Download Fraud and Internal Control

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Chapter
7
Fraud, Internal
Control, and Cash
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
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Study Objectives
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1.
Define fraud and internal control.
2.
Identify the principles of internal control activities.
3.
Explain the applications of internal control principles to cash
receipts.
4.
Explain the applications of internal control principles to cash
disbursements.
5.
Describe the operation of a petty cash fund.
6.
Indicate the control features of a bank account.
7.
Prepare a bank reconciliation.
8.
Explain the reporting of cash.
Fraud, Internal Control, and Cash
Fraud and
Internal
Control
Fraud
Internal control
Principles of
internal control
activities
Limitations
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Cash Receipts
Controls
Over-thecounter
receipts
Mail receipts
Cash
Disbursement
Controls
Voucher
system
controls
Petty cash
fund controls
Control
Features: Use
of a Bank
Making
deposits
Writing checks
Bank
statements
Reconciling
the bank
account
Electronic
funds transfer
(EFT) system
Reporting
Cash
Cash
equivalents
Restricted
cash
Compensating
balances
Fraud and Internal Control
Fraud
Dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer.
Illustration 7-1
Why does
fraud occur?
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SO 1 Define fraud and internal control.
Answer on
notes page
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Fraud and Internal Control
Internal Control
Methods and measures adopted to:
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1.
Safeguard assets.
2.
Enhance accuracy and reliability of accounting records.
3.
Increase efficiency of operations, and
4.
Ensure compliance with laws and regulations.
SO 1 Define fraud and internal control.
Fraud and Internal Control
Internal Control
Internal control systems have five primary components
A control environment
Risk assessment
Control activities
Information and communication
Monitoring
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SO 1 Define fraud and internal control.
Fraud and Internal Control
Principles of Internal Control Activities
The spesific control activities, measures vary depend
on management’s assessment of the risks faced.
 Influence by size and nature of the company.
Six principles of controls activities:






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Establishment of responsibility
Segregation of duties
Documentation procedures
Physical controls
Independent internal verification
Human resource controls
SO 2 Identify the principles of internal control activities.
Fraud and Internal Control
Principles of Internal Control Activities
ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible
for a given task.
SEGREGATON OF DUTIES
Related duties, including physical custody and record keeping,
should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents and all
documents should be accounted for.
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SO 2 Identify the principles of internal control activities.
Fraud and Internal Control
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SO 2
Fraud and Internal Control
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SO 2 Identify the principles of internal control activities.
Fraud and Internal Control
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SO 2
Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
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Illustration 7-2
SO 2 Identify the principles of internal control activities.
Fraud and Internal Control
Principles of Internal Control Activities
INDEPENDENT INTERNAL
VERIFICATION
Illustration 7-3
1. Verify records periodically
or on a surprise basis.
2. Verify records by an
employee who is
independent.
3. Discrepancies reported
to management.
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SO 2 Identify the principles of internal control activities.
Fraud and Internal Control
Principles of Internal Control Activities
HUMAN RESOURCE CONTROLS
1. Bond employees.
2. Rotate employees’ duties and
require vacations.
3. Conduct background checks.
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SO 2 Identify the principles of internal control activities.
Fraud
and
Internal
Control
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SO 2
Fraud and Internal Control
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SO 2
Fraud and Internal Control
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SO 2
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Answer on
notes page
Fraud and Internal Control
Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
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SO 2 Identify the principles of internal control activities.
Cash Receipts Controls
Over-the-Counter Receipts
Illustration 7-4
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Establishment of
Responsibility
Only designated
personnel are authorized
to handle cash receipts
(cashiers)
Documentation
Procedures
Use remittance advice
(mail receipts), cash
register tapes, and
deposit slips
Independent Internal
Verification
Supervisors count cash
receipts daily; treasurer
compares total receipts
to bank deposits daily
Segregation of Duties
Different individuals
receive cash, record
cash receipts, and hold
the cash
Physical Controls
Store cash in safes
and bank vaults; limit
access to storage
areas; use cash
registers
Human Resource
Controls
Bond personnel who
handle cash; require
employees to take
vacations; deposit all
cash in bank daily
SO 3 Explain the applications of internal control principles to cash receipts.
Cash Receipts Controls
Cash consists of coins, currency, checks, money orders, and
money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets
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SO 3 Explain the applications of internal control principles to cash receipts.
Over-theCounter
Receipts
Illustration 7-5
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SO 3 Explain the applications of internal control principles to cash receipts.
Cash Receipts Controls
Mail Receipts
Mail receipts should be opened by two people, a list
prepared, and each check endorsed.
Copy of the list, along with the checks and remittance
advices, sent to cashier’s department.
Cashier adds the checks to the over-the-counter receipts,
prepares a daily cash summary and makes the daily bank
deposit.
