Chapter 7: Internal Control and Cash Notes

Financial Accounting: Tools for Business Decision Making

Chapter 7: Internal Control and Cash

1. Bank Reconciliation
  • Definition: The process of comparing the bank's balance with the company’s cash balance to identify differences and make them agree.
  • Learning Objective (LO) 3: Understand the bank reconciliation process and its necessity.
2. Bank Statements
  • Contents of Bank Statements:
    • Amounts Reducing Depositor's Account Balance:
    • Checks paid.
    • Other debits: includes electronic funds transfers (EFT) or debit card transactions for bill payments.
    • Amounts Increasing Depositor's Account Balance:
    • Deposits: direct deposit, EFT, and other credits.
  • Learning Objective (LO) 3: Know the information contained in bank statements.
3. Example of a Bank Statement
  • National Bank & Trust, Midland, Michigan.
  • Includes:
    • Deposits and credits, total amounts, checks and debits, account number, balances.
    • Specific transactions: e.g., deposits, EFTs, outstanding checks, service charges, bounce checks.
    • Symbols Defined:
    • CM: Credit Memo.
    • EC: Error Correction.
    • DM: Debit Memo.
    • INT: Interest Earned.
    • NSF: Not Sufficient Funds.
    • SC: Service Charge.
  • Learning Objective (LO) 3: Familiarity with bank statement structure.
4. Bank Statement Contents Explained
  • Deposits (Credits): Listed by date of processing.
  • Canceled Checks (Debits): Checks that have been cashed and are listed numerically by date paid.
  • Bank Statement Memoranda: Explanations of other debits and credits made.
  • NSF Check: A check that the bank cannot pay due to insufficient funds.
  • Learning Objective (LO) 3: Understand detailed components of bank statements.
5. Bank Accounts from the Bank's Perspective
  • Payments made by the bank result in decreases (debited) to the bank’s liabilities.
  • Deposits by depositors increase (credited) the bank’s liabilities.
  • Learning Objective (LO) 3: Grasp the perspective of bank operations concerning liabilities.
6. Reconciling the Bank Account (Part 1)
  • Objective: Align the balance per books with the balance per bank into adjusted cash balances.
    • Definitions:
    • Book Balance: Cash balance as per company accounting records.
    • Bank Balance: Cash balance as per monthly bank statement.
  • Causes for Reconciliation Necessity:
    • Timing differences prevent concurrent recording by both parties.
    • Recording errors by either party.
  • Learning Objective (LO) 3: Understand why reconciliation is necessary.
7. Bank Reconciliation Process
  • Steps:
    • Adjustments involve:
    • Per Bank Statement:
      • Add: Deposits in Transit, EFT collections, bank errors.
      • Subtract: Outstanding checks, NSF checks, service charges.
    • Per Books:
      • Add: Unrecorded EFT deposits, corrections of company errors.
      • Subtract: Unrecorded payments, service charges, NSF check returns.
  • Correct Cash Balance: The resulting adjusted balances from both sides should align.
8. Reconciling Items per Bank
  • Deposits in Transit: Items recorded by the depositor not yet processed by the bank; added to the bank statement balance.
  • Outstanding Checks: Issued checks not cashable yet; deducted from the bank statement balance.
  • Bank Errors: Any miscalculations must be added to or subtracted from the bank statement balance.
  • Learning Objective (LO) 3: Understand the detailed steps of bank reconciliation from the bank's view.
9. Reconciling Items per Books
  • Other Deposits (EFT): Entries not recorded in company records; added to balances.
  • Other Payments: Charges and NSF checks not recorded; deducted from balances.
  • Book Errors: Need for corrections based on depositor errors; either added or subtracted as necessary.
  • Learning Objective (LO) 3: Detailed process for reconciliation from the company's perspective.
10. Bank Reconciling Items: Detailed Calculation
  • Bank’s Total:
    • Start with April 30 bank statement balance: $15,907.45.
    • Add: Deposits in transit of $2,201.40.
    • Adjusted cash balance per bank: $18,108.85.
  • Outstanding Checks Subtraction:
    • Check No. 453: $3,000.00.
    • Check No. 457: $1,401.30.
    • Check No. 460: $1,502.70.
    • Total outstanding checks: $5,904.00.
    • Final adjusted cash balance per bank: $12,204.85.
11. Reconciling Items for Books
  • Initial Balance:
    • April 30 accounting records indicate $11,709.45.
    • Add unrecorded deposits (EFT) of $1,035.00.
    • Total before adjustments: $12,744.45.
    • Subtracting unrecorded payments (NSF, charges):
    • NSF check: $425.60, debit/credit fees: $120.00, bank charge: $30.00.
    • Total deductions: $575.60.
    • Final adjusted cash balance per books: $12,204.85.
12. Journal Entries from Bank Reconciliation
  • Depositor Responsibilities: Record each reconciling item to adjust the cash account.
  • Journal Entries Examples:
    • EFT Receipt:
    • Apr. 30: Cash $1,035 / Accounts Receivable $1,035.
    • Book Error & NSF Check:
    • Apr. 30: Cash $36 / Accounts Payable $36.
    • Apr. 30: Accounts Receivable $425.60 / Cash $425.60.
  • Learning Objective (LO) 3: Grasp the importance of posting journal entries as part of reconciliation.
13. Adjusted Balance in Cash Account
  • The adjusted cash balance in the ledger must correspond with the adjusted cash balance indicated from the bank reconciliation processes.
14. Knowledge Check: Bank Reconciliation
  • Question Options:
    • a. Outstanding checks.
    • b. Deposit in transit.
    • c. Bank error.
    • d. Bank service charges.
  • Correct Answer: d. Bank service charges will lead to an adjusting entry.
15. Bank Reconciliation Preparation Exercises
  • Pat 1: Format for Abet, Inc.:
    • Cash balance per bank: $1,245; deposits in transit: $98; outstanding checks: $42 leads to adjusted bank balance of $1,301.
  • Part 2: Format for Abet, Inc. books:
    • Cash balance per books: $1,136; unrecorded EFT collection: $187; less service charge of $22 gives adjusted cash balance of $1,301.
16. Operation of a Petty Cash Fund
  • Involves Events:
    • Establishing the fund for small payments.
    • Making payments from this fund.
    • Replenishing the fund when cash balance is low or at the end of the period.
17. Establishing the Petty Cash Fund
  • Steps:
    • Appoint a custodian responsible for the fund.
    • Determine the fund size.
    • Example for Laird Company: Fund of $100 established on March 1.
18. Replenishing the Petty Cash Fund
  • Example Scenario:
    • On March 15, a request for $87 is made, fund contains $13 cash and receipts totaling $44, $38, and $5.
    • Journal entry recorded as:
    • Mar. 15: Postage Expense $44, Freight-Out $38, Miscellaneous Expense $5 / Cash $87.
19. Replenishing with a Shortage
  • Shortage Example:
    • Total cash in fund for replenishment calculated as:
    • $100 - ($44 + $38 + $5 + $12) = $1.
    • Journal entries for shortages must reflect missing amounts correctly.
20. Knowledge Check: Petty Cash Fund
  • Scenario for Seal Mate’s fund:
    • Establish entry: Jun. 1: Petty Cash $100 / Cash $100.
    • Replenishment entry for June 30 reflecting total receipts and cash handling.
21. Conclusion of Chapter 7
  • End of chapter highlights key concepts of internal control over cash management and the importance of proper banking procedures.