Unit 5 Cash

UNIT 5
CASH
5.1 INTRODUCTION
Since cash is the asset most likely to be used improperly by employees, exposed for embezzlement and many
business transactions either directly or indirectly affect it, it is therefore necessary to have effective control of
cash.
5. 2 MEANING OF CASH
Cash includes money on deposit in banks and other items that a bank will accept for immediate deposit. Money
on deposit in banks includes checking and saving accounts. Other items such as ordinary checks received from
customers, money orders, coins and currency and petty cash also are included as cash. Banks do not accept
postage stamps, travel advances to employees, notes receivable or post-dated checks as cash.
5.3 CHARACTERISTICS OF CASH
The following are some of the characteristics of cash:
a) Cash is used as medium of exchange
b) Cash is the most liquid asset
c) Cash is mostly affected by business transactions
d) Cash is used to measure the value of other assets
e) Cash is mostly exposed to embezzlements
5.4 MANAGEMENT OF CASH
Cash management refers to planning, controlling and accounting for cash transactions and cash balances.
Efficient management of cash is essential to the survival and success of every business organization. Managing
cash requires planning wisely so that there will not be excess cash held on hand at any point in time; or there is
no shortage of cash at any point in time to meet the business’s needs.
5.5 INTERNAL CONTROL OF CASH

The need to safeguard cash is crucial in most businesses because cash is mostly exposed to embezzlement.
Firms address this problem through the internal control system. An internal control system is a set of policies
and procedures designed to protect assets, provide accurate accounting records and evaluate performances.
A sound internal control system for cash increases the likely hood that the reported values for cash are accurate.
Internal control for cash should include the following procedures:

a) The individuals who receive cash should not also disburse (pay) cash
b) The individuals who handle cash should not access accounting records
c) Cash receipts are immediately recorded and deposited and are not used directly to make payments.
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d) Disbursements are made by serially numbered checks, only upon proper authorization by someone other
than the person writing the check
e) Bank accounts are reconciled monthly.
The following are the most common elements of cash control and managements: bank account system, petty
cash fund, voucher system, change fund, and cash short and over.
5.5.1 Control of Cash through Bank Accounts
Bank accounts are one of the most important means of controlling cash that provide several advantages such as:
- Cash is physically protected by the bank,
- A separate record of cash is maintained by the bank,
- And customers may remit payments directly to the bank.
If a company uses a bank account, monthly statements are received from the bank showing beginning and
ending balances and transactions occurring during the month including checks paid, deposits received, and
service charges. These monthly statements (reports) received from the bank are called bank statements. Bank
statements generally are accompanied by checks paid and charged to the accounts during the month, debit and
credited memos, which inform the company about changes in the cash accounts. For a bank, the depositor’s
cash balance is a liability, the amount the bank owes to the firm. Therefore, a debit memo describes the amount
and nature of decrease is the company’s cash accounts. A credits memo indicates an increase in the cash
balance of the depositor that it has with the bank.
5.5.1.1 Reconciliation of Bank and Book Cash Balances
Monthly reconciling of the bank balance with the depositor’s cash accounts balance is essential cash control
procedure. To reconcile a bank statement means to verify that the bank balance and the accounting records of
the depositor are consistent. The balance shown in a monthly bank statement seldom equals the balance
appearing in the depositor’s accounting records. Certain transactions recorded by the depositor may not have
been recorded by the bank and vice versa.
The most common examples that cause disparity between the two balances are:
a) Outstanding checks:
Checks issued and recorded by the company, but not yet presented to the bank for payment.
b) Deposits in transit:
Cash receipts recorded by the depositor, but not reached the bank to be included in the bank statement for the
current month.

c) Service charges:
Banks often charge a fee for handling checking accounts. The amount of this charge is deducted by the bank
form bank balance and debit memo is issued for the depositor.
d) Charges for depositing NSF- checks:
NSF stands for “Not Sufficient Funds.” When checks are deposited in an account, the bank generally gives the
depositor immediate credit. On occasion, one of these checks may prove to be uncollectible because the maker
of the check does not have sufficient funds in his or her account. In such a case, the bank will reduce the
depositor’s account by the amount of this uncollectible item & return the check to the depositor marked “NSF”.
e) Notes collected by bank:
If the bank collects a note receivable on behalf of the depositor, it credits the depositor’s account and issues a
credit memorandum for the depositor.
When the depositor prepares bank reconciliation, the balances shown in the bank statement and in the
accounting records both are adjusted for any unrecorded transactions. Additional adjustments may be required
to correct any errors discovered in the bank statements or in the accounting records.
5.5.1.2 Steps in Preparing Bank Reconciliation

Bank reconciliation is a schedule prepared by the depositor to bring the balance shown in the bank statement
and the balance shown in the depositor’s accounting into agreement.
The steps to prepare bank reconciliation are:

