Bank Reconciliations and Internal Controls

Upcoming Schedule and Exam Information

  • Conceptual Roadmap:

    • Next week: Inventory, covering duty charges, discounts, ownership criteria (regardless of physical warehouse location).

    • Week after: Long-lived assets.

    • Following week: Practice session leading up to the San Antonio event.

  • Exam Review:

    • The final week will include a comprehensive review page, which is an exact replica of a former exam from previous years, providing a realistic preview of the actual exam.

  • Closing Entries:

    • This is a crucial concept, emphasized as one of the "easiest steps of grade" on the exam.

    • Correctly completing closing entries can secure 55 to 99 marks, significantly impacting the overall grade.

    • The topic will be revisited after the Progolas case study.

  • Instructor Office Hours:

    • To manage high demand, especially from first-year students, the registration system for next week's office hours will open later today.

    • Drop-in hours have been added to assist first-year students and free up bookable slots.

    • More hours will be added closer to the exam period.

Understanding Internal Controls and Fraud

  • Introduction to Fraud:

    • Discussion initiated with examples of fraud. One example highlighted a discrepancy: $200,000\$200,000 initially thought, but actual fraud was $199,600\$199,600.

    • The overarching point is that such unexpected fraudulent activities occur frequently.

  • Human Behavior and Opportunity (Studies):

    • Roughly 20%20\% of people can be trusted at all times.

    • Another 20%20\% can never be trusted.

    • A significant 60%60\% of individuals are likely to engage in questionable behavior if given the opportunity and believe they will not be detected.

  • Importance for Accountants:

    • Understanding internal controls is critical for anyone in accounting or business, whether owning or working for a company.

    • It's essential to differentiate between a seemingly "fine" situation and one that poses a significant risk.

  • Personal Story Example (Gas Station Fraud):

    • Scenario: A colleague at a gas station job (dubbed "petroleum transfer engineer") exploited a lack of oversight regarding corporate cards on file for businesses.

    • Mechanism: The colleague would charge these corporate cards and then take an equivalent amount of cash from the till. This ensured the till balanced at the end of each night, masking the fraud.

    • Detection: It took several months for account personnel receiving monthly invoices to notice unusual charges, leading to the colleague's discovery.

    • Impact: The colleague accumulated $5,000\$5,000 in fraudulent charges over several months, primarily spent on small items at a variety store.

    • Control Weakness: The critical missing check was the lack of separation of duties – the same person had access to the till and the ability to swipe unattended corporate cards. Corporate cards should ideally be kept off-site with the client.

Bank Reconciliations: Core Concepts

  • Responsibility for Reconciliation:

    • Should be prepared by an employee separate from cash-handling duties (e.g., recording cash receipts/disbursements) to ensure segregation of duties and prevent theft/errors.

      • Example: The gas station colleague could have done bank reconciliations, and his books (till) balanced, but not against external bank statements.

  • Reasons for Balance Differences (Bank vs. Books):

    • Time Lags:

      • Outstanding Checks: Company has recorded cash outflow, but the bank hasn't yet processed the payment.

      • Deposits in Transit: Company has recorded cash inflow, but the bank hasn't yet received/recorded the deposit.

      • Bank Service Fees: Bank records immediately; company only learns upon receiving the bank statement.

    • Errors:

      • Company Errors: More common (e.g., writing $101\$101 instead of $110\$110).

      • Bank Errors: Less common; generally, assume company error first in cases.

  • Process Overview:

    • Compare the company's list of receipts and disbursements with the bank's deposits and withdrawals.

    • The vast majority of transactions ("smallinthemiddleofthediagram""small in the middle of the diagram") should overlap and be identical.

  • NSF (Non-Sufficient Funds) Checks:

    • Definition: A "bounced check" where the customer's bank account lacks sufficient funds to cover the check amount.

    • Treatment in Reconciliation: Deducted from the company's book balance (as the original receipt was erroneously recorded as good cash).

    • Correcting Journal Entry:

      • Debit Accounts Receivable (to re-establish the claim against the customer for the original amount plus any bank NSF fees passed on).

      • Credit Cash (to reflect the reduction in the company's cash balance).

