I have attached both the chapters from which you will be answering the following question.

• Ch 8 (p 387 of text or p 35 of the pdf) ?Exercise D. Prepare the bank reconciliation and any required journal entries. Show all work!
• Ch 9 (p 57 of text or p 48 of the pdf) ?Exercise E. Compute the sales tax amount and prepare journal entries necessary to pay this.

Chapter 8 \"Control of Cash\" from Accounting Principles: A Business Perspective, Volume 1, Financial Accounting by Edwards and Hermanson is available under Creative Commons license AttributionNoncommercial-Share Alike 3.0. Textbook Equity (2010) This book is licensed under a Creative Commons Attribution 3.0 License 8. Control of cash Learning objective After studying this chapter, you should be able to: Describe the necessity for and features of internal control. Define cash and list the objectives sought by management in handling a company's cash. Identify procedures for controlling cash receipts and disbursements. Prepare a bank reconciliation and make necessary journal entries based on that schedule. Explain why a company uses a petty cash fund, describe its operations, and make the necessary journal entries. Analyze and use the financial results-quick ratio. A career in forensic accounting This chapter emphasizes the importance of having effective internal controls in every business. Unfortunately, many smaller companies do not heed this advice. Failure to implement adequate internal controls can result in financial statement fraud (purposely misstated financial statements) or embezzlement (theft). This is when the services of a forensic accountant may be necessary. Forensic accounting is the application of accounting methodology to legal issues. It is frequently associated with the investigation of civil or criminal white-collar crime such as fraud, embezzlement, and general abuse of funds issues. Typical tools used in forensic accounting are bank records, personal financial statements, interviews, and credit reports. The forensic accountant's responsibility is to gather and analyze the evidence and deliver clear, accurate, and unbiased reports reflecting the results of the investigation. Forensic accounting is commonly performed by Certified Fraud Examiners (CFEs). CFEs have extensive training and possess special expertise in investigation and interview techniques specifically designed to detect or prevent fraud. A well-known agency performing forensic accounting in the United States is in the Federal Bureau of Investigation (FBI). You can learn more about the FBI from their homepage at www.fbi.gov. Click on employment in the 'About Us' section and then click on special agent employment to learn more about what it takes to be an FBI special agent. Did you know that the fastest track to becoming an FBI agent is with an accounting undergraduate degree? There are four entry programs for becoming an FBI special agent: accounting, law, language, and diversified. Law requires an undergraduate degree and a law degree, language requires an undergraduate degree and proficiency in a second language, and diversified requires three years of work experience beyond an undergraduate degree. The only entry program requiring only an undergraduate degree is one with an undergraduate accounting option. Why accounting? Because an ever-increasing portion of crimes investigated by the FBI are white-collar crimes where accounting knowledge is essential. Accounting Principles: A Business Perspective 354 A Global Text 8. Control of cash In a small corporation the president might make all the important decisions and will usually maintain a close watch over the affairs of the business. However, as the business grows and the need arises for additional employees, officers, and managers, the president begins to lose absolute control. Realizing that precautions are necessary to protect the company's interests, the company establishes an internal control structure at this point. The internal control structure of a company consists of "the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved".27 The three elements of an internal control structure are the control environment, the accounting system, and the control procedures. The control environment reflects the overall attitude, awareness, and actions of the board of directors, management, and stockholders. The accounting system consists of the methods and records that identify, assemble, analyze, classify, record, and report an entity's transactions to provide complete, accurate, and timely financial information. The control procedures of a company are additional policies and procedures that management establishes to provide reasonable assurance that the company achieves its specific objectives. These control procedures may pertain to proper authorization, segregation of duties, design and use of adequate documents and records, adequate safeguards over access to assets, and independent checks on performance. Internal control not only prevents theft and fraud but also serves many purposes: (1) Companies must implement policies requiring compliance with federal law; (2) personnel must perform their assigned duties to promote efficiency of operations; and (3) correct accounting records must supply accurate and reliable information in the accounting reports. This chapter discusses the internal control structure that a company establishes to protect its assets and promote the accuracy of its accounting records. You will learn how to establish internal control through control of cash receipts and cash disbursements, proper use of the bank checking account, preparation of the bank reconciliation, and protection of petty cash funds. The internal control structure is enhanced by hiring competent and trustworthy employees, a fact you will appreciate if you become a business owner. Internal control An effective internal control structure includes a company's plan of organization and all the procedures and actions it takes to: Protect its assets against theft and waste. Ensure compliance with company policies and federal law. Evaluate the performance of all personnel to promote efficient operations. Ensure accurate and reliable operating data and accounting reports. 27 AICPA, Statement on Auditing Standards No. 55, "Consideration of the Internal Control Structure in a Financial Statement Audit" (New York, 1988), p. 4. The sixth and seventh editions of this text use the terminology (internal control structure) of the AICPA. Previous editions referred to the "internal control system." 355 This book is licensed under a Creative Commons Attribution 3.0 License As you study the basic procedures and actions of an effective internal control structure, remember that even small companies can benefit from using some internal control measures. Preventing theft and waste is only a part of internal control. In general terms, the purpose of internal control is to ensure the efficient operations of a business, thus enabling the business to effectively reach its goals. Since additional control procedures are necessary in a computer environment, a discussion of these controls concludes this section on internal control. An accounting perspective: Business insight When performing an audit, one of an outside auditor's first duties is to examine the internal control structure of the corporation. To understand the internal control structure, an auditor focuses mainly on management's attitude and awareness concerning controls and the accounting system's processing of transactions. To increase understanding, the auditor inspects documents in the accounting system, discusses external influences on the company with management, reads accounting manuals, and observes the happenings in the company. This understanding of the company's control environment helps the auditor to plan the audit and to determine the nature, timing, and extent of tests. Companies protect their assets by (1) segregating employee duties, (2) assigning specific duties to each employee, (3) rotating employee job assignments, and (4) using mechanical devices. Segregation of