Internal Controls & Cash Management

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Questions and Answers

What is the primary purpose of internal controls within a company?

  • To eliminate the need for external audits.
  • To ensure reliable financial reporting, effective operations, and compliance with laws. (correct)
  • To maximize employee bonuses and shareholder dividends.
  • To guarantee profitability and high stock valuation.

Which of the following is NOT one of the five primary components of a good internal control system?

  • Risk assessment
  • Control environment
  • Shareholder relations (correct)
  • Monitoring activities

How does the 'control environment' contribute to an entity's internal control system?

  • By ensuring physical security through alarms and surveillance systems.
  • By establishing the culture, structure, and discipline of the entity. (correct)
  • By focusing solely on IT infrastructure and security.
  • By managing external communications and public relations.

Which of the following best describes 'risk assessment' in the context of internal controls?

<p>Identifying and responding to potential business risks. (B)</p> Signup and view all the answers

Segregation of duties is a crucial control activity. Why is it implemented?

<p>To assign responsibility so one individual cannot complete all parts of a process. (A)</p> Signup and view all the answers

What is the primary goal of 'physical controls' as a control activity?

<p>To safeguard assets and enhance the accuracy and reliability of accounting records. (D)</p> Signup and view all the answers

What is the purpose of 'review and reconciliation' as a control activity?

<p>To ensure the data prepared by employees is reviewed for accuracy and completeness. (B)</p> Signup and view all the answers

How do 'information systems and communication' support internal controls?

<p>By capturing and exchanging information to manage and control operations. (C)</p> Signup and view all the answers

Why is 'monitoring of controls' a critical component of internal control systems?

<p>To assess the effectiveness of controls and modify them as conditions change. (D)</p> Signup and view all the answers

Which of the following is a limitation of internal control systems?

<p>They can only provide reasonable assurance due to factors like human error and collusion. (A)</p> Signup and view all the answers

According to the 'Fraud Triangle', what three elements are typically present when fraud occurs?

<p>Pressure, opportunity, and rationalization. (C)</p> Signup and view all the answers

Where on the financial statements is cash typically reported?

<p>On both the balance sheet as a current asset and the statement of cash flows. (C)</p> Signup and view all the answers

How are cash equivalents defined, and how should they be reported?

<p>They are short-term, highly liquid investments with insignificant risk of value change, often combined with cash for reporting. (B)</p> Signup and view all the answers

A company has an overdraft at year-end. How is this typically reported on the balance sheet?

<p>As a current liability called bank indebtedness. (B)</p> Signup and view all the answers

Why is cash considered to have high inherent risk?

<p>Cash is liquid, easily concealed, and interchangeable. (D)</p> Signup and view all the answers

What is the primary purpose of performing a bank reconciliation?

<p>To detect and correct errors in a company's accounting records or the bank's records. (A)</p> Signup and view all the answers

Which of the following is an example of a control activity over cash receipts?

<p>Authorizing only designated personnel to handle cash receipts. (B)</p> Signup and view all the answers

Why are control activities over cash payments more effective when using electronic funds transfer (EFT)?

<p>EFTs provide an easier audit trail compared to cash transactions. (C)</p> Signup and view all the answers

Why might the cash balance shown on a company's books differ from the cash balance shown on the bank statement?

<p>Time lags in recording transactions or errors made by either party. (D)</p> Signup and view all the answers

What is an 'outstanding cheque' in the context of a bank reconciliation?

<p>A check that was recorded by the company but not received by the bank as of the reconciliation date. (A)</p> Signup and view all the answers

What is the correct treatment of 'deposits in transit' when preparing a bank reconciliation?

<p>Add them to the bank balance. (E)</p> Signup and view all the answers

What is the impact of a bank service charge on the book side of the bank reconciliation?

<p>It is deducted from the book balance. (C)</p> Signup and view all the answers

What does NSF stand for in the context of bank reconciliation, and how does it affect the bank reconciliation?

<p>Non-Sufficient Funds; deducted from the book balance. (C)</p> Signup and view all the answers

How are bank collections treated in a bank reconciliation?

<p>Added to the book balance. (D)</p> Signup and view all the answers

A company erroneously recorded a check for $54, but the check was actually written for $45. How is this error treated in the bank reconciliation?

<p>The difference of $9 is added to the book balance. (B)</p> Signup and view all the answers

What is the order of items for the principles of cash management?

<p>Increase the speed of the receivables collection, keep inventory low, take advantage of credit periods, plan timing of major expenditures, invest idle cash, prepare a cash budget. (D)</p> Signup and view all the answers

What is the meaning of the cash management principle: Increase the speed of receivables collection?

<p>Make sure customers pay quickly and do not default on payments. (D)</p> Signup and view all the answers

What is the purpose of the cash management principle: Prepare a cash budget?

<p>So that you prepare for potential sales and what you need for your company. (D)</p> Signup and view all the answers

What is Electronic Funds Transfer (EFT)?

