SOX and Internal Controls
The Sarbanes-Oxley Act of 2002, referred to simply as Sarbanes-Oxley or SOX, was established due to the public outcry from stockholders, investors and others who lost jobs and money due to the financial scandals of the early 2000's that included Enron, WorldCom and Tyco International. It is named after the act's sponsors Senator Paul Sarbanes (Democrat from Maryland) and Michael Oxley (Republican from Ohio). It is also known as the Public Company Accounting Reform and Investor Protection Act of 2002.
Although SOX is only applicable to publicly held companies (companies whose stock is traded on public exchanges), it highlights the need to assess financial controls and reporting of all companies. SOX emphasizes the importance of effective internal controls. internal controls are the procedures and processes used by a company as safeguards to assets, used to process information accurately, and used to ensure compliance with laws and regulations.
SOX requires companies to maintain strong and effective internal controls over the recording of transactions, as well as the preparing of the financial statements. It requires companies, and their independent accountants, to report on the effectiveness of the internal controls. These reports are then filed with the Securities and Exchange Commission, or SEC.
Internal controls help safeguard the company and it's assets against theft, fraud, misuse, or misplacement. Accurate information is necessary for operating a business successfully. Management is responsible for the design and implementation of the five elements of internal control. These elements are the control environment, risk assessment, control procedures, monitoring, and information and communications.
Cash includes coins, currency, checks, money orders and money on deposit that is available for unrestricted withdrawal from banks and other financial institutions. Because of the ease that money can be transfered, cash is the asset most likely to be used improperly by employees. Businesses must, therefore, design and use controls that safeguard cash.
To protect cash, a business must control cash flows from the time it is received until it is deposited in a bank. Normally, a business receives cash from two main sources. These are customers purchasing products or services, and customers making payments on account.
When a register is used for collecting cash, such as with over-the-counter sales, the clerk (or cashier) enters the amount of the sale, and the register displays the amount. This is a control to ensure that the clerk has charged the correct amount. At the start of a work shift, the clerk is given a cash drawer that contains a specific predetermined amount. At the end of the shift, the clerk and the supervisor will count the cash in that clerk's drawer. The amount at the end of the shift should equal the beginning amount plus the cash sales for the day. Errors in recording cash sales or errors in making change can cause the amount of cash on hand to differ from this amount. These differences are noted in the cash short and over account. At the end of the accounting period, a debit balance in this account is included in the Miscellaneous Expense section of the Income Statement. A credit balance is included in the Other Income section of the balance sheet.
Bank Accounts and Bank Statements
At the end of each accounting period, a business must reconcile its accounts. It does this by comparing what the General Ledger states it has against what the bank states it has. This is done by comparing the bank statement to the General Ledger.
It's important to note that transactions do not always happen in the same period for both the bank and the GL. For example, a business period ends on June 30. The final deposit is entered for the period on June 30 in the business' GL. However, because the deposit did not arrive until later in the day, the bank may not record it as received until July 1. In addition, checks that have been written may not have cleared the bank yet: that is, the person who received the check may not have received it yet, may not have cashed it yet, or may have cashed it, but their bank has not sent the transaction to the business' bank yet. Such deposits that are appearing on the GL but not the bank statement are referred to as Deposits in Transit.
Deposits in Transit have to be factored in to the Bank Reconciliation in order to balance the accounts. However, there may also be items on the bank statement that have not been recorded in the General Ledger, which must also be factored in to the Bank Reconciliation. These include items such as interest, fees, notes receivables and NSF checks. Also, there may be errors either on the side of the bank, or the business, in recording transactions. Recording these adjustments is also important in balancing the Bank Reconciliation.
