Ch. 5 (Fraud, Internal Control, and Cash)

True/False: A company records each reconciling item used to determine the adjusted cash balance per books.

True

True/False: Cash is the asset most susceptible to fraudulent

True

True/False: Companies use a petty cash fund to pay relatively small amounts.

True

True/False: Internal control consists of all the related methods and measures adopted within an organization to safeguard its assets and to enhance the accuracy and reliability of its accounting records.

True

True/False: Internal control over cash disbursements is more effective when companies pay by check, rather than by cash.

True

True/False: The lack of agreement between the bank balance and the book balance is due to time lags and errors.

True

Apply internal control principles to cash payments (LO 5-3)

p. 215 When applied to cash payments, internal control principles require that... (1) only certain individuals or departments initiate purchase requests (2) different individuals be assigned to order, receive, and pay for purchases (3) access to checks and valuable property be restricted (4) purchase requisitions, purchase orders, receiving reports, and pre numbered checks be used to document the work done (5) each step in the payment process occurs only after the preceding step has been independently verified using the documents listed in (4).

A company has $8,000 cash balance per its books. The bank statement has a balance of $8,450. The bank reconciliation included $800 of deposits-in-transits, $500 of checks outstanding, ETFs of $1,000 were received from customers, a $200 NSF check from a customer, and a $50 bank service charge. Given the following reconciling items, the up-to-date cash balance equals ________ .

$8,750

2 reasons internal control for CASH is important

1. Because the volume of cash transactions is enormous, the risk of cash-handling errors is significant. 2. Because cash is valuable, portable, and "owned" by the person who possesses it, it poses a high risk of theft.

Many organizations use the following control components as a framework when analyzing their internal control systems...

1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information & Communication 5. Monitoring Activities

3 Internal Controls for Cash

1. Controls for cash RECEIPTS 2. Controls for cash PAYMENTS 3. Controls from BANK PROCEDURES

What are three categories of employee fraud? Which is most common? Which is associated with the largest losses?

1. Corruption 2. Asset Misappropriation 3. Financial Statement Fraud

Explain common principles of internal control. (LO 5-2)

1. Establish responsibility (assign each task to only one employee -- ex: give a separate cash register drawer to each cashier at the beginning of each shift) 2. Segregate Duties (Do not make one employee responsible for all parts of a process -- ex: Inventory buyers do not also approve payments to suppliers) 3. Restrict Access (Do not provide access to assets or information unless it is needed to fulfill assigned responsibilities -- ex: Secure valuable assets such as cash and restrict access to computer systems [via passwords, firewalls]) 4. Document Procedures (prepare documents to show activities that have occurred -- ex: pay suppliers using prenumbered checks and digitally documented electronic fund transfers) 5. Independent Verify (check others work -- ex: compare the cash balance in the company's accounting records to the cash balance reported by the bank and account for any differences)

A petty cash system involves 3 steps...

A petty cash system involves 3 steps... (1) putting money into petty cash to establish a fund (2) paying money out to reimburse others (3) putting money back into petty cash to replenish the fund.

(Voucher System

A process for approving and documenting all purchases and payments on account.

Which of the following is not required by the Sarbanes-Oxley Act? A. Companies must file financial statements with the Internal Revenue Service. B. All publicly traded companies must maintain adequate internal controls. C. The Public Company Accounting Oversight Board was created to establish auditing standards and regulate auditor activity. D. Corporate executives and board of directors must ensure that controls are reliable and effective and they can be fined or imprisoned for failure to do so.

A. Companies must file financial statements with the Internal Revenue Service.

The fraud triangle consists of three factors: A. Opportunity, rationalization and financial pressure B. Ability, opportunity, rationalization C. Rationalization, ability and financial pressure D. Financial pressure, opportunity and ability

A. Opportunity, rationalization and financial pressure

The use of cash register tapes is an example of A. documentation procedures. B. other controls. C. physical controls. D. independent internal verification.

A. documentation procedures.

Allowing only designated personnel to handle cash receipts is an example of A. establishment of responsibility. B. segregation of duties. C. documentation procedures. D. independent internal verification.

A. establishment of responsibility.

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.

A. having bank auditors verify the correctness of the bank balance per books.

Restricted cash expected to be used within the next year should be A. reported as a current asset. B. reported as a noncurrent asset. C. disclosed in the notes to the financial statements. D. reported as a reduction of cash.

A. reported as a current asset.

An organization uses internal controls to enhance the accuracy and reliability of its accounting records and to A. safeguard its assets. B. prevent fraud. C. produce correct financial statements. D. deter employee dishonesty.

