Download Fraud and Internal Control

Chapter
8-1
Chapter
8
Fraud, Internal
Control, and Cash
Chapter
8-2
Accounting Principles, Ninth Edition
Study Objectives
1.
Define fraud and internal control.
2. Identify the principles of internal control.
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.
Chapter
8-3
Fraud, Internal Control, and Cash
Fraud and
Internal Control
Fraud
The SarbanesOxley Act
Internal control
Principles of
internal control
Limitations
Chapter
8-4
Cash Controls
Control
Features: Use of
a Bank
Reporting Cash
Cash receipts
controls
Making deposits
Cash equivalents
Writing checks
Restricted cash
Cash
disbursements
controls
Bank statements
Compensating
balances
Reconciling the
bank account
Electronic funds
transfer (EFT)
system
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 8-1
Why does
fraud occur?
Chapter
8-5
SO 1 Define fraud and internal control.
Chapter
8-6
Fraud and Internal Control
The Sarbanes-Oxley Act
Companies must
develop principles of control over financial
reporting.
continually verify that controls are working.
Independent auditors must attest to the adequacy
of internal control.
SOX created the Public Company Accounting
Oversight Board (PCAOB).
Chapter
8-7
SO 1 Define fraud and internal control.
Fraud and Internal Control
Internal Control
Methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records.
3. Increase efficiency of operations, and
4. Ensure compliance with laws and regulations.
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations
are required to maintain an adequate system of internal control.
Chapter
8-8
SO 1 Define fraud and internal control.
Fraud and Internal Control
Internal Control
Internal control systems have five primary components
1. A control environment
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring
Chapter
8-9
SO 1 Define fraud and internal control.
Fraud and Internal Control
Principles of Internal Control Activities
Measures vary with
management’s assessment of the risks faced.
size and nature of the company.
Six principles of controls activities:
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



Chapter
8-10
Establishment of responsibility
Segregation of duties
Documentation procedures
Physical controls
Independent internal verification
Human resource controls
SO 2 Identify the principles of internal control.
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 for all
documents should be accounted for.
Chapter
8-11
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
Chapter
8-12
Illustration 8-2
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
INDEPENDENT INTERNAL
VERIFICATION
Illustration 8-3
1. Verify records
periodically or on a
surprise basis.
2. Records verified by an
employee who is
independent.
3. Discrepancies reported
to management.
Chapter
8-13
SO 2 Identify the principles of internal control.
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.
Chapter
8-14
SO 2 Identify the principles of internal control.
Chapter
8-15
Fraud and Internal Control
Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
Chapter
8-16
SO 2 Identify the principles of internal control.
Cash Controls
Cash Receipts Controls
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,
Mechanical, and
Electronic Controls
Human Resource
Controls
Illustration 8-4
Chapter
8-17
Store cash in safes
and bank vaults; limit
access to storage
areas; use cash
registers
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 Controls
Discussion Question
Q8-6. At the corner grocery store, all sales clerks
make change out of one cash register drawer. Is this
a violation of internal control? Why?
See notes page for discussion
Chapter
8-18
SO 3 Explain the applications of internal control principles to cash receipts.
Cash Controls
Discussion Question
Q8-11. The management of Sewell Company asks
you, as the company accountant, to explain (a) the
concept of reasonable assurance in internal control
and (b) the importance of the human factor in
internal control.
See notes page for discussion
Chapter
8-19
SO 3 Explain the applications of internal control principles to cash receipts.
Cash 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
Chapter
8-20
SO 3 Explain the applications of internal control principles to cash receipts.
Over-theCounter
Receipts
Illustration 8-4
Chapter
8-21
SO 3 Explain the applications of internal control principles to cash receipts.
Mail Receipts
Control Procedures:
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 and 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.
Chapter
8-22
SO 3 Explain the applications of internal control principles to cash receipts.
Cash 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.
Chapter
8-23
SO 3 Explain the applications of internal control principles to cash receipts.
Cash Controls
Cash Disbursements 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
Chapter
8-24
SO 4 Explain the applications of internal
control principles to cash disbursements.
Cash Controls
Cash Disbursements Controls
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
Chapter
8-25
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
Illustration 8-6
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 Controls
Discussion Question
Q8-17 Joe Griswold Company’s internal controls over
cash disbursements provide for the treasurer to sign
checks imprinted by a checkwriting machine in indelible
ink after comparing the check with the approved invoice.
Identify the internal control principles that are present
in these controls.
See notes page for discussion
Chapter
8-26
SO 4 Explain the applications of internal
control principles to cash disbursements.
Cash 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.
