9.1 Introduction

Cash, the most liquid of assets, is the standard medium of exchange and provide the basis for measuring and accounting for all other item. It is generally classified as a current asset. To be report as “cash” it must be readily available for the payment of current obligations, it must be free from any contractual restriction that limits its use in satisfying debts.

Cash consists of coins, currency, and available funds on deposit at the bank. Negotiable instruments such as money orders, certified checks, cashiers’ check, personal checks, and bank drafts are viewed as cash. Savings accounts are usually classified as cash, although the bank has a legal right to demand notice before withdrawal. But the privilege of prior notice is rarely exercised by banks, so savings accounts are considered cash.

Certificates of deposits (CDs), deposit receipts, treasury bills, commercial and finance company paper, similar types of deposits, and “short-term paper” that provides small investors with an opportunity to earn high rates of interest are more appropriately classified as temporary investment than cash. The logic for this classification is that these situations usually contain restrictions or penalties on their conversion to cash.

Items that present classification problem are postdated checks, IOUs, travel advances, postage stamps, and special cash funds. Travel advances are properly treated at receivables if the advances are to be collected from the employees or deducted from their salaries. otherwise, classification of the travel advance as prepaid expense is more appropriate postdated checks and IOUs are treated as receivables.

Postage stamps on hand are classified as part of office supplies inventory or as a prepaid expense. Petty cash fund and change funds are included in the current assets as cash balance these funds are used to meet current operating expense and to liquidate current liabilities.


9.2 Management and Control of Cash

Cash presents special management and control problems not only because it enters into a great many transactions but also for these reasons.

  1. Cash is the single asset readily convertible into any other type of asset.
    It is easily concealed and transported, and it is almost universally desired. Correct accounting for cash transactions therefore requires that control be established to ensure that cash belonging to the enterprise is not improperly converted to personal use by someone in, or connected with, the enterprise.
  2. The amount of cash owned by an enterprise should be regulated carefully so that neither too much nor too little is available at any time.

Two problems of accounting for cash transactions face the accounting department.

  1. Proper controls must be established to ensure that no unauthorized transactions are entered into by officers or employees;
  2. Information necessary to the proper management of cash on hand and cash transactions must be provided.

Most companies fix the responsibility for obtaining proper record control over cash transactions in the accounting department. Record control of course, is not possible without adequate physical control; therefore the accounting department must take an interest in preventing intentional or unintentional mistakes in cash transactions.

Regulating the amount of cash on hand is primarily a management problem, but accountants must be able to provide the information required by management for regulating cash on hand through the special transactions of borrowing or investing.

Internal Controls for Cash Should

  • Separate custody of and accounting for cash
  • Account for all cash transaction
  • Maintain only the minimum cash balance needed
  • Provide for periodic test counts of cash balances


9.3 Controlling Cash Receipts and Payments

The objective in the control of cash receipts is to ensure that all cash that is receivable by the business enterprise is collected and recorded without loss. The system of controlling cash payments should be designed to ensure that no unauthorized payments are made.


   9.3.1 A Bank Reconciliation

Once a month, the bank sends each depositor a statement and returns the canceled checks that it has paid and charged to the depositor’s account. The returned checks are said to be “canceled” because the bank stamps or cancels, them to show that they have been paid. The bank statement shows the balance at the beginning of the month, the deposits, the checks paid, other debits and credits during the moth, and the balance at the end of the month.

Rarely will the balance of a company’s cash account exactly equal the cash balance shown on the bank statement. Certain transactions shown in the company’s records may not have been recorded by the bank, and certain bank transactions may not appear in the company’s records. Therefore, a necessary step in internal control is to prove both the balance shown on the bank statement and the balance of cash in the accounting records.

A bank reconciliation is the process of accounting for the difference between the balance of cash according to the company’s records. This process involves making additions to and subtractions from both balances to arrive at the adjusted cash balance.

The most common examples of transactions shown in a company’s records but not entered in the bank’s records are the following:

  1. Outstanding checks: these are checks that have been issued and recorded by the company, but do not yet appear on the bank statement.
  2. Deposits in transit: these are deposits that were mailed or taken to the bank but were not received in time to be recorded on the bank statement.