employee duties Segregation of duties requires that someone other than the employee responsible for safeguarding an asset must maintain the accounting records for that asset. Also, employees share responsibility for related transactions so that one employee's work serves as a check on the work of other employees. When a company segregates the duties of employees, it minimizes the probability of an employee being able to steal assets and cover up the theft. For example, an employee could not steal cash from a company and have the theft go undetected unless someone changes the cash records to cover the shortage. To change the records, the employee stealing the cash must also maintain the cash records or be in collusion with the employee who maintains the cash records. Assignment of specific duties to each employee When the responsibility for a particular work function is assigned to one employee, that employee is accountable for specific tasks. Should a problem occur, the company can quickly identify the responsible employee. When a company gives each employee specific duties, it can trace lost documents or determine how a particular transaction was recorded. Also, the employee responsible for a given task can provide information about that task. Being responsible for specific duties gives people a sense of pride and importance that usually makes them want to perform to the best of their ability. Accounting Principles: A Business Perspective 356 A Global Text 8. Control of cash Rotation of employee job assignments Some companies rotate job assignments to discourage employees from engaging in long-term schemes to steal from them. Employees realize that if they steal from the company, the next employees assigned to their positions may discover the theft. Frequently, companies have the policy that all employees must take an annual vacation. This policy also discourages theft because many dishonest schemes collapse when the employee does not attend to the scheme on a daily basis. Use of mechanical devices Companies use several mechanical devices to help protect their assets. Check protectors (machines that perforate the check amount into the check), cash registers, and time clocks make it difficult for employees to alter certain company documents and records. Internal control policies are effective only when employees follow them. To ensure that they carry out its internal control policies, a company must hire competent and trustworthy employees. Thus, the execution of effective internal control begins with the time and effort a company expends in hiring employees. Once the company hires the employees, it must train those employees and clearly communicate to them company policies, such as obtaining proper authorization before making a cash disbursement. Frequently, written job descriptions establish the responsibilities and duties of employees. The initial training of employees should include a clear explanation of their duties and how to perform them. In publicly held corporations, the company's internal control structure must satisfy the requirements of federal law. In December 1977, Congress enacted the Foreign Corrupt Practices Act (FCPA). This law requires a publicly held corporation to devise and maintain an effective internal control structure and to keep accurate accounting records. This law came about partly because company accounting records covered up bribes and kickbacks made to foreign governments or government officials. The FCPA made this specific type of bribery illegal. To evaluate how well employees are doing their jobs, many companies use an internal auditing staff. Internal auditing consists of investigating and evaluating employees' compliance with the company's policies and procedures. Companies employ internal auditors to perform these audits. Trained in company policies and internal auditing duties, internal auditors periodically test the effectiveness of controls and procedures throughout the company. Internal auditors encourage operating efficiency throughout the company and are alert for breakdowns in the company's internal control structure. In addition, internal auditors make recommendations for the improvement of the company's internal control structure. All companies and nonprofit organizations can benefit from internal auditing. However, internal auditing is especially necessary in large organizations because the owners (stockholders) cannot be involved personally with all aspects of the business. Companies should maintain complete and accurate accounting records. The best method to ensure such accounting records is to hire and train competent and honest individuals. Periodically, supervisors evaluate an employee's performance to make sure the employee is following company policies. Inaccurate or inadequate accounting records serve as an invitation to theft by dishonest employees because theft can be concealed more easily. 357 This book is licensed under a Creative Commons Attribution 3.0 License One or more business documents support most accounting transactions. These source documents are an integral part of the internal control structure. For optimal control, source documents should be serially numbered. (Transaction documentation and related aspects of internal control are presented throughout the text.) PURCHASE REQUISITION No. 2 4 1 6 BRYAN WHOLESALE COMPANY From; Automotive Supplies Department Date: 2010 N o v e m b e r 2 0 To: Purchasing Department Suggested supplier: W i l k e s R a d i o C o m p a n y Please purchase the following items; Description Item Number Quantity Estimated Price Model No. 5868200 $50 per unit 24393 Reason for request: To be filled in by purchasing department: Customer order Dated ordered 2 0 1 0 N o v e m b e r 2 9 Baier Company Purchase order number N - M S Approved R . S . T. Exhibit 65: Purchase requisition Since source documents serve as documentation of business transactions, from time to time firms check the validity of these documents. For example, to review a purchase transaction, they check the documents used to record the transaction against the proper accounting records. When the accounting department records a purchase transaction, it should receive copies of the following four documents: A purchase requisition (Exhibit 65) is a written request from an employee inside the company to the purchasing department to purchase certain items. A purchase order (Exhibit 66) is a document sent from the purchasing department to a supplier requesting that merchandise or other items be shipped to the purchaser. An invoice (Exhibit 67) is the statement sent by the supplier to the purchaser requesting payment for the merchandise shipped. A receiving report is a document prepared by the receiving department showing the descriptions and quantities of all items received from a supplier in a particular shipment. A copy of the purchase order can serve as a receiving report if the quantity ordered is omitted. Then, because receiving department personnel do not know what quantity to expect, they will count the quantity received more accurately. These four documents together serve as authorization to pay for merchandise and should be checked against the accounting records. Without these documents, a company might fail to pay a legitimate invoice, pay fictitious invoices, or pay an invoice more than once. Companies can accomplish proper internal control only by periodically checking the source documents of business transactions with the accounting records of those transactions. In Exhibit 68 we show the flow of documents and goods in a merchandise transaction. Accounting Principles: A Business Perspective 358 A Global Text 8. Control of cash PURCHASE ORDER No. N-145 BRYAN WHOLESALE COMPANY 476 Mason Street Detroit, Michigan 48823 To: Wilkes Radio Company 2515 West Peachtree Street Date: 2010 November 21 Atlanta, Georgia 30303 Ship by: 2010 December 20 Ship to: Above address FOB terms requested: Destination Discount terms requested: 2/10, n/30 Please send the foil owing item; Price Total Description Item Number Quantity Per Unit Amount True-tone