SarbanesOxley, Internal Control and Cash

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Sarbanes-Oxley, Internal Control and Cash
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After studying this chapter, you should be able
to

• Describe the Sarbanes-Oxley Act of 2002 and its
  impact on internal controls and financial
  reporting.

• Describe and illustrate the objectives and
  elements of internal control.
• Describe and illustrate the application of
  internal controls to cash.

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After studying this chapter, you should be able
to

• Describe the nature of a bank account and its use
  in controlling cash.

• Describe and illustrate the use of a bank
  reconciliation in controlling cash.
• Describe the accounting for special-purpose cash
  funds.

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After studying this chapter, you should be able
to

• Describe and illustrate the reporting of cash and
  cash equivalents in the financial statements.

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8-1
Objective 1
Describe the Sarbanes-Oxley Act of 2002 and its
impact on internal controls and financial
reporting.
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8-1
The Sarbanes-Oxley Act of 2002 (referred to
simply as Sarbanes-Oxley) applies only to
companies whose stock is traded on public
exchanges. Its purpose is to restore public
confidence and trust in the financial statements
of companies.
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8-1
Sarbanes-Oxley requires companies to maintain
strong and effective internal control.
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8-1
Internal control is broadly defined as the
procedures and processes used by a company to
safeguard its assets, process information
accurately, and ensure compliance with laws and
regulations.
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8-1
Effect of Sarbanes-Oxley Act
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8-2
Objective 2
Describe and illustrate the objectives and
elements of internal control.
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8-2
Objectives of Internal Control
To provide reasonable assurance that

• assets are safeguarded and used for business
  purposes,
• business information is accurate, and
• employees comply with laws and regulations.

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8-2
Employee fraud is the intentional act of
deceiving an employer for personal gain.
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8-2
Five Elements of Internal Control
Management is responsible for designing and
applying five elements of internal control to
meet the three internal control objectives.
These elements are

• the control environment,
• risk assessment,
• control procedures,
• monitoring, and
• information and communication.

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8-2
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8-2
Control Environment
A businesss control environment is the overall
attitude of management and employees about the
importance of controls.
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8-2
Factors That Influence the Control Environment

• Managements philosophy and operating style
• The businesss organizational structure
• Personnel policies

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8-2
Control Environment
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8-2
Example of control procedures for an all-night
convenience store

• Locate the cash register near the door, so that
  it is fully visible from outside the store have
  two employees work late hours employ a security
  guard.
• Deposit cash in the bank daily, before 5 p.m.

(Continued)
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8-2

• Keep only small amounts of cash on hand after 5
  p.m. by depositing excess cash in a store safe
  that cant be opened by employees on duty.

• Install cameras and alarm systems.

(Concluded)
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8-2
Indicators of Internal Control Problems
Warning Signs With Regard to People

• Abrupt change in lifestyle.
• Close social relationships with suppliers.
• Refusing to take a vacation.
• Frequent borrowing from other employees.
• Excessive use of alcohol or drugs.

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8-2
Indicators of Internal Control Problems
Warning Signs from the Accounting System

• Missing documents or gaps in transaction numbers.
• An unusual increase in customer refunds.
• Differences between daily cash receipts and bank
  deposits.
• Sudden increase in slow payments.
• Backlog in recording transactions.

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8-2
-
Identify each of the following as relating to (a)
the control environment, (b) risk assessment, or
(c) control procedures.

• Mandatory vacations
• Personnel policies
• Report of outside consultants on future market
  changes