Transactions that may appear on the bank statement but that have not been recorded by the company include the following:

  1. Service charge:  Banks often charge a fee, or a service charge, for the use of a checking account. Many banks have the service charge on a number of factors, such as the average balance of the account during the month or the number of checks drawn.
  2. NSF (Non-Sufficient Funds) check:  A check deposited by the company that is not paid when the company’s bank present it to the makers bank. The bank charges the company’s account and returns the check so that the company can try to collect the amount due. If the bank has deducted the NSF check from the bank statement but the company has not deducted it from its book balance, an adjustment must be made in the bank reconciliation. The depositor usually reclassifies the NSF check from cash to Account Receivable because the company must now collect from the person or company that wrote the check.
  3. Interest income: It is very common for banks to pay interest on a company’s average balance. These accounts are sometimes called N.O.W or money market accounts but can take other forms. Such interest is reported on the bank statement.
  4. Miscellaneous charges and credits: Banks also charge for other services such as collection and payment of promissory note, stopping payment on checks and printing checks. The bank notifies the depositor of each deduction including a debit memorandum with the monthly statement. A bank will sometimes serve as an agent in collecting on promissory notes for the depositor. In such case, a credit memorandum will be included.

An error by either the bank or the depositor will, of course, require immediate correction.

Assume the following data for September 1996 for Nile Corporation to illustrate the preparation of bank reconciliation:

  1. Cash balance in the bank according to September 30 bank statement: Br. 114,621
  2. Cash balance in the bank according to Sept. 30 general ledger account: Br. 126,372.
  3. Deposits made at the bank during Sept. recorded on Nile’s books:
    Sept. 3 ------Br. 10,000       Sept. 10 -----Br. 15,000      Sept. 24 ------Br. 8,000
    Sept. 6 -------- 12,000       Sept. 18 ------25,000       Sept. 30 --------12,000
                                                                                                     Total = Br. 82,000
  4. Deposits made by Nile Co. on august 31 that had not cleared the bank (deposit in transit) by August 31: Br. 16,000
  5. Checks written by Nile Co. prior to Sept. 1 that had not cleared the bank (checks outstanding) by August 31
                                                                                                                                              Check no. 555 ------------ Br. 25
                                                                                                                                              Check no. 580 ---------------- 90
  6. Checks written during Sept. recorded on Nile’s book
    Check No. 621 ----- Br. 48    check no. 625 ----- Br. 88    check no 629 ----- Br. 62   check no 634 ---- Br. 81
    622 -----123          626 -----704        630 ------12           635 -------- 95
    623 -----308          627 -----29          632 ------112         Total = ________
    624 -----94            628 -----66          633 ------53
  7. Deposits shown on the Sept. bank statement:
    Sept. 1 ------Br. 16,000       Sept. 7 -----Br. 12,000      Sept 19 ------25,000
    Sept. 4 -------10,000        Sept. 11 -----15,000      Sept. 25. ------- 8000
                                                                                                      Total = 86,000
  8. Cancelled checks of Nile Corporation returned with the Sept. bank statement and recorded there on:
    Check No. 580 --- Br. 90  check No 624 --- Br. 94  check no 629 --- Br. 62 check no. 633 --- Br. 53
    621 ------- 48       626 ------704       630 -----12         634 ----- 81
    622 ------123        627 -----29          631 -----34
    623 ------308        628 -----66          632 -----112        Total Br. 1816
  9. Cancelled check of Nice Corporation returned with the Sept. bank statement of Nile Corporation and recorded thereon: Br. 98
  10. Bank service charge of Br 7 made against Nile’s account but not recorded by Nile Corporation
  11. A customers check for Br. 60 returned with the Sept. bank statement and marked NSF, not yet redpostied and not recorded on Nile’s books.
  12. Interest of Br. 125 collected on behalf of Nile, not yet recorded by Nile Corporation.
  13. Cancelled check no. 631 returned by the bank for Br. 34 (correct amount) for office supplies recorded as Br. 43 in the accounting records.
  14. Miscellaneous revenue collected by the bank for Nile Corpn. Br. 72 not yet recorded by Nile Corpn.
  15. The cash receipt journal indicated that the cash received during Sept. totaled Br. 82,000 and the cash payment journal showed payments during spet, Br. 1, 918
  16. The bank statement for Sept. total deposits, Br. 86,197, payments Br. 1,981.

Required: prepare Bank Reconciliation for Nile Corpn for the month of Sept 1996.

There are three formats of preparing bank reconciliation

I. The first format reconciles the balance per bank statement and the balance per book with adjusted cash balance.

II. The second format reconciles the balance per bank statement with the balance per depositor’s record and then with adjusted cash balance.

III. The third format reconciles the balance per depositor’s record with the balance per bank statement and then with adjusted cash balance.

