Sarbanes-Oxley, Internal Control, and

Cash

Chapter 7
Student Version
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2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Prepared by: C. Douglas

Cloud
Professor Emeritus of
Accounting
Pepperdine University

Learning Objective 1
Describe the
Sarbanes-Oxley Act
of 2002 and its
impact on internal
controls and financial
reporting.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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

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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.

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Learning Objective 2
Describe and
illustrate the
objectives and
elements of internal
control.

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LO 2

Elements of Internal Control

Employee fraud is the intentional act
of deceiving an employer for
gain.
personal
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.
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LO 2

Control Environment
The control environment is the
overall attitude of management and
employees about the importance of
controls. Three factors influencing a
companys control environment are:
Managements philosophy and operating
style
The companys organizational structure
The companys personnel policies

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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LO 2

Control Procedures
Control procedures provide
reasonable assurance that business
goals will be achieved. Control
procedures include:
Competent personnel, rotating duties, and
mandatory vacations
Separating responsibilities for related
operations
Separating operations, custody of assets,
and accounting
Proofs and security measures
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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.

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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 human element of controls
Cost-benefit considerations

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 3

Describe and
illustrate the
application of
internal controls
to cash.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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.
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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-thecounter 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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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.
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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.from
Cash
may
also
be received
customers through electronic funds
transfers (EFT). Customers may
authorize automatic electronic
transfers from their checking
accounts to pay monthly bills.

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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.
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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.

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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.
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Learning Objective 4

Describe the nature

of a bank account
and its use in
controlling cash.

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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.
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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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 5

Describe and illustrate

the use of a bank
reconciliation in
controlling cash.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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.

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LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance

Power Networkings Records

$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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance
Add deposit not
recorded by bank

Power Networkings Records

$3,359.78
816.20
$4,175.98

Step 2
A deposit on July 31
of $816.20 is not
recorded on the
bank statement.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance
Add deposit not
recorded by bank
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60

Power Networkings Records

$3,359.78
816.20
$4,175.98

1,544.99

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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance
Add deposit not
recorded by bank
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60
Adjusted balance

Power Networkings Records

$3,359.78
816.20
$4,175.98

Step 4
Determine the
adjusted balance.

1,544.99
$2,630.99

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance
Add deposit not
recorded by bank
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60
Adjusted balance

Power Networkings Records

$3,359.78

Cash balance

816.20
$4,175.98

1,544.99

$2,549.99

Step 5
The cash balance in
Power Networkings
ledger on July 31 is
$2,549.99.

$2,630.99

2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Banks Records

Cash balance
Add deposit not
recorded by bank
Deduct outstanding
checks:
No. 812
$1,061.00
No. 878
435.39
No. 883
48.60
Adjusted balance

Power Networkings Records

$3,359.78
816.20
$4,175.98

Cash balance
Add note and interest
collected by bank

$2,549.99
408.00
$2,957.99

Step 6
1,544.99
$2,630.99

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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Power Networkings Records
Banks Records
$3,359.78 Cash balance
Add note and interest
collected by bank
816.20
$4,175.98
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
Cash balance
Add deposit not
recorded by bank

Adjusted balance

$2,630.99

Step 7

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

$2,549.99
408.00
$2,957.99

LO 5

Power Networking Bank

Reconciliation 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?
(continued)

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation Error
Power Networking made the error, so the item is
placed on the companys side of the reconciliation.
By correcting the error, the cash account goes
down. (Thus, it is a deduction on the reconciliation.)

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Power Networkings Records
Banks Records
$3,359.78 Cash balance
Add note and interest
collected by bank
816.20
$4,175.98
Deduct check
Deduct outstanding
NSF
$300.00
checks:
No. 812
$1,061.00
Bank service
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
Cash balance
Add deposit not
recorded by bank

Error
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

$2,549.99
408.00
$2,957.99

LO 5

Power Networking Bank

Reconciliation
Power Networkings Records
Banks Records
$2,549.99
$3,359.78 Cash balance
Add note and interest
collected by bank
408.00
816.20
$2,957.99
$4,175.98
Deduct check
Deduct outstanding
NSF
$300.00
checks:
No. 812
$1,061.00
Bank service
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
$2,630.99
Adjusted balance
Cash balance
Add deposit not
recorded by bank

Step 8
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Power Networking Bank

Reconciliation
Power Networkings Records
Banks Records
$2,549.99
$3,359.78 Cash balance
Add note and interest
collected by bank
408.00
816.20
$2,957.99
$4,175.98
Deduct check
Deduct outstanding
NSF
$300.00
checks:
No. 812
$1,061.00
Bank service
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
$2,630.99
Adjusted balance
Cash balance
Add deposit not
recorded by bank

Step 9
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LO 5

Power Networking Bank

Reconciliation

The journal entries for Power Networking, based

on the bank reconciliation, are as follows:

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Learning Objective 6

Describe the
accounting for specialpurpose cash funds.

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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.

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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:

At the end of August, the petty cash receipts

indicate expenditures for the following items: office
supplies, $380; postage (debit Office Supplies),
$22; store supplies, $35; and miscellaneous
administrative expense, $30.
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LO 6

Petty Cash Fund

The entry to replenish the petty cash fund is
shown below.

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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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 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.

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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:
Cash as of Year-End
Ratio of Cash to
Monthly Cash Expenses = Monthly Cash Expenses

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LO 8

Ratio of Cash to Monthly Cash

Expenses
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 Cash
follows:
Negative
Flow
Monthly Cash Expenses =

from Operations
12

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Sarbanes-Oxley, Internal Control, and

Cash

The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.