 Hello and welcome to this session. This is Professor Farhad and this session we would look at cash and cash equivalent and control over cash receipts and cash payment. These topics are covered in a financial accounting introductory basic accounting course and also covered on the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover. If you like my lectures, please like them. Click on the like button. It doesn't cost you anything. Share them. Put them in playlist. If they benefit you, it means they might benefit other people, especially these days with the coronavirus students are studying at home. Also connect with me on Instagram. On my website you will have additional, you have access to additional material, especially if you are studying for your CPA exam or if you'd like to supplement your accounting education. So in this session, we're going to talk about the control of cash. And in the prior session, we looked at internal control. What is internal control? Internal control are procedures that's going to help us protect our assets, ensure reliable accounting, make sure we are following rules and regulation. So specifically in this session, we're going to be talking about controls that deals with cash. So an effective system of internal control that protects cash and cash equivalents, and we'll talk about cash equivalent in a moment, should meet three basic guidelines. And those are not the only guidelines, but at least those three basic guidelines. The first one, which is very important, and we talked about this one, we talked about internal control, and we're going to see this in practice today. Handling cash is separated from recording of cash. What does that mean? It means people that touch the cash should not be able to record the cash. So simply put the accounting department and the cashier and the treasury department are two different are two different tasks. You cannot touch the cash and be able to change the record. Those should be separated. Cash receipts are promptly deposited in a bank. Don't keep any cash on hand. Why? Because it's susceptible to theft. It's susceptible to loss. It's susceptible to fire. So you want to deposit the cash immediately. Once the cash in the bank, then we make sure, you know, we are in good shape. Okay, also when you make cash disbursement, it's always going to be made in a check. And we'll talk about this later on when we talk about the bank reconciliation. Why is that important? And we're also going to talk about something called petty cash, which we'll talk about that as well, because it's for small for small disbursement. We might use actual cash, but we'll talk about that topic. First, let's talk about cash and cash equivalent. What is cash means? Well, cash is easy. Cash is liquid is a liquid asset. It's very important to make sure we are controlled of it. What is considered cash? Cash, we should all be familiar with cash, currency, coins, deposit in the bank. Also customer checks, cash years checks, certified checks and money orders. All of these, we add them up and they go under the account cash. Now we have another account called cash equivalent. What is cash equivalent? That's another category. It might go away. The FASB been discussing this for this category to go away, but right now we still have cash equivalent. So who knows? Maybe two years down the road, you're listening to this recording and you might say there is no longer cash equivalent. Well, right now we have cash equivalent. Those are short-term, highly liquid investments. What's considered a highly liquid investment? It can be readily convertible to a known amount of cash. So you have something, you have a piece of paper in your hand that you could easily, readily, immediately convert it to cash and close to maturity date and not sensitive to changes. Usually it has less than three month maturity. What does that mean? It means in three month, you can turn it into cash. So the original maturity is three month or less. What are we talking about here? We have something called commercial paper. Maybe you learn about this in your finance course. If not, when you go to my finance course, you could learn about this. Commercial paper are a piece of paper that companies issued and borrow cash against. So they give you this piece of paper saying we would like to borrow a million dollar. Usually it's for two weeks or 10 days and you give them the million dollar. Then two weeks or 10 days you'll go back and you will get one million and $5,000. So you'll make a $5,000 profit because you lend them that money. Now this commercial paper, it's technically an investment because it's readily be convertible to cash and so close to maturity. It's called cash equivalent. Also when the government borrow on a short term basis, government borrows for 30 days for 60 days for two years for 10 years and for 30 years. But when they borrow for 33 month or less, less than 90 days, any time the government borrows and they give you a piece of paper, they're going to pay you back the money in 90 days. That's also considered cash equivalent. So they are, they're almost cash. Why? Because you could easily convert them into cash. They're very liquid, liquid. They are liquid. Liquid means they can be converted into cash. Cash is 100% liquid. Think of cash equivalent 99.999% liquid. They're 100% liquid. Let's say 99%. Okay, but they are not actual cash. They can be converted to cash very quickly. Okay, cash management. So what should be the goal of people who are in charge of cash? Well, usually top management. Well, they should have two goals in mind. Plan cash receipts to meet cash payment when due. That's important. You want to have enough cash receipts. We have cash coming in to pay the cash out. Otherwise you're going to be in trouble if you can't pay your bill and keep a minimum amount of cash necessary to operate. You also need extra cash to buy supplies to pay your employees, so on and so forth to operate. And sometimes you need extra cash if there's an opportunity to maybe make a large purchase. Okay, so what would an effective cash management involved? Okay, first, you want to encourage collection of cash. You want to bring the cash in as early as possible. How do you do so? Well, we already learned about this. You offer your customers discounts. You offer them discount. You place mailboxes close to your customer's area. For example, if you have many customers in New York City, what you do is create a PO box in New York City, usually inside a