Based on the above given information the bank reconciliation for Nile corporation for the month of September 1996 is prepared as follows:

Using the first format, the bank reconciliation is:

Nile Corporation

Bank Reconciliation

September 30,1996

Balance per bank statement ------------------------------------------- Br. 114,621

Add: Deposits in transit ---------------------------- 12,000

         Error                                                                   98                      12,098

Dedu: Outstanding checks, June 30,1996

Check No 555 -------------------------- 25

Check No 625                                    88

Check No 635                                    95                        (208)

Adjusted cash balance                                                                 Br. 126,511

Balance per depositor’s record                                                    Br. 126,372

Add: Interest collected by the bank---------------------- 125

         Miscellaneous revenue collected by the bank -----72

          Error                                                                        9                   206

Dedu: Bank service charge                                              7

           Not sufficient fund                                             60                   (67)

Adjusted cash balance                                                                    126,511

This form of bank reconciliation serves three functions:

  1. to determine the correct cash balance to be reported in the balance sheet
  2. to disclose errors made in recording cash transactions either by the bank or by the depositor, and
  3. to provide information necessary to bring the accounting records up to date

The journal entry required to adjust the accounting records for errors and omissions is taken from the adjustments to the depositor’s records in the bank reconciliation. All items appearing in the reconciliation as adjustments to or deductions from the “balance in depositors records” must be included in the journal entry. The journal entry on September 30,1996, to adjust the accounting records of Nile corporation is shown below:

1996                          Cash in bank --------------------------------------------------206

September 30        Miscellaneous Expense (bank service charge) ------7

                                  Account receivable ------------------------------------------- 60

                                                      Interest revenue ------------------------------------- 125

                                                      Miscellaneous revenue ------------------------------ 72

                                                      Supplies expense -------------------------------------- 9

             To adjust cash ledger accounts per September 30,1996, bank reconciliation

Using the second format, the bank reconciliation is:

Nile Corporation

Bank Reconciliation

September 30,1996

Balance per bank statement                                                            Br. 114,621

Add: Deposit in transit                                     12,000

         Error made by the bank                                 98

         Bank service charge                                        7

         NSF check                                                    60                           12,165

Dedu: Outstanding checks

               Check no 555                                         25

              Check no 625                                          88

             Check no 635                                          95                              (206)

Balance per depositor’s record                                                        126,372

Add: Adjustments to cash account                                                     139*

         Adjusted cash balance                                                     Br. 126,511

*Br. 139 ==>Items not recorded by depositor

              ==> 206 – 67

In the above form of bank reconciliation the bank balance is reconciled to the unadjusted balance of the depositors cash account in the general ledger. Then, the required adjustment to the cash account is entered in the bank reconciliation resulting in the correct cash balance.

The journal entry is the same as the first format.

Using the third format, the bank reconciliation is

Nile Corporation

Bank Reconciliation

September 30,1996

Balance per depositor’s record                                                   Br. 126,372

Add: Outstanding checks:

Check no 555                                       25

Check no 625                                       88

Check no 635                                      95                         208

Interest revenue collected by bank                                              125

Miscellaneous revenue collected by bank                                     72

Error made by the depositor                                                            9       414

Dedu: Deposits in transit                                                       12,000

           Bank service charge                                                        7

           NSF check                                                                    60

           Error made by bank                                                      98         12,165

Balance per bank statement                                                                 114,621

Add: Adjustment to cash account                                                          11,890*

Adjusted cash balance                                                                           126,511

* 11,890 ==> Items not recorded by bank

                = 12,000 + 98 – 208


   9.3.2 Proof of Cash

Cash balances in the bank statement and the depositor’s ledger are reconciled to establish the accuracy of the cash records on a specific date. A full reconciliation of cash receipts and payments (known as a proof of cash) also may be made to establish the accuracy of the cash balance and the effectiveness of internal control over cash receipts and cash payment for a selected month or a longer period.2

Proof of cash is preferred by auditors as a means of identifying all differences between the books and the bank statement during the period covered by the reconciliation. It is generally prepared when a company has weak internal control over cash; it assists in identifying unauthorized and unrecorded transfer of cash.

    Proof of cash has four columns

The first column reconciles the beginning of the cash balances per bank statement and the depositors records. The second column reconciles the current period cash receipts (deposits) per bank statement to receipts recorded in the books. The third column reconciles the current period cash disbursements per bank statement to disbursements recorded in the books. The fourth column reconciles the end of period cash balances per the bank statement and the books.

