201 chapt 4 v2

2. Risk assessments:

assessment of risks that a company faces offers hints of where mistakes or fraud might arise. A company must be able to identify its business risks, as well as to establish procedures for dealing with those risks to minimize their impacts on the company.

reconciling items that affect the bank balance

deposits in transit, outstanding checks and bank errors

In the voucher system, when making a purchase, it has to go through a certain amount of what before it's approved?

procedures

Section 404

requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting. requires that managers document and assess their internal controls and that auditors provide and opinion on managers' documentation and assessment

Sarbanes-Oxley Act (SOX)

requires the managers and auditors of companies whose stock is traded on an exchange to document and certify the system of internal controls

electronic funds transfer (EFT)

the electronic transfer of cash from one party to another

check

used by a depositor to withdraw money from an account, a document signed by the depositor instructing the bank to pay a specified amount of money to a specified recipient

voucher

where documents are accumulated, an internal document used to accumulate information to control cash disbursements and to ensure that a transaction is properly recorded

Components of Internal Control: knowing the various parts and what are the typical controls in each category

1. The control environment;2. Risk assessments;3. The information system ;4. Control procedures ;5. Monitoring provides

What are bank accounts?

Authorized individuals are able to withdraw and pay cash from accounts

What are the 6 banking activities as controls?

Bank accounts, signature cards, deposit tickets, checks, electronic funds transfer, bank statements

What's another reason why the balances on the bank statement and the company's books could be different?

Bank recorded certain items that customer has not or vice versa for customers.

When recording a shortage, you're doing what to the account?

Cash Over + Short Account is debited

Establish Responsibilty

Control is more effective when one person does a certain task. Every employee has a specific job. Makes it easier to figure out who did what tasks.

What does cash include?

Currency, coins, and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders

Segregate Duties

Different individuals should do related activities and Responsibilities of recording should be seperate from people who have a hold on those assets and separate from approval.

What are the limitations of internal controls?

Human error, human fraud, costs. Vs benefit

What are the cons of technology in internal control?

Limited evidence of processing, increased e commerce, crucial separation of duties

What is costs vs benefit?

Look at internal controls from a cost vs. benefit perspective

What are the two types of cash receipts?

Over the Counter Cash Receipts and Cash Receipts by Mail

Rationalization

Reason it's ok to commit the fraud -"I need it more than the other person" -"I am underpaid, so this is due compensation"

What does it mean to establish responsibilities?

Responsibilities for task should be clearly defined

What are bank statements?

Statements that bank sends to customers each month to give info about bank activity

liquidity

a company's ability to pay for its near-term obligations

Lapping

a fraudulent scheme to steal cash through misappropriating certain customers payments and posting payments from other customers to the affected accounts to cover it up; caused by weak internal controls

Fidelity Bond

an insurance policy taken out on employees who handle cash. It enables a company if their employees who handle cash either stole money to be reimbursed by insurance company, or if employee steal from customer to be reimbursed for damages created by their meployees.

current assets

consumed in a year or less. Include cash, a/r, prepaid rent and insurance, supplies, inventory, etc

Check

document instructing a bank to pay the designated person or business the specified amount of money

1.The control environment, is

the "tone at the top" of the business. It starts with the owner and the top managers. They must behave honorably to set a good example for company employees.

bank reconciliation

to make sure ending balance in cash is correct at the end of each month

Cash Receipts: Process Activities

1. Receive cash and remittance advice in mail 2. Prepare remittance listing 3. Enter total from remittance listing in cash receipts journal 4. Prepare deposit slip and deposit cash receipts in bank (daily) 5. Record update to subsidiary AR using remittance advice 6. Reconcile remittance listing, subsidiary accounts receivable, and deposit slip daily

principles of internal control

1. establish responsibilities 2. maintain adequate records 3. insure assets and bond key employees 4. separate recordkeeping from custody of assets 5. divide responsibility for related transactions 6. apply technological controls 7. perform regular and independent reveiws

2. Comparisons and compliance monitoring

2. Comparisons and compliance monitoring. No person or department should be able to completely process a transaction from beginning to end without being cross-checked by another person or department.