bank, so the mailing gets there very quickly and the money gets to the bank immediately. Two, delay payment of liabilities. When you have to pay, try to negotiate terms where you take longer for you to pay, but faster for you to receive the money. Keep only necessary assets by assets that you don't need. Plan expenditure properly and if you have any extra cash, invest the cash wisely. So those are some techniques of cash. What is important is when we receive the cash, we want to make sure the cash makes it to the bank. Otherwise, if we are losing the cash, if somebody is committing fraud, that cash management is not really beneficial because if we don't have the cash, we cannot manage it. So how do we manage the cash over the counter? What do we mean by over the counter? Over the counter means when the customer comes in and you have a cash sale. Basically, they hand you the cash, you hand them the product. Think about Dunkin Donuts. When you go to buy a cup of coffee, you give them cash, they'll give you the coffee. Think about when you go to the mall to buy something. Well, who knows? Maybe the malls will be closing after the coronavirus, but the point is over the counter is when you hand in the cash and they give you the product, okay? So the first thing, what are some good techniques? What's some good internal control? Well, the first thing is cash sales should be recorded on a lock-in permanent cash register. Simply put, once you record that sale, the person that recorded it cannot change it. After each sale, that should be the case. You make the sale, it's recorded permanently in the record. Now, it's better if that record is linked to the accounting information system. So if your record is computerized and most places are, it's linked to the accounting information system and the cash record is updated immediately as well as the sales. So simply put, once you make a sale for cash, the system debits cash, debits cash and credit sales. Immediately that will happen. Also, the customer should get a receipt. Why should the customer get a receipt? Because the receipt is created after a sale and once the receipt is created, the transaction is recorded permanently in the system. Therefore, the person that receives the cash can no longer steal the money. And I'm pretty sure, or not pretty sure, maybe you saw it in certain places. For example, in Dunkin' Donuts, they will have a sign on their window saying, if you don't get a receipt, your coffee is free. What are they encouraging the customers to do? They're encouraging the customer to say something if the person that's working on the window did not give them the receipt. Why? Because if when you give them the money, let's assume you paid $1.50 for your coffee and you don't get a receipt, but you get your coffee, you don't care. Why? Because you get your coffee, you paid $1.50. Now, the business is concerned that the person that received this money did not rang up the sale. Therefore, you tell the customers, if you don't receive a receipt, your coffee is free. So, people are more encouraged to say something if they don't get a receipt and that's why they do that. In some places, they say, look at your receipt and if you find five stars, we'll give you $5 or something like that because they want you to check your receipt. They want you to ask for the receipt. Okay? So, that's the first thing. So, when the sale is made, it's recorded. So, the cash clerk, the person that rang up the sale, should be separate from record keeping. So, this person should not be able to change the record. So, what can the cash clerk do? The person that's receiving the cash? Well, they should be able to count the cash at the end of the day, obviously record the amount, the total, and turn over the cash to the cashier. So, they do this and they take the cash and they gave it to somebody called the cashier. The person who is responsible, who's responsible for handling the cash. Okay? Now, the cashier should not have access to the record. So, the cashier should not be able to go in and change the record of the sale. So, they have access to the cash, but they cannot have access to the record. Okay? Now, the cashier has the cash. All what they can do with that cash is deposit that cash and receive a deposit slip. So, take this money and put it in the bank. Now, this process is good, but you need a third employee, usually a supervisor, check the work of both the clerk and the cashier, and compare the amount from the sales register to the amount that's deposited. In this way, usually no one can steal the money unless you have a collusion between those individuals to steal money from the company. So, this is one way to control cash over the counter. When you have cash over the counter, there's always the possibility of a mistake happening. So, you could have cash over and cash short, basically, overage or shortage. So, sometime errors and make and change are discovered, sometime you may give the customer more money, sometime the customer may give you more money by mistake. So, there's a difference between the cash and the cash register and the record. Why? Because there's an error. So, let's assume that happens. Let's assume that the cash register record chose 550, but the count of cash shows 555. So, simply put, we receive an extra $5 in cash sales. Usually, what entry do we make to reconcile? Well, we're going to debit cash 555. How much we received? We're going to credit sales 550. Then, we're going to credit an account called cash over and short. Now, what type of account is cash over and short? It's simply other revenue, other revenue or gains. It goes under that category. So, simply put, think of it as a revenue account, but it's not sales, it's somehow by mistake we received extra $5. Now, what happened if it's the opposite? If the cash register shows 625 of sales, but we counted the cash and we only have 621. Now, we have a cash shortage. What entry do we make to record the cash shortage? We debit cash exactly how much we received at 621. This is how much cash we received. The sales is 625 and now we have a cash short, cash over and short, but now it's a debit. What type of account is this? Think of it of other expense or loss, other expense slash loss. That's what the cash over and short is now. It's a debit. Usually, over time, they cancel each other and hopefully they don't happen often. Usually, it should be minimized. Now, this is if you receive the cash over the counter. It means you receive the cash. What happened