Topic 7 internal controls cash receivables PDF

TOPIC INTERNAL CONTROLS, CASH & RECEIVABLES Topic Learning Objectives Part (of 3) Internal Controls & Bank Reconciliation On completion of this topic, you should be able to: Define internal control & appreciate management’s responsibility in relation to internal control Identify the effect of business transactions on cash Describe electronic banking processes Explain the application of internal control principles for handling cash Prepare a bank reconciliation Discuss the basic principles of cash management INTERNAL CONTROLS Internal controls are the processes used by management and staff designed to provide "reasonable assurance" that the business in running as effectively and efficiently as possible • safeguard its assets from employee theft, robbery and unauthorised use • enhance the completeness, accuracy and reliability of its accounting records by reducing the risk of errors and • permit the timely preparation of financial information Five important principles of internal controls Establishment of responsibility Segregation of duties Documentation procedures Physical, mechanical & electronic controls Independent internal validation | Limitations of internal controls  human error and mistakes in judgement that results in a breakdown in internal control  ineffective understanding of the purpose of a control Cash includes  collusion by two or more individuals to circumvent a control • Cash on hand (notes and coins) • Cash at bank • EFTPOS  a control within a software program being overridden or disabled  decisions made by management as to the nature and extent of the control it chooses to implement (e.g a decision to over-ride a control)  non-routine transactions Cash is the most desirable asset because it is readily convertible into any other asset and thus has the highest risk of theft Therefore there is a need for good internal controls for handling cash and recording cash transactions | INTERNAL CONTROL OVER CASH RECEIPTS | INTERNAL CONTROL OVER CASH PAYMENTS | BANK RECONCILIATION The Cash at Bank Account as an internal control device The Bank Reconciliation • There are two records of a business’ cash, namely its Cash at Bank account in its own general ledger and the bank statement, which tells the actual amount of cash the business has in the bank at a specific point in time • The balance in the business’ Cash at Bank rarely equals the balance shown on the bank statement at any particular date • Differences arise because of a time lag in recording transactions • To ensure accuracy of the financial records, the firm’s accountant must explain all differences between the firm’s own cash records and the bank statement figures on a certain date • | The result of this process is a document called the bank reconciliation BANK ACCOUNTS & RECONCILIATION The Bank Reconciliation Procedure Step 1: Check all items and errors from last reconciliation have cleared and tick off on the current bank statement • Any items still not cleared “roll over” into current reconciliation Step 2: Compare The Bank Reconciliation Procedure The following is required:  The previous bank reconciliation  The cash receipts & payments journals covering the period to be reconciled  The cash at bank ledger balance  The latest bank statement for reconciliation • Cash receipts journal with credits (deposits) on bank statement • Cash payments journal with debits (withdrawals) on bank statement • Mark entries that appear in both and identify any differences • Unmarked entries will explain difference Step 3: Update cash journals for items captured by bank statement Step 4: Deal with errors • Adjust cash journals for any errors made by entity • Notify bank of any errors in statement (Note these errors on reconciliation until corrected) Step 5: Total cash journals and post to ledgers Step 6: Prepare bank reconciliation | BANK RECONCILIATION The following transactions appear on the bank statement but are not recorded* in Kelly Cook eTravel’s accounts: • • • • • RightLaw has made an EFT to settle an outstanding invoice for $1,325 The bank paid the electric bill of $654 via Direct Debit There was a $200 cheque returned for insufficient funds (NSF) Interest earned on the account was $26 Bank service charges were $12 The cash receipts & payments journals covering the period to be reconciled for Kelly Cook eTravel’s indicate: • A cheque for $1,250 from a customer was received at 5pm on September 30 was recorded in the accounts but not deposited in bank • Cheques were issued, recorded and mailed to suppliers on the September 29 for $1,263 and thus have yet been paid by the bank The balance in the cash at bank account ledger account for 30/9/2017 is $27,385 Debit | PRINCIPLES OF CASH MANAGEMENT | 10 Topic Learning Objectives Part (of 3) On completion of this topic, you should be able to: Define internal control & appreciate management’s responsibility in relation to internal control Identify the effect of business transactions on cash Describe electronic banking processes Explain the application of internal control principles for handling cash Prepare a bank reconciliation Discuss the basic principles of cash management Topic Learning Objectives Part (of 3) – Accounts Receivable On completion of this topic, you should be able to: Identify the different types of receivables Describe how to value accounts receivables RECEIVABLES Why grant ‘credit’ TYPES OF RECEIVABLES Accounts Receivable (Trade Debtors) • Specifically relate to the sale of goods or provision of services • Recognised at time of sale usually Notes Receivable • More formal arrangement than account receivable • Mostly used for financing purposes Other Receivables • include non-trade receivables such as interest receivable, loans to officers, advances to employees, and GST receivable Businesses grant ‘credit’ to customers in order to increase sales • The benefit: The business increases revenues and profits by making sales to good customers who not want to pay cash immediately • The risk/cost: The business will be unable to collect from some of its credit customers • This cost is commonly referred to as bad