<p>It is using an external credit transfer and doing it by an electronic way. (C)</p> Signup and view all the answers

What are the three types of activities on the cash flow statements?

<p>Operating, Investing, Financing. (D)</p> Signup and view all the answers

What does reconciliation involve in the context of internal controls?

<p>Comparison between two or more documents. (A)</p> Signup and view all the answers

What does documentation provide for business processes?

<p>Documentation shows evidence that transactions and events have occurred at specified times and specified amounts. (A)</p> Signup and view all the answers

What does assigning responsibility do in the scope of internal controls?

<p>Responsibility should be assigned to specific employees, making them accountable for carrying out a task appropriately. (D)</p> Signup and view all the answers

Bank errors can happen, what is the treatment for that?

<p>Add or subtract for bank errors on reconciliation. (A)</p> Signup and view all the answers

Why is cash useful to a business?

<p>Medium of exchange and highly fungible (interchangeable). (D)</p> Signup and view all the answers

Why is it important to keep inventory low under cash management?

<p>Inventory is expensive to own. (C)</p> Signup and view all the answers

If you subtract outstanding cheques, are you subtracting from the...

<p>Bank Balance (B)</p> Signup and view all the answers

Why would the bank statement and cash accounts be different?

<p>Time lags in recording transactions (B)</p> Signup and view all the answers

Flashcards

Internal Control

Systems adopted to achieve reliable financial reporting, effective operations, regulatory compliance, prevent errors, and detect fraud.

Control Environment

Culture, structure, and discipline within an entity.

Risk Assessment Process

The entity's process for identifying and responding to business risks.

Control Activities

Actions taken to mitigate risks and ensure objectives are met.

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Information Systems and Communication

Capturing and exchanging information to manage operations.

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Monitoring of controls

Monitoring controls and modifying them as needed

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Assignment of Responsibility

Assigning tasks to specific employees, who are then accountable.

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Segregation of Duties

Dividing responsibilities to prevent fraud and errors.

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Documentation (Internal Control)

Evidence that transactions occurred at specified times and amounts.

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Physical Controls

Safeguarding assets and ensuring reliable records.

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Review and Reconciliation

Reviewing data and comparing different document sets.

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Limitation of Internal Control

Reasonable assurance that assets are safe and records are accurate.

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Pressure (Fraud Triangle)

Financial or emotional stress that leads to fraudulent activity.

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Opportunity (Fraud Triangle)

Ability to commit fraud without detection.

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Rationalization (Fraud Triangle)

Justifying dishonest actions with excuses.

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Reporting Cash

Reported on both the statement of financial position and cash flows.

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Cash Equivalents

Short-term, liquid investments with insignificant value change risk.

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Bank Indebtedness

Reported as a current liability when cash is in deficit.

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Bank Reconciliation

Checks accounting of banks cash against accountant's own record.

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Assignment of Responsibility (Cash)

Authorizing only particular employees to handle cash.

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Segregation of Duties (Cash)

Different people record cash receipts and handle cash.

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Timing Differences (Bank Reconciliation)

Differences in company records vs. the bank statement.

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Outstanding Cheques

Cheques written but not yet processed by the bank.

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Deposits in Transit

Receipts recorded by the company but not yet by the bank.

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adjusted cash balance

Adjust books and bank balance to correct values.

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Deposits in transit (Bank Side)

Add to the bank balance in bank reconciliation.

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Outstanding Cheques (Bank Side)

Subtract from the bank balance in bank reconciliation.

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Bank Collections (Book Side)

Add to the book balance in bank reconciliation.

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Service Charge (Book Side)

Subtract from the book balance in bank reconciliation.

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EFT

Electronic Funds Transfer

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Cash Management

Increase speed of collections, keep inventory low

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Study Notes

  • Lecture 13 will cover internal controls and cash management, including a review of concepts and bank reconciliation.
  • The next class will cover cash flow statements.

Administrivia

  • Ryan Stack can be reached at ryan.stack@acadiau.ca.
  • Ryan Stack's office is located in Patterson Hall, Office 102.
  • Office hours are available on Thursdays from 11:30 AM to 1:30 PM and by appointment.
  • Office hours and drop-in hours are times set aside for students to connect with professors about questions, concerns, or issues.

Learning Objectives

  • Identify and describe components of a good internal control system, including its 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 Defined

  • Internal control is a system adopted within a company to achieve reliable financial reporting, effective/efficient operations, and compliance with laws/regulations.
  • It helps prevent and detect errors, preventing unintentional misstatements.
  • It is an effective way to prevent and detect fraud.

Components of Internal Control Systems

  • Control environment
  • Risk assessment
  • Control activities
  • Information and communication
  • Monitoring activities

System of Internal Controls

  • Entity-level internal controls can impact all entity processes.

Control Environment

  • Comprises the culture, structure, and discipline of an entity.
  • Dictates how management responsibilities are carried out.
  • It attracts, develops, and retains competent employees.
  • It requires independent and active participation by those charged with governance.
  • Assigns authority and responsibility, including IT environment.
  • Outlines how the entity holds individuals accountable for meeting internal control objectives.