if you receive cash receipts by mail? Usually, there's no cash receipts by mail. You receive check by mail, because no one, it's illegal to mail cash, but we say cash receipts by mail. Let's technically check. The first thing you need to do is two people should be assigned to open the mail. Now, I used to work in a place where we used to give out loans, loans to individuals, and the payment used to be sent to our office, so we would service the loan right from that office, so we would write, underwrite the loan, write the check, also receive the payment this way. Customers, the purpose of that business was for the customers to feel at ease that they are dealing with actual people, not large corporations, so they make the payment at the office, they mailed or checked at the office, so there's one in an individual relationship. That's the goal of it. So, I remember I used to open the mail with someone else, so two people open the mail, and usually it's, I would open the mail with someone else, and every day we will rotate, and I will open the mail, for example, with with Amy, the following day I will open the mail with George, then the third day I don't open the mail. Amy and George open the mail, so you have two individuals randomly selected by manager to open the mail. Okay, why that's the case? Because collision is required, now if somebody, if we're going to steal the check and somehow convert them to us, then we need to collude, we need to agree on this, and it's harder for two individuals to agree, so that's why that's what you do, why we do so. Then the next thing you do is you restrictively endorse the check, what does that mean? Immediately as we open the check, I used to open the mail, give the check to the other person, let's assume Amy, Amy will turn the check on its back, and it will stamp the cash for deposit only in our bank account at the business bank account, so what this does is restrictively endorse the check, so now the check can no longer be stolen by anyone, because now it's endorsed, also we would make a list of the name of the person that paid, their account number, and the purpose of the payment, for our purposes was easy, payment on their loan, then what we do is we will send a cash, the cash, plus a copy to the cashier, we would have a cashier individual, okay that's in charge of the cash, we send the copy to record keeping to our the person that's in charge of updating the record, and we will keep one copy, so basically we'll have three copy, what would the cashier do? The cashier will take the cash and will deposit the cash and get a deposit slip from the bank, then the record keeper which is the accounting department will record the amount received in the accounting record, then they will update the accounting record, so notice that the steps that are taken here, each individual is responsible for one task, one person for counting the check, another person to make the deposit, and a third person to change the record, so you have, remember we talked about separation of duties, so not one individual is taking care of the whole thing, and each individual is checking the work of the other individual, so this is the purpose of internal control, now receiving cash is important, but also the control of cash payment, when we make cash payment that's also important, we want to make, we want to make only payment to individuals who are who are legitimate vendors, legitimate lenders, legitimate suppliers, so on and so forth, so control of cash payment is as important as most large theft occur from that, from that, from that angle, so when people steal money from their company, usually if you go to any newspaper or to local newspaper or Google and see cash theft, it usually happen through cash, through cash disbursement, what happened, one person at the company in charge of writing the check, they might pay, they might make payment for their spouses, boyfriend, girlfriend, relatives, friends, what they do is they create a fictitious company and they send checks to that fictitious company as legitimate payments, and this is how they steal the cash, so it's very important that cash disbursements is being controlled just like cash receipts, okay, so what do we need to do, all payment should be made by check, and we'll talk about why by check later when we prepare the bank reconciliation, but the check is a good record because when you make a payment and a check, it tells you who signs the check, who wrote the check, to whom the check is being paid, the amount, the time, and the purpose, so we can have a record when we write everything in check, and limit access to checks except those who authorize to sign the checks, obviously that's a good control too, you want to make sure the checks are protected, and some companies what they do, they need two signatures for each check, so not one individual can sign the check, you need two signatures, and we'll talk later on and shortly what internal control the company will need to have to make sure the payments are being made to legitimate vendors, okay, and also we need to have a cash budget, include projected cash receipts and projected cash disbursement, because if you prepare a proper budget, okay, then if somebody is overpaying it's going to appear in the budget, because we're going to find out that we're paying more than what we thought, okay, same thing with cash receipts and cash disbursement, if we received more it's not it's not a problem, but if we received less than what we projected, it is a problem, we need to find out why, because if somebody is stealing the cash budget might be able to help us kind of start our investigation, or it's a red flag, okay, now we need to use something called the voucher system of control, what's a voucher system, a voucher system is a file system, simply it's a bunch of files put together, and if you are an auditor, if you're studying accounting later, you're going to see understanding how voucher system work will help you tremendously when you're auditing a company or studying for your audit course, so let's see what a voucher system is, a voucher system established procedure for verifying, approving, recording libraries for eventual cash payment, and issuing cash only for verified, approved and recorded libraries, so how does the voucher system work, so it's very important to take a look at a picture how the voucher system work, so you see the importance of a voucher system, but basically this is a voucher, it's a file, it's just a regular