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Slide 7-2 Chapter 7 Fraud, Internal Control, and Cash Financial Accounting, Seventh Edition

Slide Define fraud and internal control Identify the principles of internal control 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

Slide 7-4 Fraud The Sarbanes- Oxley Act 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

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

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Slide 7-7 Companies must develop principles of control over financial reporting. continually verify that controls are working. Fraud and Internal Control The Sarbanes-Oxley Act 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.

Slide 7-8 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. Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control. Internal Control

Slide 7-9 Internal control systems have five primary components 1.A control environment 2.Risk assessment 3.Control activities 4.Information and communication 5.Monitoring Fraud and Internal Control SO 1 Define fraud and internal control. Internal Control

Slide 7-10 Measures vary with management’s assessment of the risks faced. size and nature of the company. SO 2 Identify the principles of internal control. 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

Slide 7-11 SO 2 Identify the principles of internal control. 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. Fraud and Internal Control Principles of Internal Control Activities

Slide 7-12 SO 2 Fraud and Internal Control

Slide 7-13 SO 2 Identify the principles of internal control. Fraud and Internal Control

Slide 7-14 SO 2 Fraud and Internal Control

Slide 7-15 SO 2 Identify the principles of internal control. PHYSICAL CONTROLS Illustration 7-2 Fraud and Internal Control Principles of Internal Control Activities

Slide 7-16 SO 2 Identify the principles of internal control. INDEPENDENT INTERNAL VERIFICATION 1.Verify records periodically or on a surprise basis. 2.Records verified by an employee who is independent. 3. Discrepancies reported to management. Fraud and Internal Control Illustration 7-3 Principles of Internal Control Activities

Slide 7-17 SO 2 Identify the principles of internal control. 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

Slide 7-18 SO 2 Fraud and Internal Control

Slide 7-19 Fraud and Internal Control SO 2

Slide 7-20 Fraud and Internal Control SO 2

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Slide 7-22 SO 2 Identify the principles of internal control. Limitations of Internal Control Costs should not exceed benefit. Human element. Size of the business. Fraud and Internal Control

Slide 7-23 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

Slide 7-24 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

Slide 7-25 Over-the- Counter Receipts SO 3 Explain the applications of internal control principles to cash receipts. Illustration 7-5

Slide 7-26 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 Receipts Controls Mail Receipts

Slide 7-27 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

Slide 7-28 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.

Slide 7-29 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

Slide 7-30 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

Slide 7-31 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

Slide 7-32 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

Slide 7-33 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

Slide 7-34 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

Slide 7-35 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

Slide 7-36 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.

Slide 7-37 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

Slide 7-38 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

Slide 7-39 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

Slide 7-40 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

Slide 7-41 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

Slide 7-42 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

Slide 7-43 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

Slide 7-44 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

Slide 7-45 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.

Slide 7-46 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.

Slide 7-47 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.

Slide 7-48 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

Slide 7-49 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.

Slide 7-50 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

Slide 7-51 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.

Slide 7-52  Identity thieves determine your identity by going through your mail or trash, stealing your credit cards, redirecting mail through change of address forms, or acquiring personal information you share on unsecured sites. In a recent year, more than 7 million people were victims of identity theft.  During a single computer-virus outbreak, called the “ Hearse, ” thieves stole 90,000 pieces of personal data.  The average identity-theft victim spends 600 hours clearing up his or her finances and financial and other records to recover from the crime. Protecting Yourself from Identity Theft

Slide 7-53  Victims incur an average of $1,400 in out-of-pocket expenses.  Consumers have $1.7 trillion worth of assets with online brokerage firms. Many of the largest identity theft losses have been the result of thieves completely cleaning out online brokerage accounts.  The Federal Trade Commission reports identify theft is the No. 1 fraud complaint among consumers. Phoenix and Las Vegas top the list for identity theft per capita. Protecting Yourself from Identity Theft

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Slide 7-55 Do you feel it is safe to store personal financial data (such as Social Security numbers and bank and credit account numbers) on your computer? YES: I have anti-virus software that will detect and stop any intruder. NO: Even the best anti-virus software does not detect every kind of intruder.

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