CHAPTER FIVE

CASH AND RECIEVABLES

6.1 INTRODUCTION
Since cash is the asset most likely to be used improperly by employees, exposed for embezzlement and many
business transactions either directly or indirectly affect it, it is therefore necessary to have effective control of
cash.

6.2 MEANING OF CASH

Cash includes money on deposit in banks and other items that a bank will accept for immediate deposit. Money
on deposit in banks includes checking and saving accounts. Other items such as ordinary checks received from
customers, money orders, coins and currency and petty cash also are included as cash. Banks do not accept
postage stamps, travel advances to employees, notes receivable or post-dated checks as cash.

6.3 CHARACTERISTICS OF CASH

The following are some of the characteristics of cash:
a) Cash is used as medium of exchange
b) Cash is the most liquid asset
c) Cash is mostly affected by business
transactions
d) Cash is used to measure the value of other
assets
e) Cash is mostly exposed to embezzlement

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6.4 MANAGEMENT OF CASH
Cash management refers to planning, controlling and accounting for cash transactions and cash
balances. Efficient management of cash is essential to the survival and success of every business
organization. Managing cash requires planning wisely so that there will not be excess cash held
on hand at any point in time; or there is no shortage of cash at any point in time to meet the
business’s needs.

6.5 INTERNAL CONTROL OF CASH

The need to safeguard cash is crucial in most businesses because cash is mostly exposed to
embezzlement. Firms address this problem through the internal control system. An internal
control system is a set of policies and procedures designed to protect assets, provide accurate
accounting records and evaluate performances.
A sound internal control system for cash increases the likely hood that the reported values for
cash are accurate.
Internal control for cash should include the following procedures:
a) The individuals who receive cash should not also disburse (pay) cash
b) The individuals who handle cash should not access accounting records
c) Cash receipts are immediately recorded and deposited and are not used directly to make
payments.
d) Disbursements are made by serially numbered checks, only upon proper authorization by
someone other than the person writing the check
e) Bank accounts are reconciled monthly.
The following are the most common elements of cash control and managements: bank account
system, petty cash fund, voucher system, change fund, and cash short and over.

6.5.1 Control of Cash through Bank Accounts

Bank accounts are one of the most important means of controlling cash that provide several
advantages such as:
- Cash is physically protected by the bank,
- A separate record of cash is maintained by the bank,
- And customers may remit payments directly to the bank.

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If a company uses a bank account, monthly statements are received from the bank showing
beginning and ending balances and transactions occurring during the month including checks
paid, deposits received, and service charges. These monthly statements (reports) received from
the bank are called bank statements. Bank statements generally are accompanied by checks paid
and charged to the accounts during the month, debit and credited memos, which inform the
company about changes in the cash accounts. For a bank, the depositor’s cash balance is a
liability, the amount the bank owes to the firm. Therefore, a debit memo describes the amount
and nature of decrease in the company’s cash accounts. A credits memo indicates an increase in
the cash balance of the depositor that it has with the bank.

6.5.1.1 Reconciliation of Bank and Book Cash Balances

Monthly reconciling of the bank balance with the depositor’s cash accounts balance is essential
cash control procedure. To reconcile a bank statement means to verify that the bank balance and
the accounting records of the depositor are consistent. The balance shown in a monthly bank
statement seldom equals the balance appearing in the depositor’s accounting records. Certain
transactions recorded by the depositor may not have been recorded by the bank and vice versa.
The most common examples that cause disparity between the two balances are:
a) Outstanding checks:
Checks issued and recorded by the company, but not yet presented to the bank for
payment.
b) Deposits in transit:
Cash receipts recorded by the depositor, but not reached the bank to be included in the
bank statement for the current month.
c) Service charges:
Banks often charge a fee for handling checking accounts. The amount of this charge is
deducted by the bank form bank balance and debit memo is issued for the depositor.
d) Charges for depositing NSF- checks: NSF stands for “Not Sufficient Funds.” When
checks are deposited in an account, the bank generally gives the depositor immediate
credit. On occasion, one of these checks may prove to be uncollectible because the maker
of the check does not have sufficient funds in his or her account. In such a case, the bank

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 will reduce the depositor’s account by the amount of this uncollectible item and return the
check to the depositor marked “NSF”.
e) Notes collected by bank:
If the bank collects a note receivable on behalf of the depositor, it credits the depositor’s
account and issues a credit memorandum for the depositor.
When the depositor prepares bank reconciliation, the balances shown in the bank statement and
in the accounting records both are adjusted for any unrecorded transactions. Additional
adjustments may be required to correct any errors discovered in the bank statements or in the
accounting records.

