Sarbanes-Oxley, Internal Control, and Cash Chapter 8 These slides should be viewed using the presentation mode (click the icon to start presentation).

Learning Objective 1 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting.

LO 1 Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 (often 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. Sarbanes-Oxley requires companies to maintain strong and effective internal controls over the recording of transactions and the preparing of financial statements.

Process information accurately. LO 1 Sarbanes-Oxley Act of 2002 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.

Limitation of internal control Internal controls are not a guarantee, due to the following factors: The human elements of controls Cost-benefit considerations

Learning Objective 3 Describe the Sarbanes-Oxley Act of 2002 and the impact on internal controls and financial reporting. Describe and illustrate the application of internal controls to cash.

Cash Controls Over Receipts and Payments LO 3 Cash Controls Over Receipts and Payments Cash includes coins, currency (paper money), checks, and money orders. Money on deposit with a bank or other financial institution that is available for withdrawal is also considered cash. Cash is the asset most likely to be stolen or used improperly in a business.

Control of Cash Receipts Businesses normally receive cash from two main sources: Customers purchasing products or services Customers making payments on account Cash received from Cash sales: One of the most important controls to protect cash received in over-the-counter sales is a cash register.

Control of Cash Receipts At the begging of every work shift a predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund. Salespersons may make errors in making change for customers or in ringing up cash sales. As a result, the amount of cash on hand may differ from the amount of cash sales. Such differences are recorded in a Cash Short and Over account.

Cash Received from Cash Sales LO 3 Cash Received from Cash Sales Cash sales for May 3 totaled $35,690 per the cash register tape. After removing the change fund, only $35,668 was left in the cash drawer. The cash sales and shortage would be recorded as follows: If there had been cash over, Cash Short and Over would have been credited for the overage.

LO 3 Cash Received by EFT Cash Received by EFT Cash may also be received from customers through electronic funds transfers (EFT). Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills e.g. cell phones, internet & electronic services.

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.

LO 3 Voucher System A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized. A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer.

Learning Objective 4 Describe the Sarbanes-Oxley Act of 2002 and the 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.

LO 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.

LO 4 Bank Statement A summary received from the bank (usually monthly) of all checking account transactions is called a bank statement. It shows the beginning balance, additions, deductions, and the ending balance.

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

LO 5 Bank Reconciliation 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. This is used to determine the adjusted cash balance.

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 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.

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Step 2 Add deposit not recorded by bank 816.20 $4,175.98 A deposit on July 31 of $816.20 is not recorded on the bank statement.

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Step 3 Add deposit not recorded by bank 816.20 Three checks that were written during the month did not appear on the bank statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60. $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Step 4 Add deposit not recorded by bank 816.20 Determine the adjusted balance. $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 $2,630.99 Adjusted balance

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Cash balance $2,549.99 Add deposit not recorded by bank 816.20 $4,175.98 Step 5 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 The cash balance in Power Networking’s ledger on July 31 is $2,549.99. Adjusted balance $2,630.99

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Cash balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $2,957.99 $4,175.98 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Step 6 A credit memo on the bank statement indicates that the bank collected a note in the amount of $400 and the related interest of $8 for Power Networking. Adjusted balance $2,630.99

Power Networking Bank Reconciliation LO 5 Power Networking Bank Reconciliation Step 7 A check from a customer (Thomas Ivey) for $300 was returned by the bank because of insufficient funds (NSF) as indicated by a debit memo. A bank service charge of $18 was also indicated by a debit memo.

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Cash balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct NSF check $300.00 Bank service charges 18.00 Step 7 Adjusted balance $2,630.99

Power Networking Bank Reconciliation LO 5 Power Networking Bank Reconciliation Error Check No. 879 for $732.26 to Taylor Company on account was erroneously recorded in the journal as $723.26. When an error is made, two questions are asked: (1) Who made the error? (2) Does correcting the error cause the cash account to go up or down? Power Networking made the error, so the item is placed on the company’s side of the reconciliation. By correcting the error, the cash account goes down. (Thus, it is a deduction on the reconciliation.)

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

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Cash balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Chk. No. 879 9.00 327.00 Adjusted balance $2,630.99 Adjusted balance $2,630.99 Step 8

Power Networking’s Records LO 5 Power Networking Bank Reconciliation Bank’s Records Power Networking’s Records Cash balance $3,359.78 Cash balance $2,549.99 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $4,175.98 $2,957.99 Deduct outstanding checks: No. 812 $1,061.00 No. 878 435.39 No. 883 48.60 1,544.99 Deduct check NSF $300.00 Bank service charges 18.00 Error recording Chk. No. 879 9.00 327.00 Adjusted balance $2,630.99 Adjusted balance $2,630.99 Step 9

Power Networking Bank Reconciliation LO 5 Power Networking Bank Reconciliation The journal entries for Power Networking, based on the bank reconciliation, are as follows:

Learning Objective 6 Describe and illustrate the use of a bank reconciliation in controlling cash. Describe the accounting for special-purpose cash funds.

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

The entry to replenish the petty cash fund is shown below. At the end of August, the petty cash receipts indicate expenditures for the following items: The entry to replenish the petty cash fund is shown below.

Special-Purpose Funds LO 6 Special-Purpose Funds Companies often use other cash funds for special needs, such as payroll or travel expenses. Such funds are called special-purpose funds.

Learning Objective 7 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 Statement Reporting of Cash LO 7 Financial Statement Reporting of Cash A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents. Mornin Joe Balance sheet Decmber31,2012 Assets Current assets*:   Cash and cash equivalent** $235,000 Current assets: Cash and other resources that are expected to turn to cash or to be used up within one year of the balance sheet date. Or current asset is an asset which can either be converted to cash or used to pay current liabilities within 12 months. ** Cash equivalents are distinguished from other investments through their short-term existence; they mature within 3 months whereas short-term investments are 12 months or less.

Sarbanes-Oxley, Internal Control, and Cash The End