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

Click to edit Master title style 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:

Click to edit Master title style 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:

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

Click to edit Master title style 5 5 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. Objective 1 8-1

Click to edit Master title style 6 6 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

Click to edit Master title style 7 7 Sarbanes-Oxley requires companies to maintain strong and effective internal control. 8-1

Click to edit Master title style 8 8 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

Click to edit Master title style Effect of Sarbanes-Oxley Act

Click to edit Master title style 10 As a company that listed on the New York Stock Exchange, Telkom is obliged to comply with all existing rules, including the Sarbanes Oxley Act (SOA). The SOA requires internal control over the financing reporting and guarantee from Telkom’s management that all information in the financial report is accurate and can be accounted for. To meet the SOA requirement, Telkom has conducted internal improvement through organizational transformation and the application of Good Corporate Governance (GCG) policies. The internal control over the financing reporting has become the priority for improving the system. 8-1

Click to edit Master title style 11 Describe and illustrate the objectives and elements of internal control. Objective 2 8-2

Click to edit Master title style 12 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

Click to edit Master title style 13 Employee fraud is the intentional act of deceiving an employer for personal gain. 8-2

Click to edit Master title style 14 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

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Click to edit Master title style 16 A business’s control environment is the overall attitude of management and employees about the importance of controls. 8-2 Control Environment

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

Click to edit Master title style Control Environment

Click to edit Master title style 19 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

Click to edit Master title style 20  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)

Click to edit Master title style 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.

Click to edit Master title style 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.

Click to edit Master title style Example Exercise 8-1 Identify each of the following as relating to (a) the control environment, (b) risk assessment, or (c) control procedures Mandatory vacations 2.Personnel policies 3.Report of outside consultants on future market changes

Click to edit Master title style 24 Follow My Example For Practice: PE 8-1A, PE 8-1B 1.(c) control procedures 2.(a) the control environment 3.(b) risk assessment

Click to edit Master title style 25 Describe and illustrate the application of internal controls to cash. Objective 3 8-3

Click to edit Master title style 26 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

Click to edit Master title style 27 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

Click to edit Master title style 28 Mar 19Cash Cash Short and Over8 000 To record cash sales and actual cash on hand. Sales Cash sales for March 19 totaled Rp3,150,000 per the cash register tape. After removing the change fund, only Rp3,142,000 was on hand. 8-3 Cash Short and Over Note that the shortage was debited to Cash Short and Over.

Click to edit Master title style Control of Cash Receipts

Click to edit Master title style 30 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

Click to edit Master title style 31 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

Click to edit Master title style 32 A voucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer. 8-3

Click to edit Master title style 33 Describe the nature of a bank account and its use in controlling cash. Objective 4 8-4

Click to edit Master title style 34 A major reason that businesses use bank accounts is for control purposes. Use of Bank Accounts 8-4

Click to edit Master title style 35 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

Click to edit Master title style 36 A summary received from the bank of all checking account transaction is called a bank statement. 8-4 Bank Statement

Click to edit Master title style Bank Statement (Continued)

Click to edit Master title style Bank Statement (Concluded) 37

Click to edit Master title style 39 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

Click to edit Master title style Example Exercise 8-2 The following items may appear on a bank statement: 40 (1)NSF check (2)EFT Deposit (3)Service Charge (4)Bank correction of an error from recording a Rp400,000 check as Rp40,000. 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.

Click to edit Master title style 41 Follow My Example 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

Click to edit Master title style 42 Power Networking should determine the reason for difference in these two amounts. Power Networking’s Records and Bank Statement 8-4

Click to edit Master title style 43 Describe and illustrate the use of a bank reconciliation in controlling cash. Objective 5 8-5

Click to edit Master title style 44 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

Click to edit Master title style Bank’s records Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Power Network prepares to reconcile the monthly bank statement as of July 31. The bank statement shows an ending cash balance of Rp3,359,780. The company’s Cash account has a July 31 balance of Rp2,549,990. Company’s records

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank 816,200 Rp4,175,980 A deposit of Rp816,200 did not appear on the bank statement. Company’s recordsBank’s records

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank Rp4,175,980 The bank collected a note in the amount of Rp400,000 and the related interest of Rp8,000 for Power Networking Add note and interest collected by bank 408,000 Rp2,957,990 Company’s recordsBank’s records

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank Rp4,175,980 Add note and interest collected by bank 408,000 Rp2,957,990 Three checks that were written during the period did not appear on the bank statement: No. 812, Rp1,061,000; No. 878, Rp435,390, No. 883, Rp48,600. Deduct outstanding checks: No. 812Rp1,061,000 No ,390 No ,600 1,544,990 Company’s recordsBank’s records

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank 816,200 Rp4,175,980 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct outstanding checks: No. 812Rp1,061,000 No ,390 No ,600 1,544,990 The bank returned a check for Rp300,000 from customer (Thomas Tarigan) because of insufficient funds (NSF). Company’s recordsBank’s records Deduct check NSFRp300,000

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank 816,200 Rp4,175,980 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct outstanding checks: No. 812Rp1,061,000 No ,390 No ,600 1,544,990 Bank service charges18,000 The bank service charges totaled Rp18,000. Company’s recordsBank’s records Deduct check NSFRp300,000