3. Adequate records

3. Accounting records provide the details of business transactions. The general rule is that all major groups of transactions should be supported by either hard copy documents or electronic records. Examples of documents include sales invoices, shipping records, customer remittance advices, purchase orders, vendor invoices, receiving reports, and canceled (paid) checks. Documents should be pre-numbered to assure completeness of processing and proper transaction cutoff, and to prevent theft and inefficiency.

4. Limit access to assets

4. Limit access to assets only to those persons or departments that have custodial responsibilities. For example, access to cash should be limited to persons in the treasurer's department. Cash receipts might be processed through a lock-box system.

5. Proper Approval

5. Proper Approval : No transaction should be processed without management's general or specific approval. The bigger the transaction, the more specific approval it should have. For individual small transactions, management might delegate approval to a specific department.

How can you control cash disbursements (make sure don't have too much loose cash lying around) and what is the only exception?

All expenditures should be made by check. Only exception is for small payments from petty cash. Separate authorization for check signing and recordkeeping duties. Use a voucher system.

How can you control Over the Counter Cash Receipts?

Cash register with locked in record of transactions and compare cash register record with cash reported

Earning quality

Earnings quality: the ability of current net income to help us predict the future performance of a company

A voucher system of control helps with what?

Helps with controlling cash disbursements

At the end of the accounting period if the overall balance of cash over and short account is debited, this means what?

It's an miscellaneous expense

At the end of the accounting period if the overall balance of cash over and short account is credited, this means what?

It's recorded as other income

What does it mean to perform regular and independent reviews?

Makes sure internal control is still effective

Why use a bank to provide internal control on cash?

Minimizes cash on hand and reconcile book & bank records

External auditors

Provide an annual report to whether an internal control system is reasonable

What are electronic funds transfer?

Quick and popular way to transfer money from 1 bank account to another.

What is the maturity date for cash equivalents?

Short ... less than 90 days

What are cash equivalents?

Short term highly liquid investments that are 1. Readily convertible to a known cash amount and 2. Close to maturity date and not sensitive to interest rate changes

Are the differences in the balances temporary or permanent?

Temporary

Fraud Triangle

The 3 elements that are present in almost all cases of this; elements are: motive, opportunity, rationalization on the part of the perpetrator

What are deposit tickets?

Tickets given to bank's customer as proof that they made deposit to bank

Why we prepare bank reconciliations?

Time lags of book and bank not recording in same period and errors by either of them in recording transactions.

Dual Custody of Cash at all Times

Two people in mailroom/open mail containing customer checks -Endorse checks immediately after out of envelope -Prepare list of cash receipts as soon as possible -Separate cash from record keeping documents

Opportunity

Weak internal controls Circumventing internal controls The greater the position the greater the trust and exposure

Cash Budget

a budget that projects the entity's future cash receipts and cash disbursements

1.Smart hiring practices and segregation of duties

1. Smart hiring practices. The company should be careful to hire both competent and honest personnel. Smart hiring practices involve conducting background checks on job applicants, as well as training and supervision on the job. Separation of duties is essential for safeguarding assets. The person who has custody of an asset should not also account for the asset, smart management separates three key duties: asset handling, record keeping, and transaction approval.

Adjustments to Bank balance during reconcilation

Add deposits in transit. Less outstanding checks. Also note any plus or minus bank errors.

Adjustments to Book balance during reconciliation

Add notes collected by bank (EFT and Non EFT). Less EFT, NSF (bounced) checks and service/bank charges. Also note any plus and or minus company errors. THOSE ADJUSTMENTS WILL BE THE OBJECT OF JOURNAL ENTRIES AFTER THE RECONCILIATION IS DONE

When recording an excess, you're doing what to the account?

Cash Over + Short account is credited

Specific controls are in place to safeguard cash

Cash is the most liquid asset, and it is easy to conceal and relatively easy to steal. Specific controls are in place to safeguard cash, and these documents are used to control a bank account: signature card, bank statement, deposit ticket, bank reconciliation, and check.

