Chapter 5

Cash,
Internal Controls,
and Ethics
Chapter Outline
• Applications to people within and
outside the firm
• Cash and cash equivalents
• Internal control over cash
• Components of internal control
structure
• Auditing the financial statements
• Making ethical decisions
• Accounting careers
• Appendix: E-business and E-risk
APPLICATIONS TO PEOPLE
WITHIN & OUTSIDE THE FIRM

• Internal users: An internal control

structure helps safeguard the assets
of a business and helps ensure the
reliability of accounting records.
• External users: A solid system of
internal controls provides greater
trust by external users that a
company’s reports can be relied
upon.
CASH AND CASH
EQUIVALENTS
• Cash includes coins & currency on
hand, deposits in bank accounts, and
checks and money orders.
• Cash is so vital to business
operations, one of the four financial
statements — the statement of
cash flows —focuses solely on cash.
• A cash equivalent is a short-term,
highly liquid investment that will
convert to cash in less than 90 days.
– Liquidity refers to how readily an asset
can be converted to cash.
INTERNAL CONTROL
OVER CASH
• Inadequate internal controls
can foster an environment in
which employees are tempted
to engage in questionable
activities.
• Types of internal controls:
1. Preventive
2. Feedback.
 Preventive controls

• Prevent errors and irregularities

(intentional misrepresentations)
• Preventive controls include:
– Separation of duties.
– Hiring competent & ethical employees.
– Written policies and procedures.
– Physical security of firm assets.
– Appropriate management supervision.
– Adequate documents and records.
Feedback controls

• identify errors and irregularities

after they occur so that
corrective action may be taken.

• Feedback controls include:

– Cash budget
– Bank checking account
– Bank reconciliation
Cash budget

• The cash budget is used to project

financing needs and to provide
internal controls over cash inflows
and outflows.
• In the budget, a firm lists the
amount of cash it wants to have
on hand at the end of the period;
this is called the budgeted cash
balance.
 Argonaut Shipping Company
Cash Budget
Exhibit 5.1 For Year Ended December 31, 20Y1
(Millions $)
Cash balance, Jan. 1, 20Y1 $ 162
Estimated cash receipts:
Collections from customers $12,748
Sale of assets 160 12,908
13,070
Estimated cash disbursements
Payments of operating expenses 8,760
Purchase of equipment 3,700
Payment of debt 330
Dividends 240 13,030
Cash available before financing 40
Budgeted cash balance, December 31, 20Y1 125
New financing needed $ 85
Bank checking account

• A checking account is an internal

control.
• For control purposes, all cash
receipts should be deposited in the
bank.
• Under a lockbox system, customers
send cash payments to an address
that is effectively a bank account.
• A remittance advice specifies the
purpose of a check
Bank reconciliation

• This internal control shows whether

cash transactions have been
recorded properly on the bank
statement and on the firm’s
accounting records (books).
• The firm’s record of cash
transactions must be reconciled to
the bank statement.
 JK Productions’ Bank Reconciliation Exhibit 5.3
Bank: Balance, September 30 14,620
Add: Deposits in transit 9,455
Less: Outstanding checks No. 57326 (784)
No. 57329 (1,222) (2,006)
Adjusted cash balance 22,069

Books: Balance, September 30 22,246

Add: Correction of book error 10
Check No. 57327, for $558,
erroneously recorded for $568,
for purchase of supplies
Less:
NSF check from customer (144)
Cost of checks (28)
Bank service charge (15) (177)
Adjusted cash balance 22,069
Adjusting journal entries to
correct the Book balance

• To correct error in recording check.

Cash 10
Supplies 10
• To record NSF check from customer.
Accounts Receivable 144
Cash 144
• To record purchase of checks.
Checks Expense 28
Cash 28
• To record bank service charge.
Bank Service Charge Exp. 15
Cash 15
Petty cash fund

• The petty cash fund is a small

amount of cash kept on hand by
a firm in order to pay for minor
expenditures.
• For control purposes, a check
written to cash should be used
to replenish the fund.
Cash disbursements
process

• Paying with checks provides better

control over cash.
• A voucher is a control document
that authorizes preparation of a
check.
• When the treasurer receives the
voucher package, the documents
are reviewed for consistency.
 Document: Prepared by: Sent to:

Purchase Marketing, Production, Purchasing department

Requisition or other department and copy to Accounting

Document Purchase
Order
Purchasing department Vendor (supplier)
and copy to Accounting

flow
leading to Bill from Vendor Vendor Accounting department

check (Invoice)

preparation
Receiving Receiving department Accounting department

Exhibit 5.4 Report

Accounting department Treasurer

Voucher (Voucher is attached to
the first 4 documents
received to make the
voucher package.)

