1. Fraud and Internal Control
Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.
Illustration 7-1
Why does fraud occur?
SO 1 Define fraud and internal control.

2. 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.

3. 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.

4. 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.

5. 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.

6. 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.

7. Fraud and Internal Control
Principles of Internal Control Activities
PHYSICAL CONTROLS
Illustration 7-2
SO 2 Identify the principles of internal control.

8. 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 7-3
SO 2 Identify the principles of internal control.

9. 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.

10. 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.

11. Cash Receipts Controls
Over-the-Counter Receipts
Illustration 7-4
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 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
SO 3 Explain the applications of internal control principles to cash receipts.

12. Cash Receipts 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.

13. Over-the-Counter Receipts
Illustration 7-5
SO 3 Explain the applications of internal control principles to cash receipts.

14. Cash Receipts Controls
Mail Receipts
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.

15. Cash Disbursement 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.

16. Cash Disbursement Controls
Illustration 7-6
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

17. Cash Disbursement Controls
Voucher System 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.

18. Cash Disbursement Controls
Petty Cash Fund 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.

19. Cash Disbursement 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
SO 5 Describe the operation of a petty cash fund.

20. Cash Disbursement 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
Miscellaneous expense 5
Cash 87
SO 5 Describe the operation of a petty cash fund.

21. Cash Disbursement 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
Miscellaneous expense 5
Cash over and short 1
Cash 88
SO 5 Describe the operation of a petty cash fund.