# Equity The remainder is the shareholders claim on the assets-equity. It is often referred to as residual equity.

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1 ACT 1600 Fundamental of Financial Accounting Chapter 1 The Basic Accounting Equation Asset = Liabilities + Equity Asset Assets are resources a business owns. The common characteristic possessed by all assets is the capacity to provide future services or benefits. For example, a local restaurant, buildings, equipment and etc. Liabilities Liabilities are existing debt and obligations. Business of all sizes usually borrows money and purchase merchandise on credit. For example, note payable, accounts payable, salaries and wages payable and etc. Equity The remainder is the shareholders claim on the assets-equity. It is often referred to as residual equity. Share capital ordinary Share capital-ordinary is the term used to describe the amounts paid in by shareholders for the ordinary shares they purchased. Retained earnings Retained earnings is determined by three items : revenues, expenses, and dividends. Revenues Revenues are the gross increase in equity resulting from business activities entered into for the purpose of earning income. Expenses Expenses are the cost of assets consumed or services used in the process of earning revenue. Dividends Net income represents an increase in net assets which is then available to distribute to shareholders. The distribution of cash or other assets to shareholders is called a dividends. Transactions Transactions are a business s economic events recorded by accountants. Transactions may be external or internal. Transaction analysis We use the basic accounting equation to study transaction analysis. There are 10 differences transaction 1.Investment by shareholders The asset cash increases \$15,000,and equity identified as Share Capital-ordinary increase \$15,000 2.Purchase of equipment for cash Cash decreases \$ 7,000,and the asset Equipment increases \$7,000

2 3.Purchase of supplies on credit The asset Supplies increases \$ 1,600, and the liability Accounts Payable increases by \$1,600 4.Services provide for cash Cash increases \$1,200, and revenues increases \$1,200 5.Purchase of advertising on credit Accounts Payable increases \$ 250,and equity decreases \$250 due to advertising expense 6.Services provided for cash and credit Three specific items are affected: Cash increases \$ 1,500, Accounts Receivable increases \$2,000, and service revenue increases \$3,500 7.Payment of expenses Cash decreases \$ 1,700,and the specific expense categories decrease equity by the same amount. 8.Payment of Accounts payable This cash payment on account decrease the asset cash by \$250 and also decreases the liability accounts payable by \$ Receipt of cash on account Cash increases \$ 600,and Accounts receivable decreases \$ Dividends Cash decreases \$ 1,300,and equity decreases \$1,300 due to dividends There are four financial statements from summarized accounting data 1. An income statement - the revenues and expenses and resulting net income or net loss 2. A retained earnings - summarizes the change in retained earnings 3. A statement of financial position - reports assets, liabilities, and equity 4. A statement of cash flows - summarizes information about the cash flows This is the example of the financial statements Legal Services Company was incorporated on July 1, During the first month of operations, the following transaction occurred 1. Shareholders invested \$10,000,000 in cash in exchange for ordinary shares of Legal Services Company 2. Paid \$ 800,000 for July rent on office space. 3. Purchased office equipment on account \$3,000, Provided legal services to clients for cash \$ 1,500, Borrowed \$ 700,000 cash from a bank on a note payable 6. Performed legal services for client on account \$ 2,000, Paid monthly expenses: salaries \$500,000, utilities \$ 300,000, and advertising \$ 100,000 Prepare the income statement, retained earnings statement, and statement of financial position at July 31 for Legal Services Company. Legal Services Company Income Statement For the Month Ended July 31,2014

3 Revenues Service revenue \$3,500,000 Expense Rent expense (\$800,000) Salaries and wages expense (\$500,000) Utilities expense (\$300,000) Advertising expense (\$100,000) Total expense \$1,700,000 Net income \$1,800,000 Legal Services Company Retained Earnings Statement For the Month Ended July 31,2014 Retained earnings, July 1 \$0 Net income \$1,800,000 Retained earnings, July 31 \$1,800,000 Legal Services Company Statement of Financial Position July 31,2014 Assets Equipment \$3,000,000 Accounts receivable \$2,000,000 Cash \$10,500,000 Total assets \$15,500,000 Equity and Liabilities Equity

