ACC 210 Chapter 4

common items that will decrease the company's cash balance once the reconciliation occurs (4)

nsf checks, debit cards, electronic funds transfers (eft's), and service fees charged by banks

examples of detective controls (3)

reconciliations, performance reviews, and audits

e-commerce

refers to the wide range of electronic activities of a company, such as buying and selling over the internet, digital information processing, and electronic communication

sox represents one of the greatest...

reforms in business practices in u.s. history

restricted cash

represents cash that is not available for current operations

when companies make errors in their financial statements, what do they often have to do?

restate the financial statements affected

in addition to the current, available for for spending at the end of the reporting period cash companies report in the balance sheet, what do some companies separately report?

restricted cash

information and communication (in terms of one of the components of internal controls) depend on the reliability of...

the accounting system itself

performance reviews (detective controls)

the actual performance of individuals or processes should be checked against their expected performance (ex. the amount of concessions sold should be compared to the number of tickets sold over a period of time. if concession sales are lower than expected for a certain amount of tickets, then employees could be wasting food, stealing snacks, or giving it to their friends for free. alternatively, vendors may be supplying lower-quality food, driving down sales) management may also wish to evaluate the overall performance of the firm by comparing sales in the current year to those in the previous year

what is on the left side of a company's bank reconciliation?

the adjustment of the bank's cash balance by adding deposits outstanding and subtracting checks outstanding

the term debit card refers to...

the bank's liability to the company being decreased (debited) when the company uses a debit card

what must a company do when the company's accountant understates the amount that a check that they wrote was for?

the cash balance needs to be reduced by the amount that they understated the check for, and the company may want to review its internal control procedures to identify the source of the error

true or false: a company's cash balance as recorded in the books rarely equals the cash balance reported in the bank statement; why or why not?

true; timing differences or errors

managers should design proper controls for cash disbursements to prevent any... and ensure...

unauthorized payments; proper recording

collapse of enron

used questionable accounting practices to avoid reporting billions in debt and losses in its financial statements

when does fraud occur?

when a person intentionally deceives another person for personal gain or to damage that person

how does a company receive cash from credit card sales?

when a transaction occurs, the credit card company deposits cash in the company's bank for the amount of the sale, less service fees

employees should be aware of procedures in place to deal with any perceived internal control...

failures (ex. an anonymous tipline should be in place to encourage communication about unethical activities)

true or false: effective internal controls and ethical employees alone can ensure a company's success and survival

false

other, less obvious ways to commit fraud with a company's cash

falsifying documents, causing the company to overpay the employee for certain expenses, to issue an inflated paycheck, or to make payment to a fictitious company

the balance sheet provides only the... balance for cash and does not provide any details regarding...

final; cash receipts and cash payments

coso suggests that internal control consists of how many components?

five

all forms of cash disbursements require...

formal internal control procedures

internal controls

formal procedures companies implement to eliminate opportunity

a recent survey by financial executives international reports that the average total cost to a public company in complying with section 404 is nearly...

$4 million

due to occupational fraud, companies expect to lose an average of what percentage of their total revenues each year?

5

what does the acfe report as the median loss caused by fraudulent financial statement schemes?

1,000,000 per instance

control items used to ensure that all expenditures made by employees with company funds are legitimate and that the company resources are not being wasted or stolen (5)

1. employees should be required to provide receipts and justification for those receipts on a timely basis 2. a separate employee reviews receipts and supporting documents to ensure all expenditures are made appropriately 3. credit card receipts are reconciled to credit card statements, just like we reconciled checks and debit card transactions to the bank statement 4. spending limits are placed on employees who are authorized to use a company credit card or have access to company cash. major expenditures require pre-approval through formal purchasing procedures 5. only those employees that need to make timely business expenditures should receive authorization

common controls over cash disbursements include: (6)

1. make all disbursements, other than very small ones, by check, debit card, or credit card. this provides a permanent record of all disbursements 2. authorize all expenditures before purchase and verify the accuracy of the purchase itself 3. make sure checks are serially numbered and signed only by authorized employees. require two signatures for larger checks 4. periodically agree amounts shown in the debit card and credit card statements against purchase receipts. the employee verifying the accuracy of the debit card and credit card statements should not also be the employee responsible for actual purchases 5. set maximum purchase limits on debit cards and credit cards. give approval to purchase above the amounts only to upper-level employees 6. employees responsible for making cash disbursements should not also be in charge of handling cash receipts

reconciling the bank account requires three steps:

