Internal Control System

All policies and procedures used to : Protect assets Ensure reliable accounting Promote efficient operations Encourage adherence to company policies

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Principles of Internal Control

1.

2.

3.
4.

5.

Ensure transactions and activities are authorized. Maintain adequate records. Insure assets. Separate recordkeeping and custody of assets. Establish a separation of duties
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Principles of Internal Control

6. 7.

Apply technological controls. Perform internal and external audits.

Internal controls will vary based on the nature and size of the organization.

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Limitations of Internal Control

Human Error Negligence Fatigue Misjudgment Confusion Human Fraud Intent to defeat internal controls for personal gain. Costs vs. Benefits The costs of internal control must not exceed their benefits.
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Cash

Is an important asset for every company. Control of cash on hand and access to it is critical. Cash includes:

Currency Coins Deposits in bank accounts Other items acceptable for deposit
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LO 2

Internal Control for Cash

Guidelines: 1. Separate handling of cash from recordkeeping of cash. 2. Deposit cash receipts daily. 3. Make cash disbursements by cheque.

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Control of Cash Disbursements

All expenditures should be made by cheque. The only exception is for small payments from petty cash. Separate authorization, cheque signing, and recordkeeping duties. Apply a voucher system.

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Petty Cash System of Internal Control

Good internal control procedures require cash disbursements be made by cheque.

The exception:
Small payments required in most companies for items such as postage, courier fees, repairs, and supplies.

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Operating a Petty Cash Fund

Cashiers Office

Prepares cheque to establish petty cash fund.

Petty Cashier

GENERAL JOURNAL
Date Description Cash May 1 Petty Cash

Page 4
150 150

PR Debit Credit

To establish a petty cash fund

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Operating a Petty Cash Fund

The petty cashier makes payments from this fund for small disbursements.
and ensures a petty cash receipt is signed by the person receiving the money to easily identify the expenses paid from petty cash.

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Operating a Petty Cash Fund

A cheque is issued and the fund is replenished when the amount of cash on hand becomes low.
A cash over and short account is used if needed.

GENERAL JOURNAL
Date Description Courier Expense Cash May 15 Postage Expense

Page 4
46 80 126

PR Debit Credit

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Banking Activities as Controls

Basic Bank Services Bank account Bank deposits and cheques Electronic funds transfer Bank credit card transactions Debit card transactions

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Credit Card Transactions

Many companies allow customers to use bank credit cards for their purchases. The risk of bad debts is transferred to the credit card company. The company collects cash from the sale quickly. The credit card companies charge a fee to the vendor.
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Debit Card Transactions

Many companies allow customers to use debit cards for their purchases. The bank transfers funds from the customers account to the vendors bank account. The bank charges a fee to the vendor. The entries are identical to a bank credit card sale.
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Illustration-Credit Card Transaction

TechCom has $100 of credit card sales with a 4% fee and cash is received immediately (assume cost of sales is $40).
GENERAL JOURNAL
Date Description 2011 Aug. 15 Cash Credit Card Expense Sales PR Debit 96.00 4.00 100.00

Page 8
Credit

To record credit card expense less 4% fee

15 Cost of Goods Sold Merchandise Inventory

To record cost of sales
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Bank Reconciliations
Bank reconciliations are: Prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on companys books. An important element of internal control.

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Statement Date 31-Oct-11 Account Number 494 504 2 Total Deposits and Credits 1,163.42 Deposits and Credits Amount 240.00 180.00 100.00 150.00 485.00 Current Balance 2,050.00

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

Daily Balance 1,609.58 1,794.58 1,949.58 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

121 128

55.00 25.00 50.00 23.00 DM 70.00 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

The bank statement provides information about everything that has gone through the bank account for a given period of time.

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CM Credit Memo DM Debit Memo EC Error Correction IN Interest Earned NSF Non-sufficient Funds OD Overdraft SC Service Charge

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Cash Disbursements Journal

Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00 15 16 31 $ 100.00 150.00 145.00 815.00 (101)

Cheque # 119 120 121 122 123 124 125 126 127 128

Amount 55.00 200.00 120.00 70.00 25.00 150.00 15.00 200.00 50.00 135.00 1,020.00 (101)

The general ledger, cash receipts, and cash disbursements journals provide information about everything that has gone through our accounting records for a given period of time.

General Ledger Cash Account Cash Account # 101 Date Explanation PR Debit Credit Balance 30-Sep Balance 1,609.58 31-Oct CR6 815.00 2,424.58 31-Oct CD4 1,020.00 1,404.58

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Bank Reconciliation - Example

National Bank Hamilton, ON L8P 2X5
VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125 Bank Statement

Why are the balances different?

