Sarbanes-Oxley, Internal Control and Cash

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SarbanesSarbanes--Oxley, Oxley, Internal Control Internal Control and Cashand Cash

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and Cashand Cash


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1. Describe the Sarbanes-Oxley Act of

2002 and its impact on internal

controls and financial reporting.

After studying this chapter, you should

be able to:

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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.


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4. Describe the nature of a bank account

and its use in controlling cash.

Describe and illustrate the use of a


be able to:

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5. Describe and illustrate the use of a

bank reconciliation in controlling

cash.

6. Describe the accounting for special-

purpose cash funds.


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7. Describe and illustrate the reporting

of cash and cash equivalents in the

financial statements.


be able to:

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Describe the Sarbanes-Oxley

Act of 2002 and its impact on

Objective 1Objective 1

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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

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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

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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

safeguard its assets, process

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safeguard its assets, process

information accurately, and

ensure compliance with laws

and regulations.


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8-1Effect of Sarbanes-Oxley Act

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Describe and illustrate the


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objectives and elements of

internal control.


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1) assets are safeguarded and used for

business purposes,

To provide reasonable assurance that:

8-2Objectives of Internal Control

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business purposes,

2) business information is accurate, and

3) employees comply with laws and

regulations.


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Employee fraud is the

intentional act of

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deceiving an employer

for personal gain.


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1) the control environment,

Management is responsible for designing and

applying five elements of internal control to

meet the three internal control objectives.

These elements are—

8-2Five Elements of Internal Control

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1) the control environment,

2) risk assessment,

3) control procedures,

4) monitoring, and

5) information and communication.


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A business’s control

environment is the overall

attitude of management and

8-2Control Environment

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attitude of management and

employees about the

importance of controls.


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8-2Factors That Influence the Control

Environment

� Management’s philosophy and

operating style

� The business’s organizational

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� The business’s organizational

structure

� Personnel policies


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8-2Control Environment

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Example of control procedures for an all-

night convenience store:

� Locate the cash register near the door, so that

it is fully visible from outside the store; have

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two employees work late hours; employ a

security guard.

� Deposit cash in the bank daily, before 5 p.m.

(Continued)


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� 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.

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employees on duty.

� Install cameras and alarm systems.

(Concluded)


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8-2Indicators of Internal

Control Problems

Warning Signs With Regard to People

1. Abrupt change in lifestyle.

2. Close social relationships with suppliers.

3. Refusing to take a vacation.

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3. Refusing to take a vacation.

4. Frequent borrowing from other

employees.

5. Excessive use of alcohol or drugs.


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8-2Indicators of Internal

Control Problems

Warning Signs from the

Accounting System

1. Missing documents or gaps in transaction

numbers.

2. An unusual increase in customer refunds.

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2. An unusual increase in customer refunds.

3. Differences between daily cash receipts

and bank deposits.

4. Sudden increase in slow payments.

5. Backlog in recording transactions.


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8-2-

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

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1. Mandatory vacations

2. Personnel policies

3. Report of outside consultants on

future market changes


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Follow My Example 8-1

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1. (c) control procedures

2. (a) the control environment

2323For Practice: PE 8-1A, PE 8-1B

3. (b) risk assessment


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application of internal

controls to cash.


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One of the most important

controls to protect cash

received in over-the-counter

8-3Control of Cash Receipts

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received in over-the-counter

sales is a cash register.


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A predetermined amount of

money that is given to each cash

8-3Change Fund

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money that is given to each cash

register clerk in a cash drawer is

called a change fund.


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Mar 19 Cash 3 142 00

Cash sales for March 19 totaled $3,150.00 per

the cash register tape. After removing the

change fund, only $3,142.00 was on hand.

8-3Cash Short and Over

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Mar 19 Cash 3 142 00

Cash Short and Over 8 00

To record cash sales and

actual cash on hand.

Sales 3 150 00

Note that the shortage was debited to Cash

Short and Over.


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8-3Control of Cash Receipts

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Cash may be received from

customers through electronic

funds transfers. Customers may

8-3Electronic Funds Transfers

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funds transfers. Customers may

authorize automatic electronic

transfers from their checking

accounts to pay monthly bills.


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A voucher system is a set of

procedures for authorizing and

recording liabilities and cash

Voucher System 8-3

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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

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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


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Describe the nature of a bank

account and its use in

controlling cash.


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A major reason that

businesses use bank accounts

Use of Bank Accounts 8-4

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businesses use bank accounts

is for control purposes.


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Bank accounts provide an

independent recording of cash

transactions that can be used as a

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transactions that can be used as a

verification of the business’s

recording of transactions.


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A summary received from

the bank of all checking

8-4Bank Statement

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account transaction is called

a bank statement.


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8-4Bank Statement

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(Continued)


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8-4Bank Statement

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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.

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NSF — Not sufficient funds check.

SC — Service charge.

ACH — Automated Clearing House entry

for electronic funds transfer.

MS — Miscellaneous items.


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8-4-


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.

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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 depositor’s

account.


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Appears on the

Bank Statement

as a Debit or

Credit

Memorandum

Increases or

Decreases the

Balance of the

Depositor’s

Bank AccountItem No.


Memorandum Bank AccountItem No.

(1) Debit Memorandum Decreases

(2) Credit Memorandum Increases




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8-4Power Networking’s Records

and Bank Statement

4141

Power Networking

should determine the

reason for difference in

these two amounts.


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Describe and illustrate the use


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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

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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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8-5

Bank’s records

Beginning balance $3,359.78 Beginning balance $2,549.99

Power Network prepares to reconcile

Company’s records

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Power Network 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.


