Chapter 8: Internal Control and Cash

Cash short and over account:

Where differences in the cash sale are recorded.

Because, the bank statement is prepared from the bank's point of view:

A CREDIT MEMO entry on the bank statement indicates an INCREASE (A CREDIT) to the company's account.

A Debit Memo entry on the bank statement indicates:

A DECREASE (A DEBIT) in the company's account.

Before the Sarbanes-Oxley Act...

1. Changed accounting field completely 2. As long as accountants were doing a good job, they weren't told what to do. 3. ACPA: Responsible for issuing accounting standards. 4. Several scandals happened, due to scandals, investors lost billions in their investment, it was so bad that it affected American economy. Realized they had to do something about it.

Differences between the company and bank balance may arise because of the following:

- A delay by either the company or bank in recording transactions (ex. Customer say they made payment and deposited the money but accounting department didn't put in the data). - The bank has debited or credited the company's account for transactions that the company will not know about until the bank statement is received (ex. Client made payment, but didn't inform you). - Errors, such as an incorrect posting, made by either the company or the bank (ex. Bank or you made mistake; Don't assume you're always right).

Warning signs with regard to people:

- Abrupt change in lifestyle (without winning the lottery) - Close social relationships with suppliers. - Refusing to take a vacation. - Frequent borrowing from other employees. - Excessive use of alcohol or drugs.

Businesses face risks such as:

- Changes in customer requirements - Competitive threats - Regulatory changes - Changes in economic factors

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

A bank makes credit entries (issues credit memos) for the following:

- Deposits made by electronic funds transfer (EFT) = Send cash to account - Collections of notes receivable for the company = Payments made directly to bank - Proceeds for a loan made to the company by the bank = Interest earned = Credit (Bank) - Interest earned on the company's account - Correction (if any) of bank errors

The following types of credit or debit memo entries are found on a 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 item such as collection of a note receivable on behalf of the company or receipt of a loan by the company from the bank.

After passage of Sarbanes-Oxley

- Effective internal controls - An decrease in fraud and theft - Happy investors, stockholders, creditors

Management should:

- Identify such risks - Analyze their significance - Assess their likelihood of occurring - Take any necessary actions to minimize them

Warning signs from the accounting system:

- 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 being deposited). - Sudden increase in slow payments (employee may be pocketing the payments). - Backlog in recording transactions (possibly an attempt to delay detection of fraud).

A bank makes debit entries (issues debit memos) for the following:

- Payments made by Electronic Funds Transfer (EFT) - Service charges (Debit entry) - Customer checks returned for not sufficient funds (Credit), if client didn't order check = Debit - Correction (if any) of bank errors.

Prior to passage of Sarbanes-Oxley

- Weak internal controls - An increase in fraud and theft - Unhappy investors, stockholders, creditors

Identify each of the following as relating to (a) the control environment, (b) risk assessment, or (c) control procedures: 1. Mandatory vacations 2. Personnel policies 3. Report of outside consultants on future market changes

1. (c) Control procedures 2. (a) The control environment 3. (b) Risk assessment

Sarbanes-Oxley Act

1. A law passed by Congress that requires the CEO and CFO to certify that their firm's financial statements are accurate. 2. Applies only to companies whose stock is traded on public exchange (Public Companies).

Internal Control

1. A process designed to provide reasonable assurance regarding the achievement of company objectives related to operations, reporting, and compliance 2. The procedures and processes used by a company to: - Safeguard its assets - Process information accurately - Ensure compliance with laws and regulations - No requirements in internal controls.

Bank statement

1. A report of deposits, withdrawals, and bank balances sent to a depositor by a bank 2. A summary of all transactions that is mailed usually each month, to the company (depositor) or made available online.

Cash Short and Over

1. A special ledger account that is used to keep track of unexplained shortages or overages of cash.

Cash is:

1. Anything that a bank would accept for deposit in your account. 2. Cash is the asset most likely to be stolen or used improperly in a business.

