ACCT 2113 1st Edition Lecture 4 Outline of Previous Lecture II. ReviewA. Debits and creditsB. Account MenusIII. Accrual-Basis AccountingIV. Revenue Recognition PrincipleA. ExamplesV. Matching PrincipleA. DefinitionB. ExampleVI. Accrual vs. Cash-Basis AccountingA. DefinitionB. ExamplesVII. The Measurement ProcessA. Accounting CycleB. Adjusting EntriesC. DefinitionsVIII. Prepaid ExpensesA. ExamplesIX. Unearned RevenuesA. ExamplesX. Accrued ExpensesA. ExamplesXI. Accrued RevenuesA. ExamplesXII. The Reporting ProcessA. Preparing the Financial StatementsXIII. The Closing ProcessA. 4 stepsB. Closing Entries and Post-Cost Trial BalanceOutline of Current Lecture I. Accounting scandalA. ImpactsII. Sarbanes-Oxley ActThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.A. Major ProvisionsIII. Internal ControlA. Components, responsibilities, and limitationsIV. Control ActivitiesA. Detective and preventiveV. CashA. Net income to free cash flowsB. Cash receiptsCurrent Lecture Ch. 4 Cash and Internal ControlsThe impact of accounting scandals and the passage of the Sarbanes-Oxley Act: Managers are entrusted with the resources of both the company’s lenders (liabilities) and owners (stockholders' equity). In this sense, managers of the company act as stewards or caretakers of the company’s assets. However, in recent years some managers have shirked their ethical responsibilities and misused or misreported the company’s funds. In many cases, top executivesmisreported accounting information to cover up their company’s poor operating performance. They hoped to fool investors into overvaluing the company’s stock. Two of the highest-profiled cases of accounting fraud in U.S. history are the collapses of Enron and WorldCom.Sarbanes-Oxley Act of 2002- In response to these corporate accounting scandals and to public outrage over seemingly widespread unethical behaviour of top executives, Congress passed the Sarbanes-Oxley Act, also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly referred to as SOX. SOX applies to all companies that are required to file financial statements with the SEC and represents one of the greatest reforms in business practices in U.S. history.Major Provisions: Oversight board. The Public Company Accounting Oversight Board (PCAOB) has the authority to establish standards dealing with auditing, quality control, ethics, independence, and other activities relating to the preparation of audited financial reports. The board consists of five members who are appointed by the Securities and Exchange Commission. Corporate executive accountability. Corporate executives must personally certify the company’sfinancial statements and financial disclosures. Severe financial penalties and the possibility of imprisonment are consequences of fraudulent misstatement.Non-audit services. It’s unlawful for the auditors of public companies to also perform certain non-audit services, such as consulting, for their clients. Retention of work papers. Auditors of public companies must retain all work papers for seven years or face a prison term for willful violation.Auditor rotation. The lead auditor in charge of auditing a particular company (referred to as theaudit partner ) must rotate off that company within five years and allow a new audit partner to take the lead.Conflicts of interest. Audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company’s audit during the preceding year.Hiring of auditor. Audit firms are hired by the audit committee of the board of directors of the company, not by company management. Internal control. Section 404 of the act requires (a) that company management document and assess the effectiveness of all internal control processes that could affect financial reporting and (b) that company auditors express an opinion on whether management’s assessment of the effectiveness of internal control is fairly stated.Components, responsibilities, and limitations of internal control: From a financial accounting perspective, internal control is a company’s plan to: (1) Safeguard the company’s assets. (2) Improve the accuracy and reliability of accounting information and (3) Effective internal control builds a wall to prevent misuse of company funds by employees and fraudulent or errant financial reporting. Strong internal control systems allow greater reliance by investors on reported financial statements.Framework of internal control: Methods for collection of relevant information andcommunication in a timely manner, enabling people to carry out their responsibilities. Components: Control Environment: The overall attitudes and actions of management greatly affect the control environment. If employees notice unethical behavior or comments by management, they are more likely to behave in a similar manner, wasting the company’s resources.Risk Assessment: includes careful consideration of internal and external risk factors.Monitoring: of internal controls needs to occur on an ongoing basis. Continual monitoring of internal activities and reporting of deficiencies is required.Control Activities: include a variety of policies and procedures used to protect a company’s assets. There are two general types of control activities: detective and preventive.Detective controls are designed to detect errors or fraud that already have occurred; Preventive controls are designed to keep errors or fraud from occurring in the first place. Common examples of preventive controls include:Separation of duties Authorizing transactions, recording transactions, and maintaining control of the related assets should be separated among employees.Physical controls over assets and accounting records. Proper authorization to prevent improper use of the company’s resources. Employee management. The company should provide employees with appropriate guidance toensure they have the knowledge necessary to carry out their job duties.Some examples of detective controls include: Reconciliations. Management should periodically determine whether the amount of physical assets of the company (cash, supplies, inventory, and other property) match—reconcile with—the accounting records. Performance reviews. The actual performance of individuals or processes should be checked