University of California, Santa Barbara

University of California, Santa Barbara
Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright ©2015 Pearson Education Inc. All rights reserved.

DESCRIBE FRAUD AND ITS IMPACT Fraud Intentional misrepresentation of facts Causes injury or damage to another party Increased with expansion of e-commerce via the Internet Some common types Insurance fraud Check forgery Medicare fraud Credit card fraud Identity theft LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Misappropriation of Assets Fraudulent Financial Reporting
DESCRIBE FRAUD AND ITS IMPACT Two common types of fraud that impact financial statements Misappropriation of Assets Fraudulent Financial Reporting Committed by employees Theft of money or inventory Bribery or kickback schemes Overstate expense reimbursement Committed by managers False and misleading entries in the books Deceives investors and creditors LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESCRIBE FRAUD AND ITS IMPACT
Exhibit 4-1 | The Fraud Triangle Motive Fraud is the ultimate unethical act in business! Opportunity Rationalization LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

EXPLAIN THE OBJECTIVES AND COMPONENTS OF INTERNAL CONTROL Internal Control Primary way fraud and errors are: Prevented Detected or Corrected Management and Board of Directors implement a: Plan of organization System of procedures LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

EXPLAIN THE OBJECTIVES AND COMPONENTS OF INTERNAL CONTROL
Objectives of Internal Control Safeguard assets Encourage employees to follow policies Promote operational efficiency Ensure accurate, reliable records Comply with legal requirements LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Sarbanes-Oxley Act (SOX) SOX Provisions Public companies must maintain a system of internal control issue an internal control report Auditors must evaluate and report on internal controls Created Public Company Accounting Oversight Board Limits non-audit services of auditing firms Penalties for violators LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Components of Internal Control Monitoring of Controls
Control Environment Risk Assessment Information System Control Procedures Monitoring of Controls Tone at the top Code of ethics LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Environment Risk Assessment Information System Control Procedures Monitoring of Controls Identify business risks Establish procedures to deal with risks LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Environment Risk Assessment Information System Control Procedures Monitoring of Controls System to capture, process, and report transactions LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Environment Risk Assessment Information System Control Procedures Monitoring of Controls Built into the control environment and information system LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Environment Risk Assessment Information System Control Procedures Monitoring of Controls Controls programmed into a company’s information technology Internal and external auditors LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Background checks Training and supervision Competitive salaries Clear employee responsibility Separation of Duties Comparison and Compliance Monitoring Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Separates three key duties: Asset handling Record keeping Transaction approval Separation of Duties Comparison and Compliance Monitoring Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Separation of Duties Operating and cash budgets Exception reporting Audits Comparison and Compliance Monitoring Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Separation of Duties Comparison and Compliance Monitoring Details of business transactions Hard copy documents or electronic Prenumbered documents Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Separation of Duties Comparison and Compliance Monitoring Physical access to assets Lock-box system Lock and key Passwords Encryption Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Control Procedures Smart Hiring Practices Separation of Duties Comparison and Compliance Monitoring Management’s general or specific approval Credit department Purchasing department Human resources department Adequate Records Limited Access Proper Approvals LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Information Technology Accounting systems rely less on manual procedures and more on information technology (IT) Examples: Electronic sensors Bar code scanning Use of computers greatly improves speed and accuracy LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Loss prevention specialists
Safeguard Controls Job rotation Fireproof vaults Fidelity bonds Security cameras Mandatory vacations Alarms Loss prevention specialists LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Internal Controls for E-Commerce E-commerce pitfalls include: Stolen credit card numbers Computer viruses and Trojan Horses Phishing expeditions Security measures: Encryption Firewalls LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Limitations of Internal Control—Costs and Benefits Ways internal control can be circumvented Collusion Management override Fatigue & negligence Benefits should outweigh the costs LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Documents used to control a bank account
DESIGN AND USE A BANK RECONCILIATION Documents used to control a bank account Signature Card Deposit Ticket Check Bank Statement Bank Reconciliation Protects against forgery LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESIGN AND USE A BANK RECONCILIATION Documents used to control a bank account Signature Card Deposit Ticket Check Bank Statement Bank Reconciliation Proof of deposit transaction LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESIGN AND USE A BANK RECONCILIATION Documents used to control a bank account Signature Card Deposit Ticket Check Bank Statement Bank Reconciliation Maker, payee, and bank LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Three parties to a check
Exhibit 4-5 | Check with Remittance Advice Maker Payee Bank LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESIGN AND USE A BANK RECONCILIATION Documents used to control a bank account Signature Card Deposit Ticket Check Bank Statement Bank Reconciliation Report of customer’s cash activity LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESIGN AND USE A BANK RECONCILIATION Documents used to control a bank account Signature Card Deposit Ticket Check Bank Statement Bank Reconciliation Differences between company’s cash records and bank balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Bank Reconciliation Two records of a business’s cash Cash account in company’s general ledger Bank statement Differences because of time lag in recording transactions LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Bank Reconciliation Bank Side Book Side Deposits in transit Outstanding checks Bank errors Bank collections Electronic funds transfers Service charge Interest revenue Nonsufficient funds (NSF) checks Cost of printed checks Book errors LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Bank Reconciliation Illustrated The December 31 bank balance of Mid-Atlantic Manufacturing is $5,900. The company’s Cash account has a balance of $3,340. Additional information related to the cash account at December 31 is as follows: Deposit in transit, $1,600. Bank error: The bank deducted $100 for a check written by another company. Add $100 to the bank balance. Outstanding checks—total of $1,340. EFT receipt of your dividend revenue earned on an investment, $900. Bank collection of your account receivable, $2,100. Interest revenue earned on your bank balance, $30. Book error: You recorded check no. 333 for $510. The amount you actually paid on account was $150. Add $360 to your book balance. Bank service charge, $20. NSF check from a customer, $50. Subtract $50 from your book balance. EFT payment of insurance expense, $400. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Bank Reconciliation Illustrated Bank reconciliation for Mid-Atlantic at December 31 Cash balance per bank statement Adjusted bank balance Cash balance per bank statement $ ,900 Add: Deposit in transit 1,600 Correction of bank error 100 Less: Outstanding checks (1,340) Adjusted bank balance $ ,260 Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Cash balance per books Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Cash 900 Dividend Revenue 900 Receipt of dividend earned LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Cash 2,100 Accounts Receivable 2,100 Receivables collected by bank LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Cash 30 Interest Revenue 30 Interest earned on bank balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Cash 360 Accounts Payable 360 Correction of check no. 333 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Miscellaneous Expense 20 Cash 20 Bank service charge LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Accounts Receivable 50 Cash 50 NSF check returned by bank LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Journalizing transactions from Bank reconciliation Cash balance per books $ ,340 Add: EFT receipt of dividends 900 Bank collection of accounts receivable 2,100 Interest revenue 30 Correction of book error (Check no. 333) 360 Less: Service charge (20) NSF check (50) EFT payment of insurance expense (400) Adjusted book balance $ ,260 Account Debit Credit Insurance Expense 400 Cash 400 Payment of monthly insurance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Summary of the various reconciling items: BANK BALANCE—ALWAYS Add deposits in transit Subtract outstanding checks Add or subtract corrections of bank errors BOOK BALANCE—ALWAYS Add bank collections, interest revenue, and EFT receipts Subtract service charges, NSF checks, and EFT payments Add or subtract corrections of book errors LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

