1. 7-1 FRAUD, INTERNAL CONTROL, AND CASH Accounting, Fifth Edition 7

2. 7-2 After studying this chapter, you should be able to: SELF-STUDY (Quiz Tuesday, March 1 st ): 1. 1.Define fraud and internal control. 2. 2.Identify the principles of internal control activities. 3. Explain the applications of internal control principles to cash receipts. 4. Explain the applications of internal control principles to cash disbursements. In-Class: 5. Prepare a bank reconciliation. 6. Explain the reporting of cash. 7. Discuss the basic principles of cash management. 8. 8.Identify the primary elements of a cash budget. Appendix 7A: Petty Cash Fund Learning Objectives

3. 7-3 Fraud and Internal Control Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. LO 1 Define fraud and internal control. Three factors that contribute to fraudulent activity. Illustration 7-1 Fraud

4. 7-4  Applies to publicly traded U.S. corporations.  Required to maintain a system of internal control.  Corporate executives and boards of directors must ensure that these controls are reliable and effective.  Independent outside auditors must attest to the adequacy of the internal control system.  SOX created the Public Company Accounting Oversight Board (PCAOB). LO 1 Define fraud and internal control. Fraud and Internal Control The Sarbanes-Oxley Act

5. 7-5 Methods and measures adopted to: 1.Safeguard assets. 2.Enhance accuracy and reliability of accounting records. 3.Increase efficiency of operations. 4.Ensure compliance with laws and regulations. LO 1 Define fraud and internal control. Internal Control Fraud and Internal Control

6. 7-6 Five Primary Components: 1.Control environment. 2.Risk assessment. 3.Control activities. 4.Information and communication. 5.Monitoring. LO 1 Define fraud and internal control. Fraud and Internal Control Internal Control

7. 7-7 Establishment of Responsibility  Control is most effective when only one person is responsible for a given task.  Establishing responsibility often requires limiting access only to authorized personnel, and then identifying those personnel. LO 2 Identify the principles of internal control activities. Fraud and Internal Control Principles of Internal Control Activities

8. 7-8 Segregation of Duties  Different individuals should be responsible for related activities.  The responsibility for record- keeping for an asset should be separate from the physical custody of that asset. LO 2 Identify the principles of internal control activities. Fraud and Internal Control Principles of Internal Control Activities

9. 7-9 Documentation Procedures  Companies should use prenumbered documents, and all documents should be accounted for.  Employees should promptly forward source documents for accounting entries to the accounting department. LO 2 Identify the principles of internal control activities. Fraud and Internal Control Principles of Internal Control Activities

10. 7-10 LO 2 Identify the principles of internal control activities. Fraud and Internal Control Principles of Internal Control Activities Illustration 7-2 Physical Controls

11. 7-11  Records periodically verified by an employee who is independent.  Discrepancies reported to management. LO 2 Identify the principles of internal control activities. Illustration 7-3 Fraud and Internal Control Independent Internal Verification Principles of Internal Control Activities

12. 7-12 LO 2 Identify the principles of internal control activities. Fraud and Internal Control Principles of Internal Control Activities Human Resource Controls  Bond employees who handle cash.  Rotate employees’ duties and require vacations.  Conduct background checks.

13. 7-13  Costs should not exceed benefit.  Human element.  Size of the business. LO 2 Identify the principles of internal control activities. Fraud and Internal Control Limitations of Internal Control Helpful Hint Controls may vary with the risk level of the activity. For example, management may consider cash to be high risk and maintaining inventories in the stockroom as lower risk. Thus, management would have stricter controls for cash.