debts expense • Need to adjust for an estimate of amount that will become bad and use two methods: Direct write-off method Allowance method | 13 VALUING ACCOUNTS RECEIVABLE Need to adjust for an estimate of amount that will become bad and use two methods: Direct write-off method Allowance method Direct Writeoff Method Ageing of accounts receivable General Journal (Direct Write-Off) Jul 31 Bad Debts Expense GST Receivable Accounts Receivable–J Evans (Write-off of J Evans account as bad) Allowance Method 620 62 682 % of net credit sales | 14 VALUING ACCOUNTS RECEIVABLE Direct Writeoff Method Allowance Method Ageing of accounts receivable % of net credit sales Allowance Method • Used for significant credit • Estimates % debts will go bad to • record as bad debts expense and in Allowance for bad (doubtful) debts • The amount of the allowance estimated is determined by either Percentage of net credit sales Ageing of accounts receivable | 15 ALLOWANCE METHOD • Ageing of accounts receivable method, also known as balance sheet approach • Analyse Individual accounts receivable (older accounts statistically more likely to be bad) • Calculates the amount the allowance for doubtful debts should be, therefore what is recorded is an adjustment to the year end balance • Exclude GST & consider existing balance in allowance account… Kelly Cook eTravel uses the aging of accounts receivable method to estimate bad debts at year end 31 December 2017 (there is no existing balance in the allowance for doubtful debts account) The following table is compiled from the accounts receivable ledger Estimate the amount to record as uncollectible | 16 ALLOWANCE METHOD • • • Percentage of net sales method, also referred to as the income statement approach • Analyse history of bad debts to establish relationship between credit sales and bad debts • GST is excluded from calculation as sales revenue is recorded ex GST • Year-end adjustment to recognise bad debts expense • Kelly Cook eTravel uses the Percentage of net sales method to estimate bad debts at year end 31 December 2017 Credit sales for the year were $30,800 (inc GST) and it is estimated at 1% the amount will be uncollectible On the 15th January 2018, Kelly Cook eTravel heard that one of their account customers had gone bankrupt and decided to write off the debt for $88 (inc GST) Record the above two events in the general journal | 17 Topic Learning Objectives Part (of 3) On completion of this topic, you should be able to: Identify the different types of receivables Describe how to value accounts receivables Topic Learning Objectives Part (of 3) On completion of this topic, you should be able to: Describe how receivables are reported in financial statements Describe how to value Notes receivables and manage receivables Analyse receivables RECEIVABLES Notes (Bills) Receivable • A note receivable is a formal credit instrument • It does not always arise from transactions with customers • It is included as an asset in the financial statements • Different types, Trade Bills, Commercial Bills, Promissory Notes Accounts Receivable (Trade Debtors) • Specifically relate to the sale of goods or provision of services • Recognised at time of sale usually • • • • Both accounts and notes receivable can be sold to a 3rd party Also known as factoring Realise cash to finance trading/other activities Minimise costs of credit control | 20 NOTES RECEIVABLE Record these two events in the general journal • On Dec 2017 Kelly Cook eTravel accepts a 90 day note receivable at 15% from IslandHops in settlement of overdue account for $1500 • On the maturity date, 28 Feb 2018, Island Hop settles the note with cash | 21 ANALYSING FINANCIAL STATEMENTS FOR DECISION MAKING CREDIT RISK RATIO is measure of the risk that customers may not pay their accounts RECEIVABLES TURNOVER is the number of times per year on average receivables are collected and the AVERAGE COLLECTION PERIOD converts this metric to days by dividing the receivable turnover into 365 These measure how effective the business is at extending credit and in collecting debts on that credit | 22 ANALYSING FINANCIAL STATEMENTS FOR DECISION MAKING Kelly Cook eTravel Pty Ltd Statement of Financial Performance for month period December 2017 Revenue Gross Sales Revenue Less Sales Returns & Allowances Net Sales Revenue Less Cost of sales (COS) GROSS PROFIT Operating Expenses Advertising Expense Depreciation Expense Electricty Expense Rent expense Salaries Expense Total operating Expenses NET PROFIT 48,500 -1260 47,240 -14,230 33,010 6,100 1,000 420 6600 7200 Kelly Cook eTravel Pty Ltd Statement of Financial Position as at 30 December 2017 Current Assets Cash 22,273 Accounts Receivable Inventory Prepaid rent Total Current Assets 4,160 1,460 1,100 28,993 Non-current Assets PPE Less Acc Dep Totsl Non-current Assets 10,000 1,333 8,667 TOTAL ASSETS 37,660 Liabilites Accounts Payable Unearned Revenue Salaries Payable 840 650 300 Total Current Liabilites 1,790 NET ASSETS 21,320 $ 11,690 35,870 Equity Capital Retained Earnings 30,000 5,870 35,870 EQUITY RATIO Credit Risk Ratio Receivables T/O & (Ave collection days) FORMULA $ Allowance for Doubtful Debts 271 Accounts Receivable 4431 Net Credit Sales 47,240 Ave Net Receivables 4,160 Kelly Cook 2017 Kelly Cook 2018 6.1% 5.8% 11.4 (32 days) 12.5 (29 days) | 23 Topic Learning Objectives Part (of 3) On completion of this topic, you should be able to: Describe how receivables are reported in financial statements Describe how to value Notes receivables and manage receivables Analyse receivables  ... for handling cash and recording cash transactions | INTERNAL CONTROL OVER CASH RECEIPTS | INTERNAL CONTROL OVER CASH PAYMENTS | BANK RECONCILIATION The Cash at Bank Account as an internal control... balance in the cash at bank account ledger account for 30/9/20 17 is $ 27, 385 Debit | PRINCIPLES OF CASH MANAGEMENT | 10 Topic Learning Objectives Part (of 3) On completion of this topic, you should... journal | 17 Topic Learning Objectives Part (of 3) On completion of this topic, you should be able to: Identify the different types of receivables Describe how to value accounts receivables Topic