Chapter Four Internal Controls, Accounting for Cash, and Ethics © 2015 McGraw-Hill Education.

An Integrated Framework 1.Control Environment – integrity and ethical values of a company 2.Risk Assessment – management identification of potential risks 3.Control Activities – internal controls 4.Information and Communication – internal and external reporting process 5.Monitoring – over time assessment and correction of internal controls 4-2

Internal Controls 1.Separation of Duties 2.Quality of Employees 3.Bonded Employees 4.Required Absences 5.Procedures Manual 6.Authority and Responsibility 7.Prenumbered Documents 8.Physical Control 9.Performance Evaluations 4-3

Separation of Duties When duties are separated, the work of one employee can act as a check on the work of another employee. The likelihood of fraud or theft is greatly reduced. 4-4

Quality of Employees The ability of cross-trained employees to substitute for one another prevents disruptions in the workplace. Job rotation may help relieve boredom and increase productivity. 4-5

Bonded Employees A fidelity bond provides insurance that protects a company from loss caused by employee dishonesty. To become bonded, an employee’s background is investigated. 4-6

Required Absences An employee may be able to cover up fraudulent activities if they are always present at work. All employees should be required to take regular vacations and their duties should be rotated periodically. 4-7

Procedures Manual Accounting and other important procedures should be written in a procedures manual. Periodically,. management should conduct an investigation to see that required procedures are actually being followed. 4-8

Authority and Responsibility General authority applies to all members of the organization. For example, all employees are required to fly coach and purchase airline tickets from a specific vendor. Specific authority applies only to a specific position within the organization. For example, all checks must be cosigned by the Controller and Treasurer. 4-9

Prenumbered Documents Prenumbered forms are used for all important documents such as checks, purchase orders, receiving reports, and invoices. The use of prenumbered forms helps keep track of all forms issued during a particular period. 4-10

Physical Control All companies should maintain adequate physical control over valuable assets that may be misappropriated. For example, inventory should be properly stored in a secure location. Serial numbers should be placed on all valuable assets to assist in a physical count of these assets. 4-11

Performance Evaluation Internal controls should include independent verification of employee performance. A physical inventory should be taken at least annually by someone other than a person who has control over inventory. An independent reconciliation between the general ledger balance and inventory should be compared to the inventory count. Auditors should evaluate the effectiveness of the control system. 4-12

Limitations Internal controls can be circumvented by collusion among employees. Two or more employees working together can hide embezzlement by covering for each other. No system can prevent all fraud. Good internal controls minimize fraud and increase likelihood of detection. 4-13

Accounting for Cash Controlling Cash Cash receipts should be recorded immediately upon receipt and deposited intact daily. Cash disbursements should be made by prenumbered check. Up to date signature card should be maintained. A deposit ticket should be used for all deposits. A monthly bank reconciliation should be prepared by an independent party. 4-14

Reconciling the Bank Account The bank reconciliation reports on the differences between the balance on the bank statement and the balance in the general ledger cash account. The reconciliation results in the true cash balance that will appear on the balance sheet. 4-15

Reconciling the Bank Statement If an error is found on the bank statement, an adjustment for it is made to the unadjusted bank balance to determine the true cash balance. An error found on our book balance requires an adjustment to our books. 4-16

Importance of Ethics  The accountant’s role requires trust and credibility.  Accounting information is worthless if the accountant is not trustworthy.  Therefore, the accounting profession requires high ethical standards. 4-17

The Fraud Triangle RationalizationPressure Opportunity Key to protecting yourself and your company: personal integrity. 4-18

Materiality and Financial Audits Auditors do not guarantee that financial statements are absolutely correct—only that they are materially correct. Material Item An error, or other reporting problem, that would influence the decision of an average prudent investor. 4-19

Types of Audit Opinions UnqualifiedAdverse QualifiedDisclaimer 4-20

End of Chapter Four 4-21