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FINANCIAL ACCOUNTING

2ND EDITION

BY

DUCHAC, REEVE, & WARREN

7 Sarbanes-Oxley, Internal Control, &

Cash

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LEARNING GOALS

When you finish this chapter, you should be able to

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1. Describe Sarbanes-Oxley Act, 2002, its impact on internal control, reporting.

2. Describe, illustrate objectives, elements of internal control.

3. Describe, illustrate application of internal controls to cash.

LEARNING GOALSLEARNING GOALS

Continued

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LEARNING GOALSLEARNING GOALS

4. Describe nature of bank account, its use in controlling cash.

5. Describe, illustrate use of bank reconciliation in controlling cash.

6. Describe accounting for special-purpose cash funds.

Continued

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LEARNING GOALSLEARNING GOALS

7. Describe, illustrate reporting cash, cash equivalents in financial statements.

8. Interpret cash flow to net income ratio, cash to monthly cash expense ratio.

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WALT DISNEY COMPANY

Walt Disney Company

Has extensive cash collection, control activities to protect against fraud, errors

Cash collected, counted, deposited from all activities

Collections in form of cash, credit cards, checks, electronic funds

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LEARNING GOALSLEARNING GOALS

1Describe Sarbanes-Oxley Act, 2002, its impact on internal control, reporting.

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BEFORE SARBANES-BEFORE SARBANES-OXLEY ACTOXLEY ACT

BEFORE SARBANES-BEFORE SARBANES-OXLEY ACTOXLEY ACT

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SARBANES-OXLEY ACT 2002

Congress’ attempt to restore public confidence

Requires public companies to improve internal controls that

safeguard assets

LG 1

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LEARNING GOALSLEARNING GOALS

2Describe, illustrate objectives, elements of internal control.

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INTERNAL CONTROL INTERNAL CONTROL OBJECTIVESOBJECTIVES

INTERNAL CONTROL INTERNAL CONTROL OBJECTIVESOBJECTIVES

LG 2

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How does management achieve its internal control

objectives?

LG 2

INTERNAL CONTROL?

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5 ELEMENTS OF INTERNAL CONTROL

•Control environment

•Risk assessment

•Control procedures

•Information & communication

•Monitoring

LG 2

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LG 2

EXHIBIT EXHIBIT 22

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Control environment includes management and employee attitudes about

the importance of internal control

LG 2

CONTROL ENVIRONMENTCONTROL ENVIRONMENT CONTROL ENVIRONMENTCONTROL ENVIRONMENT

Continued

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Respect

Competency

Honesty

Respect

Competency

Honesty

LG 2

CONTROL ENVIRONMENTCONTROL ENVIRONMENT CONTROL ENVIRONMENTCONTROL ENVIRONMENT

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Risk assessment identifies risks so management can

take steps to control them.

LG 2

RISK ASSESSMENTRISK ASSESSMENT RISK ASSESSMENTRISK ASSESSMENT

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Control Procedures Competent personnel

Separating responsibilities

Separating operations

Security measures

LG 2

CONTROL PROCEDURESCONTROL PROCEDURES CONTROL PROCEDURESCONTROL PROCEDURES

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LG 2

EXHIBIT EXHIBIT 44

Information & Communications

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Monitoring

LG 2

MONITORINGMONITORING MONITORINGMONITORING

To locate weaknesses & improve control effectiveness

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LEARNING GOALSLEARNING GOALS

3Describe, illustrate application of internal controls to cash.

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CONTROL: CASH CONTROL: CASH RECEIPTSRECEIPTS

CONTROL: CASH CONTROL: CASH RECEIPTSRECEIPTS

•To protect cash from theft when

–Customers buy products, services

–Customers pay on account

LG 3

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Cash deposits

Cash Records

LG 3

CASH RECEIPTSCASH RECEIPTS

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LG 3

RECORDING PROCESSRECORDING PROCESS RECORDING PROCESSRECORDING PROCESS

Continued

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LG 3

CASH DEPOSITSCASH DEPOSITS CASH DEPOSITSCASH DEPOSITS

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CASH PAYMENTSCASH PAYMENTS

Payment made through

•Voucher system

•EFT

LG 3

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LEARNING GOALSLEARNING GOALS

4Describe nature of bank account, its use in controlling cash.

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BANK ACCOUNTS

Bank accounts control accounts bySafeguarding cash

Providing double recording of cash transactions

Providing comparison with business records

Bank accounts control accounts bySafeguarding cash

Providing double recording of cash transactions

Providing comparison with business records

LG 4

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BANK RECONCILIATIONBANK RECONCILIATION

Bank Statement Company

Cash Records

LG 5

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EXHIBIT EXHIBIT 66

LG 5

Beginning Balance $XXX

Additions XX

Deductions X

Ending Balance XXX

Bank Statement Power Networking RecordsBeginning Balance $XXX

Deposits XX

Checks X

Ending Balance XXX

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LEARNING GOALSLEARNING GOALS

5Describe, illustrate use of bank reconciliation in controlling cash.

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RECONCILIATION PROCESS

RECONCILIATION PROCESS

1. Add deposits not recorded to bank balance

2. Deduct checks not paid from bank balance

3. Add credit memos not recorded to company balance

4. Deduct debit memos not recorded from company balance

5. Correct all errors

LG 5

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EXERCISE 7-16aEXERCISE 7-16a

Which of the following adds to the bank balance?

