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?
Slide
7-1
SO 1 Define fraud and internal control.
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).
Slide
7-2
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.
Slide
7-3
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
Slide
7-4
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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Slide
7-5
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.
Slide
7-6
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
Slide
7-7
Illustration 7-2
SO 2 Identify the principles of internal control.
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. Records verified by an
employee who is
independent.
3. Discrepancies reported
to management.
Slide
7-8
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.
Slide
7-9
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
Slide
7-10
SO 2 Identify the principles of internal control.
Cash Receipts Controls
Over-the-Counter Receipts
Slide
7-11
Illustration 7-4
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
Slide
7-12
SO 3 Explain the applications of internal control principles to cash receipts.
Over-theCounter
Receipts
Illustration 7-5
Slide
7-13
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 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.
Slide
7-14
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
Slide
7-15
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
Slide
7-16
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
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.
Slide
7-17
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.
Slide
7-18
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
Slide
7-19
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:
Mar. 15
Postage expense
44
Freight-out
38
Miscellaneous expense
Cash
Slide
7-20
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
Slide
7-21
88
SO 5 Describe the operation of a petty cash fund.