1. reconcile the bank's cash balance 2. reconcile the company's cash balance 3. update the company's cash account by recording items identified in step 2

the two primary ways in which credit card companies earn revenues

1. the cardholder has a specified grace period before he or she has to pay the credit card balance in full. if the balance is not paid by the end of the grace period, the issuing company will charge a fee (interest) 2. credit card companies charge the retailer, not the customer, for the use of the credit card (this charge generally ranges from 2% to 4% of the amount of the sale

most obvious way that employees steal cash

by physically removing it from the company (ex. pulling it out of the cash register and walking out the door)

what are the two reasons as to why companies would issue incorrect financial statements?

errors and fraud

petty cash fund

a company's cash on hand to pay for minor purchases

what do internal controls represent?

a company's plan to safeguard the company's assets and improve the accuracy and reliability of accounting information

separation of duties (preventative controls)

a set of procedures intended to separate duties among employees for authorizing transactions, recording transactions, and controlling related assets; the same person shouldn't be responsible for both controlling for the asset and accounting for it)

companies report information about cash receipts and cash payments during the period in...

a statement of cash flows

what did sox establish?

a variety of guidelines related to auditor-client relations and internal control procedures

types of errors that could occur during the financial accounting process

accidental erros in recording (or failing to record) transactions or in applying accounting rules

in addition to accounting for employee purchases, a system of internal control needs to be in place to ensure that...

all expenditures are legitimate and that the company resources are not being wasted or stolen

who does sox apply to?

all the companies that are required to file financial statements with the sec

when a company withdraws money from the bank for its petty cash fund, how is the balance sheet affected?

assets are increased and decreased by this same amount, resulting in no net change

if a company allows credit cards as a method of payment, how is the balance sheet affected?

assets are increased by the amount of cash received from the sale of the goods and/or services minus the credit card company's required service fee, and stockholders' equity is decreased by the amount of the credit card company's required service fee and increased by the amount of cash received from the sale of the goods and/or services

how can we minimize fraud?

at least one of the three elements of the fraud triangle must be eliminated

hiring of auditor (sox)

audit firms are hired by the audit committee of the board of directors of the company, not by company management

conflicts of interest (sox)

audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company's audit during the preceding year

retention of work papers (sox)

auditors of public companies must retain all work papers for seven years or face a prison term for willful violation

electronic funds transfers (eft) (items that will decrease the company's cash balance once the reconciliation occurs)

automatic transfers from one bank account to another (sometimes referred to as electronic checks or e-checks) for example, a company may pay its mortgage or utility bill by having it automatically withdrawn from its bank account

how can a manager ensure that their control procedures work effectively? give examples of how they can do this

by actively reviewing daily operations; they should compare daily cash with amount of inventory sold and make sure employees are only paid for actual hours worked

in which two financial statements do companies report cash?

balance sheet and statement of cash flows

common items that will increase the company's cash balance once the reconciliation occurs (2)

bank collections and earned interest

what is the asset most frequently involved with fraudulent activity?

cash

if a company allows credit cards as a method of payment, what is the resulting journal entry?

cash is debited the amount received from the sale of the goods and/or services minus the credit card company's required service fee, service fee expense is debited the amount of the credit card company's required service fee, and service revenue is credited the amount received from the sale of the goods and/or services. (sell tickets with credit card and ...% service fee) at the bottom

deposits outstanding

cash receipts of the company that have not yet been added to the bank's record of the company's balance

whether a customer uses cash or a check to make a purchase, the company records the transaction as a...

cash sale

examples of restricted cash

cash set aside by the company for specific purposes such as repaying debt, purchasing equipment, or making investments in the future

what is the first thing to consider when reconciling the bank's cash balance?

cash transactions recorded by the company, but not yet recorded by its bank

most businesses receive payment from the sale of products and services either in the form of... or as a...

cash; check received immediately or through the mail

the... and... sign a report each year assessing whether the internal controls are adequate

ceo; cfo

what are debit cards sometimes referred to as?

check cards

checks outstanding

checks the company has written that have not been subtracted from the bank's record of the company's balance

internal control systems are especially susceptible to...

collusion

a framework for designing an internal control system was provided by the...

committee of sponsoring organizations (coso) of the treadway commission

earned interest (items that will increase the company's cash balance once the reconciliation occurs)

companies may receive this based on the average daily balance of their checking or savings accou

purchase cards

company-issued credit or debit cards used by employees

monitoring (component of internal control)

continual monitoring of internal activities and reporting of deficiencies is required. monitoring includes formal procedures for reporting control deficiencies

the overall attitude and actions of management greatly affect the...; how so?

