Acct Ch. 5

Voucher System

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

Imprest System

A process that controls the amount paid to others by limiting the total amount of money available for making payments to others

Reporting

Reporting objectives include producing reliable and timely accounting information for use by people internal and external to the organization (ex-checking the accuracy of your bank account)

Fraud Triangle

Research has found that three factors exist when a fraud occurs; Incentive/Opportunity/Rationalization

Opportunity

The employee has a means of committing fraud. Opportunities to commit fraud usually stem from weak internal controls.

Principles of Control Activities

1- Establish Responsibility: when possible, assign each task to only one employee to allow you to determine who caused any errors or thefts that occur 2- Segregate Duties: involves assigning responsibilities so that one employee can't make a mistake of commit a dishonest act without someone else discovering it 3-Restrict Access: Physically locking up valuable assets and electronically securing access to other assets and info. 4-Document Procedures: By documenting each business activity, a company created a record of whether a goods were shipped, customers will bulled, cash was recieved, etc. Without documents, a company wouldn't know what transactionshave been or need to be entered into the accounting system 5-Independently Verify: hire someone to check (an auditor) that the work done by others within the company is appropriate and supported by documentation

Purchasing System Steps (Voucher System)

1- System begins with an authorized employee completing a manual or electronic purchase requisition form. (no journal entry yet, the company has not entered into an exchange, transaction not yet occurred) 2- After purchase requisition is approved, company's purchasing agent completes a prenumbered purchase order. Purchase order identifies the company that will supply the goods. Purchase order also indicates location to which the goods will be delivered as well as the approved cost for items. Order is sent to company providing the items. (still no journal entry, at this point the company has only promised to pay for the items on order, but has not received them yet) 3-When goods are received, receiving report is prepared. Receiving report indicates date, quantity and condition of items received. Purchase is recorded 4- Invoice is sent to the buyer from the supplier. They will make sure everything is correct. Once everything is complete, the accounting department will prepare a journal entry to record the purchase of the office supplies on account. Documents will be submitted for payment. 5- Final step, check or electronic funds transfer is processed for goods paid for and received- reduces both cash account and the account payable to the supplier. Voucher is marked 'paid' so it cant be accidentally or intentionally resubmitted for duplicate payment

Compliance

Compliance objectives focus on adhering to laws and regulations (ex- obeying the speed limit)

Sarbenes Oxley Act (SOX)

A set of regulations passed by Congress in 2002 in an attempt o improve financial reporting and restore investor confidence. It introduced many new requirements including: Counteract Incentives/Reduce Opportunities/ Encourage Honesty

Petty Cash Fund

A system used to reimburse employees for expenditures they have made on behalf of the organization. Acts as a control by establishing a limited amount of cash to use for specific types of expenses

Internal Control

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

EFT

Adjust your records if you discover this on your bank statement

Information and Communications Component

An effective internal control system generated and communicated info about activities affecting the organization to support sound decision making

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 also covering it up through another assigned duty

Bank Reconciliation

An internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual -key internal control because it provides independent verification of all cash transactions that the bank has processed for the company.

NSF Checks (not sufficient funds)

Another name for bounced checks, they arise when the check writer does not have sufficient funds to cover the amount of the check - the bank will decrease your balance when they realize you deposited a bad check

Bank Errors

Ask the Bank to fix its records, but you should not change yours

Controls from Bank Procedures

Bank's services help businesses control cash: 1- Restricting access: banks provide a place for a company to keep their money, which reduces the risk that it will be stolen or misplaced 2- Documenting Procedures: by processing payments made by check or EFT, banks facilitate and document business transactions 3- Independently Verifying: Company accountants can use the statement of account prepared by the bank to double check the accuracy of the cash records. By comparing the two sets of records and looking for differences, they can verify that the company's records are accurate or identify necessary adjustments

Control Limitations

Criminally Minded people have been known to override (disarm) internal controls or collude (work together) to get around them.

