6.2 Internal Controls and Bank Reconciliation

Safeguarding Assets: A company's primary responsibility is to protect its assets, especially cash.
Cash Vulnerability: Cash is highly susceptible to misuse, theft, and mismanagement by employees.
Management's Problems in Accounting for Cash:
- Establishing proper controls to prevent unauthorized transactions.
- Providing information to manage cash on hand and cash transactions effectively.
Importance of Minimizing On-Hand Cash: Excess cash should be invested to increase shareholder returns.

Checks and Balances: Implement systems to prevent unauthorized transactions.
Dual Signatures: Require two signatures on checks for added security.
Rotation of Duties: Rotate employees involved in reviewing accounts receivable, cash management, making deposits, and check writing.
Separation of Duties: Divide responsibilities to prevent a single employee from controlling all aspects of cash transactions.

Separation of Duties: Proper segregation of duties among employees is crucial.
Intact Cash Deposits: All cash receipts should be deposited fully without deductions.
- Example: Avoid taking cash from the register for courier payments; use a petty cash account instead.
Petty Cash Account: Use a petty cash account for small, miscellaneous expenditures.
Major Disbursements by Check or EFT: Make payments via checks or electronic fund transfers to create an audit trail.
- Checks should be in sequential order and processed by an external party (the bank).
Monthly Bank Reconciliation: Prepare a month-end bank reconciliation to verify the true amount of available cash.

Two-Column Format: Use a two-column format to reconcile timing differences and errors.
Need for Bank Reconciliation: Discrepancies often exist between the bank statement balance and the company's cash ledger balance due to timing differences.
Bank Statement: The bank statement lists all checks processed and deposits made.
Company's Cash Ledger: This reflects the company's record of cash transactions.

Deposit in Transit:
- Definition: A deposit recorded by the company but not yet processed by the bank.
- Treatment: Add to the bank balance.
Bank Errors:
- Definition: Errors made by the bank in processing transactions.
- Example: Processing another company's check on your account.
- Treatment: Adjust for any errors found.
Outstanding Checks:
- Definition: Checks written by the company but not yet processed by the bank.
- Treatment: Deduct from the bank balance.

Goal: To reconcile the bank and book balances to arrive at the true cash balance.
True Cash Balance: The adjusted cash balance after accounting for all reconciling items.

Bank Credit:
- Definition: A note collected directly by the bank and deposited into the company's account.
- Treatment: Add to the book balance.
Book Errors:
- Definition: Errors made by the company in recording transactions.
- Example: Transposing numbers when recording a check.
- Treatment: Adjust for any errors found.
Insufficient Funds (NSF) Checks:
- Definition: Checks from customers that were not honored due to insufficient funds.
- Treatment: Deduct from the book balance.
Bank Service Charges:
- Definition: Fees charged by the bank for services.
- Treatment: Deduct from the book balance.
Overdraft Charges:
- Definition: Charges incurred when the company overdraws its account.
- Treatment: Deduct from the book balance.

Updating Books: The company must update its cash ledger for all reconciling items on the book side.
Journal Entries: Record journal entries for each reconciling item to adjust the cash balance.
Increasing Cash Balance: Debit cash to increase the balance.
Decreasing Cash Balance: Credit cash to decrease the balance.

Debit Memo: Indicates the bank reduced the balance in the company's account.
Credit Memo: Indicates the bank increased the balance in the company's account.
Bank's Perspective: These terms are from the bank's perspective, where customer deposits are liabilities.
Example: Customer Deposits:
- When a customer deposits $1,000$ into a checking account, the bank has physical custody of the cash, but it is still the customer's cash.
- The bank owes the customer this amount and it is payable on demand.
Reducing a Liability: To reduce a liability (e.g., when a customer withdraws cash), the bank debits the account.
Increasing a Liability: To increase a liability (e.g., when a customer deposits cash), the bank credits the account.

Scenario:
- Sparky Company's books show a cash balance of $9,070$ on July 31.
- The bank statement shows an ending balance of $8,650$ on the same date.
Need: Prepare a bank reconciliation to determine the correct cash balance.
Required Information:
- Access to the June bank reconciliation.
- July bank statement.
- Sparky's accounting records.
Reconciling Items:
- Deposits in transit.
- Outstanding checks.
- Note collected by the bank.
- Bank fees.
- Insufficient funds check.
- Error in recording check number 7322.

Note Collected: The bank collected a note for $1,000$ and deposited it into Sparky's account.
Bank Fee: A bank fee was charged.
Insufficient Funds Check: An NSF check was returned.
Book Error: Check number 7322 was incorrectly recorded.
- The check was written for $130$ , but recorded as $310$ .

Reconcile Deposits: Compare deposits in transit from the June reconciliation with July deposits.
Reconcile Checks: Compare outstanding checks from the June reconciliation with July checks.
Determine the True Cash Balance: Adjust both the bank and book balances to arrive at the same true cash balance.
Prepare Journal Entries: Record journal entries for all reconciling items on the book side.

Deposits in Transit Schedule:
- Deposits in transit from June: $1,540$
- Deposits per books in July: $5,810$
- Total deposits: $7,350$
- Deposits processed by the bank in July: $5,000$
- Deposits in transit as of July 31: $2,350$
Outstanding Checks Schedule:
- Outstanding checks from June: $2,000$
- New checks written in July: $3,100$
- Total checks: $5,100$
- Checks processed by the bank in July: $4,000$
- Outstanding checks as of July 31: $1,100$

True Cash Balance (Bank Side):
- Bank balance: $8,650$
- Add: Deposits in transit ( $2,350$ )
- Deduct: Outstanding checks ( $1,100$ )
- True cash balance: $9,900$
True Cash Balance (Book Side):
- Book balance: $9,070$
- Add: Note collected by the bank ( $1,000$ ), Correction of error ( $180$ )
- Deduct: Bank service charges ( $15$ ), Insufficient funds check ( $335$ )
- True cash balance: $9,900$

Note Collected:
- Debit: Cash $1,000$
- Credit: Note Receivable $1,000$
Correction of Error:
- Debit: Cash $180$
- Credit: Accounts Payable $180$
Bank Fee:
- Debit: Bank Fee Expense $15$
- Credit: Cash $15$
Insufficient Funds Check:
- Debit: Accounts Receivable $335$
- Credit: Cash $335$