control environment; if an employee notices unethical behavior or comments by management, they are more likely to behave in a similar manner, wasting the company's resources

corporate executive responsibility (sox)

corporate executives must personally certify the company's financial statements and financial disclosures. severe financial penalties and the possibility of imprisonment are consequences of fraudulent misstatement

in many cases, top executives misreported accounting information in recent years to...

cover up their company's poor operating performance

other common types of financial statement fraud

creating fictitious revenues, improperly valuing assets, hiding liabilities, and mismatching revenues and expenses

which is higher: the fees charged for companies to accept credit cards or debit cards?

credit cards

smaller companies often use... to make purchases, whereas larger companies...

credit cards; buy on account (or on credit)

what accounting information does a company use to determine if they should allow credit card sales or not?

credit sales, service fee expense, and internal controls

bank statements refer to an increase (or deposit) in the cash balance as a... and a decrease (or withdrawal) as a ...; why?

credit; debit; the bank views deposits as an increase in the amount owed to a company, or a liability, and the bank views withdrawals as a decrease in the amount owed to a company

the amount of cash recorded in a company's balance sheet includes...

currency, coins, and balances in savings and checking accounts, as well as items acceptable for deposit in these accounts, such as checks received from customers. in addition, when a company sells products or services to customers who use credit cards or debit cards, the cash to be collected from those sales is nearly always included in the total cash balance immediately. cash equivalents are also included

what type of asset is cash?

current

a system should be in place to ensure that... are reflected in current reports

current transactions of the company

the components of internal control are built on the foundation of the...

ethical tone set by top management in its control environment

cash transactions recorded by the company but not yet recorded by its bank include...

deposits outstanding and checks outstanding

detective controls

designed to detect errors or fraud that already have occurred

preventative controls

designed to keep errors or fraud from occurring in the first place

petty cash custodian

employee responsible for petty cash fund

... have historically been the most common means of detecting employee fraud

employee tips

debit cards (items that will decrease the company's cash balance once the reconciliation occurs)

employees sometimes use these to make purchases. these purchases are immediately withdrawn from the bank account, but they may not be known by the company's accountant until examination of the bank statement

e-commerce controls (preventative controls)

given the tremendous growth of these activities in recent years, internal controls over these activities are becoming increasingly important (ex. only authorized personnel should have passwords to conduct electronic business transactions, the company should maintain and systematically check the firewall settings to prevent unauthorized access to accounts and credit card numbers, and all employees should update the system's antivirus software periodically)

does collusion make theft easier or harder to detect?

harder

both enron and worldcom committed fraud to...

hopefully fool investors into overvaluing the company's stock

risk assessment (component of internal control)

identifies and analyzes internal and external risk factors that could prevent a company's objectives from being achieved; implementation of specific control activities and continuous monitoring of all systems

a bank reconciliation connects the company's cash balance to the bank's cash balance by...

identifying differences due to timing and errors

when should a company allow credit card sales?

if the benefits (increased sales, reduced handling of cash by employees) exceeds the costs (service fee expense, credit card fraud)

what is the difference in the journal entry if the company pays with debit card, cash, or check compared to paying with a credit card?

if the company pays with debit card, cash, or check, it credits cash. if it pays with credit card, it credits accounts payable

coso is dedicated to...

improving the quality of financial reporting through, among other things, effective internal controls

when were the enron and worldcom frauds, along with several others, uncovered? what happened to these companies?

in 2001 and 2002; their stock prices plummeted and investors lost $200 billion as a result. they declared bankruptcy, resulting in employee termination, reduced salaries and increased workloads for those who were left, and loss of employee retirement funds, stock options, and health benefits

pcaob chairman william mcdonough's explanation of the significance of the internal control (sox) provision

in the past, internal controls were merely considered by auditors; now they will have to be tested and examined in detail

five components of internal control

in the shape of a triangle, from bottom to top: control environment, risk assessment, control activities, and monitoring, with information and communication written alongside the entire triangle

investing activities

include cash investments in long-term assets and investment securities. when the firm later sells those assets, we consider those transactions investing activities also. tend to involve long-term assets

operating activities

include cash transactions involving revenue and expense events during the period. include the cash effect of the same activities that are reported in the income statement to calculate net income

financing activities

include transactions designed to raise cash or finance the business. there are two ways to do this: borrow cash from lenders or raise cash from stockholders. we also consider cash outflows to repay debt and cash dividends to stockholders to be financing activities. involve liabilities and stockholders' equity

in recent years, cash holdings of u.s. companies have... enormously; why?

increased; the financial crisis of 2008. as uncertainty in the business environment increases, companies hold more cash to prevent bankruptcy caused by short-term negative shocks in the business cycle

having too much cash leads to...

