CHAPTER FIVE

ACCOUNTING FOR CASH

Cash is any medium of exchange that a bank will accept at face value, such as: coins, paper
money, currency, checks, bank deposit, money orders, bank drafts, Bankers’ acceptance,
Certificate of Deposit, traveler's checks, and the charge slips signed by customers using bank
credit cards, such as VISA and master card etc.
Cash is listed first in the balance sheet, because it represents resources that can be used
immediately to pay any type of obligation.
Cash equivalents are short term investment and they are liquid. Example- Treasury bills,
commercial paper, Certificate of Deposit, Bankers’ acceptance, Repurchase Agreements (Repo),
money market fund, and so on. Not all short - term investments are viewed as cash equivalents.
Investments in stocks and bonds, for instance, are not considered cash equivalents. Such
investments appear in the balance sheet as "Marketable securities" which usually is listed
second among the current assets.
6.1 Internal control over cash
Due to the reason that cash is the most likely transportable, easily hidden and used improperly by
employees, it is therefore necessary that cash be effectively safeguarded by a special control.
Internal control is especially needed to prevent fraud and theft relating to cash transaction. Cash
is high in value, but light in weight and small in bulk - hence cash needs a strong control.
Need for cash controls: Control over cash is important because:
1. Cash is the one asset that is readily convertible in to any other type of assets.
2. It is easily conceded and transported
3. It is highly desired
4. It affects large volume of transaction, because of these characteristics; cash is the asset most
susceptible to improper diversion and use. Therefore, to safeguard cash & assure the accuracy of
the accounting records for cash, effective internal control over cash is imperative.
The major steps in establishing internal control over cash include the following
1) Establishment of responsibility, 2) Segregation of Duties, 3) Documentation procedures,
4) Physical control, 5) Independent internal verification. Further explanations are the followings:
1. Separate the function of handing cash from the maintenance of accounting records. Employees
who handle cash should not have access to the accounting records, and accounting personnel
should not have access to cash.
2. Prepare a control listing of cash receipts at the time and place the money is received. For cash
sales, this listing may be a cash register tape, created by ringing up each sale on a cash register.

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For checks received through the mail, a control listing of including checks should be prepared by
the employee assigned to open the mail.
3. Require that all cash receipts be deposited daily in the bank.
4. Make all payments by check. The only exception should be for small payments to be made in
cash from a petty cash fund. Payments should never be made out of cash receipts. Checks
should never be drawn payable to cash. A check drawn to a named payee requires endorsement
by the payee on the back of the check before it can be cashed or deposited. This endorsement
provides permanent evidence identifying the person who received the funds. On the other hand, a
check payable to cash can be deposited or cashed by anyone.
5. Require that the validity and amount of every expenditure be verified before a check is issued
in payment.
6. Separate that the function of approving expenditures from the function of signing checks.
It is necessary to safeguard cash effectively because of the ease with which it can be transferred.
The two controlling devices for controlling cash are: a) The bank account and b) Petty cash
a. The bank account
It is one of the major devices for maintaining control over cash. To get the most benefit from the
bank account, all cash received must be deposited in the bank and all payments must be made by
checks drawn on the bank or from special cash funds. When such system is strictly followed,
there is a double record of cash, one maintained by the business and the other by the bank. In
some cases a bank may require a business to maintain a minimum cash balance called
compensating balance. This requirement is generally imposed by the bank as a part of a loan
agreement or line of credit (an amount the bank is willing to lend).
Forms used in a bank account
A) Signature card: At the time account is opened, an identifying number is assigned to the
account which is used for verification. The depositor will sign on. It is a written check.
B) Deposit ticket (slip): Used by the business as a receipt to record the cash deposit. A copy is
given by the bank to the depositor.
C) Check: is a written document signed by the depositor, ordering the bank to pay a sum of
money to an individual or business entity (to the order of a designated person). Three parties
involved in a check:
1) Maker (drawer): The one who signs the check.
2) Payer (drawee): the bank on which the check is drawn.
3) Payee: the one (party) to whom payment is made. Is the one (party) to whose order the
check is drawn.
Make check payee check Bank

