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Cash and Internal Controls. Chapter 4 . Learning Objectives. Discuss the impact of accounting scandals and the passage of the Sarbanes-Oxley Act Identify the components, responsibilities, and limitations of internal control Define cash and cash equivalents - PowerPoint PPT Presentation
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Spiceland | Thomas | Herrmann
Financial Accounting
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Cash andInternal Controls
Chapter 4
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Learning Objectives
• Discuss the impact of accounting scandals and the passage of the Sarbanes-Oxley Act
• Identify the components, responsibilities, and limitations of internal control
• Define cash and cash equivalents• Understand controls over cash receipts and cash
disbursements• Reconcile a bank statement
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Learning Objectives
• Account for petty cash• Identify the major inflows and outflows of cash• Assess earnings quality by comparing net income
and cash flows
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Part A
Internal Controls
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Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Incorrect Financial Statements
• 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.
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The Fraud Triangle
Motive (or pressure)
Rationalization
Opportunity
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Internal Controls
• Eliminate opportunity• Represent plans to:
• Safeguard the assets• Improve accuracy and reliability of information
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 1
Discuss the impact of accounting scandals and the passage of the Sarbanes-Oxley Act
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Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Accounting Scandals and Response by Congress
• Managers are entrusted with the resources of both the company’s lenders and owners
• Managers act as stewards or caretakers of the company’s assets
• Some managers have shirked their ethical responsibilities• Top executives misreported and fooled investors
into overvaluing the company’s stock
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Accounting fraud in U.S. history
WorldCom Enron
Avoided reporting billions in debt and losses
Misclassified expenditures to overstate assets and
profitability
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Sarbanes-Oxley Act of 2002
• Passed by Congress• Also known as the Public Company Accounting
Reform and Investor Protection Act of 2002• Applies to all companies that are required to file
financial statements with the SEC• Established guidelines on:
• Internal control procedures• Auditor-client relations
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Major Provisions of the Sarbanes-Oxley Act of 2002
• Oversight board• Corporate executive accountability• Nonaudit services• Retention of work papers• Auditor rotation• Conflicts of interest• Hiring of auditor• Internal control
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Learning Objective 2
Identify the components, responsibilities, and limitations of internal control
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Control Activities
Preventive controls
• Separation of duties
• Physical controls
• Proper authorization
• Employee management
• E-commerce controls
Detective controls
• Reconciliations
• Performance reviews
• Audits
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Responsibilities for Internal Control
• The CEO and CFO to sign a report each year assessing adequacy of internal controls
• Auditors to provide an opinion on management’s assessment
• Auditor to express its own opinion on company’s internal control over financial reporting
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Limitations of Internal Control
• Bad employee cannot be turned into a good one• Internal control systems are especially susceptible
to collusion• Collusion: two or more people acting together to
circumvent internal controls.• Top-level employees who can override internal
control procedures can commit fraud• Effective internal controls and ethical employees
cannot ensure success or even survival
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Part B
Cash
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Learning Objective 3
Define cash and cash equivalents
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Cash and Cash Equivalents
• Cash• Currency• Coins• Balances in savings and checking accounts• Checks
• Cash equivalents—mature within three months• Money market funds• Treasury bills• Certificates of deposit
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 4
Understand controls over cash receipts and cash disbursements
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Cash Controls• Controls over cash receipts
• Separate duties of handling cash and verifying receipts• Deposit cash daily• Prefer credit cards or debit cards
• 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
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Learning Objective 5
Reconcile a bank statement
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Bank Reconciliation
• Bank reconciliation: matching the balance of cash in the bank account with the balance of cash in the company’s own records
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Illustration 4.6—Bank Reconciliation
• Timing differences• Errors
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Step 1: Reconciling the Bank’s Cash Balance
• Deposits outstanding: cash receipts of the company that have not been added to the bank’s record of the company’s balance
• Checks outstanding: checks the company has written that have not been subtracted from the bank’s record of the company’s balance
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Step 2: Reconciling the Company’s Cash Balance
• Interest earned by the company• Collections made by the bank on the company’s
behalf• Service fees• Charges for NSF checks
• NSF checks: Customers’ checks written on “nonsufficient funds,” otherwise known as “bad” checks
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Step 3: Adjusting the Company’s Cash Account Balance
• Update the balance in its Cash account:• To adjust for the items used to reconcile the
company’s cash balance
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Learning Objective 6
Account for petty cash
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Petty Cash Fund
• Petty cash fund: small amount of cash kept on hand to pay for minor purchases
• Accounting for the petty cash fund involves recording for:• Establishing the fund• Recognizing expenditures from the fund• Replenishing the fund
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Learning Objective 7
Identify the major inflows and outflows of cash
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Reporting Cash
• Balance sheet• Statement of Cash Flows
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Activities on Cash Flows Statement
• Operating activities• Cash transactions involving revenues and expenses
• Investing activities• Cash investments in long-term assets and investment
securities• Financing activities
• Transactions designed to finance the business through borrowing and owner investment
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Learning Objective 8
Assess earnings quality by comparing net income and cash flows
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Comparing Net Income toCash Flow
• Free cash flow: operating cash flows + investing cash flows during the period
• Earnings quality: the ability of current net income to help us predict the future performance of a company
• Declining free cash flow in relation to the trend in net income indicates lower-quality earnings
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End of Chapter 4
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