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©2008 Pearson Prentice Hall. All rights reserved.
4-2
Internal Control - Objectives
• Safeguard assets
• Encourage employees to follow company policy
• Promote operational efficiency
• Ensure accurate, reliable accounting records
• Comply with legal requirements
©2008 Pearson Prentice Hall. All rights reserved.
4-3
Sarbanes-Oxley Act (SOX)
• Accounting scandals shook the public’s confidence in the accounting profession Enron and WorldCom overstated profits Auditors Arthur Anderson went out of
business
• In response, Congress passed SOX Established new provisions for how large
corporations are audited
©2008 Pearson Prentice Hall. All rights reserved.
4-4
Learning Objective 1
Set up an internal control system
©2008 Pearson Prentice Hall. All rights reserved.
4-5
Control Environment Tone set “at the top”
Top management should set good example for employees
Information SystemProvides accurate information to keep track of
assets and measure income
Risk assessment Identify risks in the business environment
Control Procedures Ensure goals are achieved
Monitoring of ControlsAuditors make sure controls are working
©2008 Pearson Prentice Hall. All rights reserved.
4-6
Internal Control Procedures
• Competent, reliable and ethical employees Staff should be trained and fairly rewarded for
its work
• Assignment of Responsibilities Job descriptions should be clear
• Separation of Duties Operations from accounting Custody of assets from accounting
©2008 Pearson Prentice Hall. All rights reserved.
4-7
Internal Control Procedures
• Audits Internal or External
• Documents
• Electronic Devices
• Other controls Fireproof vaults for important documents Bonds on employees who handle cash Mandatory vacations and job rotation
©2008 Pearson Prentice Hall. All rights reserved.
4-8
Internal Controls for E-Commerce
• Risks of online business Stolen credit cards Computer viruses Phishing
• Security measures Encryption Firewalls
©2008 Pearson Prentice Hall. All rights reserved.
4-9
Limitations of Internal Control
• Collusion Two people working together can circumvent
system
• Cost Company must weigh the benefits of controls
with the cost
©2008 Pearson Prentice Hall. All rights reserved.
4-10
Bank Account as Control
• Keeping cash in a bank account safeguards the asset
• Bank account documents provide controls Signature card Deposit tickets Checks Bank Statements Electronic Funds Transfer (EFT)
©2008 Pearson Prentice Hall. All rights reserved.
4-11
Learning Objective 2
Prepare and use a bank reconciliation as a control device
©2008 Pearson Prentice Hall. All rights reserved.
4-12
Bank Reconciliation
• Process to update cash account
Book Balance
Cash account in General Ledger
Bank Balance
Cash amount according to
bank statement
Amounts don’t equal due to time lags in recording transactions
©2008 Pearson Prentice Hall. All rights reserved.
4-13
Bank balance
Add: Deposits in transit
Subtract: Outstanding checks
Add or Subtract: Bank errors
Equals: Adjusted Cash Balance
Book balance
Subtract: EFT payments, service charges, NSF checks
Add: Bank collections & Interest revenue
Add or Subtract: Book errors
Equals: Adjusted Cash Balance
Preparing a Bank Reconciliation
©2008 Pearson Prentice Hall. All rights reserved.
4-14
E4-20
Bank Balance, May 31 $595
Plus: deposit in transit $1,788
Less: outstanding checks ($603)
Adjusted Cash Balance $1,780
©2008 Pearson Prentice Hall. All rights reserved.
4-15
E4-20
Book Balance, May 31 $1,882
Plus: Rent collection $300
Less: Service charge ($12)
Less: NSF checks ($120)
Less: Printed checks ($9)
Less: Error____________
_
Adjusted Cash Balance $1,780
What would be the amount of
the error?
Subtract the actual amount of the deposit from
the amount recorded
©2008 Pearson Prentice Hall. All rights reserved.
4-16
Entries from Reconciliation
• All items on the book side require a journal entry All items added will result in a debit to cash All items subtracted will result in a credit to
cash
• After entries are posted Cash Balance in Ledger = Adjusted Cash
Balance on Reconciliation
©2008 Pearson Prentice Hall. All rights reserved.
4-17
E4-21
JOURNAL
Date Accounts Debit Credit
31-May Cash $300
Rent revenue $300
Miscellaneous Expense $21
Cash ($9 +$12) $21
©2008 Pearson Prentice Hall. All rights reserved.
