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🔹 Bank Reconciliations: Bank Side Adjustments (4 total)
🧠Key Items to Memorize:
- âś… The direction of adjustment: whether to ADD to or DEDUCT from the Bank Balance.
- đź’Ż Exam Pro Tip: Journal Entries are NEVER required for Bank Side Adjustments!
- Journal entries aren’t needed for bank side adjustments because they correct the bank's records, which is the bank's responsibility, not the company's.
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- What it means: Amounts received and recorded by a company, but not yet recorded by its bank.
- Example 1: A company deposits a check from a customer on the last day of the month; it shows on the next month's bank statement.
- Example 2: A company makes a cash deposit in the bank's night depository after banking hours on the last day of the month, which the bank does not record until the next business day.
- ✅ How it’s handled on Bank Reconciliation: Always ADDED to Bank Side
- ❌ No Journal Entry Required!
- Never Record Journal Entries for Bank Side Adjustments! Journal entries are not required for bank side adjustments because they are errors made by the bank and not the company's accounting records.
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- What it means: Checks issued by a company not yet cleared by the bank. Outstanding checks always refer to expenses we’re paying for, not a check received from a customer that we will deposit.
- Example 1: A company writes a check to a supplier, but the supplier hasn’t cashed it by the statement date.
- Example 2: An employee is issued a payroll check at the end of the month, which they do not cash until the following month, leaving it outstanding at the statement date.
- ✅ How it’s handled on Bank Reconciliation: Always DEDUCTED from Bank Side
- ❌ No Journal Entry Required!
- Never Record Journal Entries for Bank Side Adjustments! Journal entries are not required for bank side adjustments because they are errors made by the bank and not the company's accounting records.
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- What it means: Bank errors in depositing can occur if the bank records a deposit amount incorrectly.
- Example 1: If the bank records a deposit of $500 as $50, the discrepancy of $450 is added to the bank side once the error is identified.
- Example 2: Conversely, if a $50 deposit is recorded as $500, the excess $450 is subtracted from the bank side to rectify the mistake.
- Example 3: Should the bank erroneously deposit $100 into your account, this amount is subtracted from the bank side once the bank reverses the transaction.
- ✅ How it’s handled on Bank Reconciliation: Either ADDED or DEDUCTED on the bank side, depending on the error.
- âś… Approach Tip: Treat the bank's error as if it occurred in your personal bank account; the bank would rectify it by either adding or subtracting the error amount!
- ❌ No Journal Entry Required!
- Never Record Journal Entries for Bank Side Adjustments! Journal entries are not required for bank side adjustments because they are errors made by the bank and not the company's accounting records.
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- What it means: Bank errors in withdrawals can occur if the bank records a withdrawl amount incorrectly.
- Example 1: If the bank records a withdrawl of $500 as $50, the discrepancy of $450 is subtracted to the bank side once the error is identified.
- Example 2: Conversely, if a $50 withdrawal is recorded as $500, the excess $450 is added back to the bank side to rectify the mistake.
- Example 3: Should the bank erroneously withdraw $100 from your account, this amount is add to the bank side once the bank reverses the transaction.
- ✅ How it’s handled on Bank Reconciliation: Either ADDED or DEDUCTED on the bank side, depending on the error.
- âś… Approach Tip: Treat the bank's error as if it occurred in your personal bank account; the bank would rectify it by either adding or subtracting the error amount!
- ❌ No Journal Entry Required!
- Never Record Journal Entries for Bank Side Adjustments! Journal entries are not required for bank side adjustments because they are errors made by the bank and not the company's accounting records.
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🔹 Bank Reconciliations: Book Side Adjustments (7 total)
🧠Key Items to Memorize:
- âś… The direction of adjustment: whether to ADD to or DEDUCT from the Book Balance.
- âś… The necessary journal entry for each type of adjustment.
- đź’Ż Exam Pro Tip: ADDING an adjustment to the book balance always involves a DEBIT to cash, while DEDUCTING from the book balance always involves a CREDIT to cash.
- When adjusting your book balance, you're updating the actual cash account in your books. Since cash is an asset (+/-), debits increase its balance and credits decrease it.
