Sarbanes-Oxley, Internal Control, and Cash

Sarbanes-Oxley, Internal Control, and Cash
Chapter 8
Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University
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Learning Objectives
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.
4. Describe the nature of a bank account and its use
in controlling cash.
Learning Objectives
5. Describe and illustrate the use of a bank
reconciliation in controlling cash.
Learning Objectives
6. Describe the accounting for special-purpose cash
funds.
Learning Objectives
funds.
7. Describe and illustrate the reporting of cash and
cash equivalents in the financial statements.
Learning Objectives
funds.
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.
Learning Objective 1

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.
LO 1

 Sarbanes-Oxley requires companies to maintain
strong and effective internal controls over the
recording of transactions and the preparing of
financial statements.
LO 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.
LO 1
LO 1

reporting.
LO 2
Internal Control
LO 2
Internal Control
 Employee fraud is the intentional act of deceiving

an employer for personal gain.
LO 2
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
LO 2
Elements of Internal Control
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 Environment
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
Control Procedures
LO 2
Monitoring
 Monitoring the internal control system is used to

locate weaknesses and improve controls.
LO 2
Monitoring
 Monitoring often includes observing employee
behavior and the accounting system for indicators
of control problems.
LO 2
Monitoring
LO 2
Monitoring
EE 8-1
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
1. Describe the Sarbanes-Oxley Act of 2002 and the

reporting.
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
LO 3
Cash Received from Cash Sales
 One of the most important controls to protect

cash received in over-the-counter sales is a cash
register.
LO 3
LO 3
 A predetermined amount of money that is given

to each cash register clerk in a cash drawer is
called a change fund.
LO 3

 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 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:
LO 3

 If there had been cash over, Cash Short and
Over would have been credited for the
overage.
LO 3
Cash Received in the 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.
LO 3
Cash Received by EFT
 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.
LO 3
Voucher System
 A voucher is any document that serves as proof of
authority to pay cash or issue an electronic funds
transfer.
1. Describe the Sarbanes-Oxley Act of 2002 and the

reporting.
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.
LO 4
Impact of Debit and Credit Memos
LO 4
Bank Statement
 The following types of credit or debit memo

entries are found on a bank statement:
EE 8-2
LO 4
Using the Bank Statement as a Control Over 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
Bank Reconciliation
 A bank reconciliation is usually divided into two
sections as follows
1. The bank section begins with the cash balance
according to the bank statement and ends with the
adjusted balance.
2. The company section begins with the cash balance
according to the company’s records and ends with
the adjusted balance.
LO 5
Bank Reconciliation
LO 5
Steps of a Bank Reconciliation
LO 5
Steps of a Bank Reconciliation
LO 5
Power Networking Bank Reconciliation
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
Bank’s Records Power Networking’s Records

Cash balance $3,359.78
Step 1
LO 5
Step 2
A deposit on July 31 of $816.20 is not recorded on the

bank statement.
LO 5

Add deposit not
recorded by bank 816.20
$4,175.98
Step 2
LO 5
Step 3
Three checks that were written during the month did

not appear on the bank statement: No. 812, $1,061;
No. 878, $435.39, No. 883, $48.60.
LO 5

Add deposit not
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00
No. 878 435.39
No. 883 48.60 1,544.99
Step 3
LO 5

Add deposit not
$4,175.98
Deduct outstanding
checks:
No. 812 $1,061.00
No. 878 435.39
No. 883 48.60 1,544.99
Adjusted balance $2,630.99
Step 4
LO 5
Step 5
The cash balance in Power Networking’s ledger on

July 31 is $2,549.99.
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
No. 878 435.39
No. 883 48.60 1,544.99
LO 5
Step 6
A credit memo on the bank statement indicates that

the bank collected a note in the amount of $400 and
the related interest of $8 for Power Networking.
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
No. 878 435.39
Step 6
No. 883 48.60 1,544.99
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
Adjusted balance $2,630.99 Adjusted balance 327.00
$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
Adjusted balance $2,630.99 Adjusted balance 327.00
$2,630.99
Step 9
LO 5

The journal entries for Power Networking, based
on the bank reconciliation, are as follows:
LO 5
EE 8-3

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.
LO 6
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

IMPORTANT!
The only time Petty Cash is debited is when the fund

is initially established or when the fund is increased.
The only time Petty Cash is credited is when the
fund is being decreased.
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.
EE 8-4

funds.
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.
LO 7
 Companies that have invested excess cash in cash

equivalents usually report Cash and cash
equivalents as one amount on the balance sheet.
LO 7
 Banks may require depositors to maintain

minimum cash balances in their bank accounts.
Such a balance is called a compensating balance.
funds.
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
EE 8-5
Sarbanes-Oxley, Internal Control, and Cash
The End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

Sarbanes-Oxley, Internal Control, and Cash

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Sarbanes-Oxley, Internal Control, and Cash

Prepared by: C. Douglas Cloud

1. Describe the Sarbanes-Oxley Act of 2002 and its

 The Sarbanes-Oxley Act of 2002 (often referred

Sarbanes-Oxley Act of 2002

 Internal control is broadly defined as the

Sarbanes-Oxley Act of 2002

1. Describe the Sarbanes-Oxley Act of 2002 and its

 Employee fraud is the intentional act of deceiving

 Management is responsible for designing and

Elements of Internal Control

 The control environment is the overall attitude of

 Management’s philosophy and operating style

 Control procedures provide reasonable assurance

 Monitoring the internal control system is used to

 Internal controls can provide only reasonable

1. Describe the Sarbanes-Oxley Act of 2002 and the

Cash Controls Over Receipts and Payments

 Cash includes coins, currency (paper money),

 Businesses normally receive cash from two main

 One of the most important controls to protect

Cash Received from Cash Sales

 A predetermined amount of money that is given

Control of Cash Receipts

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

Cash Received from Cash Sales

 Cash is received in the mail when customers pay

 Cash may also be received from customers

Cash Received by EFT

 The control of cash payments should provide

 A voucher system is a set of procedures for

1. Describe the Sarbanes-Oxley Act of 2002 and the

 A major reason that businesses use bank accounts

 A summary received from the bank (usually

 The following types of credit or debit memo

5. Describe and illustrate the use of a bank

 A bank reconciliation is an analysis of the items

Steps of a Bank Reconciliation

Power Networking Bank Reconciliation

Power Networking prepares to reconcile the monthly

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Power Networking Bank Reconciliation

A deposit on July 31 of $816.20 is not recorded on the

Power Networking Bank Reconciliation

Bank’s Records Power Networking’s Records

Cash balance $3,359.78

Power Networking Bank Reconciliation

Three checks that were written during the month did

Power Networking Bank Reconciliation

Power Networking Bank Reconciliation

Adjusted balance $2,630.99

Power Networking Bank Reconciliation

The cash balance in Power Networking’s ledger on

Power Networking Bank Reconciliation

Adjusted balance $2,630.99

Power Networking Bank Reconciliation

A credit memo on the bank statement indicates that

Power Networking Bank Reconciliation

Adjusted balance $2,630.99

Power Networking Bank Reconciliation

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

Power Networking Bank Reconciliation