Money

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Check register: A modified form of the cash payment journal used to record all transaction paid
by check. Usually in a check the address and the name of the depositor are printed.
D) Record the checks drawn: A memorandum record of the basic details of a check should be
prepared at the time the check is written. Business firms may prepare a copy of each check
drawn and then use it as a basis for recording the transaction in the cash payment journal.
Checks issued to a creditor on account are usually accompanied by a notification of the specific
invoice that is being paid. The purpose of such notification, sometimes called a remittance
advice, is to make sure that proper credit is recorded in the accounts of the creditor.
Bank statement
Bank statement is the monthly statement send by the bank to the depositor. The bank statement
usually indicates the beginning and ending cash balance of the depositor in the bank and the
monthly transaction (additions and deductions). It also includes cancelled checks (paid checks)
and which the bank has make payment on behalf of the depositor. It also includes the deposits
made by the depositor and other thing.
6.2 Bank reconciliation
Bank reconciliation is a schedule explaining any difference between the balance shown in bank
statement and the balance shown in the company or depositor's account (cash ledger of the
depositor). At the end of each month, the depositor should prepare bank reconciliation to verity
that these independent sets of records are in agreement. For strong internal control, the employee
who reconciles the bank statement should not have any other responsibilities for cash.
It might seem that the two balances should be equal but they are not likely to be equal on any
specific date because of the following:
a) Items recorded by the company but not yet recorded by the bank.
1) Deposit in transit: is the deposit that the Depositor has recorded but not recorded by
the bank.
2) Outstanding checks: These have been issued by the company and recorded on its
book but have not yet been paid by the bank.
b) Items recorded by the bank only.
1) Bank collection: notes receivable and interest accrued on notes receivable may be
collected by the bank. The bank will notify (remind) the amount of collection whenever the
bank is sending the bank statement to the depositor.
2) Service charge: the amount of banks fee for processing check. The bank will notify when
the bank provides the bank statement to the depositor.
c) Not sufficient fund (NSF) received from customer.
d) Interest revenue on checking account.
e) Checks collected, deposited and returned to payee by the bank for reason other than NSF

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The bank return checks to the payee because: If the maker account has closed, if the signature is
not authorized, if the check form is improper, if the check has been altered. Accounting for all
returned check is the same for NSF.
f) The cost of printing check.
g) Error by either the company or the bank or both.
E.g. 1) a check written for $225 is drawn by the bank as $252.
2) A check written for $225 is journalized by the depositors as $522 that will understate the cash
ledger balance of the depositor.
A/p…………………………………….522
Cash……………………………………………522
To record the balance of cash:
Cash……………………………………..297
A/p………………………………………………297
Bank credit memorandums: are additions by bank not recorded by depositor. They are traced
to the cash receipt journal that can be added to the balance according to depositor’s record.
Bank debit memorandums: are the deductions by bank not recorded by the depositor. They are
traced to the cash payment journals that have to be deducted from the balance according to
depositor’s record.
Format for bank reconciliation
XXX Company
Bank Reconciliation
Sep.30, XXXX
Bank balance according to bank record ………………………………………………………..xxx
Add: Additions of depositor not on bank statement (deposit in transit) .....................................xxx
Bank error that under state bank balance ………………….……………………………..xxx
Subtotal …………………………………………………………………………………….….xxx
Deduct: deduction by the depositor not by bank (outstanding Checks ………………………..xxx
Bank error that overstate bank balance …………………………………………………..xxx
Adjusted cash balance……………………………………………………………………….. xxx

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Bank balance according to depositor records…………………………………………………..xxx
Add: additions by bank not recorded by depositor (credit memorandum: Notes &interest
collection, interest revenue on checking accounts) ………………………………………….....xxx
Depositor error that understate the depositor cash ledger balance…………….………..xxx
Subtotal……………………..…………………………………………………………………xxx
Deduct: Deduction by bank not recorded by the depositor (Debit memorandum:
NSF checks, service charges) ……………………………………….…………………………xxx
Depositor error that overstate cash ledger balance………………………………………..xxx
Adjusted cash balance………………………………………………………………………...xxx
For instance
The bank statement for ABC Company indicates a balance of $3359.78 as of July 31, 2013. The
balance in cash in ABC Company ledger of same date is $2549.99.
Additional information:
-Deposit of July 31, not recorded on bank statement --------816.20
-Outstanding checks: #812-----------1061.00, #878-----------435.39, #883----------48.60
-Note plus interest of $8 collected by bank (credit memorandum) not recorded in cash receipt
journal -------408.00.
-Bank service charge (debit memorandum) not recorded in cash payment journal is 18.00
-Check #879 for $732.26 to “X”company on account, recorded in cash payment journal as
$723.26.
-NSF checks is $300.00
Instruction
a) Prepare bank reconciliation.
b) Journalize the necessary journal entries.