Chapter
8-27
SO 4 Explain the applications of internal
control principles to cash disbursements.
Cash Controls
Cash Disbursements 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.
Chapter
8-28
SO 4 Explain the applications of internal
control principles to cash disbursements.
Cash Controls
Cash Disbursements 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.
Chapter
8-29
SO 5 Describe the operation of a petty cash fund.
Cash Controls
E8-8 Lincolnville Company uses an imprest petty cash system. The
fund was established on March 1 with a balance of $100. During
March the following petty cash receipts were found in the petty cash
box.
March 5
Stamp inventory
March 7
Freight-out
March 9
Miscellaneous expense
March 11
Travel expense
March 14
Miscellaneous expense
$39
21
6
24
5
The fund was replenished on March 15 when the fund contained $3 in
cash. On March 20, the amount in the fund was increased to $150.
Instructions: Journalize the entries in March that pertain to the
operation of the petty cash fund.
Chapter
8-30
SO 5 Describe the operation of a petty cash fund.
Cash Controls
E8-8 The fund was established on March 1 with a
balance of $100.
March 1
Chapter
8-31
Petty cash
Cash
100
100
SO 5 Describe the operation of a petty cash fund.
Cash Controls
E8-8 The fund was replenished on March 15 when the
fund contained $3 in cash.
March 15
Postage expense
Freight-out
39
21
Miscellaneous expense
Travel expense
Cash over and short
11
24
2
Cash
Chapter
8-32
97
SO 5 Describe the operation of a petty cash fund.
Cash Controls
E8-8 On March 20, the amount in the fund was
increased to $150.
March 20
Chapter
8-33
Petty cash
Cash
50
50
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.
Chapter
8-34
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Making Bank Deposits
Authorized employee
should make deposit.
Front Side
Chapter
8-35
Illustration 8-8
Bank Code
Numbers
Reverse Side
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Writing Checks
Illustration 8-9
Written order signed by depositor directing bank to pay
a specified sum of money to a designated recipient.
Maker
Payee
Payer
Chapter
8-36
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Bank Statements
Illustration 8-10
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)
Credit Memorandum
Collect notes
receivable.
Interest earned.
Chapter
8-37
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.
Chapter
8-38
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.
Chapter
8-39
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Reconciliation Procedures
Illustration 8-11
+ Deposit in Transit
+ Notes collected by bank
-
-
NSF (bounced) checks
-
Check printing or other
service charges
Outstanding Checks
+- Bank Errors
+- Company Errors
CORRECT BALANCE
Chapter
8-40
CORRECT BALANCE
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
E8-11 The following information pertains to Family Video Company.
1.
Cash balance per bank, July 31, $7,263.
2.
Cash balance per books, July 31, $7,284.
3.
July bank service charge not recorded by the depositor $28.
4.
Deposits in transit, July 31, $1,500.
5.
Bank collected $900 note for Family in July, plus interest $36,
less fee $20.The collection has not been recorded by Family, and
no interest has been accrued.
6.
Outstanding checks, July 31, $591.
Instructions
a) Prepare a bank reconciliation at July 31.
b) Journalize the adjusting entries at July 31 on the books of Family
Video Company.
Chapter
8-41
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
E8-11 a) Prepare a bank reconciliation at July 31.
Cash balance per bank statement
Add:
Deposit in transit
Less:
Outstanding checks
Adjusted cash balance per bank
Cash balance per books
Add:
Collection of notes receivable
Collection of interest
Less:
Bank service charge
Note collection fee
Adjusted cash balance per books
Chapter
8-42
$7,263
1,500
(591)
$8,172
$7,284
900
36
(28)
(20)
$8,172
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
E8-11 b) Journalize the adjusting entries at July 31 on
the books of Family Video Company.
Dr.
Cr.
July 31
Miscellaneous expense
28
July 31
Cash
Cash
916
Miscellaneous expense
Interest revenue
Notes receivable
28
20
36
900
Note: Adjusting journal entry includes only the
adjustments to the cash balance per books.
Chapter
8-43
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.
Chapter
8-44
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Electronic Funds Transfers (EFT)
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.
Chapter
8-45
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Discussion Question
Q8-23. Lori Figgs is confused about the lack of
agreement between the cash balance per books and the
balance per the bank. Explain the causes for the lack of
agreement to Lori, and give an example of each cause.
See notes page for discussion
Chapter
8-46
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 8-14
Cash equivalents
Restricted cash
Compensating balances
Chapter
8-47
SO 8 Explain the reporting of cash.
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.
Chapter
8-48
SO 8 Explain the reporting of cash.
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Chapter
8-49