Some items are reflected on the bank statement but not in the accounting records and vice versa.
General Ledger Cash Account Cash Account # 101 Date Explanation PR Debit Credit Balance 30-Sep Balance 1,609.58 31-Oct CR6 815.00 2,424.58 31-Oct CD4 1,020.00 1,404.58

Statement Date 31-Oct-11 Account Number 494 504 2 Total Deposits and Credits 1,163.42 Current Balance 2,050.00

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

Deposits and Credits Amount 240.00 180.00 100.00 150.00 485.00

Daily Balance 1,609.58 1,794.58 1,949.58 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

121 128

55.00 25.00 50.00 23.00 DM 70.00 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

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Reconciling Items

Bank Statement

General Ledger

Outstanding cheques. Deposits in transit. Bank errors.

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Non-sufficient funds cheque (NSF). Bank service charges. Interest earned on bank account. Collections made by the bank. Book errors.
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Lets prepare the bank reconciliation for VideoBuster Company at the end of October 31, 2011.

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

These items 15 100.00 Statement Date appear on both the 31-Oct-11 16 150.00 Account Number 494 504 2 Cash Receipts 31 145.00 $ 815.00 Journal and the Total Deposits Current (101) and Credits Balance bank statement; 1,163.42 2,050.00 therefore, none of Deposits and these items is a Cash Disbursements Journal Daily Credits Balance Amount reconciling item. Cheque # Amount
240.00 180.00 100.00 150.00 485.00 1,609.58 1,794.58 1,949.58 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

119 120 121 122 123 124 125 126 127 128

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55.00 200.00 120.00 70.00 25.00 150.00 15.00 200.00 50.00 135.00 1,020.00 (101)

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

These items appear on both Total Deposits the Cash Current and Credits Balance Disbursements 1,163.42 2,050.00 Journal AND the Deposits and bank statement; Daily Credits Balance therefore, none of Amount these1,609.58 is a items 240.00 1,794.58 reconciling item. 180.00 1,949.58
Statement Date 31-Oct-11 Account Number 494 504 2 100.00 150.00 485.00 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00 15 16 31 $ 100.00 150.00 145.00 815.00 (101)

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Cash Disbursements Journal Cheque # Amount 119 $ 55.00 120 200.00 121 120.00 122 70.00 123 25.00 124 150.00 125 15.00 126 200.00 127 50.00 128 135.00 $ 1,020.00 (101)

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

These items appear only in Statement Date 31-Oct-11 the Cash Account Number 494 504 2 Receipts Journal OR the Total Deposits Current Cash and Credits Balance Disbursements 1,163.42 2,050.00 Journal OR the bank Deposits and Daily statement; Credits Balance Amount therefore, each of 1,609.58 these items is a 240.00 1,794.58 180.00reconciling item. 1,949.58
100.00 150.00 485.00 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00 15 16 31 $ 100.00 150.00 145.00 815.00 (101)

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Cash Disbursements Journal Cheque # Amount 119 $ 55.00 120 200.00 121 120.00 122 70.00 123 25.00 124 150.00 125 15.00 126 200.00 127 50.00 128 135.00 $ 1,020.00 (101)

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Statement Date 31-Oct-11 Account Number 494 504 2 Total Deposits and Credits 1,163.42 Deposits and Credits Amount 240.00 180.00 100.00 150.00 485.00 Current Balance 2,050.00

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

Daily Balance 1,609.58 1,794.58 1,949.58 1,999.58 2,126.58 2,541.58 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

The items that show up only on the bank statement are reconciling items on the book side of the bank reconciliation.

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Statement Date 31-Oct-11 Account Number 494 504 2 Total Deposits and Credits 1,163.42 Deposits and Credits Amount 240.00 180.00 100.00 150.00 485.00 Current Balance 2,050.00

VIDEOBUSTER COMPANY Bank Reconciliation October 31, 2011 1,404.58

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

Daily Balance

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

Book Balance Add: 1,609.58 Collection of $500 note 1,794.58 less $15 collection fee 1,949.58 Interest earned
1,999.58 2,126.58 2,541.58Less: 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

485.00 8.42

493.42 1,898.00

NSF cheque plus s/c Cheque printing charge

30.00 23.00

53.00 1,845.00

8.42

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National Bank Hamilton, ON L8P 2X5

