Accounting: The Language of Business - Vol. 2 (Intermediate: Part 152)

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Short-Term Operating Assets: Cash and Receivables (Part Q)

by

Charles Lamson

 

Internal Controls over Cash

Internal controls are processes implemented in a company to ensure that key objectives are met, including the objectives of reliable financial reporting, effective and efficient operations, and compliance with regulations. Internal controls over cash must be highly effective because cash is an asset that is highly susceptible to misappropriation.

Cash Control Guidelines

An effective system of internal controls over cash receipts and disbursements:

• Clearly establishes responsibilities

• Ensures proper segregation of duties

• Uses documentation to create proper monitoring over cash movement

• Establishes proper physical control over cash

• Includes independent verification of cash transactions (e.g., preparing monthly bank reconciliation)

• Creates proper controls over human resources, such as conducting background checks, bonding employees handling cash, and requiring that all employees take vacation days

Separation of duties is one of the most critical internal controls to deter theft and misappropriation of cash. Any individuals who have physical custody over cash should not also handle accounting records. Specifically, any employees handling cash should not have access to ledger accounts and bank statements and should not be responsible for reconciling the bank statements to the ledger accounts. Similarly, the responsibility for approving, signing, and mailing checks and handling cash disbursements documents and records should be separate functions. 

A typical cash receipts process should include the following steps:

1. An employee receives checks, opens the envelopes, and prepares a cash receipts summary. The summary should include the customer name, account number, and the amount of the check.

2. The summary is then forwarded to the employee responsible for depositing checks.

3. The summary is also sent to the employee in charge of preparing the cash receipts journal.

Control procedures to prevent any misappropriation and irregularities in the cash disbursements process include the following:

1. All cash disbursements except for immaterial payments made from petty cash must be made by check.

2. Authorization is required for all cash disbursements prior to preparing a check. The person preparing the check must have all appropriate documentation, including the vendor invoice, the approved purchase order; the receiving report that verifies that the correct items were received and the proper price was charged; and the signed check requested.

3. Checks can be signed only by authorized individuals.

The Sarbanes-Oxley Act of 2002 (SOX) requires that publicly traded U.S. companies maintain an effective system of internal controls. SOX also establishes the Public Company Accounting Oversight Board (PCAOB), which is responsible for establishing generally accepted auditing standards and overseeing assurance functions for publicly traded companies.

Section 404 of SOX requires the documentation and assessment of internal control systems by publicly traded entities. PCAOB Standard No. 5 requires that auditors issue an opinion on the effectiveness of these systems over financial reporting (Public Company Accounting Oversight Board, Auditing Standards No. 5, “An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements” (Washington, DC: PCAOB, 2007).

Important internal control procedures for cash include the use of bank reconciliations and an imprest petty cash fund. We discuss both of these in the next part. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 500-501*

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