sarbanes-oxley, internal control and cash

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8Sarbanes-Sarbanes-

Oxley, Internal Oxley, Internal Control and Control and

CashCash

Describe the Sarbanes-Oxley Act of 2002 and its impact on

internal controls and financial reporting.

Objective 1Objective 1Objective 1Objective 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 requires companies to maintain

strong and effective internal control.

Internal control is broadly defined as the procedures and

processes used by a company to safeguard its assets, process information accurately, and

ensure compliance with laws and regulations.

8-1Effect of Sarbanes-Oxley Act

Describe and illustrate the objectives and elements of

internal control.

1) assets are safeguarded and used for business purposes,

2) business information is accurate, and

3) employees comply with laws and regulations.

To provide reasonable assurance that:

8-2Objectives of Internal Control

Employee fraud is the intentional act of

deceiving an employer for personal gain.

1) the control environment,

2) risk assessment,

3) control procedures,

4) monitoring, and

5) information and communication.

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

A business’s control environment is the overall attitude of management and

employees about the importance of controls.

8-2Control Environment

8-2Factors That Influence the Control Environment

Management’s philosophy and operating style

The business’s organizational structure

Personnel policies

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 two employees work late hours; employ a security guard.

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

(Continued)

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.

Install cameras and alarm systems.

(Concluded)

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.

4. Frequent borrowing from other employees.

5. Excessive use of alcohol or drugs.

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.

3. Differences between daily cash receipts and bank deposits.

4. Sudden increase in slow payments.

5. Backlog in recording transactions.

Describe and illustrate the application of internal

controls to cash.

One of the most important controls to protect cash

received in over-the-counter sales is a cash register.

8-3Control 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.

8-3Change Fund

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

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

Note that the shortage was debited to Cash Short and Over.

8-3Control of Cash Receipts

Cash may be received from customers through electronic

funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills.

8-3Electronic Funds Transfers

Describe the nature of a bank account and its use in

controlling cash.

A major reason that businesses use bank accounts

is for control purposes.

Use of Bank Accounts 8-4

Bank accounts provide an independent recording of cash

transactions that can be used as a verification of the business’s

recording of transactions.

A summary received from the bank of all checking

account transaction is called a bank statement.

8-4Bank Statement

(Continued)

8-4Bank Statement

(Concluded) 37

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.

Power Networking should determine the reason for difference in these two amounts.

Power Networking’s Records and Bank Statement

Describe and illustrate the use of a bank reconciliation in

controlling cash.

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.

Bank’s recordsBeginning balance $3,359.78 Beginning balance $2,549.99

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.

Company’s records

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

$4,175.98

A deposit of $816.20 did not appear on the bank statement.

Company’s recordsBank’s records

$4,175.98

The bank collected a note in the amount of $400 and the related interest of $8 for Power

Networking

Add note and interest collected by bank

408.00$2,957.9

$4,175.98

408.00$2,957.9

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.

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

$4,175.98

408.00$2,957.9

9Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF).

Deduct check NSF $300.00

$4,175.98

408.00$2,957.9

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Bank service charges 18.00

The bank service charges totaled $18.00.

Beginning balance $3,359.78

Company’s recordsBeginning balance $2,549.99

Add deposit not recorded by bank 816.20

$4,175.98

408.00$2,957.9

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Bank service charges 18.00Error recording Check No. 879 9.00

327.00

Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

Bank’s records

$4,175.98

408.00$2,957.9

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Bank service charges 18.00

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

Error recording Check No. 879 9.00

Journal entries must be prepared for those items that

affected the company’s (depositor’s) side of the

reconciliation.

Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00Bank service charges 18.00

327.00

Company’s records

July 31 Cash 408 00

Note collected by bank.

Notes Receivable 400 00

Interest Income8 00

Entry to Record Plus Items

Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00Bank service charges 18.00

327.00

Company’s records

July 31 Cash 408 00

Note collected by bank.

Notes Receivable 400 00

Interest Income8 00

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.

Entry to Record Minus Items

Describe the accounting for special-

purpose cash funds.

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.

On August 1, issued Check No. 511 for $500 to established a petty cash fund.

Post. Ref.

JOURNAL

Date Description Debit Credit

Aug. 1 Petty Cash 500 002008

Cash 500 00Established petty cash fund issuing Check 511.

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.

Aug. 31 Office Supplies 402 00

Replenished petty cash fund.

Cash 467 00

Store Supplies 35 00

Miscellaneous Administrative Exp. 30 00

Replenishing the petty cash fund restores it to its original amount of $500. Note that there is no

entry to Petty Cash when the fund is replenished.

Businesses often use special cash funds to meet other needs, such as payroll. Such funds are called special-purpose funds.

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

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

are called cash equivalents.

Companies that have invested excess cash in cash equivalents usually

report cash and cash equivalents as one amount

on the balance sheet.

Banks may require depositors to maintain minimum cash

balances in their bank accounts. Such a balance is called a

compensating balance.

A cash ratio that is especially useful for companies, starting up or in financial

distress, is the ratio of cash to monthly cash expense. First, the monthly cash

expenses are determined.

8-7Ratio of Cash to Monthly Cash Expenses

Monthly Cash Expenses =

Negative Cash Flows from Operations

The ratio of cash to monthly cash expenses can then be

computed as follows:

Ratio of Cash to Monthly Cash Expenses

Cash and Cash Equivalent as of Year-End

Monthly Cash Expenses=

Northwest Airlines Corporation reported the following data (in millions) at the end of 2005:

Negative cash flows from operations

$(436)

Cash and cash equivalents, Dec. 31, 2005

= $36.3 per mo.$436

Monthly Cash Expense =

Monthly cash expense is sometimes referred to as cash burn.

$1,284

$36.3= 35.4

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.

Ratio of Cash to Monthly Cash

Expenses=

1. Describe the Sarbanes-Oxley Act of 2002 and its 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.

After studying this chapter, you should be able to:

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 special-purpose cash funds.

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

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 vacations2. Personnel policies3. Report of outside consultants on

future market changes

Follow My Example 8-1

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

1. (c) control procedures

2. (a) the control environment

3. (b) risk assessment

8-4-Example Exercise 8-2

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 depositor’s account.

Appears on the Bank Statement

as a Debit or Credit

Memorandum

Increases or Decreases the Balance of the

Depositor’s Bank AccountItem No.

(1) Debit Memorandum Decreases

(2) Credit Memorandum Increases

The following data were gathered to use in reconciling the bank account of Photo Op.

58(Continued)

Balance per bank $14,500Balance per company records 13,875Bank service charges 75Deposit in transit 3,750NSF check 800Outstanding checks 5,250

a. What is the adjusted balance on the bank reconciliation?

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

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 – $800 = $13,000b. Accounts Receivable 800

Miscellaneous Expense 75Cash 875

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.

a) Petty Cash 500Cash500

b) Office Supplies 300Miscellaneous Admin. Expense 75Cash Short and Over 5

Cash380

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

Voucher System 8-3

A voucher is any document that serves as proof of

authority to pay cash or issue an electronic funds transfer.

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