Sarbanes-Oxley, Internal Control, and Cash

1. 8 Sarbanes-Oxley, Internal Control, and Cash

2. Describe the Sarbanes-Oxley Act of 2002 and the impact on internal controls and financial reporting. 1 Describe and illustrate the objectives and elements of internal control. 2 Describe and illustrate the application of internal controls to cash. 3 Sarbanes-Oxley, Internal Control, and Cash After studying this chapter, you should be able to: 8-2

3. Describe and illustrate the use of a bank reconciliation in controlling cash. 5 Describe the accounting for special-purpose cash funds. 6 Describe and illustrate the reporting of cash and cash equivalents in the financial statements. 7 Describe the nature of a bank account and its use in controlling cash. 4 Sarbanes-Oxley, Internal Control, and Cash (continued) 8-3

4. 1 Describe the Sarbanes-Oxley Act of 2002 and its impact on internal controls and financial reporting. 9-4 8-4

5. 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.

6. 1 Sarbanes-Oxley requires companies to maintain strong and effective internal control.

7. 1 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.

8. 1

9. Exhibit 1 1 Sarbanes-Oxley Report of Nike

10. 2 Describe and illustrate the objectives and elements of internal control. 8-10

11. 2

12. 2 Employee fraud is the intentional act of deceiving an employer for personal gain.

13. 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

14. Exhibit 2 2 Elements of Internal Control

15. 2 Control Environment Thecontrol environment is the overall attitude of management and employees about the importance of controls.

16. 2 Factors That Influence the Control Environment Management’s philosophy and operating style The company’s organizational structure The company’s personnel policies

17. 2

18. 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.

19. Exhibit 3 2 Internal Control Procedures

20. 2 Monitoring Monitoring the internal control system is used to locate weaknesses and improve controls.

21. 2 Monitoring Monitoring often includes observing employee behavior and the accounting system for indicators of control problems.

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

23. 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

24. 2 Limitations of Internal Control • The human element of control • Cost-benefit considerations

25. Follow My Example 8-1 For Practice: PE 8-1A, PE8-1B 2 Example Exercise 8-1 Internal Control Elements Identify each of the following as relating to (a) the control environment, (b) risk assessment, or (c) control procedures. • Mandatory vacations • Personnel policies • Report of outside consultants on future market changes 1. (c) control procedures 2. (a) the control environment • (b) risk assessment 8-25

26. 3 Describe and illustrate the application of internal controls to cash. 8-26

27. 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.

28. 3 Sources of Cash Businesses normally receive cash from two main sources: • Customers purchasing products or services. • Customers making payments on account.

29. 3 Control of Cash Receipts One of the most important controls to protect cash received in over-the-counter sales is a cash register.

30. 3 Using the Cash Register to Control Cash

31. 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.

32. 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.

33. 3 Cash Received in Mail 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.

34. 3 Cash may be received from customers through electronic funds transfers (EFT). Customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills.

35. 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.

36. 3 A voucher system is a set of procedures for authorizing and recording liabilities and cash payments. It may be either manual or computerized.

37. 3 Avoucher is any document that serves as proof of authority to pay cash or issue an electronic funds transfer.

38. 4 Describe the nature of a bank account and its use in controlling cash. 8-38

39. 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.

40. 4 A summary received from the bank of all checking account transactions is called a bank statement.

41. 4 Impact of Debit and Credit Memos

42. Exhibit 5 4 Bank Statement (continued)

43. Exhibit 5 4 Bank Statement (continued)

44. 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.

45. 4 Example Exercise 8-2 Items on Company’s Bank Statement The following items may appear on a bank statement: • (1) NSF check • (2) EFT Deposit • Service Charge • 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 the company’s account. 8-45

46. Follow My Example 8-2 For Practice: PE 8-2A, PE 8-2B 4 Example Exercise 8-2 (continued) Increases or Decreases the Balance of the Company’s Bank Account Appears on the Bank Statement as a Debit or Credit Memo Item No. (1) debit memo decreases (2) credit memo increases (3) debit memo decreases (4) debit memo decreases 8-46

47. Exhibit 6 4 Power Networking’s Records and Bank Statement

48. 5 Describe and illustrate the use of a bank reconciliation in controlling cash. 8-48

49. 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.

50. 5 The Adjusted Balance Must be equal