The bank statement balance is $4,500 and shows a service charge of $15, interest earned of $5, and an NSF check for $300. Deposits in transit total $1,200; outstanding checks are $575. The bookkeeper recorded as $152 a check of $125 in payment of an account payable. This created a book error of $27 (positive amount to correct the error). What is the adjusted bank balance? What was the book balance of cash before the reconciliation? Answer: (1) $5,125 ($4,500 + $1,200 – $575). (2) $5,408 ($5,125 + $15 – $5 + $300 – $27). The adjusted book and bank balances are the same. Advance slide in presentation mode to reveal answers LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Logan Harmon operates an ice skating rink. He has just received the monthly bank statement at July 31 from Valley National Bank, and the statement shows an ending balance of $1,500. Listed on the statement are a bank collection of accounts receivable of $818, a service charge of $14, two NSF checks totaling $240, and a $20 charge for printed checks. In reviewing his cash records, Logan identifies outstanding checks totaling $1,220 and a July 31 deposit in transit of $3,530. During July, he recorded a $540 check for the salary of a part-time employee as $54. Logan’s Cash account shows a July 31 cash balance of $3,752. How much cash does Logan actually have at July 31, 2014? LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration The monthly bank statement at July 31 from Valley National Bank shows an ending balance of $1,500. Bank Books Balance, July 31 Balance, July 31 Balance, July 31 $1,500 Balance, July 31 Adjusted bank balance Adjusted book balance Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Logan’s Cash account shows a July 31 cash balance of $3,752. Bank Books Balance, July 31 Balance, July 31 $1,500 Balance, July 31 Balance, July 31 $3,752 Adjusted bank balance Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Listed on the bank statement are a bank collection of an accounts receivable of $818, a service charge of $14, two NSF checks totaling $240, and a $20 charge for printed checks. Bank Books Balance, July 31 $1,500 Balance, July 31 $3,752 Add: Collection on account 818 Less: Service charge (14) NSF checks (240) Printed check charge (20) Adjusted bank balance Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration In reviewing his cash records, Logan identifies a July 31 deposit in transit of $3,530 and outstanding checks totaling $1,220. Bank Books Balance, July 31 $1,500 Balance, July 31 $3,752 Add: Deposit in transit 3,530 Add: Collection on account 818 Less: Outstanding checks (1,220) Less: Service charge (14) NSF checks (240) Printed check charge (20) Adjusted bank balance Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration During July, Logan recorded a $540 check for the salary of a part-time employee as $54. Bank Books Balance, July 31 $1,500 Balance, July 31 $3,752 Add: Deposit in transit 3,530 Add: Collection on account 818 Less: Outstanding checks (1,220) Less: Service charge (14) NSF checks (240) Printed check charge (20) Correction of book error (486) Adjusted bank balance Adjusted book balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration How much cash does Logan actually have at July 31, 2014? Bank Books Balance, July 31 $1,500 Balance, July 31 $3,752 Add: Deposit in transit 3,530 Add: Collection on account 818 Less: Outstanding checks (1,220) Less: Service charge (14) NSF checks (240) Printed check charge (20) Correction of book error (486) Adjusted bank balance Adjusted bank balance $3,810 Adjusted book balance Adjusted book balance $3,810 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Prepare the journal entries that Logan should record on July 31 to update his Cash account. Journal Entries Books Cash 818 Accounts Receivable 818 Miscellaneous Expense 34 Cash 34 Accounts Receivable 240 Cash 240 Salary Expense 486 Cash 486 Balance, July 31 $3,752 Add: Collection on account 818 Less: Service charge (14) NSF checks (240) Printed check charge (20) Correction of book error (486) Adjusted book balance $3,810 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

