Lesson 12
Internal Control and Business
Ethnics
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Outline
•
•
•
•
•
•
•
The Fundamental Principles of Internal Control
Internal Control to Cash
Explain and Record Petty Cash Fund Transactions.
Prepare a Bank Reconciliation
Exploring the Concept of Accounting Ethics
Accounting Ethics and Social Responsibilities
Accounting Ethics and Decision Making
2
Opening Story
• The Failure of Firms
and Internal Control
– Enron
– Worldcom
– CAO
3
Opening Story
• China Aviation Oil
(Singapore) Corp., an
overseas arm of China's
main jet-fuel supplier,
revealed the end of 2004
that it has racked up about
$550 million in tradingrelated losses.
4
Ranked 29th most
transparent company
Today’s organizations are concerned about:
•
•
•
•
Risk Management
Governance
Control
Assurance (and Consulting)
5
Internal Control
•
•
•
•
•
Internal Check
Internal Control
Internal Control Structure
Internal Control-----Integrated Framework
ERM
6
Internal Control
• What is internal control?
• It is the organizational plan and all the related
measures that an entity adopts to…
– safeguard assets,
– encourage adherence to company policies,
– promote operational efficiency, and...
– ensure accurate and reliable accounting records.
7
Establishing an Effective System of
Internal Control
• Characteristics of an effective internal control
system include:
– Competent, reliable, and ethical personnel
– Assignment of responsibilities
– Proper authorization
– Separation of duties
8
Separation of Duties
Separation of operations from accounting
Separation of the custody of assets from accounting
Separation of the authorization of transactions
from the custody of related assets
Separation of duties within the accounting function
9
Internal Controls for
e-Commerce
Stolen credit card numbers
Computer virus and Trojan horses
Impersonation of companies
10
Internal Controls for
e-Commerce
• What is an encryption?
• It is the primary method of achieving
confidentiality in e-commerce.
• Plain-text messages are rearranged by some
mathematical process.
• The encrypted message cannot be read by
anyone who does not know the process.
11
Internal Controls for e-Commerce
Firewall
The Internet
Corporate Intranet
Network
Computers
12
The Internal Control Integrated
Framework
13
ERM Defined
“… a process, effected by an entity's board of
directors, management and other personnel,
applied in strategy setting and across the
enterprise, designed to identify potential
events that may affect the entity, and manage
risks to be within its risk appetite, to provide
reasonable assurance regarding the
achievement of entity objectives.”
Source: COSO Enterprise Risk Management – Integrated Framework. 2004. COSO.
14
Why ERM Is Important
• Underlying principles:
– Every entity, whether for-profit
or not, exists to realize value for
its stakeholders.
– Value is created, preserved, or eroded by
management decisions in all activities, from
setting strategy to operating the enterprise dayto-day.
15
Why ERM Is Important
• ERM supports value creation by enabling
management to:
– Deal effectively with potential future events that
create uncertainty.
– Respond in a manner that reduces the likelihood
of downside outcomes and increases the upside.
16
Enterprise Risk Management
——Integrated Framework
•
This COSO ERM framework defines essential
components, suggests a common language,
and provides clear direction and guidance for
enterprise risk management.
17
The ERM Framework
•
Entity objectives can be viewed in the context
of four categories:
Strategic
– Operations
– Reporting
– Compliance
–
18
The ERM Framework
•
ERM considers activities at all levels of the
organization:
Enterprise-level
– Division or subsidiary
– Business unit processes
–
19
The ERM Framework
• Enterprise risk management
requires an entity to take a portfolio view of
risk.
20
The ERM Framework
•
•
Management considers how
individual risks interrelate.
Management develops a portfolio view from
two perspectives:
Business unit level
– Entity level
–
21
The ERM Framework
•
The eight components of the framework are
interrelated …
22
Fundamental Principles of Internal
Accounting Control
• Ensure transactions and activities are
authorized.
• Maintain adequate records.
• Insure assets.
• Separate recordkeeping and custody of assets.
• Establish a separation of duties.
23
Fundamental Principles of Accounting
Internal Control
• Apply technological controls.
• Perform internal and external audits.
Internal controls will vary based on the
nature and size of the organization.
24
Limitations of Internal Accounting
Control
Human Error
Human Fraud
Negligence
Fatigue
Misjudgment
Confusion
Intent to
defeat internal
controls for
personal gain
25
Limitations of Internal Control
The costs of internal
controls must not
exceed their benefits.
Benefit
s
Costs
26
Cash
• Is an important asset for every company.
• Control of cash on hand and access to it is
critical.
Cash includes:
– Currency
– Coins
– Deposits in bank accounts
– Other items acceptable for deposit
27
The Bank Account as a Control Device
• Documents used to control a bank account
include:
– signature card
– deposit ticket
– check
– bank statement
– bank reconciliation
28
Liquidity
• Refers to how easily an asset can be converted
into another asset or used in paying for
services or obligations.
Examples:
– Cash- highly liquid
– A specialized piece of equipment -not very liquid.
Inventory
Cash
29
The Bank Reconciliation
• What are two records of a business’s cash?
– Cash account in the business’s own general ledger.