stereo Model No. 200 $50 $10,000 radios 5868-24393 Ordered by: J a n e K n i g h t Please include order number on all invoice and shipments. Exhibit 66: Purchase order Unfortunately, even though a company implements all of these features in its internal control structure, theft may still occur. If employees are dishonest, they can usually figure out a way to steal from a company, thus circumventing even the most effective internal control structure. Therefore, companies should carry adequate casualty insurance on assets. This insurance reimburses the company for loss of a nonmonetary asset such as specialized equipment. Companies should also have fidelity bonds on employees handling cash and other negotiable instruments. These bonds ensure that a company is reimbursed for losses due to theft of cash and other monetary assets. With both casualty insurance on assets and fidelity bonds on employees, a company can recover at least a portion of any loss that occurs. According to the Committee of Sponsoring Organizations of the Treadway Commission, there are five components of an internal control structure. When these components are linked to the organization's operations, they can quickly respond to shifting conditions. The components are: Control environment. The control environment is the basis for all other elements of the internal control structure. The control environment includes many factors such as ethical values, management's philosophy, the integrity of the employees of the corporation, and the guidance provided by management or the board of directors. Risk assessment. After the entity sets objectives, the risks (such as theft and waste of assets) from external and internal sources must be assessed. Examining the risks associated with each objective allows management to develop the means to control these risks. Control activities. To address the risks associated with each objective, management establishes control activities. These activities include procedures that employees must follow. Examples include procedures to protect the assets through segregation of employee duties and the other means we discussed earlier. Information and communication. Information relevant to decision making must be collected and reported in a timely manner. The events that yield these data may come from internal or external sources. Communication throughout the entity is important to achieve management's goals. Employees must understand what is expected of them and how their responsibilities relate to the work of others. Communication with external parties such as suppliers and shareholders is also important. 359 This book is licensed under a Creative Commons Attribution 3.0 License Monitoring. After the internal control structure is in place, the firm should monitor its effectiveness so that it can make changes before serious problems arise. In testing components of the internal control structure, companies base their thoroughness on the risk assigned to those components. Internal control is the general responsibility of all members in an organization. However, the following three groups have specific responsibilities regarding the internal control structure. INVOICE Invoice No. 1 5 7 4 Date: 2010 Dec. 15 WILXES RADIO COMPANY 2515 West Peachtree Street Atlanta, Georgia 30303 Customer's Orders No. N-14S Sold to: Bryan Wholesale Co. Address: 475 Mason Street Detroit, Michigan 4S823 Terms: 2/10, n/30, FOB destination Date shipped: 2010 D e c e m b e r 1 5 Shipped by: Nagel Trucking Co. Item Number Quantity Price Per Unit Total Amount Model No. 5868-24393 Description 200 $50 $10,000 Total $10,000 Exhibit 67: Invoice Management holds ultimate responsibility for establishing and maintaining an effective internal control structure. Through leadership and example, management demonstrates ethical behavior and integrity within the company. The board of directors provides guidance to management. Because board members have a working knowledge of the functions of the company, they help shield the company from managers who try to override some control procedures for dishonest purposes. Often, an efficient board that has access to the company's internal auditors can discover such fraud. Auditors within the organization evaluate the effectiveness of the internal control structure and determine whether company policies and procedures are being followed. All employees are part of a communications network that enables an internal control structure to work effectively. Computerized financial records require the same internal control principles of separation of duties and control over access as a manual accounting system. The exact control steps depend on whether a company is using mainframe computers and minicomputers or microcomputers. Large corporations might use all three types of computers in their accounting environments. The size and complexity of mainframe computers and minicomputers require specially trained persons to keep these systems operating. While systems specialists operate the computer system itself, programmers develop the programs that direct the computer to perform specific tasks. In a mainframe or minicomputer environment, internal control should include the following: Accounting Principles: A Business Perspective 360 A Global Text 8. Control of cash Control computer access by placing the computer in an easily secured room, and allow only persons authorized to operate the computer to enter the room. Restrict the access of systems specialists (who operate the computer) to software programs and the access of programmers to the computer. This policy prevents the running of unauthorized, altered programs. Require the use of passwords to access sensitive company data and confidential personal data. Change the passwords as necessary. Many smaller companies use microcomputers instead of a mainframe or a minicomputer. Also, large companies might supply certain employees with personal computers. The use of personal computers changes the control environment somewhat. Small companies generally do not employ systems specialists and programmers. Instead, these companies use off-the-shelf programs such as accounting, spreadsheet, database management, and word processing packages. The data created by use of these programs are valuable (e.g. the company's accounting records) and often sensitive. Thus, controls are also important. In a personal computer environment, the following controls can be useful: Exhibit 68: Flow of documents and goods in a merchandising transaction 361 This book is licensed under a Creative Commons Attribution 3.0 License Require computer users to have tight control over storage of programs and data. Just as one person maintains custody over a certain set of records in a manual system, in a computer system one person maintains custody over certain information (such as the accounts receivable subsidiary ledger). Make backup copies that are retained in a different secured location. Require passwords (kept secret) to gain entry into data files maintained on the hard disk. In situations where a local area network (LAN) links the personal computers into one system, permit only certain computers and persons in the network to have access to some data files (the accounting records, for example). Computerized accounting systems do not lessen the need for internal control. In fact, access to a computer by an unauthorized person could result in significant theft in less time than with a manual system. Controlling cash Since cash is the most liquid of all assets, a business cannot survive and prosper if it does not have adequate control over its cash. In accounting, cash includes coins; currency; undeposited negotiable instruments such as checks, bank drafts, and money orders; amounts in checking and savings accounts; and demand certificates of deposit. A certificate of deposit (CD) is an interest-bearing deposit that can be withdrawn from a bank at will (demand CD) or at a fixed maturity date (time CD). Only demand CDs that may be withdrawn at any time without prior notice or penalty are included in cash. Cash