Correct Option: B. When the fund is established and every time it is replenished
Detailed Explanation:
- Understanding Petty Cash:
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A petty cash account is a small fund of cash kept on hand to pay for minor expenses that arise in the course of business operations. This could include things like office supplies, postage, or small repairs.
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Establishing the Fund:
- When a petty cash fund is first established, the company needs to record this transaction in its accounting system. This is done by debiting the petty cash account and crediting the cash or bank account from which the petty cash is drawn.
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Example: If a company establishes a petty cash fund of $500, the journal entry would be:
- Debit Petty Cash $500
- Credit Cash/Bank $500
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Replenishing the Fund:
- Over time, as petty cash is used to pay for various small expenses, the cash balance in the petty cash fund will decrease. To maintain the fund at its established level (the "float"), the company will need to replenish it.
- When replenishing the petty cash fund, the company will again debit the petty cash account to bring it back to the original amount. The expenses paid out of petty cash will be recorded in the appropriate expense accounts (like Office Supplies Expense, Travel Expense, etc.), and the cash account will be credited.
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Example: If $300 has been spent from the petty cash fund, the replenishment entry would be:
- Debit Petty Cash $300
- Credit Cash/Bank $300
- Additionally, you would debit the relevant expense accounts for the amounts spent.
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Why Other Options Are Incorrect:
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Option A: "When the fund is established and every time money is spent"
- This option is incorrect because while the fund is established, the petty cash account is not debited every time money is spent. Instead, the expenses are recorded in their respective accounts, and only the replenishment of the fund involves debiting the petty cash account.
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Option C: "When the fund is established and when the size of the float is decreased"
- This option is misleading. The petty cash account is not debited when the size of the float is decreased. Instead, it is debited when the fund is established and when it is replenished to its original amount. Decreasing the float would typically involve a credit to the petty cash account, not a debit.
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Option D: "Every time money is drawn from the petty cash"
- This option is incorrect because the petty cash account is not debited every time money is drawn. Instead, the petty cash account is only debited when the fund is established and when it is replenished. Each withdrawal is recorded as an expense, not as a debit to the petty cash account.
Common Pitfalls:
- Confusing Petty Cash with Expense Accounts: Remember that while petty cash is used to pay for expenses, the actual expenses are recorded separately in their respective accounts.
- Not Replenishing on Time: Failing to replenish the petty cash fund can lead to cash shortages and disrupt operations.
- Misrecording Transactions: Ensure that every transaction involving petty cash is accurately recorded to maintain proper financial records.
Revision Summary:
- A petty cash account is debited when the fund is established and when it is replenished.
- Replenishment involves debiting the petty cash account and crediting the cash account.
- Expenses paid from petty cash are recorded in their respective expense accounts, not in the petty cash account.
- Understanding the flow of transactions is crucial for accurate financial reporting.