1. Chapter 8-1

2. Chapter 8-2 Chapter 8 Fraud, Internal Control, and Cash Accounting Principles, Ninth Edition

3. Chapter 8-3 1. 1.Define fraud and internal control. 2. 2.Identify the principles of internal control. 3. 3.Explain the applications of internal control principles to cash receipts. 4. 4.Explain the applications of internal control principles to cash disbursements. 5. 5.Describe the operation of a petty cash fund. 6. 6.Indicate the control features of a bank account. 7. 7.Prepare a bank reconciliation. 8. 8.Explain the reporting of cash. Study Objectives

4. Chapter 8-4 Fraud The Sarbanes- Oxley Act Internal control Principles of internal control Limitations Cash equivalents Restricted cash Compensating balances Making deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer (EFT) system Cash receipts controls Cash disbursements controls Fraud and Internal Control Cash Controls Control Features: Use of a Bank Reporting Cash Fraud, Internal Control, and Cash

5. Chapter 8-5 Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Fraud and Internal Control Fraud SO 1 Define fraud and internal control. Why does fraud occur? Illustration 8-1

6. Chapter 8-6

7. Chapter 8-7 Companies must develop principles of control over financial reporting. continually verify that controls are working. Fraud and Internal Control The Sarbanes-Oxley Act 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.

8. Chapter 8-8 Methods and measures adopted to: 1.Safeguard assets. 2.Enhance accuracy and reliability of accounting records. 3.Increase efficiency of operations, and 4.Ensure compliance with laws and regulations. Fraud and Internal Control SO 1 Define fraud and internal control. Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of internal control. Internal Control

9. Chapter 8-9 Internal control systems have five primary components 1.A control environment 2.Risk assessment 3.Control activities 4.Information and communication 5.Monitoring Fraud and Internal Control SO 1 Define fraud and internal control. Internal Control

10. Chapter 8-10 Measures vary with management’s assessment of the risks faced. size and nature of the company. SO 2 Identify the principles of internal control. Principles of Internal Control Activities Fraud and Internal Control Six principles of controls activities:  Establishment of responsibility  Segregation of duties  Documentation procedures  Physical controls  Independent internal verification  Human resource controls

11. Chapter 8-11 SO 2 Identify the principles of internal control. 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. Fraud and Internal Control Principles of Internal Control Activities

12. Chapter 8-12 SO 2 Identify the principles of internal control. PHYSICAL CONTROLS Illustration 8-2 Fraud and Internal Control Principles of Internal Control Activities

13. Chapter 8-13 SO 2 Identify the principles of internal control. INDEPENDENT INTERNAL VERIFICATION 1.Verify records periodically or on a surprise basis. 2.Records verified by an employee who is independent. 3. Discrepancies reported to management. Fraud and Internal Control Illustration 8-3 Principles of Internal Control Activities

14. Chapter 8-14 SO 2 Identify the principles of internal control. HUMAN RESOURCE CONTROLS 1.Bond employees. 2.Rotate employees’ duties and require vacations. 3.Conduct background checks. Fraud and Internal Control Principles of Internal Control Activities

15. Chapter 8-15

16. Chapter 8-16 SO 2 Identify the principles of internal control. Limitations of Internal Control Costs should not exceed benefit. Human element. Size of the business. Fraud and Internal Control

17. Chapter 8-17 Cash Receipts Controls SO 3 Explain the applications of internal control principles to cash receipts. Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips Physical, Mechanical, and Electronic 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 Illustration 8-4 Cash Controls

18. Chapter 8-18 Q8-6. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why? See notes page for discussion Discussion Question SO 3 Explain the applications of internal control principles to cash receipts. Cash Controls

19. Chapter 8-19 Q8-11. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control. See notes page for discussion Discussion Question Cash Controls SO 3 Explain the applications of internal control principles to cash receipts.

20. Chapter 8-20 Cash 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.

21. Chapter 8-21 Over-the- Counter Receipts SO 3 Explain the applications of internal control principles to cash receipts. Illustration 8-4

22. Chapter 8-22 Mail Receipts Control Procedures: 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.

23. Chapter 8-23 Permitting only designated personnel to handle cash receipts is an application of the principle of: a. segregation of duties. b. establishment of responsibility. c. independent check. d. Human resource controls. Review Question Cash Controls SO 3 Explain the applications of internal control principles to cash receipts.

24. Chapter 8-24 Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash. Applications: Voucher system Petty cash fund Cash Controls SO 4 Explain the applications of internal control principles to cash disbursements. Cash Disbursements Controls

25. Chapter 8-25 Cash Controls Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly Establishment of Responsibility Only designated personnel are authorized to sign checks (treasurer) and approve vendors Segregation of Duties Different individuals approve and make payments; check signers do not record disbursements Documentation Procedures Use prenumbered checks; checks must have an approved invoice; require employees to use corporate credit cards for reimbursable expenses Physical Controls Store blank checks in safes, with limited access; print check amounts by machine in indelible ink Illustration 8-6 Cash Disbursements Controls Human Resource Controls Bond personnel who handle cash; require employees to take vacations; conduct background checks

26. Chapter 8-26 Q8-17 Joe Griswold Company’s internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls. See notes page for discussion Discussion Question Cash Controls SO 4 Explain the applications of internal control principles to cash disbursements.