Click to edit Master title style Beginning balanceRp3,359,780 Company’s records Beginning balanceRp2,549,990 Add deposit not recorded by bank 816,200 Rp4,175,980 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct outstanding checks: No. 812Rp1,061,000 No ,390 No ,600 1,544,990 Bank service charges18,000 Error recording Check No , ,000 Check No. 879 for Rp732,260 to CV Tunggal Jaya on account, erroneously recorded in journal as Rp723,260. Bank’s records Deduct check NSFRp300,000

Click to edit Master title style Beginning balanceRp3,359,780 Beginning balanceRp2,549,990 Add deposit not recorded by bank 816,200 Rp4,175,980 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct outstanding checks: No. 812Rp1,061,000 No ,390 No ,600 1,544,990 Deduct check NSFRp300,000 Bank service charges18,000 Adjusted balanceRp2,630, Company’s recordsBank’s records Error recording Check No , ,000

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Click to edit Master title style 54 Journal entries must be prepared for those items that affected the company’s (depositor’s) side of the reconciliation. 8-5

Click to edit Master title style Beginning balanceRp2,549,990 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct check NSFRp300,000 Bank service charges18, ,000 Error recording Check No ,000 Company’s records

Click to edit Master title style July 31Cash Note collected by bank. Notes Receivable Interest Income8 000 Entry to Record Plus Items

Click to edit Master title style Beginning balanceRp2,549,990 Add note and interest collected by bank 408,000 Rp2,957,990 Deduct check NSFRp300,000 Bank service charges18, ,000 Error recording Check No ,000 Company’s records 8-5

Click to edit Master title style July 31Cash Note collected by bank. Notes Receivable Interest Income Accounts Receivable— Thomas Tarigan Miscellaneous Expense Accounts Payable— CV Tunggal Jaya Cash NSF check, bank service charges, and error in recording Check no Entry to Record Minus Items

Click to edit Master title style Example Exercise 8-3 The following data were gathered to use in reconciling the bank account of Depok Photo Studio 58 (Continued) Balance per bank Rp14,500,000 Balance per company records 13,875,000 Bank service charges 75,000 Deposit in transit 3,750,000 NSF check 800,000 Outstanding checks 5,250,000

Click to edit Master title style Example Exercise a. What is the adjusted balance on the bank reconciliation? b. Journalize any necessary entries for Depok Photo Studio based upon the bank reconciliation.

Click to edit Master title style 61 Follow My Example For Practice: PE 8-3A, PE 8-3B a.Rp13,000,000 as shown below. Bank section of reconciliation: Rp14,500,000 – Rp5,250,000 + Rp3,750,000 = Rp13,000,000 Company section of reconciliation: Rp13,875,000 – Rp75,000 – Rp800,000 = Rp13,000,000 b.Accounts Receivable800,000 Miscellaneous Expense75,000 Cash875,000

Click to edit Master title style 62 Describe the accounting for special- purpose cash funds. Objective 6 8-6

Click to edit Master title style 63 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

Click to edit Master title style On August 1, issued Check No. 511 for Rp500,000 to established a petty cash fund. Post. Ref. JOURNAL DateDescriptionDebitCredit Page 9 Aug. 1 Petty Cash Cash Established petty cash fund issuing Check

Click to edit Master title style At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, Rp380,000, postage (office supplies), Rp22,000; store supplies, Rp35,000, and miscellaneous administrative items, Rp30,000. Aug. 31 Office Supplies Replenished petty cash fund. Cash Store Supplies Miscellaneous Administrative Exp

Click to edit Master title style 66 Replenishing the petty cash fund restores it to its original amount of Rp500,000. Note that there is no entry to Petty Cash when the fund is replenished. 8-6

Click to edit Master title style 67 Businesses often use special cash funds to meet other needs, such as payroll. Such funds are called special-purpose funds. 8-6

Click to edit Master title style Example Exercise 8-4 Prepare journal entries for each of the following; a) Issued check to establish a petty cash fund of Rp500,000. b) The amount of cash in the petty cash fund is currently Rp120,000. Issued a check to replenish the fund, based on the following summary of petty cash receipts: office supplies, Rp300,000 and miscellaneous administrative expense, Rp75,000. Record any missing funds in the cash short and over account. 67

Click to edit Master title style 69 Follow My Example For Practice: PE 8-4A, PE 8-4B a)Petty Cash500,000 Cash500,000 b)Office Supplies300,000 Miscellaneous Admin. Expense75,000 Cash Short and Over5,000 Cash380,000

Click to edit Master title style 70 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. Objective 7 8-7

Click to edit Master title style 71 A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents. 8-7

Click to edit Master title style 72 Companies that have invested excess cash in cash equivalents usually report cash and cash equivalents as one amount on the balance sheet. 8-7

Click to edit Master title style 73 Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance. 8-7

Click to edit Master title style A cash ratio that is especially useful for companies, starting up or in financial distress, is the ratio of cash to monthly cash expenses. 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

Click to edit Master title style 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 =

Click to edit Master title style Northwest Airlines Corporation reported the following data (in millions) at the end of 2005: Negative cash flows from operationsRp(436,000) Cash and cash equivalents, Dec. 31, 20051,284, Ratio of Cash to Monthly Cash Expenses = Rp36,300 per mo. Rp436, Monthly Cash Expense = Monthly cash expense is sometimes referred to as cash burn.

Click to edit Master title style Rp1,284,000 Rp36,300 = Rp35,400 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 =