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Slide 7-1. Slide 7-2 Chapter 7 Fraud, Internal Control, and Cash Financial Accounting, IFRS Edition Weygandt Kimmel Kieso.

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Presentation on theme: "Slide 7-1. Slide 7-2 Chapter 7 Fraud, Internal Control, and Cash Financial Accounting, IFRS Edition Weygandt Kimmel Kieso."— Presentation transcript:

1 Slide 7-1

2 Slide 7-2 Chapter 7 Fraud, Internal Control, and Cash Financial Accounting, IFRS Edition Weygandt Kimmel Kieso

3 Slide Define fraud and internal control Identify the principles of internal control activities Explain the applications of internal control principles to cash receipts Explain the applications of internal control principles to cash disbursements Describe the operation of a petty cash fund Indicate the control features of a bank account Prepare a bank reconciliation Explain the reporting of cash. Study Objectives

4 Slide 7-4 Fraud Internal control Principles of internal control activities Limitations Cash equivalents Restricted cash Compensating balances Making deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer (EFT) system Over-the- counter receipts Mail receipts Fraud and Internal Control Cash Receipts Controls Control Features: Use of a Bank Reporting Cash Cash Disbursement Controls Fraud, Internal Control, and Cash Voucher system controls Petty cash fund controls

5 Slide 7-5 Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Fraud and Internal Control Fraud SO 1 Define fraud and internal control. Why does fraud occur? Illustration 7-1

6 Slide 7-6 Answer on notes page

7 Slide 7-7 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. Fraud and Internal Control SO 1 Define fraud and internal control. Internal Control

8 Slide 7-8 Internal control systems have five primary components A control environment Risk assessment Control activities Information and communication Monitoring Fraud and Internal Control SO 1 Define fraud and internal control. Internal Control

9 Slide 7-9 Measures vary with management’s assessment of the risks faced. size and nature of the company. SO 2 Identify the principles of internal control activities. Principles of Internal Control Activities Fraud and Internal Control Six principles of controls activities:  Establishment of responsibility  Segregation of duties  Documentation procedures  Physical controls  Independent internal verification  Human resource controls

10 Slide 7-10 ESTABLISHMENT OF RESPONSIBILITY Control is most effective when only one person is responsible for a given task. SEGREGATON OF DUTIES Related duties, including physical custody and record keeping, should be assigned to different individuals. DOCUMENTATION PROCEDURES Companies should use prenumbered documents and all documents should be accounted for. Fraud and Internal Control Principles of Internal Control Activities SO 2 Identify the principles of internal control activities.

11 Slide 7-11 SO 2 Fraud and Internal Control

12 Slide 7-12 Fraud and Internal Control SO 2 Identify the principles of internal control activities.

13 Slide 7-13 SO 2 Fraud and Internal Control

14 Slide 7-14 PHYSICAL CONTROLS Illustration 7-2 Fraud and Internal Control Principles of Internal Control Activities SO 2 Identify the principles of internal control activities.

15 Slide 7-15 INDEPENDENT INTERNAL VERIFICATION 1.Verify records periodically or on a surprise basis. 2.Verify records by an employee who is independent. 3. Discrepancies reported to management. Fraud and Internal Control Illustration 7-3 Principles of Internal Control Activities SO 2 Identify the principles of internal control activities.

16 Slide 7-16 HUMAN RESOURCE CONTROLS 1.Bond employees. 2.Rotate employees’ duties and require vacations. 3.Conduct background checks. Fraud and Internal Control Principles of Internal Control Activities SO 2 Identify the principles of internal control activities.

17 Slide 7-17 SO 2 Fraud and Internal Control

18 Slide 7-18 Fraud and Internal Control SO 2

19 Slide 7-19 Fraud and Internal Control SO 2

20 Slide 7-20 Answer on notes page

21 Slide 7-21 Limitations of Internal Control Costs should not exceed benefit. Human element. Size of the business. Fraud and Internal Control SO 2 Identify the principles of internal control activities.