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- What it means: Fees charged by the bank for account maintenance or specific transactions which have not been recorded in the company's book.
- ✅ How it’s handled on Bank Reconciliation: Always DEDUCTED from book balance.
- âś… Journal Entry is Required!
You discover a bank service charge of $35 on your bank statement. This was previously unrecorded by the company.
Fee Expense 35
Cash 35
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- What it means: A check received by a company is returned by the bank due to the customer’s lack of funds, and no fee is charged by the bank for the returned check.
- ✅ How it’s handled on Bank Reconciliation: Always DEDUCTED from book balance, as the original check receipt entry is reversed.
- âś… Journal Entry is Required!
An NSF check from a customer was returned for $100. The bank charged no fee for this bounce. This was previously unrecorded by the company.
NSF Check Entry:
Accounts Receivable 100
Cash 100
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- What it means: A check received is returned due to insufficient funds, and the bank also charges a fee for processing the returned check.
- ✅ How it’s handled on Bank Reconciliation: Deduct the amount of the check AND the fee from the book balance.
- âś… Journal Entry is Required!
An NSF check from a customer was returned for $100. Your bank charged a $10 fee for this bounce. This was previously unrecorded by the company.
NSF Check Entry:
Accounts Receivable 100
Cash 100
NSF Fee Entry:
Fee Expense 10
Cash 10
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- What it means: A check is returned for insufficient funds; the bank charges a fee, and the company decides to charge this fee to the customer.
- ✅ How it’s handled on Bank Reconciliation: Always DEDUCT the amount of the check AND the fee from the book balance. You will increase accounts receivable for both the NSF check and the NSF fee charged back to the customer.
- âś… Journal Entry is Required!
An NSF check from a customer was returned for $100. Your bank charged a $10 fee for this bounce. You pass the fee to your customer. This was previously unrecorded by the company.
NSF Check Entry:
Accounts Receivable 100
Cash 100
NSF Fee Entry:
Accounts Receivable 10
Cash 10
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- What it means: The bank adds interest to the company's account, increasing the balance.
- ✅ How it’s handled on Bank Reconciliation: Always ADD to book balance.
- âś… Journal Entry is Required!
Your bank credited interest of $50 to your account. This was previously unrecorded by the company.
Cash 50
Interest Revenue 50
From a bank's perspective... why is a deposit to your account called a credit?
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A bank is crediting their own cash to deposit into your account. Cash is an asset (+/-), so they credit (reduce) their cash to put it into your account! This is common with a savings account, where interest is added every month.
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- What it means: The bank has charged interest, decreasing the account balance.
- ✅ How it’s handled on Bank Reconciliation: Always DEDUCT from book balance.
- âś… Journal Entry is Required!
Your bank debited interest of $50 to your account. This was previously unrecorded by the company.
Interest Expense 50
Cash 50
From a bank's perspective... why is a withdrawal from your account called a debit?
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A bank is debiting their own cash when they take money from your account and add it to theirs! Cash is an asset (+/-), so they debit (increase) their cash to remove it from your account! This is common if you take out a loan or line of credit, where interest is deducted every month.
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- What it means: The bank collects a note receivable on the company's behalf, adding the amount to the company's account.
- ✅ How it’s handled on Bank Reconciliation: Always ADD to book balance.
- âś… Journal Entry is Required!
Your bank collected a $1000 note on your behalf. This was previously unrecorded by the company.
Cash 1000
Note Receivable 1000
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A check for $321 was processed correctly by the bank. The company recorded this purchase for advertising expense incorrectly in the amount of $231.
3 Step Process for Correcting Book Side Errors:
- ✅ How it’s handled on Bank Reconciliation: Either ADDED or DEDUCTED from the Book Balance. It depends on the error.
- âś… Journal Entry is Required! (See STEP 3 in this example for the required entry.)
STEP 1: Write out the error entry with the incorrect amount.
Advertising Expense 231
Cash 231
STEP 2: Write out the correct version of the entry — i.e. what it should look like.
Advertising Expense 321
Cash 321
STEP 3: Compare the two entries. Record the necessary adjustment that fixes the error.