Risk Assessment Process

  • Assesses how organizations identify and respond to business risks.

Control Activities

  • Include: assignment of responsibility, segregation of duties, documentation, physical controls, review and reconciliation.
  • Specific control activities used depend on the risks faced and management's assessment, as well as company size and nature.

Assignment of Responsibility

  • Responsibility should be assigned to specific employees, making them accountable for carrying out a task appropriately.
  • Each cashier is responsible for their own cash drawer.

Segregation of Duties

  • The responsibility for authorization, recording of transactions, and custody of assets should be assigned to different individuals.
  • All purchasing activities, including ordering, approving, receiving and authorizing payment, should not be carried out by the same employee.

Documentation

  • Evidence that transactions and events have occurred at specified times and specified amounts.
  • Evidence includes shipping documents that indicate goods have been shipped.

Physical Controls

  • Used for safeguarding of assets and enhancing the accuracy and reliability of accounting records.
  • Computer passwords, building alarms, security cameras, safes, vaults, and locked doors.

Review and Reconciliation

  • Data prepared by employees should be subject to independent review, both internally and externally.
  • Reconciliation involves a comparison between two or more documents, such as bank reconciliations.

Information Systems and Communication

  • Designed to capture and exchange information to conduct, manage, and control entity's operations.
  • They include manual and automated systems.
  • Systems are relevant to financial reporting but may also report non-financial information.

Monitoring of Controls

  • Asks whether management monitors controls and modifies them as required when conditions change.
  • Ongoing monitoring procedures should be part of regular activities, such as an internal audit function.

Limitations of Internal Control

  • Can only provide reasonable assurance that assets are safeguarded and records are reliable.
  • Limitations include cost/benefit considerations, human error, collusion, and management override.

Fraud Triangle

  • A framework for spotting high-risk fraud situations that require Pressure: financial or emotional force pushing towards fraud.
  • Opportunity: Ability to execute plan without being caught.
  • Rationalization: Is the personal justification of dishonest actions.

Reporting Cash

  • 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 can be combined with cash equivalents, such as short-term, highly liquid held-for-trading investments with insignificant risk of value changes.
  • If cash is in a deficit or overdraft at year-end, it is reported as a current liability called bank indebtedness.

Controlling Cash

  • Cash is liquid and highly fungible, making it a key medium of exchange.
  • This makes cash useful; however, it also creates risk, as cash is easy to conceal and relatively easy to steal.
  • Forms of documentation safeguard customer money and include signature cards, deposit slips, checks, and bank statements.
  • Accountants use these documents to check the bank's accounting of their cash position against their own records.
  • This process is called a bank reconciliation.

Control Activities over Cash Receipts and Payments

  • Assignment of responsibility: Authorize only designated personnel to handle cash receipts.
  • Segregation of duties: Ensure different individuals record cash receipts and handle cash.
  • Documentation: Use remittance advices, cash register tapes, POS system reports, and deposit slips or confirmations.
  • Physical controls: Store cash in safes with limited access; use cash registers; and deposit all cash in bank daily.
  • Review and reconciliation: Supervisors count cash receipts daily; have an accountant compare total receipts with bank deposits daily.
  • Control activities over cash payments are more effective when payments are made by check or by electronic funds transfer rather than in cash.

Bank Reconciliation Defined

  • A bank reconciliation compares two records of a business's cash: the cash account in the general ledger (books) and the bank statement.
  • Amounts in the cash account and bank statement are usually different due to time lags in recording transactions.
  • Bank reconciliation explains differences and adjusts the book side where necessary.

Differences Between Company Records and Bank Statement

  • Timing differences may cause one party to record the transaction before the other knows about it.
  • Examples include the period after a check is written but not yet presented to the bank and the period between the deposit being recorded by the company and recorded by the bank.
  • Errors can also happen by either party when recording transactions.

Reconciling the Bank Account

  • Reconcile the balance per the bank statement with the company's cash balance per the general ledger ("books").
  • Both the books and bank balance are reconciled to their adjusted (correct) cash balance.
  • Adjusted cash balance equates to reconciled balance.

Bank Side of the Reconciliation

  • Reconciling items cash balance per bank: Determining deposits in transit at the end of the period as well as outstanding checks at the end of the period, and any bank errors.

Book Side of the Reconciliation

  • Includes bank collections, electronic funds transfers (EFT), service charges, interest income, non-sufficient funds (NSF) checks, costs, and book errors.

Summary of Reconciling Items

  • Bank side: Add deposits in transit and add or subtract correction of bank errors. Substract outstanding checks.
  • Book side: Add bank collections, interest revenue, and EFT receipts; substract service charges, NSF cheques, EFT payments and substract or add correction of book errors.

Principles of Cash Management

  • Involves increasing the speed of receivables collection.
  • Keeping inventory low.
  • Taking advantage of credit periods.
  • Planning the timing of major expenditures.
  • Investing idle cash.
  • Preparing a cash budget.

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