Internal Control and Cash

Fraud and Its Impact

Fraud is defined as the intentional misrepresentation of facts, designed to persuade another party to act in a way that causes injury or damage. Fraud can significantly impact organizations, both financially and reputationally.

• Financial Impact: Organizations lose an average of 5% of revenue annually to fraud, amounting to trillions globally.

• Types of Fraud:

  • Misappropriation of Assets: Employees steal money or assets and cover it up by falsifying records.

  • Fraudulent Financial Reporting: Managers manipulate accounting entries to deceive investors and creditors.

• Common Red Flags: Living beyond means, financial difficulties, close associations with vendors/customers.

Objectives and Components of Internal Control

Internal control is a plan of organization and system of procedures implemented by management and the board of directors to achieve five key objectives:

• Safeguard assets

• Encourage employees to follow firm policies

• Promote operational efficiency

• Ensure accurate, reliable accounting records

• Comply with legal requirements

The main components of internal control include:

• Control environment

• Risk assessment

• Information system

• Control procedures

• Monitoring of controls

Cash Management and Internal Controls

Tools of Effective Cash Management

Effective cash management is essential for safeguarding assets and ensuring accurate financial reporting. Key tools include:

• Cash Flow Statement

• Cash Budgets

• Petty Cash Funds

• Bank Reconciliation

• Internal Controls over Cash Receipts and Disbursements

Internal controls for cash receipts involve recording when received, depositing receipts intact, and separating duties among employees. For cash disbursements, major payments are made by check, petty cash is used for small expenditures, and bank reconciliations are prepared regularly.

Bank Statement and Cash Control

Bank Statement Overview

A bank statement is a detailed list provided by the bank of all activity for a particular account during the month. It helps control cash by providing a safe place for funds and a detailed record of transactions for comparison with company books.

• Includes: Beginning balance, deposits, check payments, NSF checks, EFTs, service charges, interest earned, customer notes, credit/debit memos, ending balance.

Bank Reconciliation

Purpose and Process

Bank reconciliation resolves differences between the ending balance on the bank statement and the ending balance in the company's Cash T-account. It ensures both records are correct and establishes the balance of cash to report on the balance sheet.

• Two Sides: Bank side and Book side

• Bank Side Adjustments: Add deposits in transit, subtract outstanding checks, correct bank errors

• Book Side Adjustments: Add credit memos (interest, bank collections), subtract debit memos (NSF checks, service charges), correct book errors

Bank Side of Reconciliation

• Start with ending bank balance

• Add deposits in transit

• Subtract outstanding checks

• Correct bank errors

• Calculate adjusted bank balance

Book Side of Reconciliation

• Start with ending book balance

• Add credit memoranda (interest, bank collections)

• Subtract debit memoranda (NSF checks, service charges, EFT payments)

• Correct book errors

• Calculate adjusted book balance

• Prepare journal entries for all changes on book side

Reporting Cash on the Balance Sheet

Cash and Cash Equivalents

All cash amounts are combined into a single total called "Cash and Cash Equivalents" on the balance sheet. This includes:

• Cash on Hand: Coin and currency, petty cash funds

• Cash on Deposit: Checking and savings accounts

• Undeposited Checks: Checks received but not yet deposited

• Cash Equivalents: Investments with maturity of 3 months or less at purchase, such as time deposits, high-grade government securities, certificates of deposit

Items not included as cash or cash equivalents: postage stamps, IOUs, accounts receivable.

Example Table: Cash and Cash Equivalents Classification

Bank Reconciliation Example

Steps to Prepare a Bank Reconciliation

1. Compare the bank statement and the company's books for differences.

2. Adjust the bank side for deposits in transit, outstanding checks, and bank errors.

3. Adjust the book side for credit/debit memos, book errors, and unrecorded transactions.

4. Calculate the adjusted balances and ensure they match.

5. Prepare journal entries for all book side adjustments.

Journal Entry Example

For each adjustment on the book side, a journal entry is required. For example:

• To record bank collections:

• To record service charges:

• To record NSF checks:

Key Formulas

Bank Reconciliation Formula

The adjusted bank and book balances should be equal after reconciliation:

Where:

Additional info: These notes expand on brief points in the original material, providing definitions, examples, and formulas for clarity and completeness.