Advertising Expense 90
Cash 90
Explanation
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The correct amount that should have been recorded was $321. This means the company underreported its expense by $90 ($321 - $231 = $90). To correct the error, we need to increase the advertising expense by the difference, which is $90. This is done by debiting the Advertising Expense account. Since this expense was paid in cash, we'll also need to credit the Cash account by the same amount to show a reduction in cash. The reason we're debiting Advertising Expense and crediting Cash is to reflect the additional cash outflow of $90 that wasn't captured initially.
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A check for $231 was processed correctly by the bank. The company recorded this purchase for advertising expense incorrectly in the amount of $321. 3 Step Process for Correcting Book Side Errors:
- ✅ How it’s handled on Bank Reconciliation: Either ADDED or DEDUCTED from the Book Balance. It depends on the error.
- âś… Journal Entry is Required! (See STEP 3 in this example for the required entry.)
STEP 1: Write out the error entry with the incorrect amount.
Advertising Expense 321
Cash 321
STEP 2: Write out the correct version of the entry — i.e. what it should look like.
Advertising Expense 231
Cash 231
STEP 3: Compare the two entries. Record the necessary adjustment that fixes the error.
Cash 90
Advertising Expense 90
Explanation
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In contrast to the previous example, here the company overrecorded its advertising expense by $90. To correct this, we need to decrease the advertising expense by the difference of $90. This is done by crediting the Advertising Expense account. Simultaneously, since the company initially reported an excessive cash outflow, we'll need to debit the Cash account by $90 to show an increase in the cash balance. This restores the Cash account to its correct position by reflecting the overrecorded cash outflow that did not actually take place.
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🔹 Internal Control Principles (7 total)
📌 To excel in your exams, you will need to become proficient at evaluating hypothetical scenarios concerning seven internal control principles. Here’s how to approach them:
- Identify the Principle: Determine which internal control principle applies to the given situation.
- Assess Effectiveness: Evaluate whether the scenario demonstrates a strong or weak application of the principle.
- Predict Consequences: Think about the potential negative outcomes if the principle is not properly followed. What could happen?
- Understand Prevention: Consider how adhering to the principle can prevent the identified issues.
Mastering these steps is essential for analyzing hypothetical situations on your exams and answering questions correctly. Dig in further below!
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- Explanation: Assign specific tasks to specific individuals to establish clear lines of accountability.
- Purpose/Reasoning: Assigning clear responsibilities helps prevent task overlap and confusion, thereby reducing the risk of errors or misconduct.
- Internal Control Strength Example: Designating a single employee with the sole authority to issue refunds ensures clarity in tracing transactions.
- Internal Control Weakness Example: Sharing the duty of cash handling among several staff without clear individual transaction logs can lead to ambiguity in pinpointing responsibility.
- Internal Control Failure Example: Multiple employees using a common login for a financial system makes it impossible to trace discrepancies back to an individual, leading to potential fraud.
- Prevention through Proper Adherence: Individual logins and access controls would ensure a clear audit trail, deterring fraudulent activities by enabling traceability to an individual.
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- Explanation: Ensure complete and precise recording of financial transactions and asset tracking.
- Purpose/Reasoning: Adequate record-keeping is critical for verifying the integrity of financial information and supporting audit activities.
- Internal Control Strength Example: Utilizing digital time-stamped entries for all transactions ensures a verifiable audit trail.
- Internal Control Weakness Example: Manual entries in logs without immediate digital backup can be susceptible to loss or manipulation
- Internal Control Failure Example: Failing to reconcile bank statements promptly leads to undetected discrepancies caused by fraudulent activities.
- Prevention through Proper Adherence: Timely reconciliation and review of bank statements could quickly highlight discrepancies for investigation and action, minimizing the window for fraudulent activities to go unnoticed.
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- Explanation: Purchase insurance for company assets and fidelity bonds for employees in trust positions to mitigate risks of loss.
- Purpose/Reasoning: This coverage protects the organization’s financial interests and adds a layer of security against theft, fraud, etc.
