ACC Chapter 7: Internal Controls + Glossary Terms

Voucher

an authorization form prepared for each expenditure. Companies require vouchers for all types of cash disbursements except those from petty cash.q

Cash is reported on:

balance sheet and statement of cash flows

Reasons for the commission of a Fraud are described in the Fraud triangle:

1. Opportunity 2. Financial pressure 3, Rationalization

Cash Receipts Internal Controls: physical controls

A company must store cash in secure areas, limit access to storage areas, and use cash registers

cash management principles: Increase the speed of receivables collection

A company wants to receive cash as speedily as possible so that it can have the use of this money

An NSF check is debuted to...

Accounts Receivable

Cash receipts internal controls: segregation of duties

Custody of record-keeping and cash should be separated

A company's objective in the management of cash is to...

Have sufficient cash enough to make payments as they come due but to minimize the amount of the non-revenue generating cash on hand

The Key question to ask when preparing a bank reconciliation is:

Who knows about the transaction, and who has already recorded it?

petty cash fund

to pay relatively small amounts

Mail Receipts

-Mail receipts should be opened by two people, a list prepared, and each check endorsed "For Deposit Only." -Each mail clerk signs the list to establish responsibility for the data. -Original copy of the list, along with the checks, is sent to the cashier's department. -Copy of the list is sent to the accounting department for recording. Clerks also keep a copy.

How employees steal

1. ASSET MISAPPROPRIATION, such as theft of cash on hand, fraudulent disbursements, false refunds, ghost employees, personal purchases, and fictitious employees. This fraud is the most common but the least costly. 2. CORRUPTION, such as bribery, illegal gratuities, and economic extortion. This fraud generally falls in the middle between asset misappropriation and financial statement fraud as regards frequency and cost. 3. FINANCIAL STATEMENT FRAUD, such as fictitious revenues, concealed liabilities and expenses, improper disclosures, and improper asset values. This fraud occurs less frequently than other types of fraud but it is the most costly.

Five Primary Components of Internal Control

1. Control Environment: Showing that the management values ethics and integrity; "tone at the top" 2. Risk Assessment: by which the company determines risk factors and how to manage these risk factors; "where are we exposed"? 3. Control Activities: Policies and procedures designed to address specific risks 4. Information and Communication: ensuring that important information is communicated both up and down the organization; "Transparency" everyone internally and externally has the necessary information 5. Monitoring: by which the system is checked periodically to ensure adequacy; "healthy checkups"

Balance per bank statements adjustment

1. Deposits in transit: (deposits which the company has recorded but bank has not), are always added to the balance per bank column. 2. Outstanding Checks: (checks recorded by the company which have not yet been paid by the bank) are always subtracted from the balance per bank column 3. Errors may either be added to or subtracted from the column depending on the nature of the error.

A Cash Budget includes

1. FINANCING: The Financing section shows expected borrowings and repayments of borrowed funds plus interest. Financing is needed when there is a cash deficiency or when the cash balance is less than management's minimum required balance. 2. CASH RECEIPTS: The Cash receipts section includes expected receipts from the company's principal source(s) of cash, such as cash sales and collections from customers on credit sales. This section also shows anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock. 3. CASH DISBURSEMENTS: The Cash disbursements section shows expected payments for inventory, labor, overhead, and selling and administrative expenses. It also includes projected payments for income taxes, dividends, investments, and plant assets. Note that it does not include depreciation since depreciation expense does not use cash.

cash management principles

1. Increase the speed of receivables collection 2. Keep inventory low 3. Monitor payment of liabilities 4. Plan timing of major expenditures 5. Invest idle cash

Balance per books adjustments

1. NSF checks (bounced checks) are subtracted from the balance per books column 2. Bank service charges are subtracted from the balance per books column 3. Note and interest collections are added to the balance per books column 4. Errors may either be added or subtracted from the column depending on the nature of the error

Internal control methods and measures adopted within a business to:

1. Safeguard assets; from employer theft, robbery, and unauthorized use 2. Enhance accuracy and reliability of accounting records; by reducing the risk of errors (unintentional mistakes), and irregularities (intentional mistakes and misrepresentations) in the accounting process 3. Increase efficiency of operations. 4. Ensure compliance with laws and regulations.

Under the Sarbanes-Oxley (SOX) Act of 2002, what happened?

1. all public traded U.S. corporations are required to maintain and adequate system of internal control 2. independent outside auditors are required to maintain an adequate system of internal control 3. Corporate executives and boards of directors must ensure that these controls are reliable and effective. Failure to comply can result in company fines and prison terms for company officers

Six principles of internal control activities

1. establishment of responsibility 2. segregation of duties 3. documentation procedures 4. physical controls 5. independent internal verification 6. human resource controls

Limitations of any internal control system

A Company attempts to have the benefits of the system outweigh the costs 1. Human element: a dishonest or careless employee can render the system ineffective, and two or more employees may collude to circumvent the system (performing a thorough background check when considering whether to hire a person is crucial) 2. The size of the company: a large company has the resources, both human and financial, to put into place a sophisticated system of internal control. A small company may be very limited in both areas and must do the best it can with what it has.