The proof of cash for Nile Corporation is prepared below:

Nile Corporation

Proof of Cash

September 30,1996

                                                      Balance on        Receipts       Payments     Balance on

                                                    August 31,1996                                          September 30,1996

Balance per bank statement          Br. 30,405         Br. 86,197   Br. 1,981            114,621

Deposit in transit:

        August 31,1996                          16,000            (16,000)

        September 30,1996                                            12,000

Outstanding checks:

        August 31,1996                           (115)                                 (115)

       Sept 30,1996                                                                           208                    (208)

Other reconciling items:

    Bank service charges for Sept.                                                   (7)                         7

    NSF check                                                                                 (60)                       60

    Bank error                                                                                 (98)                       98

    Depositor error                                                                            9                         (9)

Collection by bank                             _______         (197)       ______                 (197)

Balance per depositors record Br. 46,290              Br. 82,000    Br. 1,918         Br. 126,372

Add: Adjustment to cash account                                                                            131

Adjusted cash balance                                                                                          Br.126,51

The proof of cash for Nile Corporation on September 30,1996 is explained below:

  1. Reconciliation of cash receipts in bank statement and in depositor’s records.
    The Br. 16,000 deposit in transit on August 31,1996 is deducted from the deposits recorded by the bank in September because it was a receipt of cash in August. The Br. 12,000 deposit in transit on September 30 is a receipt of cash in September and should be included in total cash receipts for September. The Br. 197 (Br. 125 + Br. 72) interest and miscellaneous revenue collected by the bank must be deducted from the deposits recorded by the bank because these revenues had not been entered in the accounting records (before adjustment) on September 30,1996.
  2. Reconciliation of cash payments in bank statement and in depositor’s records.
    The autstanding checks of Br. 115 on August 31 are included in the bank debits for September. These do not represent cash payments during September but rather were shown properly as cash payments in August. The outstanding checks of Br. 208 on September 30 did not include any checks that were outstanding on August 31; therefore, this total is properly classified as a cash payment by Nile Corporation during September. The bank service charges of Br. 7 and the NSF checks of Br. 60 were included in the banks debit for September but not in the accounting records (unadjusted). The bank recorded check no. 631 at its correct amount of Br. 34, that amount is Br. 9 larger than the Br. 43 a check of Nice Corporation, which amounts Br. 98 in the account of Nile Corporation incorrectly
  3. Reconciliation of bank and depositor cash balances
    The last column of the reconciliation is identical to the reconciliation of the bank and depositor balances to the correct cash balance


   9.3.3. The petty cash fund (impress petty cash system)

Almost every company finds it necessary to pay small amounts for a great many things such as employees lunches, and taxi fare, purchase of minor office supply items, and small expense payments. It is frequently impractical to require that such disbursements be made by check yet some control over them is important. A common method of obtaining reasonable control, simplicity of operation, and general adherence to the rule of disbursement by check is the impress system for petty cash disbursements.

This is how the system works:

1. Some individual is designated as the petty cash custodian and given a small amount of currency as a fund from which to make small payments. For example, if the fund established is Br. 300, the journal entry will be

              Petty cash fund             300

                         Cash                               300

2. As disbursements are made, the petty cash custodian obtains signed receipts from each individual to whom cash is paid. If possible, evidence of the disbursements should be attached to the petty cash receipt. (Petty cash transactions are not recorded until the fund is reimbursed and, then such entries are recorded by someone in accounting not the petty cash custodian)

3. When the supply of money runs low, the custodian presents to the general casher a request for reimbursement supported by the petty cash receipts and other evidence that has been obtained for all disbursements, and receives a company check drawn to “cash” or “petty cash” to replenish the fund.

     Office supplies expense                        42

     Postage expense                                   53

     Entertainment expense                         76

     Cash over and short                               2

                             Cash                                         173

N.B. These expenses are paid form the petty cash fund.

4. It is  decided that the amount of cash in petty cash fund is excessive, an adjustment may be made as follows (lowering the fund balance from Br. 300 to Br. 200)

     Cash                        100

             Petty cash                    100

The journal entry to increase this fund balance would be a debit to petty cash and a credit to cash.

Entries are made to the petty cash account only to increase or decrease the size of the fund, or to adjust the petty cash account balance and related expenses if not replenished at year-end. The reimbursement entry does not affect the petty cash account, but it does affect the amount of petty cash on hand.

The cash short and over account is used when the fund fails to prove out. If the cash proves out short (that is, the sum of the vouchers and cash in their fund is less than the impress amount), the shortage is debited to the cash short and over account. It is proves out over, the overage is credited to cash short and over account. This account is left open until the end of the year, when it is closed and generally shown on the income statement as a miscellaneous expense or income.

