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Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting

Pepperdine University

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Sarbanes-Oxley, Internal Control, and Cash

Chapter 7 Student Version These slides should be viewed

using the presentation mode (left

click your mouse on the icon).



Learning Objective 1

Describe the

Sarbanes-Oxley Act of

2002 and its impact on

internal controls and

financial reporting.



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.

LO 1

Sarbanes-Oxley requires companies to

maintain strong and effective internal

controls over the recording of transactions

and the preparing of financial statements.



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.




Describe and

illustrate the

objectives and

elements of internal

control.



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 control

environment, risk assessment, control

procedures, monitoring, information and

communication.

LO 2

Employee fraud is the intentional act of

deceiving an employer for personal gain.



Control Environment

The control environment is the overall

attitude of management and employees

about the importance of controls. Three

factors influencing a company’s control

environment are:

LO 2

Management’s philosophy and operating

style

The company’s organizational structure

The company’s personnel policies



Control Procedures

Control procedures provide reasonable

assurance that business goals will be

achieved. Control procedures include:

Competent personnel, rotating duties, and

mandatory vacations

Separating responsibilities for related

operations

Separating operations, custody of assets, and accounting

Proofs and security measures

LO 2



Monitoring

Monitoring the internal control system is

used to locate weaknesses and improve

controls.

LO 2

Monitoring often includes observing

employee behavior and the accounting

system for indicators of control problems.



Limitations of Internal Control

Internal controls can provide only

reasonable assurance for safeguarding

assets, processing accurate information,

and compliance with laws and regulations.

This is due to:

The human element of controls

Cost-benefit considerations

LO 2




Describe and

illustrate the

application of

internal controls

to cash.



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.

LO 3



Control of Cash Receipts

Businesses normally receive cash from two

main sources:

Customers purchasing products or services

Customers making payments on account

LO 3

One of the most important controls to

protect cash received in over-the-counter

sales is a cash register.

A predetermined amount of money that is

given to each cash register clerk in a cash

drawer is called a change fund.



LO 3

Control of Cash Receipts

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 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:

Cash Received from Cash Sales

LO 3

If there had been cash over, Cash Short and Over

would have been credited for the overage.



Cash Received in the Mail and by EFT

Cash is received in the mail when

customers pay their bills. Most companies

design their invoices so that customers

return a portion of the invoice, called a

remittance advice, with their payment.

LO 3

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.



Cash Received by EFT

Companies encourage customers to use EFT

for the following reasons:

1. EFTs cost less than receiving cash payments

through the mail.

2. EFTs enhance internal controls over cash

since the cash is received directly by the

bank without any employees handling cash.

3. EFTs reduce late payments from customers

and speed up the processing of cash

receipts.

LO 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.

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.

LO 3




Describe the nature

of a bank account

and its use in

controlling cash.



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.

LO 4




Describe and illustrate

the use of a bank

reconciliation in

controlling cash.



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.

LO 5



LO 5

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Cash balance $3,359.78

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.

Step 1



LO 5


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.

Step 2



LO 5


Add deposit not


$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 month

did not appear on the

bank statement: No.

812, $1,061; No. 878,

$435.39, No. 883,

$48.60.



LO 5


Add deposit not


$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

Step 4

Determine the

adjusted balance.



LO 5


Add deposit not


$4,175.98



Deduct outstanding

checks:

No. 812 $1,061.00

No. 878 435.39

No. 883 48.60 1,544.99


Step 5

The cash balance in

Power Networking’s

ledger on July 31 is

$2,549.99.




LO 5


Add deposit not


$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.

Add note and interest

collected by bank 408.00

$2,957.99



LO 5

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.

Step 7




Add deposit not


$4,175.98


Cash balance $3,359.78 Cash balance $2,549.99

Deduct outstanding

checks:

No. 812 $1,061.00

No. 878 435.39

No. 883 48.60 1,544.99



$2,957.99

LO 5


Deduct NSF

check $300.00

Bank service

charges 18.00

Step 7




LO 5

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?

Error


(continued)



LO 5

Error


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.)



Add deposit not


$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

LO 5


Error

Error recording

Chk. No. 879 9.00




Add deposit not


$4,175.98



Deduct outstanding

checks:

No. 812 $1,061.00

No. 878 435.39

No. 883 48.60 1,544.99




NSF $300.00

Bank service

charges 18.00

LO 5


Error recording

Chk. No. 879 9.00 327.00


Step 8




LO 5


Add deposit not


$4,175.98


Deduct outstanding

checks:

No. 812 $1,061.00

No. 878 435.39

No. 883 48.60 1,544.99




NSF $300.00

Bank service

charges 18.00

$2,630.99 Adjusted balance $2,630.99 Adjusted balance

Step 9


Error recording

Chk. No. 879 9.00 327.00



The journal entries for Power Networking, based

on the bank reconciliation, are as follows:

LO 5





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:

Petty Cash Fund

LO 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; and miscellaneous

administrative expense, $30.



Petty Cash Fund

LO 6

The entry to replenish the petty cash fund is

shown below.



Special-Purpose Funds

LO 6

Companies often use other cash funds for

special needs, such as payroll or travel

expenses. Such funds are called special-

purpose funds.




Describe and illustrate the

use of the ratio of cash to

monthly cash expenses to

assess the ability of a

company to continue in

business.



LO 8

Ratio of Cash to Monthly Cash Expenses

A cash ratio that is especially useful for

startup companies or companies in

financial distress is the ratio of cash to

monthly cash expenses. The ratio is

computed as shown below:

Ratio of Cash to

Monthly Cash Expenses =

Cash as of Year-End

Monthly Cash Expenses



Ratio of Cash to Monthly Cash Expenses

Cash, including any cash equivalents, is

taken from the balance sheet as of year-

end. The monthly cash expenses,

sometimes called cash burn, are estimated

from the operating activities section of the

statement of cash flows as follows:

LO 8

Monthly Cash Expenses =

Negative Cash Flow

from Operations

12

Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting

Pepperdine University



Sarbanes-Oxley, Internal Control, and Cash

The End

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