Solution:

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A) Bank reconciliation
ABC Company
Bank reconciliation
July 31, 2013
Cash balance according to bank record ----------------------------------------------------------- 3359.78
Add: Additions of depositor not on bank statement (deposit in transit) ----------------------- 816.20
Deduct: outstanding Checks ------#812------------------- 1061.00
#878------------------ 435.39
#883------------------- 48.60 ----------------------------1544.99
Adjusted cash balance ---------------------------------------------------------------------------- 2630.99
Cash balance according to depositor records------------------------------------------------------2549.99
Add: additions by bank not recorded by depositor (Note plus interest collection) ---------- 408.00
Subtotal----------------------------------------------------------------------------------------------2957.99
Deduct: NSF checks----------------------------------------------------------------300.00
Service charge------------------------------------------------------------18.00
Depositor error that overstate cash ledger balance-------------------9.00 ----------- 327.00
Adjusted cash balance------------------------------------------------------------------------------2630.99
B) Journal entries
July 31/ Cash----------------------------------408.00
Notes receivable---------------------------------------400.00
Interest revenue-----------------------------------------8.00
Accounts payable------------------300.00
Cash ------------------------------------------------300.00
Miscellaneous administrative expense-----18
Cash--------------------------18.00
Accounts payable -----------------------------9.00
Cash-----------------------------------------------------9.00

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6.3 Petty cash and change fund
Petty cash is the small fund used to make payment for small expenditures. There are three steps
involved in the operation of the petty cash.
1) Establishing the petty cash
2) Making payment from the petty cash.
3) Replenishing (reimbursing) the petty cash.
1) Establishing the petty cash: in establishing the petty cash fund, the first step is to estimate
the amount of cash needed for disbursement of relatively small amounts during certain period,
such as week or a month and appointing the petty cash custodian, the one who is responsible for
the operation of the petty cash fund and for making disbursements from the petty cash fund.
Checks payable to the petty cash fund custodian will be issued.
Petty cash-------------------------------------------------- xxx
Cash in bank---------------------------------------------------------- xx
No entry will be made to the petty cash account unless the petty cash fund is changed (increased
or decreased).
2) Making payment from the petty cash:
Petty cash receipt: The employee who request for payment and the petty cash
custodian will sign on it. The petty cash custodian will make payment for the
specified employee who request disbursement.
NB: No journal entry will be made at the time of disbursement (payment) from the
petty cash fund.
The balance of petty cash fund = Amount in the petty cash receipt + cash in bank
3) Replenishing (reimbursing) the petty cash: When the money in the petty cash fund
reaches a minimum level the fund is replenished (reimbursed). Replenishing the petty cash
fund restores to its original amount. The request for this is initiated by the petty cash
custodian. The custodian will provide the summery of the petty cash payment with the
petty cash receipt to the treasurer .Then the treasurer approves the request and check is
prepared to restore the fund to its established amount.
Journal entry will be made to restore the petty cash fund to previously established amount and to
record all expenditures.
Example: If “X” company desires to establish a $100 fund on August 1, the entry will be
August 1/ Petty cash-----------$ 100 If voucher system is used
Cash in bank--------------100 Petty cash............... $ 100
A/P……………………. 100
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 If check is drawn to pay a voucher
A/p…………...... $ 100
Cash in bank……….. 100
Assume that on August 31, the petty cash custodian request check number 3 for $87. The fund
contains $13 cash and petty cash receipt for postage expense $44, freight in, $38 and
miscellaneous expense, $5.
The entry to record the replenishment on August 31 will be: If voucher system is used
August 31/ Postage expense------------44 Postage exp. ………. $ 44
Freight in--------------------38 Freight in ………….... 38
Miscellaneous exp. -------- 5 Misc. exp. …………… 5
Cash in bank------------------87 A/p …………………. 87
If check is drawn to pay a voucher
A/P ………………… $ 87
Cash in bank ……….. 87
Cash change Fund
Retail stores of other business that receive cash directly from customers must keep some
currency & coins on hand in order to make change. This cash is recorded in a cash change fund
account.
- Accounting procedures in relation to change fund:
A- Check is drawn for the required amount
B. Journal entry is made to record the change fund establishment
Cash on hand -----------------------------xxx
Cash in Bank--------------------------------xxx
- Note that no additional changes or credits to the cash on hand account are necessary unless the
amount of fund is increased or decreased. The total amount of cash received during the day is
deposited, and the original amount of the change fund is retained.
Cash short and over
The amount of cash actually received during a day often does not agree with the record of cash
receipts. Whenever there is difference b/n the record and the actual cash and no error can be
found in the record, it must be assumed that the mistake occurred in making change. The cash