does not include postage stamps, IOUs, time CDs, or notes receivable. In its general ledger, a company usually maintains two cash accountsCash and Petty Cash. On the company's balance sheet, it combines the balances of these two accounts into one amount reported as Cash. An accounting perspective: Business insight Users of financial data must look to see the real meaning behind the numbers. Reader's Digest publishes the world's most widely read magazine as well as various other books, home entertainment products, and special interest magazines. In Reader's Digest's annual report, for example, the company defines cash and cash equivalents in this footnote: The company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Since many business transactions involve cash, it is a vital factor in the operation of a business. Of all the company's assets, cash is the most easily mishandled either through theft or carelessness. To control and manage its cash, a company should: Account for all cash transactions accurately so that correct information is available regarding cash flows and balances. Accounting Principles: A Business Perspective 362 A Global Text 8. Control of cash Make certain that enough cash is available to pay bills as they come due. Avoid holding too much idle cash because excess cash could be invested to generate income, such as interest. Prevent loss of cash due to theft or fraud. The need to control cash is clearly evident and has many aspects. Without the proper timing of cash flows and the protection of idle cash, a business cannot survive. This section discusses cash receipts and cash disbursements. Later in the chapter, we explain the importance of preparing a bank reconciliation for each bank checking account and controlling the petty cash fund. When a merchandising company sells its merchandise inventory, it may receive cash immediately or several days or weeks later. A clerk receives the cash immediately over the counter, records it, and places it in a cash register. The presence of the customer as the sale is rung up usually ensures that the cashier enters the correct amount of the sale in the cash register. At the end of each day, stores reconcile the cash in each cash register with the cash register tape or computer printout for that register. Payments received later are almost always in the form of checks. Stores prepare a record of the checks received as soon as they are received. Some merchandising companies receive all their cash receipts on a delayed basis as payments on accounts receivable. (See the cash receipts cycle for merchandise transactions in Exhibit 69.) Although businesses vary their specific procedures for controlling cash receipts, they usually observe the following principles: Prepare a record of all cash receipts as soon as cash is received. Most thefts of cash occur before a record is made of the receipt. Once a record is made, it is easier to trace a theft. Deposit all cash receipts intact as soon as feasible, preferably on the day they are received or on the next business day. Undeposited cash is more susceptible to misappropriation. Arrange duties so that the employee who handles cash receipts does not record the receipts in the accounting records. This control feature follows the general principle of segregation of duties given earlier in the chapter, as does the next principle. Arrange duties so that the employee who receives the cash does not disburse the cash. This control measure is possible in all but the smallest companies. Companies also need controls over cash disbursements. Since a company spends most of its cash by check, many of the internal controls for cash disbursements deal with checks and authorizations for cash payments. The basic principle of segregation of duties also applies in controlling cash disbursements. Following are some basic control procedures for cash disbursements: Make all disbursements by check or from petty cash. Obtain proper approval for all disbursements and create a permanent record of each disbursement. Many retail stores make refunds for returned merchandise from the cash register. When this practice is followed, clerks should have refund tickets approved by a supervisor before refunding cash. 363 This book is licensed under a Creative Commons Attribution 3.0 License Require all checks to be serially numbered and limit access to checks to employees authorized to write checks. Require two signatures on each check over a material amount so that one person cannot withdraw funds from the bank account. Exhibit 69: Cash receipts cycle for merchandise transactions Arrange duties so that the employee who authorizes payment of a bill does not sign checks. Otherwise, the checks could be written to friends in payment of fictitious invoices. Require approved documents to support all checks issued. Instruct the employee authorizing cash disbursements to make certain that payment is for a legitimate purpose and is made out for the exact amount and to the proper party. Stamp the supporting documents paid when liabilities are paid and indicate the date and number of the check issued. These procedures lessen the chance of paying the same debt more than once. Arrange duties so that those employees who sign checks neither have access to canceled checks nor prepare the bank reconciliation. This policy makes it more difficult for an employee to conceal a theft. Have an employee who has no other cash duties prepare the bank reconciliation each month, so that errors and shortages can be discovered quickly. Void all checks incorrectly prepared. Mark these checks void and retain them to prevent unauthorized use. Exhibit 70 shows an overview of some of the internal control considerations relating to cash. Most companies use checking accounts to handle their cash transactions. The company deposits its cash receipts in a bank checking account and writes checks to pay its bills. The bank sends the company a statement each month. The company checks this statement against its records to determine if it must make any corrections or adjustments in either the company's balance or the bank's balance. You learn how to do bank reconciliations later in this Accounting Principles: A Business Perspective 364 A Global Text 8. Control of cash chapter. In the next section, we discuss the bank checking account. If you have a personal checking account, some of this information will be familiar to you. Exhibit 70: Internal control considerations regarding cash An accounting perspective: Uses of technology Many companies are using Electronic Data Interchange (EDI) to transmit business documents such as purchase orders, invoices, and even payments for goods and services. Instead of mailing paper copies of these documents, the entire transaction is done electronically. This procedure speeds up the transaction and eliminates the expense of sending paper copies. One concern of such procedures is the security of the transaction. Since this issue is being successfully addressed by various methods, including encrypting the data, we can expect the use of EDI to continue to increase in the future. The bank checking account Banks earn income by providing a variety of services to individuals, businesses, and other entities such as churches or libraries. One of these services is the checking account. A checking account is a money balance maintained in the bank; it is subject to withdrawal by the depositor, or owner of the money, on demand. To provide depositors with an accurate record of depositor funds received and disbursed, a bank uses the business documents discussed in this section.28 28 Due to relaxed federal regulations, institutions other than bankssuch as savings and loan associations and credit unionsnow offer checking account services. All of these institutions function somewhat similarly; but, for simplicity's sake, we discuss only banks here. 365 This book is licensed under a Creative Commons Attribution 3.0 License A bank requires a new depositor to complete a signature card, which provides the signatures of persons authorized to sign checks drawn