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Chapter Four

Internal Control andCash

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Sarbanes-Oxley Act (SOX)

In 2001-2002, several serious accounting scandals in whichpeople lost millions of dollars.

Enron

WorldCom

In response to the public outcry, SOX was passed in 2002 inorder to improve corporate governance.

Public Company Accounting Oversight Board (PCAOB). Restricted consulting services.

Internal control report by companies/auditors.

Increased penalties.

For more information, visit:

www.aicpa.org/info/sarbanes_oxley_summary.htm

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Internal Controls

Goals of Internal Controls: Safeguarding assets.

Encouraging adherence to companypolicies.

Promoting operational efficiency.

Ensuring accurate and reliable accountingrecords.

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Internal Controls

Components of an Internal Control System Competent, reliable, and ethical personnel

furthermore, should treat employees well.

Assignment of duties specific positions in chargeof specific functions.

Proper authorization approving a creditapplication, signing a check.

Supervision of employees critical for a smallbusiness that may not have other controls.

Separation of duties separate (1) operations andaccounting; (2) asset custody and accounting.

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Internal Controls

Additional Components of an InternalControl System

Proper use and design of documents pre-numbered, easy to understand.

Control access to assets and records (Physical

Control) security cameras, storing records off-site. Independent checks verification of performance by

someone who was not originally responsible forpreparing the data.

Adapted from Smith (2001)

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Internal Controls

Audit An examination by an outside party of a

companys financial statements, accountingsystems, and internal controls.

External Auditor Independent; does not work for the

company.

Must be a CPA.

Internal Auditor

Employee of the business.

Need not be a CPA.

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Internal Controls Issues

Collusion effort by 2 or moreemployees to override the system No system is fool-proof.

Need to rely upon the honesty and ethical behavior

ofall employees. Benefits > Costs to implement

Many small businesses may not reach thisthreshold.

If Benefits < Costs for certain controls, the day-to-

day involvement of the owner and others in thebusinesss operations is critical.

Make sure that the complexity of the systemdoes not hurt the businesss efficiency and/or

customer relations.

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Internal Control Cash Focus

Why the emphasis on cash? Very liquid.

A very easy target of theft and/or fraud.

More controls over cash = less temptation.

Important to deposit in bank account (as acontrol), but should also reconcile betweenthe company and banks records.

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Bank Reconciliation

Bank account keeps track of balance of Cash in aparticular account.

Accounting records keep track of balance of Cashaccount (think of your checkbook balance).

Companies need to reconcile the value of cash per

the bank account and per company records in orderto determine the actual cash balance.

Protects against bank errors.

Safeguard against errors and/or embezzlementsby company employees.

Helps determine the correct cash balance whichshould be displayed in the companys accountingrecords/financial statements.

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Bank Reconciliation

Key: Think about what the company hasrecorded that the bank does not knowabout, and what the bank has recordedthat the company does not yet know

about.

**Study Exhibit 4-9 on page 186 for the format of a

bank reconciliation.

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Bank Reconciliation

Items recorded by the company, but notthe bank: Deposits in Transit (add to bank).

Outstanding Checks (subtract from bank).

Errors made by the bank (add/subtract from bank).

Items on the bank statement, but notyet recorded by

the company: Bank Collections (add to book).

Electronic Fund Transfers (EFTs) (add/subtract tobook).

Service Charges (subtract from book).

Interest Revenue earned on account (add to book).

Non-Sufficient Funds (NSF) Checks (subtract frombook).

Errors made by the company (add/subtract to book).

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Bank Reconciliation

Compute the Adjusted Bank Balance: Begin with the balance per the bank statement. Add or subtract items that the company knows about,

but which are not known by the bank.

Compute the Adjusted Book Balance:

Begin with the balance per company records. Add or subtract items which are known by the bank, but

which are not yet known by the company.

At the end of the reconciliation process, theAdjusted Bank Balance and Adjusted Book Balanceshould be equal.

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BAL PER BANK $ 325BAL PER BANK $ 325ADD: DEPOSITSADD: DEPOSITS

IN TRANSITIN TRANSIT125125

DEDUCT:DEDUCT:

OUTSTANDINGOUTSTANDING

CHECKSCHECKS( 75)( 75)

ADJ BANK ADJ BANKBALANCEBALANCE $$375375

BAL PER BOOKS $ 350ADD: BANK

COLLECTIONS 325

INTEREST 50

DEDUCT: RETURNED

ITEMS (200 )EFT PMTS (110 )

BANK FEES -

SERV CHG (15 )

PRINT CK CHGS ( 25 )

ADJ BOOK BAL $ 375

Preparing the BankReconciliation-Example

AMOUNTS ARE IN

AGREEMENT

Example is from T. Evans (2006)

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Accounting for Transactionsfrom the Reconciliation

THESE ITEMS

NEED TO BERECORDED INTHE COMPANYACCOUNTS

These are itemsthat the companydoes not yetknow about.

BAL PER BOOKS $ 350

ADD: BANK

COLLECTIONS 325

INTEREST 50

DEDUCT: RETURNED

ITEM NSF (200)

EFT PMTS (110 )

BANK FEES -

SERV CHG (15 )

PRINT CK CHGS ( 25 )

ADJ BOOK BAL $ 375

Example is from T. Evans (2006)

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Internal Controls Cash

Petty Cash Minor amounts.

Need to keep records of how cash is spent.

Can be over-used; still need control.

Payments by Check Purchase requests, purchase orders, receivingreport.

Often are exceptions for smaller items (P Cards).

Cash Receipts Lockbox system.

If by mail, the checks and remittance advices shouldideally be separately entered.

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Cash Budget

Even though companies use accrualaccounting, it is still essential to havesufficient cash in order to run operationsand maintain certain expenses.

Need an idea of the cash inflows and outflows. Additional financing needed if insufficient

inflows.

If excess cash, this is often invested togenerate additional revenue.

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Cash Budget

A budget is a plan of business activities, whichis expressed in dollars.

Cash Budget:

Cash balance, beginning+ Budgeted cash receipts

- Budgeted cash payments

Expected cash balance, ending

Refer to Exhibit 4-14, Page 192 for a detailed example of a cash budget.

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Cash on the Financial Statements

Cash is reported on the Balance Sheet.

The account Cash generally includes

Cash and Cash Equivalents Petty Cash. Cash in checking accounts.

Cash in savings accounts.

Certificates of Deposit (CDs).Time Deposits.

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Questions?

Any questions or concerns?