Internal Cash Controls and Cash

Introduction
In this module:

You will be introduced to:

• Various controls over cash
• The operation of a petty cash fund
• The reconciliation of a bank account and any necessary journal entries resulting from that
reconciliation

Learning Outcomes
Upon successful completion of Module 7 you will be able to:
1. Understand and discuss various internal controls over cash.
2. Understand the operation of a petty cash fund as well as the related journal entries.
3. Prepare a bank reconciliation and all related journal entries.

Pre-Test
Instructions: You’re going to test your accounting knowledge before you begin the module content.

1. In business, “cash” may refer to cheques, petty cash, short term highly liquid investments, as
well as coins and paper bills.
a) True
b) False
2. A bank reconciliation compares a company’s records of its cash account balance with the bank
records for the same account.
a) True
b) False
3. Preparing a bank reconciliation is optional in a company, because banks almost never make
errors in their records.
a) True
b) False
4. A company cheque made payable to cash may be cashed by anyone who receives it.
a) True
b) False
5. Internal controls are methods used to safeguard a company’s cash.
a) True
b) False
6. Smaller companies should do their banking only once a week or once a month, to save
employees’ time.
a) True
b) False
 7. The role of an auditor includes making sure that proper documentation exists in a company’s
accounting records.
a) True
b) False
8. Petty cash is a small amount of cash kept on hand in a company.
a) True
b) False
9. Petty cash does not need to be accounted for in the accounting records.
a) True
b) False
10. A cheque may be recorded in a company’s general ledger in one period, but not appear on the
bank statement until the next period.
a) True
b) False
Answers:

1. A - True
2. A - True
3. B - False
4. A - True
5. A - True
6. B - False
7. A - True
8. A - True
9. B - False
10. A - True

What is Cash?
Cash is “king”!

• It is the most liquid asset

• Everyone needs cash
• It is important to control and to protect cash so it is not misused
• Businesses use a variety of internal controls to manage cash

Even in companies that handle large volumes of cash transactions (retail store, restaurants), very little
cash is kept on hand at the business location. So accounting for cash involves:

• The money that rustles and jingles in a cash register drawer

• Other amounts kept on hand to cover small expenses (petty cash)
• Sums of money that flow in and out of various bank accounts
• Documents that represent cash, such as cheques
• Short term, highly liquid temporary investments

Liquid: little or no effort required to convert the asset into usable money
Internal Controls: policies and procedures that determine how cash is handled and who can handle it

Why do we need Internal Controls over Cash?

Let us look at some principles of internal controls:

• Ensure all cash resources are used as effectively and efficiently as possible
• Prevent misuse and detect errors
• Safeguard assets
• Maintain reliable accounting records

Principles of Internal Controls

Proper Authorization

• Principle: All transactions or events undertaken by a company must be appropriately

authorized.
• More Information: An invoice must be authorized or approved before it is paid.

Segregation of Duties

• Principle: Where possible related activities should be assigned to different persons.

• More Information: The person who maintains the accounts receivable records should not be the
same person who receives payments from customers.

Safeguarding of Assets

• Principles: All assets (cash as well as non-cash) must be protected from misuse.
• More Information: Any cash on site must be kept in a locked box or safe, with access restricted,
preferably to one person only.

Appropriate Documentation

• Principle: Documents must be provided as evidence that a transaction has occurred.

• More Information: A receiving report, prepared by the company’s receiving department, is
evidence that a purchased item was actually received.
This report must be matched with the company purchase order and supplier invoice to
substantiate the payment of the supplier invoice.

Verification

• Principle: Review procedures to ensure appropriate internal controls are in place and are being
followed.
• More Information: Managers, supervisors or an internal audit department may review accounts
payable records. Among other things, they will check to see that appropriate documentation
procedures (as described above) are being followed by the company.
How Operating Procedures and Job Responsibilities Provide Internal
Controls
In a well-run organization, both operating procedures and job responsibilities are designed to provide
internal controls over cash receipts and disbursements.

