Slide
7-1
Chapter
7
Fraud, Internal
Control, and Cash
Financial Accounting,
Seventh Edition
Slide
7-2
Study Objectives
Slide
7-3
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.
Fraud, Internal Control, and Cash
Fraud and
Internal
Control
Fraud
The SarbanesOxley Act
Internal control
Principles of
internal control
activities
Limitations
Slide
7-4
Cash Receipts
Controls
Over-thecounter
receipts
Mail receipts
Cash
Disbursement
Controls
Voucher
system
controls
Petty cash
fund controls
Control
Features: Use
of a Bank
Making
deposits
Writing checks
Bank
statements
Reconciling
the bank
account
Electronic
funds transfer
(EFT) system
Reporting
Cash
Cash
equivalents
Restricted
cash
Compensating
balances
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?
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7-5
SO 1 Define fraud and internal control.
Slide
7-6
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
7-7
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
7-8
SO 1 Define fraud and internal control.
Fraud and Internal Control
Internal Control
Internal control systems have five primary components
1. A control environment
CRIMC
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring
Slide
7-9
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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7-10
Establishment of responsibility
Segregation of duties (2)
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.
 Cash register
 Tracking computer transactions to passcode
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7-11
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
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
7-12
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
SEGREGATON OF DUTIES – RELATED ACTIVITIES -DON’T
DO THIS! Why?
•
•
Slide
7-13
Purchasing –
•
Purchasing Agent orders goods W/O Supervisory approval
•
Employee orders goods AND handles receipt of goods
Sales
•
Sales person makes sale w/o supervisory approval
•
Shipping clerk who ALSO has access to accounting records
•
Billing clerk who handles billing and receipt of goods
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
SEGREGATON OF DUTIES – Record-Keeping from Physical
Custody-DON’T DO THIS! Why?
Slide
7-14
•
Accountant should NOT have access to physical goods
•
Asset custodian (warehouse, sales floor clerk) should NOT have access
to Accounting records
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Principles of Internal Control Activities
DOCUMENTATION PROCEDURES
Be able to trace each document back to
transaction/person.
Don’t have unnumbered checks, invoices, blank forms!
Require approval signatures
Account for missing checks!
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7-15
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Slide
7-16
SO 2
Fraud and Internal Control
Slide
7-17
SO 2 Identify the principles of internal control.
Fraud and Internal Control
Slide
7-18
SO 2
Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
Slide
7-19
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
7-20
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
7-21
SO 2 Identify the principles of internal control.
Fraud
and
Internal
Control
Slide
7-22
SO 2
Fraud and Internal Control
Slide
7-23
SO 2
Fraud and Internal Control
Slide
7-24
SO 2
Slide
7-25
Fraud and Internal Control
Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
Slide
7-26
SO 2 Identify the principles of internal control.
Cash Receipts Controls
Over-the-Counter Receipts
Slide
7-27
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
7-28
SO 3 Explain the applications of internal control principles to cash receipts.
Over-theCounter
Receipts
Illustration 7-5
Slide
7-29
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
7-30
SO 3 Explain the applications of internal control principles to cash receipts.
Cash Receipts 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.
Slide
7-31
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
7-32
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
7-33
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
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.
Slide
7-34
SO 4 Explain the applications of internal
control principles to cash disbursements.
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
7-35
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
7-36
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
7-37
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
7-38
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
7-39
88
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.
Slide
7-40
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Making Bank Deposits
Authorized employee
should make deposit.
Front Side
Slide
7-41
Illustration 7-8
Bank Code
Numbers
Reverse Side
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Writing Checks
Written order signed by depositor directing bank to pay
a specified sum of money to a designated recipient.
Illustration 7-9
Maker
Payee
Payer
Slide
7-42
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Bank Statements
Illustration 7-10
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)
Credit Memorandum
Collect notes
receivable.
Interest earned.
Slide
7-43
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Review Question
The control features of a bank account do not include:
a. having bank auditors verify the correctness of the
bank balance per books.
b. minimizing the amount of cash that must be kept on
hand.
c. providing a double record of all bank transactions.
d. safeguarding cash by using a bank as a depository.
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7-44
SO 6 Indicate the control features of a bank account.
Control Features: Use of a Bank
Reconciling the Bank Account
Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Errors.
