Internal controls are a system of checks and balances designed to prevent and detect fraud and errors Both of these actions are required under SOX Companies find that internal control review is a costly process One study estimates the cost for U S companies at over 35 billion with audit fees doubling in the first year of compliance The enhanced internal control standards apply only to large public companies listed on U S exchanges There is continuing debate over whether foreign issuers should have to comply Slide 3 88 Most companies use accrual basis accounting recognize revenue when it is earned and expenses in the period incurred without regard to the time of receipt or payment of cash Under the strict cash basis companies record revenue only when they receive cash and record expenses only when they disperse cash Cash basis financial statements are not in conformity with IFRS Slide 3 89 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Illustration Quality Contractor signs an agreement to construct a garage for 22 000 In January Quality begins construction incurs costs of 18 000 on credit and by the end of January delivers a finished garage to the buyer In February Quality collects 22 000 cash from the customer In March Quality pays the 18 000 due the creditors Illustration 3A 1 Slide 3 90 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Illustration Quality Contractor signs an agreement to construct a garage for 22 000 In January Quality begins construction incurs costs of 18 000 on credit and by the end of January delivers a finished garage to the buyer In February Quality collects 22 000 cash from the customer In March Quality pays the 18 000 due the creditors Illustration 3A 2 Slide 3 91 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Conversion From Cash Basis To Accrual Basis Illustration Dr Diane Windsor like many small business owners keeps her accounting records on a cash basis In the year 2010 Dr Windsor received 300 000 from her patients and paid 170 000 for operating expenses resulting in an excess of cash receipts over disbursements of 130 000 300 000 170 000 At January 1 and December 31 2010 she has accounts receivable unearned service revenue accrued liabilities and prepaid expenses as shown in Illustration 3A 5 Illustration 3A 5 Slide 3 92 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Conversion From Cash Basis To Accrual Basis Illustration Calculate service revenue on an accrual basis Illustration 3A 8 Illustration 3A 5 Slide 3 93 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Conversion From Cash Basis To Accrual Basis Illustration Calculate operating expenses on an accrual basis Illustration 3A 11 Illustration 3A 5 Slide 3 94 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Conversion From Cash Basis To Accrual Basis Illustration 3A 12 Slide 3 95 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Theoretical Weaknesses of the Cash Basis Today s economy is considerably more lubricated by credit than by cash The accrual basis not the cash basis recognizes all aspects of the credit phenomenon Investors creditors and other decision makers seek timely information about an enterprise s future cash flows Slide 3 96 LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting Illustration of Reversing Entries Accruals Illustration 3B 1 Slide 3 97 LO 9 Identifying adjusting entries that may be reversed Illustration of Reversing Entries Deferrals Illustration 3B 2 Slide 3 98 LO 9 Identifying adjusting entries that may be reversed Summary of Reversing Entries 1 All accruals should be reversed 2 All deferrals for which a company debited or credited the original cash transaction to an expense or revenue account should be reversed 3 Adjusting entries for depreciation and bad debts are not reversed Recognize that reversing entries do not have to be used Therefore some accountants avoid them entirely Slide 3 99 LO 9 Identifying adjusting entries that may be reversed A company prepares a worksheet either on columnar paper or within an electronic spreadsheet A company uses the worksheet to adjust account balances and to prepare financial statements Slide 3 100 LO 10 Prepare a 10 column worksheet Worksheet Columns A company prepares a worksheet either on columnar paper or within an electronic spreadsheet Slide 3 101 LO 10 Prepare a 10 column worksheet Adjusted Trial Balance Slide 3 102 Illustration 3C 1 LO 10 Prepare a 10 column worksheet Preparing Financial Statements from a Worksheet The Worksheet Provides information needed for preparation of the financial statements Sorts data into appropriate columns which facilitates the preparation of the statements Slide 3 103 LO 10 Prepare a 10 column worksheet Illustration 3 39 Slide 3 104 LO 10 Illustration 3 40 Slide 3 105 LO 10 Prepare a 10 column worksheet Illustration 3 41 Slide 3 106 LO 10