Fraud and Internal Control
1. (L.O. 1) Fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. The fraud triangle refers to the three factors that contribute to fraudulent activity by employees: opportunity, financial pressure, and rationalization.
2. Internal control consists of all the related methods and measures adopted within an organization to (a) safeguard assets, (b) enhance the reliability of accounting records, (c) increase efficiency of operations, and (d) ensure compliance with laws and regulations.
3. (L.O. 2) An essential characteristic of internal control is the establishment of responsibility to specific employees. Control is most effective when only one person is responsible for a given task.
4. The rationale for segregation of duties is this: The work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee.
5. The responsibility for related transactions should be assigned to different individuals, and the responsibility for establishing the accountability for an asset should be separate from the physical custody of that asset.
6.
Documentation procedures provide evidence that transactions and events have occurred.
7. Physical controls relate primarily to the safeguarding of assets and include such measures as safes for the storage of cash prior to deposit, vaults for the deposit of cash, safety deposit boxes for the storage of important business papers, and locked warehouses for inventories. These controls also include alarms, television monitors, garment sensors and time clocks.
8. Most systems of internal control provide for independent internal verification.
This principle involves the review of data prepared by employees.
9. In large companies, independent internal verification is often assigned to internal auditors. Internal auditors are company employees who continuously evaluate the effectiveness of the company’s internal control systems.
10. Human resource control measures include bonding of employees who handle cash, rotating employees’ duties and requiring employees to take vacations, and conducting thorough background checks.
Limitations of Internal Control
11. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefits.
12. The human element is also an important factor in every system of internal control. A good system can become ineffective through employee fatigue, carelessness, or indifference.
13. Collusion may result when two or more individuals work together to get around prescribed controls and may significantly reduce the effectiveness of a system.

Cash Controls
14. To safeguard cash and to assure the accuracy of the accounting records for cash, effective internal control over cash is imperative.
Cash Receipts Controls
15. (L.O. 3) The application of internal control principles to cash receipts transactions includes: (1) only designated personnel should be authorized to handle or have access to cash receipts;
(2) different individuals should be assigned the duties of receiving cash, recording cash receipt transactions, and having custody of cash; (3) documents should include remittance advices, cash register tapes, and deposit slips; (4) cash should be stored in company safes and bank vaults, access to storage areas should be limited to authorized personnel, and cash registers should be used;
(5) daily cash counts and daily comparisons of total receipts should be made; and (6) all personnel who handle cash receipts should be bonded and required to take vacations.
16. Control of over-the-counter receipts is centered on cash registers that are visible to customers.
Cash Disbursements Controls
17. (L.O. 4) Generally, internal control over cash disbursements is more effective when companies pay by check or electronic funds transfer (EFT), rather than by cash, except for incidental amounts that are paid out of petty cash.
18. The application of internal control principles to cash disbursements transactions includes: (1) only designated individuals should be authorized to sign checks; (2) different individuals should be assigned the duties of approving an item for payment and paying it; (3) prenumbered checks should be used and each check should be supported by an approved invoice or other document; (4) blank checks should be stored in a safe and access should be restricted to authorized personnel, and a machine should be used to imprint the amount on the check in indelible ink; (5) each check should be compared with the approved invoice before it is issued; and (6) bonding personnel who handle cash, requiring employees to take vacations, and conducting background checks.
Voucher System
19. Companies use a voucher system to enhance the internal control over cash disbursements. A voucher system is a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper. A voucher system includes the use of authorization forms called vouchers which are recorded by the accounting department in the voucher register.
Petty Cash Fund
20. (L.O. 5) A petty cash fund is a cash fund used to pay relatively small amounts. a. The operation of the fund, often called an imprest system, involves (1) establishing the fund, (2) making payments from the fund, and (3) replenishing the fund. b. Accounting entries are required when (1) the fund is established, (2) the fund is replenished, and (3) the amount of the fund is changed.

Control Features: Use of a Bank
21. (L.O. 6) The use of a bank minimizes the amount of currency that must be kept on hand and therefore contributes significantly to good internal control over cash.
22. A check is a written order signed by the depositor directing the bank to pay a specified sum of money to a designated recipient. The three parties to a check are as follows: a. The maker (or drawer) who issues the check. b. The bank (or payer) on which the check is drawn. c. The payee to whom the check is payable.
23. A bank statement shows (a) checks paid and other debits charged against the account, (b) deposits and other credits made to the account, and (c) the account balance after each day’s transactions.
24. A bank debit memorandum is usually included with the bank statement to indicate charges against the depositor’s account such as a bank service charge, cost of printing checks, issuing traveler’s checks, and when a previously deposited customer’s check “bounces” because of insufficient funds (NSF check).
25. A bank credit memorandum shows such items as the collection of a note receivable for the depositor by the bank.
Reconciling the Bank Account
26. (L.O. 7) A reconciliation of a bank account is necessary because the balance per bank and balance per books are seldom in agreement. The need for agreement may be the result of time lags and errors.
27. To obtain maximum benefit from a bank reconciliation, the reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.
28. In reconciling the bank statement, it is customary to reconcile the balance per books and balance per bank to their adjusted cash balances. The reconciliation schedule consists of two sections. The steps in preparing a bank reconciliation are: a. Determine deposits in transit. b. Determine outstanding checks. c. Note any errors discovered. d. Trace bank memoranda to the depositor’s records.
29. Each reconciling item used in determining the adjusted cash balance per books should be recorded by the depositor.
Reporting Cash
30. (L.O. 8) Cash on hand, cash in banks, and petty cash are often combined and reported simply as Cash.
Because it is the most liquid asset, cash is listed first in the current assets section of the balance sheet under the title “Cash and cash equivalents.” Cash equivalents are short-term highly liquid investments that are both readily convertible to known amounts of cash, and so near their maturity that their market value is relatively insensitive to changes in interest rates. They include Treasury bills, Commercial paper, and money market funds.