Internal Controls,

Accounting for Cash, and Ethics

Chapter 04

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Learning Objectives1. Identify the key elements of a strong

system of internal control.2. Prepare a bank reconciliation.3. Discuss the role of ethics in the accounting

profession.4. Discuss the auditor’s role in financial

reporting.

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An Integrated Framework

1. Control Environment – integrity and ethical values of a company

2. Risk Assessment – management identification of potential risks

3. Control Activities – internal controls4. Information and Communication – internal

and external reporting process5. Monitoring – over time assessment and

correction of internal controls

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Internal Controls1. Separation of Duties2. Quality of Employees3. Bonded Employees4. Required Absences5. Procedures Manual6. Authority and Responsibility7. Prenumbered Documents8. Physical Control9. Performance Evaluations

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LimitationsInternal controls can be circumvented by collusion among employees. Two or more

employees working together can hide embezzlement by covering for each

other. No system can prevent all fraud. Good internal controls minimize fraud and increase likelihood of detection.

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Accounting for Cash

ControllingCash

ControllingCash

Cash receiptsCash receipts should be recorded should be recorded immediately upon immediately upon

receipt and receipt and deposited intact deposited intact

daily.daily.

Cash receiptsCash receipts should be recorded should be recorded immediately upon immediately upon

receipt and receipt and deposited intact deposited intact

daily.daily.

Cash disbursementsCash disbursements should be made by should be made by

prenumbered prenumbered check.check.

Cash disbursementsCash disbursements should be made by should be made by

prenumbered prenumbered check.check.

Up to date Up to date signature cardsignature card

should be should be maintained.maintained.

Up to date Up to date signature cardsignature card

should be should be maintained.maintained.

A A deposit ticketdeposit ticket should be used for should be used for

all deposits.all deposits.

A A deposit ticketdeposit ticket should be used for should be used for

all deposits.all deposits.

A monthly A monthly bank bank reconciliationreconciliation should should be prepared by an be prepared by an independent party.independent party.

A monthly A monthly bank bank reconciliationreconciliation should should be prepared by an be prepared by an independent party.independent party.

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Reconciling the Bank Account

Unadjusted bank balance

Add + Deposits in transit

Deduct - Outstanding checks

Equals = True cash balance

Adjustment to the Bank Balance

The bank reconciliation reports on the differences between the balance on the bank

statement and the balance in the general ledger cash account. The reconciliation results

in the true cash balance that will appear on the balance sheet.

The bank reconciliation reports on the differences between the balance on the bank

statement and the balance in the general ledger cash account. The reconciliation results

in the true cash balance that will appear on the balance sheet.

Unadjusted book balance

Add + Accounts receivable collections

Add + Interest earned

Deduct - Bank service charges

Deduct - Non-sufficient funds (NSF) check

Equals = True cash balance

Adjustments to the Book Balance

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Bank ReconciliationGreen Shades Resorts, Inc.’s bank reconciliation for

September.

1. The September 30th balance on the bank statement is $3,516.45, and the Cash general ledger balance on this date is $3,361.22.

2. There was a deposit in transit in the amount of $724.11.

3. The bank erroneously deducted a $25 check drawn on the books of Green Valley Resorts from our account.

4. At September 30th there were three checks outstanding. Check 639 dated 9/18, for $13.75; Check 646 dated 9/20, for $29.00; and Check 672 dated 9/27, for $192.50.

5. During the month of September the bank collected an account receivable for us in the amount of $940.

6. A check actually written for $36.45 for supplies was erroneously recorded in our records by the bookkeeper as $63.45.

7. The bank assessed a service charge of $8.40 for September and we deposited a NSF check in the amount of $289.51.

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Bank Reconciliation

Unadjusted bank balance, September 30 3,516.45$ Add: Deposits in transit 724.11 Bank error 25.00 Less: Outstanding checks Check No. 639 - September 18 13.75 Check No. 646 - September 20 29.00 Check No. 672 - September 27 192.50 (235.25) True Cash balance, September 30 4,030.31$

Unadjusted Book Balance, June 30 4,240.54$ Add: Account collected by bank 875.00 Bookkeeping error 27.00 Interest earned on checking account 9.25 Less: Bank service charge (12.75) NSF Check (413.11) True Cash balance, June 30 4,725.93$

Green Shades Resorts, Inc.Bank Reconciliation Statement

September 30, 2012

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Bank Reconciliation

Unadjusted Bank Balance, September 30 3,516.45$ Add: Deposits in transit 724.11 Bank error 25.00 Less: Outstanding checks Check No. 639 - September 18 13.75 Check No. 646 - September 20 29.00 Check No. 672 - September 27 192.50 (235.25) True Cash balance, September 30 4,030.31$

Unadjusted Book Balance, September 30 3,361.22$ Add: Account collected by bank 940.00 Bookkeeping error 27.00 Less: Bank service charge (8.40) NSF Check (289.51) True Cash balance, September 30 4,030.31$

Green Shades Resorts, Inc.Bank Reconciliation Statement

September 30, 2006

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The Fraud Triangle

Rationalization

Pressure

Opportunity

Key to protecting yourself and your company: personal integrity.

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Role of the Independent Auditor

How can a financial analyst

know that a company really did

follow GAAP? Certified Public

Accountants

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Materiality and Financial Audits

Auditors do not guarantee that financial statements are absolutely

correct—only that they are materially correct.

Material ItemAn error, or other

reporting problem, that would influence

the decision of an average prudent

investor.

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Types of Audit Opinions

Unqualified Adverse

Qualified Disclaimer

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End of Chapter Four