1 Click to edit Master title style Sarbanes-Oxley, Internal Control and Cash 8 1 2 Click to edit Master title style After studying this chapter, you should be able to: 1. Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. 2. Describe and illustrate the objectives and elements of internal control. 3. Describe and illustrate the application of internal controls to cash. 2 3 Click to edit Master title style After studying this chapter, you should be able to: 4. Describe the nature of a bank account and its use in controlling cash. 5. Describe and illustrate the use of a bank reconciliation in controlling cash. 6. Describe the accounting for specialpurpose cash funds. 3 4 Click to edit Master title style After studying this chapter, you should be able to: 7. Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 4 5 Click to edit Master title style Objective 1 8-1 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. 5 6 Click to edit Master title style 8-1 The Sarbanes-Oxley Act of 2002 (referred to simply as SarbanesOxley) 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. 6 7 Click to edit Master title style 8-1 Sarbanes-Oxley requires companies to maintain strong and effective internal control. 7 8 Click to edit Master title style 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. 8 9 Effect of Sarbanes-Oxley Act Click to edit Master title style 8-1 99 10 Click to edit Master title style 8-1 As a company that listed on the New York Stock Exchange, Telkom is obliged to comply with all existing rules, including the Sarbanes Oxley Act (SOA). The SOA requires internal control over the financing reporting and guarantee from Telkom’s management that all information in the financial report is accurate and can be accounted for. To meet the SOA requirement, Telkom has conducted internal improvement through organizational transformation and the application of Good Corporate Governance (GCG) policies. The internal control over the financing reporting has become the priority for improving the system. 10 11 Click to edit Master title style 8-2 Objective 2 Describe and illustrate the objectives and elements of internal control. 11 12 Objectives of Internal Control Click to edit Master title style 8-2 To provide reasonable assurance that: 1) assets are safeguarded and used for business purposes, 2) business information is accurate, and 3) employees comply with laws and regulations. 12 13 Click to edit Master title style 8-2 Employee fraud is the intentional act of deceiving an employer for personal gain. 13 14 Five Elements of Internal Control Click to edit Master title style 8-2 Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are— 1) the control environment, 2) risk assessment, 3) control procedures, 4) monitoring, and 5) information and communication. 14 15 Click to edit Master title style 8-2 15 15 16 Control Environment Click to edit Master title style 8-2 A business’s control environment is the overall attitude of management and employees about the importance of controls. 16 17 Factors That Influence the Control Environment Click to edit Master title style 8-2 Management’s philosophy and operating style The business’s organizational structure Personnel policies 17 18 Control Environment Click to edit Master title style 8-2 18 18 19 Click to edit Master title style 8-2 Example of control procedures for an allnight 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) 19 20 Click to edit Master title style 8-2 Keep only small amounts of cash on hand after 5 p.m. by depositing excess cash in a store safe that can’t be opened by employees on duty. Install cameras and alarm systems. (Concluded) 20 21 Indicators of Internal Control Problems Click to edit Master title style 8-2 Warning Signs With Regard to People 1. Abrupt change in lifestyle. 2. Close social relationships with suppliers. 3. Refusing to take a vacation. 4. Frequent borrowing from other employees. 5. Excessive use of alcohol or drugs. 21 22 Indicators of Internal Control Problems Click to edit Master title style 1. 2. 3. 4. 5. 8-2 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. 22 23 8-2 - Click to edit Master title style Example Exercise 8-1 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 23 23 24 8-2 Click to edit Master title style Follow My Example 8-1 1. (c) control procedures 2. (a) the control environment 3. (b) risk assessment For Practice: PE 8-1A, PE 8-1B 24 24 25 Click to edit Master title style 8-3 Objective 3 Describe and illustrate the application of internal controls to cash. 25 26 Control of Cash Receipts Click to edit Master title style 8-3 One of the most important controls to protect cash received in over-the-counter sales is a cash register. 26 27 Change Fund Click to edit Master title style 8-3 A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund. 27 28 Cash Short and Over Click to edit Master title style 8-3 Cash sales for March 19 totaled Rp3,150,000 per the cash register tape. After removing the change fund, only Rp3,142,000 was on hand. Mar 19 Cash 3 142 000 Cash Short and Over Sales To record cash sales and 8 000 3 150 000 actual cash on hand. Note that the shortage was debited to Cash Short and Over. 28 28 29 Control of Cash Receipts Click to edit Master title style 8-3 29 29 30 Electronic Funds Transfers Click to edit Master title style 8-3 Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills. 30 31 Voucher System Click to edit Master title style 8-3 A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized. 31 32 Click to edit Master title style 8-3 A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer. 32 33 Click to edit Master title style 8-4 Objective 4 Describe the nature of a bank account and its use in controlling cash. 33 34 Use of Bank Accounts Click to edit Master title style 8-4 A major reason that businesses use bank accounts is for control purposes. 