There are usually expense items in the fund except immediately after reimbursement; therefore, if accurate financial statements are desired, the fund must be reimbursed at the end of each accounting period and also when nearly depleted.

Under the imprest system the petty cash custodian is responsible at all times for the amount of the fund on hand either as cash or in the form of signed vouchers.

These vouchers provide the evidence required by the disbursing officer to issue a reimbursement check. Two additional procedures are followed to obtain more complete control over the petty cash fund.

  1. Surprise counts of the funds are made from time to time by a superior of the petty cash custodian to determine that the fund is being accounted for satisfactory.
  2. Petty cash vouchers are cancelled or mutilated after they have been submitted for reimbursement, so that they cannot be used to secure a second and improper reimbursement.


   9.3.4 Change Fund

A change fund is used to facilitate the collection of cash from customers. The amount of the change fund is deducted from the total cash (including checks, money orders, etc) on hand at the close of business each day to determine the daily cash collections. The cash should be counted and compared with the cash register tape daily. In general, change and petty cash funds are combined with cash on hand and in the bank and are presented as a single amount in the balance sheet.


9.4 Cash Overdraft

The issuance of checks in excess of the balance on deposit creates an overdraft in the bank account. Banks often (but not always) refuse to pay a check that exceeds the balance of the depositor’s account. Such refusal prevents an overdraft from occurring. In the rare situation in which a business enterprise maintains only one bank account and that account is overdrawn on the balance sheet date, the overdraft amount is reported as a current liability. However, if can enterprise has other accounts in the same bank with larger positive balances, it is reasonable to present the net balance of cash as a current asset. This treatment is based on the reasoning that users of financial statements are interested in an enterprise’s net cash position, rather than in the status of its individual bank accounts in a particular bank.

An overdraft in an account in one bank should not be offset against positive balances in other banks because no right of offset exists. The overdraft in the one bank account is a current liability, and the total of the positive balances is a current asset.

In rare instances, an accountant may discover a situation in which checks are written (and recorded) in excess of the amount on deposit, but the checks are not issued to creditors. In the preparation of financial statement, the credit balance in the cash ledger account should be eliminated by a debit to the cash account and a credit to the Accounts payable account (or to either liability accounts) for the amount of the checks written but not issued.


9.5 Compensating Cash Balances

A compensating balance generally is defined as the portion of any  demand deposit maintained by a depositor that constitutes support for existing borrowing arrangements with banks.

Disclosure of compensating balance arrangements is required because such balances are not available for discretionary use by management on the balance sheet date. Because the maintenance of compensating cash balances affects liquidity and the effective cost of borrowing from banks, users of financial statements may find such information useful.


9.6 Summary

Cash consists of coin, currency, bank deposits, and negotiable instruments such as money orders, checks and bank drafts. Control over the handing of cash and cash transactions is an important consideration for any business enterprise. It is the most liquid asset held by an enterprise and is the asset most easily converted to personal use by officers or employees. Numerous control procedures are available for cash transactions, but the two commonly used procedures are impres petty cash systems and bank reconciliation.

In an impres petty cash system, a petty cash custodian is given a small amount of currency from which to make small payments (minor office supplies, taxi, postage etc). Each time a disbursement is made, the petty cashier obtains a signed receipts for the payment. When cash in the fund runs low, the petty cashier submits the signed receipts to the general cashier and a check is prepared to replenish the petty cash fund. This process is designed to promote control over small cash disbursements which would be awkward to pay by check.

A basic cash control is preparation of a monthly bank reconciliation. The bank reconciliation, when properly prepared, proves that the cash balance per bank and the cash balance per book are in agreement.

It is common practice for an enterprise to have an agreement which a bank concerning credit and borrowing arrangement when such an agreement exists, the bank usually requires the enterprise to maintain a minimum cash balance on deposit.

This minimum balance is known as a compensating balance. Compensating balances that result in legally restricted deposits must be separately classified in the balance sheet. The nature of the borrowing arrangement determines whether the compensating balance is classified as current asset or a non-current asset.

Proper cash management involves the problem of liquidity Vs profitability. In terms of liquidity, management attempts to provide an ample amount of cash to meet all its obligations as they mature. However, when the focus is on profitability, management attempts to make maximum use of cash by purchasing revenue-providing assets. Thus, the problem concerns the identification of an optimum cash position, one that will permit prompt payment of maturing obligations and provide for maximum investment in revenue – producing assets. In most instances some trade-off between liquidity and profitability must be made.



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