Sarbanes-Oxley, Internal Control, and Cash

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Sarbanes-Oxley, Internal Control, and Cash
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Sarbanes-Oxley, Internal Control, and Cash
After studying this chapter, you should be able
to
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Sarbanes-Oxley, Internal Control, and Cash
(continued)
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Describe the Sarbanes-Oxley Act of 2002 and its
impact on internal controls and financial
reporting.
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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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Sarbanes-Oxley requires companies to maintain
strong and effective internal control.
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Internal control is broadly defined as the
procedures and processes used by a company to

1. Safeguard its assets.

1. Process information accurately.

1. Ensure compliance with laws and regulations.

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Sarbanes-Oxley Report of Nike
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Describe and illustrate the objectives and
elements of internal control.
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Employee fraud is the intentional act of
deceiving an employer for personal gain.
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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 as follows

1. Control environment
2. Risk assessment
3. Control procedures
4. Monitoring
5. Information and communication

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Elements of Internal Control
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Control Environment
The control environment is the overall attitude
of management and employees about the importance
of controls.
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Factors That Influence the Control Environment

1. Managements philosophy and operating style
2. The companys organizational structure
3. The companys personnel policies

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Control Procedures

1. Competent personnel, rotating, duties, and
   mandatory vacations.
2. Separating responsibilities for related
   operations.
3. Separating operations, custody of assets, and
   accounting.
4. Proofs and security measures.

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Internal Control Procedures
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Monitoring
Monitoring the internal control system is used to
locate weaknesses and improve controls.
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Monitoring
Monitoring often includes observing employee
behavior and the accounting system for indicators
of control problems.
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Warning Signs of Internal Control Problems
Edwin C. Bliss , Employee Theft, Boardroom
Reports, July 15, 1994, pp. 56
(continued)
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Warning Signs of Internal Control Problems
(continued)

• 1. Missing documents or gaps in transaction
  numbers (could mean documents are being used for
  fraudulent transactions).
• An unusual increase in customer refunds (refunds
  may be phony).
• Differences between daily cash receipts and bank
  deposits (could mean receipts are being pocketed
  before deposited).
• Sudden increase in slow payments (employee may be
  pocketing the payment).
• Backlog in recording transactions (possibly an
  attempt to delay detection of fraud).

Edwin C. Bliss , Employee Theft, Boardroom
Reports, July 15, 1994, pp. 56
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Limitations of Internal Control

1. The human element of control

1. Cost-benefit considerations

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Example Exercise 8-1
Internal Control Elements
Identify each of the following as relating to (a)
the control environment, (b) risk assessment, or
(c) control procedures.

1. Mandatory vacations
2. Personnel policies
3. Report of outside consultants on future market
   changes

1. (c) control procedures
2. (a) the control environment

1. (b) risk assessment

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Describe and illustrate the application of
internal controls to cash.
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Cash includes coins, currency (paper money),
checks, and money orders. Cash is the asset most
likely to be stolen or used improperly in a
business.
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Sources of Cash
Businesses normally receive cash from two main
sources

1. Customers purchasing products or services.

1. Customers making payments on account.

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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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Using the Cash Register to Control Cash
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Control of Cash Receipts
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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Cash Short and Over
Cash sales for March 19 totaled 35,690 per the
cash register tape. After removing the change
fund, only 35,668 was on hand.
If there had been cash over, Cash Short and Over
would have been credited for the overage.
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Cash Received in Mail
Cash is received in the mail when customers pay
their bills. Most companies design their invoices
so that customers return a portion of the
invoice, called a remittance advice, with their
payment.
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Cash may be received from customers through
electronic funds transfers (EFT). Customers may
authorize automatic electronic transfers from
their checking accounts to pay monthly bills.
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Control of Cash Payments
The control of cash payments should provide
reasonable assurance that

