance, the bank records it
with a credit to the liability account
b) Debit memos from the bank produce credits on the depositors books and a
credit memo from the bank produces debits on the depositor's books
c) Canceled checks: checks that the bank has deducted from the customer's
account during the period
* Similar: uncollectible checks, corrections to previous errors,
withdrawals, periodic payments
* Notified with a debit memorandum
d) Transactions that increase the depositor's account
* Notified with a credit memorandum
IX. Bank reconciliation
A. Bank statement proves the accuracy of its cash records
B. Bank reconciliation is a report explaining any differences between the checking account
balance according to the depositor's records and the balance reported on the bank statement
C. Purpose
1. Balance of a checking account rarely equals the depositor's accounting records
because one party has information that the other party does not have
a) Outstanding checks: checks written by the depositor, deducted from the
depositor's records and sent to the payees but not yet received by the bank for
payment
b) Deposits in transit: deposits made and recorded by the depositor but not yet
recorded on the bank statement
c) Deductions for uncollectible items and for services
* Non-sufficient funds: bank initially credited the depositor's account for
the amount of the check nut since the check is non-collectable, the bank
debits the depositor's account
* Same applies for service fees for processing the uncollectible check
d) Additions for collections and for interest
* When a bank collects an item, it is added to the depositor's account, less
any service fee
* Unrecorded until the bank reconciliation is prepared
* Bank statement includes interest
D. Illustration of a bank reconciliation
1. Identify the bank statement balance of the cash
2. Identify and list any unrecorded deposits and any bank errors understating the bank
balance. Add them to the bank balance.
3. Identify and list any outstanding checks and any bank errors overstating the bank
balance. Deduct them from the bank balance.
4. Compute the adjusted bank balance
5. Identify the company's book balance of the cash account
6. Identify and list any unrecorded credit memoranda from the bank, any interest earned
and any errors understating the book balance. Add them to the book balance.
7. List any unrecorded debit memoranda from the bank, any service charges and errors
overstating the book balance. Deduct them from the book balance.
8. Compute the adjusted book balance
9. Verify that two adjusted balances are equal
E. Adjusting entries from a bank reconciliation
1. Journal entries adjust the book balance to the correct balance
a) Collection of note
* Debit cash for note value collection expense
* Debit collection expense
* Credit notes receivable
b) Interest earned
* Debit cash
* Credit interest revenue
c) Check printing
* Debit miscellaneous expenses
* Credit cash
d) Non-sufficient funds check
* Debit accounts receivable
* Credit cash
2. Only items reconciling the book balance require adjustment