A. safeguard its assets.

Internal Control

Actions taken at every level of an organization to promote efficient and effective operations, protect assets, enhance accounting information, and adhere to laws and regulations. The components of internal control include the control environment, risk assessment, control activities, information & communication, and monitoring activities.

Fraud

An attempt to deceive others for personal gain.

Segregation of Duties

An internal control designed into the accounting system to prevent an employee from making a mistake or committing a dishonest act as part of one assigned duty and then covering it up through another assigned duty.

Outstanding Check

Another common time lag. This lag occurs when your bank doesn't find out about it until that company deposits the check in its own bank, which then notifies your bank.

What roles do auditors play in the financial reporting process?

Auditors provide quality assurance by reporting on the effectiveness of a company's internal controls over financial reporting and by providing an independent opinion about whether the company's financial statements are prepared in accordance with GAAP.

Journal entries are required by the depositor for all of the following except A. collection of a note receivable. B. bank errors. C. bank service charges. D. a NSF check.

B. bank errors.

Physical controls do not include A. safes and vaults to store cash. B. independent bank reconciliations. C. locked warehouses for inventories. D. bank safety deposit boxes for important papers.

B. independent bank reconciliations.

A company reports a debit balance in Cash Over and Short as a(n) A. liability. B. miscellaneous expense. C. miscellaneous revenue. D. asset.

B. miscellaneous expense.

Having different individuals receive cash, record cash receipts, and hold the cash is an example of A. establishment of responsibility. B. segregation of duties. C. documentation procedures. D. independent internal verification.

B. segregation of duties.

Deposits in transit are added to the _________ (bank/book) side of the bank reconciliation

Bank

Electronic Funds Transfer (EFT)

Businesses also receive payments from customers via EFT's. An EFT occurs when a customer electronically transfers funds from his bank account to the company's bank account. Most businesses encourage customers to use EFT's because they speed up collections. Eliminate the need for some internal controls because these payments are deposited directly into the account. To process an EFT, the accounting department merely records journal entries to DEBIT CASH and CREDIT ACCOUNTS RECEIVABLE from each customer.

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.

C. Cash is listed first in the current assets section.

Which of the following is not an element of the fraud triangle? A. Rationalization. B. Financial pressure. C. Segregation of duties. D. Opportunity.

C. Segregation of duties.

An employee authorized to sign checks should not record A. owner cash contributions. B. mail receipts. C. cash disbursement transactions. D. sales transactions.

C. cash disbursement transactions.

Bonding employees who handle cash is an example of application of the principle of A. establishment of responsibility. B. segregation of duties. C. human resource controls. D. independent internal verification.

C. human resource controls.

Large companies often assign independent internal verification to the A. bookkeeper. B. controller. C. internal auditors. D. treasurer.

C. internal auditors.

The Sarbanes-Oxley Act requires that all major U.S. corporations A. prepare bank reconciliations monthly. B. maintain a petty cash fund. C. maintain an adequate system of internal control. D. must file reports with the National Commission on Fraudulent Financial Reporting.

C. maintain an adequate system of internal control.

The principles of internal control do not include A. establishment of responsibility. B. documentation procedures. C. management responsibility. D. independent internal verification.

C. management responsibility.

Storing cash in a company safe is an application of which internal control principle? A. segregation of duties B. documentation procedures C. physical controls D. establishment of responsibility

C. physical controls

The principles of internal control include all of the following except A. establishment of responsibility. B. combining of duties. C. physical controls. D. independent internal verification.

C. physical controls.

When a check is presented to a bank for payment and the amount is deducted from the payer's account the check is said to have __________ the bank.

Cleared the bank

Override & Collude

Criminally minded employees have been known to OVERRIDE (disarm) internal controls or COLLUDE (work together) to get around them.

Which of the following control activities is relevant when a company uses a computerized (rather than manual) accounting system? A. Establishment of responsibility. B. Segregation of Duties. C. Independent internal verification. D. All of these control activities are relevant to a computerized system.

D. All of these control activities are relevant to a computerized system.

Journal entries are required by the depositor for all of the following except A. collection of a note receivable. B. an NSF check. C. bank service charges. D. bank errors.

D. bank errors

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.

D. bank service charges.

All of the following are classified as cash except A. checks. B. money orders. C. money on hand. D. commercial paper.

D. commercial paper

On a bank reconciliation, bank service charges are A. added to the bank balance. B. deducted from the bank balance. C. added to the book balance. D. deducted from the book balance.

D. deducted from the book balance.

All of the following would involve a debit memorandum except A. a bank service charge. B. an NSF check. C. the cost of printing checks. D. interest earned.