4 Share capital - ordinary \$10,000,000 Retained earnings \$1,800,000 \$11,800,000 Liabilities Notes payable \$70,000 Accounts payable \$3,000,000 \$3,700,000 Total equity and liabilities \$15,500,000 From the equation Assets = Liabilities + Equity So it means that you do it correctly Chapter 2 The Recording Process An account in an individual accounting record of increases and decreases in a specific asset, liability, or equity item. Debits and Credits Debit(Dr) indicates left side of an account, and credit (Cr) indicates right side. We use the terms debit and credit repeatedly in the recording process to describe where entries are made in accounts. Debits and Credits Procedure From Chapter 1, we know that both sides of the basic equation (Assets = Liabilities + Equity ) must be equal. It therefore follows that increases and decreases in liabilities will have to be recorded opposite from that increases and decreases in assets. Thus, increases in liabilities must be entered on the right or credit side, and decreases in liabilities must be entered on the left or debit side. Debits Increases assets Decreases liabilities Credits Decreases assets Increases liabilities Equity

5 Share Capital Ordinary Companies issues share capital ordinary in exchange for owners investment paid in to the company. Credits increase the Share Capital Ordinary account, and debit decrease it. Debits Decreases Share Capital Ordinary Credits Increases Share Capital Ordinary Revenues and expenses Credits increase revenue accounts and debits decrease them. Expenses are the reverse of the revenues so, debit increase expenses accounts, and credits decrease them. Debits Credits Increases expenses Decreases revenues Decreases expenses Increases revenues The Journal The journal is referred to as the book of original entry in order to record transactions.companies use various kinds of journals; a basic form of journal is a general jounal. This is the example of General Journal General Journal J1 Date Accounts Titles and Explanation Ref. Debit Credit Sept,1 Cash 101 8,000 Share Capital - Ordinary 490 8,000 (Issues shares for cash) Sept,2 Equipment 295 7,000 Cash 101 7,000 (Purchased equipment for cash) The Ledger The entire group of accounts maintained by a company is the Ledger.Companies use various kinds of journals; a basic form of ledger that every company use is a general ledger. This is the example of General Ledger 101 Cash

6 Date Accounts Titles and Explanation Ref. Debit Credit Sept,1 8, , , , , ,000 16,000 The Trial Balance A trial balance is a list of accounts and their balances at a given time. The trial balance proves the mathematical equity of debits and credits after posting. The step for preparing trial balances 1. List the accounts titles and their balances 2. Total the debit and credit columns 3. Prove the equality of the two columns. This is the example of the trial balance Pioneer Advertising Company Trial Balance August 31,2014 Debit Credit Cash 15,200 Supplies 2,500 Prepaid Insurance 600 Equipment 5,000 Notes Payable 5,000 Accounts Payable 2,500 Unearned Service Revenue 1,200 Share Capital - Ordinary 10,000 Dividends 500 Service Revenue 10,000

7 Salaries and Wages Expense 4,000 Rent Expense ,700 28,700 Transactions A group of student investors in Hong Kong opened Campus Laundromat Inc. on September 1, During the first month of operations, the following transactions occurred Sept. 1 Shareholders invested HK\$200,000 cash in the business in exchange for Ordinary shares 2 Paid HK \$10,000 cash for store rent for the month of September. 3 Purchased washers and dryers for HK\$ 250,000, paying HK \$100,000 in cash And singing a HK\$150,000, 6-month, 12% note payable 4 Paid HK \$12,000 for a one-year accident insurance policy. 10 Received a bill from the Daily News for advertising the opening of the Laundromat HK \$2, Declared and paid a cash dividend to shareholders HK\$7, Determined that cash receipts for laundry fees for the month were HK\$ 62,000 Instructions (a) Journalize the September transactions (J1 for the journal page number) (b) Open ledger accounts and post the September transactions (c) Prepare a trial balance at September 30,2014 General Journal General Journal J1 Date Accounts Titles and Explanation Ref. Debit Credit Sept,1 Cash ,000 Share Capital - Ordinary ,000 (Shareholders investment of cash in business) Sept,2 Rent expense ,000 Cash ,000 (Paid September rent) Sept,3 Equipment ,000 Cash ,000 Notes payable ,000

8 (Purchased equipment for cash and 6-month,12% note payable ) Sept,4 Prepaid Insurance ,000 Cash ,000 (Paid one year insurance policy) Sept,10 Advertising expense 610 2,000 Accounts payable 201 2,000 (Received bill from Daily News for advertising) Sept,20 Dividends 332 7,000 Cash 101 7,000 (Declared and paid a cash dividend) Sept,10 Cash ,000 Service revenue ,000 (Received cash for services provided) General Ledger 101 Cash Date Accounts Titles and Explanation Ref. Debit Credit Sept,1 J1 200,000 2 J1 10,000 3 J1 100,000 4 J1 12, J1 7, J1 62, ,000