6.5.1.2 Steps in Preparing Bank Reconciliation

Bank reconciliation is a schedule prepared by the depositor to bring the balance shown in the
bank statement and the balance shown in the depositor’s accounting into agreement.
The steps to prepare bank reconciliation are:
a) The deposits listed on the bank statement are compared with the deposits shown in the
accounting records. Any deposits not yet recorded by the bank are deposits in transit and
should be added to the balance shown in the bank statements.
b) The paid and received checks from the bank are compared with the check stubs. Any
checks issued but not yet paid by the bank are outstanding checks and should be deducted
from the balance reported in the bank statements.
c) Any credit memorandums issued by the bank that have not been recorded by the
depositor, are added to the balance per depositor’s record.
d) Any debit memorandums issued by the bank that have not been recorded by the depositor
are deducted from the balance per depositor’s record.
e) Any errors in the bank statement or depositor’s accounting records are adjusted.
f) The equality of adjusted balance of bank statement and adjusted balance of the
depositor’s record is compared.
g) Journal entries are prepared to record any items delayed by the depositor.

6.5.1.3 Illustration of Bank Reconciliation

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The January bank statement sent by Awash Bank to RAM Company shows Br.5,000.17. Assume
also that on January 31, 2000, the Cash account of RAM Co. shows a balance of Br. 4,262.83.
The accountant of RAM Company has identified the following items:
1. A deposit of Br. 410.90 made after banking hours on Jan. 31 does not appear on the bank
statement.
2. Two checks issued in January have not yet been paid by the bank:
Check No. 301 Br. 110.25
Check No. 342 607.50
3. A credit memorandum was included in the bank statement, which was for proceeds from
collection of a non-interest bearing note receivable from MAN Company Br. 524.74.
4. Three debit memorandums accompanied the bank statement: Fee charged by bank for
handling collection of notes receivable Br.5; a check of Br. 50.25 received from a
customer, RON company, and deposited by RAM company was charged back as NSF;
and service charge by bank for the month of January amounts to Br. 12.00.
5. Check No. 305 was issued by RAM Company for payment of telephone expense in the
amount of Br. 85 but was erroneously recorded in the cash payments journal as Br. 58.

RAM Company
Bank Reconciliation
January 31, 2000
Balance per bank statement, Jan. 31,2000 Br. 5,000.17
Add: Deposit of Jan. 31 not recorded by bank 410.90
Subtotal Br. 5,411.07
Deduct: outstanding checks:
No. 301 Br. 110.25
No. 342 607.50 117.75
Adjusted cash balance Br. 4,693.32
Balance per depositor’s record, Jan. 31, 2000 Br. 4,262.83
Add: Note Receivable collected by bank 524.74

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 Subtotal Br. 4,787.57
Deduct: collection fee Br. 5.00
NSF check of Ron Co. 50.25
Service charge 12.00
Error on check stub No. 305 27.00 94.25
Adjusted cash balance Br. 4,693.32
The following are journal entries related to the bank reconciliation.
Jan. 31, 2000
Cash in bank 524.74
Notes Receivable 524.74
(To record collection of Note Receivable
Collected by bank)
Jan. 31, 2000
Miscellaneous Expense 17.00
Accounts Receivable-RON Co. 50.25
Utilities Exp. 27.00
Cash in bank 94.25
(To record bank service charges,
NSF check and error in recording Check No. 305)

6.5.2 Petty Cash Fund

Petty cash fund, which is part of the total cash balance, is used to handle many types of small
payments such as employee transportation costs, purchase of office supplies, purchase of postage
stamps, and delivery charges. Many businesses find it convenient to make minor expenditures
instead of writing checks. The petty cash amount various from Br. 50 or less to more than Br.
1,000, which will cover small expenditures for a period of two or three weeks.

