1. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 1

2. 22 Internal Control and Cash Chapter 4

3. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 3 Describe fraud and its impact

4. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 4 Fraud Intentional misrepresentation of facts Causes injury or damage to another party Large problem that increases each year

5. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 5 Types of Fraud Misappropriation of assets Employees steal assets from company Cash Inventory False expense reports Fraudulent financial reporting Managers make false entries so company appears more profitable Deceives investors and creditors

6. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 6 Fraud Triangle Motive Rationalization Opportunity

7. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 7 Explain the objectives and components of internal control

8. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 8 Internal Control Primary way fraud and errors are: ▫Prevented ▫Detected or ▫Corrected Management and Board of Directors implement a: ▫Plan of organization ▫System of procedures

9. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 9 Objectives of Internal Control Safeguard assets Encourage employees to follow policy Promote operational efficiency Ensure accurate, reliable records Comply with legal requirements

10. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 10 Sarbanes-Oxley Act (SOX) Federal law requiring public companies to have system of internal controls ▫Auditors examine controls and issue reports on reliability Provisions: ▫Require internal control report by companies ▫Create Public Company Accounting Oversight Board ▫Limit non-audit services of auditing firms ▫Penalize violators

11. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 11 Shield of Internal Control Internal Controls Fraud Waste Inefficiency Company assets

12. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 12 Control Procedures Monitoring Information System Control Environment Risk Assessment Components of Internal Control

13. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 13 Control Environment Tone at the top ▫Starts with owner(s) and top managers acting ethically Key ingredient ▫Corporate code of ethics

14. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 14 Risk Assessment Identify business risks Establish procedures to deal with risks

15. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 15 Information System and Control Procedures Information System ▫How accounting information enters and exits company ▫System must capture, process, and report transactions accurately Control procedures ▫Built-in control environment and information system ▫How companies meet five objectives of internal control

16. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 16 Monitoring Controls Prohibit one employee or a group from processing a transaction completely Program controls into computerized system Hired auditors to monitor controls ▫Internal – monitor from the inside to safeguard assets ▫External – test from the outside to ensure accounting records are accurate

17. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 17 Internal Control Procedures Smart Hiring Practices Separation of Duties ▫Asset handling ▫Record keeping ▫Transaction approval Comparison and Compliance Monitoring ▫Operating and cash budgets ▫Audits ▫Manual or computer checks

18. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 18 Internal Control Procedures Adequate Records ▫Hard copy or electronic Limited Access ▫Assets by custodians ▫Records by accounting department Proper Approvals ▫The larger the transaction, the more specific approval

19. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 19 SCALP Smart hiring practices and segregation of duties Comparisons and compliance monitoring Adequate records Limited access Proper approvals

20. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 20 Information Technology (IT) Accounting systems rely on more than ever before Examples: ▫Electronic sensors ▫Barcode scanning Basic attributes of internal control do not change ▫Procedures to implement are different Use of computers can greatly improve speed and accuracy

21. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 21 Safeguard Controls Fireproof vaults Security cameras Fidelity bonds Mandatory vacations Loss prevention specialists Job rotation

22. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 22 Internal Controls for E-Commerce Pitfalls of e-commerce ▫Stolen credit card numbers ▫Computer viruses and Trojan Horses ▫Phishing expeditions Security measures ▫Encryption ▫Firewalls

23. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 23 Costs and Benefits of Internal Control Ways good internal control can be circumvented ▫Collusion ▫Management override ▫Fatigue & negligence The stricter the internal control, the more it costs ▫The benefits should outweigh the costs

24. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 24 Design and use a bank reconciliation

25. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 25 Bank Account as Control Device Signature card Bank statement Deposit ticket Bank reconciliation Check

26. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 26 Bank Account Documents Signature card ▫Protects against forgery Deposit ticket ▫Proof of transaction Check ▫Maker – signs the check ▫Payee – to whom the check is paid ▫Bank – where funds are drawn

27. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 27 Bank Statement Reports: ▫Cash receipts ▫Cash payments Electronic Funds Transfer (EFT) ▫Make payments by electronic communication

28. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 28 Bank Reconciliation Two records of a business’s cash ▫The Cash account in the general ledger ▫The bank statement Amounts are usually different ▫Time lags in recording transactions Bank reconciliation explains differences

29. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 29 Bank Side of the Reconciliation Deposits in transit Outstanding checks Bank errors

30. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 Book Side of the Reconciliation Bank collections Electronic funds transfers (EFT) Service charges Interest revenue Nonsufficient funds (NSF) checks Cost of printed checks Book errors

31. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 31 Exercise 4-21A Bank:Books: Balance, November 30$570Balance, November 30$1,780 Add: Deposit in transit1,765 EFT rent collection335 Less: Service charges(18) Less: NSF checks(120) Outstanding checks(601) Correction of error(243) $1,734

32. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 32 Summary of Reconciling Items BANK BALANCE - ALWAYSBOOK BALANCE - ALWAYS Add deposits in transitAdd bank collections, interest revenue, and EFT receipts Subtract outstanding checksSubtract services charges, NSF checks, EFT payments Add or subtract correction of bank errors Add or subtract correction of book errors

33. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 33 Journalizing Bank Reconciliation Items All items on the book side of the bank reconciliation require journal entries If the item is added to book side ▫Debit Cash If the items is subtracted from the book side ▫Credit Cash

34. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 34 JOURNAL DateAccounts and explanationDebitCredit Cash Interest Revenue To record interest earned on the bank statement Cash Accounts Receivable Account receivable collected by bank Miscellaneous Expense Cash Bank service charges Accounts Receivable Cash NSF check returned by bank

35. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 35 Evaluate internal controls over cash receipts and cash payments

36. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 36 Internal Control over Cash Cash is easy to steal All transactions ultimately affect cash Cash receipts should be deposited quickly Companies can receive cash ▫Over the counter ▫Through the mail

37. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 37 Cash Receipts over the Counter Point-of-sale terminals provide control over cash receipts ▫Also record sale, cost of item sold, and reduction to inventory Customer issued a receipt as proof of purchase Sales associate turns in cash drawer at end of shift ▫Combined with other cash and deposited Accounting department reconciles sales per terminal to cash in drawer

38. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 38 Cash Receipts by Mail Mailroom Checks Remittance advices Accounting Department Treasurer Debit to Cash Deposit receipt Bank Controller

39. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 39 Controls Over Payments by Check Payment by check or EFT payment is an important internal control ▫Provides record of the payment ▫Check must be signed by an authorized official ▫EFT must be approved by an authorized official ▫Should be supported by evidence payment

40. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 40 Cash Payments by Check Receiving Report Invoice Inventory Purchase Order Check or EFT Company A Company X 1 4 3 2 2

41. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 41 Internal Control for Purchasing Segregate the following duties: ▫Purchasing ▫Receiving ▫Approving and Paying

42. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 42 Payment Packet Receiving Report Invoice Purchase Order

43. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 43 Petty Cash Small fund to make minor purchases One employee is responsible for the accounting ▫Custodian Set amount of cash Voucher prepared for each payment Sum of fund plus paid voucher should equal set amount ▫Imprest system

44. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 44 Construct and use a cash budget

45. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 45 Budgeting Budget ▫Financial plan to coordinate activities Cash budget ▫Planning receipts and payments Steps: ▫Start with beginning cash balance ▫Add budgeted receipts and subtract budget payments ▫Equals expected cash balance ▫Compare cash available to budgeted cash balance

46. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 46 Expected Cash Balance If expected cash is greater than minimum needed Invest excess If expected cash is less than minimum needed Consider borrowing

47. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 47 Cash Budget Beginning cash balance Budgeted cash receipts: Collections from customers Dividends from investments Sale of plant and equipment Budgeted cash payments: Purchases of inventory Operating expenses Purchase of long-term assets Payment of dividends Payment of long-term debt Cash available (needed) Budgeted cash balance, end of period Cash available for investing or (new financing needed)

48. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 48 Exercise 4-25A Cash Budget - Gale Communications Inc. Beginning cash balance $78 Budgeted cash receipts: Collections from customers 11,335 Sale of assets 157 11,570 Budgeted cash payments: Cost of services and products $6,169 Operating expense 2,553 Purchase of new equipment 1,822 Debt payments 578 Cash dividends 35811,480

49. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 49 Cash available $90 Budgeted cash balance, end of period (78) Cash available for investing $12 Exercise 4-25A (continued)

50. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 50 Reporting Cash on the Balance Sheet All cash accounts combined into a single total ▫Cash & Cash Equivalents Cash equivalents include ▫Time deposits ▫Certificates of deposit ▫High grade government securities

51. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 51 Compensating Balances Cash balance should not include cash that is restricted in any way Company that borrows agrees to maintain a minimum cash balance ▫Compensating balance agreement

52. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 52

53. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 53