Slide 7-1 Chapter Fraud, Internal Control, and Cash Financial Accounting, IFRS Edition Weygandt Kimmel Kieso Slide 7-2 Study Study Objectives Objectives Slide 7-3 Define fraud and internal control Identify the principles of internal control activities Explain the applications of internal control principles to cash receipts Explain the applications of internal control principles to cash disbursements Describe the operation of a petty cash fund Indicate the control features of a bank account Prepare a bank reconciliation Explain the reporting of cash Fraud, Fraud, Internal Internal Control, Control, and and Cash Cash Fraud Fraudand and Internal Internal Control Control Fraud Internal control Principles of internal control activities Limitations Slide 7-4 Cash CashReceipts Receipts Controls Controls Over-thecounter receipts Mail receipts Cash Cash Disbursement Disbursement Controls Controls Voucher system controls Petty cash fund controls Control Control Features: Features:Use Use of ofaaBank Bank Making deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer (EFT) system Reporting Reporting Cash Cash Cash equivalents Restricted cash Compensating balances Fraud Fraud and and Internal Internal Control Control Fraud 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? Slide 7-5 SO Define fraud and internal control Answer on notes page Slide 7-6 Fraud Fraud and and Internal Internal Control Control Internal Control Methods and measures adopted to: Slide 7-7 Safeguard assets Enhance accuracy and reliability of accounting records Increase efficiency of operations, and Ensure compliance with laws and regulations SO Define fraud and internal control Fraud Fraud and and Internal Internal Control Control Internal Control Internal control systems have five primary components A control environment Risk assessment Control activities Information and communication Monitoring Slide 7-8 SO Define fraud and internal control Fraud Fraud and and Internal Internal Control 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:       Slide 7-9 Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls SO Identify the principles of internal control activities Fraud Fraud and and Internal Internal Control 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 and all documents should be accounted for Slide 7-10 SO Identify the principles of internal control activities Control Control Features: Features: Use Use of of aa Bank Bank Reconciliation Procedures Illustration 7-11 + Deposit in Transit + Notes collected by bank - - NSF (bounced) checks - Check printing or other service charges Outstanding Checks +- Bank Errors +- Company Errors CORRECT BALANCE Slide 7-41 CORRECT BALANCE SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank Illustration: The bank statement for Laird Company (Illustration 712), shows a balance per bank of $15,907.45 on April 30, 2011 On this date the balance of cash per books is $11,589.45 Using the four reconciliation steps, Laird determines the following reconciling items Slide 7-42 Control Control Features: Features: Use Use of of aa Bank Bank Illustration: a) Prepare a bank reconciliation at April 30 Cash balance per bank statement $15,907.45 Add: Deposit in transit 2,201.40 Less: Outstanding checks (5,904.00) Adjusted cash balance per bank $12,204.85 Cash balance per books $11,589.45 Add: Error in recording check no 443 36.00 Collection of notes + interest - fee 1,035.00 Less: NSF check (425.60) Bank service charge (30.00) Adjusted cash balance per books $12,204.85 Slide 7-43 Illustration 7-12 SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank 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: Apr 30 Cash 1,035.00 Miscellaneous expense 15.00 Notes receivable 1,000.00 Interest revenue 50.00 Slide 7-44 SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank 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: Apr 30 Cash 36.00 Accounts payable 36.00 Slide 7-45 SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor The entry is: Apr 30 Accounts receivable 425.60 Cash 425.60 Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense The entry is: Apr 30 Slide 7-46 Miscellaneous expense Cash 30.00 30.00 SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank Review Question 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 Slide 7-47 SO Prepare a bank reconciliation Control Control Features: Features: Use Use of of aa Bank Bank Electronic Funds Transfers (EFT) System 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 Slide 7-48 SO Prepare a bank reconciliation Reporting Reporting Cash Cash Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository Illustration 7-14 Cash equivalents Restricted cash Compensating balances Slide 7-49 SO Explain the reporting of cash While cash equivalents are now frequently reported with cash, it appears likely that the IASB will end this practice in the future Instead, items now referred to as cash equivalents will be reported as short-term investments Reporting Reporting Cash Cash Review Question 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 Slide 7-50 SO Explain the reporting of cash Understanding Understanding U.S U.S GAAP GAAP Key Differences Fraud, Internal Control, and Cash The fraud triangle discussed in this chapter is applicable to U.S companies as well Some of the most infamous U.S fraud scandals are Enron, Worldcom, and, more recently, the Bernie Madoff ponzi scheme After numerous corporate scandals, the U.S Congress passed the Sarbanes-Oxley Act of 2002 (SOX) Under SOX, all publicly traded U.S corporations are required to maintain an adequate system of internal control Slide 7-51 As a result of SOX, corporate executives and boards of directors must ensure that internal controls are reliable and effective In