Chapter 7: Internal Control and Cash – Study Notes

Internal Control and Cash

Learning Objectives

• Explain the components of an internal control system, including its control activities and limitations.

• Apply key control activities to cash receipts and payments.

• Prepare a bank reconciliation.

• Explain the reporting and management of cash.

Internal Control

Definition and Purpose

Internal control refers to the systems and procedures implemented by a company to achieve:

• Reliable financial reporting

• Effective and efficient operations

• Compliance with relevant laws and regulations

Internal controls help prevent and detect errors (unintentional misstatements) and are an effective way to prevent and detect fraud.

Components of Internal Control

• Control environment: The overall attitude, awareness, and actions of management and employees regarding internal controls.

• Risk assessment: Identifying and analyzing risks that may prevent the achievement of objectives.

• Control activities: Policies and procedures that help ensure management directives are carried out.

• Information and communication: Systems that support the identification, capture, and exchange of information in a form and time frame that enables people to carry out their responsibilities.

• Monitoring activities: Ongoing or separate evaluations of the effectiveness of internal controls.

Control Activities

Types of Control Activities

Control activities are the specific policies and procedures that help ensure management directives are carried out. They include:

• Assignment of responsibility: Assigning specific tasks to specific employees to ensure accountability.

• Segregation of duties: Dividing responsibilities among different individuals to reduce the risk of error or inappropriate actions.

• Documentation: Maintaining evidence that transactions and events have occurred at specified times and amounts.

• Physical controls: Safeguarding assets and enhancing the accuracy and reliability of accounting records (e.g., passwords, alarms, safes).

• Review and reconciliation: Independent checks of performance and records, such as bank reconciliations.

The specific control activities used depend on the risks faced and the size and nature of the company.

Assignment of Responsibilities

• Each employee is accountable for their assigned tasks (e.g., each cashier is responsible for their own cash drawer).

Segregation of Duties

• Authorization, recording, and custody of assets should be assigned to different individuals (e.g., no single employee should order, approve, receive, and authorize payment for purchases).

Documentation

• Transactions should be supported by evidence, such as shipping documents indicating goods have been shipped.

Physical Controls

• Examples include computer passwords, building alarms, security cameras, safes, and vaults.

Review and Reconciliation

• All controls should be independently reviewed, both internally and externally. Reconciliation involves comparing two or more documents (e.g., bank reconciliations).

Brief Exercise 7.2: Matching Control Activities

Control Activity	Description
1. Assignment of responsibility	d. Responsibility for related activities should be assigned to specific employees.
2. Segregation of duties	e. Cheque signers are not allowed to record cash transactions.
3. Documentation	a. All transactions should include original, detailed receipts.
4. Physical controls	b. Undeposited cash should be stored in the company safe.
5. Review and reconciliation	c. Surprise cash counts are performed by internal audit.

Limitations of Internal Control

• Internal controls provide reasonable assurance but not absolute assurance that assets are safeguarded and records are reliable.

• Limitations include:

  • Cost/benefit considerations

  • Human error

  • Collusion

  • Management override

Fraud

Definition and Examples

Fraud is an intentional act to misappropriate (steal) assets or to misstate financial information. Common examples include:

• Recording expenses as assets

• Overstating useful lives of assets

• Recording revenues that do not exist

Fraud typically involves three elements: opportunity, pressure, and rationalization.

Cash Controls

Nature of Cash and Its Controls

• Cash is highly susceptible to theft.

• Cash includes coins, currency, cheques, money orders, and money on hand or in the bank.

• General rule: If the bank will accept it for deposit, it is considered cash.

Cash Receipts

Forms and Controls

Cash receipts can be over-the-counter, cheque, or electronic funds transfer (EFT). Internal control is more effective when receipts are deposited daily or made by EFT.

Control Activity	Application to Cash Receipts
Assignment of Responsibility	Authorize only designated personnel to handle cash receipts.
Segregation of Duties	Have different individuals receiving and handling cash, and recording cash receipts.
Documentation	Use remittance registers, POS receipts, cash register tapes, and deposit slips or confirmations.
Physical Controls	Store cash in safes with limited access; deposit all cash in bank daily.
Review and Reconciliation	Conduct independent cash counts and compare total receipts with bank deposits daily.

Cash Payments

Controls Over Payments

Control activities are more effective when payments are made by cheque or EFT rather than cash.

