BY R A C H E L L E A G AT H A , C PA , M B A

Sarbanes-Oxley, Internal Control and Cash

Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

1. 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.

Objectives:

4. 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.

Objectives:

7. Describe and illustrate the reporting of cash and cash equivalents in the financial statements.

Objectives:

Describe the Sarbanes-Oxley Act

of 2002 and its impact on internal

controls and financial reporting.

Objective 1

Objective 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.

Sarbanes-Oxley requires companies to maintain strong

and effective internal control.

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.

Describe and illustrate the objectives and

elements of internal control.

Objective 2

Objective 2

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:

Objectives of Internal Control

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

8-2

1) the control environment,2) risk assessment,3) control procedures,4) monitoring, and5) 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—

Five Elements of Internal Control

A business’s control environment is the overall attitude of management and

employees about the importance of controls.

Control Environment

Factors That Influence the Control Environment

Management’s philosophy and operating style

The business’s organizational structure

Personnel policies

Control Environment

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.

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.

Indicators of Internal Control Problems

Warning Signs With Regard to People1. 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.

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.

Describe and illustrate the application of

internal controls to cash.

Objective 3Objective 3

One of the most important controls to protect cash received in over-the-counter

sales is a cash register.

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.

Change Fund

Mar 19Cash 3 142 00Cash Short and Over 8 00

To record cash sales and

actual cash on hand.

Sales 3 150 00

Cash sales for March 19 totaled $3,150.00 per the cash register tape. After removing the change fund, only $3,142.00 was on hand.

Cash Short and Over

Note that the shortage was debited to Cash Short and Over.

Control of Cash Receipts

Cash may be received from customers through electronic funds

transfers. Customers may authorize automatic

electronic transfers from their checking accounts to

pay monthly bills.

Electronic Funds Transfers

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

A voucher is any document that

serves as proof of authority to pay cash or issue an electronic funds

transfer.

Describe the nature of a bank account and its

use in controlling cash.

Objective 4

Objective 4

A major reason that businesses use bank

accounts is for control purposes.

Use of Bank Accounts

Bank accounts provide an independent recording of cash transactions that can be used as a verification of the business’s recording of

transactions.

A summary received from the bank of all checking account

transaction is called a bank statement.

Bank Statement

Bank Statement

Bank Statement

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.

-The following items may appear on a bank statement:

(1) NSF check(2) EFT Deposit(3) Service Charge(4) 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 depositor’s account.

Appears on the Bank

Statement as a Debit or

Credit Memorandu

m

Increases or Decreases

the Balance of the

Depositor’s Bank

Account

Item No.

(1) Debit Memorandum Decreases

(2) Credit Memorandum Increases

(3) Debit Memorandum Decreases

(4) Debit Memorandum Decreases

Power Networking should determine the reason for difference in these two amounts.

Power Networking’s Records and Bank Statement

Describe and illustrate the use of a bank reconciliation in controlling cash.

Objective 5Objective 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.

Cash balance according to bank statement 8,600.50$ Add: Deposit in transit on October 31 13,690.45

22,290.95 Deduct: Outstanding checks 7,115.35 Adjusted balance 15,175.60$

Cash balance according to company's records 9,305.60$ Add:Error in recording Check No. 1007 as $4,715instead of $4,175 540 Note for $5,000 collected by bank, including Interest 5,375 5,915.00

15,220.60 Deduct: Bank service charges 45.00 Adjusted balance 15,175.60$

LOCK-IT CO.Bank Reconciliation

31-Oct-08

Bank Reconcilation

Bank’s records

Beginning balance $3,359.78 Beginning balance $2,549.99

Power Network 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.

Company’s records

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

A deposit of $816.20 did not appear on the bank statement.

Company’s recordsBank’s records

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

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

Company’s recordsBank’s records

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Add note and interest collected by bank

408.00 $2,957.99

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.

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99

Company’s recordsBank’s records

48

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Add note and interest collected by bank

408.00 $2,957.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99

The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient

funds (NSF).

Company’s recordsBank’s records

Deduct check NSF $300.00

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Add note and interest collected by bank

408.00 $2,957.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99

Bank service charges 18.00

The bank service charges totaled $18.00.

