Introduction to Financial
Accounting
BUS ADM 201
Chapter 7
Chapter 7: Fraud, Internal Control, and
Cash
LO1 Define fraud and the principles of internal
control
LO2 Apply internal control principles to cash
LO3 Identify the control features of a bank
account
LO4 Explain the reporting of cash and the basic
principles of cash management
LO5 Explain the operation of a petty cash fund
(Appendix 7A)
2
Learning Objective 1
DEFINE FRAUD AND THE
PRINCIPLES OF INTERNAL CONTROL
3
Fraud
• A dishonest act by an employee that results in
personal benefit to the employee at a cost to the
employer
• Why fraud occurs
• Fraud triangle
illustrates three
contributing
factors
LO
1
4
The Sarbanes-Oxley (SOX) Act
• Applies to publicly traded U.S. corporations
• Requirements imposed
•
Required to maintain a system of internal control
•
Corporate executives and boards of directors must
ensure that these controls are reliable and effective
•
Independent outside auditors must attest to
adequacy of internal control system
• SOX created Public Company Accounting Oversight
Board (PCAOB)
LO
1
5
Purposes of Internal Control
• To safeguard assets
• To enhance accuracy and reliability of accounting
records
• To increase efficiency of operations
• To ensure compliance with laws and regulations
LO
1
6
Internal Controls
• Five Primary Components of Internal Controls:
1.
2.
3.
4.
5.
Control Environment
Risk Assessment
Control Activities
Information and Communication
Monitoring
Covered more in future accounting classes
7
Internal Control – Principles
•
•
•
•
•
•
Establishment of Responsibility
Segregation of Duties
Documentation Procedures
Physical Controls
Independent Internal Verification
Human Resources Controls
8
Internal Control – Principles
• Establishment of
Responsibility
– Control is most effective when
only one person is responsible
for a given task
– Establishing responsibility often
requires limiting access only to
authorized personnel, and then
identifying those personnel
9
Internal Control – Principles
• Segregation of Duties
– Different individuals should
be responsible for related
activities
– The responsibility for recordkeeping for an asset should
be separate from the physical
custody of that asset
10
Internal Control – Principles
• Documentation
Procedures
– Companies should use
prenumbered documents,
and all documents should
be accounted for
– Documentation should be
required for any
transaction
11
Internal Control – Principles
• Physical Controls
– Limited physical access to important documents
or resources
12
Internal Control – Principles
• Independent
Internal Verification
– Records periodically
verified by an
employee who is
independent
– Discrepancies
reported to
management
13
Internal Control – Principles
• Human Resources
Controls
– Conduct
background
checks
– Rotate employees’
duties and require
vacations
14
Internal Control Limitations
• Costs should not exceed benefits
• Human element
• Size of the business
15
Learning Objective 2
APPLY INTERNAL CONTROL
PRINCIPLES TO CASH
16
Cash Receipts
• If an employee receives cash from a customer,
what is to stop them from pocketing the cash?
• Companies have controls in place to prevent theft
or misuse of their cash
• Internal Controls: Methods and measures
adopted to:
– Safeguard assets
– Enhance reliability of accounting records
– Ensure compliance with regulations
17
Cash Receipt Controls
LO
2
18
Cash Receipt Controls
LO
2
19
Cash Receipt
Controls
Over-the-Counter
Receipts
• Segregation of
recordkeeping from
physical custody
• An important
internal control
principle
LO
2
20
Cash Disbursements
• If an employee has access to a company
checkbook, what is to stop them from writing
himself a check?
• Just like cash receipts, there are controls in
place on cash disbursements
21
Cash Disbursements
• Electronic Fund Transfers (ETFs): Disbursement
system that uses wire, telephone, or
computers to transfer cash from one location
to another
– Prevents employees from handling actual cash
– Maintains records for receipts and disbursements
22
Cash Disbursement
Controls
LO
2
23
Cash Disbursement Controls
LO
2
24
Learning Objective 3
IDENTIFY THE CONTROL FEATURES
OF A BANK ACCOUNT
25
Control Features of a Bank Account
Use of a bank contributes significantly to good internal control over
cash.
• Minimizes amount of currency on hand
• Creates a double record of bank transactions
• Bank records create an independent record of which to agree
the company’s books with the bank records
• Bank reconciliation
Helpful Hint
Essentially, the bank statement is a copy of the bank’s records sent
to the customer or made available online for review.
LO
3
26
Cash in Bank
Illustration 7-7
• Bank statement
includes:
–
–
–
–
–
–
Statement date
Deposits
Withdrawals
Debit memoranda
Credit memoranda
Running balance
27
Cash in Bank
• Debit and Credit Memoranda
– Debit memoranda decrease cash in your account
• NSF charges (non-sufficient funds)
• Bank service charges
– Credit memoranda increase cash in your account
• Collections on notes made by the bank
• Interest earned
28
Recall – T Accounts
• If debits increase cash…why does a debit memo reduce cash?