– The bank statement which tells the actual amount
of cash the business has in the bank.
30
The Bank Reconciliation
• Items recorded by a company not on the bank
statement:
– deposit in transit
– outstanding checks
31
The Bank Reconciliation
• Items on a bank statement and not
recorded by the business:
– bank collections
– bank fees
– interest earned on account
– NSF checks
32
The Paths That Two Checks Take
(Good Check)
Maker
writes check
to payee.
Maker’s bank
pays the check.
Payee’s bank
sends check to
maker’s bank.
33
Payee
deposits check
in bank.
The Paths That Two Checks Take
(NFS Check)
Maker’s bank
balance is not
sufficient to
pay the check.
Maker’s bank
sends the
worthless
check back to
payee’s bank.
Payee’s bank
decreases payee’s
balance.
34
Payee holds
worthless
check.
The Bank Reconciliation Example
• At the beginning of July, Sahita, Inc. received the
June’s bank statement.
• It indicated the following:
• The bank balance was $63,275.
• The bank had collected a note receivable from one
of Sahita’s customers in the amount of $1,325.
35
The Bank Reconciliation Example
•
•
•
•
The bank paid the electric bill of $1,500.
There was a $200 check returned for NSF.
Interest earned on the account was $265.
Bank service charges were $12.
36
The Bank Reconciliation Example
• Sahita’s books indicates a cash balance of $66,647.
• A deposit of $11,250 was mailed to the bank on
June 30.
• Checks issued in June for $8,000 have not yet
been paid by the bank.
37
The Bank Reconciliation Example
Balance per bank, June 30
$63,275
Add deposit in transit
11,250
$74,525
Less outstanding check
Adjusted bank balance
8,000
$66,525
38
The Bank Reconciliation Example
Balance per books, June 30
Add: Note receivable
collected by the bank
Interest income
$66,647
1,325
265
$68,237
1,500
200
12
$66,525
Less: Payment of electric bill
NSF check
Service charge
Adjusted book balance
39
The Bank Reconciliation Example
Balance per books
$66,525
Balance per bank
$66,525
Equal amounts
40
Record Reconciling Items
June 30, 200x
Cash
1,325
Notes Receivable
Notes collected by the bank
1,325
June 30, 200x
Cash
265
Interest Income
265
Interest earned on bank balance
41
Record Reconciling Items
June 30, 200x
Utilities Expense
Cash
Monthly electricity expense
June 30, 200x
Accounts Receivable – NSF
Cash
NSF check returned by bank
42
1,500
1,500
200
200
Record Reconciling Items
June 30, 200x
Bank Service Fees
Cash
Bank service charges
43
12
12
Internal Controls for Cash
Guidelines:
1. Separate handling of cash from
recordkeeping of cash.
2. Deposit cash receipts daily.
3. Make cash disbursements by cheque.
44
Cash Receipts Over the Counter
• The terminal should be positioned so that customers can see
the amount the cashier enters into the cash register.
• The cash drawer should open only when the sales clerk enters
an amount on the keypad.
• The roll of tape locked inside the machine records each sale
and cash transaction.
• Pricing merchandise at “uneven” amounts means that the clerk
has to open the cash drawer.
• This requires entering the amount of the sale on the keypad
and so onto the register tape.
45
Cash Receipts Over the Counter
•
•
At the end of the day, the cashier deposits
the cash in the bank.
The tape goes to accounting.
46
Cash Receipts by Mail
• All incoming mail should be opened by a mailroom employee.
• This person should compare the check received with the
remittance advice.
• Cash receipts should be given to the cashier.
• The mailroom employee forwards the remittance advice to
accounting.
• Many companies use a lock-box system.
• Customers send their checks directly to an address that is a
bank account.
• Company personnel do not handle the cash.
47
Cash Short and Over
• Assume that the cash register tapes indicate
sales revenue of $25,000.
• However, the cash received was $24,980.
• What entry would record the day’s sales?
Cash
Cash Short and Over
Sales Revenue
Daily cash sales
24,980
20
25,000
48
Petty Cash System of Control
Good internal control procedures require cash
disbursements be made by cheque.
The exception:
Small payments required
in most companies for items such as postage, courier
fees, repairs and supplies.
This is an example of the cost-benefit limitation.
Petty Cashier
49
Control of Cash Disbursements
• All expenditures should be made by cheque.
The only exception is for small payments from
petty cash.
• Separate authorization, cheque signing and
recordkeeping duties.
• Apply a voucher system.
50
Control Over Approval of Payments
• The accounting department...
– combines all of these documents,
– checks them for accuracy, and...
– forwards this disbursement packet to designated
officers for approval and payment.
51
Controlling Petty Cash Payments
• On June 15, Sahita Inc. manager decided to
establish a $250 petty cash fund.
• What is the entry?
June 15, 200x
Petty Cash
250
Cash in Bank
250
To open the petty cash fund
52
Controlling Petty Cash Payments
• Jose is the petty cash custodian responsible for the
fund.
• On June 20, he purchased supplies in the amount of
$70.
• For each disbursement, he prepares a petty cash
ticket.