Cash Receipts Procedures

1. Cash is received by a person other than the one responsible for maintaining the accounts
receivable records.
2. The person responsible for receiving cash prepares a list of cash received and gives that list to
the person responsible for maintaining the accounts receivable records.
3. All cash receipts are deposited to the bank account daily.
4. Cash deposit slips are approved by a senior person who is not involved in maintain the accounts
receivable records.
5. Whenever cash is counted, at least two persons are present to verify the count.
6. Access to any cash kept on site is restricted and the cash is stored in a locked box or safe.
7. If cash registers are used, reconcile cash in drawer with cash register tape.
8. Prepare a monthly bank reconciliation (more on this a little later in the unit).

Cash Disbursements Procedures

1. All disbursements – with the exception of petty cash – are made by cheque.
2. All cheques are:
a. Substantially numbered
b. Payable to either a specific individual or company
c. Signed by two authorized persons if it’s over a specific amount for example, $1000
3. All payments are substantiated with an approved supplier invoice (and other appropriate
documents) such as a purchase order and receiving report.
4. A bank reconciliation is prepared monthly.
5. When petty cash is used, only one individual has access to the fund.

Match these Statements…

Select the Internal Control Principle that is being followed in each of these procedures.

1. Cash deposit slips are approved by a senior person who is not involved in maintaining the
accounts receivable records.
a) Authorization
b) Documentation
c) Safeguarding
d) Segregation
e) Verification
2. Cash is received by a person other than the one responsible for maintaining the accounts
receivable records.
a) Authorization
b) Documentation
 c) Safeguarding
d) Segregation
e) Verification
3. Access to any cash kept on site is restricted and the cash is stored in a locked box or safe.
a) Authorization
b) Documentation
c) Safeguarding
d) Segregation
e) Verification
4. All payments are substantiated with an approved supplied invoice (and other appropriate
documents such as a purchase order and receiving report).
a) Authorization
b) Documentation
c) Safeguarding
d) Segregation
e) Verification
5. Whenever cash is counted, at least two persons are present to verify the count.
a) Authorization
b) Documentation
c) Safeguarding
d) Segregation
e) Verification

Answers:

1. A - Authorization
2. D - Segregation
3. C - Safeguarding
4. B - Documentation
5. E - Verification

What is Petty Cash?

Petty cash is a small amount of money kept on hand in an organization. It is generally used to reimburse
employees for small expenses they have incurred on behalf of the company. Because the expenses are
small, it is easier and less expensive to reimburse employees through the petty cash fund than to issue
them a cheque.

This type of petty cash fund is known as Imprest Petty Cash fund.

As with all other transactions, petty cash transactions must be journalized and posted to the general
ledger at the end of the period, or whenever a cheque is issued that affects the fund.

Imprest Petty Cash: The fund uses a fixed amount. Assuming no errors have been made, the amount of
actual cash plus the sum of the receipts should always equal this fixed amount.
How Does Petty Cash Work?
1. The petty cash custodian verifies the voucher and receipt, then reimburses the employee.
2. Periodically, cash is added to the fund to replace what has been paid out.
3. Employees who make small purchases on behalf of the company provide an approved petty
cash voucher and a receipt to the petty cash custodian.
4. The voucher and receipt are placed In the petty cash fund, replacing the cash that was paid out
to the employee.

Petty cash custodian: the person responsible for the petty cash fund.

Journalizing Petty Cash

Let us assume that the petty cash fund was established on January 1. Several transactions have affected
the fund during January. At the end of the month, the petty cash fund would be reimbursed for these
expenses, at which time the expenses would be journalized and posted.

The journal entry below reflects the reimbursement of the petty cash fund and the recognition of
expenses.

The most common error related to petty cash is reimbursing an employee with too much or too little
cash.

With that in mind, let’s journalize some transactions!

• Jan. 1 – Establish a petty cash fund of $100

• Jan. 5 – Reimburse employee $10 for mileage
• Jan. 10 – Reimburse employee $15 for mileage
• Jan. 17 – Reimburse employee $5 for snacks for office
• Jan. 20 – Reimburse employee $30 for lunch for themselves and a client
• Jan. 25 – Reimburse employee $15 for stamps
• Jan 30 - $25 remains in the petty cash fund. Reimburse the petty cash fund with $75 to bring the
total cash back to $100

GENERAL LEDGER

Date Account Titles and Explanations Ref. Debits Credits

Jan. 1 Petty cash – the imprest amount 100
Cash 100
Jan. 30 Mileage expense (total mileage receipts) 25
Meal expense (total of meal receipts) 35
Stamp Expense 15
Cash (this amount will be added to petty cash box) 75
Jan. 30 Petty Cash 150
Cash 150

Notice:
 • The petty cash account in the ledger is debited or credited only when we establish the fund or
change the imprest amount (we increased it from $100 to $250).
• To refill the petty cash fund, charge the petty cash receipts to the appropriate expense
accounts. Then write a cheque on the company’s operating bank account to replenish the petty
cash fund.