inefficient use of funds and could be a signal that a company's management does not see additional opportunities for profitable expansion

from the statement of cash flows, investors know a company's cash... and cash... related to...

inflows; outflows; operating activities, investing activities, and financing activities

what happens when a company cannot resolve the discrepancy between the reconciled bank balance and the reconciled company balance?

it records the difference to either miscellaneous expense or miscellaneous revenue, depending on whether it has a debit or credit balance (this also either increases or decreases cash)

nonaudit service (sox)

it's unlawful for the auditors of public companies to also perform certain nonaudit services, such as investment advising, for their clients

rationalization

justification for the deceptive act by the one committing the fraud

managers are entrusted with the resources of both the company's...

lenders (liabilities) and owners (stockholders' equity); basically take care of the company's assets

what additional thing must we do after completing a company's bank reconciliation?

look for and correct any bank errors

bank reconciliations are used to...

maintain control of cash

reconciliations (detective controls)

management should periodically determine whether the amount of physical assets of the company (cash, supplies, inventory, and other property) agree with the accounting records. (ex. accounting personnel should routinely reconcile the company's cash records with those of its bank, and any discrepancy should be investigated

true or false: at the end of the period, the company needs to replenish the petty cash fund

true

audits (detective controls)

many companies, such as those listed on a stock exchange, are required to have an independent auditor attest to the adequacy of their internal control procedures. other companies can voluntarily choose each year to have an auditor assess their internal control procedures to detect any deficiencies or fraudulent behavior of employees

bank reconciliation

matches the balance of cash in the bank account with the balance of cash in the company's own records

collapse of worldcom

misclassified certain expenditures to overstate assets and profitability by $11 billion

two sources of occupational fraud

misuse of company resources and financial statement manipulation

common examples of cash equivalents (3)

money market funds, treasury bills, and certificates of deposit

... of internal controls needs to occur on an ongoing basis

monitoring

fraud cases that involve collusion are typically several times... severe than are fraud cases involving one person

more

information and communication (component of internal control)

must be timely. employees at all levels must understand the importance of high-quality information. lower-level employees must report information accurately and in a timely manner to those higher in the organization. top executives of a company then must effectively communicate this information to external parties such as investors and creditors through financial statements

which cash flow is related most directly to the company's profitability?

net cash flows from operating activities

are employee purchases made with credit cards or the petty cash fund immediately recorded in the accounting records?

no

does the balance of cash in one's checkbook often equal the balance of cash in one's bank account? why or why not?

no; you (or your bank) made a recording error, or more likely, you've written a check or have cash receipts that haven't yet reached the bank, or maybe the bank has made an adjustment you haven't yet recorded

nsf checks (items that will decrease the company's cash balance once the reconciliation occurs)

occur when customers' checks are written on "nonsuffcient funds". the company receives a customer's check and deposits that check, recording an increase in cash. however, the company later finds out from the bank statement that the customer's check was "bad", and the company then needs to decrease its cash balance to undo the initial increase

collusion

occurs when two or more people act in coordination to circumvent internal controls

bank collections (items that will increase the company's cash balance once the reconciliation occurs)

on the company's behalf offer a convenient and safer way for the company to collect cash. with the increase in electronic banking, these types of cash collections are becoming increasingly popular, especially in certain business settings such as recurring payments from customers, real estate transactions, collection agencies, and lending arrangements

common controls over cash receipts include: (4)

open mail each day, and make a list of checks received, including the amount and payer's name; designate an employee to deposit cash and checks into the company's bank account each day, different from the person who receives cash and checks; have another employee record cash receipts in the accounting records as soon as possible. verify cash receipts by comparing the bank deposit slip with the accounting records; accept credit cards or debit cards, to limit the amount of cash employees handle

of the three elements of the fraud triangle, companies have the greatest ability to eliminate...

opportunity

physical controls (preventative controls)

over assets and accounting records (ex. money each night should be put in a safe or deposited at the bank, important documents should be kept in fireproof files, and electronic records should be backed up daily and require user-id and password for access, supplies should be kept in a locked room with access allowed only to authorized personnel)

8 major provisions of sox

oversight board, corporate executive accountability, nonaudit services, retention of work papers, auditor rotation, conflicts of interest, hiring of auditor, and internal control

a company needs enough cash, or enough assets that can be quickly converted to cash, to...

pay obligations as they become due and respond quickly to new, profitable opportunities before competitors do

motives for managers to "cook the books"

personal gain (maximizing their compensation, increasing the company's stock price, and preserving their jobs)

journal entry when a company withdraws money from the bank for its petty cash fund

petty cash (on hand) is debited and cash (checking account) is credited. (establish the petty cash fund) at the bottom

what does the journal entry look like when a company replenishes the petty cash fund?