addition, independent outside auditors must attest to the adequacy of the internal control system Understanding Understanding U.S U.S GAAP GAAP Key Differences Fraud, Internal Control, and Cash SOX created the Public Company Oversight Board (PCAOB), to establish auditing standards and regulate auditor activity One study estimates the cost of compliance for U.S companies at over $35 billion, with audit fees doubling in the first year of compliance At the same time, examination of internal controls indicates lingering problems in the way companies operate One study of first compliance with the internal-control testing provisions documented material weaknesses for about 13% of companies reporting in 2004 and 2005 (PricewaterhouseCoopers’ Global Economic Crime Survey, 2005) Slide 7-52 Understanding Understanding U.S U.S GAAP GAAP Key Differences Fraud, Internal Control, and Cash The enhanced internal control standards apply only to large public companies listed on U.S exchanges There is continuing debate over whether foreign issuers should have to comply with this extra layer of regulation Most companies report cash and cash equivalents together under IFRS and GAAP, as shown in this textbook In addition, GAAP follows the same accounting policies related to the reporting of restricted cash Slide 7-53 Understanding Understanding U.S U.S GAAP GAAP Looking to the Future Fraud, Internal Control, and Cash High-quality international accounting requires both high-quality accounting standards and high-quality auditing Similar to the convergence of GAAP and IFRS, there is a movement to improve both U.S and international auditing standards.The International Auditing and Assurance Standards Board (IAASB) functions as an independent standard-setting body It works to establish highquality auditing and assurance and quality-control standards throughout the world Whether the IAASB adopts internal control provisions similar to those in SOX remains to be seen Also, under proposed new standards being developed jointly by the FASB and IASB for financial statement presentation, cash equivalents cannot be combined with cash Slide 7-54 Copyright Copyright “Copyright © 2011 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Slide 7-55 [...]... principles to cash disbursements Cash Cash Disbursement Disbursement Controls Controls Illustration 7-6 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 Slide 7-28 Documentation Procedures Use prenumbered checks; checks... Disbursement Disbursement Controls Controls Review Question 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 Slide 7-29 SO 4 Explain the applications of internal control principles to cash disbursements Cash Cash Disbursement Disbursement Controls... approvals, by authorized individuals, to ensure all disbursements by check are proper A voucher is an authorization form prepared for each expenditure Slide 7-30 SO 4 Explain the applications of internal control principles to cash disbursements Cash Cash Disbursement Disbursement Controls Controls Petty Cash Fund Controls Petty Cash Fund - Used to pay small amounts Involves: 1 establishing the fund,... $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 Slide 7-33 87 SO 5 Describe the operation of a petty cash fund Cash Cash Disbursement Disbursement Controls Controls Illustration: Occasionally, the company may need to recognize a 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 Slide 7-34 88 SO 5 Describe the operation of a petty cash fund Control Control Features: Features: Use Use of of aa Bank Bank Contributes to good internal control over... cash receipts is an application of the principle of: a segregation of duties b establishment of responsibility c independent check d human resource controls Slide 7-26 SO 3 Explain the applications of internal control principles to cash receipts Cash Cash Disbursement Disbursement Controls Controls Generally, internal control over cash disbursements is more effective when companies pay by check, rather... Slide 7-31 SO 5 Describe the operation of a petty cash fund Cash Cash Disbursement Disbursement Controls 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 Slide 7-32 SO 5 Describe the operation of a petty cash fund Cash Cash Disbursement Disbursement Controls Controls Illustration: Assume that on March 15 Laird’s petty... 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 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 Cash Cash Disbursement... receipts (cashiers) Use remittance advice (mail receipts), cash register tapes, and deposit slips Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily Segregation of Duties Physical Controls Different individuals receive cash, record cash receipts, and hold the cash Store cash in safes and bank vaults; limit access to storage areas; use cash registers Human... transactions Bank reconciliation Slide 7-35 SO 6 Indicate the control features of a bank account Control Control Features: Features: Use Use of of aa Bank Bank Making Bank Deposits Authorized employee should make deposit Front Side Slide 7-36 Illustration 7-8 Bank Code Numbers Reverse Side SO 6 Indicate the control features of a bank account  ... receipts Mail receipts Cash Cash Disbursement Disbursement Controls Controls Voucher system controls Petty cash fund controls Control Control Features: Features:Use Use of ofaaBank Bank Making deposits... Disbursement Disbursement Controls Controls Review Question The use of prenumbered checks in disbursing cash is an application of the principle of: a establishment of responsibility b segregation... cash disbursements Cash Cash Disbursement Disbursement Controls Controls Voucher System Controls Voucher System Network of approvals, by authorized individuals, to ensure all disbursements by