Ch07 wrd12e instructor_final

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Sarbanes-Oxley, Internal


Control, and Cash

Control, and Cash

Chapter 7Chapter 7Chapter 7Chapter 7

Learning ObjectivesLearning Objectives

1.1.Describe the Sarbanes-Oxley Act of 2002 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and and its impact on internal controls and financial reporting.financial reporting.

2.2.Describe and illustrate the objectives and Describe and illustrate the objectives and elements of internal control.elements of internal control.

3.3.Describe and illustrate the application of Describe and illustrate the application of internal controls to cash.internal controls to cash.

4.4.Describe the nature of a bank account Describe the nature of a bank account and its use in controlling cash.and its use in controlling cash.


5.5. Describe and illustrate the use of a bank Describe and illustrate the use of a bank reconciliation in controlling cash.reconciliation in controlling cash.



6.6. Describe the accounting for special-Describe the accounting for special-purpose cash funds.purpose cash funds.




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




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

8.8. Describe and illustrate the use of the ratio Describe and illustrate the use of the ratio of cash to monthly cash expenses to of cash to monthly cash expenses to assess the ability of a company to assess the ability of a company to continue in business.continue in business.


Learning Learning Objective

ObjectiveDescribe the Sarbanes-Oxley Act

Describe the Sarbanes-Oxley Act

of 2002 and its impact on

of 2002 and its impact on

internal controls and financial

internal controls and financial reporting.reporting.

11


Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002

o The The Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002 (often (often referred to simply as referred to simply as Sarbanes-OxleySarbanes-Oxley) ) applies only to companies whose stock is applies only to companies whose stock is traded on public exchanges. Its purpose is traded on public exchanges. Its purpose is to restore public confidence and trust in to restore public confidence and trust in the financial statements of companies.the financial statements of companies.



o Sarbanes-Oxley requires companies to Sarbanes-Oxley requires companies to maintain strong and effective internal maintain strong and effective internal controls over the recording of transactions controls over the recording of transactions and the preparing of financial statements.and the preparing of financial statements.



o Internal controlInternal control is broadly defined as the is broadly defined as the procedures and processes used by a procedures and processes used by a company to:company to: Safeguard its assets.Safeguard its assets.

Process information accurately.Process information accurately.

Ensure compliance with laws and Ensure compliance with laws and regulations.regulations.

SARBANES-SARBANES-OXLEY ACT OF OXLEY ACT OF

20022002

SARBANES-SARBANES-OXLEY ACT OF OXLEY ACT OF

20022002



ObjectiveDescribe and illustrate the

Describe and illustrate the

objectives and elements of

objectives and elements of internal control.

internal control.

22

Internal ControlInternal Control


Internal ControlInternal Control

o Employee fraud Employee fraud is the intentional act of is the intentional act of deceiving an employer for personal gain.deceiving an employer for personal gain.


Elements of Internal ControlElements of Internal Control

o Management is responsible for designing Management is responsible for designing and applying five and applying five elements of internalelements of internal controlcontrol to meet the three internal control to meet the three internal control objectives. These elements are as follows:objectives. These elements are as follows: Control environmentControl environment

Risk assessmentRisk assessment

Control proceduresControl procedures

MonitoringMonitoring

Information and communicationInformation and communication

Elements of Internal ControlElements of Internal Control


Control EnvironmentControl Environment

o The The control environment control environment is the overall is the overall attitude of management and employees attitude of management and employees about the importance of controls. Three about the importance of controls. Three factors influencing a company’s control factors influencing a company’s control environment are as follows:environment are as follows: Management’s philosophy and operating styleManagement’s philosophy and operating style

The company’s organizational structureThe company’s organizational structure

The company’s personnel policiesThe company’s personnel policies

Control EnvironmentControl Environment


Control ProceduresControl Procedures

o Control procedures provide reasonable Control procedures provide reasonable assurance that business goals will be assurance that business goals will be achieved. Control procedures include the achieved. Control procedures include the following:following: Competent personnel, rotating duties, and Competent personnel, rotating duties, and

mandatory vacationsmandatory vacations

Separating responsibilities for related Separating responsibilities for related operationsoperations

Separating operations, custody of assets, Separating operations, custody of assets, and accountingand accounting

Proofs and security measuresProofs and security measures

Control ProceduresControl Procedures


1.1.Monitoring the internal control system is Monitoring the internal control system is used to locate weaknesses and improve used to locate weaknesses and improve controls.controls.



o Monitoring often includes observing Monitoring often includes observing employee behavior and the accounting employee behavior and the accounting system for indicators of control problems.system for indicators of control problems.