The adjusted balances in the bank and company sections of the reconciliation must be equal. If the balances are
not equal, an item has been overlooked and must be found.
Sometimes, the adjusted balances are not equal because either the company or the bank has made an error. In
such cases, the error is often discovered by comparing the amount of each item (deposit and check) on the bank
statement with that in the company’s records.
Any bank or company errors discovered should be added or deducted from the bank or company section of the

reconciliation depending on the nature of the error.
For example, assume that the bank incorrectly recorded a company check for $50 as $500. This bank error of
$450 ($500 – $50) would be added to the bank balance in the bank section of the reconciliation. In addition, the
bank would be notified of the error so that it could be corrected. On the other hand, assume that the company
recorded a deposit of $1,200 as $2,100. This company error of $900 ($2,100 – $1,200) would be deducted from
the cash balance in the company section of the bank reconciliation. The company would later correct the error
using a journal entry.
Illustration
This bank statement shows a balance of $3,359.78 as of July 31. The cash balance in Power Networking’s
ledger on the same date is $2,549.99. Using the preceding steps, the following reconciling items were identified:
Step 2. Deposit of July 31, not recorded on bank statement: $816.20
Step 3. Outstanding checks:
Check No. 812 $1,061.00
Check No. 878 435.39
Check No. 883 48.60
Total $1,544.99
Step 6. Note receivable of $400 plus interest of $8 collected by bank not recorded in the journal as indicated by
a credit memo of $408.
Step 7. Check from customer (Thomas Ivey) for $300 returned by bank because of insufficient funds (NSF) as
indicated by a debit memo of $300.00.
Bank service charges of $18, not recorded in the journal as indicated by a debit memo of $18.00.
In addition, an error of $9 was discovered. This error occurred when Check No. 879 for $732.26 to Taylor Co.,
on account, was recorded in the company’s journal as $723.26.

The journal entries for Power Networking, based on the bank reconciliation shown are as follows:
5.5.2 Petty Cash Fund

Petty cash fund, which is part of the total cash balance, is used to handle many types of small payments such as
employee transportation costs, purchase of office supplies, purchase of postage stamps, and delivery charges.
Many businesses find it convenient to make minor expenditures instead of writing checks. The amount of petty
cash varies depending on magnitude of the firm/organization
5.5.2.1 Establishment of Petty Cash
To establish a petty cash fund a check is issued to a bank. This check is cashed and the money is kept on hand
in a petty cash box. One employee is designated as custodian of the fund. The issuance of the check for
establishment is recoded by debiting petty cash account and crediting cash.
Petty cash xxxx
Cash xxxx
assume that a petty cash fund of $500 is established on August 1.
N.B. Petty cash account will be debited in the following two cases
 When petty cash is established
 When the firm decides to increase the amount of petty cash balance
Petty cash account will be edited only when the firm decides to reduce the amount of petty cash balance
Petty cash account will not be affected at time of replenishing the petty cash
5.5.2.2 Replenishment of Petty Cash

During the period, the custodian makes small payments form the petty cash fund and obtains a receipt or
prepares a petty cash voucher. This petty cash voucher explains the nature and amount of every expenditure and
is kept with the fund. When the fund runs low or at the end of the company’s fiscal period, a check is issued to
reimburse the fund for the expenditures made during the period. The issuance of this check is recorded by
debiting the appropriate expense accounts and crediting cash or vouchers payable.
Supplies expense xxx
Postage expense xxx

Miscellaneous expense xxx
Cash xxxx
At the end of August, the petty cash receipts indicate expenditures for the following items:
Office supplies $380
Postage (debit Office Supplies) 22
Store supplies 35
Miscellaneous administrative expense 30
Total $467
The entry to replenish the petty cash fund on August 31 is as follows:
5.5.3 Voucher System
One method to control cash disbursements is a voucher system. A voucher is a special form, which contains
relevant data about a liability and its payment.
In a voucher system, a voucher is prepared for each expenditure and approved by the designated officials. Each
approved voucher represents liability and recorded in a voucher register, which is similar to purchases journal.
Those registered vouchers are filed according to their payment date in an unpaid vouchers file. The vouchers
and supporting documents then are sent to the treasure or other official is the finance department before issuing
checks. When the checks are signed, the paid vouchers are recorded in a check register which is similar to cash
payments journal. Those paid vouchers are filed in paid vouchers file according to their serial number for future
reference.
5.5.4 Change Fund

Some businesses that receive cash directly from customers should maintain a fund of currency and coins in
order to make change (Amharic=>” zirzir”). This fund, which is part of the total cash balance, is called change
fund. A change fund is established by issuing a check to the bank and transferring the cash to the custodian. The

issuance of a check to establish a change fund is recorded by debiting cash on hand and crediting cash or
voucher payable.
Establishing cash changed fund
Cash on hand xxx
Cash at bank xxx
Once a change fund is established, there will be no change in its balance unless there is a decision by
management to increase or decrease the fund balance.
5.5.5 Cash Short and Over
In handling cash receipts from daily sales, a few errors in making changes will occur. These errors may cause a
cash shortage or overage at the end of the day. The account cash short and over is debited if there is shortage&
credited if there is overage. At the end of the period if the account had a debit balance, it appears in the Income
statement as miscellaneous expense; if it has a credit balance, it is shown as miscellaneous revenue.
For example, assume that the total cash sales recorded during the day amounts to Br. 12,420. However, the cash
receipts in the cash register drawer (actual cash count) total Br. 12,415.
The following entry would be made to adjust the accounting records for the shortage in the cash receipts:
Cash Short and Over 5.00
Cash 5.00
To record a Br. 5.00 (Br. 12,420 – 12,415)
Shortage in cash receipts for the day

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UNIT 5

5.5 INTERNAL CONTROL OF CASH

Internal control for cash should include the following procedures:

5.5.1.1 Reconciliation of Bank and Book Cash Balances

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5.5.1.2 Steps in Preparing Bank Reconciliation

The steps to prepare bank reconciliation are:

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5.5.2 Petty Cash Fund

5.5.2.2 Replenishment of Petty Cash

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5.5.3 Voucher System

5.5.4 Change Fund

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5.5.5 Cash Short and Over

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