chapter 8-1. chapter 8-2 chapter 8 fraud, internal control, and cash accounting principles, ninth...

Chapter 8-1

Chapter 8-2

Chapter 8

Fraud, Internal

Control, and Cash

Accounting Principles, Ninth Edition

Chapter 8-3

1. Define fraud and internal control.

2. Identify the principles of internal control.

3. Explain the applications of internal control principles to cash receipts.

4. Explain the applications of internal control principles to cash disbursements.

5. Describe the operation of a petty cash fund.

6. Indicate the control features of a bank account.

7. Prepare a bank reconciliation.

8. Explain the reporting of cash.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 8-4

FraudFraud

The Sarbanes-The Sarbanes-Oxley ActOxley Act

Internal controlInternal control

Principles of Principles of internal controlinternal control

LimitationsLimitations

Cash equivalentsCash equivalents

Restricted cashRestricted cash

Compensating Compensating balancesbalances

Making depositsMaking deposits

Writing checksWriting checks

Bank statementsBank statements

Reconciling the Reconciling the bank accountbank account

Electronic funds Electronic funds transfer (EFT) transfer (EFT) systemsystem

Cash receipts Cash receipts controlscontrols

Cash Cash disbursements disbursements controlscontrols

Fraud and Fraud and Internal ControlInternal Control

Fraud and Fraud and Internal ControlInternal Control Cash ControlsCash ControlsCash ControlsCash Controls

Control Control Features: Use of Features: Use of

a Banka Bank

Control Control Features: Use of Features: Use of

a Banka BankReporting CashReporting CashReporting CashReporting Cash

Fraud, Internal Control, and CashFraud, Internal Control, and CashFraud, Internal Control, and CashFraud, Internal Control, and Cash

Chapter 8-5

Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.

Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control

FraudFraud

SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.

Why does fraud occur?

Illustration 8-1

Chapter 8-6

Chapter 8-7

Companies must

develop principles of control over financial reporting.

continually verify that controls are working.


The Sarbanes-Oxley ActThe Sarbanes-Oxley Act

Independent auditors must attest to the adequacy

of internal control.

SOX created the Public Company Accounting Oversight Board (PCAOB).


Chapter 8-8

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.



Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of

internal control.

Internal ControlInternal Control

Chapter 8-9

Internal control systems have five primary components

1. A control environment

2. Risk assessment

3. Control activities

4. Information and communication

5. Monitoring



Internal ControlInternal Control

Chapter 8-10

Measures vary with

management’s assessment of the risks faced.

size and nature of the company.

SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.

Principles of Internal Control Principles of Internal Control ActivitiesActivities


Six principles of controls activities:

Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls

Chapter 8-11 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.

ESTABLISHMENT OF RESPONSIBILITYESTABLISHMENT OF RESPONSIBILITY

Control is most effective when only one person is Control is most effective when only one person is responsible for a given task.responsible for a given task.

SEGREGATON OF DUTIESSEGREGATON OF DUTIES

Related duties, including physical custody and record Related duties, including physical custody and record keeping, should be assigned to different individuals.keeping, should be assigned to different individuals.

DOCUMENTATION PROCEDURESDOCUMENTATION PROCEDURES

Companies should use prenumbered documents for all Companies should use prenumbered documents for all documents should be accounted for.documents should be accounted for.




PHYSICAL CONTROLS Illustration 8-2




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.


Illustration 8-3



HUMAN RESOURCE CONTROLS

1. Bond employees.

2. Rotate employees’ duties and require vacations.

3. Conduct background checks.



Chapter 8-15


Limitations of Internal ControlLimitations of Internal Control

Costs should not exceed benefit.

Human element.

Size of the business.


Chapter 8-17

Cash Receipts ControlsCash Receipts Controls

SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.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, Mechanical, and

Electronic 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 dailyIllustration 8-4

Cash ControlsCash ControlsCash ControlsCash Controls

Chapter 8-18

Q8-6. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why?

See notes page for discussion

Discussion QuestionDiscussion Question



Chapter 8-19

Q8-11. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control.





Chapter 8-20


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 assetsSO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash

receipts.receipts.