petty cash is debited, cash is credited, and (replenish the petty cash fund) at the bottom

two types of control activities

preventative and detective

internal control (sox)

section 404 of the act requires (a) that company management document and assess the effectiveness of all internal control processes that could affect financial reporting and (b) that company auditors express an opinion on whether management's assessment of the effectiveness of internal controls is fairly stated. smaller companies are exempt from requirement b

examples of preventative controls (5)

separation of duties, physical controls, proper authorization, employee management, and e-commerce controls

control environment (component of internal control)

sets the overall ethical tone of the company with respect to internal control. it includes formal policies related to management's philosophy, assignment of responsibilities, and organizational structure; include a variety of policies and procedures used to protect a company's assets

cash equivalents

short-term investments that have a maturity date no longer than three months from the date of purchase

motivation (in terms of the fraud triangle)

someone feels the need to commit fraud

true or false: companies develop strict procedures to maintain control of cash

true

why when a company sells products or services to customers who use credit cards or debit cards is the cash to be collected from those sales nearly always included in the total cash balance immediately?

the cash from those transactions typically will be deposited electronically into the company's bank account within a few days

what are two of the highest-profile cases of accounting fraud in u.s. history?

the collapses of enron and world com

what is included on the right side of the bank reconciliation?

the company balance per reconciliation

the effect of an nsf check

the company must adjust its balance of cash downward to reverse the increase in cash it recorded at the time of deposit. this also creates an account receivable for the company until the customers pays them back

timing differences in cash occur when...

the company records transactions either before or after the bank records the same transactions (ex. if a company pays a supplier in the form of a check, they decrease cash immediately, but the bank doesn't do it until the supplier deposits the check)

employee management (preventative controls)

the company should provide employees with appropriate guidance to ensure they have the knowledge necessary to carry out their job duties. employees should be made fully aware of the company's internal control procedures, ethical responsibilities, and channels for reporting irregular activities

employee purchases should be included in the accounting records by...

the end of the reporting period

auditor rotation (sox)

the lead auditor in charge of auditing a particular company (referred to as the audit partner) must rotate off that company within five years and allow a new audit partner to take the lead

control activities (component of internal control)

the policies and procedures that help ensure that management's directives are being carried out. these activities include authorizations, reconciliations, and separation of duties

what makes bank reconciliation a useful cash control tool?

the possibility of errors and fraudulent activity

true or false: occupational fraud is a big business

true

oversight board (sox)

the public company accounting oversight board (pcaob) has the authority to establish standards dealing with auditing, quality control, ethics, independence, and other activities relating to the preparation of audited financial reports. the board consists of five members who are appointed by the securities and exchange commission

for the bank reconciliation to be complete...

the reconciled bank balance must equal the reconciled company balance

in response to the many corporate accounting scandals and to public outrage over seemingly widespread ethical behavior of top executives, what did congress pass?

the sarbanes-oxley act (also known as the public company accounting reform and investor protection act of 2002, and is commonly referred to as sox)

opportunity (in terms of the fraud triangle)

the situation allows the fraud to occur

fraud triangle

the three elements necessary for every fraud (opportunity, motivation, rationalization)

employee purchases made with debit cards and checks will be captured in the accounting records at...

the time the bank reconciliation is prepared

association of certified fraud examiners (acfe)'s definition of occupational fraud

the use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employer's resources

service fees charged by banks (items that will decrease the company's cash balance once the reconciliation occurs)

these are related to monthly maintenance, overdraft penalties, atm use, wire transfers, foreign currency exchanges, automatic payments, and other account services. these fees may not be known by the company until examination of the bank statement

proper authorization (preventative controls)

to prevent improper use of the company's resources. (ex. formal guidelines should be established on how to handle cash receipts and make purchases, etc. only management should be authorized to make purchases over a certain amount)

everyone in a company has an impact on the operation and effectiveness of internal controls, but the... are the ones who must take final responsibility for their establishment and success

top executives

... who have the ability to override internal control features also have opportunity to commit fraud

top-level employees

example of when a bank would record a transaction before a company does

when banks charge service fees which immediately reduce the bank's record of. the company's balance for cash. however, the company may not become immediately aware of these fees, and they'll only become aware when inspecting the bank statement

cash disbursements include not only disbursing physical cash, but also...

writing checks and using credit cards and debit cards to make payments

does the use of a debit card by customers result in a fee being charged to the retailer?

yes