Limitations of Internal ControlLimitations of Internal Control

o Internal controls can provide only Internal controls can provide only reasonable assurance for safeguarding reasonable assurance for safeguarding assets, processing accurate information, assets, processing accurate information, and compliance with laws and and compliance with laws and regulations. This is due to the following regulations. This is due to the following factors:factors: The human element of controlsThe human element of controls

Cost-benefit considerationsCost-benefit considerations





application of internal controls to

application of internal controls to cash.cash.

33


Cash Controls Over Receipts and Cash Controls Over Receipts and PaymentsPayments

o CashCash includes coins, currency (paper includes coins, currency (paper money), checks, and money orders. money), checks, and money orders. Money on deposit with a bank or other Money on deposit with a bank or other financial institution that is available for financial institution that is available for withdrawal is also considered cash. Cash withdrawal is also considered cash. Cash is the asset most likely to be stolen or is the asset most likely to be stolen or used improperly in a business.used improperly in a business.


Control of Cash ReceiptsControl of Cash Receipts

o Businesses normally receive cash from Businesses normally receive cash from two main sources:two main sources: Customers purchasing products or servicesCustomers purchasing products or services

Customers making payments on accountCustomers making payments on account


Cash Received from Cash Sales Cash Received from Cash Sales

o One of the most important controls to One of the most important controls to protect cash received in over-the-counter protect cash received in over-the-counter sales is a cash register.sales is a cash register.

CASH CASH RECEIVED RECEIVED

FROM CASH FROM CASH SALES SALES



o A predetermined amount of money that is A predetermined amount of money that is given to each cash register clerk in a cash given to each cash register clerk in a cash drawer is called a drawer is called a change fundchange fund..



o Salespersons may make errors in making Salespersons may make errors in making change for customers or in ringing up cash change for customers or in ringing up cash sales. As a result, the amount of cash on sales. As a result, the amount of cash on hand may differ from the amount of cash hand may differ from the amount of cash sales. Such differences are recorded in a sales. Such differences are recorded in a cash short and over accountcash short and over account..


Cash Received from Cash SalesCash Received from Cash Sales

o Cash sales for May 3 totaled $35,690 per Cash sales for May 3 totaled $35,690 per the cash register tape. After removing the the cash register tape. After removing the change fund, only $35,668 was left in the change fund, only $35,668 was left in the cash drawer. The cash sales and shortage cash drawer. The cash sales and shortage would be recorded as follows:would be recorded as follows:


Cash Received from Cash SalesCash Received from Cash Sales

o If there had been cash over, Cash Short If there had been cash over, Cash Short and Over would have been and Over would have been creditedcredited for the for the overage.overage.


Cash Received in the MailCash Received in the Mail

o Cash is received in the mail when Cash is received in the mail when customers pay their bills. Most companies customers pay their bills. Most companies design their invoices so that customers design their invoices so that customers return a portion of the invoice, called a return a portion of the invoice, called a remittance adviceremittance advice, with their payment., with their payment.


Cash Received by EFTCash Received by EFT

o Cash may also be received from Cash may also be received from customers through customers through electronic funds electronic funds transfers (EFT)transfers (EFT). Customers may authorize . Customers may authorize automatic electronic transfers from their automatic electronic transfers from their checking accounts to pay monthly bills.checking accounts to pay monthly bills.


Cash Received by EFTCash Received by EFT

o Companies encourage customers to use Companies encourage customers to use EFT for the following reasons:EFT for the following reasons: EFTs cost less than receiving cash payments EFTs cost less than receiving cash payments

through the mail.through the mail.

EFTs enhance internal controls over cash since EFTs enhance internal controls over cash since the cash is received directly by the bank the cash is received directly by the bank without any employees handling cash.without any employees handling cash.

EFTs reduce late payments from customers and EFTs reduce late payments from customers and speed up the processing of cash receipts.speed up the processing of cash receipts.


Control of Cash PaymentsControl of Cash Payments

o The control of cash payments should The control of cash payments should provide reasonable assurance that:provide reasonable assurance that: Payments are made for only authorized Payments are made for only authorized

transactions.transactions.

Cash is used effectively and efficiently.Cash is used effectively and efficiently.


Voucher SystemVoucher System

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


Voucher SystemVoucher System

o A A vouchervoucher is any document that serves as is any document that serves as proof of authority to pay cash or issue an proof of authority to pay cash or issue an electronic funds transfer.electronic funds transfer.



ObjectiveDescribe the nature of a bank

Describe the nature of a bank

account and its use in controlling

account and its use in controlling cash.cash.

