Appendix I - The Sarbanes-Oxley Act, Internal Controls, and Management Accounting
APPENDIX I
The Sarbanes-Oxley Act, Internal Controls, and
Management Accounting
ANSWERS TO REVIEW QUESTIONS
I-1 The Sarbanes-Oxley Act of 2002 was enacted by the U.S. Congress to bring about
reform in companies’ financial reporting processes, as well as the internal and
external auditing of the financial reporting process.
I-2 Internal controls over financial reporting refers to the broad set of policies,
processes, and procedures that enable both the organization’s management and
interested outside parties to have confidence in the organization’s financial reports.
Internal controls over financial reporting include a range of activities as diverse as
approvals, authorizations, verifications, reconciliations, reviews of operating
performance, security of assets, and separation of duties.
I-3 The Public Company Accounting Oversight Board (PCAOB) is an agency established
by the Sarbanes-Oxley Act to oversee and investigate the audits and auditors of
public companies, and sanction both firms and individuals for violations of laws,
rules, and regulations.
I-4 SOX 302 is a section of the Sarbanes-Oxley Act, which requires the signing officers
of a company’s financial reports to establish, maintain, and periodically evaluate the
effectiveness of the company’s internal controls over financial reporting.
I-5 SOX 404 is a section of the Sarbanes-Oxley Act, which requires a company to
include in its annual report a report on the company’s internal controls over financial
reporting.
I-6 SOX sections 302 and 404 are controversial because they place a great burden on
businesses to document and report on their internal controls over financial
reporting. This burden is particularly costly for small businesses, which often do not
have the resources to fully comply with SOX 302 and 404. Some in Congress have
called for the repeal of SOX or its modification. Other lawmakers have urged that its
requirements be waived for small businesses. Many, however, defend SOX as a
necessary reform in the wake of various scandals in accounting and corporate
governance.
App I-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
,Appendix I - The Sarbanes-Oxley Act, Internal Controls, and Management Accounting
SOLUTIONS TO EXERCISES
EXERCISE I-7 (15 MINUTES)
Answers will vary depending on each students work experience and the college the student
attends. As for internal controls in a typical college, in many respects they are the same as
those in a business. Among such internal controls would be the following: safeguarding
assets, requiring two signers on checks, and controlling who has access to the college’s
computer software systems and data.
EXERCISE I-8 (15 to 30 MINUTES)
Students typically have varying opinions about the extent to which a CEO can really know
what is going on at all levels in the organization the CEO leads.
EXERCISE I-9 (30 MINUTES)
Many relatively short SOX articles can be found on the Internet. Since the story is evolving,
the content of these stories will vary over time.
EXERCISE I-10 (30 to 45 MINUTES)
Students’ opinions about SOX will vary widely. An in-class debate can be an interesting
exercise.
EXERCISE I-11 (15 MINUTES)
Some observers have suggested that it is unrealistic to expect a company to regularly
report on the minutia of its internal controls over financial reporting. It’s just too costly and
burdensome to do so. If, instead, a company concentrates on those internal control areas
where lapses in internal control have the greatest potential to result in material
misstatement of the company’s financial reports, then the goals of SOX could perhaps be
achieved at a much more tolerable level of cost and effort.
EXERCISE I-12 (15 MINUTES)
The company’s internal control system is flawed. The same employee is responsible for
keeping the inventory records and taking the physical inventory count. In addition, when
the records and the count do not agree, the employee changes the count, rather than
investigating the reasons for the discrepancy. This leaves open the possibility that the
employee would steal inventory and conceal the theft by altering both the records and
the count. Even without any dishonesty by the employee, this system is not designed to
control inventory since it does not encourage resolution of discrepancies between the
App I-2
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
,Appendix I - The Sarbanes-Oxley Act, Internal Controls, and Management Accounting
EXERCISE I-12 (CONTINUED)
records and the count.
SOX sections 302 and 404 require the company’s management to establish, maintain,
and regularly report on the firm’s internal controls. In the process, any flawed internal
control procedures would presumably be identified and strengthened. The internal
control system could be strengthened in two ways: (a) Assign two different employees
the responsibilities for the inventory records and the physical count. With this
arrangement, collusion would be required for theft to be concealed. (b) Require that
discrepancies between the inventory records and the physical count be investigated and
resolved when possible.