There are three parties to a check:

Check: To pay cash, the depositor can write a check, which tells the bank to pay the designated party a specified amount. There are three parties to a check: ■ the maker, who signs the check ■ the payee, to whom the check is paid ■ the bank on which the check is drawn

remittance advice

Checks written by companies often have a stub attached, called a remittance advice, that tells the payee the purpose of the payment. The payee is required to endorse the back of the check when cashing it as proof that only the authorized payee received the funds.

Independent internal verification

Companies should verify records periodicaly or on surprise basis, an employee who usually has a different task should make the verifuication, exceptions should be reported to management level that can take corrective action.

Surbanes-Oxley Act of 2002 (SOX)

Corporations must maintain good internal control. Corporate executives and board must see that it is reliable and effective. outside auditors must see that internal control system is good. Enacted because of numerous frauds and scandals occuring.

Declining free cash flow in relation to the trend in net income indicates ?

Declining free cash flow in relation to the trend in net income indicates lower-quality earnings

Physical Controls over the Security of Assets

Deposit cash and checks daily and intact Lockbox account Dual custody over cash

Internal controls greatly diminish what? But it doesn't guarantee what?

Diminishes error and fraud but doesn't guarantee getting rid of it.

What are the 7 principles of internal control?

Establish responsibilities, maintain adequate records, insure assets and bond key employees, separate recordkeeping from custody of assets, divide responsibility for related transactions, apply technological controls, and perform regular and independent reviews

Principles of Internal Control

Establish responsibilty, Segregate duties, Documentation procedures, Physical, mechanical and eleectronic controls, Independent internal verification, Human resource controls

What does a voucher system of control do?

Establishes procedures for verifying, approving and recording obligations for eventual cash disbursements and issuing checks for payment of verified, approved, and recorded obligations

Public Company Accounting Oversight Board (PCAOB)

Establishes standards of auditing and regulates auditor activity. Created by SOX.

Internal auditors

Evaluate system of internal controls for the companies that employ them

Human resource controls

Fidelity Bond personnel who handles cash, rotate employee positions, require employees to take vacations, do background checks of employees

Fraudulent Financial Reporting

Fraud perpetrated by management, by preparing misleading financial statements

Free Cash Flow

Free cash flow: operating cash flows + investing cash flows during the period

What three basic guidelines should an effective system of internal control that protects cash and cash equivalents follow?

Handling cash is separated from recordkeeping of cash, cash disbursements are made by check, cash receipts are promptly deposited in a bank

Internal Control

Helps keep assets safe and records reliable and accurate

Limitations of Internal control

Human element of employees getting together to get around controls, "reasonable assurance"of safegaurding assets and reliable records, size of a business (ex. if small it's hard to segregate duties)

How do you know if you have a shortage?

If petty cash receipts + cash in box < petty cash fund. Cash over and short is debited

How do you know if you have an overage or excess?

If petty cash receipts + cash in box > petty cash funds. Cash over and short is credited

Cash Receipts and Disbursements: Key Control Activities

Information Processing Physical Controls over the security of assets Segregation of duties

Fidelity Bonds

Insurance policy that covers most kinds of cash embezzlement losses -Doesn't prevent it or detect it

What are some of the limitations of internal control?

Internal controls can be circumvented by collusion of 2 or more people. Internal controls cost money, so a company always has to weigh the cost and the benefit.

Documentation procedures

Keeping records on items, such as prenumbering documents. Having organized invoices, knowing which is approved and paid.

List the 5 objectives of internal control

List the 5 objectives of internal control a. Safeguard assets: b. Encourage employees to follow company policy c. Promote operational efficiency d. Ensure accurate, reliable accounting records: Accurate records are essential. e. Comply with legal requirements: Companies, like people, are subject to laws, such as those of regulatory agencies like the SEC, the IRS, and state, local, and international governing bodies. ensure compliance with the law and avoidance of legal difficulties.

What are the 3 parties for a check?

Maker/payer, Drawee (Bank), and Payee (Party designated by payer who gets payment)

Elements of Fraud

Motivation Opportunity Rationalization *High risk when all three overlap

Motivation

Motive -Pressure a person believes is unsharable with friends and confidants Usually (always) -Economic: desperate need for money -Egocentric: for personal prestige Sometimes -Psychotic: Steals for the sake of stealing -Idealogical: Cause is morally superior

What are checks?

