Sarbanes-Oxley, Internal Control, and Cash Chapter 5

Learning Objectives Describe the Sarbanes-Oxley Act and its impact on internal controls and financial reporting Describe and illustrate the objectives and elements of internal control Describe and illustrate the application of internal controls to cash Describe the nature of a bank account and its use in controlling cash (continued…)

Learning Objectives Describe and illustrate the use of a bank reconciliation in controlling cash Describe the accounting for special-purpose cash funds Describe and illustrate the reporting of cash and cash equivalents in the financial statements Financial Analysis: Describe and illustrate the ratio of cash to monthly cash expenses in assessing the ability of a company to continue operating

Learning Objective 1 Describe the Sarbanes-Oxley Act and its impact on internal controls and financial reporting

Sarbanes-Oxley Act

Learning Objective 2 Describe and illustrate the objectives and elements of internal control

Objectives of Internal Control Safeguarded assets & used for business purposes Ensure accurate information Compliance with laws and regulations

Elements of Internal Control Control Environment Risk assessment Control Procedures Monitoring Information & Communication

Control Environment Three factors influencing a company’s control environment are: Management’s philosophy and operating style – emphasizing internal control. The company’s organizational structure – framework for planning and controlling operations. The company’s personnel policies – hiring, training, evaluating, compensation & promotion of employees.

Risk Assessment Changes in customer requirements Identify risks Competition Regulatory changes Economic changes ASSESSMENT: Identify risks Analyze significance Assess likelihood of risk Take action to minimize

Control Procedures One of the most important elements of internal control. It includes: Competent personnel, rotating duties, and mandatory vacations Separating responsibilities for related operations Separating operations, custody of assets, and accounting Proofs and security measures

Monitoring Locates weaknesses and improves controls. Includes on-going efforts and separate evaluations Exhibit 3 – pg. 181

Information and Communication Used by management to: guide operations ensure compliance with reporting, legal and regulatory requirements assess external events and conditions report externally

Limitations of Internal Controls Human Element Cost/ Benefit Considerations Human Element – human errors due to fatigue, carelessness, confusion, or misjudgment Cost/Benefit – costs for internal control should not exceed benefits of internal controls (ex. retail stores search all customers to prevent theft – result in loss of customer sales; instead signs, cameras and security tags

Learning Objective 3 Describe and illustrate the application of internal controls to cash

The Nature of Cash Coins Currency (“commercial paper”) Checks Money Orders Money on Deposit Money Market Funds

Cash Received from Sales

Cash Short/Over Difference in the amount of cash on hand vs. amount of cash register sales Result of error in making change for a customer or sale rung up incorrectly Normal business operating activity Cash Short – register sale is more than cash received Operating expense = “Miscellaneous Expense” recorded as a negative Cash Over – cash received is more than register sale Operating income = “Other Income” – recorded as a positive

Cash Short/Over - Examples 1. Short or Over? How much? Cash register totals from cash sales: $35,690 Cash “on hand” (counted) from sales: $35,668 Answer - $22.00 short 2. Short or Over? How much? Cash register totals from cash sales: $66,876 Cash “on hand” from sales: $67,654 Answer - $778 over Go to pg: 203-204 – do E5-12 & E5-13,

Other forms of Cash Payments Cash received by mail Customers send payment with “remittance advice” – portion of invoice Helps to control cash Checks are stamped with “For Deposit Only” – deposit is made; transaction is recorded with customer acct and cash received Cash received by EFT EFT = electronic funds transfer Enhances internal controls Reduces late payments – faster processing Less cost

Control of Cash Payments – voucher system Invoice, Purchase Order, and Receiving Report Computerized voucher Submitted for approval Payment is made

Learning Objective 4 Describe the nature of a bank account and its use in controlling cash

Nature of a Bank Account CASH Acct. Pay

Banking Basics EC: error correction to correct bank error Bank issued debit memos (DM): Payments made by EFT Service charges (SC) Customer checks returned for insufficient funds Corrections – due to bank error Abbreviations: EC: error correction to correct bank error NSF: not sufficient funds check SC: service charge ACH: automated clearing house entry for EFT MS: miscellaneous item

Learning Objective 5 Describe and illustrate the use of a bank reconciliation in controlling cash

Bank Reconciliation Def. – analysis of the items and amounts that result in the cash balance reported in the bank statement differing from the balance of the cash account in the ledger. 2 sections: Bank section – cash balance according to the bank Company section – cash balance according to the company Terms: Cleared/cancelled checks or deposits – checks or deposits that have been paid/processed by the bank Outstanding checks or deposits – checks or deposits that have been made by the company but NOT cleared by the bank

Bank Reconciliation – 2 sections Must be EQUAL

Steps in the Reconciliation Process

Learning Objective 6 Describe the accounting for special-purpose cash funds

Petty Cash / Special-Purpose Funds Def. – a special asset account to take care for small cash amounts; such as: postage, office supplies, and minor repairs. Open (establish) Petty Cash (check is written from Cash) Debit + Petty Cash Credit – Cash Replenish Petty Cash – determination of what has been spent from petty cash. *usually replenished monthly Add receipts from expenditures – debit Assets & Expenses Credit Cash for the amount to add back into Petty Cash Special-Purpose Funds – other cash funds for special needs; such as: payroll or travel. *Treated like Petty Cash

Special Purpose Cash Funds – Petty Cash Petty cash fund of $500 is established on August 1. Replenished the petty cash fund on August 31. There is no adjustment to Petty Cash when the fund is replenished.

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

Financial Statement Reporting of Cash Cash Equivalent – high liquid investments purchased by a company to earn interest. Ex. U.S. Treasury bills, money market funds, etc. Purchased if a company has an excess of cash.

Learning Objective 8 Financial Analysis: Describe and illustrate the ratio of cash to monthly cash expenses in assessing the ability of a company to continue operating

Ratio of Cash to Monthly Cash Expenses Assesses the ability of a company to continue to operate when the company reports negative net cash flows from operations Ratio of Cash to Monthly Cash Expenses _Cash & Cash Equivalents = Monthly Cash Expenses Net Cash Flows from Operations Monthly Cash Expenses = 12

Ratio of Cash to Monthly Cash Expenses Year 2 Year 1 Net cash flows from operating activities $(29,062) $(52,537) End of the year cash and cash equivalents 48,344 37,304 Calculate: Monthly cash expenses: Year 2 Year 1 Ratio of cash to monthly cash expenses: