Fraud and Internal Control

							     Chapter    8
           Fraud, Internal
          Control and Cash

Chapter
  8-1          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
  8-2
                  Fraud, Internal Control, and Cash



                                            Control
     Fraud and
                        Cash Controls   Features: Use of    Reporting Cash
  Internal Control
                                            a Bank


    Fraud               Cash receipts    Making deposits     Cash equivalents
    The Sarbanes-       controls         Writing checks      Restricted cash
    Oxley Act           Cash             Bank statements     Compensating
    Internal control    disbursements                        balances
                                         Reconciling the
                        controls
    Principles of                        bank account
    internal control                     Electronic funds
    Limitations                          transfer (EFT)
                                         system



Chapter
  8-3
    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
  8-4                               SO 1 Define fraud and internal control.
Chapter
  8-5
    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
  8-6                               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
  8-7                                 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


                          See page 348

Chapter
  8-8                                    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:
             Establishment of responsibility
             Segregation of duties
             Documentation procedures
             Physical controls
             Independent internal verification
             Human resource controls
Chapter
  8-9                             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
 8-10                             SO 2 Identify the principles of internal control.
    Fraud and Internal Control

     Principles of Internal Control Activities
     PHYSICAL CONTROLS                                      Illustration 8-2




Chapter
 8-11                    SO 2 Identify the principles of internal control.
    Fraud and Internal Control

     Principles of Internal Control Activities
     INDEPENDENT INTERNAL                                                Illustration 8-3

     VERIFICATION
          1. Verify records
             periodically or on a
             surprise basis.
          2. Records verified by an
             employee who is
             independent.
          3. Discrepancies reported
             to management.

Chapter
 8-12                                 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
 8-13                            SO 2 Identify the principles of internal control.
Chapter
 8-14
    Fraud and Internal Control

     Limitations of Internal Control
          Costs should not exceed benefit.
          Human element.
          Size of the business.




Chapter
 8-15                      SO 2 Identify the principles of internal control.
    Cash Controls



                                Do It

                              See page 356




Chapter
 8-16     SO 3 Explain the applications of internal control principles to cash receipts.
    Cash Controls
     Cash Receipts Controls
           Establishment of            Documentation           Independent Internal
             Responsibility              Procedures                 Verification
            Only designated            Use remittance          Supervisors count cash
             personnel are               advice (mail              receipts daily;
          authorized to handle         receipts), cash          treasurer compares
             cash receipts           register tapes, and       total receipts to bank
               (cashiers)               deposit slips              deposits daily

     Segregation of Duties                Physical,               Human Resource
      Different individuals           Mechanical, and                Controls
      receive cash, record           Electronic Controls         Bond personnel who
     cash receipts, and hold         Store cash in safes        handle cash; require
            the cash                and bank vaults; limit        employees to take
                                      access to storage         vacations; deposit all
Illustration 8-4                       areas; use cash            cash in bank daily
                                          registers
Chapter
 8-17        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-the-
 Counter
 Receipts




      Illustration 8-4




Chapter
 8-21      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.


                              See Page 358
Chapter
 8-22
    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                       SO 4 Explain the applications of internal
 8-23
                                   control principles to cash disbursements.
    Cash Controls

   Cash Disbursements Controls                           Illustration 8-6

                                  Documentation
       Establishment of             Procedures          Independent Internal
         Responsibility         Use prenumbered              Verification
        Only designated        checks; checks must        Compare checks to
         personnel are           have an approved      invoices; reconcile bank
       authorized to sign         invoice; require        statement monthly
     checks (treasurer) and      employees to use
        approve vendors       corporate credit cards
                                                          Human Resource
                                 for reimbursable
                                                              Controls
     Segregation of Duties           expenses
                                                           Bond personnel
      Different individuals                               who handle cash;
                                Physical Controls        require employees
       approve and make
        payments; check       Store blank checks in      to take vacations;
     signers do not record     safes, with limited      conduct background
         disbursements         access; print check             checks
                              amounts by machine in
Chapter
                                  indelible ink
 8-24
    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                               SO 4 Explain the applications of internal
 8-25
                                           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                       SO 4 Explain the applications of internal
 8-26
                                   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                      SO 4 Explain the applications of internal
 8-27
                                  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
 8-28                      SO 5 Describe the operation of a petty cash fund.
    Cash Controls

   Illustration: If Laird Company decides to establish a $100
   fund on March 1, the journal entry is:


   Mar. 1    Petty cash                           100
                Cash                                          100




Chapter
 8-29                     SO 5 Describe the operation of a petty cash fund.
    Cash 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:

   Mar. 15    Postage expense                         44
              Freight-out                             38
              Miscellaneous expense                     5
                 Cash                                              87


Chapter
 8-30                       SO 5 Describe the operation of a petty cash fund.
    Cash 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                                             88

Chapter
 8-31                       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
 8-32                  SO 6 Indicate the control features of a bank account.
    Control Features: Use of a Bank
                                     Illustration 8-8
    Making Bank Deposits
    Authorized employee            Bank Code
                                   Numbers
    should make deposit.




                            Reverse Side
          Front Side
Chapter
 8-33                  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
 8-34                  SO 6 Indicate the control features of a bank account.