CPA, MBA BY RACHELLE AGATHA, CPA, MBA Sarbanes-Oxley, Internal Control and Cash Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

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. Objectives:

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. Objectives:

7. Describe and illustrate the reporting of cash and cash equivalents in the financial statements. Objectives:

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

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.

Sarbanes-Oxley requires companies to maintain strong and effective internal control.

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.

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

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: Objectives of Internal Control

Employee fraud is the intentional act of deceiving an employer for personal gain. 8-2

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— Five Elements of Internal Control

A business’s control environment is the overall attitude of management and employees about the importance of controls. Control Environment

Factors That Influence the Control Environment  Management’s philosophy and operating style  The business’s organizational structure  Personnel policies

Control Environment

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.

 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.

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.

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.

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

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

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

Mar 19Cash Cash Short and Over8 00 To record cash sales and actual cash on hand. Sales Cash sales for March 19 totaled $3, per the cash register tape. After removing the change fund, only $3, was on hand. Cash Short and Over Note that the shortage was debited to Cash Short and Over.

Control of Cash Receipts

Cash may be received from customers through electronic funds transfers. Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills. Electronic Funds Transfers

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

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. Objective 4

A major reason that businesses use bank accounts is for control purposes. Use of Bank Accounts

Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of transactions.

A summary received from the bank of all checking account transaction is called a bank statement. Bank Statement

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.

- The following items may appear on a bank statement: (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.

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

Power Networking should determine the reason for difference in these two amounts. Power Networking’s Records and Bank Statement

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

Bank Reconcilation

Bank’s records Beginning balance$3, Beginning balance$2, Power Network prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of $3, The company’s Cash account has a July 31 balance of $2, Company’s records

Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, A deposit of $ did not appear on the bank statement. Company’s recordsBank’s records

Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, 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 $2, Company’s recordsBank’s records

Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, Add note and interest collected by bank $2, 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, $ Deduct outstanding checks: No. 812$1, No No , Company’s recordsBank’s records

48 Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, Add note and interest collected by bank $2, Deduct outstanding checks: No. 812$1, No No , 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

Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, Add note and interest collected by bank $2, Deduct outstanding checks: No. 812$1, No No , Bank service charges18.00 The bank service charges totaled $ Company’s recordsBank’s records Deduct check NSF$300.00

Beginning balance$3, Company’s records Beginning balance$2, Add deposit not recorded by bank $4, Add note and interest collected by bank $2, Deduct outstanding checks: No. 812$1, No No , Bank service charges18.00 Error recording Check No Check No. 879 for $ to Taylor Co. on account, erroneously recorded in journal as $ Bank’s records Deduct check NSF$300.00

Beginning balance$3, Beginning balance$2, Add deposit not recorded by bank $4, Add note and interest collected by bank $2, Deduct outstanding checks: No. 812$1, No No , Deduct check NSF$ Bank service charges18.00 Adjusted balance$2, Company’s recordsBank’s records Error recording Check No

Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation.

Beginning balance$2, Add note and interest collected by bank $2, Deduct check NSF$ Bank service charges Error recording Check No Company’s records

July 31Cash Note collected by bank. Notes Receivable Interest Income8 00 Entry to Record Plus Items

Beginning balance$2, Add note and interest collected by bank $2, Deduct check NSF$ Bank service charges Error recording Check No Company’s records

July 31Cash Note collected by bank. Notes Receivable Interest Income Accounts Receivable—Thomas Ivey Miscellaneous Expense18 00 Accounts Payable—Taylor Co.9 00 Cash NSF check, bank service charges, and error in recording Check no Entry to Record Minus Items

The following data were gathered to use in reconciling the bank account of Photo Op. Balance per bank$14,500 Balance per company records13,875 Bank service charges75 Deposit in transit3,750 NSF check800 Outstanding checks5,250

a. What is the adjusted balance on the bank reconciliation? b. Journalize any necessary entries for Photo OP based upon the bank reconciliation.

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

Bank Reconcilation

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

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.

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 Cash Established petty cash fund issuing Check 511.

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 Replenished petty cash fund. Cash Store Supplies Miscellaneous Administrative Exp

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.

Businesses often use special cash funds to meet other needs, such as payroll. Such funds are called special- purpose funds.

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.

a)Petty Cash500 Cash500 b)Office Supplies300 Miscellaneous Admin. Expense75 Cash Short and Over5 Cash380

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

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

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

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

Summary  Internal Controls & Cash  Bank Reconcilations  Petty Cash & Special Cash Funds  Cash Equivalents