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The Sarbanes-Oxley Act of 2002 (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 companies.

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Sarbanes-Oxley Act of 2002

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Sarbanes-Oxley requires companies to maintain strong and effective internal control.

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Sarbanes-Oxley Act of 2002

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Internal control is broadly defined as the procedures and processes used by a company to:1. Safeguard its assets.

2. Process information accurately.

3. Ensure compliance with laws and regulations.

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Sarbanes-Oxley Act of 2002

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Sarbanes-Oxley Report of NikeExhibit 1

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

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Objectives of Internal Control

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1. Control environment

2. Risk assessment

3. Control procedures

4. Monitoring

5. Information and communication

Management is responsible for designing and applying five elements of internal control to meet the three internal control objectives. These elements are as follows:

Five Elements of Internal Control

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Elements of Internal ControlExhibit 2

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The control environment is the overall attitude of management and employees about the importance of controls.

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Control Environment

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1. Management’s philosophy and operating style

2. The company’s organizational structure

3. The company’s personnel policies

Factors That Influence the Control Environment

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1. Competent personnel, rotating, duties, and mandatory vacations.

2. Separating responsibilities for related operations.

3. Separating operations, custody of assets, and accounting.

4. Proofs and security measures.

Control Procedures

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Exhibit 3 Internal Control Procedures

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Monitoring the internal control system is used to locate weaknesses and improve controls.

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Monitoring

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Monitoring often includes observing employee behavior and the accounting system for indicators of control problems.

Monitoring

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Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6

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Warning Signs of Internal Control ProblemsExhibit 4

(continued)

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Warning Signs of Internal Control Problems (continued)

Edwin C. Bliss , “Employee Theft,” Boardroom Reports, July 15, 1994, pp. 5–6

1. Missing documents or gaps in transaction numbers (could mean documents are being used for fraudulent transactions).

2. An unusual increase in customer refunds (refunds may be phony).

3. Differences between daily cash receipts and bank deposits (could mean receipts are being pocketed before deposited).

4. Sudden increase in slow payments (employee may be pocketing the payment).

5. Backlog in recording transactions (possibly an attempt to delay detection of fraud).

1. Missing documents or gaps in transaction numbers (could mean documents are being used for fraudulent transactions).

2. An unusual increase in customer refunds (refunds may be phony).

3. Differences between daily cash receipts and bank deposits (could mean receipts are being pocketed before deposited).

4. Sudden increase in slow payments (employee may be pocketing the payment).

5. Backlog in recording transactions (possibly an attempt to delay detection of fraud).

Exhibit 4

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Limitations of Internal Control

1. The human element of control

2. Cost-benefit considerations

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Cash includes coins, currency (paper money), checks, and money orders. Cash is the asset most likely to be stolen or used improperly in a business.

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Sources of Cash

Businesses normally receive cash from two main sources:

1. Customers purchasing products or services.

2. Customers making payments on account.

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One of the most important controls to protect cash received in over-the-counter sales is a cash register.

Control of Cash Receipts

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Using the Cash Register to Control Cash

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A predetermined amount of money that is given to each cash register clerk in a cash drawer is called a change fund.

Control of Cash Receipts

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Cash sales for March 19 totaled $35,690 per the cash register tape. After removing the change fund, only $35,668 was on hand.

Cash Short and Over

If there had been cash over, Cash Short and Over would have been credited for the overage.

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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

1. Bank accounts reduce the amount of cash on hand.

2. Bank accounts provide an independent recording of cash transactions.

3. Use of bank accounts facilitates the transfer of funds using EFT systems.

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A summary received from the bank of all checking account transactions is called a bank statement.

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Bank Accounts

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Impact of Debit and Credit Memos4

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Typical credit or debit memorandum entries found

on the bank statement:

EC — Error correction to correct bank error.

NSF — Not sufficient funds check.SC — Service charge.ACH — Automated Clearing House entry

for electronic funds transfer.MS — Miscellaneous items.

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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 in order to determine the adjusted cash balance.

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Bank Reconciliation

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The Adjusted Balance5

Must be equal

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Steps in a Bank Reconciliation5

(continued)

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Steps in a Bank Reconciliation5

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Bank’s Records

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. The company’s Cash account has a July 31 balance of $2,549.99.

Step 1

Beginning balance $3,359.78 Beginning balance $2,549.99

5Power Networking’s Records

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A deposit of $816.20 did not appear on the bank statement.

Add deposit not recorded by bank 816.20

$4,175.98

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Step 2

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

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Three checks that were written during the period did not appear on the bank statement: No. 812, $1,061; No. 878, $435.39, No. 883, $48.60.

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

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Step 3

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99 Add deposit not recorded by bank 816.20

$4,175.98

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The bank collected a note in the amount of $400 and the related interest of $8 for Power Networking

Add note and interest collected by bank 408.00

$2,957.99

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Step 4

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Add deposit not recorded by bank 816.20

$4,175.98

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The bank returned a check for $300 from customer (Thomas Ivey) because of insufficient funds (NSF).

Deduct check NSF $300.00

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Step 5

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Add note and interest collected by bank 408.00

$2,957.99

Add deposit not recorded by bank 816.20

$4,175.98

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Bank service charges for the month, $18.

Bank service charges 18.00

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Step 6

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Add deposit not recorded by bank 816.20

$4,175.98Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00

7-40Check No. 879 for $732.26 to Taylor Co. on account, erroneously recorded in journal as $723.26.

Error recording Chk. No. 879 9.00

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Step 7

Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Add deposit not recorded by bank 816.20

$4,175.98Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00Bank service charges 18.00

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5Bank’s Records Power Networking’s Records

Beginning balance $3,359.78 Beginning balance $2,549.99

Deduct outstanding checks:

No. 812 $1,061.00No. 878 435.39No. 883 48.60

1,544.99

Add deposit not recorded by bank 816.20

$4,175.98Add note and interest collected by bank 408.00

$2,957.99Deduct check

NSF $300.00

Error recording Chk. No. 879 9.00

Bank service charges 18.00

327.00 $2,630.99 $2,630.99Adjusted balance Adjusted balance

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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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Petty Cash Fund

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A petty cash fund of $500 is established on August 1. The entry to record the transaction is as follows:

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Petty Cash Fund

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IMPORTANT!

The only time Petty Cash is debited is when the fund is initially established or when the fund is increased. The only time Petty Cash is credited is when the fund is being decreased.

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At the end of August, the petty cash receipts indicate expenditures for the following items:

Office supplies $380Postage (debit Office Supplies) 22Store supplies 35Misc. administrative expenses 30 Total $467

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A company’s excess cash is normally invested in highly liquid investments. These investments are called cash equivalents.

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Cash Equivalents

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Companies that have invested excess cash in cash equivalents usually report Cash and cash equivalents as one amount on the balance sheet.

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Cash Equivalents

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Banks may require depositors to maintain minimum cash balances in their bank accounts. Such a balance is called a compensating balance.

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Compensating Balance