Chapter 8: Sarbanes-Oxley, Internal Control, & Cash

The 4 Control Procedures

(1) Competent personnel, Rotating Duties, and Mandatory Vacations (2) Separating Responsibilities for Related Operations (3) Separating Operations, Custody of Assets, and Accounting (4) Proofs and Security Measures

Factors influencing company's control environment (3)

(1) Management's philosophy and operating style→ Relates to whether management emphasizes the importance of internal controls. (2) The company's organizational structure→ Is the framework for planning and controlling operations. (3) The company's personnel policies→ Involve the hiring, training, evaluation, compensation, and promotion of employees. In addition, job descriptions, employee codes of ethics, and conflict-of-interest policies are part of the personnel policies.

Elements of Internal Control

(five), set forth by the Integrated Framework. (1) Control environment (2) Risk assessment (3) Control procedures (4) Monitoring (5) Information and Communication

Cash equivalents

A company may temporarily have excess cash; in such cases, the company normally invests in highly liquid investments in order to earn interest. This is what these investments are called.

Petty cash fund

A company often has to pay small amounts for such items as postage, office supplies, or minor repairs. Though small, such payments may occur often enough to total a significant amount; thus, it is desirable to control such payments...this is why this special cash fund is used.

Monthly cash expenses (sometimes called cash burn)

Cash, including any cash equivalents, is taken from the balance sheet as of year-end. The ___ ____ ____ are estimated from the operating activities section of the statement of cash flows as follows: = Negative Cash Flow from Operations / 12

Special-purpose funds

Companies often use other cash funds for special needs, such as payroll or travel expenses; such funds are called these.

Credit and debit memo entries

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: Misc. item such as collection of a note receivable on behalf of the company or receipt of a loan by the company from the bank

Manual voucher system

In this, a voucher is normally prepared after all necessary supporting documents have been received. (normally supported by the supplier's invoice, a purchase order, and a receiving report)

Computerized voucher system

In this, data from the supporting documents are entered directly into computer files. At the due date, the checks are automatically generated and mailed to creditors; the voucher is then electronically transferred to a paid voucher file.

Line of credit

a preapproved amount the bank is willing to lend to a customer upon request.

Voucher system

a set of procedures for authorizing and recording liabilities and cash payments.

Bank reconciliation

an analysis of the items and amounts that result in the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger. The adjusted cash balance determined in the bank reconciliation is reported on the balance sheet. Usually divided into two sections. The adjusted balance from both sections must be equal

Voucher

any document that serves as proof of authority to pay cash or issue an electronic funds transfer. Ex: an invoice that has been approved for payment. In many businesses, however, a _____ is a special form used to record data about a liability and the details of its payment.

Electronic Funds Transfer (EFT)

cash may also be received from customers in this manner. For example, customers may authorize automatic electronic transfers from their checking accounts to pay monthly bills. In such cases, the company sends the customer's bank a signed form from the customer authorizing the monthly electronic transfers.

Compensating balance

banks may require that companies maintain minimum cash balances in their bank accounts; such a balance is called this. Requirements for these are normally disclosed in notes to the financial statements. This is often required by the bank as part of a loan agreement or line of credit.

Bank statement

banks usually maintain a record of all checking account transactions. This is a summary of all account transactions; it is mailed, usually each month, to the company (depositor) or made available online. It shows the beginning balance, additions, deductions, and the ending balance.

Two sections of bank reconciliation: Bank section

begins with the cash balance according to the bank statement and ends with the adjusted balance. The company's records do not need to be updated for any items in the bank section of the reconciliation. However, the bank should be notified of any errors that need to be corrected.

Two sections of bank reconciliation: Company section

begins with the cash balance according to the company's records and ends with the adjusted balance. The company's records do need to be updated for any items in the company section of the reconciliation. The company's records are updated using journal entries.

Control of Cash Receipts

businesses normally receive cash from two main sources: (1) Customers purchasing products or services (2) Customers making payments on account -Cash received from cash sales -Cash received in the mail -Cash received by EFT

Internal Control

defined as the procedures and processes used by a company to: (1) Safeguard its assets; (2) Process information accurately; (3) Ensure compliance with laws and regulations. The act requires companies to maintain effective ____ ____ over the recording of transactions and the preparing of financial statements; these controls deter fraud and prevent misleading financial statements.

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 _____. Basically, you can think of ____ as anything that a bank would accept for deposit in your account. This is the asset most likely to be stolen or used improperly in a business.

Sarbanes-Oxley Act of 2002

is one of the most important laws affecting US companies in recent history; its purpose is to maintain public confidence and trust in the financial reporting of companies. Applies only to companies whose stock is traded on public exchanges (publicly held companies); however, this act highlighted the importance of assessing the financial controls and reporting of all companies, thus, companies of all sizes are influenced by it.

Bank accounts

major reason companies use these is for internal control: (1) They reduce the amount of cash on hand (2) They provide an independent recording of cash transactions. Reconciling the balance of the cash account in the company's records with the cash balance according to the bank is an important control. (3) Use of these facilitates the transfer of funds using EFT systems.

Control Procedures

one of the most important elements of internal control; provide reasonable assurance that business goals will be achieved, including the prevention of fraud

Limitations of Internal Control

only reasonable assurance for safeguarding assets, processing accurate information, and compliance with laws and regulations, due to the following factors: (1) Human element→ human errors can occur because of fatigue, carelessness, confusion, or misjudgment. In addition, two or more employees may collude together to defeat or circumvent internal controls. (2) Cost-benefit considerations→ recognize that the cost of internal controls shouldn't exceed their benefits. (Ex: stores don't search all customers before they leave the store, it would be time consuming and upset customers)

Cash short and over account

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 this account.

Control of Cash Payments

should provide reasonable assurance that: (1) Payments are made for only authorized transactions (2) Cash is used effectively and efficiently. For example, controls should ensure that all available purchase discounts are taken. Use Voucher System and/or Cash Paid by EFT.

Employee fraud

the intentional act of deceiving an employer for personal gain. May range from minor overstating of a travel expense report to stealing millions of dollars. Usually affects the accuracy of business information.

Control environment

the overall attitude of management and employees about the importance of controls.

Internal Control--Integrated Framework

the standard by which companies design, analyze, and evaluate internal control.

Objectives of Internal Control

to provide reasonable assurance that: (1) Assets are safeguarded and used for business purposes; (2) Business information is accurate; (3) Employees and managers comply with laws and regulations.

Ratio of cash to monthly cash expenses

useful for assessing how long a company can continue to operate without (1) additional financing or (2) generating positive cash flows from operations. It is computed as follows: = Cash as of Year-End / Monthly Cash Expenses