Journalizing Petty Cash – Accounting Errors

Example:

Using the previous example, let’s assume that the petty cash custodian made an error in reimbursing an
employee. A count of the money in the petty cash shows that there is actually $24 in the fund, not $25.

So cash remaining ($24) and total receipts ($75) do not equal the total imprest amount ($100).
Therefore, to bring the cash in the fund back to the imprest amount, we need to add $76 to the fund,
not $76.

The only problem is that we have receipts for $75. To deal with this we use the account called “Cash
over/short” to record the $1 difference. The entry to record the capital purchase looks like this:

Date Account Name Debits Credits

Jan. 30 Mileage Expense (total of mileage receipts) 25
Meal Expense (total of meal receipts) 35
Stamp Expense 15
Cash Over/Short 1
Cash (this amount will be added to the petty cash box) 76

Journal Entries – Petty Cash Fund

Instructions: Prepare journal entries to reflect the activity in the petty cash fund during the month of
December.

Note: For the following exercises, accounts need to be entered in the order as they occur.

1. Dec. 1 – Establish a petty cash fund of $100.

2. Dec. 30 – Reimburse employee $10 for stamps.
3. Dec. 10 – Reimburse employee $30 for mileage.
4. Dec. 17 – Reimburse employee $5 for courier cost.
5. Dec. 20 – Reimburse employee $30 for lunch for themselves and a client
6. Dec. 30 – Reimburse the petty cash fund to bring the total cash back to $100.
7. Dec. 30 – We decide to increase the petty cash fund from its current imprest amount of $100 to
$300.

GENERAL LEDGER

Date Account Titles and Explanation Debit Credit

Dec. 1 Petty Cash 100
Cash 100
 Date Account Titles and Explanation Debit Credit
Dec. 30 Stamp Expense 10
Mileage Expense 30
Courier Expense 5
Meal Expense 30
Cash 75
Petty Cash 200
Cash 200

What is a Bank Reconciliation?

A bank reconciliation is a document prepared by a company to compare its accounting records with
those of its bank. A separate document will be prepared for each of the company’s bank accounts.

A bank reconciliation helps determine if all cash receipt and disbursements have been included and
recorded in the general ledger, and if all transactions on the bank statement truly belong to the
business. If not, the company must identify and correct the error.

Remember: The preparation of a monthly bank reconciliation is a necessary form of internal control
over both cash receipts and disbursements.

A bank reconciliation is a process to:

• Ensure all transactions recorded in the cash account of the general ledger have been processed
in the bank account, and outstanding items have been identified.
• Ensure all transactions processed in the bank account have been recorded in the cash account of
the general ledger.
• Identify and correct errors.

The Impact of Differences in Timing

Very often there are timing differences between when a transaction is recorded in a company’s general
ledger and when it is processed by the bank.

Example:

Mary Smith writes a cheque today to pay a utility expense of $200. The cheques recorded in Mary’s
general ledger as follows. The entry to record the expense looks like this:

Account Name Debits Credits

Utility Expense 200
Cash 200

According to this entry, the cash in Mary’s general ledger has been reduced immediately. But, if the
utility company does not present Mary’s cheque to the bank for several days (or weeks), the bank will
not even know the cheque exists. So, Mary’s actual bank cash will not be affected until the cheque is
presented to the bank to be cashed. On a bank reconciliation, these types of cheques are known as
“outstanding cheques”.

A similar timing difference can occur when Mary Smith receives cash, it is recorded in Mary’s general
ledger as follows. The entry to record revenue looks like this:

Account Name Debits Credits

Cash 300
Revenue 300

According to Mary’s general ledger, the Cash account has been increased immediately. But, if the
money is not deposited to the bank right away, or if the bank does not recognize the deposit in the same
period as you recognize it in your general ledger, the money will not appear as a deposit on that
person’s bank statement. On a bank reconciliation these types of deposits are known as “deposits in
transit”.