9 130 Prepaid Insurance Date Accounts Titles and Explanation Ref. Debit Credit Sept,4 J1 12,000 12,000 Equipment 157 Date Accounts Titles and Explanation Ref. Debit Credit Sept,3 J1 250, , Notes Payable Date Accounts Titles and Explanation Ref. Debit Credit Sept,3 J1 150, , Accounts Payable Date Accounts Titles and Explanation Ref. Debit Credit Sept,10 J1 2,000 2,000 Share Capital - Ordinary 311 Date Accounts Titles and Explanation Ref. Debit Credit Sept,10 J1 200, , Dividends

10 Date Accounts Titles and Explanation Ref. Debit Credit Sept,20 J1 7,000 7, Service Revenue Date Accounts Titles and Explanation Ref. Debit Credit Sept,30 J1 62,000 62, Advertising Expense Date Accounts Titles and Explanation Ref. Debit Credit Sept,10 J1 2,000 2, Rent Expense Date Accounts Titles and Explanation Ref. Debit Credit Sept,2 J1 10,000 10,000 A trial balance Campus Laundromat Inc. Trial Balance September 30,2014 Debit Credit Cash 133,000 Prepaid Insurance 12,000

11 Equipment 250,000 Notes Payable 150,000 Accounts Payable 2,000 Share Capital - Ordinary 200,000 Dividends 7,000 Service Revenue 62,000 Advertising Expense 2,000 Rent Expense 10, , ,000 Chapter 3 Adjusting the accounts Table of contents 1. Adjusting entries Prepaid expense Unearned revenue Accrued revenue Accrued expense 2. Correction entries 3. Depreciation Adjusting entries Straight line method Unit of activity method Double declining balance method The meaning is that the improvement of balance to be a correct one, ending of balance for each periods are correct for sure. Accounting period divided into 4 type 1. Monthly (1 month period) 2. Quarterly (3 months period) 3. Semiannually (6 months period) 4. Annually (12 months period)

12 For adjusting entries 1. Prepaid expense The money that we pay for a future likes a rent sush as in groups as a office supplies,prepaid insurance,prepaid advertising Example: The office supplies showed a debit balance of \$1300 on Jan 1, On dec 31 a physical count of supplies showed the balance valued as \$400. Account title Dr Cr Supplies expense 900 Office supplies Unearned revenue The money that you earn from customer before taking a goods. Example: \$7000 received in advance from customer for rendering service. This was initially credited to unearned revenue. As of Mar 31, % was not earned. Account title Dr. Cr. Unearned revenue 2,800 Service revenue 2, Accrued revenue the occur that already happened but don t earn a money yet,but it will receiving in a future Example: Invoices representing \$5000 of service performed during the month have not been record as of Jun 30. Account title Dr. Cr. Accounts receivable 5,000 Service revenue 5, Accured expense The cost of happening but not paid yet Example: FF company hired a worker \$255 for a 5 evening week, payable each Friday,Jan 1,fell on Thursday what will be on Dec 31 Account title Dr. Cr. Salaries expense (255/5*4) 180

13 Salaries payble 180 Correction entries Step to solve 1. Write a correct Journal entires 2. Write a wrong one in a question 3. Improving a accounts by replacement a values with correct one Method of depreciation 1. Straight line Note that; how to counts a month: buying in 1-15 of months count that Depreciation / year = Cost salvage value/useful life Buying in of months not count that month Ex. An equipment was purchased on March 16,1999 at cost of \$2,000,000, useful life is 5 years and salvage value is \$200,000.Straight line of depreciation was used.record on December 31,2000 (1 year) Use formula = 2,000, ,000 / 5 = 360,000 Account title Dr. Cr. Depreciation expense 360,000 Accumulated equipment 360,000 2.Unit of activity Depreciation = Cost salvage value / Total units of activity x unit of act during a year Ex. An automobile cost \$15,400, estimated value \$1,400 useful life 200,000 miles, Accmulated at Jan 1,1999,during the year is 20,000 miles Use formula = 15,400 1,400 / 200,000 x 20,000 = 1400 Account title Dr. Cr. Depreciation automobile 1,400 Accumulated automobile 1,400 3.Double declining balance Depreciation / year = (Cost accumulated depreciation) x 2 / useful life