22 Slide 7-22 SO 3 Explain the applications of internal control principles to cash receipts. Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips 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 Illustration 7-4 Cash Receipts Controls Over-the-Counter Receipts

23 Slide 7-23 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 SO 3 Explain the applications of internal control principles to cash receipts. Cash Receipts Controls

24 Slide 7-24 Over-the- Counter Receipts SO 3 Explain the applications of internal control principles to cash receipts. Illustration 7-5

25 Slide 7-25 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, 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. SO 3 Explain the applications of internal control principles to cash receipts. Cash Receipts Controls Mail Receipts

26 Slide 7-26 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. Review Question SO 3 Explain the applications of internal control principles to cash receipts. Cash Receipts Controls

27 Slide 7-27 Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash. Applications: Voucher system Petty cash fund Cash Disbursement Controls SO 4 Explain the applications of internal control principles to cash disbursements.

28 Slide 7-28 Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly 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 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 Illustration 7-6 Human Resource Controls Bond personnel who handle cash; require employees to take vacations; conduct background checks Cash Disbursement Controls

29 Slide 7-29 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. Review Question SO 4 Explain the applications of internal control principles to cash disbursements. Cash Disbursement Controls

30 Slide 7-30 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. SO 4 Explain the applications of internal control principles to cash disbursements. Voucher System Controls Cash Disbursement Controls

31 Slide 7-31 Petty Cash Fund - U sed to pay small amounts. Involves: 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund. SO 5 Describe the operation of a petty cash fund. Petty Cash Fund Controls Cash Disbursement Controls

32 Slide 7-32 Illustration: If Laird Company decides to establish a $100 fund on March 1, the journal entry is: SO 5 Describe the operation of a petty cash fund. Petty cash100Mar. 1 Cash 100 Cash Disbursement Controls

33 Slide 7-33 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: SO 5 Describe the operation of a petty cash fund. Postage expense44Mar. 15 Cash 87 Freight-out38 Miscellaneous expense5 Cash Disbursement Controls

34 Slide 7-34 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: SO 5 Describe the operation of a petty cash fund. Postage expense44Mar. 15 Cash 88 Freight-out38 Miscellaneous expense5 Cash over and short1 Cash Disbursement Controls

35 Slide 7-35 Contributes to good internal control over cash. Minimizes the amount of currency on hand. Creates a double record of bank transactions. Bank reconciliation. Control Features: Use of a Bank SO 6 Indicate the control features of a bank account.

36 Slide 7-36 Making Bank Deposits Authorized employee should make deposit. SO 6 Indicate the control features of a bank account. Bank Code Numbers Front Side Reverse Side Illustration 7-8 Control Features: Use of a Bank

37 Slide 7-37 Writing Checks Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient. SO 6 Indicate the control features of a bank account. Maker Payee Illustration 7-9 Payer Control Features: Use of a Bank

38 Slide 7-38 Bank Statements Debit Memorandum Bank service charge NSF (not sufficient funds) SO 6 Indicate the control features of a bank account. Illustration 7-10 Credit Memorandum Collect notes receivable. Interest earned. Control Features: Use of a Bank

39 Slide 7-39 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. Review Question SO 6 Indicate the control features of a bank account. Control Features: Use of a Bank

40 Slide 7-40 Reconciling the Bank Account SO 7 Prepare a bank reconciliation. 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. Control Features: Use of a Bank

41 Slide 7-41 Reconciliation Procedures SO 7 Prepare a bank reconciliation. + Deposit in Transit - Outstanding Checks +- Bank Errors +Notes collected by bank -NSF (bounced) checks -Check printing or other service charges +-Company Errors CORRECT BALANCE Illustration 7-11 Control Features: Use of a Bank

42 Slide 7-42 Illustration: Illustration: The bank statement for Laird Company (Illustration 7-12), shows a balance per bank of $15, on April 30, On this date the balance of cash per books is $11, Using the four reconciliation steps, Laird determines the following reconciling items. Control Features: Use of a Bank

43 Slide 7-43 Illustration: Illustration: a) Prepare a bank reconciliation at April 30. SO 7 Prepare a bank reconciliation. Cash balance per bank statement$15, Add: Deposit in transit2, Less:Outstanding checks(5,904.00) Adjusted cash balance per bank$12, Cash balance per books$11, Collection of notes + interest - fee1, Add:Error in recording check no Less:NSF check(425.60) Bank service charge(30.00) Adjusted cash balance per books$12, Control Features: Use of a Bank Illustration 7-12

44 Slide 7-44 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: Cash 1,035.00Apr. 30 Miscellaneous expense15.00 Notes receivable1, Interest revenue50.00 Control Features: Use of a Bank SO 7 Prepare a bank reconciliation.

