Sarbanes-Oxley, Internal Control, and Cash 8 Sarbanes-Oxley, Internal Control, and Cash Student Version

1 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. 9-2 8-2

1 Sarbanes-Oxley Act of 2002 requires companies to maintain strong and effective internal control.

Process information accurately. 1 Internal control is broadly defined as the procedures and processes used by a company to: Safeguard its assets. Process information accurately. Ensure compliance with laws and regulations.

2 Describe and illustrate the objectives and elements of internal control. 8-5

Five Elements of Internal Control 2 Five Elements of Internal Control Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are as follows: Control environment Risk assessment Control procedures Monitoring Information and communication

Factors That Influence the Control Environment 2 Factors That Influence the Control Environment Management’s philosophy and operating style The company’s organizational structure The company’s personnel policies

2 Control Procedures Competent personnel, rotating, duties, and mandatory vacations. Separating responsibilities for related operations. Separating operations, custody of assets, and accounting. Proofs and security measures.

2 Monitoring Monitoring the internal control system is used to locate weaknesses and improve controls. Monitoring often includes observing employee behavior and the accounting system for indicators of control problems.

2 Exhibit 4 Warning Signs of Internal Control Problems (continued) Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6 (continued)

2 Exhibit 4 Warning Signs of Internal Control Problems (continued) 1. Missing documents or gaps in transaction numbers (could mean documents are being used for fraudulent transactions). An unusual increase in customer refunds (refunds may be phony). Differences between daily cash receipts and bank deposits (could mean receipts are being pocketed before deposited). Sudden increase in slow payments (employee may be pocketing the payment). Backlog in recording transactions (possibly an attempt to delay detection of fraud). Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6

Limitations of Internal Control 2 Limitations of Internal Control The human element of control Cost-benefit considerations

Describe and illustrate the application of internal controls to cash. 3 Describe and illustrate the application of internal controls to cash. 8-13

3 Cash includes coins, currency (paper money), checks, and money orders. Cash is the asset most likely to be stolen or used improperly in a business.

Control of Cash Receipts 3 Control of Cash Receipts One of the most important controls to protect cash received in over-the-counter sales is a cash register.

3 Cash Short and Over Cash sales for March 19 totaled $35,690 per the cash register tape. After removing the change fund, only $35,668 was on hand. If there had been cash over, Cash Short and Over would have been credited for the overage.

Control of Cash Payments 3 Control of Cash Payments The control of cash payments should provide reasonable assurance that: Payments are made for only authorized transactions. Cash is used effectively and efficiently.

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

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

Describe the nature of a bank account and its use in controlling cash. 4 Describe the nature of a bank account and its use in controlling cash. 8-20

4 Bank Accounts A major reason that businesses use bank accounts is for internal control. Some of the control advantages of using bank accounts are as follows: Bank accounts reduce the amount of cash on hand. Bank accounts provide an independent recording of cash transactions. Use of bank accounts facilitates the transfer of funds using EFT systems.

4 Power Networking’s Records and Bank Statement Exhibit 6

5 Describe and illustrate the use of a bank reconciliation in controlling cash. 8-23

5 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.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Step 1 Power Networking 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.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Step 2 A deposit of $816.20 did not appear on the bank statement.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Step 3 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.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,957.99 Step 4 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,957.99 Deduct check NSF $300.00 Step 5 The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF).

Power Networking’s Records Bank service charges for the month, $18. 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,957.99 Deduct check NSF $300.00 Bank service charges 18.00 Step 6 Bank service charges for the month, $18.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,957.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Chk. No. 879 9.00 Step 7 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

Power Networking’s Records 5 Bank’s Records Power Networking’s Records Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,957.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Chk. No. 879 9.00 327.00 $2,630.99 Adjusted balance

5 Exhibit 7 Bank Reconciliation for Power Networking

5 The journal entries for Power Networking, based on the bank reconciliation in Slide 33, are as follows:

Describe the accounting for special-purpose cash funds. 6 Describe the accounting for special-purpose cash funds. 8-35

6 Petty Cash Fund 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.

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

6 At the end of August, the petty cash receipts indicate expenditures for the following items: Office supplies $380 Postage (debit Office Supplies) 22 Store supplies 35 Misc. administrative expenses 30 Total $467