14. 7-14 LO 3 Cash Controls Cash Receipt Controls Illustration 7-4

15. 7-15 Illustration 7-4 LO 3 Cash Controls Cash Receipt Controls

16. 7-16 Cash Controls Cash Receipt Controls Important internal control principle— segregation of record- keeping from physical custody. Over-the-Counter Receipts LO 3 Explain the applications of internal control principles to cash receipts. Illustration 7-5

17. 7-17 Mail Receipts  Mail receipts should be opened by two people, a list prepared, and each check endorsed “For Deposit Only.”  Each mail clerk signs the list to establish responsibility for the data.  Original copy of the list, along with the checks, is sent to the cashier’s department.  Copy of the list is sent to the accounting department for recording. Clerks also keep a copy. LO 3 Explain the applications of internal control principles to cash receipts. Cash Controls Cash Receipt Controls

18. 7-18 Generally, internal control over cash disbursements is more effective when companies pay by check or electronic funds transfer (EFT) rather than by cash. Applications:  Voucher System Controls  Bank Reconciliation  Petty Cash Fund (Appendix 7A) LO 4 Explain the applications of internal control principles to cash disbursements. Cash Controls Cash Disbursement Controls

19. 7-19 Illustration 7-6 LO 4 Cash Controls Cash Disbursement Controls

20. 7-20 Illustration 7-6 LO 4 Cash Controls Cash Disbursement Controls

21. 7-21 Voucher System of Control A voucher system establishes procedures for: A voucher system establishes procedures for: Verifying, approving and recording obligations for eventual cash disbursements. Verifying, approving and recording obligations for eventual cash disbursements. Issuing checks for payment of verified, approved and recorded obligations. Issuing checks for payment of verified, approved and recorded obligations. A voucher system establishes procedures for: A voucher system establishes procedures for: Verifying, approving and recording obligations for eventual cash disbursements. Verifying, approving and recording obligations for eventual cash disbursements. Issuing checks for payment of verified, approved and recorded obligations. Issuing checks for payment of verified, approved and recorded obligations. P4 6-21

22. 7-22 Voucher System of Control Cashier Accounting Receiving Supplier (Vendor) Purchasing SALES Requesting Cashier Accounting, Requesting & Purchasing Accounting Supplier (Vendor) Purchasing and Accounting Supplier, Requesting, Receiving & Accounting Check Invoice Approval Receiving Report Invoice Purchase Order Purchase Requisition Voucher P4 Sender Receiver 6-22

23. 7-23 The use of a bank contributes significantly to good internal control over cash.  Minimizes the amount of currency on hand.  Creates a double record of bank transactions.  Bank reconciliation. LO 5 Prepare a bank reconciliation. Control Features: Use of a Bank The bank statement is a copy of the bank’s records sent to the customer or made available online for review.

24. 7-24 Debit Memorandum  Bank service charge.  NSF (not sufficient funds). Illustration 7-7 Credit Memorandum  Collect notes receivable.  Interest earned. Control Features: Use of a Bank Bank Statements LO 5 Prepare a bank reconciliation.

25. 7-25 Reconcile balance per books and balance per bank to their “correct or true” balance. Reconciling Items: 1.Deposits in transit. 2.Outstanding checks. 3.Bank memoranda. 4.Errors. Time Lags Control Features: Use of a Bank Reconciling the Bank Account LO 5 Prepare a bank reconciliation.

26. 7-26 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 Illustration 7-8 Control Features: Use of a Bank LO 5 Prepare a bank reconciliation.

27. 7-27 LO 5 Prepare a bank reconciliation. Control Features: Use of a Bank

28. 7-28 Illustration: Prepare a bank reconciliation at April 30. LO 5 Prepare a bank reconciliation. Cash balance per bank statement $15,907.45 Deposit in transit2,201.40 Outstanding checks(5,904.00) Adjusted cash balance per bank$12,204.85 Cash balance per books $11,589.45 Collection of notes receivable1,035.00 Error in check No. 44336.00 NSF check(425.60) Bank service charge(30.00) Adjusted cash balance per books$12,204.85 Control Features: Use of a Bank

29. 7-29 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 receivable1,000.00 Interest revenue50.00 LO 5 Prepare a bank reconciliation. Entries From Bank Reconciliation Control Features: Use of a Bank

30. 7-30 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 LO 5 Prepare a bank reconciliation. NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is: Accounts receivable425.60Apr. 30 Cash425.60 Control Features: Use of a Bank

31. 7-31 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 LO 5 Prepare a bank reconciliation. Control Features: Use of a Bank Illustration 7-10

32. 7-32  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. LO 5 Prepare a bank reconciliation. Control Features: Use of a Bank Electronic Funds Transfer (EFT) System

