Chapter Four Internal Control and Cash

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Chapter Four Internal Control and Cash
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Sarbanes-Oxley Act (SOX)

• In 2001-2002, several serious accounting scandals
  in which people lost millions of dollars
• Enron
• WorldCom
• In response to the public outcry, SOX was passed
  in 2002 in order to improve corporate governance.
• Public Company Accounting Oversight Board (PCAOB)
• Restricted consulting services
• Internal control report by companies/auditors
• Increased penalties
• For more information, visit
• www.aicpa.org/info/sarbanes_oxley_summary.htm

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Internal Controls

• Goals of Internal Controls
• Safeguarding assets
• Encouraging adherence to company policies
• Promoting operational efficiency
• Ensuring accurate and reliable accounting records
  
• Comply with legal requirements

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Internal Controls

• Internal Control Procedures
• Competent, reliable, and ethical personnel
  furthermore, should treat employees well
• Assignment of duties specific positions in
  charge of specific functions
• Separation of duties separate (1) operations and
  accounting (2) asset custody and accounting
• Proper use and design of documents
  pre-numbered, easy to understand
• Control access to assets and records (Physical
  Control) security cameras, storing records
  off-site

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Internal Controls

• Audit
• An examination by an outside party of a companys
  financial statements, accounting systems, and
  internal controls
• External Auditor
• Independent does not work for the company
• Must be a CPA
• Internal Auditor
• Employee of the business
• Need not be a CPA

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Internal Controls Issues

• Collusion effort by 2 or more employees to
  override the system
• No system is fool-proof
• Need to rely upon the honesty and ethical
  behavior of all employees
• Benefits gt Costs to implement
• Many small businesses may not reach this
  threshold
• If Benefits lt Costs for certain controls, the
  day-to-day involvement of the owner and others in
  the businesss operations is critical
• Make sure that the complexity of the system does
  not hurt the businesss efficiency and/or
  customer relations

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Internal Control Cash Focus

• Why the emphasis on cash?
• Very liquid
• A very easy target of theft and/or fraud
• More controls over cash less temptation
• Important to deposit in bank account (as a
  control), but should also reconcile between the
  company and banks records

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Bank Reconciliation

• Bank account keeps track of balance of Cash in
  a particular account
• Accounting records keep track of balance of
  Cash account (think of your checkbook balance)
• Companies need to reconcile the value of cash per
  the bank account and per company records in order
  to determine the actual cash balance.
• Protects against bank errors
• Safeguard against errors and/or embezzlements by
  company employees
• Helps determine the correct cash balance which
  should be displayed in the companys accounting
  records/financial statements

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Bank Reconciliation

• Key Think about what the company has recorded
  that the bank does not know about, and what the
  bank has recorded that the company does not yet
  know about.

Study Exhibit 4-7 for the format of a bank
reconciliation.
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Bank Reconciliation

• Items recorded by the company, but not the bank
• Deposits in Transit (add to bank)
• Outstanding Checks (subtract from bank)
• Errors made by the bank (add/subtract from bank)
• Items on the bank statement, but not yet recorded
  by the company
• Bank Collections (add to book)
• Electronic Fund Transfers (EFTs) (add/subtract to
  book)
• Service Charges (subtract from book)
• Interest Revenue earned on account (add to book)
• Non-Sufficient Funds (NSF) Checks (subtract from
  book)
• Errors made by the company (add/subtract to book)

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Bank Reconciliation

• Compute the Adjusted Bank Balance
• Begin with the balance per the bank statement
• Add or subtract items that the company knows
  about, but which are not known by the bank
• Compute the Adjusted Book Balance
• Begin with the balance per company records
• Add or subtract items which are known by the
  bank, but which are not yet known by the company
• At the end of the reconciliation process, the
  Adjusted Bank Balance and Adjusted Book Balance
  should be equal.

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Preparing the Bank Reconciliation-Example

• BAL PER BANK 325
• ADD DEPOSITS
• IN TRANSIT 125
• DEDUCT
• OUTSTANDING
• CHECKS ( 75)
• ADJ BANK
• BALANCE 375

• BAL PER BOOKS 350
• ADD BANK
• COLLECTIONS 325
• INTEREST 50
• DEDUCT RETURNED
• ITEMS (200 )
• EFT PMTS (110 )
• BANK FEES -
• SERV CHG (15 )
  
• PRINT CK CHGS ( 25 )
• ADJ BOOK BAL 375

AMOUNTS ARE IN AGREEMENT
Example is from T. Evans (2006)
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Accounting for Transactions from the
Reconciliation

• BAL PER BOOKS 350
• ADD BANK
• COLLECTIONS 325
• INTEREST 50
• DEDUCT RETURNED
• ITEM NSF (200)
• EFT PMTS (110 )
• BANK FEES -
• SERV CHG (15 )
  
• PRINT CK CHGS ( 25 )
• ADJ BOOK BAL 375

• THESE ITEMS NEED TO BE RECORDED IN THE COMPANY
  ACCOUNTS
• These are items that the company does not yet
  know about.

Example is from T. Evans (2006)
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Internal Controls Cash

• Petty Cash
• Minor amounts
• Need to keep records of how cash is spent
• Can be over-used still need control
• Payments by Check
• Purchase requests, purchase orders, receiving
  report
• Often are exceptions for smaller items (P
  Cards)
• Cash Receipts
• Lockbox system
• If by mail, the checks and remittance advices
  should ideally be separately entered

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Cash Budget

• Even though companies use accrual accounting, it
  is still essential to have sufficient cash in
  order to run operations and maintain certain
  expenses
• Need an idea of the cash inflows and outflows
• Additional financing needed if insufficient
  inflows
• If excess cash, this is often invested to
  generate additional revenue

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Cash Budget

• A budget is a plan of a business activities,
  which is expressed in dollars.
• Cash Budget
• Cash balance, beginning
• Budgeted cash receipts
• - Budgeted cash payments
• Expected cash balance, ending

Refer to Exhibit 4-13 for a detailed example of a
cash budget.
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Cash on the Financial Statements

• Cash is reported on the Balance Sheet
• The account Cash generally includes Cash and
  Cash Equivalents
• Petty Cash
• Cash in checking accounts
• Cash in savings accounts
• Certificates of Deposit (CDs)
• Time Deposits

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Questions?

• Any questions or concerns?