Internal control over cash receipts

A company must have internal control over cash receipts, whether they are over-the- counter or Mail receipts. All six principles of internal control mush apply to cash receipts as well.

Cash Receipts internal controls: documentation procedures

A company must use remittance advices, cash register tapes, and document slips

Monthly bank statements

A company receives monthly bank statements and must reconcile the ending balance on the statement with the ending balance in the general ledger account "cash". The two numbers are often not the same because of time lags (the bank has recorded something that the company has not, or vice versa) and errors made by either the bank or the company

cash management principles: plan timing of major expenditures

A company tries to make major expenditures when it has cash, usually during cutoff season

Cash management principles: Delay payment of liabilities

A company wants to pay its bills on time but not to early. It certainly wants to take advantage of all the discounts offered

Fraud

A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.

cash budget

A projection of anticipated cash flows, usually over a one- to two-year period.

Imprest System

A way to account for petty cash by maintaining a constant balance in the petty cash account. (1) establishing the fund (2) making payments from the fund, and (3) replenishing the fund.

cash disbursements internal controls: segregation of duties

Again, custody and record-keeping should be separated: those who make payments should not record the transactions

cash disbursements internal controls: Physical Controls

Blank checks should be secured, and check amounts should be printed with indelible ink

What is the asset most susceptible to Fraudulent Activity?

Cash Cash is the one asset that is readily convertible into any other type of asset. It also is easily concealed and transported, and is highly desired.

cash management principles: invest idle cash

Cash that does not generate revenue earns a company nothing. Invested cash should be highly liquid (easy to sell) and risk free

cash disbursements internal controls: Human Resource Controls

Cash-handling personnel should be bonded and required to take vacations, and background checks should be conducted.

cash disbursements: independent internal verification

Checks and invoices should be compared, and a monthly bank reconciliation should be prepared

cash disbursements internal controls: documentation procedures

Checks should be prenumbered and used in sequence, and they should be issued only if an invoice has been approved. Invoices should be stamped "paid".

Purchasing Activities

Companies should, for example, assign related purchasing activities to different individuals. Related purchasing activities include ordering merchandise, approving orders, receiving goods, authorizing payment, and paying for goods or services. Various frauds are possible when one person handles related purchasing activities: • If a purchasing agent is allowed to order goods without obtaining supervisory approval, the likelihood of the purchasing agent receiving kickbacks from suppliers increases. • if an employee who orders goods also handles the invoice and receipt of the goods, as well as payment authorization, he or she might authorize payment for a fictitious invoice.

Segregation of Duties

Different individuals should be responsible for related activities. Record-keeping and physical custody of assets should be assigned to different individuals. In a corporation the controller is responsible for record-keeping functions, while the treasurer has physical custody of assets.

Electronic Funds Transfer (EFT)

Disbursement systems that use wire, telephone, or computer to transfer cash from one location to another

What Must happen after the bank reconciliation has been prepared?

Each reconciling items in the balance per books column must be recorded by the company in a journal entry

Fraud Triangle: Rationalization

Employees provide a rationalization for their dishonest actions ex. An employee might falsify financial reports to stave off bankruptcy, thus enabling fellow workers to keep their jobs. Or an employee might steal money to pay a personal bill / debt, with the intention of paying back the money later.

The use of a voucher system, whether done manually or electronically, improves internal control over cash disbursements.

First, the authorization process inherent in a voucher system establishes responsibility. Each individual has responsibility to review the underlying documentation to ensure that it is correct. In addition, the voucher system keeps track of the documents that back up each transaction. By keeping these documents in one place, a supervisor can independently verify the authenticity of each transaction.

Reconciliation

It is customary to reconcile the balance per books and balance per bank to their adjusted (correct or true) cash balances. The reconciliation should be prepared by someone who has no other responsibilities for cash.

voucher register

Journal (referred to as book of original entry) in which all vouchers are recorded after they have been approved.

cash disbursements internal controls: Establishment of responsibility

Only authorized personnel should sign checks and approve vendors

Cash Receipts Internal Controls: Establishment of responsibility

Only designated personnel should be authorized to handle cash receipts

Fraud triangle: financial pressure

Personal financial problems caused by things like debt, for instance, that promote these dishonest actions

Physical Controls

Physical controls (such as safes and locked computer rooms) relate to the safeguarding of assets, while mechanical and electronic controls (such as time clocks, television controls, and computer passwords) safeguard assets and enhance the accuracy and reliability of the accounting records. Their use is essential.

Internal controls generally...

Provide reasonable assurance that assets are safeguarded and that the accounting records are accurate and reliable.