33. 7-33 Exercise 8 (page 376)

34. 7-34 Cash equivalents are short-term, highly liquid investments that are both: 1.Readily convertible to known amounts of cash, and 2.So near their maturity that their market value is relatively insensitive to changes in interest rates. LO 6 Explain the reporting of cash. Reporting Cash Cash Equivalents Cash that is not available for general use but rather is restricted for a special purpose. Restricted Cash

35. 7-35 Illustration 7-11 LO 6 Explain the reporting of cash. Reporting Cash

36. 7-36 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. LO 6 Explain the reporting of cash. Review Question Reporting Cash

37. 7-37 Illustration 7-12 Operating Cycle of a Merchandising Company LO 7 Discuss the basic principles of cash management. Managing and Monitoring Cash

38. 7-38 Basic Principles of Cash Management LO 7 Managing and Monitoring Cash

39. 7-39 Cash Budget NOT COVERED!! ► Shows anticipated cash flows, usually over a one- to two- year period. ► Contributes to more effective cash management. LO 8 Identify the primary elements of a cash budget. Managing and Monitoring Cash

40. 7-40 Involves: 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund. Petty Cash Fund - Used to pay small amounts. LO 9 Explain the operation of a petty cash fund. Operation of the Petty Cash Fund Appendix 7A Ethics Note Internal control over a petty cash fund is strengthened by: (1) having a supervisor make surprise counts of the fund to confirm whether the paid petty cash receipts and fund cash equal the fund amount, and (2) canceling or mutilating the paid petty cash receipts so they cannot be resubmitted for reimbursement.

41. 7-41 Petty Cash System of Control Small payments required in most companies for items such as postage, courier fees, repairs and supplies. P2 6-41

42. 7-42 Operating a Petty Cash Fund Petty Cash Company Cashier Petty Cashier Accountant P2 6-42

43. 7-43 Petty Cash Operating a Petty Cash Fund Petty Cashier P2 6-43

44. 7-44 39¢ Stamps $45 Courier $80 Operating a Petty Cash Fund Petty Cashier A petty cash fund is used only for business expenses. P2 6-44

45. 7-45 Operating a Petty Cash Fund Receipts Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Petty Cashier 39¢ Stamps $45 Courier $80 P2 6-45

46. 7-46 Receipts Company Cashier $125 To reimburse petty cash fund Use a Cash Over and Short account if needed. Use a Cash Over and Short account if needed. Operating a Petty Cash Fund Petty Cashier Accountant P2 6-46

47. 7-47 Operating a Petty Cash Fund Sometimes, the petty cash receipts plus the cash remaining will not total to the fund balance. i. A shortage is recorded as an expense in the reimbursing entry with a debit to the Cash Over and Short account. ii. An overage is recorded with a credit to the Cash Over and Short account in the reimbursing entry.

48. 7-48 Petty Cash Example Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses $79.30 Travel Expenses $79.30 Customer Business Lunches 93.42 Express Mail Postage 55.00 Miscellaneous Office Supplies 32.48 $260.20 Let’s look at replenishing the fund if the Let’s look at replenishing the fund if the Cash Balance on July 31 was $137.80. Cash Balance on July 31 was $137.80. Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses $79.30 Travel Expenses $79.30 Customer Business Lunches 93.42 Express Mail Postage 55.00 Miscellaneous Office Supplies 32.48 $260.20 Let’s look at replenishing the fund if the Let’s look at replenishing the fund if the Cash Balance on July 31 was $137.80. Cash Balance on July 31 was $137.80. P2 6-48

49. 7-49 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 What amount of cash will be required to replenish the petty cash fund? What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 P2 6-49

50. 7-50 Petty Cash Example What amount of cash will be required to replenish the petty cash fund? What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 What amount of cash will be required to replenish the petty cash fund? What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 Let’s prepare the journal entry to replenish the petty cash fund. P2 6-50

51. 7-51 Petty Cash Example Journal entry to replenish petty cash fund P2 6-51

52. 7-52 Brief Exercise 14 (page 374) Exercise 15 (page 378) Exercise 16 (page 379)