1. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Fraud, Ethics, and Controls

2. 7-2 Learning Objective 1 Define workplace fraud and explain the four elements common to all fraud schemes. All workplace fraud... 1.Is secret. 2.Violates the employee’s duties to his or her employer. 3.Is done to provide direct or indirect benefit to the employee. 4.Costs the employer money. Workplace fraud involves the use of one’s job for personal gain, through the deliberate misuse of employer's assets. LO1

3. 7-3 Learning Objective 2 Describe the three major types of workplace fraud. Asset misappropriation involves the theft or misuse of the employer’s resources. Corruption involves an employee’s wrongful use of influence in a business transaction with the result that the employee receives financial gain at the expense of the employer. Fraudulent financial statements involve falsification of the employer’s financial statements. LO2

4. 7-4 Learning Objective 3 Define internal control and identify its purpose and principles. An internal control system is a collection of policies and procedures that protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies. LO3

5. 7-5 Principles of Internal Control 1. Establish responsibilities. 2. Maintain adequate records. 3. Insure assets and bond key employees. 4. Separate recordkeeping from custody of assets. 5. Divide responsibility for related transactions. 6. Apply technological controls. 7. Perform regular and independent reviews. 1. Establish responsibilities. 2. Maintain adequate records. 3. Insure assets and bond key employees. 4. Separate recordkeeping from custody of assets. 5. Divide responsibility for related transactions. 6. Apply technological controls. 7. Perform regular and independent reviews. Internal controls vary across companies due to factors like the nature of the business and its size. Certain fundamental internal control principles apply to all companies. The principles of internal control are to: LO3

6. 7-6 Learning Objective 4 Explain how technology impacts an internal control system. Technology can help reduce processing errors and allow more extensive testing of records. However, it can limit evidence of processing. Technology may also create situations that cause a lack of separation of duties. Technology has also encouraged the growth of e-commerce, which has greatly enhanced the need for strong internal controls. LO4

7. 7-7 Learning Objective 5 Describe the limitations of internal control. Negligence Fatigue Misjudgment Confusion Intent to defeat internal controls for personal gain 2) Cost-benefit principle: the costs of internal controls must not exceed their benefits. 2) Cost-benefit principle: the costs of internal controls must not exceed their benefits. LO5

8. 7-8 Control of Cash Disbursements All expenditures should be made by check. The only exception is for small payments from petty cash. Separate authorization for check signing and recordkeeping duties. Use a voucher system. All expenditures should be made by check. The only exception is for small payments from petty cash. Separate authorization for check signing and recordkeeping duties. Use a voucher system. Control of cash disbursements is especially important as most large thefts occur from payment of phony invoices. Therefore: LO5

9. 7-9 Voucher System of Control A voucher system also limits the type of obligations that a department or individual can incur. A voucher system establishes procedures that help to verify, approve, and properly record cash disbursements. LO5

10. 7-10 Learning Objective 6 Explain provisions of the Sarbanes-Oxley Act that are designed to detect and curtail fraud. Congress passed the Sarbanes-Oxley Act in 2002. This act has several provisions designed to reduce financial fraud. All U.S. public companies must follow the provisions of this act. Congress passed the Sarbanes-Oxley Act in 2002. This act has several provisions designed to reduce financial fraud. All U.S. public companies must follow the provisions of this act. This act requires each annual report to include an internal control report, which must: 1.State managers’ responsibility for establishing and maintaining adequate internal controls for financial reporting. 2.Assess the effectiveness of those controls. LO6

11. 7-11 Learning Objective 7 Describe the use of documentation and verification to control cash disbursements.  A purchase requisition initiates the process for a purchase.  If approved, the purchase requisition triggers the issuance of a purchase order.  An invoice is received from the vendor once a purchase is made.  A receiving report indicates that we actually received the goods.  The invoice approval indicates that we ordered the goods, we received the goods we ordered, and that we were billed for the goods we ordered and received.  The invoice approval triggers the check preparation for a valid purchase.  Copies of all of these documents are kept as supporting documentation for the disbursement in the voucher file. LO7

12. 7-12 End of Chapter 7