Chapter
Four
Internal
Controls,
Accounting for
Cash, and
Ethics
© 2015 McGraw-Hill Education.
LO 1
LO 1
Identify the key
elements of a strong
system of internal
control.
4-2
An Integrated Framework
1. Control Environment – integrity and ethical values
of a company
2. Risk Assessment – management identification of
potential risks
3. Control Activities – internal controls
4. Information and Communication – internal and
external reporting process
5. Monitoring – over time assessment and
correction of internal controls
4-3
Internal Controls
1.
2.
3.
4.
5.
6.
7.
8.
9.
Separation of Duties
Quality of Employees
Bonded Employees
Required Absences
Procedures Manual
Authority and Responsibility
Prenumbered Documents
Physical Control
Performance Evaluations
4-4
Separation of Duties
When duties are separated, the work of one
employee can act as a check on the work of
another employee. The likelihood of fraud or theft
is greatly reduced.
4-5
Quality of Employees
The ability of cross-trained employees to substitute
for one another prevents disruptions in the
workplace. Job rotation may help relieve boredom
and increase productivity.
4-6
Bonded Employees
A fidelity bond provides insurance that protects a
company from loss caused by employee
dishonesty. To become bonded, an employee’s
background is investigated.
4-7
Required Absences
An employee may be able to cover up
fraudulent activities if they are always present
at work. All employees should be required to
take regular vacations and their duties should
be rotated periodically.
4-8
Procedures Manual
Accounting and other important procedures should be
written in a procedures manual. Periodically,
management should conduct an investigation to see
that required procedures are actually being followed.
4-9
Authority and Responsibility
General authority applies to all members of the
organization. For example, all employees are
required to fly coach and purchase airline tickets
from a specific vendor.
Specific authority applies only to a specific
position within the organization. For example, all
checks must be cosigned by the Controller and
Treasurer.
4-10
Prenumbered Documents
Prenumbered forms are used for all important
documents such as checks, purchase orders,
receiving reports, and invoices. The use of
prenumbered forms helps keep track of all forms
issued during a particular period.
4-11
Physical Control
All companies should maintain adequate physical
control over valuable assets that may be
misappropriated. For example, inventory should be
properly stored in a secure location. Serial numbers
should be placed on all valuable assets to assist in a
physical count of these assets.
4-12
Performance Evaluation
•Internal controls should include independent verification
of employee performance.
•A physical inventory should be taken at least annually
by someone other than a person who has control over
inventory. An independent reconciliation between the
general ledger balance and inventory should be
compared to the inventory count.
•Auditors should evaluate the effectiveness of the control
system.
4-13
Limitations
Internal controls can be circumvented by
collusion among employees. Two or more
employees working together can hide
embezzlement by covering for each other. No
system can prevent all fraud. Good internal
controls minimize fraud and increase likelihood
of detection.
4-14
Accounting for Cash
Cash receipts should
be recorded
immediately upon
receipt and deposited
intact daily.
Up to date signature
card should be
maintained.
A monthly bank
reconciliation should
be prepared by an
independent party.
Controlling
Cash
A deposit ticket
should be used for all
deposits.
Cash disbursements
should be made by
prenumbered check.
4-15
Most companies
combine currency and
other payable on
demand items in a
single balance sheet
account with varying
titles.
4-16
LO 2
LO 1
Prepare a
bank
reconciliation.
4-17
Reconciling the Bank Account
The bank reconciliation reports on the differences
between the balance on the bank statement and the
balance in the general ledger cash account. The
reconciliation results in the true cash balance that
will appear on the balance sheet.
Adjustment to the Bank Balance
Unadjusted bank balance
+ Deposits in transit
Deduct - Outstanding checks
Equals = True cash balance
Add
Adjustments to the Book Balance
Unadjusted book balance
Add + Accounts receivable collections
+
Deduct Deduct Equals =
Add
Interest earned
Bank service charges
Non-sufficient funds (NSF) check
True cash balance
4-18
Reconciling the Bank Statement
If an error is found on the bank statement, an
adjustment for it is made to the unadjusted
bank balance to determine the true cash
balance. An error found on our book balance
requires an adjustment to our books.
4-19
Bank Reconciliation
Green Shades Resorts, Inc.’s bank reconciliation for September.
1.
