Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 7 Sarbanes-Oxley, Internal Control, and Cash 329

SUMMARY OF LEARNING GOALS

In preparing the statement of cash flows, generally accepted ac-
counting principles require a company to reconcile net income
with cash flows from operating activities. This reconciliation for
The Walt Disney Companyis shown below for the year
ended September 30, 2004.

Year Ended

September 30, 2004

(in thousands)

Net income $2,345,000
Operating activities, cash flows
provided by or used in:
Depreciation 1,210,000
Adjustments to net income 866,000
Changes in accounts receivable (115,000)
Changes in liabilities 237,000
Changes in inventories (84,000)
Changes in other operating
activities (89,000)
Total cash flow from operating
activities $4,370,000

The preceding reconciliation begins by adding back depre-

ciation of $1,210,000. This is because depreciation is deducted

as an expense in arriving at net income, but it does not impact

cash. That is, no cash related to yearly depreciation is paid.

The other reconciling items involve increases or decreases

in other financial statement accounts. The logic behind includ-

ing these reconciling items involves the accounting equation.

Specifically, the accounting equation must always balance.

AssetsLiabilitiesStockholders’ Equity

Therefore, changes in the cash account can be determined by

analyzing changes in the other accounts:

Changes in Liabilities 

Changes in CashChanges in Stockholders’Equity

Changes in Noncash Assets

As shown in the illustration for The Walt Disney Company,

some changes in the noncash accounts affect the reporting of

cash flows from operating activities. Changes in noncash ac-

counts also affect the reporting of cash flows from financing

and investing activities.

Reconciling Net Income and Cash Flows from Operating Activities

FOCUS ON CASH FLOW

Describe the Sarbanes-Oxley Act of 2002 and its im-
pact on internal controls and financial reporting.The
purpose of the Sarbanes-Oxley Act of 2002 is to restore
public confidence and trust in the financial statements of
companies. Sarbanes-Oxley requires companies to maintain
strong and effective internal controls over the recording
of transactions and the preparing of financial statements.
Sarbanes-Oxley also requires companies and their
independent accountants to report on the effectiveness
of a company’s internal controls.

Describe and illustrate the objectives and elements
of internal control.The objectives of internal control
are to provide reasonable assurance that (1) assets are
safeguarded and used for business purposes, (2) business
information is accurate, and (3) laws and regulations are
complied with. The elements of internal control are the
control environment, risk assessment, control procedures,
monitoring, and information and communication.

Describe and illustrate the application of internal
controls to cash.One of the most important controls to
protect cash received in over-the-counter sales is a cash reg-
ister. A remittance advice is a control for cash received

through the mail. Separating the duties of handling cash

and recording cash is also a control. A voucher system is a

control system for cash payments that uses a set of proce-

dures for authorizing and recording liabilities and cash pay-

ments. Many companies use electronic funds transfers to

enhance their control over cash receipts and cash payments.

Describe the nature of a bank account and its use in

controlling cash.Businesses use bank accounts as a

means of controlling cash. Bank accounts reduce the amount

of cash on hand and facilitate the transfer of cash between

businesses and locations. In addition, banks send monthly

statements to their customers, summarizing all of the trans-

actions for the month. The bank statement allows a business

to reconcile the cash transactions recorded in the accounting

records to those recorded by the bank.

Describe and illustrate the use of a bank reconcilia-

tion in controlling cash.The first section of the bank

reconciliation begins with the cash balance according to the

bank statement. This balance is adjusted for the company’s

changes in cash that do not appear on the bank statement

and for any bank errors. The second section begins with the

cash balance according to the company’s records. This

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