ACCOUNT NAME
Debit Side (Dr.)
Credit Side (Cr.)
means LEFT
means RIGHT
Example:
CASH IN CHECKING
BALANCE
50.00
100.00
60.00
250.00
300.00
510.00
20.00
30.00
15.00
1,270.00
65.00
1,205.00
29
Cash in Bank
• Keep in mind that the bank statement is the
bank’s record of your money
• The bank statement is actually a statement of
the bank’s Account Payable to you
– Credits increase payables
– Debits decrease payables
30
Cash in Bank
• The bank statement and your ledger for cash
may not have the exact same ending balance
• This is typically due to timing issues
• We therefore must reconcile the balance per
books and the balance per bank to the “true”
balance
31
Cash in Bank
• Reconciling items
– Deposits in transit
– Outstanding checks
– Bank memoranda
– Errors
Timing Differences
32
Reconciling Cash
+ Deposits in transit
-
Outstanding checks
+/- Bank errors
CORRECT BALANCE
Items in books
but not recorded
by bank
+ EFT collections and other
deposits
-
NSF (bounced) checks
Items recorded by
- Service charges and other
bank but not in
payments
books
+/- Company errors
CORRECT BALANCE
33
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
34
Reconciling Cash
Cash balance per bank statement
$15,907.45
Cash balance per books
$11,709.45
35
Reconciling Cash
Cash balance per bank statement
Deposit in transit
$15,907.45
2,201.40
Cash balance per books
$11,709.45
36
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded el ectronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
37
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
$15,907.45
2,201.40
(5,904.00)
Cash balance per books
$11,709.45
38
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
39
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
Cash balance per books
Electronic funds transfer received
$15,907.45
2,201.40
(5,904.00)
$11,709.45
$1,035.00
40
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
41
Reconciling Cash – Error Example
Per Bank
Cash originally decreased
$1,226
Per Books
Cash originally decreased
$1,262
This was
WRONG
We must increase
cash to fix it
1,262 – 1,226 = 36
42
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
Cash balance per books
Electronic funds transfer received
Error in recording check No. 443
$15,907.45
2,201.40
(5,904.00)
$11,709.45
$1,035.00
36.00
43
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
44
Reconciling Cash – NSF Check
Per Bank
Per Books
“We received $425.60 from a
customer”
Increase cash $425.60
“The check from your
customer was garbage, it
bounced”
We must remove the cash from
our cash account
45
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
Cash balance per books
Electronic funds transfer received
Error in recording check No. 443
NSF check
$15,907.45
2,201.40
(5,904.00)
$11,709.45
$1,035.00
36.00
(425.60)
46
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
47
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
Cash balance per books
Electronic funds transfer received
Error in recording check No. 443
NSF check
Debit and credit card fees
Bank service charge
$15,907.45
2,201.40
(5,904.00)
$11,709.45
$1,035.00
36.00
(425.60)
(120.00)
(30.00)
48
Reconciling Cash
The bank statement for Laird Co shows a balance per bank of $15,907.45. The
balance per books is $11,709.45. Laird determines the following reconciling items.
Deposits in transit: April 30 deposit (received by
bank on May 1).
$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457,
$1,401.30; No. 460, $1,502.70.
5,904.00
Other deposits: Unrecorded electronic receipt from customer
on account on April 9 determined from bank statement.
1,035.00
Other payments: Unrecorded charges determined from the
bank statement are as follows:
Returned NSF check on April 29
Debit and credit card fees on April 30
Bank service charges on April 30
Company errors: Check No. 443 was correctly written by Laird
for $1,226 and was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books.
425.60
120.00
30.00
36.00
49
Reconciling Cash
Cash balance per bank statement
Deposit in transit
Outstanding checks
Adjusted cash balance per bank
Cash balance per books
$15,907.45
2,201.40
(5,904.00)
$12,204.85
Electronic funds transfer received
Error in recording check No. 443
NSF check
Debit and credit card fees
Bank service charge
$11,709.45
$1,035.00
36.00
(425.60)
(120.00)
(30.00)
Adjusted cash balance per books
$12,204.85
50
Reconciling Cash
• Entries from the bank reconciliation:
– Collection of EFT. Payment on account by
customer, not recorded yet
Date
Account Title
Ref.
Debit
Credit
4/30
51
Reconciling Cash
• Entries from the bank reconciliation:
– Collection of EFT. Payment on account by
customer, not recorded yet
Date
4/30
Account Title
Cash
Accounts Receivable
Ref.