- Internal Control Strength Example: Key personnel handling large transactions are bonded via insurance policies, providing protection against potential theft.
- Internal Control Weakness Example: Partial coverage of assets and unbonded personnel may leave the organization exposed to risk.
- Internal Control Failure Example: An employee with a history of dishonesty is not bonded, later commits fraud, and the company bears the financial loss.
- Prevention through Proper Adherence: Conducting thorough background checks and insuring key employees would limit the risk of fraud by providing financial security and deterring fraud among staff.
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- Explanation: Delineate the roles between managing assets and maintaining records to avoid conflicts of interest or potential for fraud.
- Purpose/Reasoning: Separation of duties serves as a fundamental check against embezzlement and ensures the integrity of financial data.
- Internal Control Strength Example: A separate accounts team handles ledger entries, while the cashier is responsible for cash transactions.
- Internal Control Weakness Example: A lack of division between handling and recording can give rise to misuse without detection.
- Internal Control Failure Example: An employee embezzles funds by altering the financial records they also maintain, due to a lack of oversight.
- Prevention through Proper Adherence: Enforcing segregation of duties would make it more difficult for an employee to commit and conceal fraudulent activities, as alterations would require collusion and be subject to detection by independent checks.
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- Explanation: Distribute related financial tasks among different individuals or teams.
- Purpose/Reasoning: Division of transactional duties helps prevent fraud by creating a system of mutual oversight and checks.
- Internal Control Strength Example: Different staff members handle order placement, receiving goods, and making payments to suppliers.
- Internal Control Weakness Example: Concentrating transaction authority in one person increases the potential for unchecked errors or abuse.
- Internal Control Failure Example: Unauthorized bonuses are issued to management because a single employee controls payroll processing without sufficient review.
- Prevention through Proper Adherence: Implementation of a multi-person review system for payroll processing would create a system of checks that could detect and prevent unauthorized transactions.
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- Explanation: Leverage advanced software and hardware solutions to secure assets and sensitive data.
- Purpose/Reasoning: Technology, when used effectively, can automate controls and reduce the human error factor.
- Internal Control Strength Example: The use of encryption and two-factor authentication protects sensitive financial information.
- Internal Control Weakness Example: Relying on legacy systems without regular updates can lead to security breaches.
- Internal Control Failure Example: A cyber attack results in data theft because the company neglected to implement recommended security updates and patches.
- Prevention through Proper Adherence: Regular updating and patching of security systems, as well as adherence to technological best practices, would greatly reduce the vulnerability to cyber attacks.
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- Explanation: Carry out periodic and impartial assessments of the internal control system from unbiased third parties.
- Purpose/Reasoning: Regular audits are essential for verifying the operational effectiveness of internal controls and identifying areas for improvement.
- Internal Control Strength Example: Engaging a third-party auditor to perform unannounced financial reviews enhances transparency.
- Internal Control Weakness Example: Predictable or infrequent assessments can result in oversight gaps, complacency, and an environment for potential fraud.
- Internal Control Failure Example: Consistent overstatement of inventory levels goes unnoticed due to a lack of independent review, making it easy for employees to steal inventory unnoticed.
- Prevention through Proper Adherence: Regular, unannounced audits by an independent third party would likely uncover any overstatements of inventory, discouraging theft and identifying discrepancies promptly.
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🔹 Cash & Cash Equivalents
📌 Exam Tip: To ace questions on 'cash equivalents,' students should understand that these are highly liquid assets, meaning they’re easily convertible into cash within 90 days without losing value. Determining their liquidity is essential for classifying them correctly as cash equivalents.
- Cash:
- Physical currency (notes and coins)
- Balances with banks (checking accounts, savings accounts)
- Cash Equivalents:
- Any asset that can be converted into cash quickly without significant penalty or loss in value
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Short-term government securities with a maturity of one year or less, sold at a discount and redeemable at face value upon maturity.
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Investment funds that invest in highly liquid cash and cash equivalent securities with short-term maturities.
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Unsecured, short-term debt instruments issued by corporations, typically used for financing accounts receivable and inventories, with maturities ranging up to 270 days.