      • Example: If a check for $2,000\$2,000 bounces and the bank charges a $50\$50 NSF fee, the customer might owe $2,050\$2,050.

  • Carrying Forward Outstanding Checks:

    • If a check remains outstanding (un-cleared by the bank) at the end of a month, it must be carried forward and included in the next month's bank reconciliation until it clears.

Internal Control Weakness Scenarios: Examples

  • Snowboarding Club:

    • Scenario: Coach collects $25\$25 cash per lesson directly from students and then provides total cash to the office manager at day's end.

    • Weakness: The coach could easily misreport the number of students who paid cash (e.g., report 55 people paid when 1010 did), making it difficult to detect discrepancies.

  • Software Company:

    • Scenario: Programmers on the team created the accounting software, and everyone has access to make changes for flexibility and workload sharing.

    • Weaknesses:

      • Programmers could easily alter financial records without detection due to widespread access.

      • Difficult to track who made which changes and when.

      • Lack of accountability; the developer who built it could potentially embed hidden vulnerabilities or manipulate records unnoticed.

  • University (Hypothetical):

    • Scenario: All faculty and staff have access to the university's accounting software.

    • Weakness: Individuals could illicitly process raises for themselves or manipulate payroll data, which would be very hard to detect.

    • General Principle: Restricting access to accounting software to fewer individuals is generally a strong control measure, as it limits opportunities for both intentional fraud and accidental errors.

Adjusting Entries vs. Bank Reconciliation Adjustments

  • Adjusting Entries (Accrual Basis):

    • Typically related to the accrual basis of accounting and the matching principle.

    • Often do not involve cash (e.g., debiting Prepaid Expense, crediting Insurance Expense).

    • Their purpose is to align revenues and expenses with the correct fiscal period, even if cash hasn't changed hands.

  • Bank Reconciliation Adjustments (Affecting Books):

    • These do involve actual cash transactions for the company's books.

    • They are made when new information is received from the bank statement that the company was previously unaware of (e.g., bank service fees, NSF checks).

    • Example: If a bank fee is discovered, the entry would be to credit Cash and debit a corresponding expense account.

Progolas Case: Bank Reconciliation Walkthrough

  • Objective: Prepare a bank reconciliation statement and the necessary adjusting journal entries.

  • Source Documents (Exhibits):

    • Exhibit 1: Bank Reconciliation for February: Company's previous month's reconciliation; establishes starting point and lists prior outstanding items.

    • Exhibit 2: Cash Disbursements Journal: Company's record of cash 'out' (money spent).

    • Exhibit 3: Cash Receipts Journal: Company's record of cash 'in' (money received).

    • Exhibit 4: Bank Statement (March): Bank's record of deposits (cash in) and withdrawals (cash out) for the current month.

    • Exhibit 5: Additional Information: Specific details not found in other records (e.g., new automatic withdrawals, identified check errors, specific deposits in transit).

  • Step-by-Step Reconciliation Process:

    1. Check Previous Outstanding Items (Exhibit 1):

      • Verify if previous month's outstanding checks (e.g., Check 1212 for $1,200\$1,200 and Check 1818 for $5,500\$5,500) have cleared on the current bank statement (Exhibit 4).

      • Finding: Both Check 1212 and Check 1818 have not cleared and will be carried forward as outstanding.

    2. Compare Company Disbursements (Exhibit 2) with Bank Withdrawals (Exhibit 4):

      • Cross-reference all listed checks.

      • Identified Discrepancy (Check 40): Company recorded payment as $1,300\$1,300. Bank statement shows a withdrawal for $1,366\$1,366. This is deemed a company error (company understated cash outflow by $66\$66), assuming the bank is correct.

      • Identified Outstanding Check: Check 4141 for $75.28\$75.28 was recorded by the company but has not cleared the bank.

    3. Compare Company Receipts (Exhibit 3) with Bank Deposits (Exhibit 4):

      • Cross-reference all listed deposits.

      • Identified Deposits in Transit: A deposit of $865\$865 and another for $22,233.38\$22,233.38 (customer payment) were recorded by the company but do not appear on the bank statement for the period.

    4. Identify New Items on Bank Statement (Exhibit 4) Not on Company Books (Exhibit 5 for confirmations):

      • Payroll Deduction: A withdrawal of $1,015.20\$1,015.20 (automatic).

