7 - Internal Control - Managing and reporting working capital

Question 1

What is working capital?

Answer 1

A business’s current assets minus its current liabilities

Question 2

What is internal control structure?

Answer 2

Set of policies and procedures that directs how employees should perform a business’s activities

Question 3

What is cash?

Answer 3

Money on hand, deposits in bank accounts, and cheque and credit card invoices that a business has received from its customers but not yet deposited.

Question 4

What are simple cash controls over cash receipts?

Answer 4

Managers can control cash receipts by:

• Requiring the proper use of a cash register
• Separating the duties of receiving and processing collections of accounts receivable
• Depositing receipts every day

Question 5

Why use cash controls for cash receipts?

Answer 5

A business uses internal control procedures for cash receipts to ensure that it properly records the amounts of all cash receipts in the accounting system, and to protect these from being lost or stolen.

Cash receipts from a business’s operating activities result from cash sales and from collections of accounts receivable from its customers.

Question 6

What are the control procedures to safeguard cash from accounts receivable?

Answer 6

1. Separation of duties: - Separating duties that involve handling accounting records from activities that involve receiving cash, such as opening the mail or taking cash at point of sale, prevents an employee from stealing undeposited amounts of cash and covering up the theft by making a fictitious entry in the accounting records.
2. List details: - Immediately after opening the mail or receiving cash, the employee should list or input all of the details of the money received. This allows for documentation review. Review of documentation may help the business discover that its employee is stealing money.
3. Endorsement: - Employees should ensure each incoming amount is registered at the cash register.

Question 7

What are simple cash controls over cash payments?

Answer 7

The basic rule for good internal control over cash payments is to have all payments authorised before they are made. Managers can control cash payments by:

• Paying all bills by cheque
• Paying only for approved purchases supported by source documents
• Immediately stamping ‘Paid’ on the supporting documents after payment

Question 8

What is a bank statement?

Answer 8

Statement that summarises a business’s banking activities during the month

Question 9

What is bank reconciliation?

Answer 9

Schedule used to analyse the difference between the ending cash balance in a business’s accounting records and the ending cash balance reported by the bank on the business’s bank statement

Question 10

What are the causes of differences in cash balances?

Answer 10

1. Deposits in transit
2. Outstanding or pending payments
3. Deposits made directly by the bank
4. Charges made directly by the bank
5. Errors

Question 11

What are deposits in transit?

Answer 11

A cash receipt that a business has added to its cash account but that the bank has not deducted from the cash balance reported on the bank statement because the cheque has not yet ‘cleared’ the bank

Question 12

What is NSF (Not Sufficient Funds)?

Answer 12

A customer’s cheque that has ‘bounced’ (the business’s bank is unable to collect because the customer’s bank account has insufficient funds to cover the cheque)

Question 13

What are the steps in preparing a bank reconciliation?

Answer 13

1. Set up the proper form for the bank reconciliation
2. Look for deposits in transit
3. Look for outstanding, transfer payments or cheques
4. Identify any deposits that were made directly by the bank but that are not included as increases in the business’s ‘Cash’ accounts
5. Identify any charges that were made directly by the bank but that are not included as decreases in cash on the business’s records
6. Determine the effect of any errors
7. Complete the bank reconciliation
8. Journalise and post entries for amounts adjusted in the books of the business

Question 14

What is the petty cash fund?

Answer 14

A specified amount of money that is under the control of one employee and that is used for making small cash payments for a business.

Question 15

What are accounts receivable?

Answer 15

Amounts owed by customers to the business

Question 16

Why do businesses make sales on credit?

Answer 16

1. Selling on credit may be more convenient than selling for cash
2. Offering credits will encourage customers to buy items they might not otherwise purchases
3. Signals product quality

Question 17

What are the disadvantages of accounts receivable?

Answer 17

1. Accounts receivable requires significant management efforts
2. There is always the chance that the purchaser will not pay

Question 18

What controls are there over accounts receivable?

Answer 18

1. Evaluating a customer’s ability to pay before extending credit
2. Monitoring the accounts receivable balance of each customer
3. Monitoring the total accounts receivable balance

Question 19

What is inventory?

Answer 19

Merchandise a retail business is holding for resale

Question 20

Why is it important to control and report inventory?

Answer 20

1. Selling inventory is the primary way a retail or manufacturing business gets cash from operating activities
2. A business usually expects to turn over its inventory several times during the year
3. Storing inventory is expensive, due to storage space, utilities, and insurance costs.
4. Inventory can be stolen and/or become obsolete

Question 21

What is a purchase order?

Answer 21

Document authorising a supplier to ship the items listed on the document at a specific price.

Question 22

What are simple inventory controls?

Answer 22

1. Control the ordering and acceptance of inventory deliveries
2. Establish physical controls over inventory while the inventory is being held for sale
3. Periodically take a physical count of its inventory

Question 23

What is the specific identification method?

Answer 23

Allocates costs to cost of goods sold and to ending inventory by assigning to each unit sold and to each unit in ending inventory the cost to the business of purchasing that particular unit.

Question 24

What are accounts payable?

Answer 24

Amounts owed to suppliers for credit purchases.

Question 25

What are the benefits of purchasing on credit?

Answer 25

1. More convenient than purchasing with cash

2. Can delay paying for purchases and, by doing so, obtain a short-term ‘loan’ from the supplier

Question 26

What are the concerns that controls of accounts payable address?

Answer 26

1. Ability of employees to make the business responsible for an account payable.
2. Once a business incurs an account payable, the business is concerned that it makes each payment at the appropriate time and that the supplier records each payment properly
3. Business’s total dollar amount of accounts payable