The best way to think of a bank reconciliation is as balancing your check book. Basically, the business is looking at what's on the bank statement and comparing it to what is on the cash account for the ledger. The bank reconciliation is an analysis of the items and amounts that cause the cash balance reported in the cash account on the ledger to differ from the cash balance reported on the bank statement. The bank reconciliation has two sections. The first is referred to as the bank section. This begins with the cash balance according to the bank statement and eds with the adjusted balance. The second section is the company section. This begins with the cash balance according to the company's records and ends with the adjusted balance. The two adjusted balances must be equal at the end of the reconciliation.
The reconciliation for each part looks as this:
Let's look at an example.
A company ends the accounting period on June 30. The company then receives a bank statement (or retrieves their balance and transaction information on-line). The cash account for the company is compared to the bank statement. The following are the account balances, and differences found between the ledger and bank statement:
- Company GL shows a balance of $88,372.
- A deposit from June 30 in the amount of $472 is not on the bank statement.
- Check number 843 in the amount of $15,857 is not on the bank statement.
- Check number 857 in the amount of $2,597 is not on the bank statement.
- EFT payment made, payment number 9873, in the amount of $9440 is not on the bank statement.
- Bank statement shows a balance of $95,372.
- The bank statement showed that a Note Receivable of $893 was collected, along with a fee of $35, both of which had not yet been recorded on the ledger.
- The bank statement showed that the account received interest of $487 that had not yet been recorded on the ledger.
- Check number 850, a payment to Calbreath Corp, was originally recorded in the journal as $745.48. The bank shows it as $754.48. In review, the bank was correct.
- A check received for payment in the amount of $15,472 from customer John Smith was returned as not sufficient funds.
- A second check received for payment in the amount of $6,306 from customer Zach Ivey was also returned as not sufficient funds.
- The bank charged us a miscellaneous bank fee of $50 that had not yet been recorded on the ledger.
The bank reconciliation would then look as follows:
Why are certain items placed in the bank section, and others in the company section? All of the adjustments could be made in one section, the bank section for example, and the final result should then equal the company section. So why split these up? The adjustments in the bank section are showing items that are part of the ledger that have not been recorded by the bank yet. The adjustments in the company section, however, are for the items on the bank statement that have not been recorded in the ledger yet. In other words, by separating them out, we are able to see what items we still need to make entries into the ledger to reflect, and give an accurate view of cash in the ledger. So now that we've identified these items, we have to actually make the entries.
With our example above, we have had a debit (increase) to cash due to the collection of an NSF, the fee associated with it, and the revenue from interest. The journal entry to reflect these would be:
| ||Notes Receivable|| ||928|
| ||Interest Revenue|| ||487|
With our example above, we also have a credit (decrease) to cash due to two NSFs, a bank service fee, and because we recorded an entry in error. When we recorded check number 850, we transposed to of the numbers. By doing so, we did not reduce the amounts of our Accounts Payable with Calbreath Corp, and did not reduce Cash by enough. Both accounts currently are overstated by $9. That will be corrected when we do the following journal entry to record all of these items from the bank statement:
|Accounts Receivable John Smith||15472|| |
|Accounts Receivable Zach Ivey||6306|| |
|Miscellaneous Expense||50|| |
|Accounts Payable Calbreath Corp||9|| |
| ||Cash|| ||21837|
If you take what the company initially stated the cash balance was ($88,372), add in the debit ($1,415) and subtract the credit ($21,837) from the adjustments, you get a final total of $67,950. This amount matches the adjusted balances from the Bank Reconciliation. This gives you the actual amount of net cash that the company has available.
Cash is the most liquid asset for a company, and therefore, is listed as the first asset on the balance sheet under Current Assets. A company may have cash in excess of normal operating needs. The company may invest this amount in order to earn interest. Some of these investments are long term, and others are short term. If the investment is expected to be converted into cash within 90 days, then it is referred to as a cash equivalent. These are items that, although they are investments, it makes more sense to record them along with cash due to the liquidity of their nature within 90 days. Examples of these types of investments are money market funds, treasury bills, and notes issued by major companies. Usually the cash equivalents are reported along with cash as one line on a balance sheet called Cash and Cash Equivalents.