Treasurer Vendor
Check
COMPONENTS OF INTERNAL
CONTROL SYSTEM
• 2 goals of internal control structure:
– safeguard assets
– ensure reliability of accounting
records
• Components of internal control:
1. The control environment
2. Risk assessment
3. Information and communication
4. Control activities
5. Monitoring
1. The control environment

• Sets parameters for recording business

transactions.
• Includes:
– Management’s integrity and ethics.
– The philosophy and operating style of
management.
– The organizational structure.
– An audit committee.
– Methods of assigning authority and
responsibility.
– Personnel policies and procedures.
2. Risk assessment

• Defines areas where risk is

great in regard to loss of assets
or errors occurring in the
accounting records.
– Appropriate internal controls can
be established in those areas.
3. Information and
communication
• Concerns information and
communication within the firm’s
accounting system.
• A firm's accounting system is
comprised of the methods used
to record, classify, summarize,
and report the entity's
transactions.
4. Control activities

The policies and procedures

established by management to
ensure that company plans and
directives are implemented.
Example control structure of a
movie theater (Exhibit 5.5)

1. Policy: Using pre-numbered tickets

for patron admittance.
 Benefits: Enables an independent count
of patrons. Determines the total cash
that should be collected.

2. Segregation of duties between

employee selling tickets and
employee authorizing admission.
 Prevents one individual from receiving
cash and authorizing admission.
Example control structure of a
movie theater (cont.)

3. Use of different tickets for different

admission prices.
 Reconciliation of persons admitted
(ticket stubs) with cash collected.
4. Employee authorizing admission
retains a portion of each ticket.
 Enables an independent count of the
number of patrons.
5. Cash register has "locked-in" totals.
 Enables reconciliation of items sold by
the cashier to cash collected.
Example control structure of a
movie theater (cont.)

6. Before each cashier leaves, the cash

on hand is reconciled to cash register
tape totals or ticket stubs.
 Enables cash overages and shortages to
be identified with a particular cashier.

7. Cash receipts are deposited intact on

a daily basis.
 Minimizes the chances of embezzlement,
robbery, etc. Improves cash
management.
5. Monitoring

• The evaluation of the quality of

internal control on a regular
basis.
• Includes periodic review of
company compliance with
policies and procedures.
AUDITING THE
FINANCIAL STATEMENTS
• An audit is an examination of
financial statements by an
independent, professional
accountant to verify that the
statements are presented fairly
and prepared according to GAAP.
• Two major categories of auditing:
1. External auditing
2. Internal auditing
External auditing

• The term "external" means that

the auditors do not work for the
company being audited.
• External auditors are Certified
Public Accountants (CPA) who
are licensed by the state.
• External audits are required of
publicly traded companies.
Internal auditing

• Internal audits can be performed

by the company’s accountants.
• Its purpose is to determine
whether the firm's goals and
objectives are being achieved.
• An internal audit is referred to as
a management audit or
operational audit.
Accounting Careers

Basic fields of work for accountants:

• Public accounting firms
• Private industry
• Government agencies, e.g. FBI
• Nonprofit organizations, e.g.
Salvation Army.
Public accounting

Public accounting firms offer:

Auditing and other assurance
services
Tax planning and compliance
services
Management consulting services
Private industry

• Accountants perform a variety of

tasks, such as analyzing costs for new
technologies, developing strategies
for mergers and acquisitions,
developing tax strategies, and helping
manage health care.
• From rock bands to Microsoft to Walt
Disney, all businesses require the
skills of an accountant.
Government agencies and
nonprofit organizations
• Federal agencies needing
accountants include the Internal
Revenue Service (IRS), the
Comptroller General's Office, the
CIA, and the FBI.
• An increase in accounting jobs is
expected due to the increasing
complexity of corporate
transactions and the growth in
the government sector.
MAKING ETHICAL
DECISIONS

A company can provide its

employees with a variety of
practical approaches for making
ethical decisions.
Rules, policies, and
guidelines
• Legal rules are a starting point
for making an ethical choice.
• The policies of your company or
professional organization may
apply to an ethical question.
• Ethical decisions can be based
on informal guidelines such as
morals.
The Golden Rule

Mr. J.C. Penney followed this

guiding principle in operating his
company:

“Do unto others as you would

have them do unto you.”
Corporate ethics codes

• Many firms have a corporate

ethics code.
• People need absolute standards
on which to base ethical
decisions regarding:
– information security
– personal privacy
– use of company resources
– care for the environment
– professional behavior
 Personal integrity

• Personal integrity can be defined

as knowing what’s right and
having the courage to do it.

• Society expects companies and

professionals to operate with
integrity and according to ethical
standards.
Personal integrity (cont.)

CEO of PricewaterhouseCoopers,
Sam DiPiazza, said:
“It has become dramatically clear
that the foundation of corporate
integrity is personal integrity.
News reports have repeatedly
shown us that individual failures
of integrity can be the source of
vast corporate deceptions.”
How do you measure
success?
A quality life is measured by personal
integrity, not by fame and fortune.
In his testimony at the congressional
hearing on accounting and business
ethics, Truett Cathy, founder of
Chik-Fil-A, quoted Solomon: “A good
name is more desirable than great
riches; to be esteemed is better
than silver or gold.”
APPENDIX

E-Business and E-Risk

E-business

• E-business is exchanging goods

or services using an electronic
infrastructure.
– Business-to-business (B2B) transactions
– Business-to-consumer (B2C) transactions

• The Internet and e-business activities

make the “e-conomy” a global, digital,
high velocity market economy.
E-risk
• E-risk is the potential for
financial and technological
problems resulting from doing e-
business.
• People must take precautions
against computer crime,
malicious hackers, and
computer viruses.