1. Internal control and cash
Chapter 7
Internal control and cash
© Cambridge Business Publishers

2. Fraud
Any act by management or employees of a business involving an intentional deception for personal gain.
Types of fraud:
Embezzlement of cash
Theft of assets
Filing of false insurance claims
Financial statement fraud
Punishable crime
© Cambridge Business Publishers

3. The Fraud Triangle Pressure Rationalization Opportunity
Nearly all frauds committed by individuals under either financial or vice pressure.
Financial statement fraud often associated with pressure to “make the numbers.
Rationalization
Most fraudsters come up with rationalizations to overcome the feeling of guilt.
Opportunity
Fraud only attempted if there is a chance to get away with it.
© Cambridge Business Publishers

4. Internal Controls
Measures undertaken by a business to ensure the reliability of the accounting data, protect assets from unauthorized use, and ensure employees are following policies and procedures.
Reduce the likelihood of errors.
Catch any errors that may occur.
Responsibility of management.
© Cambridge Business Publishers

5. The COSO Framework
The Committee On Sponsoring Organizations’ framework identifies five internal control components of an organization:
The control environment
Risk assessment
Control activities
Information and communication
Monitoring activities
© Cambridge Business Publishers

6. 1. The Control Environment
The control environment sets the tone for the organization.
Provides the foundation for all other internal control components
The control environment includes:
Management philosophy and style
Assignment of authority and responsibility
Process for attracting and developing competent employees
Reward system
© Cambridge Business Publishers

7. 2. Risk Assessment
Risk is the possibility that an event will occur that will have a negative impact on the organization.
Risk assessment involves identifying and analyzing relevant risks.
Risk assessment is an ongoing dynamic and iterative process.
© Cambridge Business Publishers

8. 3. Control Activities
Control activities are the specific policies and procedures designed to reduce risk.
Can be either a prevention control or a detection control.
Prevention controls are intended to deter a problem before it occurs, whereas detection controls are designed to uncover problems after they occur.
Prevention is much more desirable that detection.
It is almost always less expensive to prevent a problem than it is to recover from one.
© Cambridge Business Publishers

9. Control Activities
A company should incorporate the following elements when it designs its prevention and detection controls:
Establish clear lines of authority and responsibility
Implement segregation of duties
Hire competent personnel
Use control numbers on all business documents
Develop plans and budgets
Maintain adequate accounting records
Provide physical and electronic controls
© Cambridge Business Publishers

10. Establish Clear Lines of Authority and Responsibility
The existence of an identified supervisor is a preventive control.
Knowing somebody is evaluating performance makes it more likely employees will follow established procedures.
Supervision is also a detective control.
Supervisors are likely to discover errors during reviews.
© Cambridge Business Publishers

11. Segregation of Duties
Requires that no one individual is assigned too much responsibility.
Nobody should have the ability to perpetrate and conceal an irregularity.
The following functions should be separated:
Authorization
Recording
Custody
© Cambridge Business Publishers

12. Hire Competent Personnel
Since people are such an important part of the accounting system it is important to hire competent individuals.
Job rotation and mandatory vacations provide additional control since somebody else will be doing the job in the absence and will likely discover any irregularities.
© Cambridge Business Publishers

13. Use Control Numbers
Documents such as checks, sales invoices, and purchase orders should be pre-numbered so that any missing document is easy to spot.
© Cambridge Business Publishers

14. Develop Plans and Budgets
Budgets provide a forward thinking approach for a business.
Budgets also provide a benchmark to compare actual results against.
Material deviations from budget should be carefully examined.
© Cambridge Business Publishers

15. Maintain Adequate Accounting Records
Accounting records should be maintained so that there is a record to compare against. For example:
How much inventory should be on hand.
How much cash should be available.
How much money should be owed to suppliers.
How much money is owed by customers.
© Cambridge Business Publishers

16. Provide Physical and Electronic Controls
Examples of physical controls:
Locked doors
Safes
Fences with guards
Examples of electronic controls
Security cameras
Electronic cash registers
© Cambridge Business Publishers