Note

Deposits are listed on the bank statement int he order in which the bank processes them, Bank statement is presented from the bank's point of view

Incentive

Employees have a reason for committing fraud. Sometimes the reason is personal finance pressure. In other cases, the reason is to make the business appear successful so as to attract investors, bring in new business partners, or meet loan requirements. Many lending agreements include loan covenants. To avoid not meeting the covenant, dishonest managers may misreport the company's financial statements

Control Activities Component

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

Interest Deposited

Interest varies depending on the average balance in your account

Financial Statement Fraud

Involves misreporting amounts in the financial statements, usually to portray more favorable financial results than what actually exists

Corruption

Involves misusing one's position for inappropriate personal gain

Risk Assesment Component

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

Cash

Money or any instrument that banks will accept for a deposit an immediately credit to a company's account- includes cash deposited into the bank, petty cash on hand and cash equivalents

Controls for cash payments

Most cash payments involve (1) writing a check or completing an EFT to a supplier or (2) paying employees via EFT. In rare cases where a company pays for purchases with dollars and coines, it uses (3) a petty cash system. The primary goal of internal controls for all cash payment sis to ensure that the business pays only for properly authorized transactions

Restricted cash

Not available for general use, but rather restricted for a general purpose- classified as current or noncurrent asset

Bank Statement

Online statement for each account that a company opens Format: -Overall Summary of the account -Summary followed by list of specific transactions posted to the account and a running balance in the account

Operations

Operational objectives focus on completing work efficiently and effectively and protecting assets by reducing the risk of fraud (ex- locking your doors)

Internal Control Objectives

Operations/Reporting/Compliance

Encourage Honesty

Public companies must have tip lines that allow employees to secretly submit concerns about questionable accounting or auditing practices. SOX grant legal protection to whistleblowers so they aren't retaliated against by those charged with fraud. If you tattle, you can't be fired. Also, companies are required to adopt a code of ethics for their senior financial officers

Reduce Opportunities

SOX requires all public companies to: -establish an audit committee of independent directors that strives to ensure the company's accounting, internal control, and audit functions are effective -Evaluate and report on the effectiveness of internal control over financial reporting: must be completed by mgmt and, for large public companies, by external auditors as well

Cash equivalents

Short-term highly liquid investments purchased within three months of maturity- they are readily convertible to known amounts of cash and so near to maturity that there is little risk their value will change

Petty Cash Systems

Step 1- Put money into petty cash to establish a Fund step 2- paying money out to reimburse others step 3- putting money back into petty cash to replenish the fund

Loan covenant

Terms of a loan agreement that if broken, entitle the lender to renegotiate loan terms or force repayment

Rationalization

The employee perceives the misdeed as unavoidable or justified. In many cases, fraudsters rationalize their actions through a feelings of personal entitlement, which outweighs moral principles, such as honesty and concern for others. These employees often feel they are underpaid, so fraud is their way to get even and be paid what they think they deserve

Monitoring Activities Component

The internal control system is evaluated often to determine whether it is working as intended. Deficiencies should be communicated to those responsible for taking corrective action, including senior mgmt and/or the board of directors

Controls For Cash Reciepts

The primary internal control goal for cash receipts is to ensure that the business receives the appropriate amount of cash and safely deposited in the bank

Important reasons for internal control for cash

The volume of cash transactions is enourmous, the risk of cash-handling errors is significant/ because 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 risk

Asset Misappropriation

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

Counteract Incentives

Those who willfully misrepresent financial results face stiff penalties, including fines up to 5 million plus repayment of any fraud proceeds. Also, max jail sentences have been increased to 20 years, which can quickly add up because federal sentencing guidelines allow judges to declare consecutive jail terms for each violation

Time Lags

When you make a deposit after the bank's normal hours, but the bank doesn't process it until the next day. Ex's- Deposit in transit Outstanding check

Service charges

amounts the bank charges for processing your transactions, the bank takes the money directly out of your account (you will have to reduce the cash balance in your accounting records for these charges)

Cleared the Bank

check is cleared once person who was paid presents the check to their bank, then their bank contacts the the check writer's banks, which in turn withdraws the amount of the check from the check writer's account and reports it as a deduction on the bank statement

Fraud

generally defined as an attempt to deceive others for personal gain Grouped into three categories: Corruption/Asset Misappropriation/Financial Statement Fraud

Direct Deposit

most companies pay salaries and wages through an EFT, known as this. The company initiates the EFT when it instructs the bank to transfer the pay due each employee directly from the company's bank account to each employees' checking account. Only risk: the bank might transfer wrong amount of money, so company's use an imprest system

EFT (electronic funds transfer)

occurs when a customer electronically transfers funds from their bank account to the company's bank account. Most businesses encourage customers to use this because they speed up collections. They also eliminate the need for some internal controls because they are deposited directly into the company's account. To process and EFT, the accounting department merely records journal entries to debit cash and credit account receivable from each customer

Control Environment Conponent

refers 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 the people they hire, and how they evaluate others. A strong control environment helps employees understand the value of internal controls to their organizations success