Company’s recordsBank’s records

Deduct check NSF $300.00

Beginning balance $3,359.78

Company’s records

Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Add note and interest collected by bank

408.00 $2,957.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99

Bank service charges 18.00Error recording Check No. 879 9.00

327.00

Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

Bank’s records

Deduct check NSF $300.00

Beginning balance $3,359.78 Beginning balance $2,549.99Add deposit not recorded by bank 816.20

$4,175.98

Add note and interest collected by bank

408.00 $2,957.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60 1,544.99

Deduct check NSF $300.00

Bank service charges 18.00

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

51

Company’s recordsBank’s records

Error recording Check No. 879 9.00

327.00

Journal entries must be prepared for those

items that affected the company’s (depositor’s)

side of the reconciliation.

Beginning balance $2,549.99

Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00Bank service charges 18.00

327.00

Error recording Check No. 879 9.00

Company’s records

July 31 Cash 408 00

Note collected by bank.

Notes Receivable 400 00

Interest Income8 00

Entry to Record Plus Items

Beginning balance $2,549.99

Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00Bank service charges 18.00

327.00

Error recording Check No. 879 9.00

Company’s records

July 31 Cash 408 00

Note collected by bank.

Notes Receivable 400 00

Interest Income8 00

31 Accounts Receivable—Thomas Ivey 300 00 Miscellaneous Expense 18 00 Accounts Payable—Taylor Co. 9 00 Cash 327 00

NSF check, bank service charges, and error in recording Check no. 879.

Entry to Record Minus Items

The following data were gathered to use in reconciling the bank account of Photo Op.

Balance per bank $14,500Balance per company records13,875Bank service charges 75Deposit in transit 3,750NSF check 800Outstanding checks 5,250

a. What is the adjusted balance on the bank reconciliation?

b. Journalize any necessary entries for Photo OP based upon the bank reconciliation.

a. $13,000, as shown below.

Bank section of reconciliation: $14,500 – $5,250 + $3,750 =

$13,000

Company section of reconciliation: $13,875 – $75 – $800 = $13,000b. Accounts Receivable 800 Miscellaneous Expense 75

Cash 875

Cash balance according to bank statement 8,600.50$ Add: Deposit in transit on October 31 13,690.45

22,290.95 Deduct: Outstanding checks 7,115.35 Adjusted balance 15,175.60$

Cash balance according to company's records 9,305.60$ Add:Error in recording Check No. 1007 as $4,715instead of $4,175 540 Note for $5,000 collected by bank, including Interest 5,375 5,915.00

15,220.60 Deduct: Bank service charges 45.00 Adjusted balance 15,175.60$

LOCK-IT CO.Bank Reconciliation

31-Oct-08

Bank Reconcilation

Describe the accounting for special-purpose

cash funds.

Objective 6Objective 6

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.

On August 1, issued Check No. 511 for $500 to established a petty cash fund.

Post. Ref.

JOURNAL

Date Description Debit Credit

Page 9

Aug. 1 Petty Cash 500 00

2008

Cash 500 00Established petty

cash fund issuing Check 511.

At the end of August, the petty cash receipts indicated expenditures for the following items: office supplies, $380, postage (office supplies), $22; store supplies, $35, and miscellaneous administrative items, $30.

Aug. 31 Office Supplies 402 00

Replenished petty cash

fund.

Cash 467 00

Store Supplies 35 00

Miscellaneous Administrative Exp. 30 00

Replenishing the petty cash fund restores it to its original amount of $500.

Note that there is no entry to Petty Cash when the

fund is replenished.

Businesses often use special cash funds to

meet other needs, such as payroll. Such funds

are called special-purpose funds.

Prepare journal entries for each of the following;

a) Issued check to establish a petty cash fund of $500.

b) The amount of cash in the petty cash fund is currently $120. Issued a check to replenish the fund, based on the following summary of petty cash receipts: office supplies, $300 and miscellaneous administrative expense, $75. Record any missing funds in the cash short and over account.

a) Petty Cash 500Cash 500

b) Office Supplies 300Miscellaneous Admin. Expense 75Cash Short and Over 5

Cash 380

Describe and illustrate the reporting of cash

and cash equivalents in the financial statements.

Objective 7

Objective 7

A company’s excess cash is normally invested in

highly liquid investments. These investments are

called cash equivalents.

Companies that have invested excess cash in cash equivalents usually report cash

and cash equivalents as one

amount on the balance sheet.

Banks may require depositors to maintain

minimum cash balances in their bank accounts.

Such a balance is called a compensating

balance.

Summary

Internal Controls & Cash

Bank Reconcilations

Petty Cash & Special Cash

Funds

Cash Equivalents