Chapter 7
Fraud, Ethics, and Controls
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
LO1
Learning Objective 1
Define workplace fraud and explain the four elements
common to all fraud schemes.
Workplace fraud involves the use of one’s job for
personal gain, through the deliberate misuse of
employer's assets.
All workplace fraud . . .
1. Is secret.
2. Violates the employee’s duties to his or her
employer.
3. Is done to provide direct or indirect benefit to
the employee.
4. Costs the employer money.
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LO2
Learning Objective 2
Describe the three major types of workplace
fraud.
Asset misappropriation
involves the theft or misuse
of the employer’s resources.
Corruption involves an
employee’s wrongful use of
influence in a business
transaction with the result that
the employee receives financial
gain at the expense of the
employer.
Fraudulent financial
statements involve
falsification of the
employer’s financial
statements.
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LO3
Learning Objective 3
Define internal control and identify its
purpose and principles.
An internal control system is a
collection of policies and procedures
that protect assets, ensure reliable
accounting, promote efficient
operations, and urge adherence
to company policies.
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LO3
Principles of Internal Control
Internal controls vary across companies due to factors like the nature of
the business and its size. Certain fundamental internal control principles
apply to all companies.
The principles of internal control are to:
1. Establish responsibilities.
2.
Maintain adequate records.
3.
Insure assets and bond key employees.
4.
Separate recordkeeping from custody
of assets.
5.
Divide responsibility for related transactions.
6.
Apply technological controls.
7.
Perform regular and independent reviews.
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LO4
Learning Objective 4
Explain how technology impacts an internal
control system.
•Technology can help reduce processing errors
and allow more extensive testing of records.
However, it can limit evidence of processing.
•Technology may also create situations that
cause a lack of separation of duties.
•Technology has also encouraged the growth of
e-commerce, which has greatly enhanced the
need for strong internal controls.
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LO5
Learning Objective 5
Describe the limitations of internal control.
1) The Human Element
Negligence
Fatigue
Misjudgment
Confusion
Intent to
defeat internal
controls for
personal gain
2) Cost-benefit principle: the costs
of internal controls
must not exceed their benefits.
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LO5
Control of Cash Disbursements
Control of cash disbursements is especially important as
most large thefts occur from payment of phony invoices.
Therefore:
 All
expenditures should be made by
check. The only exception is for small
payments from petty cash.
 Separate authorization for check
signing and recordkeeping duties.
 Use a voucher system.
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LO5
Voucher System of Control
A voucher system establishes
procedures that help to verify,
approve, and properly record
cash disbursements.
A voucher system also limits the type of obligations
that a department or individual can incur.
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Learning Objective 6
LO6
Explain provisions of the Sarbanes-Oxley Act
that are designed to detect and curtail fraud.
Congress passed the Sarbanes-Oxley Act in 2002.
This act has several provisions designed to reduce
financial fraud. All U.S. public companies must follow
the provisions of this act.
This act requires each annual report to include an
internal control report, which must:
1. State managers’ responsibility for establishing and
maintaining adequate internal controls for financial
reporting.
2. Assess the effectiveness of those controls.
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Learning Objective 7
LO7
Describe the use of documentation and verification to
control cash disbursements.
 A purchase requisition initiates the process for a purchase.
 If approved, the purchase requisition triggers the issuance of
a purchase order.
 An invoice is received from the vendor once a purchase is
made.
 A receiving report indicates that we actually received the
goods.
 The invoice approval indicates that we ordered the goods,
we received the goods we ordered, and that we were billed
for the goods we ordered and received.
 The invoice approval triggers the check preparation for a
valid purchase.
 Copies of all of these documents are kept as supporting
documentation for the disbursement in the voucher file.
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End of Chapter 7
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