• At all times the amount of cash in the petty cash
fund plus the petty cash tickets must equal $250.
53
Controlling Petty Cash Payments
• Jose also spent $20 for delivery charges and $60 for
coffee and other miscellaneous expenses.
• What is the journal entry to record the
replenishment of the fund?
54
Controlling Petty Cash Payments
June 30, 200x
Supplies
Delivery Expense
Miscellaneous Expense
Cash in Bank
70
20
60
150
To replenish the petty cash fund
55
Ethical Values Do Matter!
• In making judgment, the Early Kings were perfect,
because they made more principles the starting
point of all their undertaking and the root of
everything that was beneficial. This principle,
however, is something that persons of mediocre
intellect never grasp. Not grasping it, they lack
awareness, and lacking awareness, they pursue profit.
But while they pursue profit, it is absolutely
impossible for them to be certain of attaining it.
--Lv Bu-wei 246BC,
The Annals of Lv Bu-wei, Lu Shi Chun Qiu
56
Ethical Values
• Ethical values have been changed immensely
in the last century.
• Ethical and moral values provide a foundation
to society on how to function, live, and work
within the society.
• Ethical values provide the foundation on
which a civilized society exists. Without the
foundation, civilization collapses.
57
Enron Cartoon
There are two levers to set a man in motion,
fear and self-interest.
Napoleon Bonaparte
——
58
Economic Boom and Ethics
• The boom of the 1990's -changing the business
environment, reshaping corporate
leadership.
• Financial scandals and out-ofhand executive compensation -- a
lapse of ethics and
unprecedented greed, a disdain
for the rule of law.
• The most pressing leadership
issue for today ---ensure that
corporate officers behave in an
ethical manner.
59
Ethical Issues in Accounting
• CEO ---- daily share price v.s. long-term corporate value
• Current compensation practices—
overstate earnings to boost pay
– short-term behavior
– excessive risk-taking
– aggressive accounting methods
• Legislation ---- tackle the accounting
irregularities issues caused by
unethical executives.
(G.Bush signed into law “Sarbanes-Oxley Act of 2002”)
60
Purposes of Ethics
• Direct business men and women to abide by a code
of conduct that facilitates, if not encourages, public
confidence in their products and services.
• In the accounting field, professional organizations
such as the AICPA, IMA, maintain and enforce a code
of professional conduct for public accountants
• They recognize the accounting profession's
responsibility to provide ethical guidelines to its
members.
61
Can One Person Make A Difference in
Business Ethics?
I am only one.
But still I am one.
I cannot do everything,
But still I can do something;
And because I cannot do everything
I will not refuse to do the something that I can do.
---Edward Everett Hale
62
Who Takes the Lead?
• At this moment, America’s highest economic
need is higher ethical standards --- standards
enforced by strict laws and upheld by
responsible business leaders.
George W. Bush, Corporate Responsibility
speech
July 9,2002
63
64
Ethics and Social Responsibility
Beliefs that
separate right
from wrong
Accepted
standards of
good and bad
behaviour
65
Often coincide
with laws
Social Responsibility
• Donations to not-forprofit organizations
• Programs to reduce
pollution and better use
natural resources
• Programs to improve
worker and consumer
safety
• Paid time off for workers
66
Guidelines for Ethical Decision Making
 Identify
Ethical Issues
 Analyze
Options
Use personal ethics
to recognize ethical
issues.
Consider both the
good and bad
consequences for all
affected.
67
 Make Ethical
Decision
Choose the best
option after
weighing all
consequences.
Professional Code of Ethics
• Accountants are held to very high standards of
conduct.
• There is no compromising.
• Would you hire an accountant who is “almost always”
honest?
• Internal controls rely upon basic honesty and
integrity.
68
Summary
• The Fundamental Principles of Internal Control
– Internal Check; Internal Control; Internal Control Structure;
Internal Control Integrated Framework; ERM.
• The Internal Accounting Control
–
–
–
–
The Purposes and Principles of Internal Control.
Internal Control to Cash
Record Petty Cash Fund Transactions.
Prepare a Bank Reconciliation.
• Ethical values have been changed immensely in the last
century
• Ethics are closely related to social responsibility
• Ethics influence people’s decision making
69
Case for Discussion
This connection will direct you to the complete
case
“HOW DO YOU MEASURE SUCCESS?”
(Click on the title of case)
70
Case for Discussion
This connection will direct you to the complete
case
“Ethics and Enron?”
http://www.businessethics.ca/enron/
71
Case for Discussion
• CCC company is a young business that has grown rapidly.The
company’s bookkeeper,who was hired two years ago,left town
suddenly after suddenly after the company ‘s manager
discovered that a great deal of money had disappeared over
the past 18 months.An audit disclosed that the bookkeeper
had written and signed several cheques made payable to the
bookkeeper’s sister,and then recorded the cheques as salaries
expense.The sister,who cashed the cheques but had never
worked for the company,left town with the bookkeeper.As a
result,the company incurred an uninsured loss of $ 600,000.
72
Case for Discussion
• Evaluate CCC company’s internal accounting
control appear to have been ignored in this
situation.
73
The End of Lesson 12