3 factors influencing a company's control environment:

1. Management's philosophy and operating style 2. The company's organizational structure 3. The company's personnel policies

The following items may appear on a bank statement:

1. NSF check = Debit memo = Decreases the balance of the company's bank account 2. EFT deposit = Credit memo = Increases the balance of the company's bank account 3. Service charge = Debit memo = Decreases the balance of the company's bank account 4. Bank correction of an error from recording a $400 check as $40 = Debit memo = Decreases the balance of the company's bank account

Employee fraud

1. The intentional act of deceiving an employer for personal gain. 2. A serious concern of internal control is preventing employee fraud.

Control environment

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

Purpose of the Sarbanes Oxley Act

1. To create relevant and reliable financial statements. 2. To maintain public confidence and trust in the financial reporting of companies.

Control procedures provide:

1. reasonable assurance that business goals will be achieved, including the prevention of fraud.

At the end of the accounting period:

A debit balance in Cash Short and Over is included in miscellaneous expense on the income statement.

Cash balance according to Bank:

Add: DEBITS to Cash NOT on bank statement. (ex. Deposits in transit, etc.) Deduct: CREDITS to Cash NOT on bank statement (ex. Outstanding checks, etc).

Cash according to Company:

Add: Unrecorded Bank CREDITS (ex. Notes collected by bank). Deduct: Unrecorded bank DEBITS (ex. NSF checks, service charges, etc.)

Cash register:

An important control to protect cash received in over-the-counter sales.

The 3 internal controls objectives can be achieved by:

Applying the 5 elements of internal control: 1. Control Environment 2. Risk Assessment 3. Control Procedures 4. Monitoring 5. information and Communication

Why is that?

B/c if we have a banking account, we except to receive paychecks, but it's pending = Not deposited yet. - Also interest rate can apply. - If pay supplier, send check, but he deposited the check in 1 or 2 months, and cash is still in your account, it is not theirs.

The bank section of the bank reconciliation

Begins with the cash balance according to the bank's records and ends with the adjusted balance.

The company section of the bank reconciliation

Begins with the cash balance according to the company's records and ends with the adjusted balance.

Information about the control environment, risk assessment, control procedures, and monitoring is used:

By management for guiding operations and ensuring compliance with reporting, legal and regulatory requirements.

Cash includes:

Coins, currency (paper money), checks, and money orders.

Example: The cash register total for cash sales for May 3 totaled the $35,690. However, cash receipts from cash sales totaled $35, 668. The cash sales, receipts, and shortage would be recorded as follows: Cash = 35,668 (Debit) Cash Short and Over = 22 (Debit) Sales = 35,690 (Credited)

Debit = Cash b/c Asset account. Debit = Cash Short and Over = For the difference. Over = Revenue Short = Expense Credit = Short and Over, if customer paid more than they should've. Cash Short and Over = Can be asset, but its not b/c we don't have money.

Cash from Bank =

Deposit ticket to accounting department. Then it goes to the bank.

Management also used:

External information to assess events and conditions that impact decision making and external reporting.

A major reason that businesses use bank accounts is:

For internal control. - Usually amount if not the same, may be different from receipt and deposit ticket.

Cash:

Goes to cashier's department = Receipt to accounting department.

The company's checking account balance in the bank records is a:

Liability, company have liability to give back money. - Thus, in the bank's records, the company's account has a CREDIT BALANCE.

Monitoring the internal control system is used to:

Locate weaknesses and improve controls.

Company Service

Make adjustments to bank section.

Bank Service

Make adjustments to company section.

Management's Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. - Management includes principal executive officer and principal financial officer. - Conduct an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrate Framework(2013).

Salesperson:

May make errors in making changes for customers or in ringing up cash sales.

Monitoring often includes:

Observing employee behavior and the accounting system for indicators of control problems.

Alternatively, a Credit balance is included in:

Other Income Section of the income statement.

Objectives of internal control

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

Cash may also be:

Received from customers through Electronic Funds Transfer (EFT).

Sarbanes-Oxley requirements:

Requires companies and their independent accountants to report on the effectiveness of the company's internal controls. - These reports are filed with company's annual 10-K report with the Securities and Exchange Commission.

IF there is a cash overage:

The Cash Short and Over account is credited for the overage.

IF there is a cash shortage:

The Cash Short and Over account is debited for the shortage.

Sarbanes-Oxley emphasizes...

The importance of effective internal control.

A bank statement shows:

beginning balance + additions - deductions = ending balance