Topic 7 - Internal Control, Bank Reconciliation & Accounts Receivable

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This article is a topic within the subject Accounting 1A.

Contents

Required Reading

Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP pp. 353-371.

Internal Control And Cash

Internal Control

Internal Control;

  • Increases efficiency and effectiveness of operations
  • Reliability of financial reporting
  • Improves compliance with applicable laws and regulations

It is limited by;

  • Human Mistakes
  • Management Override
  • Employee Collusion and Fraud
  • Costs Vs. Benefits

The 5 components of internal control include;[1]

  1. Control Activities - policies and procedures
  2. Risk Assessment - identification and analysis of risks
  3. Information and Communication
  4. Monitoring - processes to assess system performance
  5. Control Environment - Ethics and integrity of all employees

Examples Include;[2]

  • Top Level Reviews – assess performance compared to budgets
  • Information Processing – Check accuracy & correct authorisation of transactions
  • Separate Record Keeping from Handling Assets – If cash record keeper handles cash = fraud
  • Segregation of Duties – Asset Handling & Asset Record Keeping Separated
  • Physically Protecting Assets

Internal Control of Cash

There are a couple of ways that we can control and ensure that our cash is safe:

  1. Segregation of Duties
    • Separate record keeping and cash handling
    • Separate cash receiving and cash paying jobs
  2. Cross checking - sales/inventory and sales/cash/receivables
  3. Overall Monitoring
    • Countersign cheques and make them unrelated to invoice approval (similar to segregation of duties)
  4. Use a Petty Cash System and Reconcile Bank Accounts
Petty Cash System

A petty cash fund is established for making small cash payments

  1. Create Petty Cash Fund
    • DR Petty Cash Fund (Asset), CR Cash
  2. Making Payments
    • The firm writes a 'petty cash voucher describing the amount, date, purpose and to whom the payment is made to
    • No journal entry is made
    • Petty Cash Fund + Petty Cash Vouchers = Original Petty Cash Fund Amount
  3. Replenishing the Petty Cash Fund
    • DR Expenses, CR Cash - we remove all the vouchers and recognise the expenses now
  4. Errors
    • the firm will use a cash shortage or overage account to recognised miscellaneous expenses or revenue
Bank Reconciliation

Bank reconciliation's explain the differences between the amount in the cash account (ledger) and the bank statement. Reasons for Differences

  • Timing Differences
    • Deposits in Transit - Receipts recorded but not deposited in the bank as of yet
    • Outstanding Cheques - cheques written o suppliers that have not been banked
  • Information Asymmetry
    • Deposits not recorded - interest revenue, notes receivable (direct deposits)
    • Payments not recorded - fees and bounced cheques
  • Errors in bank statements or company records

How to do a Bank Reconciliation

Step 1

  • Check last months bank reconciliation statement:
    • Tick off any outstanding deposits/cheques that appear in this months statement
  • Tick off items that appear in this months bank statement and cash journals
  • Check for errors
    • If bank error - inform the bank and list it in the bank reconciliation statements
    • If firm error - correct relevant journal entry

Step 2

  • Check bank statement for un-ticked amounts - e.g. NSF cheques, transactions made directly through the bank (interest)
    • Enter them into the Cash receipts journal or Cash payments journal - and tick them off
  • Check Cash receipts/payments journal for un-ticked amounts - e.g. outstanding deposits or cheques
    • Put those amounts into the bank reconciliation statement under the bank account heading.

A bank reconciliation statements should be prepared in this fashion (as shown by accountingcoach.com) [3]

Bank Recon.jpg

Accounts Receivable

following on from our contra asset discussion in topic 5 we extend slightly upon accounts receivable and the allowance for doubtful debts.

  • Recognise Bad Debts
    • DR Bad Debts Expense, CR Allowance for Doubtful Debts
  • Write off
    • DR Allowance for Doubtful Debts, CR Accounts Receivable (off the companies books)
    • Recovery of 'previously written off bad debts' - DR Accounts Receivable, CR Allowance for Doubtful Debts (reverse write off), DR Cash, CR Accounts Receivable (cash collection)

Estimating Bad Debts

  • Income Statement Approach
    • Review the relationships between credit sales and bad debts, e.g. 2% of credit sales
  • Balance Sheet Approach
    • Assign probabilities to age of receivables based on past experience. E.g. 0.5% (0-30 days old) and (5% to 90 days or more)

End

This is the end of this topic. Click Accounting 1A to go back to the main subject page for Accounting 1A

References

Textbook refers to Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP

  1. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  2. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  3. http://www.accountingcoach.com/online-accounting-course/13Xpg02.html
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