8
Sarbanes-Oxley,
Internal Control,
and Cash
8-1
Sarbanes-Oxley, Internal Control, and Cash
After studying this chapter, you should be able to:
8-2
1
Describe the Sarbanes-Oxley Act of 2002
and the 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.
Sarbanes-Oxley, Internal Control, and Cash (continued)
8-3
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.
7
Describe and illustrate the reporting of
cash and cash equivalents in the financial
statements.
1
Describe the SarbanesOxley Act of 2002 and its
impact on internal controls
and financial reporting.
8-4
9-4
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.
8-5
1
Sarbanes-Oxley requires
companies to maintain strong and
effective internal control.
8-6
1
Internal control is broadly defined as
the procedures and processes used by a
company to:
1. Safeguard its assets.
2. Process information accurately.
3. Ensure compliance with laws and
regulations.
8-7
1
8-8
1
Exhibit 1
8-9
Sarbanes-Oxley Report of Nike
2
Describe and illustrate
the objectives and
elements of internal
control.
8-10
2
8-11
2
Employee fraud is the
intentional act of
deceiving an employer
for personal gain.
8-12
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 as follows:
1. Control environment
2. Risk assessment
3. Control procedures
4. Monitoring
5. Information and communication
8-13
2
Exhibit 2
8-14
Elements of Internal Control
2
Control Environment
The control environment is
the overall attitude of
management and employees
about the importance of
controls.
8-15
2
Factors That Influence the
Control Environment
1. Management’s philosophy and
operating style
2. The company’s organizational
structure
3. The company’s personnel
policies
8-16
2
8-17
2
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.
8-18
2
Exhibit 3
8-19
Internal Control Procedures
2
Monitoring
Monitoring the internal control
system is used to locate
weaknesses and improve
controls.
8-20
2
Monitoring
Monitoring often includes
observing employee behavior
and the accounting system for
indicators of control problems.
8-21
2
Exhibit 4
Warning Signs of Internal Control Problems
Edwin C. Bliss , “Employee
Theft,” Boardroom Reports,
July 15, 1994, pp. 5–6
8-22
(continued)
2
Exhibit 4
Warning Signs
of Internal
Control
Problems
(continued)
8-23
1.
Missing documents or gaps in
transaction numbers (could mean
documents are being used for
fraudulent transactions).
2.
An unusual increase in customer
refunds (refunds may be phony).
3.
Differences between daily cash
receipts and bank deposits (could
mean receipts are being pocketed
before deposited).
4.
Sudden increase in slow payments
(employee may be pocketing the
payment).
5.
Backlog in recording transactions
(possibly an attempt to delay
detection of fraud).
Edwin C. Bliss , “Employee
Theft,” Boardroom Reports,
July 15, 1994, pp. 5–6
2
Limitations of
Internal Control
1. The human element of control
2. Cost-benefit considerations
8-24
2
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
Follow My Example 8-1
1. (c) control procedures
2. (a) the control environment
3. (b) risk assessment
8-25
8-25
For Practice: PE 8-1A, PE8-1B
3
Describe and illustrate
the application of
internal controls to
cash.
8-26
3
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.
8-27
3
Sources of Cash
Businesses normally receive cash from
two main sources:
1. Customers purchasing products or
services.
2. Customers making payments on
account.
8-28
3
Control of Cash Receipts
One of the most important
controls to protect cash
received in over-the-counter
sales is a cash register.
8-29
3
8-30
Using the Cash Register
to Control Cash
3
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.
8-31
3
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.
8-32
3
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.
8-33
3
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.
8-34
3
Control of Cash Payments
The control of cash payments should
provide reasonable assurance that:
1. Payments are made for only
authorized transactions.
2. Cash is used effectively and
efficiently.
8-35
3
A voucher system is a set of
procedures for authorizing and
recording liabilities and cash
payments. It may be either
manual or computerized.
8-36
3
A voucher is any document
that serves as proof of
authority to pay cash or issue
an electronic funds transfer.
8-37
4
Describe the nature of a
bank account and its
use in controlling cash.
8-38
4
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.
2. Bank accounts provide an independent
recording of cash transactions.
3. Use of bank accounts facilitates the
transfer of funds using EFT systems.
8-39
4
A summary received from the
bank of all checking account
transactions is called a bank
statement.
8-40
4
Impact of Debit and Credit Memos
8-41
4
Exhibit 5
8-42
Bank Statement
(continued)
4
Exhibit 5
8-43
Bank Statement (continued)
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
8-44
4
Example Exercise 8-2
Items on Company’s Bank Statement
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
$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 company’s account.
8-45
8-45
4
Example Exercise 8-2 (continued)
Follow My Example 8-2
Item No.