on an account. The bank retains the card and uses it to identify signatures on checks it pays. The bank does not compare every check with this signature card. Usually, it makes a comparison only when the depositor disputes the validity of a check paid by the bank or when someone presents a check for an unusually large sum for payment. When depositors make a bank deposit, they prepare a deposit ticket or slip. A deposit ticket is a form that shows the date and the items that make up the deposit (Exhibit 71). Often, the ticket is pre-printed to show the depositor's name, address, and account number. A depositor enters the items constituting the depositcash and a list of checkson the ticket when making the deposit. The depositor receives a receipt showing the date of deposit and the amount deposited. A check is a written order to a bank to pay a specific sum of money to the party designated as the payee by the party issuing the check. Thus, every check transaction involves three parties: the bank, the payee (party to whom the check is made payable), and the drawer (depositor). Most depositors use serially numbered checks pre-printed with information about the depositor, such as name, address, and telephone number. Often a business check has an attached remittance advice. A remittance advice informs the payee why the drawer (or maker) of the check is making this payment. Before cashing or depositing it, the payee detaches the remittance advice from the check (Exhibit 72). Exhibit 71: Deposit ticket Accounting Principles: A Business Perspective 366 A Global Text 8. Control of cash Exhibit 72: Check with attached remittance advice JOHH DOE'S COMPANY P 0 BOX 216603 C0RVALLIS OR 218803 6141337 2010 September 1THRU 2010/09/29 PAGE 1 ASK US ABOUT REAL ESTATE AHD CONSTRUCTIOH LOANS BUSINESS BASIC ACCOUNT 614153 DESCRIPTION DEBITS CREDIT BALANCE 2010/08/31 BALANCE LAST STATEMENT DATE 3,594.44 CHECK # 1033 68.77 2010/09/08 3,52 5.67 CHECK # 1031 102.41 2010/09/08 3,423.26 2010/09/14 10,723.25 DEPOSIT 7,300.00 CHECK # 1036 38.95 2010/09/18 10,684.31 CHECK # 1037 16.08 2010/09/20 10,668.23 CHECK # 1035 114.50 2010/09/21 10,553.33 CHECK # 1038 7105.00 2010/09/21 3,448,33 CHECK # 1039 137.45 2010/09/25 3,310.88 2010/09/28 4,310.88 DEPOSIT 1,000.00 NEF CHECK 102.00 2010/09/30 4,208.88 SERVICE CHARGE 8,00 2010/09/30 4,200.88 SAFE DEPOSIT BOX REMT 15.00 2010/09/30 4,185.38 2010/09/30 4,1S5.3S BALANCE THIS STATEMENT TOTAL CREDITS (2) S,300.00 MINIMUM BALANCE 3,195.68 TOTAL DEBITS (7) 7,708.55 AVG AVAILABLE BALAHCE 5,236.31 Average BALANCE 5,23S,31 DATE CHECK # AMOUNT 1031* 102.41 09/08 1033* 6B. 77 09/21 1035 114.90 DATE 09/18 09/20 09/21 YOUR CHECKS SEQUENCED CHECK # AMOUNT 1036 38.95 1037 16.08 1033 7,105,00 DATE CHECK # AMOUNT 03/25 1039 137,45 Exhibit 73: Bank statement 367 This book is licensed under a Creative Commons Attribution 3.0 License A bank statement is a statement issued (usually monthly) by a bank describing the activities in a depositor's checking account during the period. Exhibit 73 shows a bank statement that includes the following data: Deposits made to the checking account during the period. Checks paid out of the depositor's checking account by the bank during the period. These checks have cleared the bank and are canceled. Other deductions from the checking account for service charges, NSF (not sufficient funds) checks, safe- deposit box rent, and check printing fees. Banks assess service charges on the depositor to cover the cost of handling the checking account, such as check clearing charges. An NSF (not sufficient funds) check is Bank Statement a customer's check returned from the customer's bank to the depositor's bank because the funds in the customer's checking account balance were insufficient to cover the check. The depositor's bank deducts the amount of the returned check from the depositor's checking account. Since the customer still owes the depositor money, the depositor restores the amount of the NSF check to the account receivable for that customer in the company's books. Other additions to the checking account from proceeds of a note collected by the bank for the depositor and interest earned on the account. Accounting Principles: A Business Perspective 368 A Global Text 8. Control of cash Exhibit 74: Debit memorandum (top) and credit memorandum (bottom) In addition to the data in the bank statement in Exhibit 73, bank statements also can show non-routine deposits made to the depositor's checking account. Such deposits are made by a third party. For example, the bank may have received a wire transfer of funds for the depositor. A wire transfer of funds is an interbank transfer of funds by telephone. Companies that operate in many widely scattered locations and have checking accounts with several different local banks often use interbank transfers of funds. These companies may set up special procedures to avoid accumulating too much idle cash in local bank accounts. One such procedure involves the use of special-instruction bank accounts. For example, a company may set up transfer bank accounts so local banks automatically transfer to a central bank (by wire or bank draft) all amounts on deposit in excess of a stated amount. In this way, transfers move funds not needed for local operations quickly to headquarters, where the company can use the funds or invest them. 369 This book is licensed under a Creative Commons Attribution 3.0 License Frequently, the bank returns canceled checks and original deposit tickets with the bank statement. Since it is expensive to sort, handle, and mail these items, some banks no longer return them to depositors. These banks usually store the documents on microfilm, with photocopies available if needed. Most depositors need only a detailed bank statement, as shown in Exhibit 73, and not the original documents to show what transactions occurred during a given period. When banks debit or credit a depositor's checking account, they prepare debit and credit memoranda (memos). Banks may also return these memos with the bank statement. A debit memo is a form used by a bank to explain a deduction from the depositor's account; a credit memo explains an addition to the depositor's account. The terms debit memo and credit memo may seem reversed, but remember that the depositor's checking account is a liability an account payableof the bank. So, when the bank seeks to reduce a depositor's balance, it prepares a debit memo. To increase the balance, it prepares a credit memo. Exhibit 74 contains examples of debit and credit memos. Some banks no longer mail these documents to the depositor and rely instead on explanations in the bank statements. Information that the depositor did not know before receiving the bank statement requires new journal entries on the company's books. After the entries have been made to record the new information, the balance in the Cash account is the actual cash available to the company. When the depositor has already received notice of NSF checks and other bank charges or credits, the needed journal entries may have been made earlier. In this chapter, we assume no entries have been made for these items unless stated otherwise. When a company receives its bank statement, it must reconcile the balance shown by the bank with the cash balance in the company's books. If you have a personal checking account, you also should reconcile your bank statement with your checkbook. You can use the reconciliation form on the back of the bank statement to list your checks that have not yet been paid by the bank and your deposits not yet shown on the bank statement. Some small businesses use this form. Others prepare a separate bank reconciliation, which we discuss in the next section. Bank reconciliation A bank reconciliation is a schedule the company (depositor) prepares to reconcile, or explain, the difference between the cash balance on the bank statement and the cash balance on the company's books. The company prepares a bank reconciliation to determine its actual cash balance and prepare the entry(ies) to correct the cash balance in the