      • Service Charge: A withdrawal of $112\$112.

      • NSF Check Related Charges: A bounced check initially for $966\$966 incurred bank charges. The total charges for this, including an NSF fee, amounted to $132\$132.

      • Automatic Insurance Withdrawal: As per Exhibit 5, a new monthly automatic withdrawal for insurance of $400\$400 started on March 1st.

  • Constructing the Bank Reconciliation Statement (March):

    • Balance Per Books (Company Side):

      • Beginning Balance (Feb 29 / March 1): $4,289.43\$4,289.43

      • Add Cash Receipts for March: $46,460.00\$46,460.00

      • Subtract Cash Disbursements for March: $38,800.00\$38,800.00

      • Subtotal (before adjustments): $11,007.28\$11,007.28

      • Adjustments (Deductions):

        • Insurance withdrawal: −$400.00-\$400.00

        • Check 4040 error (understated disbursement): −$66.00-\$66.00

        • Payroll deduction: −$1,015.20-\$1,015.20

        • Bank charges (includes NSF fee): −$132.00-\$132.00

      • Adjusted Balance Per Books: $7,625.50\$7,625.50

    • Balance Per Bank (Bank Side):

      • Beginning Balance (March 31): $8,202.40\$8,202.40

      • Adjustments (Additions):

        • Deposit in transit ($865\$865): +$865.00+\$865.00

        • Deposit in transit ($22,233.38\$22,233.38): +$22,233.38+\$22,233.38

      • Adjustments (Deductions):

        • Outstanding Check 1212: −$1,200.00-\$1,200.00

        • Outstanding Check 1818: −$5,500.00-\$5,500.00

        • Outstanding Check 4141: −$75.28-\$75.28

      • Adjusted Balance Per Bank: $7,625.50\$7,625.50

    • Note: The adjusted balances should always match.

Exam Presentation of Bank Reconciliation

  • Least Likely Scenario:

    • Students are required to build the entire bank reconciliation statement from scratch using provided raw data (receipts, disbursements, bank statement, etc.).

    • This typically implies fewer other complex transactions elsewhere on the exam due to the time commitment.

  • More Likely Scenario:

    • A pre-completed bank reconciliation statement is provided as an exhibit.

    • Students must identify which items on the statement require journal entries (specifically, the items affecting the "Balance Per Books" side).

  • Most Likely Scenario:

    • A narrative (paragraph form) describes findings from a bank reconciliation performed by staff.

    • Students extract the relevant information to create adjusting journal entries (often including bank-side information that is irrelevant for journalizing).

Journal Entries for Bank Reconciliation Adjustments (Company Book Side Only)

  • Key Principle: Only items that adjust the company's book balance require journal entries.

  • Insurance Withdrawal ($400\$400):

    • Debit: Insurance Expense (or Prepaid Insurance if context suggests it was for future periods)

    • Credit: Cash

  • Payroll Deduction ($1,015.20\$1,015.20):

    • Debit: Salary Expense (or Wages Payable if it's clearing a liability already recorded)

    • Credit: Cash

  • Check 4040 Error ($66\$66):

    • Debit: Delivery Expense (assuming original check was for delivery services)

    • Credit: Cash

    • Explanation: The company recorded the expense as $1,300\$1,300, but the bank cleared $1,366\$1,366. The company's cash account was overstated by $66\$66, and the expense was understated by the same amount, hence the additional debit to expense and credit to cash.

  • Bank Charges and NSF Fee ($132\$132 total):

    • Debit: Bank Charge Expense ($112\$112 for service charge)

    • Debit: Accounts Receivable ($20\$20 specifically for the NSF fee, which is passed on to the customer)

    • Credit: Cash ($132\$132)

    • Note: It is important to separate the NSF fee into Accounts Receivable because the company intends to collect it from the customer. If the company were to generously cover the NSF fee, it would all be debited to an expense account (e.g., NSF Expense).

General Notes on Expense Accounts

  • Often, if a student debits an expense account (even if the specific name is slightly off), it will not negatively impact their grade, as long as it's clearly an expense.

  • However, there will be specific exceptions where instructors will be very clear about requiring a precise expense account name.