ACCT 2200 CHAPTER 5 EXAM 2

Employee fraud is often grouped into three categories:

-Corruption—Involves misusing one's position for inappropriate personal gain. -Asset misappropriation—Quite simply, theft (embezzlement); cash is usually the target, but other assets can be misappropriated. Financial statement fraud—Involves misreporting amounts in the financial statements, usually to portray more favorable financial results than what actually exist.

Internal control for cash is important for two main reasons.

-First, because the volume of cash transactions is enormous, the risk of cash-handling errors is significant. -Second, because cash is valuable, portable, and "owned" by the person who possesses it, it poses a high risk of theft. To reduce these risks, internal controls are vital.

Most organizations use the following control components as a framework when analyzing their internal control systems:

Control environment—The control environment refers to the attitude people in the organization hold regarding internal control. Risk assessment—Managers continuously assess the potential for fraud and other risks that could prevent the company from achieving its objectives. Control activities—Control activities include various work responsibilities and duties completed by employees to reduce risks to an acceptable level. Information and communication—An effective internal control system generates and communicates information about activities affecting the organization to support sound decision making. Monitoring activities—The internal control system is evaluated often to determine whether it is working as intended.

Three factors exist when fraud occurs; these factors work together, as suggested by the fraud triangle:

Incentive - First, there must be an incentive for the employee to commit the fraud. This could be from the pressure to produce pleasing financial results to satisfy loan covenants, increase equity funding, or attract business partners. It could also be that the employee is trying to benefit personally from this fraud such as enhancing job security, increasing personal wealth, and obtaining a bigger paycheck. Opportunity - Second, an opportunity must exist to commit the fraud, which usually stems from weak internal controls. Rationalization - Third, the employee committing the fraud must possess personal characteristics that allow them to perceive the misdeed as unavoidable or justified. Fraudsters rationalize their actions through a feeling of personal entitlement, which outweighs moral principles, such as honesty and concern for others.

SOX was created in response to financial statement frauds that occurred in the early 2000s. Confidence in the stock markets had been shaken by frauds involving Enron and WorldCom, so the U.S. Congress passed the act in an attempt to improve financial reporting and restore investor confidence

One objective of SOX is to counteract incentives for committing fraud such as stiffer fines and prison terms. Another objective of SOX is to reduce opportunities for fraud, which is the part of the fraud triangle most affected by these changes. SOX requires all public companies to establish an audit committee of independent directors and to evaluate and report on the effectiveness of internal control over financial reporting. Encouraging honesty is another requirement under SOX whereby companies can encourage good character employees through anonymous tip lines, whistle-blower protection, and codes of ethics.

Services provided by banks help businesses control cash by:

Restricting access—Because banks provide a secure place to deposit cash, businesses need to keep only a limited amount of cash on hand, which reduces the risk it will be stolen or misplaced. Documenting procedures—By processing payments made by check or EFT, banks facilitate and document business transactions. Independently verifying—Company accountants can use the bank's statement of account to double-check the accuracy of the company's cash records.

The balance in a company's cash records usually differs from the balance in the bank's records for a variety of valid reasons.

The process of comparing two sets of records is called reconciling. Thus, the internal accounting report that compares the company's cash records with the bank's is a bank reconciliation. A bank reconciliation is a key internal control because it provides independent verification of all cash transactions that the bank has processed for the company. This procedure is done monthly, ideally by a company employee whose duties are segregated from recording and handling cash.

Internal controls can never completely prevent and detect all errors and fraud for two reasons:

-Internal controls will be implemented only to extent their benefits exceed their costs. -Internal controls can fail as a result of human error or fraud. People do make simply mistakes when performing control procedures, especially if they are tired, careless, or confused. Criminally minded employees also have been known to override (disarm) internal controls, or collude (work together) to get around them.

Company records can differ from bank's statement of account for two basic reasons:

-The company has recorded items the bank doesn't know about at the time it prepares the statement of account. -The bank has recorded items the company doesn't know about until the bank statement is examined.

Businesses can receive cash in two different ways.

-They can receive it in person at the time of a sale or from a remote source as payment on an account. Most businesses receive cash in the form of dollars, coins, and checks payable to the business or the company can also receive cash remotely through the mail or electronic transactions involving credit cards, debit cards, and electronic funds transfers.

Internal control

Actions taken to promote efficient and effective operations, protect assets, enhance accounting information, and adhere to laws and regulations. Internal control consists of actions taken throughout the organization to achieve its objectives relating to: -Operations-Operational objectives focus on completing work efficiently and effectively, and protecting assets by reducing the risk of fraud. -Reporting-Reporting objectives include producing reliable and timely accounting information for use by people internal and external to the organization. -Compliance-Compliance objectives focus on adhering to laws and regulations.

Causes of differences:

Bank errors—If you discover a bank error, you should ask the bank to correct its records, but you should not change yours. Deposit in transit—Time lag occurs when you make a deposit after the bank's normal business hours. You know you've made the deposit, but your bank doesn't know until it processes the deposit the next day. Outstanding check—Time lag occurs when the company writes and mails a check to another company, but the bank doesn't find out about it until that company deposits the check in its own bank, which then notifies your bank. Interest deposited—The company probably doesn't know the amount of interest until they read the bank statement. Electronic funds transfer (EFT) transit—Time lag occurs when funds are transferred into or out of the company account without the company knowing about it. Service charges—Time lag occurs when bank charges for processing transactions. NSF (non-sufficient funds) checks-Checks written for an amount greater than the funds available to cover them. Because the bank increased the company account when they first deposited the check, the bank will decrease the company account when it discovers the deposit was not valid. The company will need to reduce the Cash balance by the amount of these bounced checks (plus any additional bank charges), and try to collect the amount from the check writer. Company errors—These are mistakes the company made or amounts they haven't yet recorded in their records.

Cash, as reported on the balance sheet, includes cash deposited with banks, petty cash on hand, and cash equivalents

Cash is money or any instrument that banks will accept for deposit and immediate credit to a company's account, such as a check, money order, or bank draft.