Introductory Financial Accounting - Chapter 5: Sale Revenue, Receivable and Cash, Part 2
AFA100 - Introductory Financial Accounting
Chapter 5: Sale Revenue, Receivable and Cash, Part 2
Midterm Exam 2 Information
Date: March 8th, Sunday
Time: 1pm - 4pm
Location: To Be Confirmed
Format: In person, paper-based
Multiple Choice Questions (MCQ) + Short Answer Questions
Last Week Review
Topics covered include:
Accounting for sales revenue
Credit sales
Sales return and allowance
Sales discounts
Measuring and Reporting Receivables
Accounting for bad debts
Allowance for Doubtful Accounts (AFDA)
Bad debts expense
Chapter 5-Part 2 Learning Objectives
LO5-5: Report, control, and safeguard cash
Focus on internal control practices
Internal Control
Definition of Internal Control
Internal control is defined as a set of policies and procedures adopted within a company to achieve the following objectives:
Safety of assets: Protecting company resources
Accuracy of financial reporting: Ensuring authentic representation in financial statements
Effective and efficient operations: Achieving operational goals with minimal waste
Compliance with relevant laws and regulations: Adhering to legal frameworks
It is crucial for accountants to assess how well management develops and maintains a system of internal control to prevent and detect fraud and material misstatements in financial statements.
Understanding Fraud
Definition: Fraud is an intentional act to misappropriate (steal) assets or to misstate financial statements.
Common fraudulent activities by employees may include:
Stealing company resources such as cash and inventory
Claiming personal expenses as business expenses
Managers may manipulate financial reports by:
Failing to record incurred expenses
Overstating the useful lives of assets
Recording fictitious revenues that do not exist
Famous Cases of Fraud
ENRON: Utilized market accounting to record projected profits.
WorldCom: Classified expenses as capital expenditures.
Wells Fargo: Opened fake accounts to enhance sales performance.
Luckin Coffee: Inflated sales to fabricate revenue.
Components of Internal Control
A strong internal control system encompasses five primary components:
Control environment: Organizational values set by leadership.
Risk assessment: Identification and evaluation of risks within operations.
Control activities: Implementation of policies to mitigate risks.
Information and communication: Effective information sharing across the organization.
Monitoring activities: Continuous review and oversight of internal controls to ensure relevance.
Control Activities
Assignment of Responsibility:
Assign specific duties to employees to promote accountability.
Example: Cashiers at Costco use unique login passwords for transactions, ensuring errors are traceable.
Segregation of Duties:
Distribute tasks among employees to prevent any one individual from controlling all aspects.
Example: Employee A collects cash while Employee B deposits cash to ensure checks and balances.
Documentation:
Maintain records as proof of transactions (e.g., receipts, delivery documents).
Physical Controls:
Safeguard assets and enhance reliable accounting through restricted access.
Review and Reconciliation:
Independent reviews of activities ensure accuracy; internal reviews managed by auditors and external audits validate financial health.
Limitations of Control Activities
Internal controls provide reasonable assurance but have limitations:
Cost/Benefit Considerations: Costs of controls should not exceed anticipated benefits.
Human Error: Systems can fail due to lack of training or fatigue.
Collusion: Two or more individuals may collaborate to bypass controls.
Management Override: Management may misuse controls for personal benefits or artificial profit inflation.
Control Over Accounts Receivable
Practices for minimizing bad debts include:
Require independent credit history approval.
Periodic monitoring of accounts receivable age and follow-ups on overdue payments.
Incentivize both sales and collections personnel for timely collections.
Controls for Cash Receipts and Payments
Cash and Cash Equivalents
Cash Definition: Money or instruments acceptable for immediate deposit into a company's account, such as cheques and money orders.
Cash is typically classified into three categories:
Cash on hand
Cash deposited in banks
Other acceptable cash instruments
Cash Equivalents: Short-term, highly liquid investments convertible to cash with low risk of value changes. Common cash equivalents includes bank certificates of deposit and treasury bills.
Cash Management Procedures
Accurate Accounting: Ensure cash flow and balance reports are reliable.
Control Measures: Safeguard sufficient cash for operations, liabilities, and emergencies.
Avoid Idle Cash: Invest surplus cash in securities for revenue generation until needed.
Internal Control of Cash
Due to cash's susceptibility to theft, substantial internal control over cash is essential:
Separate handling and recordkeeping of cash.
Implement prescribed policies and procedures.
Separation of Duties Related to Cash Handling
Complete separation of receiving and disbursing cash is crucial:
Individuals receiving cash must not have cheque-signing authority.
Individuals handling cash receipts should not engage in cash disbursement accounting to prevent manipulation.
Typical Internal Controls for Cash
Cash Budget: Monthly forecasting and monitoring deviations from cash disbursements/receipts required.
Cash Receipts Listing: Daily cash receipt records (e.g., register receipts) mandated to be deposited daily.
Cash Payments Approval: Separate approval for expenditures and cash payments to minimize fraud potential.
Use pre-numbered cheques to ensure controlled processing.
Independent Verification: Regular independent review of cash receipts and bank deposits for discrepancies.
Employee Rotation and Vacations: Mandate employee vacations and rotate duties to facilitate fraud detection.
Bank Statement and Reconciliation
The Role of Banks in Cash Control
Essential practices include:
Regular cash deposits.
Comparing organizational cash receipts with bank totals.
Monthly bank reconciliations to ensure accuracy.
Benefits of using banks:
Reduces cash usage and theft risk.
Provides a second record of transactions through bank statements.
Understanding Bank Statements
Bank statements include:
Recorded deposits and cleared cheques for the period.
Charges made to the account (e.g., service fees).
Account balances.
Bank Reconciliation Process
Definition: A reconciliation schedule that clarifies the discrepancies between the company’s cash records and the bank's balance as per the bank statement.
Cause of Differences: Commonly its differences arise from timing issues, such as outstanding cheques or deposits in transit, and recording errors by any party.
Reconciliation Steps:
Identify unrecorded bank charges and credits.
List deposits in transit.
Account for outstanding cheques.
Examine recording errors.
Conclusion of Chapter 5
Key takeaways include understanding internal controls, their activities, and the cash management process.
Importance of bank reconciliation in ensuring accurate financial reporting and safeguarding assets.
Next Week
Note: Reading Week
Suggested reading includes: FREEDMAN's "Banned Books" and "The Jellyfish".
Final notes should comprehensively cover the core themes from the provided transcript, ensuring thorough understanding and recall of all pertinent details regarding financial accounting practices, specifically in relation to cash management, internal controls, and bank reconciliations.