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Government debt securities with short-term maturities, usually less than one year, considered safe and liquid.
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Financial instruments that can be quickly converted into cash at a reasonable price, like stocks and bonds, typically with short maturities of 90 days or less.
Items to be excluded from cash equivalents:
- Investments in stocks and bonds (with maturities greater than 90 days)
- Certificates of deposit (with maturities greater than 90 days)
- Any asset that cannot be converted into cash quickly without significant penalty or loss in value
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🔹 Petty Cash Entries
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You establish a Petty Cash fund for $100.
Petty Cash 100
Cash 100
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You decide to increase your Petty Cash fund from $100 to $150.
Petty Cash 50
Cash 50
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You decide to decrease your Petty Cash fund from $150 to $125.
Petty Cash 25
Cash 25
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Your Petty Cash fund is established at an amount of $125. At the end of the month, you see the following receipts from expenses:
Postage: $20
Advertising Expense: $50
Supplies: $10
Prepare the entry to reimburse the Petty Cash fund, assuming $45 remains in the fund.
Postage Expense 20
Advertising Expense 50
Supplies 10
Cash 80
Explanation
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- STEP 1: Determine the “replenishment” amount. Subtract the remaining balance ($45) from the initial fund amount ($125). The result, $80, is how much you need to replenish. This amount is credited to the cash account, indicating payment into the Petty Cash fund.
- STEP 2: Record the expenses. Debit each expense category with the corresponding amount.
- STEP 3: Ensure total debits (expenses) match the credit (cash). If they don't align, your Petty Cash might have discrepancies (shortages or overages). In this example, they match, so there are no short or over amounts in the fund.
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Your Petty Cash fund is established at an amount of $125. At the end of the month, you see the following receipts from expenses:
Postage: $20
Advertising Expense: $50
Supplies: $10
Prepare the entry to reimburse the Petty Cash fund, assuming $55 remains in the fund.
Postage Expense 20
Advertising Expense 50
Supplies 10
Cash 70
Cash Short & Over 10
Explanation
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- STEP 1: Determine the “replenishment” amount. Subtract the remaining balance ($45) from the initial fund amount ($125). The result, $80, is how much you need to replenish. This amount is credited to the cash account, indicating payment into the Petty Cash fund.
- STEP 2: Record the expenses. Debit each expense category with the corresponding amount.
- STEP 3: Ensure total debits (expenses) match the credit (cash). If they don't align, your Petty Cash might have discrepancies (shortages or overages). In this case, a $10 discrepancy was found between expected and actual amounts, which is reflected under "Cash Short & Over”
- HINT: If you need a CREDIT to Cash Short & Over in your entry, it always means your Petty Cash fund was OVER.
- Why? If you had $125 originally in the fund. And you spent a total of $80 on expenses — you should’ve had $45 remaining. Since you had $55 remaining instead, this means your fund was over by $10.
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Your Petty Cash fund is established at an amount of $125. At the end of the month, you see the following receipts from expenses:
Postage: $20
Advertising Expense: $50
Supplies: $10
Prepare the entry to reimburse the Petty Cash fund, assuming $35 remains in the fund.
Postage Expense 20
Advertising Expense 50
Supplies 10
Cash Short & Over 10
Cash 70
Explanation
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- STEP 1: Determine the “replenishment” amount. Subtract the remaining balance ($45) from the initial fund amount ($125). The result, $80, is how much you need to replenish. This amount is credited to the cash account, indicating payment into the Petty Cash fund.
- STEP 2: Record the expenses. Debit each expense category with the corresponding amount.
- STEP 3: Ensure total debits (expenses) match the credit (cash). If they don't align, your Petty Cash might have discrepancies (shortages or overages). In this case, a $10 discrepancy was found between expected and actual amounts, which is reflected under "Cash Short & Over”
- HINT: If you need a DEBIT to Cash Short & Over in your entry, it always means your Petty Cash fund was SHORT.
- Why? If you had $125 originally in the fund. And you spent a total of $80 on expenses — you should’ve had $45 remaining. Since you only had $35 remaining instead, this means your fund was short by $10.
