Accounting: The Language of Business (Part 37)

You have to understand accounting and you have to understand the nuances of accounting. It's the language of business and it's an imperfect language, but unless you are willing to put in the effort to learn accounting - how to read and interpret financial statements - you really shouldn't select stocks yourself.Warren Buffett

Cash (Part A)

by

Charles Lamson

If your bank returns checks it has paid from your account, along with your monthly bank statement, you may have noticed a magnetic coding in the bottom right-hand corner of each check. This coding indicates the amount of the check. In the past, you may have accepted this coding, as well as the bank statement, as correct. However, a clerk may have entered the magnetic coding incorrectly, which causes the check to be processed for the wrong amount. For example, a check written for $25 is incorrectly processed as $250.

We are all concerned about our cash. Likewise, businesses are concerned about safeguarding and controlling cash. Inadequate controls can and often do lead to theft, misuse of funds, or otherwise embarrassing situations.

To detect errors, control procedures should be used by both you and the bank. In the next several posts, we will apply basic internal control concepts and procedures to the control of cash.

Nature of Cash and the Importance of Controls Over Cash

Cash includes coins, currency (paper money), checks, money orders, and money on deposit that is available for unrestricted withdrawal from banks and other financial institutions. Normally, you can think of cash as anything that a bank would accept for deposit in your account. For example, a check made payable to you could normally be deposited in a bank and thus is considered cash.

We will assume in the next few posts that a business maintains only one bank account represented in the ledger as Cash. In practice, however, a business may have several bank accounts, such as one for general cash payments and another for payroll. For each of its bank accounts, the business will maintain a ledger account, one of which may be called Cash in Bank---First Bank, for example. It will also maintain separate ledger accounts for cash that it does not keep in the bank, such as cash for a small payment, and cash used for special purposes, such as travel reimbursement. We will introduce some of these other cash accounts in the next few posts.

Because of the ease with which money can be transferred, cash is the asset most likely to be diverted and used improperly by employees. In addition, many transactions either directly or indirectly affect the receipt or the payment of cash. Businesses must therefore design and use controls that safeguard cash and control the authorization of cash transactions. In the following paragraphs, we will discuss these controls.

Control of Cash Receipts

To protect cash from theft and misuse, a business must control cash from the time it is received until it is deposited in a bank. Such procedures are called preventative controls. Procedures that are designed to detect theft or misuse of cash are called detective controls. In a sense, detective controls are also preventative in nature since employees are less likely to steal or misuse cash if they know there is a good chance they will be discovered.

Retail businesses normally receive cash from two main sources: (1) cash receipts from customers and (2) mail receipts from customers making payments on account. These two sources of cash are shown in Exhibit 1.

EXHIBIT 1

Controlling Cash Received from Cash Sales

Regardless of the source of cash receipts, every business must properly safeguard and record its cash receipts. One of the most important controls to protect cash received in over-the-counter sales is a cash register. You may have noticed that when a clerk (cashier) enters the amount of a sale, the cash register normally displays the amount. This is a control to ensure that the clerk has charged you the correct amount. You also receive a receipt to verify the accuracy of the amount.

At the beginning of a work shift, each cash register clerk is given a cash drawer that contains a predetermined amount of cash for making change for customers. The amount in each drawer is sometimes called a change fund. At the end of the work shift, each clerk and the supervisor count the cash in the clerk's cash drawer. The amount of cash in each drawer should equal the beginning amount of cash plus the cash sales for the day. However, errors in recording cash sales or errors in making change cause the amount of actual cash on hand to differ from the amount. Such differences are recorded in a cash short and over account. For example, the following entry records a clerk's cash sales of $3,150 when the actual cash on hand is $3,142.

At the end of the accounting period, a debit balance in the cash short and over account is included in Miscellaneous Administrative Expense in the income statement. A credit balance is included in the other income section. If a clerk consistently has significant cash short and over amounts, the supervisor may require the clerk to take additional training.

After a cash register clerk's cash has been counted and recorded on a memorandum form, the cash is then placed in a store safe in the cashier's department until it can be deposited in the bank. The supervisor forwards the clerk's cash register records to the accounting department, where they become the basis for recording the transactions for the day.

Controlling Cash Received in the Mail

Cash is received in the mail when customers pay their bills. This cash is usually in the form of checks and money orders. Most companies' invoices are designed so that customers return a portion of the invoice, called a remittance advice, with their payment. The employee who opens the incoming mail should initially compare the amount of cash received with the amount shown on the remittance advice. If a customer does not return a remittance advice, an employee prepares one. Like the cash register, the remittance advice serves as a record of cash initially received. It also helps ensure that the posting to the customer's account is accurate. Finally, as a preventive control, the employee opening the mail normally also stamps checks and money orders "for deposit only" in the bank account of the business.

All cash received in the mail is sent to the Cashier's Department. An employee there combines it with the receipts from cash sales and prepares a bank deposit ticket. The remittance advices and their summary totals are delivered to the accounting department. An accounting clerk then prepares the records of the transactions and posts them to the customer accounts.

When cash is deposited in the bank, the bank normally stamps a duplicate copy of the deposit ticket with the amount received. This bank receipt is returned to the accounting department, where a clerk then compares the receipt with the total amount that should have been deposited. This control helps ensure that all the cash is deposited and that no cash is lost or stolen on the way to the bank. Any shortages are thus promptly detected.

The separation of the duties of the Cashier's Department, which handles cash, and the Accounting Department, which records cash, is a preventive control. If Accounting Department employees both handled and recorded cash, an employee could steal cash and change the accounting records to hide the theft. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 284-286*

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