ledger. Accounting Principles: A Business Perspective 370 A Global Text 8. Control of cash An accounting perspective: Business insight Within the internal control structure, segregation of duties is an important way to prevent fraud. One place to segregate duties is between the cash disbursement cycle and bank reconciliations. To prevent collusion among employees, the person who reconciles the bank account should not be involved in the cash disbursement cycle. Also, the bank should mail the statement directly to the person who reconciles the bank account each month. Sending the statement directly limits the number of employees who would have an opportunity to tamper with the statement. Look at Exhibit 75; the bank reconciliation has two main sections. The top section begins with the balance on the bank statement. The bottom section begins with the balance on the company's books. After the company makes adjustments to both the bank and book balances, both adjusted balances should be the same. The steps in preparing a bank reconciliation are as follows: Deposits. Compare the deposits listed on the bank statement with the deposits on the company's books. To make this comparison, place check marks in the bank statement and in the company's books by the deposits that agree. Then determine the deposits in transit. A deposit in transit is typically a day's cash receipts recorded in the depositor's books in one period but recorded as a deposit by the bank in the succeeding period. The most common deposit in transit is the cash receipts deposited on the last business day of the month. Normally, deposits in transit occur only near the end of the period covered by the bank statement. For example, a deposit made in a bank's night depository on May 31 would be recorded by the company on May 31 and by the bank on June 1. Thus, the deposit does not appear on a bank statement for the month ended May 31. Also check the deposits in transit listed in last month's bank reconciliation against the bank statement. Immediately investigate any deposit made during the month but missing from the bank statement (unless it involves a deposit made at the end of the period). Paid checks. If canceled checks are returned with the bank statement, compare them to the statement to be sure both amounts agree. Then, sort the checks in numerical order. Next, determine which checks are outstanding. Outstanding checks are those issued by a depositor but not paid by the bank on which they are drawn. The party receiving the check may not have deposited it immediately. Once deposited, checks may take several days to clear the banking system. Determine the outstanding checks by comparing the check numbers that have cleared the bank with the check numbers issued by the company. Use check marks in the company's record of checks issued to identify those checks returned by the bank. Checks issued that have not yet been returned by the bank are the outstanding checks. If the bank does not return checks but only lists the cleared checks on the bank statement, determine the outstanding checks by comparing this list with the company's record of checks issued. Sometimes checks written long ago are still outstanding. Checks outstanding as of the beginning of the month appear on the prior month's bank reconciliation. Most of these have cleared during the current month; list those that have not cleared as still outstanding on the current month's reconciliation. 371 This book is licensed under a Creative Commons Attribution 3.0 License Bank debit and credit memos. Verify all debit and credit memos on the bank statement. Debit memos reflect deductions for such items as service charges, NSF checks, safe-deposit box rent, and notes paid by the bank for the depositor. Credit memos reflect additions for such items as notes collected for the depositor by the bank and wire transfers of funds from another bank in which the company sends funds to the home office bank. Check the bank debit and credit memos with the depositor's books to see if they have already been recorded. Make journal entries for any items not already recorded in the company's books. Errors. List any errors. A common error by depositors is recording a check in the accounting records at an amount that differs from the actual amount. For example, a USD 47 check may be recorded as USD 74. Although the check clears the bank at the amount written on the check (USD 47), the depositor frequently does not catch the error until reviewing the bank statement or canceled checks. Deposits in transit, outstanding checks, and bank service charges usually account for the difference between the company's Cash account balance and the bank balance. (These same items can cause a difference between your personal checkbook balance and the balance on your bank statement.) Remember that all items shown on the bank reconciliation as adjustments of the book (ledger) balance require journal entries to adjust the Cash account (items 4, 5, and 6 in Exhibit 75 and in the following example). Items appearing as adjustments to the balance per bank statement do not require entries by the depositor (items 2 and 3). Of course, you should call any bank errors to the bank's attention. Accounting Principles: A Business Perspective 372 A Global Text This book is licensed under a Creative Commons Attribution 3.0 License 1 2 3 1 4 5 6 6 R.L. LEE COMPANY Bank Reconciliation 2010 May 31 Balance per bank statement, 2010 May 31 Add: Deposit in transit Less: Outstanding checks: No. 9544 No. 9545 No. 9546 Adjusted balance, 2010 May 31, Balance per ledger, 2010 May 31 Add: Note collected (including interest of $25) Less: NSF check (R. Johnson) Safe-deposit box rent Service charges Adjusted balance, 2010 May 31 $3,252 452 $3,704 $322 168 223 713 $2,991 $1,891 1,225 $3,116 $102 15 8 125 $2,991 Exhibit 75: Bank reconciliation To illustrate the preparation of the bank reconciliation in Exhibit 75, assume the following (these items are keyed to numbers in that illustration): On May 31, R. L. Lee Company showed a balance in its Cash account of USD 1,891. On June 2, Lee received its bank statement for the month ended May 31, which showed an ending balance of USD 3,252. A matching of debits to the Cash account on the books with deposits on the bank statement showed that the USD 452 receipts of May 31 were included in Cash but not included as a deposit on the bank statement. This deposit was in the bank's night deposit chute on May 31. A comparison of checks issued with checks that had cleared the bank showed three checks outstanding: No. 9544 No. 9545 No. 9546 Total $322 168 223 $713 Included with the bank statement was a credit memo for USD 1,225 (principal of USD 1,200 + interest of USD 25) for collection of a note owed to Lee by Shipley Company. Included with the bank statement was a USD 102 debit memo for an NSF check written by R. Johnson and deposited by Lee. Charges made to Lee's account include USD 15 for safe-deposit box rent and USD 8 for service charges. After reconciling the book and bank balances as shown in Exhibit 75, Lee Company finds that its actual cash balance is USD 2,991. The following entries record information from the bank reconciliation: Accounting Principles: A Business Perspective 373 A Global Text 8. Control of cash 4 5 6 Cash Notes ReceivableShipley Company (-A) Interest Receivable (-A) To record note collected from Shipley Company. Accounts ReceivableR. Johnson* (Contra Account) Cash (-A) To charge NSF check back to customer, R. Johnson. Bank Service Charge Expense (-SE) Cash (-A) To record bank service charges. 1,225 102 1,200 25 102 23 23 *This debit would be posted to the Accounts Receivable contrae account in the general ledger and to R. Johnson's account in the Accounts Receivable subsidiary ledger. The income statement would include the USD 23 bank service charge as an expense and the USD 25 interest as revenue. The May 31 balance sheet would show USD 2,991 cash, the actual cash balance. You could combine the preceding three entries into one compound entry as follows: Cash (+A) Bank Service Charge Expense (-SE) Account ReceivableR. Johnson (+A) Note Receivable (-A) Interest Revenue (+SE) To correct the accounts for needed changes identified in the bank reconciliation. 