Fraud and Internal Control 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? SO 1 Define fraud and internal control.

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). SO 1 Define fraud and internal control.

Fraud and Internal Control Methods and measures adopted to: Safeguard assets. Enhance accuracy and reliability of accounting records. Increase efficiency of operations, and 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. SO 1 Define fraud and internal control.

Fraud and Internal Control Internal control systems have five primary components A control environment Risk assessment Control activities Information and communication Monitoring 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: Establishment of responsibility Segregation of duties 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. 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. SO 2 Identify the principles of internal control.

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

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

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

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

Cash Receipts Controls Over-the-Counter Receipts 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 SO 3 Explain the applications of internal control principles to cash receipts.

Over-the-Counter Receipts Illustration 7-5 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. 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 SO 4 Explain the applications of internal control principles to cash disbursements.

Cash Disbursement Controls Illustration 7-6 Documentation Procedures Use prenumbered checks; checks must have an approved invoice; require employees to use corporate credit cards for reimbursable expenses Establishment of Responsibility Only designated personnel are authorized to sign checks (treasurer) and approve vendors 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 Segregation of Duties Different individuals approve and make payments; check signers do not record disbursements Physical Controls Store blank checks in safes, with limited access; print check amounts by machine in indelible ink

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. 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: establishing the fund, making payments from the fund, and replenishing the fund. 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 100 Cash 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 5 Cash 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 88 SO 5 Describe the operation of a petty cash fund.