34 35 Click to edit Master title style 8-4 Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions. 35 36 Bank Statement Click to edit Master title style 8-4 A summary received from the bank of all checking account transaction is called a bank statement. 36 37 Bank Statement Click to edit Master title style 8-4 37 36 (Continued) 38 Bank Statement Click to edit Master title style (Concluded) 8-4 38 37 39 Click to edit Master title style 8-4 Typical credit or debit memorandum entries found on the bank statement: — 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. EC 39 40 8-4 - Example Exercise 8-2 Click to edit Master title style The following items may appear on a bank statement: (1) NSF check (2) EFT Deposit (3) Service Charge (4) Bank correction of an error from recording a Rp400,000 check as Rp40,000. 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 depositor’s account. 40 40 41 8-4 Click to edit Master title style Follow My Example 8-2 Item No. (1) (2) (3) (4) Appears on the Bank Statement as a Debit or Credit Memorandum Debit Memorandum Credit Memorandum Increases or Decreases the Balance of the Depositor’s Bank Account Decreases Increases Debit Memorandum Decreases Debit Memorandum Decreases For Practice: PE 8-2A, PE 8-2B 41 41 42 Power Networking’s Records and Bank Statement Click to edit Master title style 8-4 Bank Statement Beginning balance Additions: Deposits Miscellaneous Deductions: Checks NSF checks Service charge Ending balance Rp 4,218,600 Rp13,749,750 408,000 Rp 14,698,570 300,000 18,000 14,157,750 15,016,570 Rp3,359,780 Power Networking Records Beginning balance Rp 4,227,600 Deposits 14,565,950 Checks 16,243,560 Ending balance Rp 2,549,990 Power Networking should determine the reason for difference in these two amounts. 42 43 Click to edit Master title style 8-5 Objective 5 Describe and illustrate the use of a bank reconciliation in controlling cash. 43 44 Click to edit Master title style 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. 44 45 Click to edit Master title style Bank’s records Beginning balance 8-5 Company’s records Rp3,359,780 Beginning balance Power Network prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of Rp3,359,780. The company’s Cash account has a July 31 balance of Rp2,549,990. Rp2,549,990 45 45 46 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 816,200 Rp4,175,980 A deposit of Rp816,200 did not appear on the bank statement. 46 46 47 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816.200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 The bank collected a note in the amount of Rp400,000 and the related interest of Rp8,000 for Power Networking 47 47 48 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816.200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 Deduct outstanding checks: No. 812 Rp1,061,000 No. 878 435,390 No. 883 48,600 1,544,990 Three checks that were written during the period did not appear on the bank statement: No. 812, Rp1,061,000; No. 878, Rp435,390, No. 883, Rp48,600. 48 48 49 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816,200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 Deduct outstanding Deduct check checks: NSF Rp300,000 No. 812 Rp1,061,000 No. 878 435,390 No. 883 48,600 1,544,990 The bank returned a check for Rp300,000 from customer (Thomas Tarigan) because of insufficient funds (NSF). 49 49 50 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816,200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 Deduct outstanding Deduct check checks: NSF Rp300,000 No. 812 Rp1,061,000 Bank service No. 878 435,390 18,000 No. 883 48,600 1,544,990 charges The bank service charges totaled Rp18,000. 50 50 51 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816,200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 Deduct outstanding Deduct check checks: NSF Rp300,000 No. 812 Rp1,061,000 Bank service No. 878 435,390 18,000 No. 883 48,600 1,544,990 charges Error recording Check No. 879 9,000 327,000 Check No. 879 for Rp732,260 to CV Tunggal Jaya on 51 51 account, erroneously recorded in journal as Rp723,260. 52 Click to edit Master title style Bank’s records Beginning balance Add deposit not recorded by bank 8-5 Company’s records Rp3,359,780 Beginning balance Rp2,549,990 Add note and interest 816,200 collected by bank 408,000 Rp4,175,980 Rp2,957,990 Deduct outstanding Deduct check checks: NSF Rp300,000 No. 812 Rp1,061,000 Bank service No. 878 435,390 18,000 No. 883 48,600 1,544,990 charges Error recording Check No. 879 9,000 327,000 Adjusted balance Rp2,630,990 Adjusted balance Rp2,630,990 52 52 53 Click to edit Master title style CV Omega Perdana Bank Reconciliation July 31, 2007 Cash balance according to bank statement Add deposit of July 31, not recorded by bank Deduct outstanding checks: No.812 No.878 N0.883 Adjusted balance Rp1 061 000 435 390 48 600 Cash balance according to Omega Perdana records Add note and interest collected by bank 8-5 Rp3 359 780 816 200 Rp4 175 980 1 544 990 2 630 990 Rp2 549 990 408 000 Rp2 957 990 Deduct: Check returned because of insufficient fundsRp 300 000 Bank service charge 18 000 Error in recording Check No.879 9 000 327 000 Adjusted balance Rp2 630 990 53 54 Click to edit Master title style 8-5 Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation. 