4. Bank memoranda.
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7-45
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Reconciliation Procedures
Illustration 7-11
+ Deposit in Transit
+ Notes collected by bank
-
-
NSF (bounced) checks
-
Check printing or other
service charges
Outstanding Checks
+- Bank Errors
+- Company Errors
CORRECT BALANCE
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7-46
CORRECT BALANCE
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Illustration: The bank statement for Laird Company (Illustration
7-12), shows a balance per bank of $15,907.45 on April 30, 2011.
On this date the balance of cash per books is $11,589.45. Using
the four reconciliation steps, Laird determines the following
reconciling items.
Slide
7-47
Control Features: Use of a Bank
Illustration: The bank statement for Laird Company (Illustration
7-12), shows a balance per bank of $15,907.45 on April 30, 2011.
On this date the balance of cash per books is $11,589.45. Using
the four reconciliation steps, Laird determines the following
reconciling items.
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7-48
Control Features: Use of a Bank
Illustration: a) Prepare a bank reconciliation at April 30.
Cash balance per bank statement
Add:
$15,907.45
Deposit in transit
2,201.40
Less:
Outstanding checks
Adjusted cash balance per bank
(5,904.00)
$12,204.85
Cash balance per books
$11,589.45
Add:
Error in recording check no. 443
Collection of notes + interest - fee
Less:
NSF check
Bank service charge
Adjusted cash balance per books
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7-49
Illustration 7-12
36.00
1,035.00
(425.60)
(30.00)
$12,204.85
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
The company records each reconciling item used to determine
the adjusted cash balance per books.
Collection of Note Receivable: Assuming interest of $50 has
not been accrued and collection fee is charged to
Miscellaneous Expense, the entry is:
Apr. 30
Cash
Miscellaneous expense
Slide
7-50
1,035.00
15.00
Notes receivable
1,000.00
Interest revenue
50.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Book Error: The cash disbursements journal shows that
check no. 443 was a payment on account to Andrea Company,
a supplier. The correcting entry is:
Apr. 30
Cash
Accounts payable
Slide
7-51
36.00
36.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
NSF Check: As indicated earlier, an NSF check becomes an
account receivable to the depositor. The entry is:
Apr. 30
Accounts receivable
425.60
Cash
425.60
Bank Service Charges: Depositors debit check printing
charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:
Apr. 30
Miscellaneous expense
Cash
Slide
7-52
30.00
30.00
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Review Question
The reconciling item in a bank reconciliation that will
result in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
Slide
7-53
SO 7 Prepare a bank reconciliation.
Control Features: Use of a Bank
Electronic Funds Transfers (EFT) System
Disbursement systems that uses wire,
telephone, or computers to transfer cash
balances between locations.
EFT transfers normally result in better
internal control since no cash or checks are
handled by company employees.
Slide
7-54
SO 7 Prepare a bank reconciliation.
Reporting Cash
Cash consists of coins, currency (paper money), checks,
money orders, and money on hand or on deposit in a bank
or similar depository.
Illustration 7-14
Cash equivalents
Restricted cash
Compensating balances
Slide
7-55
SO 8 Explain the reporting of cash.
Reporting Cash
Review Question
Which of the following statements correctly
describes the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with
Cash.
c. Cash is listed first in the current assets section.
d. Restricted cash funds cannot be reported as a
current asset.
Slide
7-56
SO 8 Explain the reporting of cash.
Protecting Yourself from Identity Theft
 Identity thieves determine your identity by going through your
mail or trash, stealing your credit cards, redirecting mail through
change of address forms, or acquiring personal information you
share on unsecured sites. In a recent year, more than 7 million
people were victims of identity theft.
 During a single computer-virus outbreak, called the “Hearse,”
thieves stole 90,000 pieces of personal data.
 The average identity-theft victim spends 600 hours clearing up
his or her finances and financial and other records to recover
from the crime.
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7-57
Protecting Yourself from Identity Theft
 Victims incur an average of $1,400 in out-of-pocket expenses.
 Consumers have $1.7 trillion worth of assets with online brokerage
firms. Many of the largest identity theft losses have been the
result of thieves completely cleaning out online brokerage
accounts.
 The Federal Trade Commission reports identify theft is the No. 1
fraud complaint among consumers. Phoenix and Las Vegas top the
list for identity theft per capita.
Slide
7-58
Slide
7-59
Do you feel it is safe to store personal financial data (such
as Social Security numbers and bank and credit account
numbers) on your computer?
YES: I have anti-virus software that will detect and stop
any intruder.
NO: Even the best anti-virus software does not detect
every kind of intruder.
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7-60
Copyright
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Reproduction or translation of this work beyond that permitted
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use of these programs or from the use of the information
contained herein.”
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