EVALUATE INTERNAL CONTROLS OVER CASH RECEIPTS AND CASH PAYMENTS Cash requires specific internal controls because Cash is easy to steal All transactions ultimately affect cash Cash receipts should be deposited quickly Companies can receive cash Over the counter Through the mail LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Receipts Over the Counter Point-of-sale terminals provide control over cash receipts record sale, cost of item sold, and reduction to inventory Customer issued a receipt as proof of purchase Sales associate turns in cash drawer at end of shift Combined with other cash and deposited Accounting department reconciles sales per terminal to cash in drawer LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Controls over Payment by Check Payment by check or electronic funds transfer (EFT) is an important internal control Provides record of the payment Check must be signed by an authorized official EFT must be approved by an authorized official Should be supported by evidence LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Controls over Payment by Check Controls over Purchase and Payment Fax or purchase order Receive goods and prepare a receiving report Receive invoice Approve and agree all documents Sends check or authorizes an electronic funds transfer (EFT) LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Controls over Payment by Check Controls over Purchase and Payment Before signing the check or approving the EFT, the treasurer’s department should examine the packet to prove that all the documents agree. Exhibit 4-13 | Payment Packet LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Controls over Payment by Check Petty Cash Small fund to make minor purchases Custodian solely responsible for the accounting Set amount of cash Voucher prepared for each payment Imprest system Sum of fund plus paid vouchers should equal set amount LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

CONSTRUCT AND USE A CASH BUDGET Budget Financial plan to coordinate business activities Cash budget Planned receipts and payments Steps: Start with beginning cash balance Add budgeted receipts and subtract budgeted payments Equals cash available before new financing Compare cash available to budgeted cash balance LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Kachina Corporation is preparing its cash budget for Kachina ended 2014 with cash of $68 million and managers need to keep a cash balance of at least $70 million for operations. Collections from customers are expected to total $11,925 million during 2015, and payments for inventory should reach $6,210 million. Kachina also expects to receive interest payments in the amount of $15 million. Operating expense payments are budgeted at $2,653 million. During 2015, Kachina expects to invest $1,922 million in new equipment. Debt payments scheduled for 2015 will total $683 million. The company forecasts net income of $893 million for 2015 and plans to pay dividends of $448 million. Prepare Kachina Corporations’ cash budget for Will the budgeted level of cash receipts leave Kachina with the desired ending cash balance of $70 million, or will the company need additional financing? If so, how much? LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Kachina Corporation Cash Budget
Cash balance, December 31, $ Budgeted cash receipts: Collections from customers 11,925 Receipt of interest 15 12,008 Budgeted cash payments: Purchase of inventory $ 6,210 Operating expenses 2,653 Investment in equipment 1,922 Debt payments 683 Dividends ,916 Cash available (needed) before financing 92 Budgeted cash balance, December 31, (70) Cash available for additional investments $ LO 5 Advance slide in presentation mode to reveal answers Copyright ©2015 Pearson Education Inc. All rights reserved.

REPORT CASH ON THE BALANCE SHEET All cash accounts combined into a single total Cash & Cash Equivalents Time deposits Certificates of deposit High-grade government securities (3 months or less) LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Compensating Balance Agreements Cash balance should not include cash that is restricted Company that borrows agrees to maintain a minimum cash balance Compensating balance agreement LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

This work is protected by United States copyright law and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Copyright ©2015 Pearson Education Inc. All rights reserved.

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