VideoBuster Company 901 Main Street Hamilton, ON L8P 2J8 Previous Balance 1,609.58 Total Cheques and Debits 723.00 Cheques and Debits Number Amount 119 123 127 122 120 125

Bank Statement

Statement Date 31-Oct-11 Account Number 494 504 2 Total Deposits and Credits 1,163.42 Deposits and Credits Amount 240.00 180.00 100.00 150.00 485.00 Current Balance 2,050.00

VIDEOBUSTER COMPANY Bank Reconciliation October 31, 2011 1,404.58

Date Oct 1 3 9 15 16 17 18 19 20 26 29 31

Daily Balance

121 128

55.00 25.00 50.00 23.00 DM 70.00 CM 200.00 15.00 20.00 NSF 10.00 DM 120.00 135.00 IN

Book Balance Add: 1,609.58 Collection of $500 note 1,794.58 less $15 collection fee 1,949.58 Interest earned
1,999.58 2,126.58 2,541.58Less: 2,341.58 2,326.58 2,296.58 2,176.58 2,041.58 2,050.00

485.00 8.42

493.42 1,898.00

NSF cheque plus s/c Cheque printing charge

30.00 23.00

53.00 1,845.00

8.42

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The items that show up only on the Cash Receipts or Cash Disbursements Journal are reconciling items on the bank side of the bank reconciliation.

Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00 15 16 31 $ 100.00 150.00 145.00 815.00 (101)

Cash Disbursements Journal Cheque # Amount 119 $ 55.00 120 200.00 121 120.00 122 70.00 123 25.00 124 150.00 125 15.00 126 200.00 127 50.00 128 135.00 $ 1,020.00 (101)

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Cash Receipts Journal Deposit Date Amount Oct 3 $ 240.00 9 180.00

VIDEOBUSTER COMPANY Bank Reconciliation October 31, 2011 Bank Balance Add: Deposit in transit $ 2,050.00 145.00 2,195.00

15 16 31 $

100.00 150.00 145.00 815.00 (101)

Less: Outstanding cheques No. 124 No. 126

$ 150.00 200.00

350.00 $ 1,845.00

Cash Disbursements Journal Cheque # Amount 119 $ 55.00 120 200.00 121 120.00 122 70.00 123 25.00 124 150.00 125 15.00 126 200.00 127 50.00 128 135.00 $ 1,020.00 (101)

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The Final Product

VIDEOBUSTER COMPANY Bank Reconciliation October 31, 2011 Bank Balance Add: Deposit in transit $ 2,050.00 145.00 2,195.00 Book Balance Add: Collection of $500 note less $15 collection fee Interest earned Less: Cheque printing charge NSF cheque plus fee Adjusted book balance 23.00 30.00 53.00 $ 1,845.00 $ 1,404.58 $ 485.00 8.42

493.42 1,898.00

Less: Outstanding cheques No. 124 $ 150.00 No. 126 200.00 350.00 Adjusted bank balance $ 1,845.00

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Recording Adjusting Entries from the Bank Reconciliation

GENERAL JOURNAL
Date Description 2011 Oct. 31 Cash Collection expense Notes Receivable
To record collection by bank

Page 8
PR Debit 485.00 15.00 500.00 Credit

Oct. 31 Cash Interest earned

To record collection by bank
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LO 6

Recording Adjusting Entries from the Bank Reconciliation

GENERAL JOURNAL
Date Description 2011 Oct. 31 Accounts Receivable - Heflin Cash
To record NSF cheque plus s/c

Page 8
PR Debit 30.00 30.00 Credit

Oct. 31 Office supplies expense Cash

To record cheque printing charge

23.00 23.00

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Recording Adjusting Entries from Bank Reconciliation

After posting the reconciling entries the cash account looks like this . . .
GENERAL LEDGER Account:
Date
2011

Cash
Item 31 31 31 31 31 Balance Adjusting entry Adjusting entry Adjusting entry Adjusting entry PR Debit

Acct. No.
Credit

101
Balance DR (CR) 1,404.58 1,889.58 1,898.00 1,868.00 1,845.00

Oct.

G8 G8 G8 G8

485.00 8.42 30.00 23.00

Adjusted balance on October 31.

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Using the Information-Appendix 9A

Acid-Test Ratio A measure of a companys liquidity. Similar to current ratio but excludes less liquid assets. Ratio will vary from industry to industry.

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Using the Information-Appendix 9A

Acid-Test Ratio =

Quick assets* Current liabilities

* cash, short-term investments, and receivables

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LO 7