6.5.2.1 Establishment of Petty Cash

To establish a petty cash fund a check is issued to a bank. This check is cashed and the money is
kept on hand in a petty cash box. One employee is designated as custodian of the fund. The

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issuance of the check for establishment is recoded by debiting petty cash account and crediting
cash.
1. Assume that a Br. 3000 petty cash fund is established at a specific location. The cash is
placed in a secured location (usually a strong box or safe under custodial control). The
journal entry is as follows:
Petty cash …………………………. 3000.00
Cash ……………………….. ………….. 3000.00

6.5.2.2 Replenishment of Petty Cash

During the period, the custodian makes small payments from the petty cash fund and obtains a
receipt or prepares a petty cash voucher. This petty cash voucher explains the nature and amount
of every expenditure and is kept with the fund. When the fund runs low or at the end of the
company’s fiscal period, a check is issued to reimburse the fund for the expenditures made
during the period. The issuance of this check is recorded by debiting the appropriate expense
accounts and crediting cash or vouchers payable.

1. At the end of the first month, Br. 560 remains in the fund, indicating that Br 2,440 was
disbursed during the month (Br. 3000 - Br. 560) and that the custodian should have Br.
2,440 in supporting payout vouchers. The following individual vouchers accompany the
fund: postage, Br. 900, office supplies, Br. 700, and taxi fares, Br. 800 (Br. 2400 in total).
There is a Br. 40 cash shortage (Br. 2,440 - Br. 2,400). Presumably, a voucher was lost,
or a voucher understates the amount disbursed. The shortage is reflected in a
replenishment entry:

Postage expense ……………………………….. 900.00

Office supplies expense ……………………….. 700.00
Transportation expense ……………………….. 800.00
Cash Short and Over ……………………………. 40.00

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 Cash …………………………….        2,440.00

This entry is recorded by the accounting department, not the custodian. Replenishment of
the petty cash fund occurs whenever the fund runs low and at the end of each fiscal
period for proper reporting of expenses and cash balance.

6.5.3 Voucher System

One method to control cash disbursements is a voucher system. A voucher is a special form,
which contains relevant data about a liability and its payment.
In a voucher system, a voucher is prepared for each expenditure and approved by the designated
officials. Each approved voucher represents liability and recorded in a voucher register, which is
similar to purchases journal. Those registered vouchers are filed according to their payment date
in an unpaid vouchers file. The vouchers and supporting documents then are sent to the treasure
or other official is the finance department before issuing checks. When the checks are signed, the
paid vouchers are recorded in a check register which is similar to cash payments journal. Those
paid vouchers are filed in paid vouchers file according to their serial number for future reference.

6.5.4 Change Fund

Some businesses that receive cash directly from customers should maintain a fund of currency
and coins in order to make change (Amharic=>”zirzir”). This fund, which is part of the total cash
balance, is called change fund. A change fund is established by issuing a check to the bank and
transferring the cash to the custodian. The issuance of a check to establish a change fund is
recorded by debiting cash on hand and crediting cash or voucher payable.
Once a change fund is established, there will be no change in its balance unless there is a
decision by management to increase or decrease the fund balance.

6.5.5 Cash Short and Over

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In handling cash receipts from daily sales, a few errors in making changes will occur. These
errors may cause a cash shortage or overage at the end of the day. The account cash short and
over is debited if there is shortage and credited if there is overage. At the end of the period if the
account had a debit balance, it appears in the Income statement as miscellaneous expense; if it
has a credit balance, it is shown as miscellaneous revenue.
For example, assume that the total cash sales recorded during the day amounts to Br. 12,420.
However, the cash receipts in the cash register drawer (actual cash count) total Br. 12,415.
The following entry would be made to adjust the accounting records for the shortage in the cash
receipts:
Cash Short and Over 5.00
Cash 5.00
To record a Br. 5.00 (Br. 12,420 – 12,415)
Shortage in cash receipts for the day