4-18
E4-21
JOURNAL
Date Accounts Debit Credit
31-May _____________________ $120
Cash $120
Salary Expense $261
Cash $261
What account is debited for NSF
checks?
©2008 Pearson Prentice Hall. All rights reserved.
4-19
Learning Objective 3
Apply internal controls to cash receipts and cash payments
©2008 Pearson Prentice Hall. All rights reserved.
4-20
Internal Control over Cash Receipts
Over the counter• Cash register record
transactions• Receipts issued to
customer• Manager compares cash
in drawer to cash register record
• Receipts deposited at least daily
By mail• Checks and remittance
advice separated • Checks sent to treasurer
for deposit• Remittance advice sent to
accounting to record• Bank deposit slip
compared with debit to cash
©2008 Pearson Prentice Hall. All rights reserved.
4-21
Internal Control Over Cash Payments
• Payment by check Provides record of payment Must be signed by authorized official Official should study evidence supporting
payment
©2008 Pearson Prentice Hall. All rights reserved.
4-22
Documents Used to Control Purchases
• Purchase order Prepared by purchasing company to place
order
• Invoice Prepared by selling company to list items sent
and to request payment
• Receiving report Prepared by purchasing company to show
that goods were received
©2008 Pearson Prentice Hall. All rights reserved.
4-23
Payment packet
Receiving Report
Invoice
Purchase Order
Documents should agree before payment is made
©2008 Pearson Prentice Hall. All rights reserved.
4-24
Separation of Duties
• Responsibilities should be split: Purchasing goods Receiving goods Approving and paying for goods
©2008 Pearson Prentice Hall. All rights reserved.
4-25
Petty Cash
• Small amount of cash kept on hand for incidental purchases
• Fund is established at a set amount
• Custodian of fund prepares ticket that lists each item purchased
• Tickets plus remaining cash should equal fund balance
©2008 Pearson Prentice Hall. All rights reserved.
4-26
Learning Objective 4
Use a budget to manage your cash
©2008 Pearson Prentice Hall. All rights reserved.
4-27
Budget
• Financial plan that helps coordinate business activities
• A cash budget helps a company manage cash by planning receipts and payments
©2008 Pearson Prentice Hall. All rights reserved.
4-28
CASH BUDGET
Beginning cash balance
Plus: Budgeted Cash Receipts
Minus: Budgeted Cash payments
Equals: Expected ending cash balance
Compare ending balance to
minimum needed If excess, invest If shortfall,
borrow
©2008 Pearson Prentice Hall. All rights reserved.
4-29
E4-24
Cash Budget 20X8
Beginning cash balance $81
Budgeted cash receipts:
Cash collections from customers $11,284
Sale of equipment 115 $11,399
©2008 Pearson Prentice Hall. All rights reserved.
4-30
E4-24
Budgeted cash payments:
Costs of services and products $6,166
Operating expenses 2,543
Purchase of new equipment 1,825
Debt payments 597
Dividend payment 338 $11,469
Expected cash balance $11
©2008 Pearson Prentice Hall. All rights reserved.
4-31
E4-24
Expected Cash Balance = $11
Company’s Minimum Cash Balance = $75
Expected Borrowing = ________
What amount of borrowing would get the company to its
minimum?
©2008 Pearson Prentice Hall. All rights reserved.
4-32
Learning Objective 5
Make ethical business judgments
©2008 Pearson Prentice Hall. All rights reserved.
4-33
Codes of Ethics
• Most companies have a code of ethics
• Owners and managers must set an ethical tone as well
• The accounting profession is expected to maintain higher standards AICPA Code of Professional Conduct Standards of Ethical Conduct for Management
Accountants
©2008 Pearson Prentice Hall. All rights reserved.
4-34
Ethical Issues in Accounting
• Pressure often exists for managers to reach earnings or stock price goals
• Earnings can be manipulated by Understating expenses Overstating revenues
• Use Framework for Making Ethical Judgments
©2008 Pearson Prentice Hall. All rights reserved.
4-35
Framework for Ethical Judgments
• Identify the ethical issue
• Specify the alternatives
• Assess the possible outcomes
• Make the decision