D. interest earned.

A credit balance in Cash Over and Short is reported as a (n) A. asset. B. liability. C. miscellaneous expense. D. miscellaneous revenue.

D. miscellaneous revenue.

Controls that enhance the accuracy and reliability of the accounting records and relate to the safeguarding of assets are A. automated controls. B. external controls. C. internal controls. D. physical controls.

D. physical controls

Cash equivalents include all of the following except A. money market funds. B. commercial paper. C. U.S. Treasury bills. D. restricted cash.

D. restricted cash.

A bank statement A. lets a depositor know the financial position of the bank as of a certain date. B. is a credit reference letter written by the depositor's bank. C. is a bill from the bank for services rendered. D. shows the activity that increased or decreased the depositor's account balance.

D. shows the activity that increased or decreased the depositor's account balance.

True/False: A bank issues a debit memorandum when it collects a note receivable for a depositor.

False

True/False: Control is most effective when two people are responsible for a given task.

False

True/False: Few internal control systems provide for independent internal verification.

False

True/False: There are two parties to a check: the maker and the payee.

False

Cash Short (Over)

If the total of cash and receipts in the cash box is less (or more) than the fund total, the fund is referred to being short (or over). Shortages (overages) are recorded in the account called Cash Short (Over) and reported on the INCOME STATEMENT as MISCELLANEOUS EXPENSE (or REVENUE)

Control Activities

Include various work responsibilities and duties completed by employees to reduce risks to an acceptable level.

Explain limitations of internal control. (LO 5-2)

Internal controls will never completely prevent and detect errors and fraud for 2 reasons: 1. An organization will implement internal controls only to the extent that their benefits EXCEED THEIR COSTS. 2. Internal controls can fail as a result of human error or fraud. May be limited by cost, human error, and fraud.

This month's bank statement shows interest earned of $45. How would this item be treated on a bank reconciliation?

It would be added to the BOOK balance -- the book balance must be increased by the amount of interest earned as reported on the bank statement. The bank balance already includes the interest.

Why would managers misrepresent the financial results of their companies?

Managers can be motivated to misreport financial reults to create business opportunities (by satisfying loan covenants, increasing equity financing, and attracting business partners) and to satisfy personal greed (enhancing job security increasing personal wealth, and obtaining a bigger paycheck).

Risk Assessment

Managers should continuously assess the potential for fraud and other risks that could prevent the company from achieving its objectives.

Loan Covenants

Many lending agreements include loan covenants, which require the company to achieve financial targets, such as maintaining specific levels of assets or SHE. If loan covenants are not met, the lender can require the company to pay a higher interest rate, repay its loan balance on demand, or put up extra collateral to secure the loan.

Cash

Money or any instrument that banks will accept for deposit and immediately credit to a company's account. Cash deposited with banks, petty cash on hand, and cash equivalents.

Which items of the bank reconciliation need to be recorded in the company's records?

Only the items on the Company's BOOKS side of the bank reconciliation need to be recorded in the company's books.

Outstanding checks written by the company should be a(n) _______ on the company's bank reconciliation

Outstanding checks written by the company should be a(n) deduction from the bank balance on the company's bank reconciliation

Control Environment

Referring to the attitude that people in the organization hold regarding internal control. It is influenced by the policies that a company's Board of Directors and senior managers set, their demonstrated commitment to integrity and ethical values, the character of people they hire, and how they evaluate others. A strong control environment helps employees understand the values of internal controls to their organization's success.

The Fraud Triangle

Research has found that three factors exist when fraud occurs. These factors work together, as suggested by the fraud triangle. The factors are.... 1. Incentive 2. Opportunity 3. Rationalization

Cash Equivalents

Short-term, highly liquid investments purchased within three months of maturity.

NSF Checks from customers should be a(n) ___________ on a bank reconciliation.

Subtraction from the book (not the bank) balance because the check was originally recorded as an increase to cash and needs to be reduced since the deposit was a bad check.

What aspect(s) of the Sarbanes-Oxley Act might allow honest employees to prevail?

The SOX Act attempts to encourage good personality in employees by mandating the creation of confidential tip lines whereby employees can report potentially fraudulent conduct. It also offers protection to whistle-blowers.

What aspects of the Sarbanes-Oxley Act might counteract the incentive to commit fraud?

The Sarbanes-Oxley Act counteracts the incentive to commit fraud by stipulating steeper fines and longer jail terms for those who wilfully represent financial data.

The Sarbanes-Oxley Act provides increased regulations for _____, ______, and _______.

The Sarbanes-Oxley Act provides increased regulations for internal controls, auditors, and corporate executives.

What aspects of the Sarbanes-Oxley Act might reduce opportunities for fraud?

