Chapter 4 Cash and Internal Controls 11 23 15 2 02 PM v Part A Internal Controls Incorrect Financial Statements o Reasons Errors accidental errors in recording transactions or applying accounting principles Fraud a person intentionally deceives another person for personal gain or to damage that person Occupational Fraud the use of one s occupation for personal enrichment through the deliberate misuse or misapplication of the employer s resources The Fraud Triangle o Motive or pressure o Rationalization o Opportunity Internal Controls o Eliminate Opportunity o Represent plans to Safeguard the assets Improve accuracy and reliability of information Accounting Scandals and Response by Congress o Managers are entrusted with the resources of both the company s lenders and owners o Managers act as stewards or caretakers of the company s assets o Some managers have shirked their ethical responsibilities Top executives misreported and fooled investors into overvaluing the company s stock Accounting fraud in the US history o Enron o WorldCom Avoided reporting billions in debt and losses Misclassified expenditures to overstate assets and profitability Sarbanes Oxley Act of 2002 o Passed by Congress o Aslo known as the Public Company Accounting Reform and Investor Protection Act of 2002 o Applies to all companies that are required to file financial Major provision of the Sarbanes Oxley Act of 2002 statements with the SEC o Established guidelines on Internal control procedures Auditor client relations o Oversight board o Corporate executive accountability o Nonaudit services o Retention of work papers o Auditor rotation o Conflicts of Interest o Hiring of auditor o Internal control Illustration 4 2 Components of Internal Control o Monitoring o Control Activities o Risk Assessment o Control Environment Control Activities o Preventative Controls Separation of duties Physical controls Proper authorization Employee management E commerce controls o Detective controls Reconciliations Performance reviews Audits Responsibilities for Internal Control o The CEO and CFO to sign a report each year assessing adequacy of internal controls o Auditors to provide an opinion on management s assessment o Auditor to express its own opinion on company s internal control over financial reporting Limitations of Internal Control o Bad employee cannot be turned into a good one o Internal control systems are especially susceptible to collusion Collusion two or more people acting together to circumvent internal controls o Top level employees who can override internal control procedures can commit fraud o Effective internal controls and ethical employees cannot ensure success or even survival v Part B Cash Cash and Cash Equivalents o Cash Currency Coins Balances in savings and checking accounts Checks o Cash Equivalents mature within 3 months Money market funds Treasury bills Certificates of deposit CD s Cash Controls o Controls over cash receipts Separate duties of handling cash and verifying receipts Deposit cash daily Prefer credit cards or debit cards o Controls over cash disbursements Prefer payments by check debit card or credit card Separate duties of authorizing payments and verifying purchases Verify records against purchase receipts Place authorization and documentation procedures Separate disbursement and collections duties Bank Reconciliation o Bank Reconciliation matching the balance of cash in the bank account with the balance of cash in the company s own records Step 1 Reconciling the Bank s Cash Balance o Deposits outstanding cash receipts of the company that have not been added to the bank s record of the company s balance Deposits in transits or outstanding receipts Added to the balance per books o Checks outstanding checks the company has written that have not been subtracted from the bank s record of the company s balance As soon as the check is written debit from cash account Subtracted from balance per books Step 2 Reconciling the Company s Cash Balance o Interest earned by the company o Collections made by the bank on the company s behalf o Service fees o Charges for NSF checks NSF checks customers checks written on nonsufficient funds otherwise known as bad checks Step 3 Adjusting the Company s Cash Account Balance o Update the balance in its Cash account To adjust for the items used to reconcile the company s cash balance Petty Cash Fund o Petty Cash Fund small amount of cash kept on hand to pay for minor purchases o Accounting for the petty cash fund involves recording for Establishing the fund Recognizing expenditures from the fund Replenishing the fund Example Petty Cash Fund o Establishing a petty cash fund of 500 Petty Cash on hand Debit 500 Cash Checking Account Credit 500 establish the petty cash fund o Expenditures from the petty cash fund Postage 75 Postage expense Debit 75 Delivery charges 85 Delivery Expense Debit 85 Office group lunch 50 Entertainment Expense Debit 50 Office supplies 120 Supplies Debit 120 Petty Cash on hand Credit 330 recognize expenditures from the petty cash o Replenishing the petty cash fund fund Petty cash on hand Debit 330 Cash checking account Credit 330 replenish the petty cash fund at the end of the period Reporting Cash o Balance Sheet o Statement of Cash Flows Activities on Cash Flows Statement o Operating Activities Cash transactions involving revenues and expenses Cash investments in long term assets and investment o Investing Activities securities o Financing Activities Transactions designed to finance the business through borrowing and owner investment Transaction External Transaction Which transactions involve the exchange of cash Type of Activity Financing Yes 1 Sell shares of common stock for 25 000 to obtain the funds necessary to start the business Borrow 10 000 from the local Financing Yes 2 Is Cash Involved Inflow or Outflow Inflow Inflow bank and sign a note promising to repay the full amount of the debt in 3 years Purchase equipment necessary for giving golf training 24000 cash Pay one year of rent in advance 6000 500 per month Purchase supplies on account 2300 Provide golf training to customers for cash 4200 Provide golf training to customers on account 2000 Receive cash in adance for 12 golf training sessions to be given in the future 600 Pay salaries to employees 2800 Pay cash dividends of 200 to shareholders Investing Yes Outflow Operating Yes Outflow Operating No Operating Yes Inflow Operating No Operating Yes Inflow Operating Yes