The September 30th balance on the bank statement is $3,516.45, and
the Cash general ledger balance on this date is $3,361.22.
2.
There was a deposit in transit in the amount of $724.11.
3.
The bank erroneously deducted a $25 check drawn on the books of
Green Valley Resorts from our account.
4.
At September 30th there were three checks outstanding. Check 639
dated 9/18, for $13.75; Check 646 dated 9/20, for $29.00; and
Check 672 dated 9/27, for $192.50.
5.
During the month of September the bank collected an account
receivable for us in the amount of $940.
6.
A check actually written for $36.45 for supplies was erroneously
recorded in our records by the bookkeeper as $63.45.
7.
The bank assessed a service charge of $8.40 for September and we
deposited a NSF check in the amount of $289.51.
4-20
Bank Reconciliation
Green Shades Resorts, Inc.
Bank Reconciliation Statement
September 30, 2014
Unadjusted bank balance, September 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 639 - September 18
13.75
Check No. 646 - September 20
29.00
Check No. 672 - September 27
192.50
True Cash balance, September 30
Unadjusted Book Balance, June 30
Add: Account collected by bank
Bookkeeping error
Interest earned on checking account
Less: Bank service charge
NSF Check
True Cash balance, June 30
$ 3,516.45
724.11
25.00
(235.25)
$ 4,030.31
$ 4,240.54
875.00
27.00
9.25
(12.75)
(413.11)
$ 4,725.93
4-21
Bank Reconciliation
Green Shades Resorts, Inc.
Bank Reconciliation Statement
September 30, 2014
Unadjusted Bank Balance, September 30
Add: Deposits in transit
Bank error
Less: Outstanding checks
Check No. 639 - September 18
13.75
Check No. 646 - September 20
29.00
Check No. 672 - September 27
192.50
True Cash balance, September 30
Unadjusted Book Balance, September 30
Add: Account collected by bank
Bookkeeping error
Less: Bank service charge
NSF Check
True Cash balance, September 30
$ 3,516.45
724.11
25.00
(235.25)
$ 4,030.31
$ 3,361.22
940.00
27.00
(8.40)
(289.51)
$ 4,030.31
4-22
Adjusting the Books
Every reconciling item that appears on the unadjusted book
balance section requires an entry to adjust the general ledger cash
balance to the true cash balance.
Cash
Assets
=
Accounts
+ Receivable =
+
940
(940) =
Cash
=
Cash
=
(8.40)
=
Assets
Cash
(289.51)
+
Equity
Revenue -
+
n/a
n/a
Retained
Earnings
=
27
Assets
Liab.
=
n/a
Liab.
+
n/a
+
=
Accounts
+ Receivable =
=
+ 289.51
+
27
n/a
Revenue
-
n/a
-
Expenses =
-
Expenses
Net
Income
n/a
=
n/a
Net
Income
=
(27) =
Cash
Flow
940 OA
Cash
Flow
27
27 OA
Equity
Retained
Earnings
Revenue
-
(8.40)
n/a
-
Liab.
n/a
+
+
Expenses =
8.40
=
Net
Income
(8.40)
Cash
Flow
(8.40) OA
Equity
n/a
Revenue - Expenses =
n/a
n/a
=
Net
Income
n/a
Cash
Flow
(289.51) OA
4-23
LO 3
LO 1
Discuss the role of
ethics in the
accounting
profession.
4-24
Importance of Ethics
The accountant’s role requires trust and
credibility.
Accounting information is worthless if the
accountant is not trustworthy.
Therefore, the accounting profession requires
high ethical standards.
4-25
AICPA Code of Professional Ethics
4-26
The Fraud Triangle
Opportunity
Key to protecting
yourself and your
company: personal
integrity.
Pressure
Rationalization
4-27
LO 4
LO 1
Discuss the auditor’s
role in financial
reporting.
4-28
Role of the Independent Auditor
How can a
financial
analyst know
that a
company
really did
follow GAAP?
Certified Public Accountants
4-29
Materiality and Financial Audits
Auditors do not guarantee that financial
statements are absolutely correct—only
that they are materially correct.
Material Item
An error, or other
reporting problem, that
would influence the
decision of an average
prudent investor.
4-30
Types of Audit Opinions
Unqualified
Qualified
Adverse
Disclaimer
4-31
End of Chapter Four
4-32