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8-2

• (c) control procedures
• (a) the control environment
• (b) risk assessment

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For Practice PE 8-1A, PE 8-1B
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8-3
Objective 3
Describe and illustrate the application of
internal controls to cash.
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8-3
Control of Cash Receipts
One of the most important controls to protect
cash received in over-the-counter sales is a cash
register.
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8-3
Change Fund
A predetermined amount of money that is given to
each cash register clerk in a cash drawer is
called a change fund.
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8-3
Cash Short and Over
Cash sales for March 19 totaled 3,150.00 per the
cash register tape. After removing the change
fund, only 3,142.00 was on hand.
Mar 19 Cash 3 142 00 Cash Short and Over 8 00
Sales 3 150 00
To record cash sales and actual cash on hand.
Note that the shortage was debited to Cash Short
and Over.
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8-3
Control of Cash Receipts
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8-3
Electronic Funds Transfers
Cash may be received from customers through
electronic funds transfers. Customers may
authorize automatic electronic transfers from
their checking accounts to pay monthly bills.
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8-3
Voucher System
A voucher system is a set of procedures for
authorizing and recording liabilities and cash
payments. It may be either manual or
computerized.
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8-3
A voucher is any document that serves as proof of
authority to pay cash or issue an electronic
funds transfer.
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8-4
Objective 4
Describe the nature of a bank account and its use
in controlling cash.
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Use of Bank Accounts
A major reason that businesses use bank accounts
is for control purposes.
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8-4
Bank accounts provide an independent recording of
cash transactions that can be used as a
verification of the businesss recording of
transactions.
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8-4
Bank Statement
A summary received from the bank of all checking
account transaction is called a bank statement.
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8-4
Bank Statement
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(Continued)
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8-4
Bank Statement
(Concluded)
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Typical credit or debit memorandum entries found
on the bank statement
EC Error correction to correct bank
error. NSF Not sufficient funds
check. SC Service charge. ACH Automated
Clearing House entry for electronic funds
transfer. MS Miscellaneous items.
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8-4
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The following items may appear on a bank
statement

• (1) NSF check
• (2) EFT Deposit
• Service Charge
• Bank correction of an error from recording a 400
  check as 40.

Indicate whether the item would appear as a debit
or credit memorandum on the bank statement and
whether the item would increase or decrease the
balance of depositors account.
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8-4
Appears on the Bank Statement as a Debit or
Credit Memorandum
Increases or Decreases the Balance of the
Depositors Bank Account
Item No.
(1) Debit Memorandum Decreases
(2) Credit Memorandum Increases
(3) Debit Memorandum Decreases
(4) Debit Memorandum Decreases
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For Practice PE 8-2A, PE 8-2B
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8-4
Power Networkings Records and Bank Statement
Power Networking should determine the reason for
difference in these two amounts.
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8-5
Objective 5
Describe and illustrate the use of a bank
reconciliation in controlling cash.
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8-5
A bank reconciliation is an analysis of the items
and amounts that cause the cash balance reported
in the bank statement to differ from the balance
of the cash account in the ledger in order to
determine the adjusted cash balance.
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8-5
Banks records
Companys records
Beginning balance 3,359.78
Beginning balance 2,549.99
Power Network prepares to reconcile the monthly
bank statement as of July 31. The bank statement
shows an ending cash balance of 3,359.78. The
companys Cash account has a July 31 balance of
2,549.99.
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Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
4,175.98
A deposit of 816.20 did not appear on the bank
statement.
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Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
The bank collected a note in the amount of 400
and the related interest of 8 for Power
Networking
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8-5
Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Three checks that were written during the period
did not appear on the bank statement No. 812,
1,061 No. 878, 435.39, No. 883, 48.60.
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8-5
Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Deduct check NSF 300.00
The bank returned a check for 300 from customer
(Thomas Ivey) because of insufficient funds (NSF).
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Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Deduct check NSF 300.00
Bank service charges 18.00
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The bank service charges totaled 18.00.
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8-5
Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Check No. 879 9.00
327.00
Check No. 879 for 732.26 to Taylor Co. on
account, erroneously recorded in journal as
723.26.
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8-5
Companys records
Banks records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
Add note and interest collected by bank
408.00
4,175.98
2,957.99
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Check No. 879 9.00
327.00
Adjusted balance 2,630.99
Adjusted balance 2,630.99
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8-5
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8-5
Journal entries must be prepared for those items
that affected the companys (depositors) side of
the reconciliation.
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8-5
Companys records
Beginning balance 2,549.99
Add note and interest collected by bank
408.00
2,957.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Check No. 879 9.00
327.00
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Entry to Record Plus Items
July 31 Cash 408 00
Notes Receivable 400 00 Interest
Income 8 00
Note collected by bank.
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Companys records
Beginning balance 2,549.99
Add note and interest collected by bank
408.00
2,957.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Check No. 879 9.00
327.00
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Entry to Record Minus Items
31 Accounts ReceivableThomas Ivey 300 00
Miscellaneous Expense 18 00 Accounts
PayableTaylor Co. 9 00 Cash 327 00
NSF check, bank service charges, and error in
recording Check no. 879.
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The following data were gathered to use in
reconciling the bank account of Photo Op.
Balance per bank 14,500 Balance per company
records 13,875 Bank service charges 75 Deposit in
transit 3,750 NSF check 800 Outstanding
checks 5,250
(Continued)
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8-5