EXERCISE I-13 (20 MINUTES)
The accounting adjustments contemplated by John Winslow are unethical because they will
result in intentionally overstating income by understating the cost of goods sold.
SOX sections 302 and 404 require the company’s management to establish, maintain, and
regularly report on the firm’s internal controls over financial reporting. Proper internal
control procedures would be likely to identify such an inappropriate accounting treatment,
thereby allowing corrective action to be taken.
App I-3
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
, Appendix II - Compound Interest and the Concept of Present Value
APPENDIX II
Compound Interest and the Concept of Present
Value
ANSWERS TO REVIEW QUESTIONS
II-1 Compound interest is interest earned not only on the principal invested but also on
the interest earned in previous periods.
II-2 This formula says that the future value, Fn, is equal to the present value, P, multiplied
by an accumulation factor equal to (1 + r)n. The accumulation factor is included in the
formula to reflect compound interest. (In the formula, r denotes the interest rate per
year, and n denotes the number of years.)
II-3 The present value is the economic value now of a cash flow that will occur in the
future.
II-4 This statement is false. As the discount rate increases, the present value of a future
cash flow decreases. A higher discount rate means a higher return on funds that are
invested now. If funds invested now can earn a greater return, it is even more
important to have the funds now, instead of in the future, than it is if the rate of
return is lower. Also, you do not need to invest as much now to have a certain
amount in the future if you have a higher return. Therefore, the greater the discount
rate, or rate of return on invested funds, the lower will be the present value of any
future cash flow.
II-5 These two cash flows are economically equivalent in the sense that a $100 cash flow
now will be equal to a $161.10 cash flow at the end of five years. If the $100 received
now is invested for five years at 10%, it will accumulate to $161.10 at the end of five
years.
II-6 An annuity is a series of equally spaced, identical cash flows. For example, a five-
year, $100 annuity is a series of $100 cash flows occurring at the end of each year for
five years.
App II-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
APPENDIX I
The Sarbanes-Oxley Act, Internal Controls, and
Management Accounting
ANSWERS TO REVIEW QUESTIONS
I-1 The Sarbanes-Oxley Act of 2002 was enacted by the U.S. Congress to bring about
reform in companies’ financial reporting processes, as well as the internal and
external auditing of the financial reporting process.
I-2 Internal controls over financial reporting refers to the broad set of policies,
processes, and procedures that enable both the organization’s management and
interested outside parties to have confidence in the organization’s financial reports.
Internal controls over financial reporting include a range of activities as diverse as
approvals, authorizations, verifications, reconciliations, reviews of operating
performance, security of assets, and separation of duties.
I-3 The Public Company Accounting Oversight Board (PCAOB) is an agency established
by the Sarbanes-Oxley Act to oversee and investigate the audits and auditors of
public companies, and sanction both firms and individuals for violations of laws,
rules, and regulations.
I-4 SOX 302 is a section of the Sarbanes-Oxley Act, which requires the signing officers
of a company’s financial reports to establish, maintain, and periodically evaluate the
effectiveness of the company’s internal controls over financial reporting.
I-5 SOX 404 is a section of the Sarbanes-Oxley Act, which requires a company to
include in its annual report a report on the company’s internal controls over financial
reporting.
I-6 SOX sections 302 and 404 are controversial because they place a great burden on
businesses to document and report on their internal controls over financial
reporting. This burden is particularly costly for small businesses, which often do not
have the resources to fully comply with SOX 302 and 404. Some in Congress have
called for the repeal of SOX or its modification. Other lawmakers have urged that its
requirements be waived for small businesses. Many, however, defend SOX as a
necessary reform in the wake of various scandals in accounting and corporate
governance.
App I-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
,Appendix I - The Sarbanes-Oxley Act, Internal Controls, and Management Accounting
SOLUTIONS TO EXERCISES
EXERCISE I-7 (15 MINUTES)
Answers will vary depending on each students work experience and the college the student
attends. As for internal controls in a typical college, in many respects they are the same as
those in a business. Among such internal controls would be the following: safeguarding
assets, requiring two signers on checks, and controlling who has access to the college’s
computer software systems and data.