Chapter 8-21

Over-the-Over-the-Counter Counter ReceiptsReceipts

Over-the-Over-the-Counter Counter ReceiptsReceipts


Illustration 8-4

Chapter 8-22

Mail ReceiptsMail ReceiptsMail ReceiptsMail Receipts

Control Procedures:

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 SO 3 Explain the applications of internal control principles to cash

receipts.receipts.

Chapter 8-23

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 QuestionReview Question



Chapter 8-24

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 SO 4 Explain the applications of internal control principles to cash control principles to cash disbursements.disbursements.

Cash Disbursements ControlsCash Disbursements Controls

Chapter 8-25


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 reimbursableexpenses

Physical Controls

Store blank checks in safes, with limited access; print check

amounts by machine in indelible ink

Illustration 8-6Cash Disbursements ControlsCash Disbursements Controls

Human Resource Controls

Bond personnelwho handle cash;require employeesto take vacations;

conduct backgroundchecks

Chapter 8-26

Q8-17 Joe Griswold Company’s internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls.





Chapter 8-27

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.




Chapter 8-28

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.




Chapter 8-29

Petty Cash Fund - Used 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.SO 5 Describe the operation of a petty cash fund.


Chapter 8-30

Illustration: If Laird Company decides to establish a $100 fund on March 1, the journal entry is:



Petty cash 100Mar. 1

Cash 100

Chapter 8-31

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:



Postage expense 44Mar. 15

Cash 87

Freight-out 38

Miscellaneous expense 5

Chapter 8-32

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:



Postage expense 44Mar. 15

Cash 88

Freight-out 38

Miscellaneous expense 5

Cash over and short 1

Chapter 8-33

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 BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank

SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.

Chapter 8-34

Making Bank DepositsAuthorized employee should make deposit.


Bank Code

Numbers

Front Side Reverse Side

Illustration 8-8


Chapter 8-35

Writing ChecksWritten order signed by depositor directing bank to pay a specified sum of money to a designated recipient.


Maker

Payee

Illustration 8-9

Payer


Chapter 8-36

Bank Statements

Debit Memorandum

Bank service charge

NSF (not sufficient funds)


Illustration 8-10

Credit Memorandum

Collect notes receivable.

Interest earned.


Chapter 8-37

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.




Chapter 8-38

Reconciling the Bank Account

SO 7 Prepare a bank reconciliation.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.


Chapter 8-39

Reconciliation Procedures


+ Deposit in Transit

- Outstanding Checks

+- Bank Errors

+ Notes collected by bank

- NSF (bounced) checks

- Check printing or other service charges

+- Company Errors

CORRECT BALANCE CORRECT BALANCE

Illustration 8-11


Chapter 8-40

Illustration: Illustration: The bank statement for Laird Company (Illustration 8-10), shows a balance per bank of $15,907.45 on April 30, 2010. On this date the balance of cash per books is $11,589.45. Using the four reconciliation steps, Laird determines the following reconciling items.


Chapter 8-41

Illustration: Illustration: a) Prepare a bank reconciliation at April 30.


Cash balance per bank statement $15,907.45

Add: Deposit in transit 2,201.40

Less: Outstanding checks (5,904.00)

Adjusted cash balance per bank $12,204.85

Cash balance per books $11,589.45

Collection of notes + interest - fee 1,035.00

Add: Error in recording check no. 443 36.00

Less: NSF check (425.60)

Bank service charge (30.00)

Adjusted cash balance per books $12,204.85


Illustration 8-12

Chapter 8-42

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 expense 15.00

Notes receivable1,000.00Interest revenue

50.00


Chapter 8-43

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


Chapter 8-44

NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is:


Accounts receivable 425.60Apr. 30

Cash425.60

Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense. The entry is:

Miscellaneous 30.00Apr. 30

Cash30.00


Chapter 8-45

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.




Chapter 8-46

Electronic Funds Transfers (EFT)

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.



Chapter 8-47

Q8-23. Lori Figgs is confused about the lack of agreement between the cash balance per books and the balance per the bank. Explain the causes for the lack of agreement to Lori, and give an example of each cause.





Chapter 8-48

Reporting CashReporting CashReporting CashReporting Cash

SO 8 Explain the reporting of 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 8-14

Chapter 8-49

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.


Reporting CashReporting CashReporting CashReporting Cash

SO 8 Explain the reporting of cash.SO 8 Explain the reporting of cash.

Chapter 8-50

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