Lecture 6
25 April 2022
Cash
- Cash is an asset that is readily convertible into any other type of asset
- Cash includes funds immediately available from bank accounts, bank notes (paper
money), coins and things like money orders, checks, etc.
- Cash is often put in one category with cash equivalents
o short term investments readily convertible to cash with a minimal risk of price
changes due to interest rate movements
Cash in companies
- Cash is generally stored on bank accounts or invested in cash equivalents
- Stores and other types of organizations that receive cash payments from customers
also have currency stored in point-of-sale terminals
- Organizations sometimes use a petty cash fund for daily payments of small amounts
Petty cash funds
- Amount of money, held in the form of banknotes and coins, for paying small amounts
- One specific employee is made responsible for the fund
o The ‘cash fund custodian’
- Organizations use an account ‘petty cash’ to register the creation and replenishment of
the fund
o Accounting effects of payments are recorded when fund is replenished
Replenishment of petty cash funds
- Petty cash funds typically have a minimum and maximum amount
- When the minimum amount is reached, the organization replenished the fund
o Adds cash to the fund such that it is back to the maximum amount
- At the moment of replenishment, it recognizes the small expenses that were paid with
the cash in the fund
o In the meantime: no journal entries
- Always replenishment at the end of the accounting period
Petty cash funds: journal entries
Entry to record the creation of the fund
Entry to record petty cash fund replenishment
Note that there is no entry in the ‘Petty Cash’ account
Cash differences
,To ensure that the amount of cash ‘in the books’ is correct, organizations use a specific
account to record unexplained differences
- Common label: cash over and short
Why can there be differences? E.g., mathematical errors or failure to keep accurate records
Cash over and short is an income statement account
- A debit balance indicates a net cash shortfall
- A credit balance indicates a net cash oversupply
Company bank accounts
- With contemporary technology the need for petty cash funds with banknotes and coins
has reduced
- Organizations often use debit cards that employees can use to pay small amounts
directly from an organization bank account
- Employees can use the card to make payments up to a specific amount
Organization’s use of bank accounts
- Like individuals, organizations can have (multiple) bank accounts
- Bank accounts are typically tied to accounts in the organization’s accounting system
- Periodically, the two balances will have to be reconciled
- There can be differences:
o Time lags
o Errors (by either party)
o Bank memoranda
Checks
- In the USA, and some other countries, the use of checks is (still) widespread
- Checks are written orders signed by an account holder directing the bank to pay a
specified sum of money to a designated recipient
Internal control of cash
The asset most susceptible to fraudulent activities
- Everyone likes cash…
- Moreover, it is easily concealed and transported
Procedures, checks, monitoring devices, limitation of decision-making rights
- Internal control mechanisms to prevent employees and others from stealing cash
Internal control
Designing, testing, and updating internal controls is one of the most important tasks of
accountants
Adequate interna controls contribute to the accuracy of accounting numbers and the
prevention of theft and fraud
Methods and measures adopted by an organization to serve the following four general
purposes:
1. Safeguard assets prevent theft and fraud
2. Enhance accuracy and reliability of accounting records
3. Ensure compliance with laws and regulations and encourage employees to follow
company policies
4. Promote operational efficiency
,Safeguarding of assets
Preventing theft and fraud
Fraud refers to dishonest acts by employees that result in personal benefits to the employee at
a cost to the employer
There is a grey area between clearly criminal acts (like stealing money or other
assets) and behavior that is just not optimal from the employer’s perspective but not illegal
Examples of employee fraud and theft
Larceny:
- Taking cash or property from the business. Covers everything for taking cash out of
the cash register to stealing inventory from the loading dock
Embezzlement:
- Theft of cash or property by someone in position of trust, like a bookkeeper or
manager
Billing schemes:
- Setting up a false supplier account and paying the supplier (actually the employee) for
nonexistent goods or services
Expense reimbursement schemes:
- Padding expense reports by adding items that were never incurred or were not
business-related
Cost of employee theft and fraud
The costs of employee theft and fraud are immense
- Average organizations lose amount equal to roughly 5% of revenue each year
Fraud by board members has (almost) brought down large companies
Antecedents of fraud
Why do people commit fraud?
- Different theories/models
- A common model is the fraud triangle
Fraud, and less extreme forms of opportunistic behavior such as earnings management and the
deliberate misreporting of costs, is one of the main topics of academic accounting research
, Importance of internal control systems
In many countries, public companies must issue an internal control report
- A report by the company’s board describing the adequacy of the internal controls
- In the US, if internal controls turn out to be inadequate after a statement that they were
adequate, board members face criminal charges
- Up to 25 years in prison
Auditors periodically assess the controls
5 components of internal control systems
1. A control environment (“tone at the top” focused on integrity)
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring for adequacy
Principles of internal control activities
1. Establishment of responsibility
2. Segregation of duties
3. Documentation procedures
4. Physical controls
5. Independent internal verification
6. Human resource controls
1: Establishment of responsibility
- Each employee has specific responsibilities and limited decision-making authority
- Only one person is responsible for a specific task
- It should be documented who does what, such that decision processes can be traced
back
- Establishing responsibility requires limited access only to authorized personnel and
identifying them, for instance through log in codes, passwords, signatures
2: Segregation of duties
Different individuals should be responsible for related activities
- Receiving the order, preparing the order, handing over the product to the customer,
writing the invoice, receiving the payment
In general, different employees should be responsible for:
- Keeping physical custody of an asset
- Authorizing changes in the asset
- Recording changes in the asset
3: Documentation procedures
- Organizations should establish procedures for documents
o Filling out (electronic prenumbered) forms should be required for internal and
external transactions
o Forward source document to accounting department
4: Physical controls