1. $300 check recorded by company as $3,000

2. NSF check $775 returned

3. Bank service charge $35

4. Bank incorrectly charged a $129 check as $219

5. Outstanding checks, $6,137.68

6. Deposit in transit, $7500

7. Note collected by bank, $12,000

Click the button to skip this exercise

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EXERCISE 7-16bEXERCISE 7-16b

Which of the following deducts from the bank balance?

1. $300 check recorded by company as $3,000

2. NSF check $775 returned

3. Bank service charge $35

4. Bank incorrectly charged a $129 check as $219

5. Outstanding checks, $6,137.68

6. Deposit in transit, $7500

7. Note collected by bank, $12,000

Click the button to skip this exercise

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EXERCISE 7-16cEXERCISE 7-16c

Which of the following adds to the company balance?

1. $300 check recorded by company as $3,000

2. NSF check $775 returned

3. Bank service charge $35

4. Bank incorrectly charged a $129 check as $219

5. Outstanding checks, $6,137.68

6. Deposit in transit, $7500

7. Note collected by bank, $12,000

Click the button to skip this exercise

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EXERCISE 7-16dEXERCISE 7-16d

Which of the following deducts from the company balance?

1. $300 check recorded by company as $3,000

2. NSF check $775 returned

3. Bank service charge $35

4. Bank incorrectly charged a $129 check as $219

5. Outstanding checks, $6,137.68

6. Deposit in transit, $7500

7. Note collected by bank, $12,000

Click the button to skip this exercise

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EXHIBIT EXHIBIT 7 7 (partial)(partial)

LG 5

Beginning Balance $2,549.99

+ Note & interest (1) 408.00

$2957.99

- Returned check $300.00

- Service Charge 18.00

- Recording error 9.00 (2) 327.00

Adjusted Balance $2,630.99

Adjustments to Power Networking Records

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CASH ADJUSTMENTS 1

Increases cash flow operations

Net increase assets, increases equity on balance sheet

Increases revenue on income statement

Continued

LG 5

7/31 Cash

Notes Receivable

Interest Income

408

400

8

Adjusted cash for items added by bank

SCF BS IS

R

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CASH ADJUSTMENTS 2

Decreases cash flow operations

Net decrease assets, decreases liabilities, equity on balance sheet

Increases expenses on income statement

LG 5

7/31 Acct Receivable

Misc Expense

Acct Payable

Cash

300

18

9

327

Adjusted cash for items deducted by bank

SCF BS IS

E

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LEARNING GOALSLEARNING GOALS

6Describe accounting for special-purpose cash funds.

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PETTY CASHPETTY CASH

For small payments in office

Funded from bank account

LG 6

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ENTRY TO INCREASE PETTY CASH

To create petty cash

Has no effect on cash flows

Has no net effect on balance sheet

Has no effect on income statement

LG 6

8/1 Petty Cash

Cash

500

500

SCF BS IS

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ENTRY TO REPLENISH PETTY CASH

To replenish petty cash, recognize expenses

Increases cash flow operations

Net increase assets, increases equity on balance sheet

Increases revenue on income statement

LG 6

8/31 Office Supplies

Store supplies

Misc. Exp.

Cash

402

35

30

467

SCF BS IS

E

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LEARNING GOALSLEARNING GOALS

7Describe, illustrate reporting cash, cash equivalents in financial statements.

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CASH EQUIVALENTSCASH EQUIVALENTS

Includes

•Money market mutual funds

•Commercial paper

•Certificates of deposit

•Government & municipal securities

•Corporate notes, bonds

LG 7

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LEARNING GOALSLEARNING GOALS

8Interpret cash flow to net income ratio, cash to monthly cash expense ratio.

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CASH FLOW TO NET INCOME RATIO

CASH FLOW TO NET INCOME RATIO

Compares cash flow to reported profit under accrual method (GAAP)

Trends analyzed

Net cash flow, Operations / Net Income

Compares cash flow to reported profit under accrual method (GAAP)

Trends analyzed

Net cash flow, Operations / Net Income

LG 8

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WALT DISNEY: TRENDSWALT DISNEY: TRENDS

2004 2003

Net CF-Operations $4,370 $2,901

Net Income $2,345 $1,267

Cash flow ratio 1.86 2.29

What does the cash flow ratio suggest?

LG 8

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ANALYSISANALYSIS

Trend for cash flow to net income ratio is negative

Without good cash cushion & business model, this trend would suggest a problem with operations

Trend for cash flow to net income ratio is negative

Without good cash cushion & business model, this trend would suggest a problem with operations

LG 8

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CASH TO MONTHLY CASH EXPENSES

CASH TO MONTHLY CASH EXPENSES

Used to assess how long a business in financial distress can continue

Cash + cash equivalents

Monthly cash expenses

Used to assess how long a business in financial distress can continue

Cash + cash equivalents

Monthly cash expenses

Monthly Cash Expenses = Negative Cash Flow from Operations / 12 months

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GATEWAY ANALYSISGATEWAY ANALYSIS

Negative cash flow from operations

Cash + cash equivalents

$<434.2>

383.0

Ratio = 383.0/[<434.2>/12] = 10.6

Gateway will run out of cash in less than 11 months

Ratio = 383.0/[<434.2>/12] = 10.6

Gateway will run out of cash in less than 11 months

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THE END

CHAPTER 7