44


Bank AccountsBank Accounts

o A major reason that businesses use bank A major reason that businesses use bank accounts is for internal control. Some of accounts is for internal control. Some of the control advantages of using bank the control advantages of using bank accounts are as follows:accounts are as follows: Bank accounts reduce the amount of cash Bank accounts reduce the amount of cash

on hand.on hand.

Bank accounts provide an independent Bank accounts provide an independent recording of cash transactions.recording of cash transactions.

Use of bank accounts facilitates the Use of bank accounts facilitates the transfer of funds using EFT systems.transfer of funds using EFT systems.


Bank StatementBank Statement

o A summary received from the bank A summary received from the bank (usually monthly) of all checking account (usually monthly) of all checking account transactions is called a transactions is called a bank statementbank statement. It . It shows the beginning balance, additions, shows the beginning balance, additions, deductions, and the ending balance.deductions, and the ending balance.

Impact of Debit and Credit MemosImpact of Debit and Credit Memos


Bank StatementBank Statement

o The following types of credit or debit The following types of credit or debit memo entries are found on a bank memo entries are found on a bank statement:statement:

Using the Bank Statement as a Control Using the Bank Statement as a Control Over CashOver Cash



ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

a bank reconciliation in

a bank reconciliation in controlling cash.

controlling cash.

55


Bank ReconciliationBank Reconciliation

o A A bank reconciliationbank reconciliation is an analysis of the is an analysis of the items and amounts that cause the cash items and amounts that cause the cash balance reported in the bank statement to balance reported in the bank statement to differ from the balance of the cash differ from the balance of the cash account in the ledger. This is used to account in the ledger. This is used to determine the adjusted cash balance.determine the adjusted cash balance.



o A bank reconciliation is usually divided A bank reconciliation is usually divided into two sections as follows:into two sections as follows: The The bank sectionbank section begins with the cash balance begins with the cash balance

according to the bank statement and ends with according to the bank statement and ends with the adjusted balance.the adjusted balance.

The The company sectioncompany section begins with the cash begins with the cash balance according to the company’s records balance according to the company’s records and ends with the adjusted balance.and ends with the adjusted balance.


Steps of a Bank ReconciliationSteps of a Bank Reconciliation

Steps of a Bank ReconciliationSteps of a Bank Reconciliation


Step 1

Power Networking Bank ReconciliationPower Networking Bank Reconciliation

o Power Networking prepares to reconcile Power Networking prepares to reconcile the monthly bank statement as of July 31. the monthly bank statement as of July 31. The bank statement shows an ending cash The bank statement shows an ending cash balance of $3,359.78. balance of $3,359.78.

Bank’s Records

Cash balance $3,359.78

Power Networking’s Records

Step 1

Power Networking Bank Power Networking Bank ReconciliationReconciliation


Step 2


o A deposit on July 31 of $816.20 is not A deposit on July 31 of $816.20 is not recorded on the bank statement.recorded on the bank statement.

Bank’s Records Power Networking’s Records


Add deposit not recorded by bank 816.20

$4,175.98

Step 2



Step 3


o Three checks that were written during the Three checks that were written during the month did not appear on the bank month did not appear on the bank statement: No. 812, $1,061; No. 878, statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60.$435.39, No. 883, $48.60.


Step 3


$4,175.98


Deduct outstanding checks:

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

1,544.99



$4,175.98




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

1,544.99

$2,630.99Adjusted balance

Step 4



Step 5


o The cash balance in Power Networking’s The cash balance in Power Networking’s ledger on July 31 is $2,549.99.ledger on July 31 is $2,549.99.


$4,175.98




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

1,544.99

Step 5





Step 6


o A credit memo on the bank statement A credit memo on the bank statement indicates that the bank collected a note in indicates that the bank collected a note in the amount of $400 and the related the amount of $400 and the related interest of $8 for Power Networking. interest of $8 for Power Networking.



$4,175.98




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

1,544.99

Add note and interest collected by bank 408.00

$2,957.99

Step 6




Step 7


o A check from a customer (Thomas Ivey) A check from a customer (Thomas Ivey) for $300 was returned by the bank for $300 was returned by the bank because of insufficient funds (NSF) as because of insufficient funds (NSF) as indicated by a debit memo. A bank indicated by a debit memo. A bank service charge of $18 was also indicated service charge of $18 was also indicated by a debit memo.by a debit memo.