14 Ex. An equipment was purchased on September 17,2000 at a cost a of \$500,000 and an estimated useful of 5 years. The scrap value was estimated to be \$60,000. Compute depreciation expense of the equipment for the year Use formula = (500,000 60,000) x 2/5 = 176,000 Account title Dr. Cr. Depreciation equipment 176,000 Accumulated equipment 176,000 An analysis of the accounts show the following 1. insurance expires at the rate of \$100 per month 2.Office supplies on hand total \$800 3.The office equipment depreciates \$200 a month 4.One-half of the unearned revenue was earned in March No Account title debit credit 1. Insurance expense 100 Prepaid insurance Office expense 2,000 Office supplies 2, Depreciation equipment 200 Accumulated Unearned revenue 4,600 Service revenue 4,600 Chapter 4 Completion of the accounting cycle Income statement Single step income statement (for Service Company)

15 .(Name of company) Service company For the. Ended.. Revenue : Expenses : ToTal expenses Net income/net loss Multiple-step income statement (for Merchandise Company).(Name of company) Income statement For the. Ended.. Sales Sale Revenue & Allowances Sale discount Net sales Cost of goods sold Beginning inventory Purchase Purchase returns & allowances Purchase discount Net purchase Freight in Cost of goods purchased Cost of goods available for sales Ending inventory Gross profit Operating expenses : Selling Expense : Total selling expense Income from operations Other revenue: Interest revenue dividend revenue rent revenue gain Other expenses :

16 Interest expense Loss Net income/net loss Retained Earnings statement (both service and merchandise company).(name of company) Retained Earnings statement For the. Ended Retained Earnings,BB Net income (Loss / profit ) Dividends Retained Earnings,BB Statement of financial position (both service and merchandise company).(name of company) Statement of financial statement Dec 31,2010 Assets Property,Plant and Equipment Land Accumulated depreciation-building Total property,plant and Equipment Current Assets Merchandise Inventory Prepaid insurance Supplies Notes receivable Accounts receivable Cash Total current assets Total Assets Stockholder s Equity and liabilities Stockholder s Equity Common stock Retained Earnings Total stockholders Equity Non-current liabilities Mortgage payable Notes payable Total Non-current liabilities

17 Current liabilities Notes payable Accounts payable Unearned revenue Total current liabilities Total liabilities Total stockholders Equity and liabilities Closing entries 1.Close summary of revenue accounts into income summary 2. Close summary of expense accounts into income summary 3. Close income summary into retained earnings 4. Close dividend accounts into retained earnings Example of this chapter 4 Oppai Company Work sheet For the month ended Jan 31,2557 Account Titles Trial Balance Adjustment Adjusted Trial Balance Dr. Cr. Dr. Cr. Dr. Cr. Cash 5,000 5,000 Accounts receivable 1, ,200 Inventory 1, ,200 Land 200, ,000 Equipment 6,000 6,000 Accu.depreciation Unearned rev. 4,000 1,000 3,000 Share capital 102, ,500 Retained earning 100, ,000 Sales revenue 60, ,800 Sales returns and all 5,000 5,000

18 Cost of goods sold 41, ,100 Freight-out Salaries expense 6, ,500 Utilities expense Total 266, ,800 Depreciation exp Salaries payable ,500 2, , ,200 Data for adjusting entries 1.Useful life of equipment is 5 years 2.Sales revenue earned but not yed received in cash from Mr.Than \$800 3.One fourth of Unearned account is earned in Jan Accrued salaries expense not yet paid \$500 5.Inventory value on hand is only \$1,200 Multiple steps income statement for merchandising company using Perpetual sys. Sales revenue 61,800 Sales returns and allowances (5,000) Net sales 56,800 Cost of goods sold (41,100) Gross profit 15,700 Operating expenses Freight-out 800 Salaries expense 6,500 Utilities expense 300 Depreciation expense 100 Total operating expenses (7,700) Net income 8,000 Statement of financial position Asset

19 Non-current asset Plant asset Land Equipment 200,000 Accu. Depreciation 6,000 Total Plant asset (400) 5,600 Total non-current asset 205,600 Current asset 205,600 Inventory Accounts receivable 1,200 Cash 2,200 Total current asset 5,000 Total asset 8,400 Shareholder s equity and liabilities 214,000 Shareholder s equity Share capital R/E (bb+net income - dividends) 102,500 Total shareholder s equity 108,000 Liabilities 210,500 Current liabilities Unearned revenue 3,000 Salaries payable 500 Total Current liabilities 3,500 Total liabilities 3,500 Total Shareholder s and liabilities 214,000 Closing entries

