1. 7-1 FRAUD, INTERNAL CONTROL, AND CASH 7 Remember… people will lie, cheat and steal! Not everybody…. and not all the time.… but they do….

2. 7-2 Fraud and Internal Control Fraud: An intentional dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Three factors that contribute to fraudulent activity. Rationalization, Opportunity & Need (financial pressure) So when you think of fraud, you think of RON!

3. 7-3 Firms should have methods and measures adopted to: 1.Safeguard assets (assets & data might be stolen or destroyed). 2.Enhance accuracy & reliability of acct. records (reduce errors/fraud). 3.Increase efficiency of operations (better goods at a lesser cost). 4.Ensure compliance with laws & regulations (tax laws, banking laws). Fraud and Internal Control Internal Control Limitations of Internal Control  Costs should not exceed benefits (don’t spend $3,000 on controls to save only $900 in potential losses).  The human element (mistakes or misunderstandings, or worse, collusion - 2 or more people intentionally overriding controls).  The size of the business (a small company would have a hard time with the separation of duties - not enough employees).

4. 7-4 Establishment of Responsibility Control is most effective when only one person has responsibility for a given task (e.g., assign only 1 person to a cash register at a time) Separation (Segregation) of Duties Related duties should be assigned to different individuals (e.g., separate the Authorization, Recording, Custody of cash), using only 1 person increases the potential for errors and fraud. A very small company would have difficulty with the separation of duties (few employees). Documentation Procedures Companies should use pre-numbered documents and checks. All documents should be accounted for (have a supervisor or someone independent account for all used and unused documents). Principles of Internal Control Activities Fraud and Internal Control

5. 7-5 Physical Controls Fraud and Internal Control Internal Control Activities

6. 7-6 Independent Internal Verification 1.Accounting records and supporting documents should be periodically verified by an independent employee or the internal auditors. 2. Discrepancies should be reported to management. Human Resource Controls 1.Background checks are conducted before hiring 2.Bonding employees - insurance against employees misappropriating (stealing) or misusing assets. 3.Rotate employees’ duties and require vacations. Fraud and Internal Control More Principles of Internal Control Activities

7. 7-7 Cash Receipts and Disbursements Controls

8. 7-8 Cash Receipts Controls  Only 1 person assigned to a cash register at a time. Cash in the register must be compared to the register tapes by a supervisor.  Mail receipts should be opened by 2 people, a remittance list is prepared, and each check endorsed “for deposit only”.  Each mail clerk signs the remittance list to establish responsibility.  The original remittance list, along with the checks, is sent to the cashier’s department. The checks are deposited in the bank and the treasurer matches the original bank deposit slip to the remittance list (to make sure all the cash received got deposited).  A copy of the remittance list is sent to the accounting department for updating the listed accounts receivable accounts for the payments. This is done after the treasurer has approved the deposit.

9. 7-9 Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash. All payments should be supported with documentation. The Voucher system is a network of documentation showing approvals, by authorized individuals, to ensure all disbursements by check are proper.  The voucher is an authorization form prepared for each expenditure. A completed form indicates that an authorized purchase order, a receiving report, and the billing invoice all agree and are appropriate. These documents support or “vouch” the cash disbursement. Cash Disbursements Controls

10. 7-10 Using a bank contributes to good internal control over cash.  Minimizes the amount of currency on hand (don’t keep all your cash in a drawer or in a safe at the store or office).  Creates a double record of bank transactions (the company’s records of the cash account and the banks records).  The bank reconciliation (agrees the company’s cash account balance to the bank’s balance of the account). Control Features: Use a Bank Electronic Funds Transfers (EFT)  EFT disbursement systems use wire, smartphones, or computers to transfer cash balances between locations (direct deposit of payroll into your account is faster and safer).