$4,175.98


Cash balance $3,359.78 Cash balance $2,549.99


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

1,544.99


$2,957.99


Deduct NSF check $300.00

Bank service charges 18.00

Step 7



Error


o Check No. 879 for $732.26 to Taylor Company Check No. 879 for $732.26 to Taylor Company on account was erroneously recorded in the on account was erroneously recorded in the journal as $723.26. When an error is made, journal as $723.26. When an error is made, two questions are asked: (1) Who made the two questions are asked: (1) Who made the error? (2) Does correcting the error cause the error? (2) Does correcting the error cause the cash account to go up or down?cash account to go up or down?

o Power Networking made the error, so the Power Networking made the error, so the item is placed on the company’s side of the item is placed on the company’s side of the reconciliation. By correcting the error, the reconciliation. By correcting the error, the cash account goes down. (Thus, it is a cash account goes down. (Thus, it is a deduction on the reconciliation.)deduction on the reconciliation.)


$4,175.98




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

1,544.99


$2,957.99Deduct check

NSF $300.00



Error

Error recording Chk. No. 879 9.00



$4,175.98




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

1,544.99



NSF $300.00




327.00 $2,630.99Adjusted balance

Step 8




$4,175.98



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

1,544.99



NSF $300.00


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

Step 9


327.00




o The journal entries for Power Networking, The journal entries for Power Networking, based on the bank reconciliation, are as based on the bank reconciliation, are as follows:follows:




ObjectiveDescribe the accounting for

Describe the accounting for

special-purpose cash funds.

special-purpose cash funds.

66


Petty Cash FundPetty Cash Fund

o It is usually not practical for a business to It is usually not practical for a business to write checks to pay small amounts. Thus, write checks to pay small amounts. Thus, it is desirable to control such payments by it is desirable to control such payments by using a special cash fund, called a using a special cash fund, called a pettypetty cash fundcash fund..



o A petty cash fund of $500 is established A petty cash fund of $500 is established on August 1. The entry to record the on August 1. The entry to record the transaction is as follows:transaction is as follows:


IMPORTANT!


o The only time Petty Cash is debited is The only time Petty Cash is debited is when the fund is initially established or when the fund is initially established or when the fund is increased. The only time when the fund is increased. The only time Petty Cash is credited is when the fund is Petty Cash is credited is when the fund is being decreased.being decreased.



o At the end of August, the petty cash At the end of August, the petty cash receipts indicate expenditures for the receipts indicate expenditures for the following items:following items:

o The entry to replenish the petty cash fund The entry to replenish the petty cash fund is shown below.is shown below.


Special-Purpose FundsSpecial-Purpose Funds

o Companies often use other cash funds for Companies often use other cash funds for special needs, such as payroll or travel special needs, such as payroll or travel expenses. Such funds are called expenses. Such funds are called special-special-purpose fundspurpose funds..





reporting of cash and cash

reporting of cash and cash

equivalents in the financial

equivalents in the financial statements.

statements.

77


Financial Statement Reporting of CashFinancial Statement Reporting of Cash

o A company’s excess cash is normally A company’s excess cash is normally invested in highly liquid investments. invested in highly liquid investments. These investments are called These investments are called cash cash equivalentsequivalents..



o Companies that have invested excess cash Companies that have invested excess cash in cash equivalents usually report Cash in cash equivalents usually report Cash and cash equivalents as one amount on and cash equivalents as one amount on the balance sheet.the balance sheet.



o Banks may require depositors to maintain Banks may require depositors to maintain minimum cash balances in their bank minimum cash balances in their bank accounts. Such a balance is called a accounts. Such a balance is called a compensating balancecompensating balance..



ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

the ratio of cash to monthly cash

the ratio of cash to monthly cash

expenses to assess the ability of a

expenses to assess the ability of a

company to continue in business.

company to continue in business.

88


Ratio of Cash to Monthly Cash Ratio of Cash to Monthly Cash ExpensesExpenseso A cash ratio that is especially useful for A cash ratio that is especially useful for

startup companies or companies in startup companies or companies in financial distress is the financial distress is the ratio of cash to ratio of cash to monthly cashmonthly cash expensesexpenses. The ratio is . The ratio is computed as shown below:computed as shown below:

Ratio of Cash to Monthly Cash Expenses =

Cash as of Year-End

Monthly Cash Expenses


Ratio of Cash to Monthly Cash Ratio of Cash to Monthly Cash ExpensesExpenseso The cash, including any cash equivalents, The cash, including any cash equivalents,

is taken from the balance sheet as of is taken from the balance sheet as of year-end. The monthly cash expenses, year-end. The monthly cash expenses, sometimes called sometimes called cash burncash burn, are , are estimated from the operating activities estimated from the operating activities section of the statement of cash flows as section of the statement of cash flows as follows:follows:

Monthly Cash Expenses =

Negative Cash Flow from Operations

12




Control, and Cash

Control, and Cash

The EndThe EndThe EndThe End

Ch07 wrd12e instructor_final

Education

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internal control objectives

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reporting of cash

learning objectives5

internal control system

cash equivalents

ratio of cash