Internal Control and Cash Notes

Cash and Cash Equivalents

  • Definition of Cash: Includes coins, currency, cheques, money orders, cash on hand, deposits in bank, debit card slips, bank credit card slips.
    • Cash is considered the most important asset of a company.
    • There should be a balance between ensuring sufficient cash availability and avoiding excess.
  • Cash Equivalent: An item must:
    • Be readily convertible to a specific amount of cash.
    • Have minimal risk of value change from acquisition to conversion back to cash.

Reporting Cash

  • Cash is recorded in:
    • Statement of financial position.
    • Statement of cash flow.
  • Most liquid asset; appears first in current assets on the balance sheet.
    • If cash is in overdraft at year-end, it reflects as a current liability called "bank indebtedness."
  • Restricted cash (not available for general use) is shown as a non-current asset.
    • E.g., compensating balance as a restriction.

Managing Cash

Key Strategies for Cash Management:
  1. Increase collection of receivables.
  2. Keep inventory low.
  3. Delay payments of liabilities.
  4. Plan timing of major expenditures.
  5. Invest idle cash.
  6. Prepare a cash budget.

Internal Control: Definition and Importance

  • Definition: Internal control encompasses all methods and measures adopted within a company to:
    • Ensure reliable financial reporting.
    • Facilitate effective and efficient operations.
    • Ensure compliance with laws and regulations.
  • Management is responsible for:
    • Safeguarding assets from loss or unauthorized use.
    • Ensuring financial information is reliable and accurate.

Internal Control: Key Components

  • Components of Internal Control include:
    • Control Environment: The overall attitude of the organization toward internal control.
    • Risk Assessment: Identifying and analyzing relevant risks.
    • Control Activities: Policies and procedures to ensure risk responses are effectively carried out.
    • Information and Communication: Ensuring timely and effective communication of controls.
    • Monitoring: Ongoing assessment of the internal control process.

Control Activities

  1. Authorization of transactions and activities (assign responsibilities).
  2. Segregation of Duties: Assign incompatible duties to multiple people (e.g., separate authorization, recording, and asset handling).
  3. Documentation: Maintain evidence of transactions; signatures reflect responsibility.
  4. Physical Controls: Protect assets from theft and damage (e.g., safes).
  5. Independent Checks of Performance: Periodic reviews by managers/internal auditors or external auditors.
  6. Human Resource Controls: Checks on employees (background checks, bonding, changing duties).

Limitations of Internal Control

  • Limitations Include:
    • Human Factor: Errors, carelessness, and collusions can affect control effectiveness.
    • Design controls to provide "reasonable assurance" rather than absolute certainty.

Internal Control of Cash

  • Cash Properties:
    • Cash is highly liquid and anonymous, making it susceptible to theft.
    • Types of cash include coins, currency, cheques, and electronic payments.
Important Controls for Cash Coming In:
  • Segregate duties (receipt, deposit, record keeping).
  • Store cash securely.
  • Limit acceptance of cash to authorized individuals (background checks).
  • Provide receipts for received cash.
  • Regularly compare deposits to supporting documents.
  • Execute regular cash deposits.
Common Sources of Cash Exiting the Business:
  • Pay expenses, employees, purchase assets, and repay liabilities.
Important Controls over Cash Leaving the Business:
  • Require dual signatures on cheques (after verification of supporting documents).
  • Differentiate roles (cheque signer different from preparer).
  • Have an independent person mail cheques.
  • Stay accountable for all cheque numbers.
  • Limit cash expenses.
  • Require second authorization for electronic transfers.

The Accountant's Role in Internal Controls

  • Accounting systems facilitate internal controls by tracking transactions.
  • Role includes recording transactions and verifying against physical counts (e.g., inventory).

Petty Cash Management

  • Companies generally maintain a limited petty cash fund for minor expenses.

Bank Reconciliation Process

  • Purpose: To reconcile differences between the company's cash records and the bank statement.
  • Types of differences include:
    • Time lags in cheque presentation and deposits recorded.
    • Transactions not recorded (e.g., interest income).
    • Errors from either the company or bank.
  • Preparation: Should be independent; recommended to be monthly or weekly based on transaction volume.
  • Journalizing: Every reconciling item on books must be documented and journalized but none on the bank side.
Example Entry for Bank Reconciliation:
  • Adjustments to Bank Balance:
    • Deposits in transit (+)
    • Outstanding cheques (-)
    • Errors (either from company or bank)
  • Adjustments must lead to an accurate adjusted cash balance.