27. Chapter 8-27 The use of prenumbered checks in disbursing cash is an application of the principle of: a. establishment of responsibility. b. segregation of duties. c. physical, mechanical, and electronic controls. d. documentation procedures. Review Question Cash Controls SO 4 Explain the applications of internal control principles to cash disbursements.

28. Chapter 8-28 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. Cash Controls SO 4 Explain the applications of internal control principles to cash disbursements. Cash Disbursements Controls

29. Chapter 8-29 Petty Cash Fund - U sed to pay small amounts. Involves: 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund. Cash Controls SO 5 Describe the operation of a petty cash fund. Cash Disbursements Controls

30. Chapter 8-30 Illustration: If Laird Company decides to establish a $100 fund on March 1, the journal entry is: Cash Controls SO 5 Describe the operation of a petty cash fund. Petty cash100Mar. 1 Cash 100

31. Chapter 8-31 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: Cash Controls SO 5 Describe the operation of a petty cash fund. Postage expense44Mar. 15 Cash 87 Freight-out38 Miscellaneous expense5

32. Chapter 8-32 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: Cash Controls SO 5 Describe the operation of a petty cash fund. Postage expense44Mar. 15 Cash 88 Freight-out38 Miscellaneous expense5 Cash over and short1

33. Chapter 8-33 Contributes to good internal control over cash. Minimizes the amount of currency on hand. Creates a double record of bank transactions. Bank reconciliation. Control Features: Use of a Bank SO 6 Indicate the control features of a bank account.

34. Chapter 8-34 Making Bank Deposits Authorized employee should make deposit. SO 6 Indicate the control features of a bank account. Bank Code Numbers Front Side Reverse Side Illustration 8-8 Control Features: Use of a Bank

35. Chapter 8-35 Writing Checks Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient. SO 6 Indicate the control features of a bank account. Maker Payee Illustration 8-9 Payer Control Features: Use of a Bank

36. Chapter 8-36 Bank Statements Debit Memorandum Bank service charge NSF (not sufficient funds) SO 6 Indicate the control features of a bank account. Illustration 8-10 Credit Memorandum Collect notes receivable. Interest earned. Control Features: Use of a Bank

37. Chapter 8-37 The control features of a bank account do not include: a.having bank auditors verify the correctness of the bank balance per books. b.minimizing the amount of cash that must be kept on hand. c.providing a double record of all bank transactions. d.safeguarding cash by using a bank as a depository. Review Question SO 6 Indicate the control features of a bank account. Control Features: Use of a Bank

38. Chapter 8-38 Reconciling the Bank Account SO 7 Prepare a bank reconciliation. Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Errors. 4. Bank memoranda. Control Features: Use of a Bank

39. Chapter 8-39 Reconciliation Procedures SO 7 Prepare a bank reconciliation. + 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 8-11 Control Features: Use of a Bank

40. Chapter 8-40 Illustration: Illustration: The bank statement for Laird Company (Illustration 8-10), shows a balance per bank of $15,907.45 on April 30, 2010. On this date the balance of cash per books is $11,589.45. Using the four reconciliation steps, Laird determines the following reconciling items. Control Features: Use of a Bank

41. Chapter 8-41 Illustration: Illustration: a) Prepare a bank reconciliation at April 30. SO 7 Prepare a bank reconciliation. Cash balance per bank statement$15,907.45 Add: Deposit in transit2,201.40 Less:Outstanding checks(5,904.00) Adjusted cash balance per bank$12,204.85 Cash balance per books$11,589.45 Collection of notes + interest - fee1,035.00 Add:Error in recording check no. 44336.00 Less:NSF check(425.60) Bank service charge(30.00) Adjusted cash balance per books$12,204.85 Control Features: Use of a Bank Illustration 8-12

42. Chapter 8-42 The company records each reconciling item used to determine the adjusted cash balance per books. Collection of Note Receivable: Assuming interest of $50 has not been accrued and collection fee is charged to Miscellaneous Expense, the entry is: SO 5 Describe the operation of a petty cash fund. Cash 1,035.00Apr. 30 Miscellaneous expense15.00 Notes receivable1,000.00 Interest revenue50.00 Control Features: Use of a Bank

43. Chapter 8-43 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: SO 5 Describe the operation of a petty cash fund. Cash 36.00Apr. 30 Accounts payable36.00 Control Features: Use of a Bank

44. Chapter 8-44 NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is: SO 5 Describe the operation of a petty cash fund. Accounts receivable425.60Apr. 30 Cash425.60 Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense. The entry is: Miscellaneous30.00Apr. 30 Cash30.00 Control Features: Use of a Bank

45. Chapter 8-45 The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks. b. deposit in transit. c. a bank error. d. bank service charges. Review Question SO 7 Prepare a bank reconciliation. Control Features: Use of a Bank

46. Chapter 8-46 Electronic Funds Transfers (EFT) 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. Control Features: Use of a Bank SO 7 Prepare a bank reconciliation.

47. Chapter 8-47 Q8-23. Lori Figgs is confused about the lack of agreement between the cash balance per books and the balance per the bank. Explain the causes for the lack of agreement to Lori, and give an example of each cause. See notes page for discussion Discussion Question SO 7 Prepare a bank reconciliation. Control Features: Use of a Bank

48. Chapter 8-48 Reporting Cash SO 8 Explain the reporting of cash. Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository. Cash equivalents Restricted cash Compensating balances Illustration 8-14

49. Chapter 8-49 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. Review Question Reporting Cash SO 8 Explain the reporting of cash.

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