file, Manila file, but you're going to see what's included in that Manila file, when you're an auditor, when I was an auditor, I used to look at those all the time, because part of auditing is to look at the payment, to look when the company makes a payment, is this for a legitimate purchase, what do you do, you go to the voucher, you select random vouchers and you'll start to check them, so to illustrate this concept it's better to just walk you through an example, fictitious example, let's assume we want to buy five tablets for our business, the first thing we do, the the person that would like to buy the five tablet will prepare what's called a requisition purchase requisition report, and what is that purchase requisition report, it looks something like this, basically they'll have to fill out a form saying we would like to buy five tablets, usually they will get the approval of their supervision, and once we fill out this this purchase requisition report we're going to send one copy of it to the accounting department, so follow with me what's going to happen, so i'm going to highlight the accounting department in yellow as we're going through this, we'll send one copy to the accounting department, now we send this purchase purchase requisition report to the purchasing department, so it goes from their acquisition to the purchasing department, the purchasing department will prepare a purchase order, so this is what a purchase order would look like, and the purchasing department will send this request to our favorite vendor, whoever our favorite vendor is we're going to assume it's apple, so we're going to be buying five tablets from apple computer, so they will fill out you know quantity five, they want the tablet and they will send the order to apple, usually they will fill out for example you'd go online and you fill out the form, but it's nevertheless it's a purchase order, now notice what they do, they would also submit one copy of this purchase order, they will submit one copy of this purchase order to the accounting department as well, the accounting department gets a copy, obviously apple the supplier gets a copy, the person that requested the purchase will get a copy, let them know that you know we completed your order and we'll send one copy to the receiving department, who are the receiving department, the department that's going to receive the five tablets, the division, now what's going to happen apple would receive the order, they will ship it and they will send an invoice, supplier vendor invoice to our accounting department, notice we're going to the accounting department would receive an invoice, so notice let's go back and highlight the accounting, so they would receive a purchase requisition, they would receive a purchase order, then apple computer will send them an invoice, sell on them, we shipped you five tablets, please pay us, it's an invoice, do we pay, no not yet, what we do is we're going to receive until we receive the five tablets, once we receive the five tablets, once we receive the five tablets, the receiving department would prepare a receiving report that we receive, for example this is a receiving report for grade A milk, manufacturer raw milk, so on and so forth, but it will be like five tablets, so this there'll be a receiving report, so the receiving department, which is a separate department, would receive the five tablets, also will send one one copy to the accounting department, also they will send one copy to the person that requested it, the tablets will send one copy to the purchasing agent, but the most important will send one copy to the accounting department, now the accounting department they would look at the record and they will find out there's a legitimate purchase requisition, a legitimate purchase order, a legitimate bill, and legitimate five tablets, and usually you don't tell the receiving department what you are receiving, you ask them to inspect it to make sure that they count, and we did receive the five tablets, at this point the accounting department would review all the paperwork, and what they would do is they will, they are ready to pay, now we are ready to pay, because it's a legitimate purchase, notice the acquisition department is separate from the purchasing department, the purchasing department is separate from the supplier, the supplier is separate from the receiving, so all these are independent parties going through the same transaction, so there's some internal control here by default because you cannot steal unless all these individuals they kind of collude together, the accounting department would review everything, and usually in the real world what's happening these days is all of this is automated, so the receiving department they will go in and they will, you know, once they receive it they will input in the computer that we receive the order, then it updates the voucher system, so everything is electronic, but here I'm showing you the paperwork because it's easier to understand, so once we receive all these four documents, we, the accounting department will put everything together, they will update the record, they say we have a liability and they will send, they will send it to the cashier, the cashier one more time, they would look at everything, make sure everything looks good, then we write a check to apple for the five tablets, so this is what a voucher system is, so as I was saying earlier, if you're an auditor, what happened is, for example, let's assume we paid apple 5,250, let's assume that's the total check, what we do is, as an auditor, you have to go back and I have to check everything, make sure all the paperwork is in order, and the company that followed the internal control that they were supposed to this is part of auditing a company, so controlling the cash payment is very, very important, now there are more controls that you can implement in this process, but it's beyond the scope of the scores, I'm just planting the seed down the road, if you are studying audit, this topic is very important, now in the next session what we'll look at is, when you disperse money, actual money, petty cash, rather than in a check, so sometimes you make payments with petty cash, not check, we'll take a look at this in the next session, as always, please like my recording if you like them, subscribe, share them, and if you're looking for additional material, please visit my website, study hard, and please, please, please stay safe in these corona days, good luck