CH 8 Sarbanes-Oxley, Internal Control, and Cash PDF

Sarbanes-Oxley, Internal Control, and Cash
Chapter 8
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
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Learning Objective 1
1. Describe the Sarbanes-Oxley Act of 2002

and its impact on internal controls and
financial reporting.
LO 1
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.
 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.

and its impact on internal controls and
2. Describe and illustrate the objectives and
elements of internal control.
LO 2
Elements of Internal Control
 Employee fraud is the intentional act of

deceiving an employer for personal gain.
 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
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 as follows:
 Management’s philosophy and operating
style
 The company’s organizational structure
 The company’s personnel policies
LO 2
Control Procedures
 Control procedures provide reasonable

assurance that business goals will be
achieved. Control procedures include the
following:
 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.
 Monitoring often includes observing
employee behavior and the accounting
system for indicators of control problems.
LO 2
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 following factors:
 The human element of controls
 Cost-benefit considerations

and the impact on internal controls and
3. Describe and illustrate the application of
internal controls to cash.
LO 3
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
 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.
LO 3
Cash Received from Cash Sales
 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:
 If there had been cash over, Cash Short and

Over would have been credited for the
overage.
LO 3
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.
 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.
LO 3
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.

and the impact on internal controls and
3. Describe and illustrate the application of
internal controls to cash.
4. Describe the nature of a bank account and
its use in controlling cash.
LO 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.
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.
5. Describe and illustrate the use of a bank

reconciliation in controlling cash.
LO 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. This is used to determine the
adjusted cash balance.
LO 5
Power Networking Bank Reconciliation
Bank’s Records Power Networking’s Records

Cash 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.
LO 5

Add deposit not Step 2
recorded by bank 816.20
$4,175.98 A deposit on July
31 of $816.20 is
not recorded on
the bank
statement.
LO 5

$4,175.98 Three checks that
Deduct outstanding were written during
checks:
No. 812 $1,061.00 the month did not
No. 878 435.39 appear on the bank
No. 883 48.60 1,544.99 statement: No. 812,
$1,061; No. 878,
$435.39, No. 883,
$48.60.
LO 5

$4,175.98 Determine the
Deduct outstanding adjusted balance.
checks:
No. 812 $1,061.00
No. 878 435.39
No. 883 48.60 1,544.99
Adjusted balance $2,630.99
LO 5

Cash balance $3,359.78 Cash balance $2,549.99
Add deposit not
$4,175.98 Step 5
Deduct outstanding
checks:
No. 812 $1,061.00
The cash balance in
No. 878 435.39 Power Networking’s
No. 883 48.60 1,544.99 ledger on July 31 is
$2,549.99.
LO 5

Add deposit not Add note and interest
recorded by bank 816.20 collected by bank 408.00
$4,175.98 $2,957.99
Deduct outstanding
checks:
No. 812 $1,061.00
Step 6
No. 878 435.39 A credit memo on the bank
No. 883 48.60 1,544.99 statement indicates that the
bank collected a note in the
Adjusted balance $2,630.99 amount of $400 and the
related interest of $8 for
Power Networking.
LO 5
Step 7
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.
LO 5

$4,175.98 $2,957.99
Deduct outstanding Deduct NSF
checks: check $300.00
No. 812 $1,061.00 Bank service
No. 878 435.39 charges 18.00
No. 883 48.60 1,544.99
Step 7
LO 5
Error
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?
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.)
LO 5

$4,175.98 $2,957.99
Deduct outstanding Deduct check
checks: NSF $300.00
No. 878 435.39 charges 18.00
No. 883 48.60 1,544.99
Error recording
Chk. No. 879 9.00
Error
LO 5

$4,175.98 $2,957.99
checks: NSF $300.00
No. 878 435.39 charges 18.00
No. 883 48.60 1,544.99
Error recording
Chk. No. 879 9.00 327.00
Adjusted balance $2,630.99 Adjusted balance $2,630.99
Step 8
LO 5

$4,175.98 $2,957.99
checks: NSF $300.00
No. 878 435.39 charges 18.00
No. 883 48.60 1,544.99
Error recording
Chk. No. 879 9.00 327.00
Adjusted balance $2,630.99 Adjusted balance $2,630.99
Step 9
LO 5
The journal entries for Power Networking, based

on the bank reconciliation, are as follows:

6. 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:
LO 6
Petty Cash Fund
At the end of August, the petty cash receipts indicate

expenditures for the following items:
The entry to replenish the petty cash fund is shown

below.
LO 6
Special-Purpose Funds
 Companies often use other cash funds for

special needs, such as payroll or travel
expenses. Such funds are called special-
purpose funds.

purpose cash funds.
7. Describe and illustrate the reporting of cash
and cash equivalents in the financial
statements.
LO 7
Financial Statement Reporting of Cash
 A company’s excess cash is normally

invested in highly liquid investments. These
investments are called cash equivalents.
 Banks may require depositors to maintain
minimum cash balances in their bank
accounts. Such a balance is called a
compensating balance.

purpose cash funds.
7. Describe and illustrate the reporting of cash
and cash equivalents in the financial
statements.
8. 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 Cash as of Year-End
Monthly Cash Expenses = Monthly Cash Expenses
LO 8
Ratio of Cash to Monthly Cash Expenses
 The 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:
Negative Cash Flow
from Operations
Monthly Cash Expenses =
12
Sarbanes-Oxley, Internal Control, and Cash
The End
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

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Sarbanes-Oxley, Internal Control, and Cash

1. Describe the Sarbanes-Oxley Act of 2002

Sarbanes-Oxley Act of 2002

 The Sarbanes-Oxley Act of 2002 (often

Sarbanes-Oxley Act of 2002

 Internal control is broadly defined as the

1. Describe the Sarbanes-Oxley Act of 2002

Elements of Internal Control

 Employee fraud is the intentional act of

 The control environment is the overall

 Control procedures provide reasonable

 Monitoring the internal control system is

Limitations of Internal Control

 Internal controls can provide only

1. Describe the Sarbanes-Oxley Act of 2002

Cash Controls Over Receipts and Payments

 Cash includes coins, currency (paper

Control of Cash Receipts

 Businesses normally receive cash from two

 One of the most important controls to

Control of Cash Receipts

 Salespersons may make errors in making

 Cash sales for May 3 totaled $35,690 per the

 If there had been cash over, Cash Short and

 Cash is received in the mail when

Cash Received by EFT

 Companies encourage customers to use

Control of Cash Payments

 The control of cash payments should

 A voucher system is a set of procedures for

1. Describe the Sarbanes-Oxley Act of 2002

 A major reason that businesses use bank

 A summary received from the bank (usually

5. Describe and illustrate the use of a bank

 A bank reconciliation is an analysis of the

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Adjusted balance $2,630.99

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

A check from a customer (Thomas Ivey) for $300 was

Power Networking Bank Reconciliation

Power Networking Bank Reconciliation

Check No. 879 for $732.26 to Taylor Company on

Power Networking Bank Reconciliation

Power Networking Bank Reconciliation

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

The journal entries for Power Networking, based

5. Describe and illustrate the use of a bank

Petty Cash Fund

 It is usually not practical for a business to

A petty cash fund of $500 is established on August 1.

Petty Cash Fund