CASH AND CASH EQUIVALENTS on hand, demand deposits and other bank accounts are considered cash. equivalents are short-term investments (90 days or less) that can be converted into cash without any significant cost. There cannot be any contractual limitations or restrictions on the use of cash (for example, cash restricted to pay debts is not considered cash). INTERNAL CONTROL OF CASH is the asset most easily misappropriated by management and/or employees. It is extremely important that proper internal control be established to protect this asset. Internal controls should be established to prevent unauthorized cash transactions and to provide information necessary for the proper management of cash. There are two types of internal controls that enhance the reliability of the financial statements. (1) Preventive Controls Policies and procedures that are designed to prevent errors and fraud (2) Detective Controls Policies and procedures that provide an after the fact double-check to identify errors and fraud. A routine accounting activity that provides a detective control is the monthly reconciliation of cash. There are three steps in the reconciliation of cash at the end of each month. (1) Reconciliation per bank Using the bank statement the accountant reconciles the amount per bank to the actual amount that should be reflected in the accounting records at the end of the period. (2) Reconciliation per book Using the general ledger balance the accountant reconciles the amount per books to the actual amount that should be reflected in the accounting records at the end of the period. (3) Preparation of adjusting journal entries Using the information developed in the reconciliation per book the accountant prepares the necessary month end adjusting journal entry to bring the cash per the general ledger into balance with the actual balance per the bank and book reconciliations. Example: Spencer Company has the following information available as of April 30, 2002. Balance per April 30, 2002 bank statement $48,000 Balance per general ledger on April 30, 2002 39,073 Deposits in transit 12,000 Checks in transit 19,500 Note receivable, collected by the bank: Principle portion of note collection 1,000 Interest portion of note collection 200 Bank service charges for the month of April 75 Errors: Bank deposited $500 in the account by mistake Bookkeeper recorded a payment for utilities as $22 but the check was actually written for $220. F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 1
STEP #1 RECONCILIATION PER BANK Balance per bank statement, April 30, 2000 48,000 Add: Deposits in transit 12,000 Total 60,000 Less: Outstanding checks (19,500) Correction of error made by the bank (500) (20,000) Correct balance at April 30, 2000 40,000 STEP #2 RECONCILIATION PER BOOK Balance per book (general ledger), April 30, 2000 39,073 Add: Principle portion of note collection 1,000 Interest portion of note collection 200 1,200 40,273 Less: Correction of error made by company (198) Bank service charges for April 2002 (75) (273) Correct balance at April 30, 2000 40,000 STEP #3 ACCOUNT DEBIT CREDIT 1,200 Note receivable 1,000 Interest earned 200 To record the collection of a note by the bank Bank service charges 75 Utilities expense 198 273 To record the correction of an error and bank service charges for the month of April 2002 Exercise: Spencer Company has the following information available for the month ended September 30, 2002. Balance per September 30, 2002 bank statement $16,987 Balance per general ledger on September 30,2002 5,127 Deposits in transit 19,625 Checks in transit 16,750 Note receivable collected by the bank: Principle portion of note collection 10,000 Interest portion of note collection 800 F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 2
Bank service charges for the month of April 65 Errors: Bank charged the account for $500 by mistake Bookkeeper recorded a payment for prepaid insurance as $5,000 but the check was actually written for $500. Prepare the reconciliation per bank: RECONCILIATION PER BANK Balance per bank statement, September 30, 2000 Add: Deposits in transit Correction of error made by the bank Less: Outstanding checks Correct balance at September 30, 2000 RECONCILIATION PER BANK Balance per bank statement, September 30, 2000 16,987 Add: Deposits in transit 19,625 Correction of error made by the bank 500 20,125 37,112 Less: Outstanding checks (16,750) Correct balance at September 30, 2000 20,362 Prepare the reconciliation per book: RECONCILIATION PER BOOK Balance per book, September 30, 2000 Add: Principle portion of note collection Interest portion of note collection Correction of error made by company Less: Bank service charges for September 2002 Correct balance at September 30, 2000 F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 3
RECONCILIATION PER BOOK Balance per book, September 30, 2000 5,127 Add: Principle portion of note collection 10,000 Interest portion of note collection 800 Correction of error made by company 4,500 15,300 20,427 Less: Bank service charges for September 2002 (65) Correct balance at September 30, 2000 20,362 Prepare the month-end adjusting journal entries: ACCOUNT DEBIT CREDIT Note receivable Intrest earned Prepaid insurance To record the collection of a note by the bank and the correction of an error made by the company in recording prepaid insurnace. Bank service charges To the bank service charges for the month of September 2002 ACCOUNT DEBIT CREDIT 15,300 Note receivable 10,000 Intrest earned 800 Prepaid insurance 4,500 To record the collection of a note by the bank and the correction of an error made by the company in recording prepaid insurnace. Bank service charges 65 65 To the bank service charges for the month of September 2002 F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 4
RESTRICTED CASH AND COMPENSATING BALANCES a. Restricted Compensating balances: Many times a bank will require that an organization maintain a certain minimum balance in its checking account in order to qualify for loans and other bank services. This is essentially restricted cash that can t be used for current operations. As a result it must be reported separately from other cash in the balance sheet. If the compensating balances are related to long-term obligations then they should be reported on the balance sheet as non-current assets. Other types of restricted cash: Petty cash, payroll accounts and dividend funds are cash accounts that are restricted for specific use. These should be reported as current or noncurrent based on the date that the cash is expected to be disbursed. b. Bank Overdrafts Bank overdrafts occur when an organization writes checks against a checking accounting in excess of the amount available. In this situation the negative checking account balance should be reported on the balance sheet as a current liability. If the organization has multiple accounts in the same bank and one of the accounts has an overdraft, the organization may offset this amount against the positive balances in the other accounts as long as the overall net balance of the aggregated accounts is positive. This right of offset is not available if the accounts are in different banks. c. Equivalents equivalents are highly liquid short-term investments that can be converted to cash easily and are not subject to significant interest rate risk. They have a maturity date of 90 days or less. Exercise: In the space provided please indicate how each of the following should be classified in the balance sheet. F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 5
ITEM on hand in savings refund due from IRS Postdated checks Travel advances Certificates of deposit (180-day) Postage meter balance Bank overdraft Legally restricted compensating balance Short-term paper (30 days) Petty cash fund CLASSIFICATION ITEM CLASSIFICATION on hand in savings refund due from IRS Receivables Postdated checks Receivables Travel advances Receivables Certificates of deposit (180-day) Temporary investments Postage meter balance Prepaid expenses Bank overdraft Current liability Legally restricted compensating balance, separately stated in the balance sheet Short-term paper (30 days) equivalent Petty cash fund F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 6