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8-5

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Company’s recordsBank’s records

4545A deposit of $816.20 did not

appear on the bank statement.


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8-5


$4,175.98

Add note and interestcollected by bank 408.00

$2,957.99


4646The bank collected a note in the amount of $400

and the related interest of $8 for Power Networking


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8-5


$4,175.98


$2,957.99Deduct outstanding


4747Three 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.

Deduct outstandingchecks:No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99


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8-5


$4,175.98




Deduct check

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The bank returned a check for $300 from customer

(Thomas Ivey) because of insufficient funds (NSF).

Deduct check NSF $300.00


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8-5


$4,175.98




Deduct check

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Bank service charges 18.00

The bank service charges totaled $18.00.



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8-5

Beginning balance $3,359.78

Company’s records

Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98



Bank’s records

Deduct check

5050



Error recordingCheck No. 879 9.00 327.00

Check No. 879 for $732.26 to Taylor Co. on account,

erroneously recorded in journal as $723.26.



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8-5


$4,175.98



Deduct check


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Adjusted balance $2,630.99 Adjusted balance $2,630.99

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Error recordingCheck No. 879 9.00 327.00


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5252


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Journal entries must be

prepared for those items that

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affected the company’s

(depositor’s) side of the

reconciliation.


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$2,957.99

Deduct check

Company’s records

5454



327.00Error recordingCheck No. 879 9.00


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8-5

July 31 Cash 408 00

Note collected by bank.

Notes Receivable 400 00

Interest Income 8 00

Entry to Record Plus Items

5555



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$2,957.99

Deduct check

Company’s records

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5656



327.00Error recordingCheck No. 879 9.00


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8-5

July 31 Cash 408 00


Notes Receivable 400 00

Interest Income 8 00

31 Accounts Receivable—Thomas Ivey 300 00

Entry to Record Minus Items

5757

31 Accounts Receivable—Thomas Ivey 300 00

Miscellaneous Expense 18 00

Accounts Payable—Taylor Co. 9 00

Cash 327 00

NSF check, bank service

charges, and error in

recording Check no. 879.


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8-5


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

5858(Continued)

Balance per company records 13,875

Bank service charges 75

Deposit in transit 3,750

NSF check 800

Outstanding checks 5,250


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8-5


a. What is the adjusted balance on the bank

reconciliation?

b. Journalize any necessary entries for Photo OP

based upon the bank reconciliation.

5959

based upon the bank reconciliation.


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a. $13,000, as shown below.

Bank section of reconciliation: $14,500 – $5,250 +

$3,750 = $13,000

Company section of reconciliation: $13,875 – $75


Company section of reconciliation: $13,875 – $75

– $800 = $13,000

b. Accounts Receivable 800

Miscellaneous Expense 75

Cash 875


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Describe the


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Describe the

accounting for special-

purpose cash funds.


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It is usually not practical for a

business to write checks to pay

small amounts. Thus, it is

desirable to control such

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desirable to control such

payments by using a special cash

fund, called a petty cash fund.


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On August 1, issued Check No. 511 for $500

to established a petty cash fund.

JOURNAL Page 9

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6363

Post.

Ref.Date Description Debit Credit

Aug. 1 Petty Cash 500 002008

Cash 500 00

Established petty cash

fund issuing Check 511.


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At the end of August, the petty cash receipts indicated

expenditures for the following items: office supplies,

$380, postage (office supplies), $22; store supplies, $35,

and miscellaneous administrative items, $30.

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Aug. 31 Office Supplies 402 00

Replenished petty cash fund.

Cash 467 00

Store Supplies 35 00

Miscellaneous Administrative Exp. 30 00


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Replenishing the petty cash fund

restores it to its original amount

of $500. Note that there is no

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of $500. Note that there is no

entry to Petty Cash when the fund

is replenished.


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Businesses often use special

cash funds to meet other needs,

such as payroll. Such funds are

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such as payroll. Such funds are

called special-purpose funds.


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8-6


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

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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.

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8-6

a) Petty Cash 500

Cash 500

b) Office Supplies 300

Miscellaneous Admin. Expense 75


Miscellaneous Admin. Expense 75

Cash Short and Over 5

Cash 380


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Describe and illustrate


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Describe and illustrate

the reporting of cash and

cash equivalents in the



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A company’s excess cash is

normally invested in highly liquid

investments. These investments

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investments. These investments

are called cash equivalents.


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Companies that have

invested excess cash in

cash equivalents usually

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cash equivalents usually

report cash and cash

equivalents as one amount

on the balance sheet.


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Banks may require depositors to

maintain minimum cash

balances in their bank accounts.

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balances in their bank accounts.

Such a balance is called a

compensating balance.


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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

8-7Ratio of Cash to Monthly

Cash Expenses

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cash expenses. First, the monthly cash

expenses are determined.

Monthly Cash Expenses =

Negative Cash Flows

from Operations

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The ratio of cash to monthly

cash expenses can then be

computed as follows:


Cash Expenses

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Ratio of Cash to Monthly

Cash Expenses

Cash and Cash Equivalent

as of Year-End

Monthly Cash Expenses=


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Northwest Airlines Corporation reported the

following data (in millions) at the end of 2005:

Negative cash flows from operations $(436)


Cash Expenses

7575

Cash and cash equivalents, Dec. 31, 2005 1,284

= $36.3 per mo.$436

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Monthly Cash

Expense =

Monthly cash expense is sometimes

referred to as cash burn.


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$1,284

$36.3= 35.4


Cash Expenses

Ratio of Cash to

Monthly Cash

Expenses=

7676

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.

Documents

Sarbanes-Oxley, Internal Control and Cash