1. Click to edit Master title style 1 1 8 Sarbanes-Oxley, Internal Control and Cash

2. Click to edit Master title style 2 2 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. Objective 1 8-1

3. Click to edit Master title style 3 3 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. 8-1

4. Click to edit Master title style 4 4 Sarbanes-Oxley requires companies to maintain strong and effective internal control. 8-1

5. Click to edit Master title style 5 5 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. 8-1

6. Click to edit Master title style 6 6 9 8-1 Effect of Sarbanes-Oxley Act

7. Click to edit Master title style 7 7 Describe and illustrate the objectives and elements of internal control. Objective 2 8-2

8. Click to edit Master title style 8 8 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: 8-2 Objectives of Internal Control

9. Click to edit Master title style 9 9 Employee fraud is the intentional act of deceiving an employer for personal gain. 8-2

10. Click to edit Master title style 10 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— 8-2 Five Elements of Internal Control

11. Click to edit Master title style 11 A business’s control environment is the overall attitude of management and employees about the importance of controls. 8-2 Control Environment

12. Click to edit Master title style 12 8-2 Factors That Influence the Control Environment  Management’s philosophy and operating style  The business’s organizational structure  Personnel policies

13. Click to edit Master title style 13 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) 8-2

14. Click to edit Master title style 14  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. 8-2 (Concluded)

15. Click to edit Master title style 15 8-2 Indicators 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.

16. Click to edit Master title style 16 8-2 Indicators 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.

17. Click to edit Master title style 17 Describe and illustrate the application of internal controls to cash. Objective 3 8-3

18. Click to edit Master title style 18 One of the most important controls to protect cash received in over-the-counter sales is a cash register. 8-3 Control of Cash Receipts

19. Click to edit Master title style 19 A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund. 8-3 Change Fund

20. Click to edit Master title style 20 27 Mar 19Cash3 142 00 Cash Short and Over8 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. 8-3 Cash Short and Over Note that the shortage was debited to Cash Short and Over.

21. Click to edit Master title style 21 28 8-3 Control of Cash Receipts

22. Click to edit Master title style 22 Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills. 8-3 Electronic Funds Transfers

23. Click to edit Master title style 23 Describe the nature of a bank account and its use in controlling cash. Objective 4 8-4

24. Click to edit Master title style 24 A major reason that businesses use bank accounts is for control purposes. Use of Bank Accounts 8-4

25. Click to edit Master title style 25 Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions. 8-4

26. Click to edit Master title style 26 A summary received from the bank of all checking account transaction is called a bank statement. 8-4 Bank Statement

27. Click to edit Master title style 27 36 8-4 Bank Statement (Continued)

28. Click to edit Master title style 28 8-4 Bank Statement (Concluded) 37

29. Click to edit Master title style 29 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. 8-4

30. Click to edit Master title style 30 41 8-4 Power Networking should determine the reason for difference in these two amounts. Power Networking’s Records and Bank Statement

31. Click to edit Master title style 31 Describe and illustrate the use of a bank reconciliation in controlling cash. Objective 5 8-5

32. Click to edit Master title style 32 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. 8-5

33. Click to edit Master title style 33 44 8-5 Bank’s records Beginning 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

34. Click to edit Master title style 34 45 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add 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

35. Click to edit Master title style 35 46 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $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 $2,957.99 Company’s recordsBank’s records

36. Click to edit Master title style 36 47 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 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$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Company’s recordsBank’s records

37. Click to edit Master title style 37 48 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF). Company’s recordsBank’s records Deduct check NSF$300.00

38. Click to edit Master title style 38 49 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Bank service charges18.00 The bank service charges totaled $18.00. Company’s recordsBank’s records Deduct check NSF$300.00

39. Click to edit Master title style 39 50 8-5 Beginning balance$3,359.78 Company’s records Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Bank service charges18.00 Error 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 Deduct check NSF$300.00

40. Click to edit Master title style 40 8-5 Beginning balance$3,359.78 Beginning balance$2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Add note and interest collected by bank 408.00 $2,957.99 Deduct outstanding checks: No. 812$1,061.00 No. 878435.39 No. 883 48.60 1,544.99 Deduct check NSF$300.00 Bank service charges18.00 327.00 Adjusted balance$2,630.99 51 Company’s recordsBank’s records Error recording Check No. 879 9.00

41. Click to edit Master title style 41 52 8-5

42. Click to edit Master title style 42 Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation. 8-5

43. Click to edit Master title style 43 54 8-5 Beginning balance$2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF$300.00 Bank service charges18.00 327.00 Error recording Check No. 879 9.00 Company’s records

44. Click to edit Master title style 44 55 8-5 July 31Cash 408 00 Note collected by bank. Notes Receivable 400 00 Interest Income8 00 Entry to Record Plus Items