20 Dec31. Sales revenue 61,800 Income summary 61,800 Dec31. Income summary 53,800 Sales returns and allowances 5,000 Cost of goods sold 41,100 Freight-out 800 Salaries expense 6,500 Utilities expense 300 Depreciation expense 100 Dec31. Income summary 8,000 R/E 8,000 CHAPTER 5 ACCOUNTING FOR MERCHANDISING OPERATIONS Merchandising companies buy and sell merchandising rather than perform services and their primary source of revenue. The primary source of revenues for merchandising companies is the sale merchandise, often referred to simply as SALES REVERNUE or SALES. COST OF GOOD SOLD is the total cost of merchandise sold during the period.

21 Companies use one of two systems to account for inventory : - Perpetual inventory system - Periodic inventory system PERPETUAL SYSTEM big company Keep detailed records of the cost of each inventory purchase and sale. A company determines the cost of goods sold each time a sale occurs. PERIODIC SYSTEM small company Do no keep detailed inventory records of the goods on hand throughout the period. They determine the cost of goods sold only at the end of the accounting period. - Determine the cost of goods on hand at the beginning of the accounting period. - Add to it the cost of goods purchased - Subtract the cost of goods on hand at the end of the accounting period. Recording Purchased of Merchandise Companies purchase using cash or credit (on account). They normally record purchases when they receive the goods from the seller. Under the perpetual inventory system, companies record purchases of merchandise for sale in the Inventory account. Freight Costs FOB (free on board) - FOB Shipping Point : Buyer pays freight costs. - FOB Destination : Seller pays freight costs.

22 Purchase Returns and Allowances The purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. The transaction is known as purchase return. Alternatively, the purchaser may choose to keep the merchandise if the seller is willing to grant an allowance(deduction) from the purchase price. This transaction is known as a purchase allowance. Purchase Discounts Permit buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. Credit terms specify the amount of the cash discount and time period in which it is offered. Ex. 2/10,n/30 two-ten, net thirty This means that the buyer may take a 2% cash discount on the invoice price less any returns or allowances, if payment is made within 10 day JOURNAL ENTRIES FOR THE BUYER PERPETUAL PERIODIC 1 Purchase of merchandise Inventory Purchase Cash / A/P Cash / A/P 2 Return of merchandise purchased Cash / A/P Cash / A/P Inventory Purchase Returns & Allowances

23 3 Paid the Freight Cost (FOB Shipping Point) Inventory Freight-In Cash Cash 4 Payment during the discount period Accounts Payable Accounts Payable Cash Cash Inventory Purchase Discount JOURNAL ENTRIES FOR THE SELLER PERPETUAL PERIODIC 1 Sale of merchandise Cash / A/R Purchase Sales Revenue Sales Revenue Cost of Goods Sold NO ENTRY Inventory 2 Customer returned the merchandise sold Sales Returns & Allowances Sales Returns & Allowances Cash / A/R Cash / A/R Inventory NO ENTRY

24 Cost of goods sold 3 Paid the Freight Cost (FOB Destination) Delivery expense / Freight-out Delivery expense / Freight-out Cash Cash 4 Receive the money during the discount period Cash Cash Sale discount Sales discount A/R A/R Adjusting Entries The perpetual inventory records may be incorrect due to recording errors, theft, or waste. Thus, the company needs to adjust the perpetual records to make the recorded inventory amount agree with the inventory on hand. This involves adjusting Inventory and Cost of Goods Sold. Ex. PW Audio Supply has an unadjusted balance of \$40500 in Inventory. Through a physical count, PW Audio Supply determines that its actual merchandise inventory at year-end is \$ The company would make an adjusting entry as follows. Cost of Good Sold 500 Inventory 500 (to adjust inventory to physical count)

25 Closing Entries A merchandising company closes to Income Summary all accounts that affect met income. In journalizing, the company credits all temporary accounts with debit balances, and debits all temporary accounts with credit balances. 1) Close Revenue to Income summary Sales Revenue x Income summary x 2) Close Expense to Income summary Income summary x Sales Returns & Allowances x x x 3) Close Income summary to Retained earnings Income summary x Retained earning x 4) Close Dividends to Retained earnings Retained earnings x