Below are transactions affecting both Mary’s cash account in the general ledger and her company’s bank
account. These transactions will be used to prepare a bank reconciliation.

• On January 31, the cash account in Mary Smith’s general ledger showed a balance of $5700.
Mary’s bank statement showed an actual cash balance of $5000.
• On January 31, Mary made a night deposit of $1000 which the bank recognizes as a February
deposit.
• During January, Mary wrote several cheques to pay various expenses. All cheques processed by
the bank should be returned with the bank statement. The following two cheques were not
returned with her bank statement: Cheque 5 - $700, Cheque 3 - $800.
• During January, one of Mary’s customers paid by cheque for an invoice of $1200. The cheque
was returned from the bank marked NSF (non-sufficient funds).
• During January, Mary wrote a cheque 2 for $300. The bank cashed the cheque correctly but the
cheque amount was incorrectly recorded in Mary’s general ledger as $200.
• Mary’s January bank statement indicated that her company earned $200 in interest and
incurred $100 in bank service fees during January.

Both sides of the reconciliation show a balance of $4500. This proves that the true January balance
of the company cash account is $4500, and that the general ledger account should be adjusted by
means of a journal entry.

MARY SMITH BANK RECONCILIATION (JANUARY 31, 2013)

Balance per general ledger 5700 Balance per bank 5000

Add Add
Interest earned 200 Deposit in Transit 1000
Less Less
Error in recording cheque (100) Outstanding Cheques
Cheque returned NSF (1200) Cheque no. 5 (700)
 Balance per general ledger 5700 Balance per bank 5000
Bank service charge (100) (1400) Cheque no. 3 (800) (1500)
Revised balance per general 4500 Revised balance per general 4500

Check Your Understanding

Journalizing and Posting from the Bank Reconciliation

Read the transaction and match the statements with the correct location on the Bank Reconciliation
chart.

At the end of June 2013, the cash balance in the clinic’s general ledger was $4000. The cash balance in
the bank account was $2460.

SALLY’S VETERINARY CLINIC BANK RECONCILIATION (JUNE 30, 2013)

Balance per general ledger 4000 Balance per bank (2460)

Add Add
• Fill in the blank • Fill in the blank
• Fill in the blank
• Fill in the blank
Less Outstanding Cheques
• Fill in the blank • Fill in the blank
• Fill in the blank • Fill in the blank
Revise balance per general Revise balance per general

1. During June, Sally wrote several cheques to pay suppliers. These two cheques were not returned
with the bank statement: Cheque 45 for %500, Cheque 52 for %250.
2. On June 30, the clinic made a night deposit of $1350 which the bank recorded as a July deposit.
3. A bank deposit of $300 (related to cash sales) was not recorded in the general ledger.
4. Customer B’s cheque in payment of their account for $1500 was returned NSF (non-sufficient
funds)
5. The bank charged the clinic $200 bank service fees for the month.
6. A cheque written correctly for $1250 to pay an employee was incorrectly recorded as $1520 in
the general ledger.
7. Interest earned on the bank account for June was $10.

SALLY’S VETERINARY CLINIC BANK RECONCILIATION (JUNE 30, 2013)

Balance per general ledger 4000 Balance per bank 2460

Add Add
Interest earned 10 Deposit in Transit 1350
Error in recording cheque 270
Deposit not recorded 300 580 Less
 Less Outstanding Cheques
Cheques returned NSF (1500) Cheque no. 45 (500)
Bank service charge (20) (1520) Cheque no. 52 (250) (750)
Revise balance per general 3060 Revise balance per general 3060
Answer:

Journalizing and Posting from the Bank Reconciliation

The entries made on the general ledger side of Mary Smith’s bank reconciliation (for example, the
interest earned) represent cash related transactions that have occurred at the bank. They still need to
be included in her company’s cash account in the general ledger.

Example

The entry to record the capital purchase looks like this:

Account Name Debits Credits

Cash 200
Interest Revenue 200
Utilities Expense 100
Accounts Receivable 1200
Bank Service Charges Expense 100
Bank Service Charges Expense 1400

T chart:

Cash

Debit Credit
5700
200 1400
4500

The general ledger cash account balance now equals the account balance on the bank reconciliation.