17. 4. Information and Communication
Individuals must receive a clear message from top management that control responsibilities must be taken seriously.
Communication should be continual.
An iterative process of providing and sharing information, then obtaining new information
© Cambridge Business Publishers

18. 5. Monitoring Activities
Monitoring activities involve ongoing evaluations, special evaluations, or some combination of each.
© Cambridge Business Publishers

19. Conduct Internal Audits
The internal audit function provides appraisals of a company’s internal control and financial records.
The internal auditor must determine if adequate controls are in place.
And also whether the controls in place are functioning as they should.
© Cambridge Business Publishers

20. Select the correct answer.
The internal control that requires no one individual is assigned too much responsibility is:
Maintain adequate accounting records.
.Segregation of duties.
Conduct internal audits.
Use control numbers.
© Cambridge Business Publishers

21. Control Failures Even the best internal controls may fail at times
An employee may forget to lock a door
Collusion among employees can circumvent prescribed internal controls such as segregation of duties
Difficult to prevent or detect
Best approach is hiring high-quality employees, paying them adequately, and maintaining an ethical environment
Insurance is often purchased to compensate the company when control failures occur
© Cambridge Business Publishers

22. Sarbanes-Oxley Act
With the Sarbanes-Oxley Act, Congress has legislated that public companies must maintain an adequate system of internal controls.
External auditors must attest to the adequacy of these controls.
© Cambridge Business Publishers

23. Accounting for Cash
Cash includes coins, currency, checks, money orders, checking accounts, and savings accounts.
Cash is often reported combined with cash equivalents consisting of such items as certificates of deposit, Treasury bills, and money market accounts.
Cash that is restricted in its use must be reported separately.
© Cambridge Business Publishers

24. Internal Control for Cash
Because cash is so easily taken, concealed, or otherwise misappropriated, most companies have developed elaborate internal controls to safeguard their cash.
Controls for cash involve:
Mailroom or retail sales area for receipt
Treasurer or Treasury dept. for custody
Controller dept. for recording and posting
but no access of physical checks
Internal audit
© Cambridge Business Publishers

25. the bank reconciliation process.
© Cambridge Business Publishers

26. The Bank Reconciliation
The internal audit department reconciles the amount of cash appearing on the bank statement with the amount of cash showing in the company’s books.
Items such as outstanding checks, deposits in transit, interest earned, and bank fees can result in reconciling items.
© Cambridge Business Publishers

27. Effective Cash Management
Monitoring cash
Statement of cash flows identifies inflows and outflows.
Statement of cash flows also identifies whether cash is increasing or decreasing.
Cash on hand
Sufficient cash on hand is needed to pay day-to-day costs such as wages and suppliers, however too much cash on hand is wasteful.
Important activities
Manage receivables
Manage inventory levels
Manage payables
Invest excess cash
© Cambridge Business Publishers

28. Select the correct answer.
Proper control for cash includes each of the following except:
.Bank reconciliations.
Internal audits.
Mailroom for recording.
Treasurer for custody.
© Cambridge Business Publishers

29. Auditing and internal control
Appendix 7A
Auditing and internal control
© Cambridge Business Publishers

30. Auditing Financial Statement Audit Operational Audits
Performed by an independent external auditor
Procedures established by the Public Company Accounting Oversight Board (PCAOB)
The audit report expresses an “opinion” on the financial statements
Operational Audits
An evaluation of activities, systems, and internal controls
Used to determine efficiency, effectiveness, and economy
© Cambridge Business Publishers

31. Corporate Social Responsibility
Being a socially responsible company sometimes means doing more than simply following the letter of the law.
Social responsibility requires creating a culture of ethical behavior that promotes not just making money, but
Cutting corners may work in the short run, but is not a sustainable business practice.
making money in a responsible way.
making money in a responsible way.
© Cambridge Business Publishers

32. © Cambridge Business Publishers