B EC 226 Chapter 8

Internal control system

Policies and procedures used to monitor and control business activities to protect assets, ensure reliable accounting, uphold company policies, and promote efficient operations.

Sarbanes-Oxley Act (SOX) internal control mandates

Federal requirements for public company managers and auditors to document and certify internal controls, with PCAOB oversight and penalties up to 25 years in prison for violations.

Five components of the COSO internal control framework

1. Control environment, 2. Risk assessment, 3. Control activities, 4. Information and communication, 5. Monitoring.

Seven common principles of internal control

1. Establish responsibilities, 2. Maintain adequate records, 3. Insure assets and bond key employees, 4. Separate recordkeeping from custody of assets, 5. Divide responsibility for related transactions, 6. Apply technological controls, 7. Perform regular and independent reviews.

Bonding key employees

Purchasing an insurance policy against theft or fraud committed by designated personnel.

Three elements of the Fraud Triangle

Opportunity, pressure, and rationalization.

Cost-benefit constraint on internal controls

The principle that the costs of establishing and maintaining internal controls must not exceed the expected benefits derived from them.

Cash vs. Cash Equivalents

Cash comprises currency, coins, and bank deposits readily accessible for transactions. Cash Equivalents are short-term, highly liquid investments convertible to known amounts of cash with maturities close enough to present negligible risk of price changes.

Journal entry for cash overage (register: $\$550$, counted: $\$555$)

Debit Cash for $\$555$, credit Cash Over and Short for $\$5$, and credit Sales for $\$550$.

Journal entry for cash shortage (register: $\$625$, counted: $\$621$)

Debit Cash for $\$621$, debit Cash Over and Short for $\$4$, and credit Sales for $\$625$.

Two primary keys to controlling cash disbursements

1. Require all payments to be made by check or Electronic Funds Transfer (EFT). 2. Limit access to accounting records strictly to individuals authorized to sign checks.

Journal entry to establish a petty cash fund of $\$75$

Debit Petty Cash for $\$75$ and credit Cash for $\$75$.

Reimbursing a petty cash fund

Debit individual expense accounts for receipts submitted and credit Cash for the amount needed to restore the petty cash balance.

Adjusting the established petty cash fund balance

To increase the fund: debit Petty Cash and credit Cash. To decrease the fund: debit Cash and credit Petty Cash.

Bank reconciliation adjustments to the bank balance

Add deposits in transit and bank error additions; deduct outstanding checks and bank error deductions.

Bank reconciliation adjustments to the book balance

Add interest earned, unrecorded cash receipts, and notes collected by the bank; deduct bank service charges, NSF checks, and check printing fees.

Section of bank reconciliation requiring adjusting journal entries

The book balance section only, as bank adjustments reflect timing differences or errors that the bank resolves.

Journal entry to record an NSF check of $\$30$

Debit Accounts Receivable for $\$30$ and credit Cash for $\$30$.

Journal entry for a note collected by the bank for $\$485$

Debit Cash for $\$485$ and credit Notes Receivable for $\$485$.

Days' Sales Uncollected ratio

Formula: $\left(\frac{\text{Accounts Receivable}}{\text{Net Sales}}\right) \times 365$. Evaluates liquidity by calculating how many days it typically takes to convert credit sales into cash receipts.

Voucher system

A set of formal procedures for verifying, approving, and recording liabilities prior to cash disbursement, and issuing checks to settle approved obligations.

Blockchain as an internal control

Maintains a continuously synchronized, distributed ledger that prevents unauthorized alterations without leaving an indelible audit trail.