Sarbanes-Oxley Act of 2002

1. 1 Sarbanes-Oxley Act of 2002 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.

2. 1 Sarbanes-Oxley Act of 2002 Sarbanes-Oxley requires companies to maintain strong and effective internal control.

3. 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.

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5. Exhibit 1 1 Sarbanes-Oxley Report of Nike

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7. 2 Objectives of Internal Control Employee fraud is the intentional act of deceiving an employer for personal gain.

8. 2 Five 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 as follows: • Control environment • Risk assessment • Control procedures • Monitoring • Information and communication

9. Exhibit 2 2 Elements of Internal Control

10. 2 Control Environment Thecontrol environment is the overall attitude of management and employees about the importance of controls.

11. 2 Factors That Influence the Control Environment Management’s philosophy and operating style The company’s organizational structure The company’s personnel policies

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13. 2 Control Procedures Competent personnel, rotating, duties, and mandatory vacations. Separating responsibilities for related operations. Separating operations, custody of assets, and accounting. Proofs and security measures.

14. Exhibit 3 2 Internal Control Procedures

15. 2 Monitoring Monitoring the internal control system is used to locate weaknesses and improve controls.

16. 2 Monitoring Monitoring often includes observing employee behavior and the accounting system for indicators of control problems.

17. Exhibit 4 2 Warning Signs of Internal Control Problems Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6 (continued)

18. Exhibit 4 2 Warning Signs of Internal Control Problems (continued) • 1. Missing documents or gaps in transaction numbers (could mean documents are being used for fraudulent transactions). • An unusual increase in customer refunds (refunds may be phony). • Differences between daily cash receipts and bank deposits (could mean receipts are being pocketed before deposited). • Sudden increase in slow payments (employee may be pocketing the payment). • Backlog in recording transactions (possibly an attempt to delay detection of fraud). Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6

19. 2 Limitations of Internal Control • The human element of control • Cost-benefit considerations

20. 3 Cash includes coins, currency (paper money), checks, and money orders. Cash is the asset most likely to be stolen or used improperly in a business.

21. 3 Sources of Cash Businesses normally receive cash from two main sources: • Customers purchasing products or services. • Customers making payments on account.

22. 3 Control of Cash Receipts One of the most important controls to protect cash received in over-the-counter sales is a cash register.

23. 3 Using the Cash Register to Control Cash

24. 3 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.

25. 3 Cash Short and Over Cash sales for March 19 totaled $35,690 per the cash register tape. After removing the change fund, only $35,668 was on hand. If there had been cash over, Cash Short and Over would have been credited for the overage.

26. 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.

27. 4 Bank Accounts A summary received from the bank of all checking account transactions is called a bank statement.

28. 4 Impact of Debit and Credit Memos

29. 4 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.

30. 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 in order to determine the adjusted cash balance.

31. 5 The Adjusted Balance Must be equal

32. 5 Steps in a Bank Reconciliation (continued)

33. 5 Steps in a Bank Reconciliation

34. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning 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. The company’s Cash account has a July 31 balance of $2,549.99.

35. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 $4,175.98 Step 2 A deposit of $816.20 did not appear on the bank statement.

36. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 $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 period did not appear on the bank statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60.

37. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $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 Step 4 The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking

38. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $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 Step 5 The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF).

39. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $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 Step 6 Bank service charges for the month, $18.

40. 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $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 Error recording Chk. No. 879 9.00 Step 7 Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

41. 327.00 Adjusted balance Adjusted balance $2,630.99 $2,630.99 5 Power Networking’s Records Bank’s Records Beginning balance $2,549.99 Beginning balance $3,359.78 Add deposit not recorded by bank 816.20 Add note and interest collected by bank 408.00 $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 Error recording Chk. No. 879 9.00

42. 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.

43. 6 Petty Cash Fund A petty cash fund of $500 is established on August 1. The entry to record the transaction is as follows:

44. 6 IMPORTANT! The only time Petty Cash is debited is when the fund is initially established or when the fund is increased. The only time Petty Cash is credited is when the fund is being decreased.

45. 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 Misc. administrative expenses 30 Total $467

46. 7 Cash Equivalents A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents.

47. 7 Cash Equivalents Companies that have invested excess cash in cash equivalents usually report Cash andcash equivalents as one amount on the balance sheet.

48. 7 Compensating Balance Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance.