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chapter_7_slides.pptx

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Chapter
7
Financial
and
Managerial
Accounting
14e
Warren
Reeve
Duchac
Internal Control and Cash
Learning Objectives

Obj. 1: Describe the Sarbanes-Oxley Act and its impact on internal controls
and financial reporting.

Obj. 2: Describe and illustrate the objectives and elements of internal
control.


Obj. 3: Describe and illustrate the application of internal controls to cash.

Obj. 5: Describe and illustrate the use of a bank reconciliation in controlling
cash.


Obj. 6: Describe the accounting for special-purpose cash funds.

ADM: Describe and illustrate the use of days’ cash on hand to assess a
company’s ability to meet its cash commitments.
Obj. 4: Describe the nature of a bank account and its use in controlling
cash.
Obj. 7: Describe and illustrate the reporting of cash and cash equivalents in
the financial statements.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Sarbanes-Oxley Act
(slide 1 of 3)

The Sarbanes-Oxley Act (often referred to
simply as Sarbanes-Oxley) applies only to
companies whose stock is traded on public
exchanges.

Its purpose is to maintain public confidence and
trust in the financial reporting of companies.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Sarbanes-Oxley Act
(slide 2 of 3)

Sarbanes-Oxley emphasizes the importance of
effective internal control.
o
Internal control is defined as the procedures and
processes used by a company to:
▪ Safeguard its assets.
▪ Process information accurately.
▪ Ensure compliance with laws and regulations.

Sarbanes-Oxley requires companies to maintain
effective internal controls over the recording of
transactions and the preparing of financial
statements.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Effect of Sarbanes-Oxley
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Sarbanes-Oxley Act
(slide 3 of 3)

Sarbanes-Oxley also requires companies and
their independent accountants to report on the
effectiveness of the company’s internal controls.

These reports are required to be filed with the
company’s annual 10-K report with the
Securities and Exchange Commission.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
eBay’s Report of Compliance
with Sarbanes-Oxley
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Objectives of Internal Control

The objectives of internal control are to provide
reasonable assurance that:
o
Assets are safeguarded and used for business
purposes.
o
Business information is accurate.
o
Employees and managers comply with laws and
regulations.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Objectives of Internal Control Illustrated
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Employee Fraud

A serious concern of internal control is
preventing employee fraud.

Employee fraud is the intentional act of
deceiving an employer for personal gain.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Elements of Internal Control

The three internal control objectives can be
achieved by applying the five elements of
internal control. These elements are as follows:
o
Control environment
o
Risk assessment
o
Control procedures
o
Monitoring
o
Information and communication
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Elements of Internal Control Illustrated
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control Environment
(slide 1 of 2)

The control environment is the overall attitude
of management and employees about the
importance of controls.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control Environment
(slide 2 of 2)

Three factors influencing a company’s control
environment include the following:
o
Management’s philosophy and operating style
▪ Management’s philosophy and operating style relates to whether
management emphasizes the importance of internal controls.
o
The company’s organizational structure
▪ The business’s organizational structure is the framework for
planning and controlling operations.
o
The company’s personnel policies
▪ The business’s personnel policies involve the hiring, training,
evaluation, compensation, and promotion of employees.
▪ In addition, job descriptions, employee codes of ethics, and conflictof-interest policies are part of the personnel policies.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control Environment
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Risk Assessment

All businesses face risks such as changes in
customer requirements, competitive threats,
regulatory changes, and changes in economic
factors.

Management should identify such risks, analyze
their significance, assess their likelihood of
occurring, and take any necessary actions to
minimize them.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control Procedures
(slide 1 of 2)

Control procedures provide reasonable
assurance that business goals will be achieved,
including the prevention of fraud.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control Procedures
(slide 2 of 2)

Control procedures include the following:
o
o
Competent personnel, rotating duties, and mandatory vacations

Procedures should be established for properly training and supervising personnel.

By rotating duties of accounting personnel and mandating vacations for all employees, employees are
encouraged to adhere to procedures.
Separating responsibilities for related operations

The responsibility for related operations should be divided among two or more people.

o
Separating operations, custody of assets, and accounting

o
This decreases the possibility of errors and fraud.
By separating the responsibilities for operations, custody of assets, and accounting, the accounting
records serve as an independent check on the operating managers and the employees who have
custody of assets.
Proofs and security measures

Proofs involve procedures such as authorization, approval, and reconciliation.

Security measures involve measures to safeguard assets, such as keeping cash on hand in a cash
register or safe.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Internal Control Procedures
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Warning Signs of Internal Control Problems
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Information and Communication

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.

Management also uses external information to
assess events and conditions that impact
decision making and external reporting.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Check Up Corner
Internal Controls
Identify the control procedure violated in each of the following scenarios:
A. Todd Leone is the accounting clerk for Home Chic, a small boutique retail store
that is owned and operated by Al Dente. Al does not care much for the accounting
side of the business and allows Todd to make all payments to the company’s
suppliers. Todd pays all invoices that Home Chic receives. Al does not review the
payments Todd makes.
B. Jose Muldoon’s Mobile Foods is a food truck with two trusted employees. One
employee stocks the food truck each day, prepares the orders, and cleans up the
kitchen at the end of the day. The other employee takes orders, collects payment
from customers, counts the cash at the end of the day, records the cash receipts,
and deposits the cash in the night depository slot at the bank.
C. Tad is the treasurer and chief financial officer of a local bank in Wisteria,
California. Tad was born and raised in the community and has never had a desire
to travel. As a result, he has not taken a vacation or a day off of work in over 6
years.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Check Up Corner
Internal Controls (cont’d)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Limitations of Internal Control

Internal control systems can provide only
reasonable assurance for safeguarding assets,
processing accurate information, and
compliance with laws and regulations. This is
due to the following factors:
o
The human element of controls
o
Cost-benefit considerations
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash

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.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control of Cash Receipts

To protect cash from theft and misuse, a
business must control cash from the time it is
received until it is deposited in a bank.

Businesses normally receive cash from two main
sources:
o
Customers purchasing products or services
o
Customers making payments on account
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received from Cash Sales
(slide 1 of 4)

An important control to protect cash received in
over-the-counter sales is a cash register.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Register as a Control
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received from Cash Sales
(slide 2 of 4)

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.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received from Cash Sales
(slide 3 of 4)

For example, the cash register total for cash
sales for May 3 totaled $35,690. However, cash
receipts from cash sales totaled $35,668. The
cash sales, receipts, and shortage would be
recorded as follows:
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received from Cash Sales
(slide 4 of 4)

If there is a cash shortage, the Cash Short and
Over account is debited for the shortage.

If there is a cash overage, the Cash Short and
Over account is credited for the overage.

At the end of the accounting period, a debit
balance in Cash Short and Over is included in
miscellaneous expense on the income
statement.

Alternatively, a credit balance is included in the
Other Income section of the income statement.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received in the Mail

Cash is received in the mail when customers
pay their bills. This cash is usually in the form of
checks and money orders.

Most companies design their invoices so that
customers return a portion of the invoice, called
a remittance advice, with their payment.
o
This document helps to control cash received in the
mail.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received by EFT
(slide 1 of 2)

Cash may also be received from customers through
electronic funds transfers (EFT).
o
For example, customers may authorize automatic electronic
transfers from their checking accounts to pay monthly bills for
such items as cell phone, Internet, and electric services.
▪ In such cases, the company sends the customer’s bank a signed
form from the customer authorizing the monthly electronic transfers.
▪ Each month, the company notifies the customer’s bank of the
amount of the transfer and the date the transfer should take place.
▪ On the due date, the company records the electronic transfer as a
receipt of cash to its bank account and posts the amount to the
customer’s account.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Received by EFT
(slide 2 of 2)

Companies encourage customers to use EFT for
the following reasons:
o
EFTs cost less than receiving cash payments through
the mail.
o
EFTs enhance internal controls over cash, since the
cash is received directly by the bank without any
employees handling cash.
o
EFTs reduce late payments from customers and
speed up the processing of cash receipts.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Control of Cash Payments

The control of cash payments should provide
reasonable assurance that:
o
Payments are made for only authorized transactions.
o
Cash is used effectively and efficiently. For example,
controls should ensure that all available purchase
discounts are taken.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Voucher System
(slide 1 of 3)

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.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Voucher System
(slide 2 of 3)

In a manual system, a voucher is normally prepared after
all necessary supporting documents have been received.

For the purchase of goods, a voucher is supported by
the supplier’s invoice, a purchase order, and a receiving
report.
• After a voucher is prepared, it is submitted for approval.
• Once approved, the voucher is recorded in the accounts
and filed by the due date.

Upon payment, the voucher is recorded in the same
manner as the payment of an account payable.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Voucher System
(slide 3 of 3)

In a computerized system, data from the
supporting documents (such as purchase
orders, receiving reports, and suppliers’
invoices) are entered directly into computer files.

At the due date, the checks are automatically
generated and mailed to creditors.

At that time, the voucher is electronically
transferred to a paid voucher file.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Paid by EFT

Cash can also be paid by electronic funds
transfer (EFT) systems.

Examples include the following:
o
A withdrawal of cash from a bank account using an
ATM machine
o
A payment of wages or salaries (payroll check) by an
employer directly to an employee’s checking account
o
A payment to a supplier or other vendor from a
company
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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:
o
Bank accounts reduce the amount of cash on hand.
o
Bank accounts 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.
o
Use of bank accounts facilitates the transfer of funds
using EFT systems.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Bank Statement
(slide 1 of 5)

Banks maintain a record of all checking account
transactions.

A summary of all transactions, called a bank
statement, is mailed, usually each month, to the
company (depositor) or made available online.

A bank statement shows the beginning balance,
additions, deductions, and the ending balance.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Bank Statement
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Bank Statement
(slide 2 of 5)

The company’s checking account balance in the
bank records is a liability. Thus, in the bank’s
records, the company’s account has a credit
balance.

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.

Likewise, a debit memo entry on the bank
statement indicates a decrease (a debit) in the
company’s account.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Bank Statement
(slide 3 of 5)

A bank makes credit entries (issues credit
memos) for the following:
o
Deposits made by …
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