26 Dividends x *** Multiple-Step Income Statement Under a Perpetual System : Net sales = Sales Revenue Sales Return & Allowances Sales discount : Gross Profit = Net sales Cost of goods sold : Income from operations = Gross Profit Total operating expense Chapter 6: Inventories Inventories Classifying Inventory Determining Inventory Quantities Inventory Costing Inventory Errors Statement Presentation and Analysis Classifying Inventory

27 Accounting across the organization for e.g. A Big Hiccup Determining Inventory Quantities Taking a Physical Inventory Ethics Insight for e.g. Falsifying Inventory to Boost Income Determining Ownership of Goods Goods in Transit Consigned Goods Inventory Costing Specific Identification Cost Flow Assumptions 1. First-in, first-out(fifo) 2. Average-cost Financial Statement and Tax Effects of Cost Flow Methods Income Statement Effects Statement of Financial Position Effects Tax Effects Using Inventory Cost Flow Methods Consistently

28 International Insight (Is LILO Fair?) Lower-of-Cost-or-Net Realizable Value Inventory Errors Income Statement Effects Beginning Inventory + Cost of Goods Sold Ending Inventory = Cost of Goods Sold Statement Presentation and Analysis Presentation Analysis Cost of Goods Sold / Average Inventory = Inventory Turnover Accounting across the Organization Improving Inventory Control with RFID Summary of Learning Objectives 1. Describe the steps in determining inventory quantities. 2. Explain the accounting for inventories and apply the inventory cost flow methods. 3. Explain the financial effects of the inventory cost flow assumptions. 4. Explain the lower-of-cost-or-net realizable value basis of accounting for inventories. 5. Indicate the effects of inventory errors on the financial statements. 6. Compute and interpret the inventory turnover ratio. EXAMPLES Tempo Ltd. is a retailer operating in Dartmouth, Nova Scotia. Tempo uses the perpetual inventory method. All sales returns from customers result in the goods being returned to

29 inventory; the inventory is not damaged. Assume that there are no credit transactions; all amounts are settled in cash. You are provided with the following information for Tempo Ltd. for the month of January Dec 31 Ending Inventory Q=150, P=\$19 Jan 2 Purchase Q=100, P=\$21 Jan 6 Sale Q=150, P=40 Jan 9 Sale return Q=10, P=\$40 Jan 9 Purchase Q=75, P=\$24 Jan 10 Purchase return Q= 15, P=\$24 Jan 10 Sale Q=50, P=\$45 Jan 23 Purchase Q=100, P= 26 Jan 30 Sale Q=160, P=50 Instruction Calculate a) Cost of goods Sold b) Ending Inventory c) Gross Profit Using two methods i) FIFO ii) Moving-average cost CHAPTER 7: Fraud, Internal Control, and Cash

30 Fraud and Internal Control Cash Controls Control Features: Use of a Bank Reporting Cash Fraud and Internal Control Fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employee. Internal Control consists of A control environment Risk assessment Control activities Information and communication Monitoring Principles of Internal Control Activities Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls

31 Establishment of responsibility control is most effective when only one person is responsible for a given task. Segregation of duties the work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee. Segregation of related activities Making one individual responsible for related activities increases the potential for errors and irregularities. Segregation of record-keeping from physical custody The custodian of the asset is not likely to convert the asset to personal use when one employee maintains the record of the asset, and a different employee has physical custody of the asset. Documentation procedures prenumbered documents, and all documents should be accounted for. Promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transaction. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. Independent internal verification involves the review of data prepared by employees. Human Resource Control 1. Bond employees who handle cash 2. Rotate employees duties and require employees to take vacations. 3. Conduct thorough background checks. Limitations of Internal Control reasonable assurance, human element, and collusion.

32 Cash Controls Over-the-counter receipts Mail receipts Cash Disbursements Controls Voucher System Controls Petty Cash Fund Controls Establishing the petty cash fund Making payments from the petty cash fund Replenishing the petty cash fund Control Features: Use of a Bank The use of a bank contributes significantly to good internal control over cash. Making Bank Deposits Writing Checks Bank Statements Debit Memorandum Credit Memorandum Reconciling the Bank Account 1. Time lags 2. Errors

33 Reconciliation procedure The bank reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash. Step1: Deposits in transit. Step2: Outstanding checks. Step3: Errors. Step4: Bank memoranda. Bank Reconciliation Illustrated same steps as Reconciliation procedure Entries from Bank Reconciliation Collection of note receivable Book error NSF check Bank service charges Electronic Funds Transfer (EFT) System Investor insight Madoff s Ponzi scheme Reporting Cash Cash Equivalents Restricted Cash

34

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