45 Slide 7-45 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: Cash 36.00Apr. 30 Accounts payable36.00 Control Features: Use of a Bank SO 7 Prepare a bank reconciliation.

46 Slide 7-46 NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is: Accounts receivable425.60Apr. 30 Cash Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense. The entry is: Miscellaneous expense30.00Apr. 30 Cash30.00 Control Features: Use of a Bank SO 7 Prepare a bank reconciliation.

47 Slide 7-47 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. Review Question SO 7 Prepare a bank reconciliation. Control Features: Use of a Bank

48 Slide 7-48 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. Control Features: Use of a Bank SO 7 Prepare a bank reconciliation.

49 Slide 7-49 Reporting Cash SO 8 Explain the reporting of cash. Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository. Cash equivalents Restricted cash Compensating balances Illustration 7-14 While cash equivalents are now frequently reported with cash, it appears likely that the IASB will end this practice in the future. Instead, items now referred to as cash equivalents will be reported as short-term investments.

50 Slide 7-50 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. Review Question Reporting Cash SO 8 Explain the reporting of cash.

51 Slide 7-51 The fraud triangle discussed in this chapter is applicable to U.S. companies as well. Some of the most infamous U.S. fraud scandals are Enron, Worldcom, and, more recently, the Bernie Madoff ponzi scheme. After numerous corporate scandals, the U.S. Congress passed the Sarbanes-Oxley Act of 2002 (SOX). Under SOX, all publicly traded U.S. corporations are required to maintain an adequate system of internal control. As a result of SOX, corporate executives and boards of directors must ensure that internal controls are reliable and effective. In addition, independent outside auditors must attest to the adequacy of the internal control system. Understanding U.S. GAAP Key Differences Fraud, Internal Control, and Cash

52 Slide 7-52 SOX created the Public Company Oversight Board (PCAOB), to establish auditing standards and regulate auditor activity. One study estimates the cost of compliance for U.S. companies at over $35 billion, with audit fees doubling in the first year of compliance. At the same time, examination of internal controls indicates lingering problems in the way companies operate. One study of first compliance with the internal-control testing provisions documented material weaknesses for about 13% of companies reporting in 2004 and 2005 (PricewaterhouseCoopers’ Global Economic Crime Survey, 2005). Understanding U.S. GAAP Key Differences Fraud, Internal Control, and Cash

53 Slide 7-53 The enhanced internal control standards apply only to large public companies listed on U.S. exchanges. There is continuing debate over whether foreign issuers should have to comply with this extra layer of regulation. Most companies report cash and cash equivalents together under IFRS and GAAP, as shown in this textbook. In addition, GAAP follows the same accounting policies related to the reporting of restricted cash. Understanding U.S. GAAP Key Differences Fraud, Internal Control, and Cash

54 Slide 7-54 Looking to the Future Understanding U.S. GAAP High-quality international accounting requires both high-quality accounting standards and high-quality auditing. Similar to the convergence of GAAP and IFRS, there is a movement to improve both U.S. and international auditing standards.The International Auditing and Assurance Standards Board (IAASB) functions as an independent standard-setting body. It works to establish high- quality auditing and assurance and quality-control standards throughout the world. Whether the IAASB adopts internal control provisions similar to those in SOX remains to be seen. Also, under proposed new standards being developed jointly by the FASB and IASB for financial statement presentation, cash equivalents cannot be combined with cash. Fraud, Internal Control, and Cash

55 Slide 7-55 “Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” CopyrightCopyright


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