Sarbanes oxley internal control and cash
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8. Sarbanes-Oxley, Internal Control, and Cash. Describe the Sarbanes-Oxley Act of 2002 and the impact on internal controls and financial reporting. 1. Describe and illustrate the objectives and elements of internal control. 2.

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Sarbanes oxley internal control and cash

8

Sarbanes-Oxley, Internal Control, and Cash


Sarbanes oxley internal control and cash

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

1

Describe and illustrate the objectives and elements of internal control.

2

Describe and illustrate the application of internal controls to cash.

3

Sarbanes-Oxley, Internal Control, and Cash

After studying this chapter, you should be able to:

8-2


Sarbanes oxley internal control and cash

Describe and illustrate the use of a bank reconciliation in controlling cash.

5

Describe the accounting for special-purpose cash funds.

6

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

7

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

4

Sarbanes-Oxley, Internal Control, and Cash (continued)

8-3


Sarbanes oxley internal control and cash

1

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

9-4

8-4


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

1

Sarbanes-Oxley requires companies to maintain strong and effective internal control.


Sarbanes oxley internal control and cash

1

Internal control is broadly defined as the procedures and processes used by a company to:

  • Safeguard its assets.

  • Process information accurately.

  • Ensure compliance with laws and regulations.


Sarbanes oxley internal control and cash

1


Sarbanes oxley internal control and cash

Exhibit 1

1

Sarbanes-Oxley Report of Nike


Sarbanes oxley internal control and cash

2

Describe and illustrate the objectives and elements of internal control.

8-10


Sarbanes oxley internal control and cash

2


Sarbanes oxley internal control and cash

2

Employee fraud is the intentional act of deceiving an employer for personal gain.


Sarbanes oxley internal control and cash

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:

  • Control environment

  • Risk assessment

  • Control procedures

  • Monitoring

  • Information and communication


Sarbanes oxley internal control and cash

Exhibit 2

2

Elements of Internal Control


Sarbanes oxley internal control and cash

2

Control Environment

Thecontrol environment is the overall attitude of management and employees about the importance of controls.


Sarbanes oxley internal control and cash

2

Factors That Influence the Control Environment

Management’s philosophy and operating style

The company’s organizational structure

The company’s personnel policies


Sarbanes oxley internal control and cash

2


Sarbanes oxley internal control and cash

2

Control Procedures

Competent personnel, rotating, duties, and mandatory vacations.

Separating responsibilities for related operations.

Separating operations, custody of assets, and accounting.

Proofs and security measures.


Sarbanes oxley internal control and cash

Exhibit 3

2

Internal Control Procedures


Sarbanes oxley internal control and cash

2

Monitoring

Monitoring the internal control system is used to locate weaknesses and improve controls.


Sarbanes oxley internal control and cash

2

Monitoring

Monitoring often includes observing employee behavior and the accounting system for indicators of control problems.


Sarbanes oxley internal control and cash

Exhibit 4

2

Warning Signs of Internal Control Problems

Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6

(continued)


Sarbanes oxley internal control and cash

Exhibit 4

2

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. 5–6


Sarbanes oxley internal control and cash

2

Limitations of Internal Control

  • The human element of control

  • Cost-benefit considerations


Sarbanes oxley internal control and cash

Follow My Example 8-1

For Practice: PE 8-1A, PE8-1B

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.

  • Mandatory vacations

  • Personnel policies

  • Report of outside consultants on future market changes

1. (c)control procedures

2. (a)the control environment

  • (b) risk assessment

8-25


Sarbanes oxley internal control and cash

3

Describe and illustrate the application of internal controls to cash.

8-26


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

3

Sources of Cash

Businesses normally receive cash from two main sources:

  • Customers purchasing products or services.

  • Customers making payments on account.


Sarbanes oxley internal control and cash

3

Control of Cash Receipts

One of the most important controls to protect cash received in over-the-counter sales is a cash register.


Sarbanes oxley internal control and cash

3

Using the Cash Register to Control Cash


Sarbanes oxley internal control and 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.


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

3

Control of Cash Payments

The control of cash payments should provide reasonable assurance that:

  • Payments are made for only authorized transactions.

  • Cash is used effectively and efficiently.


Sarbanes oxley internal control and cash

3

A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized.


Sarbanes oxley internal control and cash

3

Avoucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer.


Sarbanes oxley internal control and cash

4

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

8-38


Sarbanes oxley internal control and cash

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:

  • Bank accounts reduce the amount of cash on hand.