Copy of list sent to treasurer’s office for comparison with
total shown on daily cash summary.
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SO 3 Explain the applications of internal control principles to cash receipts.
Cash Receipts Controls
Review Question
Permitting only designated personnel to handle cash
receipts is an application of the principle of:
a. segregation of duties.
b. establishment of responsibility.
c. independent check.
d. human resource controls.
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SO 3 Explain the applications of internal control principles to cash receipts.
Cash Disbursement Controls
Generally, internal control over cash disbursements is
more effective when companies pay by check, rather
than by cash.
Applications:
Voucher system
Petty cash fund
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SO 4 Explain the applications of internal control
principles to cash disbursements.
Cash Disbursement Controls
Illustration 7-6
Establishment of
Responsibility
Only designated
personnel are authorized
to sign checks
(treasurer) and approve
vendors
Segregation of Duties
Different individuals
approve and make
payments; check signers
do not record
disbursements
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Documentation
Procedures
Use prenumbered
checks; checks must
have an approved
invoice; require
employees to use
corporate credit cards for
reimbursable
expenses
Physical Controls
Store blank checks in
safes, with limited
access; print check
amounts by machine in
indelible ink
Independent Internal
Verification
Compare checks to
invoices; reconcile bank
statement monthly
Human Resource
Controls
Bond personnel
who handle cash;
require employees
to take vacations;
conduct background
checks
Cash Disbursement Controls
Review Question
The use of prenumbered checks in disbursing cash is an
application of the principle of:
a. establishment of responsibility.
b. segregation of duties.
c. physical, mechanical, and electronic controls.
d. documentation procedures.
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SO 4 Explain the applications of internal control
principles to cash disbursements.
Cash Disbursement Controls
Voucher System Controls
Voucher System
Network of approvals, by authorized individuals, to
ensure all disbursements by check are proper.
A voucher is an authorization form prepared for
each expenditure.
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SO 4 Explain the applications of internal control
principles to cash disbursements.
Cash Disbursement Controls
Petty Cash Fund Controls
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,
2. making payments from the fund, and
3. replenishing the fund.
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SO 5 Describe the operation of a petty cash fund.
Cash Disbursement Controls
Illustration: If Laird Company decides to establish a $100 fund on
March 1, the journal entry is:
Mar. 1
Petty cash
Cash
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100
100
SO 5 Describe the operation of a petty cash fund.
Cash Disbursement Controls
Illustration: Assume that on March 15 Laird’s petty cash
custodian requests a check for $87. The fund contains $13 cash
and petty cash receipts for postage $44, freight-out $38, and
miscellaneous expenses $5. The general journal entry to record the
check is: (Pengisian kembali kas)
Mar. 15
Postage expense
44
Freight-out
38
Miscellaneous expense
Cash
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5
87
SO 5 Describe the operation of a petty cash fund.
Cash Disbursement Controls
Illustration: Occasionally, the company may need to recognize a
cash shortage or overage. Assume that Laird’s petty cash
custodian has only $12 in cash in the fund plus the receipts as
listed. The request for reimbursement would, therefore, be for $88,
and Laird would make the following entry:
Mar. 15
Postage expense
44
Freight-out
38
Miscellaneous expense
5
Cash over and short
1
Cash
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88
SO 5 Describe the operation of a petty cash fund.
Control Features: Use of a Bank
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.
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SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Illustration 7-8
Making Bank Deposits
Authorized employee should
make deposit.
Front Side
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Bank Code
Numbers
Reverse Side
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Writing Checks
Written order signed by depositor directing bank to pay a
specified sum of money to a designated recipient.
Illustration 7-9
Maker
Payee
Payer
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SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Illustration 7-10
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)
Credit Memorandum
Collect notes
receivable.
Interest earned.
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SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Review Question
The control features of a bank account do not include:
a. having bank auditors verify the correctness of the bank
balance per books.
b. minimizing the amount of cash that must be kept on
hand.
c. providing a double record of all bank transactions.
d. safeguarding cash by using a bank as a depository.
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SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Reconciling the Bank Account
Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Errors.
4. Bank memoranda.
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SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Reconciliation Procedures
Illustration 7-11
+ Deposit in Transit
+ Notes collected by bank
-
-
NSF (bounced) checks
-
Check printing or other
service charges
Outstanding Checks
+- Bank Errors
+- Company Errors
CORRECT BALANCE
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CORRECT BALANCE
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Illustration: The bank statement for Laird Company (Illustration 7-12),
shows a balance per bank of $15,907.45 on April 30, 2011. On this
date the balance of cash per books is $11,589.45. Using the four
reconciliation steps, Laird determines the following reconciling items.
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Control Features: Use of a Bank
Illustration: a) Prepare a bank reconciliation at April 30.