• What is the adjusted balance on the bank
  reconciliation?
• Journalize any necessary entries for Photo OP
  based upon the bank reconciliation.

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8-5

• 13,000, as shown below.
• Bank section of reconciliation 14,500
  5,250 3,750 13,000
• Company section of reconciliation 13,875
  75 800 13,000

b. Accounts Receivable 800
Miscellaneous Expense 75 Cash 875

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For Practice PE 8-3A, PE 8-3B
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8-6
Objective 6
Describe the accounting for special-purpose cash
funds.
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8-6
It is usually not practical for a business to
write checks to pay small amounts. Thus, it is
desirable to control such payments by using a
special cash fund, called a petty cash fund.
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On August 1, issued Check No. 511 for 500 to
established a petty cash fund.
JOURNAL
Page 9
Date
Description
Debit
Credit
2008
Aug. 1 Petty Cash 500 00
Cash 500 00
Established petty cash fund issuing Check 511.
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8-6
At the end of August, the petty cash receipts
indicated expenditures for the following items
office supplies, 380, postage (office supplies),
22 store supplies, 35, and miscellaneous
administrative items, 30.
Aug. 31 Office Supplies 402 00
Store Supplies 35 00
Miscellaneous Administrative Exp. 30 00
Cash 467 00
Replenished petty cash fund.
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8-6
Replenishing the petty cash fund restores it to
its original amount of 500. Note that there is
no entry to Petty Cash when the fund is
replenished.
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8-6
Businesses often use special cash funds to meet
other needs, such as payroll. Such funds are
called special-purpose funds.
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8-6

• Prepare journal entries for each of the
  following
• Issued check to establish a petty cash fund of
  500.
• The amount of cash in the petty cash fund is
  currently 120. Issued a check to replenish the
  fund, based on the following summary of petty
  cash receipts office supplies, 300 and
  miscellaneous administrative expense, 75.
  Record any missing funds in the cash short and
  over account.

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8-6

• Petty Cash 500
• Cash 500

• Office Supplies 300
• Miscellaneous Admin. Expense 75
• Cash Short and Over 5
• Cash 380

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For Practice PE 8-4A, PE 8-4B
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8-7
Objective 7
Describe and illustrate the reporting of cash and
cash equivalents in the financial statements.
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A companys excess cash is normally invested in
highly liquid investments. These investments are
called cash equivalents.
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Companies that have invested excess cash in cash
equivalents usually report cash and cash
equivalents as one amount on the balance sheet.
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Banks may require depositors to maintain minimum
cash balances in their bank accounts. Such a
balance is called a compensating balance.
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Ratio of Cash to Monthly Cash Expenses
A cash ratio that is especially useful for
companies, starting up or in financial distress,
is the ratio of cash to monthly cash expenses.
First, the monthly cash expenses are determined.
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Ratio of Cash to Monthly Cash Expenses
The ratio of cash to monthly cash expenses can
then be computed as follows
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Ratio of Cash to Monthly Cash Expenses
Northwest Airlines Corporation reported the
following data (in millions) at the end of
2005 Negative cash flows from operations (436) C
ash and cash equivalents, Dec. 31, 2005 1,284
36.3 per mo.
Monthly cash expense is sometimes referred to as
cash burn.
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8-7
Ratio of Cash to Monthly Cash Expenses
Ratio of Cash to Monthly Cash Expenses
35.4

Interpretation As of December 31, 2007,
Northwest would run out of cash in less than
three years months unless it changes it
operations, sells investments, or raises
additional funds.
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