Debit
Credit
1,035.00
1,035.00
52
Reconciling Cash
• Entries from the bank reconciliation:
– Book error. The cash disbursements journal shows
that check no. 443 was a payment on account to
Andrea Company, a supplier
Date
Account Title
Ref.
Debit
Credit
4/30
53
Reconciling Cash
• Entries from the bank reconciliation:
– Book error. The cash disbursements journal shows
that check no. 443 was a payment on account to
Andrea Company, a supplier
Date
4/30
Account Title
Cash
Accounts Payable
Ref.
Debit
Credit
36.00
36.00
54
Reconciling Cash
• Entries from the bank reconciliation:
– NSF Check. As indicated earlier, an NSF check
becomes an account receivable to the depositor
Date
Account Title
Ref.
Debit
Credit
4/30
55
Reconciling Cash
• Entries from the bank reconciliation:
– NSF Check. As indicated earlier, an NSF check
becomes an account receivable to the depositor
Date
4/30
Account Title
Accounts Receivable
Cash
Ref.
Debit
Credit
425.60
425.60
56
Reconciling Cash
• Entries from the bank reconciliation:
– Bank Charges. Fees for processing debit and credit
card transactions are normally debited to the
Bank Charges Expense account, as are bank
service charges
Date
Account Title
Ref.
Debit
Credit
4/30
57
Reconciling Cash
• Entries from the bank reconciliation:
– Bank Charges. Fees for processing debit and credit
card transactions are normally debited to the
Bank Charges Expense account, as are bank
service charges
Date
4/30
Account Title
Bank Charge Expense
Cash
Ref.
Debit
Credit
150.00
150.00
58
Reconciling Cash
• Note that our ending balance in the ledger for
cash agrees to the “true” balance from our
reconciliation
59
Learning Objective 4
EXPLAIN THE REPORTING OF CASH AND
THE BASIC PRINCIPLES OF CASH
MANAGEMENT
60
Cash
• Cash consists of coins, currency (paper
money), checks, money orders, and money on
hand or on deposit
• Balance sheet reports the amount of cash
available at a given point in time
– Listed first in the current assets section
– Includes cash on hand, cash in banks, and petty
cash
61
Cash
• Where is cash?
– Cash on hand
• In register drawers, in locked boxes in offices
– Cash in banks
• Checking accounts, money market accounts
– Petty cash
• Small amounts held to pay for minor expenses
62
Cash
• Other things included in cash:
– Cash Equivalents: Short-term, highly liquid
investments that are both
1. Readily convertible to cash, and
2. So near their maturity that the market value is
relatively insensitive
– Restricted Cash: Cash that is not available for
general use but rather is restricted for a special
purpose
63
Cash
• Apple has $25.9 billion in cash as of 9/29/18
• Do you think it is all sitting at their
headquarters?
64
Recall – Operating Cycles
Cash in Bank
Cash Receipts
Cash
Disbursements
Cash in Bank
65
Cash Management
• Basic Principles of Cash Management
66
Cash Management
• Make and Use a Budget
– Showing anticipated cash flows, usually over a
one- to two-year period
• Cash receipts
• Cash disbursements
• Financing activities
Operating and Investing Activities
– Enables the company to plan ahead to cover
possible cash shortfalls and to make investments
of idle funds
– Contributes to more effective cash management
67
Cash Management
68
Learning Objective 5
EXPLAIN THE OPERATION OF A
PETTY CASH FUND (APPENDIX 7A)
69
Petty Cash
• Petty cash is used to pay for small purchases
• Journal Entries:
– Establishing the fund
– Making payments
– Replenishing the fund
70
Petty Cash
• Establishing the fund
Date
11/1
Account Title
Petty Cash
Cash
Ref.
Debit
Credit
100
100
• This moves cash from a bank account to a
small on-site location for miscellaneous
purchases
71
Petty Cash
• Making payments from Petty Cash
– There are NO ENTRIES
• Management usually limits the size of expenditures
• Does not permit use of the fund for certain types of
transactions
• Payments are documented on a prenumbered receipt
• Supporting documents should be attached to the
receipt
• Sum of the receipts and money in the fund should
equal the established total at all times
72
Petty Cash
• Replenishing the fund
– The petty cash custodian reviews all receipts and
sees that there is only $13 of cash in the petty
cash drawer. Receipts show $44 for postage, $38
for supplies, and $5 for miscellaneous expenses.
Date
Account Title
Ref.
Debit
Credit
11/1
73
Petty Cash
• Replenishing the fund
– The petty cash custodian reviews all receipts and
sees that there is only $13 of cash in the petty
cash drawer. Receipts show $44 for postage, $38
for supplies, and $5 for miscellaneous expenses.
Date
11/1
Account Title
Postage Expense
Supplies
Misc Expenses
Cash
Ref.
Debit
Credit
44
38
5
87
74
Thank You!
75