Chapter7: Cash and Receivables
Many companies have incurred significant costs in an effort to comply with the requirements of Section 404.1 A cottage industry of consulting firms and software products has arisen to help these companies. A framework for designing an internal control system is provided by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission.2 Formed in 1985, the organization is dedicated to improving the quality of financial reporting through, among other things, effective internal controls.
COSO defines internal control as a process, undertaken by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:
Internal Control Procedures—Cash Receipts
As cash is the most liquid of all assets, a well-designed and functioning system of internal control must surround all cash transactions. Separation of duties is critical. Ideally, those who handle cash should not be involved in or have access to accounting records nor be involved in the reconciliation of cash book balances to bank balances.
Consider the cash receipt process. Most nonretail businesses receive payment for goods by checks received through the mail. An approach to internal control over cash receipts might include the following steps:
The amount received should equal the amount deposited as verified by comparison with the bank-generated deposit slip and the amount recorded in the accounting records. This helps ensure accuracy as well as safeguard cash against theft.
Internal Control Procedures—Cash Disbursements
Proper controls for cash disbursements should be designed to prevent any unauthorized payments and ensure that disbursements are recorded in the proper general ledger and subsidiary ledger accounts. Important elements of a cash disbursement control system include:
Responsibilities for check signing, check writing, check mailing, cash disbursement documentation, and recordkeeping ideally should be separated whenever possible.
An important part of any system of internal control of cash is the periodic reconciliation of book balances and bank balances to the correct balance. In addition, a petty cash system is employed by many business enterprises. We cover these two topics in Appendix 7A beginning on page 369.
1In response to the high cost of 404 compliance, the PCAOB issued a second standard, Auditing Standard No. 5, to replace its Standard No. 2. The new standard emphasizes audit efficiency with a more focused, risk-based testing approach for material areas. These guidelines should reduce the total costs of 404 compliance.
2The sponsoring organizations include the AICPA, the Financial Executives International, the Institute of Internal Auditors, the American Accounting Association, and the Institute of Management Accountants.