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Compensating balancesMaking deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer EFT system counter receipts Mail receipts Cash Receipts Contr

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Fraud, Internal Control, and Cash

Financial Accounting, IFRS Edition Weygandt Kimmel Kieso

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receipts

disbursements

Study Objectives

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Compensating balances

Making deposits Writing checks Bank

statements Reconciling the bank account Electronic funds transfer (EFT) system

counter receipts Mail receipts

Cash Receipts Controls

Control Features: Use

of a Bank

Control Features: Use

of a Bank

Reporting Cash

Cash Disbursement Controls

Fraud, Internal Control, and Cash

Voucher system controls Petty cash fund controls

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Dishonest act by an employee that results in personal

benefit to the employee at a cost to the employer.

Fraud and Internal Control

Fraud

SO 1 Define fraud and internal control.

Why does fraud occur?

Illustration 7-1

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Answer on notes page

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Methods and measures adopted to:

Internal Control

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A control environmentRisk assessment

Control activitiesInformation and communicationMonitoring

Internal Control

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Measures vary with

management’s assessment of the risks faced

size and nature of the company

SO 2 Identify the principles of internal control activities.

Principles of Internal Control Activities

Six principles of controls activities:

 Establishment of responsibility

 Segregation of duties

 Documentation procedures

 Physical controls

 Independent internal verification

 Human resource controls

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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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3 Discrepancies reported

to management.

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3 Conduct background checks.

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SO 2

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SO 2

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Answer on notes page

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Limitations of Internal Control

Costs should not exceed benefit.

Human element.

Size of the business.

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to bank deposits daily

Establishment of

Responsibility

Only designated personnel are authorized

to handle cash receipts

(cashiers)

Segregation of Duties

Different individuals

receive cash, record

cash receipts, and hold

the cash

Documentation Procedures

Use remittance advice (mail receipts), cash register tapes, and deposit slips

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

Over-the-Counter Receipts

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Cash consists of coins, currency, checks, money orders, and

money on hand or on deposit in a bank

Cash receipts come from:

cash salescollections on account from customersreceipt of interest, rent, and dividendsinvestments by owners

bank loans proceeds from the sale of noncurrent assets

SO 3 Explain the applications of internal control principles to cash receipts.

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Copy of list sent to treasurer’s office for comparison with total shown on daily cash summary.

SO 3 Explain the applications of internal control principles to cash receipts.

Mail Receipts

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Permitting only designated personnel to handle cash

receipts is an application of the principle of:

SO 3 Explain the applications of internal control principles to cash receipts.

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Generally, internal control over cash disbursements is

more effective when companies pay by check, rather

than by cash.

Applications:

Voucher system Petty cash fund

SO 4 Explain the applications of internal control

principles to cash disbursements.

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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

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

to take vacations; conduct background

checks

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SO 4 Explain the applications of internal control

principles to cash disbursements.

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SO 4 Explain the applications of internal control

principles to cash disbursements.

Voucher System Controls

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Petty Cash Fund - U sed to pay small amounts.

Involves:

1 establishing the fund,

3 replenishing the fund.

SO 5 Describe the operation of a petty cash fund.

Petty Cash Fund Controls

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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:

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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:

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Contributes to good internal control over cash.

Minimizes the amount of currency on hand

Creates a double record of bank transactions

Bank reconciliation

Control Features: Use of a Bank

SO 6 Indicate the control features of a bank account.

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Making Bank Deposits

Authorized employee should

make deposit.

Bank Code Numbers

Front Side Reverse Side

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Writing Checks

Written order signed by depositor directing bank to pay a

specified sum of money to a designated recipient.

Maker

Payee

Payer

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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

Review Question

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Reconciling the Bank Account

SO 7 Prepare a bank reconciliation.

Reconcile balance per books and balance per bank to

their adjusted (corrected) cash balances.

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Illustration: The bank statement for Laird Company (Illustration 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.

7-Control Features: Use of a Bank

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Illustration: a) Prepare a bank reconciliation at April 30.

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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:

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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

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NSF Check: As indicated earlier, an NSF check becomes an

account receivable to the depositor The entry is:

Apr 30

Bank Service Charges: Depositors debit check printing

charges (DM) and other bank service charges (SC) to

Miscellaneous Expense The entry is:

Apr 30

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The reconciling item in a bank reconciliation that will

result in an adjusting entry by the depositor is:

SO 7 Prepare a bank reconciliation.

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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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Reporting Cash

SO 8 Explain the reporting of cash.

Cash consists of coins, currency (paper money), checks,

money orders, and money on hand or on deposit in a bank

or similar depository

Cash equivalents Restricted cash Compensating balances

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.

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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

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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.

Understanding U.S GAAP

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provisions documented material weaknesses for about 13% of companies reporting in 2004 and 2005 (PricewaterhouseCoopers’ Global Economic Crime Survey, 2005)

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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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Looking to the Future

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 high-

quality 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.

Fraud, Internal Control, and Cash

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