Check Your Understanding

Use your answer from Check Your Understanding: Journalizing and Posting from the Bank Reconciliation
(Sally’s Veterinary Clinic Bank Reconciliation) to complete this exercise.

Note: For the following exercise, the order of accounts need to be entered in the same order as the
“General Journal” document. However, order does not matter when preparing a general journal.

Answer:

GENERAL JOURNAL
 Date Account Titles and Explanations Ref. Debits Credits
Cash 580
Interest Revenue 10
Salary Expense 270
Sales Revenue 300
Accounts Receivable 1500
Bank Service Charge Expense 200
Cash 1520

Now post the general journal entries to Sally’s general ledger Cash account.

Cash

Debit Credit
4000 1520
580
3060

Post-Test
Answer the following multiple choice.

1. It is acceptable business practice to pay an invoice by issuing a cheque payable to cash.

a) True
b) False
2. Cash receipts should be deposited daily.
a) True
b) False
3. Requiring two signatures on all cheques over a specified amount is a good internal control.
a) True
b) False
4. All employee reimbursements should be made through the petty cash fund to speed up the
reimbursement process.
a) True
b) False
5. The combination of ash and receipts within an imprest petty cash fund should always total the
specified amount of the fund.
a) True
b) False
6. The petty cash fund should never be more than $500.00.
a) True
b) False
7. The preparation of a bank reconciliation is an example of an internal control over cash.
a) True
b) False
 8. When preparing a bank reconciliation you must account for all cheques cleared by the bank
through your account.
a) True
b) False
9. Generally, a bank reconciliation will result in adjusting entries to the company’s accounting
records.
a) True
b) False
10. Each adjusting entry as a result of a bank reconciliation will either debit or credit the
company’s cash account.
a) True
b) False

Answers:

1. B - False
2. A - True
3. A - True
4. B - False
5. A - True
6. B - False
7. A - True
8. A - True
9. A - True
10. A - True

Case Study
Instructions: Prepare a statement of charges in owner’s equity for a merchandising operation.

• Use the table “ABC Company, Adjusted Trail Balance” for reference.
• Enter the account balance in the correct location on the statement of changes in Owner’s
Equity.

Note: You must complete each entry correctly before you will be able to proceed.

ABC COMPANY
ADJUSTED TRIAL BALANCE
DECEMBER 31, 2013
Debit Credit
Cash 2000
Accounts Receivable 2500
Prepaid Rent 500
Prepaid Insurance 2400
Office Supplies 300
Warehouse Supplies 1200
Inventory 4200
 Debit Credit
Land 100000
Building 150000
Accumulated Amortization - Building 2500
Equipment 75000
Accumulated Amortization - Equipment 1500
Accounts Payable 3000
Salary Payable 9500
Mortgage Payable 100000
Bank Loan Payable 15000
Unearned Revenue 3000
Owner Equity 193700
Owner Withdrawal 10000
Sales Revenue 250000
Sales Returns & Allowances 2200
Sales Discounts 1800
Purchases 150000
Purchase Returns & Allowances 3500
Purchase Discounts 1000
Freight In 4000
Rent Expense 12000
Salary Expense 50000
Utility Expense 5000
Insurance Expense 2400
Office Supply Expense 500
Warehouse Supply Expense 1000
Amortization Expense – Building 1200
Amortization Expense – Equipment 2400
Total 618700 618700

Note: * Ending Inventory Amount 31500

Fill this table out:

Company ABC
Statement of Changes in Owner Equity
For the Year Ended December 31, 2013
Opening Balance Fill in the blank
Investments Fill in the blank
Net Income Fill in the blank Fill in the blank
Owner Withdrawal Fill in the blank
Loss Fill in the blank Fill in the blank
Closing Balance Fill in the blank
Answer to Case Study:
Company ABC
Statement of Changes in Owner Equity
For the Year Ended December 31, 2013
Opening Balance 193700
Investments 0
Net Income 11500 11500
Owner Withdrawal (10000)
Loss 0 (10000)
Closing Balance 195200

You have completed Internal Cash Controls and Cash

Remember to check the timeline before you proceed to the next module to ensure you have completed
any assignments as required. Check with your instructor if you have any questions.