Financial Accounting Chapter 5

Opportunity

The employee has a means of committing fraud. Usually stems from weak internal controls.

Incentive

The employee has a reason for committing fraud *Personal Financial Pressure *Make the business appear more successful to attract investors, bring in new business partners, or meet loan requirements *Loan Covenants

Rationalization

The employee perceives the misdeed as unavoidable or justified.

Cash received from a remote source

-Cash received by mail -Cash received electronically

Bank Statement

-Checks cleared -Deposits made -Other transactions -Interest -Service fees

Time lags

-Deposits in transit -Outstanding check

Reduce Opportunities

-Establish an audit committee of independent directors -Evaluate and report on the effectiveness of internal control over financial reporting (This evaluation must be completed by management and, for large public companies, by external auditors as well)

Control Environment

-Internal control component that refers to the attitude that people in the organization hold regarding internal control -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 the people they hire, and how they evaluate others. -helps employees understand the value of internal controls to their organizations success

3 factors exist when fraud occurs (Fraud Triangle)

1. Incentive 2. Opportunity 3. Rationalization

Internal control objectives

-Operations -Reporting -Compliance

Encourage Honesty

-Parts of SOX help honest employees confront those inclined to rationalize and conceal fraud -Legal protection to whistleblowers -Required to adopt a code of ethics

Establish Responsibility

-The principle of internal control that assigns each task to only one employee -Allows you to determine who caused the errors or thefts that occur

Segregate Duties

-The principle of internal control that assigns responsibilities for related activities to two or more people and assigns responsibilities for recordkeeping to people who do not have access to the assets for which they are accounting. -One employee should not initiate, approve, record, and have access to the items involved in the same transaction.

Document Procedures

-The principle of internal control that creates a record of whether goods were shipped, customers were billed, cash was received, and so on by documenting each business activity -To enhance this control, most companies assign sequential numbers to their documents and check that they are used in numerical sequence -This check occurs frequently, sometimes daily, to ensure that every transaction is recorded and that each document number corresponds to one and only one accounting entry.

Restrict Access

-The principle of internal control which involves rather obvious steps such as locking up valuable assets and electronically securing access to other assets and information.

Bank Reconciliation

-an internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual -Procedure is done monthly

Monitoring Activities

-internal control component that evaluates often to determine whether it is working as intended -Deficiencies should be communicated to those responsible for taking corrective action, including senior management and/or the board of directors

Cash Equivalents

-short-term, highly liquid investments purchased within three months of maturity -readily convertible to known amounts of cash -so near to maturity that there is little risk their value will change -Certificate of Deposit (personal life) -Market Funds....Government treasury bills (Companies)

Control Limitations

1. An organization will implement internal controls only to the extent that their benefits exceed their costs 2. Human error or fraud. People do make simple mistakes especially if they are tired, careless, or confused. Also criminally minded emplyees have been known to override internal controls or collude to get around them.

Reconciling Differences

1. Bank errors (proshko says bank doesn't make errors in the class) 2. Time lags 3. Interest deposited 4. Electronic funds transfer 5. Service charges 6. NSF checks 7. Your errors

Cash received in person

1. Cashiers collect cash and issue a receipt at the point of sale 2. Supervisors take custody of the cash at the end of each cashier's shift and deposit it in the bank 3.Accounting staff then ensure the receipts from cash sales are properly recorded in the accounting system

Internal Control Components

1. Control environment 2.Risk Assessment 3. Control Activities 4. Information and Communication 5. Monitoring activities

Key Requirements of the Sarbanes-Oxley ACt (SOX)

1. Counteract Incentives 2. Reduce Opportunities 3. Encourage Honesty

Cash received in person (CASHIER)

1. Document the amount charged for each item (scan the item) 2. Restrict access to cash (place in register) 3. Document the total cash sales (prepares cash count sheet. Total cash collected during shift)

Five common Principles of Internal control

1. Establish responsibility 2. Segregate Duties 3. Restrict Access 4. Document procedures 5. Independently verify

Businesses can receive cash in two different ways

1. In person at the time of sale -physically, (dollars, coins, and checks payable to the business) 2. From a remote source as payment on an account -Electronic transactions, (credit cards, debit cards, and electronic funds transfers)

