Internal Controls & Cash Management

• 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 [email protected].
• 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.