Accounting Principles, Ninth Edition Chapter 8 Fraud, Internal Control, and Cash Accounting Principles, Ninth Edition

Fraud, Internal Control, and Cash Fraud and Internal Control Cash Controls Control Features: Use of a Bank Reporting Cash Fraud The Sarbanes-Oxley Act Internal control Principles of internal control Limitations Cash receipts controls Cash disbursements controls Making deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer (EFT) system Cash equivalents Restricted cash Compensating balances Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods

Fraud and Internal Control Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Illustration 8-1 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 8-2 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 8-3 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 Controls Cash Receipts Controls 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, 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 daily Illustration 8-4 SO 3 Explain the applications of internal control principles to cash receipts.

Cash 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 8-4 SO 3 Explain the applications of internal control principles to cash receipts.

Mail 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 receipts.

Cash Controls Cash Disbursements 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 Controls Cash Disbursements Controls Documentation Procedures Illustration 8-6 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 Controls Cash Disbursements 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 Controls Cash Disbursements 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 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 Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. SO 5 Describe the operation of a petty cash fund.

Cash 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 Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. Miscellaneous expense 5 Cash 87 SO 5 Describe the operation of a petty cash fund.

Cash 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 Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. Miscellaneous expense 5 Cash over and short 1 Cash 88 SO 5 Describe the operation of a petty cash fund.

Control Features: Use of a Bank Contributes to good internal control over cash. Minimizes the amount of currency on hand. Creates a double record of bank transactions. Bank reconciliation. SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank Illustration 8-8 Making Bank Deposits Authorized employee should make deposit. Bank Code Numbers Reverse Side Front Side SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank Writing Checks Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient. Illustration 8-9 Maker Payee Payer SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank Illustration 8-10 Bank Statements Debit Memorandum Bank service charge NSF (not sufficient funds) Credit Memorandum Collect notes receivable. Interest earned. SO 6 Indicate the control features of a bank account.

Control Features: Use of a Bank Reconciling the Bank Account Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances. Reconciling Items: Deposits in transit. Outstanding checks. Errors. Bank memoranda. SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank Reconciliation Procedures Illustration 8-11 + 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 SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank 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.

Control Features: Use of a Bank 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 Add: Error in recording check no. 443 36.00 Collection of notes + interest - fee 1,035.00 Less: NSF check (425.60) Bank service charge (30.00) Adjusted cash balance per books $12,204.85 Illustration 8-12 SO 7 Prepare a bank reconciliation.

Control Features: Use of a Bank 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: Apr. 30 Cash 1,035.00 Miscellaneous expense 15.00 Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. Notes receivable 1,000.00 Interest revenue 50.00 SO 5 Describe the operation of a petty cash fund.

Control Features: Use of a Bank 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: Apr. 30 Cash 36.00 Accounts payable 36.00 Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. SO 5 Describe the operation of a petty cash fund.

Control Features: Use of a Bank NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is: Apr. 30 Accounts receivable 425.60 Cash 425.60 Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense. The entry is: Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared. Apr. 30 Miscellaneous 30.00 Cash 30.00 SO 5 Describe the operation of a petty cash fund.

Control Features: Use of a Bank 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. SO 7 Prepare a bank reconciliation.

Reporting Cash Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository. Illustration 8-14 Cash equivalents Restricted cash Compensating balances SO 8 Explain the reporting of cash.

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