1. Payments are made for only authorized
   transactions.

1. Cash is used effectively and efficiently.

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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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A voucher is any document that serves as proof of
authority to pay cash or issue an electronic
funds transfer.
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Describe the nature of a bank account and its use
in controlling cash.
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Bank Accounts
A major reason that businesses use bank accounts
is for internal control. Some of the control
advantages of using bank accounts are as follows

1. Bank accounts reduce the amount of cash on hand.

1. Bank accounts provide an independent recording of
   cash transactions.

1. Use of bank accounts facilitates the transfer of
   funds using EFT systems.

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A summary received from the bank of all checking
account transactions is called a bank statement.
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Impact of Debit and Credit Memos
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Bank Statement
(continued)
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Bank Statement (continued)
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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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Example Exercise 8-2
Items on Companys Bank Statement
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 the companys account.
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Example Exercise 8-2 (continued)
Increases or Decreases the Balance of the
Companys Bank Account
Appears on the Bank Statement as a Debit or
Credit Memo
Item No.
(1) debit memo decreases
(2) credit memo increases
(3) debit memo decreases
(4) debit memo decreases
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Power Networkings Records and Bank Statement
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Describe and illustrate the use of a bank
reconciliation in controlling cash.
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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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The Adjusted Balance
Must be equal
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Steps in a Bank Reconciliation
(continued)
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Steps in a Bank Reconciliation
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Power Networkings Records
Banks Records
Beginning balance 3,359.78
Beginning balance 2,549.99
Step 1
Power Networking 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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Power Networkings Records
Banks Records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
4,175.98
Step 2
A deposit of 816.20 did not appear on the bank
statement.
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Power Networkings Records
Banks Records
Beginning balance 3,359.78
Beginning balance 2,549.99
Add deposit not recorded by bank 816.20
4,175.98
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
Step 3
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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Power Networkings 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
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
2,957.99
Step 4
The bank collected a note in the amount of 400
and the related interest of 8 for Power
Networking
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Power Networkings 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
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
2,957.99
Deduct check NSF 300.00
Step 5
The bank returned a check for 300 from customer
(Thomas Ivey) because of insufficient funds
(NSF).
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Power Networkings 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
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
2,957.99
Deduct check NSF 300.00
Bank service charges 18.00
Step 6
Bank service charges for the month, 18.
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Power Networkings 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
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
2,957.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Chk. No. 879 9.00
Step 7
Check No. 879 for 732.26 to Taylor Co. on
account, erroneously recorded in journal as
723.26.
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Power Networkings 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
Deduct outstanding checks No.
812 1,061.00 No. 878 435.39 No. 883
48.60 1,544.99
2,957.99
Deduct check NSF 300.00
Bank service charges 18.00
Error recording Chk. No. 879 9.00
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Bank Reconciliation for Power Networking
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The journal entries for Power Networking, based
on the bank reconciliation in Slide 61 are as
follows
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Example Exercise 8-3
Bank Reconciliation
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

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

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Example Exercise 8-3 (continued)

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

b. Accounts Receivable 800
Miscellaneous Expense 75 Cash
875
For Practice PE 8-3A, PE 8-3B
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Describe the accounting for special-purpose cash
funds.
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Petty Cash Fund
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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A petty cash fund of 500 is established on
August 1. The entry to record the transaction is
as follows
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IMPORTANT!
The only time Petty Cash is debited is when the
fund is initially established or when the fund is
increased. The only time Petty Cash is credited
is when the fund is being decreased.
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At the end of August, the petty cash receipts
indicate expenditures for the following items
Office supplies 380 Postage (debit Office
Supplies) 22 Store supplies 35 Misc.
administrative expenses 30 Total 467
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Example Exercise 8-4
Petty Cash Fund

• 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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Example Exercise 8-4 (continued)

• Petty Cash........ 500
• Cash........ 500

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

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Describe and illustrate the reporting of cash and
cash equivalents in the financial statements.
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Cash Equivalents
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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Compensating Balance
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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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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