11. 7-11 Bank Debit Memorandums  The bank decreases your account from withdrawls or checks that clear the bank.  Bank service fees  NSF (non-sufficient funds) worthless checks you’ve deposited and ”bounced” Bank Credit Memorandums  The bank increases your account from deposits.  Collect notes receivable.  Adding interest earned. Control Features: Use of a Bank Bank Statements Increases Decreases

12. 7-12 Reconciliation Procedures + Deposit in Transit - Outstanding Checks +/- Bank Errors (very rare) +Notes collected by bank -NSF (bounced) checks -Service charges (monthly fees, printing checks, etc.) +/-Book Errors you’ve made CORRECT BALANCE Illustration 7-8 Control Features: Use of a Bank

13. 7-13 Exam Practice Problem #1: The balance per bank is $700; the balance in your checkbook is $830. Perform a bank reconciliation by recording the following adjustments. The bank statement doesn’t show: 1. Your company has a deposit in transit of $200 2. Your company has one outstanding check of $100 Your company doesn’t know: 3. The bank statement indicates a NSF check of $50 4. The bank statement indicates a service charge of $20 5. The bank statement indicates interest earned of $40 See the next couple of slides for the solution A Bank Reconciliation Example #1

14. 7-14 Your adjustments to the $700 balance per the bank Step 1: Deposit in transit – add $200 to the bank Step 2: Outstanding checks – subtract $100 from bank Your adjustments to the $830 balance in your checkbook Step 3: The bank statement indicated a NSF check. Subtract $50 from the checkbook! The check you deposited was worthless - it bounced! Put the A/R back on your books. Step 4: The bank statement indicated a service charge subtract $20 from the checkbook. Step 5: The bank statement indicated you’ve earned interest of add $40 to the checkbook Analyzing A Bank Reconciliation #1

15. 7-15 Cash balance per bank$700 Add Deposits in transit 200 Subtract Outstanding checks (100) Adjusted cash balance per bank $800 Cash balance per your checkbook$830 Interest earned (add) 40 NSF check (subtract) (50) Bank service charge of $20 (subtract) (20) Adjusted cash balance per books $800 Preparing the Bank Reconciliation #1 NOTE: The only journal entries we make in our books are the ones to our check books!

16. 7-16 Cash 40 Bank service charge expense 20 Accounts receivable* 50 Interest revenue 40 Since all these entries affect Cash! We could make 3 separate entries, but that’s unnecessary – see next slide using just 1 entry Dr. Cr. Adjusting Cash from the Bank Reconciliation #1 Cash 20 Cash 50 *Note: The reason we debit A/R is because a customer’s check bounced (the bank calls this a NSF check)! This person still owes you the money!

17. 7-17 Cash 30 Bank service charge expense 20 Accounts receivable* 50 Interest revenue 40 On the exam you’ll need to perform a bank reconciliation and journalize the adjusting entries. Note all these entries affect Cash! Dr.Cr. Adjusting Cash from the Bank Reconciliation #1 *Note: The reason we debit A/R is because a customer’s check bounced (the bank calls this a NSF check)! This person still owes you the money!

18. 7-18 Exam Practice Problem #2: The balance per bank is $1,400; the balance per your checkbook is $1,660. Perform a bank reconciliation by recording the following adjustments. The bank statement doesn’t show: 1. The company has a deposit in transit of $500 2. The company has one outstanding check of $100 The company (you) doesn’t know: 3. The bank statement indicated a NSF check of $150 4. The bank statement indicated a service charge of $10 5. The bank statement indicated interest earned of $300 See the next couple of slides for the solution Bank Reconciliation Example #2

19. 7-19 Cash balance per bank$1400 Add Deposits in transit 500 Subtract Outstanding checks (100) Adjusted cash balance per bank $1800 Cash balance per your checkbook$1660 Interest earned (add) 300 NSF check (subtract) (150) Bank service charge of $20 (subtract) (10) Adjusted cash balance per books $1800 Preparing the Bank Reconciliation #2 The only journal entries we make are the ones to our check books

20. 7-20 Cash 140 Bank service charge expense 10 Accounts receivable 150 Interest revenue 300 On the exam you’ll need to perform a bank reconciliation and journalize the adjusting entries. All these entries affect Cash! Dr.Cr. Adjusting Cash from the Bank Reconciliation #2 Again, we use A/R is because the NSF check bounced! Also, in this example, we earned enough interest to show that we ultimately increase cash by $140!