Chapter 6 Reporting and Analyzing Cash and Internal Controls Internal Control Managers use an internal control system to monitor and control business activities Internal control system consists of the policies and procedures managers use to protect assets ensure reliable accounting promote efficient operations urge adherence to company policies minimize the risk of fraud and theft Sarbanes oxley act requires the managers and auditors of companies whose stock is traded on an exchange to document and certify the system of internal controls o Auditors must evaluate internal controls and issue an internal control o Auditors of a client are restricted as to what consulting services they o The person leading an audit can serve no more than 7 years without a o Auditor s work is overseen by the Public Company Accounting report can provide that client 2 year break Oversight Board o Harsh penalties exist for violators o Section 404 requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting are the financial costs of complying worth it Internal controls vary based on the nature of the business and its size but certain internal control principles apply to all companies Principles of internal control o 1 Establish responsibilities if something goes wrong we know who is responsible o 2 Maintain adequate records o 3 Insure assets and bond key employees A bonded employee is when a company purchases an insurance policy against losses from theft by that employee Bonding reducing risk of loss o 4 Separate recordkeeping from custody of assets a person who controls has access to an asset must not keep that asset s accounting records o 5 Divide responsibility for related transactions separation of duties o 6 Apply technological controls o 7 Perform regular and independent reviews Committee of Sponsoring Organizations COSO gives a framework of how the 7 principles improve the quality of financial reporting Technology impacts an internal control system in many ways o Reduced processing errors o More extensive testing of records o Limited evidence of processing less hardcopies but provide new evidence such as who made the entries date time source of entry o Crucial separation of duties if I make a program I shouldn t be using o Increased e commerce risks credit card number theft computer it viruses impersonation Limitations of internal controls arise from the human element or the cost benefit principle o Human element internal controls are applied by people Human error can occur from negligence fatigue misjudgment confusion Human fraud involves intent by people to defeat internal controls such as management override for personal gain Driven by triple threat of fraud o Opportunity pressure rationalization o Cost benefit principle dictates that the costs of internal controls must not exceed their benefits Control of Cash Cash and cash assets are easily hidden and moved Guidelines to protect cash o Handling cash is separate from recordkeeping of cash o Cash receipts are promptly deposited in a bank o Cash disbursements are made by check Procedures used to achieve control over cash vary by company depending on size number of employees volume of cash transactions and sources of cash Liquidity refers to a company s ability to pay for its near term obligations Liquid assets cash similar assets can be readily used to settle obligations Cash includes currency and coins along with the amount on deposit in banks accounts checking accounts demand deposits and savings accounts time deposits customer checks cashier s checks certified checks money orders Cash equivalent are short term highly liquid investment assets that are readily convertible to a known cash amount and sufficiently close to their due date so that their market value is not sensitive to interest rate changes Goals of cash management treasurer is responsible for cash management o Plan cash receipts to meet cash payments when due o Keep a minimum level of cash necessary to operate Cash management principles o Encourage collection of receivables o Delay payment of liabilities o Keep only necessary levels of assets o Plan expenditures o Invest excess cash Control of cash receipts Cash receipts ensure that cash received is properly recorded and deposited o Over the counter cash receipts should be recorded on a cash register at the time of each sale Cash over and short account income statement records the income effects of cash overages and shortages Cash in register is more than recorded Debit cash 555 debit cash over and short 5 and sales 550 Cash in register is less than recorded debit cash 621 and debit cash over and short 4 and credit sales 625 Usually has a debit balance at the end of the period part of a general and administrative expense miscellaneous expense sometimes too o Cash receipts by mail many people Control of cash disbursements Require expenditures to be made by check Deny access to accounting records to anyone other than the owner who has the authority to sign checks Voucher system is a set of procedures and approvals designed to control cash disbursements and the acceptance of obligations establishes procedures for o Verifying approving and recording obligations for eventual cash o Issuing checks for payment of verified approved and recorded disbursement obligations o Voucher internal document file used to accumulate information to control cash disbursements and to ensure that a transaction is properly recorded All payments must be made by check exception petty cash disbursements small payments required for items such as postage o Petty cash activities are part of an imprest system which designates advance money to establish the fund o Establishing a petty cash fund estimates the total amount of small payments likely to be made Debit to petty cash amount Credit to cash Each disbursement reduces cash and increases the amount of receipts in the petty cashbox o Petty cash payments report page 261 o If the fund is not reimbursed at the end of the period the financial statements would show both an overstated cash asset and understated expenses o If the petty cashier fails to get a receipt for payment the petty cash payments report the cash remaining will not total the fund balance causes the fund to be short this shortage is recorded as an expense in the reimbursing entry with a debit to the cash over and short account o Summary of petty cash accounting Set up fund debit
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