Negotiable instrument that's signed by maker or drawer. Ask bank to pay certain sum of money to a certain entity.

Lockbox Arrangement

Payments are remitted by customer to an external location, fiduciary (bank) opens box on a daily basis for company... -Lists receipts -Deposits cash -Sends remittance advice to company

What is the purpose of internal control?

Policies and procedures managers use to protect assets, ensure reliable accounting, promote efficient operations, urge adherence to company policies

What is a bank reconciliation used for?

Prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company's books

What are the benefits of technology in internal control?

Reduced processing errors and more extensive testing of records

Physical, mechanical and electronic controls

Safegaurding of assets, enhancing the reliability of acccounting records. Keeping records, inventories, computer facilities and cash in locked places. Have breakin alarms, time clocks, and tv monitors to record and prevent theft.

Segregation of Duties

Separate -Custody -Authorization -Recording -Reconciliation

Signature Card

Signature Card: Banks require each person authorized to sign on an account to provide a signature card. This protects against forgery. Banks will not cash checks that don't bear an authorized signature and for checks presented at the bank in person will often check the signature against the one on file.

What are signature cards?

Signatures of authorized individuals to operate account

What is a petty cash system of control?

Small payments required in most companies for items such as postage, courier fees, repairs and supplies (business expenses only)

Fraud Prevention

Strong control environment and tone at the top Managing people's pressures in the workplace -Counseling services: not guarantee to prevent fraud but can have a positive impact -Hotlines: Required by SOX Control Procedures and employee monitoring -1st indicator of fraud is control violation

The key components of Sarbanes-Oxley legislation:

The key components of Sarbanes-Oxley legislation: a. Public companies must issue an internal control report and an outside auditor must evaluate it b. The PCAOB was created to oversee audits of public companies c. A CPA firm can't audit and provide consulting services for the same client d Stiff penalties (25 yrs in prison for securities fraud and 20 years for false statements)

audit to monitor compliance

To validate the accounting records and monitor compliance with company policies, most companies have an audit.An audit is an examination of the company's financial statements and its accounting system, including its controls. Audits can be internal or external. Internal auditors are employees of the business. They ensure that employees are following company policies and operations are running efficiently.

How can you control cash receipts by mail?

Two people open the mail. Then money goes to cashier's office, list to accounting department, copy of list filed

What is the account "Cash Over + Short" used for?

Used to record shortages and excesses

What does it mean by applying technological controls and give examples?

Using technology to improve internal control. Ex: Personal scanners, time clocks

Information Processing

Voucher packet matched prior to cash disbursement authorization Deposits reconciled to amounts credited to AR ledger Bank Reconciliation

What does it mean to insure assets and bond key employees?

When insuring assets, risk of fraud is greatly reduced. Bonding key employees means risk of loss greatly diminished

What does it mean by dividing responsibility for related transactions?

Work of 1 employee acts as check on another employee

Embezzlement

Wrongfully taking money or property entrusted to one's care, custody, and control, often accompanied by false accounting entries and cover-up

Non-sufficient funds (NSF) check

a "hot" check, one for which the payer's bank account has insufficient money to pay the check; cash receipts that turn out to be worthless

Outstanding Checks

a check issued by the company and recorded on its books but not yet paid by its banks

Deposit In Transit

a deposit recorded by the company but not yet by its bank

Bank Reconciliation

a document explaining the reasons for the difference between a depositor's records and the bank's records about the depositor's cash. Timing differences are the major reason for the bank reconciliation

Audit

a periodic examination of a company's financial statements and the accounting systems, controls and records that produce them; may be either external or internal

Budget

a quantitative expression of a plan that helps managers coordinate the entity's activities

Lock-Box System

a system of handling cash receipts by mail whereby customers remit payment directly to the bank, rather than through the entity's mail system

What are the two most common types of fraud?

a. Misappropriation of asset: is committed by employees of an entity who steal money from the company and cover it up through erroneous entries in the books. Other examples of asset misappropriation include employee theft of inventory b. Fraudulent financial reporting: is committed by company managers who make false and misleading entries in the books, making financial results of the company appear to be better than they actually are.

a. Safeguard assets:

a. Safeguard assets: A company must safeguard its assets against waste, inefficiency, and fraud. If management fails to safeguard assets such as cash or inventory, those assets will slip away.