Collusion

Relates to the human element two or more individuals may work together to get around prescribed controls. Such collusion can significantly reduce the effectiveness of a system, eliminating the protection offered by segregation of duties. No system of internal control is perfect.

cash equivalents

Short-term, highly liquid investments that can be readily converted to a specific amount of cash and which are relatively insensitive to interest rate changes. Ex: treasury bills, commercial paper, and money market funds

sales activities

Similarly, companies should assign related sales activities to different individuals. Related selling activities include making a sale, shipping (or delivering) the goods to the customer, billing the customer, and receiving payment. Various frauds are possible when one person handles related sales activities: • If a salesperson can make a sale without obtaining supervisory approval, he or she might make sales at unauthorized prices to increase sales commissions. • A shipping clerk who also has access to accounting records could ship goods to himself. • A billing clerk who handles billing and receipt could understate the amount billed for sales made to friends and

Cash Receipts Internal Controls: independent internal verification

Supervisors should count receipts daily, and the treasurer should compare total receipts to bank deposits daily

Check Register

The book in which you keep records of checks, deposits, debit card transactions, and ATM withdrawals.

The Sarbanes-Oxley Act also established...

The public company accounting oversight board (PCAOB) which established auditing standards and regulates auditing activity

After the entries are journalized and posted, the balance in the cash account should equal...

The total shown on the bank reconciliation

Fraud Triangle: Opportunity

The workplace environments must provide opportunity for the employee to commit fraud; allow for the situations to occur

cash management principles: keep inventory low

There are many so called "carrying costs" of inventory which a company wants to minimize as soon as possible

A major internal control over cash disbursements is...

To use the voucher system (a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by a check are proper), except for small amounts that may be disbursed via a petty cash fund)

bounced check

a check that is not honored by a bank and is returned to the payee's bank due to nonsufficient funds

voucher system

a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper.

Electronic Funds Transfer (EFT)

are disbursement systems that use wire, telephone, or computers to transfer cash from one location to another. Use of EFT is quite common. For example, many employees receive no formal payroll checks from their employers. Instead, employers send electronic payroll data to the appropriate banks. Also, companies now frequently make regular payments such as those for utilities, rent, and insurance by EFT.

The use of a ______ contributes significantly to good internal control over cash

bank

restricted cash

cash that is not available for general use but rather is restricted for a special purpose Ex: landfill companies are often required to maintain a fund of restricted cash to ensure they will have adequate resources to cover closing and clean-up costs at the end of a landfill site's useful life.

Cash receipts internal controls: human resource controls

cash-handling personnel should be bonded and required to take vacations, and background checks should be conducted

Cash consists of

coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository

internal auditors

company employees who continuously evaluate the effectiveness of the company's internal control systems • Large companies often assign independent internal verification to internal auditors. • They review the activities of departments and individuals to determine whether prescribed internal controls are being followed.

Establishment of Responsibility

control is most effective when only one person is responsible for a given task. This area includes authorization and approval of transactions. Ex: Transfer of Cash Drawers

Bonding

involves obtaining insurance protection against theft by employees. It contributes to the safeguarding of cash in two ways. 1. the insurance company carefully screens all individuals before adding them to the policy and may reject risky applicants. 2. bonded employees know that the insurance company will vigorously prosecute all offenders.

reconciling the bank account.

it is necessary to make the balance per books and the balance per bank agree with the correct or true amount. Two causes for the need to reconcile a bank amount: 1. Time lags that prevent one of the parties from recording the transaction in the same period. 2. Errors by either party in recording transactions.

disbursements

money paid out

bank statement

statement received monthly from the bank that shows the depositor's bank transactions and balances. Shows the following: (1) checks paid and other debits (such as debit card transactions or electronic funds transfers for bill payments) that reduce the balance in the depositor's account (2) deposits (by direct deposit, automated teller machine, or electronic funds transfer) and other credits that increase the balance in the depositor's account, and (3) the account balance after each day's transactions

reasonable assurance

the concept that recognizes that the costs of control activities should not exceed the benefits that are expected from the control activities

bank reconciliation explanation

the process of comparing the bank's balance with the company's balance, and explaining the differences to make them agree.

Human Resource Controls

• Bonding of Employees who handle cash • rotating of employees' duties and requiring employees to take vacations • conducting thorough background checks

Documentation Procedures

• Documents should be pre-numbered and all documents should be accounted for • Source documents should be forwarded promptly to the accounting department to ensure accurate and timely recording of a transaction

Independent Internal Verification

• The review of data prepared by employees • verification should be made periodically or on a surprise basis • verifications should be done by an employee who is independent of the personal responsible for the information, • and discrepancies and exceptions should be reported to a management level that can take appropriate corrective action • such verification is often performed by internal auditors who are employees of the company who evaluate on a continuous basis the effectiveness of the company's system of internal control