1,100 23 102 1,200 25 The bank routinely handles the deposit in transit and any outstanding checks already recorded in the depositor's books. Since these items appear on the bank balance side of the reconciliation, they require no entry in the company's books. The bank processes these items in the subsequent period. When a company maintains more than one checking account, it must reconcile each account separately with the balance on the bank statement for that account. The depositor should also check carefully to see that the bank did not combine the transactions of the two accounts. To make sure a check cannot bounce and become an NSF check, a payee may demand a certified or cashier's check from the maker. Both certified checks and cashier's checks are liabilities of the issuing bank rather than the depositor. As a result, payees usually accept these checks without question. A certified check is a check written, or drawn, by a depositor and taken to the depositor's bank for certification. The bank stamps certified across the face of the check and inserts the name of the bank and the date; a bank official signs the certification. The bank certifies a check only when the depositor's balance is large enough to cover the check. The bank deducts the amount of the check from the depositor's account at the time it certifies the check. A cashier's check is a check made out to either the depositor or a third party and written, or drawn, by a bank after deducting that amount from the depositor's account or receiving cash from the depositor. In this section, you learned that all cash receipts should be deposited in the bank and all cash disbursements should be made by check. However, the next section explains the convenience of having small amounts of cash (petty cash) available for minor expenditures. 374 This book is licensed under a Creative Commons Attribution 3.0 License An accounting perspective: Uses of technology Most companies now offer to deposit employees' paychecks directly into their bank accounts. This process of transferring money by telephone, computer, or wire is called electronic fund transferring. Often companies prefer this method because it limits the number of employees involved in the payroll process. Manipulation and fraud can still occur whenever firms do not separate duties; however, limiting access to the payroll function may eliminate some of the risk associated with internal control weaknesses. Petty cash funds At times, every business finds it convenient to have small amounts of cash available for immediate payment of items such as delivery charges, postage stamps, taxi fares, supper money for employees working overtime, and other small items. To permit these cash disbursements and still maintain adequate control over cash, companies frequently establish a petty cash fund of a round figure such as USD 100 or USD 500. Usually one individual, called the petty cash custodian or cashier, is responsible for the control of the petty cash fund and documenting the disbursements made from the fund. By assigning the responsibility for the fund to one individual, the company has internal control over the cash in the fund. A business establishes a petty cash fund by writing a check for, say, USD 100. It is payable to the petty cash custodian. The petty cash fund should be large enough to make disbursements for a reasonable period, such as a month. The following entry records this transaction as follows: Petty Cash Cash To establish a petty cash fund. 100 100 After the check is cashed, the petty cash custodian normally places the money in a small box that can be locked. The fund is now ready to be disbursed as needed. One of the conveniences of the petty cash fund is that payments from the fund require no journal entries at the time of payment. Thus, using a petty cash fund avoids the need for making many entries for small amounts. Only when the fund is reimbursed, or when the end of the accounting period arrives, does the firm make an entry in the journal. When disbursing cash from the fund, the petty cash custodian prepares a petty cash voucher, which should be signed by the person receiving the funds. A petty cash voucher (Exhibit 76) is a document or form that shows the amount of and reason for a petty cash disbursement. The custodian should prepare a voucher for each disbursement and staple any invoices for expenditures to the petty cash voucher. At all times, the employee responsible for petty cash is accountable for having cash and petty cash vouchers equal to the total amount of the fund. Accounting Principles: A Business Perspective 375 A Global Text 8. Control of cash Companies replenish the petty cash fund at the end of the accounting period, or sooner if it becomes low. The reason for replenishing the fund at the end of the accounting period is that no record of the fund expenditures is in the accounts until the check is written and a journal entry is made. (Sometimes we refer to this fund as an imprest fund since it is replenished when it becomes low.) The petty cash custodian presents the vouchers to the employee having authority to order that the fund be reimbursed. After the vouchers are examined, if all is in order, that employee draws a check to restore the fund to its original amount. To determine which accounts to debit, an employee summarizes the petty cash vouchers according to the reasons for expenditure. Next, that person stamps or defaces the petty cash vouchers to prevent reuse. The journal entry to record replenishing the fund would debit the various accounts indicated by the summary and credit Cash. 376 This book is licensed under a Creative Commons Attribution 3.0 License PETTY CASH VOUCHERS NO. 359 To Local Cartage, Inc. Date 2010 June 29 EXPLANATION Freight on parts APPROVED B ACCT NO. 27 A.E.C. AMOUNT 12 57 RECEIVED B Ken Black Exhibit 76: Petty cash voucher For example, assume the USD 100 petty cash fund currently has a money balance of USD 7.40. A summary of the vouchers shows payments of USD 22.75 for shipping, USD 50.80 for stamps, and USD 19.05 for an advance to an employee; these payments total USD 92.60. After the vouchers have been examined and approved, an employee draws a check for USD 92.60 which, when cashed, restores the cash in the fund to its USD 100 balance. The journal entry to record replenishment is: Delivery Expense Postage Expense Receivable from Employees (or Advances t) Employees) Cash To replenish a petty cash fund. 22.75 50.80 19.05 92.60 Note that the entry to record replenishing the fund does not credit the Petty Cash account. We make entries to the Petty Cash account only when the fund is established, when the end of the accounting period arrives and the fund is not replenished, or when the size of the fund is changed. At the end of an accounting period, the firm records any petty cash disbursements for which the fund has not yet been replenished. Since the fund has not been replenished, the credit would be to Petty Cash rather than Cash. Failure to make an entry at the end of an accounting period would cause errors in both the income statement and balance sheet. The easiest way to record these disbursements is to replenish the fund. After a time, if the petty cash custodian finds that the petty cash fund is larger than needed, the excess petty cash should be deposited in the company's checking account. The required entry to record a decrease in the fund debits Cash and credits Petty Cash for the amount returned and deposited. On the other hand, a petty cash fund may be too small, requiring replenishment every few days. The entry to record an increase in the fund debits Petty Cash and credits Cash for the amount of the increase. To illustrate, the entry to decrease the petty cash fund by USD 50 would be: Cash Petty Cash To decrease the size of the petty cash fund by $50. 50 50 The entry to increase the petty cash fund by USD 600 would be: Petty Cash Cash To increase the size of the petty cash fund by $600. 