  • Bank accounts provide an independent recording of cash transactions.

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


Sarbanes oxley internal control and cash

4

A summary received from the bank of all checking account transactions is called a bank statement.


Sarbanes oxley internal control and cash

4

Impact of Debit and Credit Memos


Sarbanes oxley internal control and cash

Exhibit 5

4

Bank Statement

(continued)


Sarbanes oxley internal control and cash

Exhibit 5

4

Bank Statement (continued)


Sarbanes oxley internal control and cash

4

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.


Sarbanes oxley internal control and cash

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

  • 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 company’s account.

8-45


Sarbanes oxley internal control and cash

Follow My Example 8-2

For Practice: PE 8-2A, PE 8-2B

4

Example Exercise 8-2 (continued)

Increases or Decreases the Balance of the Company’s Bank Account

Appears on the Bank Statement as a Debit or Credit Memo

Item No.

(1)debit memodecreases

(2)credit memoincreases

(3)debit memodecreases

(4)debit memodecreases

8-46


Sarbanes oxley internal control and cash

Exhibit 6

4

Power Networking’s Records and Bank Statement


Sarbanes oxley internal control and cash

5

Describe and illustrate the use of a bank reconciliation in controlling cash.

8-48


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

5

The Adjusted Balance

Must be equal


Sarbanes oxley internal control and cash

5

Steps in a Bank Reconciliation

(continued)


Sarbanes oxley internal control and cash

5

Steps in a Bank Reconciliation


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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.


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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.


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

Add deposit not

recorded by bank 816.20

$4,175.98

Deduct outstanding

checks:

No. 812$1,061.00

No. 878435.39

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.


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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. 878435.39

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


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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. 878435.39

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).


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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. 878435.39

No. 883 48.60 1,544.99

$2,957.99

Deduct check

NSF$300.00

Bank service

charges18.00

Step 6

Bank service charges for the month, $18.


Sarbanes oxley internal control and cash

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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. 878435.39

No. 883 48.60 1,544.99

$2,957.99

Deduct check

NSF$300.00

Bank service

charges18.00

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.


Sarbanes oxley internal control and cash

327.00

Adjusted balance

Adjusted balance

$2,630.99

$2,630.99

5

Power Networking’s Records

Bank’s Records

Beginning balance$2,549.99

Beginning balance$3,359.78

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. 878435.39

No. 883 48.60 1,544.99

$2,957.99

Deduct check

NSF$300.00

Bank service

charges18.00

Error recording

Chk. No. 879 9.00


Sarbanes oxley internal control and cash

Exhibit 7

5

Bank Reconciliation for Power Networking


Sarbanes oxley internal control and cash

5

The journal entries for Power Networking, based on the bank reconciliation in Slide 61are as follows:


Sarbanes oxley internal control and cash

5

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

What is the adjusted balance on the bank reconciliation?

Journalize any necessary entries for Photo OP based upon the bank reconciliation.

8-63


Sarbanes oxley internal control and cash

Follow My Example 8-3

5

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

8-64


Sarbanes oxley internal control and cash

6

Describe the accounting for special-purpose cash funds.

8-65


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

6

A petty cash fund of $500 is established on August 1. The entry to record the transaction is as follows:


Sarbanes oxley internal control and cash

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.


Sarbanes oxley internal control and cash

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 supplies35

Misc. administrative expenses 30

Total$467


Sarbanes oxley internal control and cash

6

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.

8-70


Sarbanes oxley internal control and cash

For Practice: PE 8-4A, PE 8-4B

Follow My Example 8-4

6

Example Exercise 8-4 (continued)

  • Petty Cash………………………........500

    • Cash…………………………........500

  • Office Supplies……………………….300

  • Miscellaneous Admin. Expense…..75

  • Cash Short and Over………………..5

  • Cash………………………………..380

8-71


Sarbanes oxley internal control and cash

7

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

8-72


Sarbanes oxley internal control and cash

7

Cash Equivalents

A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents.


Sarbanes oxley internal control and cash

7

Companies that have invested excess cash in cash equivalents usually report Cash andcash equivalents as one amount on the balance sheet.


Sarbanes oxley internal control and cash

7

Compensating Balance

Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance.


Sarbanes oxley internal control and cash

Negative Cash Flows from Operations

Monthly Cash Expenses =

12

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.


Sarbanes oxley internal control and cash

Cash and Cash Equivalent as of Year-End

Ratio of Cash to Monthly Cash Expenses

=

Monthly Cash Expenses

7

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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