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shortage or overage is recorded in an account entitled cash short & over. - The common method
for handling such mistake such as,
A. In the cash receipt journal a cash short & over column in to which all cash shortages are
entered, which means there is a debit balance at the end of fiscal period, so it is an expense and it
is miscellaneous administrative expense in the income statement.
Example - Assume that the total cash sales for the day amount to Birr 2,500 as recorded by the
cash registered, but the cash drawer then counted amounts of only Birr 2,480 for ABC Company
- This shows there is cash shortage of Birr 20 determined as follow:-
* Cash collections as per records birr--------------------2,500
* Actual cash available on hand birr---------------------2,480
Cash shortage --------------------------------------------- 20
Entry: Cash ------------------------------------------------ 2,480
Cash short & over----------------------------------- 20
Sales ------------------------------------------------------2,500
B. In the cash receipt journal as cash short & over column in to which all cash overage are
entered which means there is a credit balance at the end of the fiscal period, so it is revenue and
it is treated as other income sections of income statement.
Example - during January 2 through January 20 total cash sales amount to 5,600 birr as per the
cash register, but that the cash on hand was counted to be birr 5,700 & the overage of birr 100 is
computed as follow:-
Cash on hand ------------------------- birr 5,700
Cash as per records -----------------------5,600
Cash overage --------------------------------100
Entry Cash ----------------------------------5,700
Sales --------------------------------------- 5,600
Cash short & over-------------------------- 100

The Voucher System:-

A Voucher system is made up of records, methods, and procedures used in proving and
recording liabilities and in making and recording cash payments. A voucher systems uses (1)
Vouchers, (2) a voucher register, (3) a file for unpaid voucher (unpaid voucher file), 4) a check
register, and (5) a file for paid vouchers (paid voucher file.
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Voucher means any document that serves as proof of authority to pay cash, such as an invoice
approved for payment or as evidence that cash has been paid, such as a canceled check. A
voucher is a special form on which is recorded relevant data about a liability and the details of its
payment. The basic idea of this system is that every transaction that will result in cash
disbursement must be verified, approved in writing, and recorded before a check is issued. A
voucher is a written authorization form prepared for each expenditure. The following steps are
invoiced under the voucher system
1- preparation of a voucher
2- approval of the voucher
3- recording the voucher
4- filing the unpaid voucher
5- paying the voucher
1- Preparing the voucher: - A voucher form is used for all expenditures, except those from
petty cash. A voucher is normally prepared in the accounting department by an accounting
payable clerk and is based on invoice or other supporting documents. The following
comparisons and verifications have been completed and noted on the invoice:
1- Comparison of the invoice with a copy of the purchase order to verify quantities,
prices, and terms.
2- Comparison of the invoice with the receiving report to verify receipt of the items
billed.
3- Verification of the arithmetical accuracy of the invoice.
2- Approval of the voucher:- After the voucher has been prepared, the invoice or
Other supporting evidence is attached to the voucher. The voucher is then given to the
proper official for approved.
3- Recording of the voucher: - After a voucher has been approved, it recorded as credit to
account payable and a debit to the appropriate account or accounts in a voucher register.
4- Filing the unpaid voucher: - After the voucher is recorded, it is filed by date of payment in
an unpaid voucher file (sometime called a ticker file). This method of filling facilitates the
payment of bills within due date.
5- Paying the voucher: - On the due date, the voucher is removed from the tickler file and
forwarded to cash disbursements section. The employee prepares (but does not sign) the
check, insert relevant data in the payment summary of the voucher and transfers the unsigned
check and voucher to the finance department for signature. After signing the check signor
then:
1- Mails the check to the payee
2- Stamps (or marks) the voucher and supporting documents “paid” to prevent them
from being submitted again for payment.
3- Sends the “Paid” voucher and a copy of the check to accounting division
Note: - A voucher system not only provides effective controls over cash payments but also aids
management in fulfilling its responsibilities.

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