600 600 The following rules summarize how the Petty Cash account is debited and credited: Debited to establish Debited to increase Credited to decrease Credited to terminate Accounting Principles: A Business Perspective 377 A Global Text 8. Control of cash Sometimes, the petty cash custodian makes errors in making change from the fund. These errors cause the cash in the fund to be more or less than the amount of the fund less the total vouchers. When the fund is restored to its original amount, the credit to Cash is for the difference between the established amount and the actual cash in the fund. We would debit all vouchered items. Any discrepancy should be debited or credited to an account called Cash Short and Over. The Cash Short and Over account is an expense or a revenue, depending on whether it has a debit or credit balance. To illustrate, assume in the preceding example that the balance in the fund was only USD 6.10 instead of USD 7.40. Restoring the fund to USD 100 requires a check for USD 93.90. Since the petty cash vouchers total only USD 92.60, the fund is short USD 1.30. The entry for replenishment is: Delivery Expense Postage Expense Receivable from Employees Cash Short and Over Cash To replenish a petty cash fund. 22.75 50.80 19.05 1.30 93.90 Entries in the Cash Short and Over account also result from other change-making activities. For example, assume that a clerk accidentally shortchanges a customer USD 1 and that total cash sales for the day are USD 740.50. At the end of the day, actual cash is USD 1 over the sum of the sales tickets or the total of the cash register tape. The journal entry to record the day's cash sales is: Cash Sales Cash Short and Over To record cash sales for the day. 741.50 740.50 1.00 Analyzing and using the financial resultsThe quick ratio The quick ratio measures a company's short-term debt-paying ability. It is the ratio of quick assets (cash, marketable securities, and net receivables) to current liabilities. When computing quick assets, we do not include inventories and prepaid expenses because they might not be readily convertible into cash. A rule of thumb is that the ratio of quick assets to current liabilities should be 1:1 or higher. However, a lower quick ratio is satisfactory in companies that generate a steady flow of cash in their operations. Short-term creditors are interested in this ratio since it relates the pool of cash and immediate cash inflows to immediate cash outflows. The formula for the quick ratio is: Quick ratio= Quick assets Current liabilities Based on the following information, we can determine that the 2010 and 2009 quick ratios are 6.85 and 6.84, respectively: Cash Short-term investments Net receivables Total quick assets Current liabilities Total quick assets Current liabilities 2010 $315,064 119,093 320,892 $755,049 $110,147 $755,049 = 6.85 $110,147 2009 $283,913 314,872 177,300 $776,085 $113,430 $776,085 = 6.84 $113,430 378 This book is licensed under a Creative Commons Attribution 3.0 License An ethical perspective: City club restaurant The City Club Restaurant is a member-owned entity in Carson City. For 20 years, John Blue has managed the restaurant and received only minimal salary increases. He believes he is grossly underpaid in view of the significant inflation that has occurred. A few years ago he began supplementing his income by placing phony invoices in the petty cash box, writing a petty cash voucher for the amount of each invoice, withdrawing cash equal to the amount of each invoice for his personal use, and later approving the vouchers for reimbursement. Through this mechanism, John increased his income by about USD 12,000 per year, an amount that he considered fair. No one else knows what is happening, and the manager feels fully justified in supplementing his income in this way. Now that you have learned how to control a company's most liquid asset, cash, in the next chapter you are ready to study receivables and payables. As you realize, the backbone of our economy is credit. In all probability, the next automobile you plan to buy will be financed. Companies are anxious to offer credit to worthy customers and prospective customers. The many offers of credit we receive from various businesses are evidence of the importance companies place on credit as a method of stimulating sales and expanding their business. Understanding the learning objectives The internal control structure of a company includes its plan of organization and all the procedures and actions taken by the company to protect its assets against theft and waste, ensure compliance with company policies and federal law, evaluate the performance of all personnel in the company to promote efficiency of operations, and ensure accurate and reliable operating data and accounting records. The purpose of internal control is to ensure the efficient operation of a business. Cash includes coins; currency; undeposited negotiable instruments such as checks, bank drafts, and money orders; amounts in checking and saving accounts; and demand certificates of deposit. To protect their cash, companies should account for all cash transactions accurately, make certain enough cash is available to pay bills as they come due, avoid holding too much idle cash, and prevent loss of cash due to theft or fraud. Procedures for controlling cash receipts include such basic principles as recording all cash receipts as soon as cash is received; depositing all cash receipts on the day they are received or on the next business day; and preventing the employee who handles cash receipts from also recording the receipts in the accounting records or from disbursing cash. Procedures for controlling cash disbursements include, among others, making all disbursements by check or from petty cash, using checks that are serially numbered, requiring two signatures on each check, and having a different person authorize payment of a bill than the persons allowed to sign checks. Accounting Principles: A Business Perspective 379 A Global Text 8. Control of cash A bank reconciliation is prepared to reconcile, or explain, the difference between the cash balance on the bank statement and the cash balance on the company's books and to make the required entry(ies) to correct the cash balance in the ledger. A bank reconciliation is shown in Exhibit 75. Journal entries are needed for all items that appear in the bank reconciliation as adjustments to the balance per ledger to arrive at the adjusted cash balance. Companies establish a petty cash fund to permit minor cash disbursements and still maintain adequate control over cash. When the cash in the petty cash fund becomes low, the fund should be replenished. A journal entry is necessary to record the replenishment. Quick ratio equals cash, marketable securities, and net receivables divided by current liabilities. The quick ratio measures a company's short-term debt-paying ability. Demonstration problem Demonstration problem A You are the manager of a restaurant that has an ice cream parlor as a separate unit. Your accountant comes in once a year to prepare financial statements and the tax return. In the current year, you have a feeling that even though business seems good, net income is going to be lower. You ask the accountant to prepare condensed statements on a monthly basis. All sales are priced to yield an estimated gross margin of 40 per cent. You, your accountant, and several of the accountant's assistants take physical inventories at the end of each of the following four months. The resulting sales, cost of goods sold, and gross margins are: March April Restaurant Sales $36,300 Cost of goods sold 22,275 Gross Margin $13,025 Ice Cream Parlor $53,000 31,500 $21,500 Restaurant $39,050 23,800 $15,250 May Ice Cream Parlor $42,750 31,000 $11,750 Restaurant $38,100 22,975 $15,125 June Ice Cream Parlor $39,000 30,750 $8,250 Restaurant $41,250 25,500 $15,750 Ice Cream Parlor $35,500 31,125 $4,375 What would you suspect after analyzing these reports? What sales control procedures would you recommend to corre