45. Click to edit Master title style 45 56 Beginning balance$2,549.99 Add note and interest collected by bank 408.00 $2,957.99 Deduct check NSF$300.00 Bank service charges18.00 327.00 Error recording Check No. 879 9.00 Company’s records 8-5

46. Click to edit Master title style 46 57 8-5 July 31Cash 408 00 Note collected by bank. Notes Receivable 400 00 Interest Income8 00 31Accounts Receivable—Thomas Ivey 300 00 Miscellaneous Expense18 00 Accounts Payable—Taylor Co.9 00 Cash327 00 NSF check, bank service charges, and error in recording Check no. 879. Entry to Record Minus Items

47. Click to edit Master title style 47 Describe the accounting for special- purpose cash funds. Objective 6 8-6

48. Click to edit Master title style 48 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. 8-6

49. Click to edit Master title style 49 63 On August 1, issued Check No. 511 for $500 to established a petty cash fund. Post. Ref. JOURNAL DateDescriptionDebitCredit Page 9 Aug. 1 Petty Cash 500 00 2008 Cash 500 00 Established petty cash fund issuing Check 511. 8-6

50. Click to edit Master title style 50 64 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 8-6

51. Click to edit Master title style 51 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. 8-6

52. Click to edit Master title style 52 Businesses often use special cash funds to meet other needs, such as payroll. Such funds are called special-purpose funds. 8-6

53. Click to edit Master title style 53 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. Objective 7 8-7

54. Click to edit Master title style 54 A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents. 8-7

55. Click to edit Master title style 55 Companies that have invested excess cash in cash equivalents usually report cash and cash equivalents as one amount on the balance sheet. 8-7

56. Click to edit Master title style 56 Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance. 8-7

57. Click to edit Master title style 57 73 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. 8-7 Ratio of Cash to Monthly Cash Expenses Monthly Cash Expenses = Negative Cash Flows from Operations 12

58. Click to edit Master title style 58 74 The ratio of cash to monthly cash expenses can then be computed as follows: 8-7 Ratio of Cash to Monthly Cash Expenses Cash and Cash Equivalent as of Year-End Monthly Cash Expenses =

59. Click to edit Master title style 59 75 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, 20051,284 8-7 Ratio of Cash to Monthly Cash Expenses = $36.3 per mo. $436 12 Monthly Cash Expense = Monthly cash expense is sometimes referred to as cash burn.

60. Click to edit Master title style 60 76 $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. 8-7 Ratio of Cash to Monthly Cash Expenses =

61. Click to edit Master title style 61 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:

62. Click to edit Master title style 62 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. After studying this chapter, you should be able to:

63. Click to edit Master title style 63 7. Describe and illustrate the reporting of cash and cash equivalents in the financial statements. After studying this chapter, you should be able to:

64. Click to edit Master title style 64 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. 22 1.Mandatory vacations 2.Personnel policies 3.Report of outside consultants on future market changes

65. Click to edit Master title style 65 Follow My Example 8-1 23 8-2 For Practice: PE 8-1A, PE 8-1B 1.(c) control procedures 2.(a) the control environment 3.(b) risk assessment

66. Click to edit Master title style 66 8-4 - Example Exercise 8-2 The following items may appear on a bank statement: 39 (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.

67. Click to edit Master title style 67 Follow My Example 8-2 40 8-4 For Practice: PE 8-2A, PE 8-2B Appears on the Bank Statement as a Debit or Credit Memorandum Increases or Decreases the Balance of the Depositor’s Bank Account Item No. (1)Debit MemorandumDecreases (2)Credit MemorandumIncreases (3)Debit MemorandumDecreases (4)Debit MemorandumDecreases

68. Click to edit Master title style 68 8-5 Example Exercise 8-3 The following data were gathered to use in reconciling the bank account of Photo Op. 58 (Continued) Balance per bank$14,500 Balance per company records13,875 Bank service charges75 Deposit in transit3,750 NSF check800 Outstanding checks5,250

69. Click to edit Master title style 69 8-5 Example Exercise 8-3 59 a. What is the adjusted balance on the bank reconciliation? b. Journalize any necessary entries for Photo OP based upon the bank reconciliation.

70. Click to edit Master title style 70 Follow My Example 8-3 60 8-5 For Practice: PE 8-3A, PE 8-3B 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 = $13,000 b.Accounts Receivable800 Miscellaneous Expense75 Cash875

71. Click to edit Master title style 71 8-6 Example Exercise 8-4 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. 67

72. Click to edit Master title style 72 Follow My Example 8-4 68 8-6 For Practice: PE 8-4A, PE 8-4B a)Petty Cash500 Cash500 b)Office Supplies300 Miscellaneous Admin. Expense75 Cash Short and Over5 Cash380

73. Click to edit Master title style 73 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

74. Click to edit Master title style 74 A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer. 8-3