Cash Over and Short

account which is an income statement account recording the income effects of cash overages and cash shortages

Fraud

an intentional misrepresentation of facts, made for the purpose of persuading another party to act in a way that causes injury or damage to that party

Remittance Advice

an optional attachment to a check (sometimes a perforated tear-off document and sometimes capable of being electronically scanned) that indicates the payer, date and purpose of the cash payment; often used as the source documents for posting cash receipts or payments

What kind of account is petty cash?

asset

reconciling items that affect the book balance

bank service charges, NSF checks, withdrawals, EFT deposits, transposition errors or failure to record transactions and company errors related to cash

4. Control procedures

built into the control environment and information system are the means by which companies gain access to the five objectives of internal controls discussed previously. Examples include proper separation of duties, comparison and other checks, adequate records, proper approvals, and physical safeguards to protect assets from theft.

liquid assets

cash and similar assets that can be readily used to settle obligations, needed for a company to effectively operate

canceled checks

checks the bank has paid and deducted from the customer's account during the period

Bank collections

collection of money by the bank on behalf of a depositor

Bank Statement

document showing the beginning and ending balances of a particular bank account listing the month's transactions that affected the account

Misappropriation of Assets

fraud committed by employees by stealing assets from the company

Petty Cash

fund containing a small amount of cash that is used to pay minor accounts

Exception Reporting

identifying data that is not within "normal limits"" so that managers can follow up and take corrective action; used in operating and cash budgets to keep company profits and cash flow in line with management's plans

Treasurer

in a large company, the department that has total responsibility for cash handling and cash management; includes cash budgeting, cash collections, writing checks, investing excess funds, and making proposals for raising additional cash when needed

Cash equivalent

investments such as time deposits, certificates of deposit, or high-grade government securities that are considered so similar to cashbecause very short term such as Treasury bill 3 month that they are combined with cash for financial disclosure purposes on the balance sheet

3. The information system

is the means by which accounting information enters and exits. The owner of a business needs accurate information to keep track of assets and measure profits and losses.

signature card

must be signed by all persons authorized to write checks on the account which can later be used to verify signatures on checks

Internal Control

organizational plan and related measures adopted by an entity to safeguard assets, encourage adherence to company policies, promote operational efficiency and ensure accurate and reliable accounting records

cash equivalents

short-term, highly liquid investment assets that are readily convertible into a known cash amount and sufficiently close to their due date so that their market value is not sensitive to interest rate changes

bank statement

shows the activity in an account, sent to each depositor by a bank

Petty Cash

small payments required for items such as postage, courier fees, minor repairs, and low-cost supplies. part of an imprest system, which designates advance money to establish the fund, to withdraw from the fund, and to reimburse the fund

deposit ticket

supports a bank deposit by listing items such as currency, coins, and checks deposited along with their corresponding dollar amounts

Electronic Fund Transfer (EFT)

system that transfers cash by electronic communication rather than by paper documents

the basic internal control procedures (SCAPL)

the basic control procedures for any class of transactions? Look at the first letters of each of the headings in this section (SCALP): 1. Smart hiring practices and segregation of duties 2. Comparisons and compliance monitoring 3. Adequate records 4. Limited access to both assets and records 5. Proper approvals (either general or specific) for each class of transaction

internal control system

used by managers to monitor and control business activities. consists of the policies and procedures managers use to protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies

5. Monitoring provides "eyes and ears,

" so that no one person or group of persons can process a transaction completely through without being seen and checked by another person or group.

What are the 8 reasons why the balances on the bank statement and the company's books are different?

1. Deposits in transit, 2. Outstanding checks, 3. Bank errors, 4. Collections made by the bank, 5. Interest earned on checking account, 6. Non sufficient funds check, 7. Service charges, 8. Book errors