Controls from Bank Procedures

1. Restricting access 2. Document procedures 3. Independently verifying

Internal control for cash is important for two main reasons

1. The volume of cash transactions is enormous, the risk of cash-handling errors is significant 2. Cash is valuable, portable, and "owned" by the person who possesses it, it poses a high risk of theft. Internal controls are vital to reduce these risks

Cash received in person (SUPERVISOR)

4. Independently verifies (compares cash in register with cash count sheet) 5. Restricts Access (stores cash in vault box) 6. Documents Procedure (prepares deposit slip and after bank teller verifies and deposits the funds, bank teller stamps the deposit slip, which is then forwarded to the company's accounting department)

Cash received in person (Accounting Department)

7. Independently verifies (compares cash register records with cash count sheet and bank deposit slip 8. Documents procedure (Prepares journal entry)

Sarbanes-Oxley Act (SOX)

A set of regulations passed by congress in 2002 in an attempt to improve financial reporting and restore investor confidence

Internal Control

Actions taken to promote efficient and effective operations, protect assets, enhance accounting information, and adhere to laws and regulations.

Updates to bank statement

Additions: deposits in transit Deductions: outstanding checks

Updates to company's books

Additions: Interest received from the bank EFT received from customers Deductions: NSF check Bank service charge Error in recording

Segregation of duties

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

Cash Shortage (or Overage) account

Any difference between the amount rung up by the cash register and Cash at the amount deposited in the bank is reported on the income statement as a miscellaneous expense (or revenue)

Three Categories of Employee Fraud

Corruption Asset Misappropriation Financial Statement Fraud

Control Activities

Internal control component that include various work responsibilities and duties completed by employees to reduce risks to an acceptable level

Risk Assessment

Internal control component that says managers should continuously assess the potential for fraud and other risks that could prevent the company from achieving its objectives

Counteract Incentives

Stiff fines and Prison terms

Loan Covenant

Terms of a loan agreement that if broken, entitle the lender to renegotiate loan terms or force repayment. Require the company to achieve financial targets, such as maintaining specific levels of assets or stockholders' equity

Independently Verify

The principle of internal controls with various ways to implement it: 1. Hire someone (an auditor) to check that the work done by others within the company is appropriate and supported by documentation 2. Can be made part of a person's job 3. Comparing the company's accounting information to information kept by an independent third party (like the bank).

Asset misappropriation

Theft (embezzlement). Cash is usually the target, but other assets can be misappropriated.

Voucher system

a process for approving and documenting all purchases and payments on account 1. Request that goods or services be ordered (purchase recquisition form/Establish responsibility) 2. Order goods or services (Purchase Order/Restrict access) 3. Receive goods or services (Receiving report/Document procedures, Segregate duties) 4. Obtain bill for goods or services (Supplier invoice/Independently verify, Document procedures) 5. Write check or initiate an EFT to pay the bill (Company check or EFT transaction number/Document procedures, independently verify, document procedures, segregate duties)

Imprest stystem

a process that controls the amount paid to others by limiting the total amount of money available for making payments to others (Don't have to know this for Proshko's class)

Fraud

an attempt to deceive other for personal gain`

Remittance advice

customer includes this with the payment explaining the purpose of the payment

Information and communication

internal control component that generates and communicates information about activities affecting the organization to support sound decision making.

Compliance

internal control objective that focuses on adhering to laws and regulations

Operations

internal control objective that focuses on completing work efficiently and effectively and protecting assets by reducing the risk of fraud

Reporting

internal control objective that include producing reliable and timely accounting information for use by people internal and external to the organization

Financial Statement Fraud

involves misreporting amounts in the financial statements , usually to portray more favorable financial results than what actually exist.

Corruption

involves misusing one's position for inappropriate personal gain (bribery and kickbacks)

Cash

money or any instrument that banks will accept for deposit and immediately credit to a company's account

Restricted Cash

not available for general use but rather restricted for a specific purpose

Electronic Funds Transfer (EFT)

occurs when a customer electronically transfers funds from his or her bank account to the company's bank account

Controls for Cash Payments

the primary goal of internal controls for this is to ensure that the business pays only for properly authorized tranzactions

The Primary Internal Controls Goal for Cash Receipts

to ensure that the business receives the appropriate amount of cash and safely deposits it in the bank