54 55 Click to edit Master title style 8-5 Company’s records Beginning balance Rp2,549,990 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct check NSF Rp300,000 Bank service charges 18,000 Error recording Check No. 879 9,000 327,000 55 54 56 8-5 Entry to Record Plus Items Click to edit Master title style July 31 Cash Notes Receivable Interest Income Note collected by bank. 408 000 400 000 8 000 56 55 57 Click to edit Master title style 8-5 Company’s records Beginning balance Rp2,549,990 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct check NSF Rp300,000 Bank service charges 18,000 Error recording Check No. 879 9,000 327,000 57 56 58 8-5 Entry to Record Minus Items Click to edit Master title style July 31 Cash Notes Receivable Interest Income Note collected by bank. 31 Accounts Receivable— Thomas Tarigan Miscellaneous Expense Accounts Payable— CV Tunggal Jaya Cash NSF check, bank service charges, and error in recording Check no. 879. 408 000 400 000 8 000 300 000 18 000 9 000 327 000 58 57 59 8-5 Click to edit Master title style Example Exercise 8-3 The following data were gathered to use in reconciling the bank account of Depok Photo Studio Balance per bank Rp14,500,000 Balance per company records 13,875,000 Bank service charges 75,000 Deposit in transit 3,750,000 NSF check 800,000 Outstanding checks 5,250,000 (Continued) 59 58 60 8-5 Click to edit Master title style Example Exercise 8-3 a. What is the adjusted balance on the bank reconciliation? b. Journalize any necessary entries for Depok Photo Studio based upon the bank reconciliation. 60 59 61 8-5 Click to edit Master title style Follow My Example 8-3 a. Rp13,000,000 as shown below. Bank section of reconciliation: Rp14,500,000 – Rp5,250,000 + Rp3,750,000 = Rp13,000,000 Company section of reconciliation: Rp13,875,000 – Rp75,000 – Rp800,000 = Rp13,000,000 b. Accounts Receivable Miscellaneous Expense Cash For Practice: PE 8-3A, PE 8-3B 800,000 75,000 875,000 60 61 62 Click to edit Master title style 8-6 Objective 6 Describe the accounting for specialpurpose cash funds. 62 63 Click to edit Master title style 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. 63 64 8-6 Click to edit Master title style On August 1, issued Check No. 511 for Rp500,000 to established a petty cash fund. Page 9 JOURNAL Date 2008 Description Aug. 1 Petty Cash Cash Established petty cash fund issuing Check 511. Post. Ref. Debit Credit 500 000 500 000 64 63 65 Click to edit Master title style 8-6 At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, Rp380,000, postage (office supplies), Rp22,000; store supplies, Rp35,000, and miscellaneous administrative items, Rp30,000. Aug. 31 Office Supplies 402 000 Store Supplies 35 000 Miscellaneous Administrative Exp. Cash Replenished petty cash fund. 30 000 467 000 65 64 66 Click to edit Master title style 8-6 Replenishing the petty cash fund restores it to its original amount of Rp500,000. Note that there is no entry to Petty Cash when the fund is replenished. 66 67 Click to edit Master title style 8-6 Businesses often use special cash funds to meet other needs, such as payroll. Such funds are called special-purpose funds. 67 68 8-6 Click to edit Master title style Example Exercise 8-4 Prepare journal entries for each of the following; a) Issued check to establish a petty cash fund of Rp500,000. b) The amount of cash in the petty cash fund is currently Rp120,000. Issued a check to replenish the fund, based on the following summary of petty cash receipts: office supplies, Rp300,000 and miscellaneous administrative expense, Rp75,000. Record any missing funds in the cash short and over 68 67 account. 69 8-6 Click to edit Master title style Follow My Example 8-4 a) Petty Cash Cash 500,000 500,000 b) Office Supplies 300,000 Miscellaneous Admin. Expense 75,000 Cash Short and Over 5,000 Cash 380,000 For Practice: PE 8-4A, PE 8-4B 68 69 70 Click to edit Master title style 8-7 Objective 7 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 70 71 Click to edit Master title style 8-7 A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents. 71 72 Click to edit Master title style 8-7 Companies that have invested excess cash in cash equivalents usually report cash and cash equivalents as one amount on the balance sheet. 72 73 Click to edit Master title style 8-7 Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance. 73 74 Ratio of Cash to Monthly Cash Expenses Click to edit Master title style 8-7 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. Monthly Cash Expenses = Negative Cash Flows from Operations 12 74 73 75 Ratio of Cash to Monthly Cash Expenses Click to edit Master title style 8-7 The ratio of cash to monthly cash expenses can then be computed as follows: Ratio of Cash to Monthly Cash Expenses = Cash and Cash Equivalent as of Year-End Monthly Cash Expenses 75 74 76 8-7 Ratio of Cash to Monthly Cash Expenses Click to edit Master title style Northwest Airlines Corporation reported the following data (in millions) at the end of 2005: Negative cash flows from operations Rp(436,000) Cash and cash equivalents, Dec. 31, 2005 1,284,000 Rp436,000 Monthly Cash = Rp36,300 per mo. = Expense 12 Monthly cash expense is sometimes referred to as cash burn. 76 75 77 Ratio of Cash to Monthly Cash Expenses Click to edit Master title style 8-7 Ratio of Cash to Rp1,284,000 Monthly Cash = = Rp35,400 Rp36,300 Expenses 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. 77 76