Control Activity	Application to Cash Payments
Assignment of Responsibility	Authorize only designated personnel to sign cheques or approve EFTs.
Segregation of Duties	Have different individuals approving payments, signing cheques, and recording payments.
Documentation	Use pre-numbered cheques and require supporting documents for each payment.
Physical Controls	Store cheques in safes with limited access; use electronic payment controls.
Review and Reconciliation	Compare payments with bank statements monthly.

Use of a Bank

Benefits

• Safeguards cash by using a bank as a depository and clearinghouse for cheques received and written.

• Minimizes the amount of currency that must be kept on hand.

• Provides a second record of transactions (one by the business, one by the bank).

• These two accounts can be reconciled.

Understanding Debits and Credits

	Bank (Your Cash Account is a Liability to the Bank)	Books (Cash is an Asset to the Company)
Cheque	Debit (decrease)	Credit (decrease)
Deposit	Credit (increase)	Debit (increase)

Bank Statement

A bank statement is a summary of all transactions processed through a company's bank account during a period. It is used to compare the company's records with the bank's records.

Differences Between Company Records and Bank Statement

• Timing differences:

  • Outstanding cheques: Cheques written and recorded by the company but not yet cleared by the bank.

  • Deposits in transit: Receipts recorded by the company but not yet processed by the bank.

• Errors by either party in recording transactions.

Reconciling the Bank Account

Purpose and Process

Bank reconciliation matches the balance per the company's bank account with the cash balance per the general ledger ("books"). Both balances are reconciled to their adjusted (correct) cash balance:

$\text{Adjusted cash balance} = \text{Reconciled balance}$

Bank Reconciliation Procedures

Reconciling Items per Bank

1. Deposits in transit (+): Add deposits recorded in the company's books but not yet on the bank statement.

2. Outstanding cheques (–): Subtract cheques recorded in the company's books but not yet cleared by the bank.

3. Bank errors (+/–): Adjust for any errors made by the bank.

Reconciling Items per Books

1. EFT collections, interest earned, and other deposits (+): Add items collected by the bank but not yet recorded in the company's books.

2. EFT payments, service charges, interest charges, and other payments (–): Subtract items paid by the bank but not yet recorded in the company's books.

3. Book errors (+/–): Adjust for any errors made in the company's books.

Bank Reconciliation Journal Entries

• Each reconciling item affecting the adjusted balance per books must be journalized and posted.

• No entries are made on the bank side.

Bank Reconciliation Illustrated

Laird Ltd. – Bank Reconciliation (April 30, 2021)
Cash balance per bank statement	$14,604.73
Add: Deposits in transit	2,100.10
	16,704.83
Less: Outstanding cheques	5,800.00 1,031.00 1,502.70
	8,333.70
Reconciled cash balance per bank	10,904.13
Cash balance per books	8,437.55
Add: Electronic receipts from customers in account	6,787.18
Less: Returned (NSF) cheque plus service charge (465.60 + 50)	515.60
Less: Bank service and debit/credit card fees	165.00
Add: Error in recording cheque No. 439 (3,800 – 3,236)	564.00
Reconciled cash balance per books	10,904.13

Journal Entries for Bank Reconciliation

• To record electronic receipts on account:

  • Debit Cash, Credit Accounts Receivable

• To record NSF cheque:

  • Debit Accounts Receivable, Credit Cash

• To record bank service charges:

  • Debit Bank Charges Expense, Credit Cash

• To record book error:

  • Debit Cash, Credit Accounts Payable

Reporting Cash

Financial Statement Presentation

• Cash is reported in both the statement of financial position and the statement of cash flows.

• The statement of cash flows shows the receipts and payments of cash.

• Cash is the most liquid asset and is listed first in the current assets section of the statement of financial position.

Cash Equivalents

• Cash can be combined with cash equivalents: short-term, highly liquid investments subject to insignificant risk of changes in value.

• If cash is in a deficit or overdraft at year-end, it is reported as a current liability called bank indebtedness.

Managing Cash

Principles of Cash Management

Ensuring sufficient cash to meet needs is a major management challenge. Basic principles include:

1. Increase the speed of receivables collection

2. Keep inventory levels low

3. Monitor payment of liabilities

4. Plan timing of major expenditures

5. Invest idle cash

6. Prepare a cash budget

Reviewing IFRS and ASPE

Key Differences	International Financial Reporting Standards (IFRS)	Accounting Standards for Private Enterprises (ASPE)
No significant differences.

Additional info: The notes above are based on standard Financial Accounting curriculum and expand on the provided slides and text for clarity and completeness.