The Sarbanes-Oxley Act reduces the opportunity to commit fraud by requiring that management monitor their internal controls and submit a report that indicated whether the controls over financial reporting operated effectively. The board of directors must appoint an audit committee to oversee the financial matters of a company. External auditors must test the effectiveness of the company's internal controls and submit a report stating whether they agree with the internal control report issued by management.

The primary goal of internal controls for all cash payments is...

The primary goal of internal controls for all cash payments is to ensure that the business pays only for properly authorized transactions.

Deposits in Transit

Time lags are common. A time lag occurs, for example, when you make a deposit after the bank's normal business hours. YOU know you made the deposit, but your bank does not know until it processes the deposit the next day. Time lags involving deposits are called DEPOSITS IN TRANSIT.

Petty Cash Fund

To avoid the time and cost of writing checks for business expenses that are small in amount, most organizations use a petty cash fund. This is a system used to reimburse employees for expenditures they have made on behalf of the organization. Like the imprest system account, a petty cash fund acts as a control by establishing a limited amount of cash to use for specific types of expenses.

Sarbanes-Oxley Act (SOX)

To reduce fraud among public companies, the U.S. Government introduced SOX, a set of regulations passed by Congress in 2002 in an attempt to improve financial reporting and restore investor confidence. Introduced many new requirements, such as... 1. Counteract incentives (those who wilfully misrepresent financial results face stiff penalties, including fines of up to $5 million plus repayment of any fraud proceeds) 2. Reduce opportunities (establish an audit committee of independent directors, evaluate & report on the effectiveness of internal control over financial reporting) 3. Encourage honesty

Corruption

Type of employee fraud that involves misusing one's position for inappropriate personal gain.

Asset Misappropriation

Type of employee fraud that is theft (embezzlement). Cash is usually the target, but other assets can be misappropriated.

Rationalization

Via the Fraud Triangle... The employee perceives the misdeed as unavoidable or justified.

Apply internal control principles to cash receipts (LO 5-3)

pg. 215 When applied to cash receipts, internal control principles require that (1) cashiers be held individually responsible for the cash they receive (2) different individuals can be assigned to receive, maintain custody of, and record cash (3) cash be stored in a locked safe until it has been securely deposited in a bank (4) cash register receipts, cash count sheets, daily cash summary reports, and bank deposit slips be prepared to document the cash received and deposited (5) cash register receipts be matched to cash counts and and deposit slips to be independently verify that all cash was received and deposited.

Direct Deposits

pg. 220 Most companies pay salaries and wages to employees through EFT's, which are known by employees as DIRECT DEPOSITS. This system is convenient and efficient for the employer because it eliminates the tasks of physically writing and distributing the checks and for the employee who has access to the funds without having to deposit a check. One risk, however, is that the bank might accidentally overpay or underpay an employee by transferring the wrong amount of money out of a company's bank account. -- to reduce this risk, many companies use an IMPREST SYSTEM for paying employees.

Imprest System

pg. 220 A process that controls the amount paid to others by limited the total amount of money available for making payments to others.

The main difference between an imprest system account and a petty cash fund

pg. 220 Rather than transfer the funds from a general bank account to another special account at the bank, the company removes cash from its general bank account to another special account at the bank, the company removes cash from its general bank account to hold at its premises in a locked cash box. The company's petty cash custodian is responsible for operating the petty cash fund.

Perform the key control of reconciling cash to bank statements (LO 5-4)

pg. 221 The bank reconciliation requires determining two categories of items: (1) Those that have been recorded in the company's books but not in the bank's statement of account (2) those that have been reported in the bank's statement of account but not in the company's books. The second category of items provides the data needed to adjust the Cash account to the balance that will be reported on the balance sheet.

Bank Reconciliation

pg. 221-222 An internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual. Bank statements often refer to CHECKS as DEBITS and DEPOSITS as CREDITS. This apparent reversal of debit and credit rules occurs because the bank reports from its perspective, not yours. To the bank, your account is a liability that decreases when you take money out (debit the liability) and increases when you deposit the money (credit the liability)

NSF (Not Sufficient Funds) Check

pg. 223 Another name for BOUNCED CHECKS. They arise when the check writer (your customer) does not have the sufficient funds to cover the amount of the check.

Explain the reporting of cash (LO 5-5)

pg. 226 Cash is combined with cash equivalents in current assets. Cash equivalents are highly liquid investments purchased within three months of maturity. Restricted Cash is reported separately, as a current asset if expected to be used up within one year or, if not, as a noncurrent asset.

Restricted Cash

pg. 227 Not available for general use but rather restricted for a specific purpose.