Cash balance per bank statement
Add:
$15,907.45
Deposit in transit
2,201.40
Less:
Outstanding checks
Adjusted cash balance per bank
(5,904.00)
$12,204.85
Cash balance per books
$11,589.45
Add:
Error in recording check no. 443
Collection of notes + interest - fee
Less:
NSF check
Bank service charge
Adjusted cash balance per books
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Illustration 7-12
36.00
1,035.00
(425.60)
(30.00)
$12,204.85
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
The company records each reconciling item used to determine the
adjusted cash balance per books.
Collection of Note Receivable: Assuming interest of $50 has
not been accrued and collection fee is charged to Miscellaneous
Expense, the entry is:
Apr. 30
Cash
Miscellaneous expense
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1,035.00
15.00
Notes receivable
1,000.00
Interest revenue
50.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Book Error: The cash disbursements journal shows that check
no. 443 was a payment on account to Andrea Company, a
supplier. The correcting entry is:
Apr. 30
Cash
Accounts payable
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36.00
36.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
NSF Check: As indicated earlier, an NSF check becomes an
account receivable to the depositor. The entry is:
Apr. 30
Accounts receivable
425.60
Cash
425.60
Bank Service Charges: Depositors debit check printing
charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:
Apr. 30
Miscellaneous expense
Cash
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30.00
30.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Review Question
The reconciling item in a bank reconciliation that will
result in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
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SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Electronic Funds Transfers (EFT) System
Disbursement systems that uses wire, telephone,
or computers to transfer cash balances between
locations.
EFT transfers normally result in better internal
control since no cash or checks are handled by
company employees.
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SO 7 Prepare a bank reconciliation.
Reporting Cash
Cash consists of coins, currency (paper money), checks,
money orders, and money on hand or on deposit in a bank
or similar depository.
Illustration 7-14
Cash equivalents
Restricted cash
Compensating balances
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SO 8 Explain the reporting of cash.
While cash equivalents are now frequently
reported with cash, it appears likely that
the IASB will end this practice in the future.
Instead, items now referred to as cash
equivalents will be reported as short-term
investments.
Reporting Cash
Review Question
Which of the following statements correctly describes
the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with Cash.
c. Cash is listed first in the current assets section.
d. Restricted cash funds cannot be reported as a
current asset.
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SO 8 Explain the reporting of cash.
Understanding U.S. GAAP
Key Differences
Fraud, Internal Control,
and Cash
The fraud triangle discussed in this chapter is applicable to U.S.
companies as well. Some of the most infamous U.S. fraud scandals
are Enron, Worldcom, and, more recently, the Bernie Madoff ponzi
scheme.
After numerous corporate scandals, the U.S. Congress passed the
Sarbanes-Oxley Act of 2002 (SOX). Under SOX, all publicly traded
U.S. corporations are required to maintain an adequate system of
internal control.
As a result of SOX, corporate executives and boards of directors
must ensure that internal controls are reliable and effective. In
addition, independent outside auditors must attest to the adequacy
of the internal control system.
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Understanding U.S. GAAP
Key Differences
Fraud, Internal Control,
and Cash
SOX created the Public Company Oversight Board (PCAOB), to
establish auditing standards and regulate auditor activity.
One study estimates the cost of compliance for U.S. companies at
over $35 billion, with audit fees doubling in the first year of
compliance. At the same time, examination of internal controls
indicates lingering problems in the way companies operate. One
study of first compliance with the internal-control testing
provisions documented material weaknesses for about 13% of
companies reporting in 2004 and 2005 (PricewaterhouseCoopers’
Global Economic Crime Survey, 2005).
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Understanding U.S. GAAP
Key Differences
Fraud, Internal Control,
and Cash
The enhanced internal control standards apply only to large public
companies listed on U.S. exchanges. There is continuing debate
over whether foreign issuers should have to comply with this extra
layer of regulation.
Most companies report cash and cash equivalents together under
IFRS and GAAP, as shown in this textbook. In addition, GAAP
follows the same accounting policies related to the reporting of
restricted cash.
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Understanding U.S. GAAP
Looking to the Future
Fraud, Internal Control,
and Cash
High-quality international accounting requires both high-quality
accounting standards and high-quality auditing. Similar to the
convergence of GAAP and IFRS, there is a movement to improve
both U.S. and international auditing standards.The International
Auditing and Assurance Standards Board (IAASB) functions as an
independent standard-setting body. It works to establish highquality auditing and assurance and quality-control standards
throughout the world. Whether the IAASB adopts internal control
provisions similar to those in SOX remains to be seen. Also, under
proposed new standards being developed jointly by the FASB and
IASB for financial statement presentation, cash equivalents cannot
be combined with cash.
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Copyright
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