EXERCISE I-8 (15 to 30 MINUTES)
Students typically have varying opinions about the extent to which a CEO can really know
what is going on at all levels in the organization the CEO leads.
EXERCISE I-9 (30 MINUTES)
Many relatively short SOX articles can be found on the Internet. Since the story is evolving,
the content of these stories will vary over time.
EXERCISE I-10 (30 to 45 MINUTES)
Students’ opinions about SOX will vary widely. An in-class debate can be an interesting
exercise.
EXERCISE I-11 (15 MINUTES)
Some observers have suggested that it is unrealistic to expect a company to regularly
report on the minutia of its internal controls over financial reporting. It’s just too costly and
burdensome to do so. If, instead, a company concentrates on those internal control areas
where lapses in internal control have the greatest potential to result in material
misstatement of the company’s financial reports, then the goals of SOX could perhaps be
achieved at a much more tolerable level of cost and effort.
EXERCISE I-12 (15 MINUTES)
The company’s internal control system is flawed. The same employee is responsible for
keeping the inventory records and taking the physical inventory count. In addition, when
the records and the count do not agree, the employee changes the count, rather than
investigating the reasons for the discrepancy. This leaves open the possibility that the
employee would steal inventory and conceal the theft by altering both the records and
the count. Even without any dishonesty by the employee, this system is not designed to
control inventory since it does not encourage resolution of discrepancies between the
App I-2
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
,Appendix I - The Sarbanes-Oxley Act, Internal Controls, and Management Accounting
EXERCISE I-12 (CONTINUED)
records and the count.
SOX sections 302 and 404 require the company’s management to establish, maintain,
and regularly report on the firm’s internal controls. In the process, any flawed internal
control procedures would presumably be identified and strengthened. The internal
control system could be strengthened in two ways: (a) Assign two different employees
the responsibilities for the inventory records and the physical count. With this
arrangement, collusion would be required for theft to be concealed. (b) Require that
discrepancies between the inventory records and the physical count be investigated and
resolved when possible.
EXERCISE I-13 (20 MINUTES)
The accounting adjustments contemplated by John Winslow are unethical because they will
result in intentionally overstating income by understating the cost of goods sold.
SOX sections 302 and 404 require the company’s management to establish, maintain, and
regularly report on the firm’s internal controls over financial reporting. Proper internal
control procedures would be likely to identify such an inappropriate accounting treatment,
thereby allowing corrective action to be taken.
App I-3
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
, Appendix II - Compound Interest and the Concept of Present Value
APPENDIX II
Compound Interest and the Concept of Present
Value
ANSWERS TO REVIEW QUESTIONS
II-1 Compound interest is interest earned not only on the principal invested but also on
the interest earned in previous periods.
II-2 This formula says that the future value, Fn, is equal to the present value, P, multiplied
by an accumulation factor equal to (1 + r)n. The accumulation factor is included in the
formula to reflect compound interest. (In the formula, r denotes the interest rate per
year, and n denotes the number of years.)
II-3 The present value is the economic value now of a cash flow that will occur in the
future.
II-4 This statement is false. As the discount rate increases, the present value of a future
cash flow decreases. A higher discount rate means a higher return on funds that are
invested now. If funds invested now can earn a greater return, it is even more
important to have the funds now, instead of in the future, than it is if the rate of
return is lower. Also, you do not need to invest as much now to have a certain
amount in the future if you have a higher return. Therefore, the greater the discount
rate, or rate of return on invested funds, the lower will be the present value of any
future cash flow.
II-5 These two cash flows are economically equivalent in the sense that a $100 cash flow
now will be equal to a $161.10 cash flow at the end of five years. If the $100 received
now is invested for five years at 10%, it will accumulate to $161.10 at the end of five
years.
II-6 An annuity is a series of equally spaced, identical cash flows. For example, a five-
year, $100 annuity is a series of $100 cash flows occurring at the end of each year for
five years.
App II-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