Appears on the
Bank Statement
as a Debit or
Credit Memo
Increases or
Decreases the
Balance of the
Company’s Bank
Account
(1)
debit memo
decreases
(2)
credit memo
increases
(3)
debit memo
decreases
(4)
debit memo
decreases
For Practice: PE 8-2A, PE 8-2B
8-46
8-46
4
Exhibit 6
8-47
Power Networking’s Records
and Bank Statement
5
Describe and illustrate
the use of a bank
reconciliation in
controlling cash.
8-48
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.
8-49
5
The Adjusted Balance
Must
be
equal
8-50
5
Steps in a Bank Reconciliation
8-51
(continued)
5
Steps in a Bank Reconciliation
8-52
5
Bank’s Records
Beginning balance
Power Networking’s Records
$3,359.78 Beginning balance
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 company’s Cash
account has a July 31 balance of
$2,549.99.
8-53
$2,549.99
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
816.20
$4,175.98
Step 2
A deposit of $816.20 did not
appear on the bank statement.
8-54
$2,549.99
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
$2,549.99
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
8-55
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.
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
$2,549.99
816.20 Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60 1,544.99
408.00
$2,957.99
Step 4
The bank collected a note in the amount of $400
and the related interest of $8 for Power Networking
8-56
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
$2,549.99
816.20 Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60 1,544.99
Deduct check
NSF
$300.00
408.00
$2,957.99
Step 5
The bank returned a check for $300 from customer
(Thomas Ivey) because of insufficient funds (NSF).
8-57
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
816.20 Add note and interest
collected by bank
$4,175.98
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
Step 6
Bank service charges for the month, $18.
8-58
$2,549.99
408.00
$2,957.99
5
Power Networking’s Records
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
816.20 Add note and interest
collected by bank
$4,175.98
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
Chk. No. 879
9.00
$2,549.99
408.00
$2,957.99
Step 7
8-59
Check No. 879 for $732.26 to Taylor Co. on account,
erroneously recorded in journal as $723.26.
5
Bank’s Records
Beginning balance
Add deposit not
recorded by bank
$3,359.78 Beginning balance
816.20 Add note and interest
collected by bank
$4,175.98
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60 1,544.99
Adjusted balance
8-60
Power Networking’s Records
$2,549.99
408.00
$2,957.99
Deduct check
NSF
$300.00
Bank service
charges
18.00
Error recording
Chk. No. 879
9.00
327.00
$2,630.99 Adjusted balance
$2,630.99
5
Exhibit 7
8-61
Bank Reconciliation for Power Networking
5
The journal entries for Power Networking, based on
the bank reconciliation in Slide 61 are as follows:
8-62
5
Example Exercise 8-3
Bank Reconciliation
The following data were gathered to use in reconciling
the bank account of Photo Op.
a.
b.
8-63
8-63
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
What is the adjusted balance on the bank
reconciliation?
Journalize any necessary entries for Photo OP based
upon the bank reconciliation.
Example Exercise 8-3 (continued)
5
Follow My Example 8-3
a. $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
8-64
8-64
6
Describe the accounting
for special-purpose
cash funds.
8-65
6
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.
8-66
6
A petty cash fund of $500 is
established on August 1. The entry to
record the transaction is as follows:
8-67
6
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.
8-68
6
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
8-69
6
Example Exercise 8-4
Petty Cash Fund
Prepare journal entries for each of the following;
a)
Issued check to establish a petty cash fund of $500.
b) 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.
8-70
8-70
Example Exercise 8-4 (continued)
6
Follow My Example 8-4
a) Petty Cash………………………........ 500
Cash…………………………........
500
b) Office Supplies………………………. 300
Miscellaneous Admin. Expense…..
75
Cash Short and Over………………..
5
Cash………………………………..
380
For Practice: PE 8-4A, PE 8-4B
8-71
8-71
7
Describe and illustrate
the reporting of cash
and cash equivalents in
the financial statements.
8-72
7
Cash Equivalents
A company’s excess cash is
normally invested in highly
liquid investments. These
investments are called cash
equivalents.
8-73
7
Companies that have invested
excess cash in cash equivalents
usually report Cash and cash
equivalents as one amount on
the balance sheet.
8-74
7
Compensating Balance
Banks may require depositors to
maintain minimum cash balances
in their bank accounts. Such a
balance is called a compensating
balance.
8-75
7
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.
Monthly Cash Expenses =
8-76
Negative Cash Flows
from Operations
12
7
Ratio of Cash to Monthly
Cash Expenses
The ratio of cash to monthly
cash expenses can then be
computed as follows:
Ratio of Cash to Monthly
=
Cash Expenses
8-77
Cash and Cash
Equivalent as of Year-End
Monthly Cash Expenses
8-78