ACCT: CH 4

employee theft of company assets

Embezzlement

A cash shortage requires a ---- to cash over and short, whereas a cash overage would require a ---.

debit, credit (cash over and short: debits and credits)

All errors made by the company must be added or subtracted from the ''---'' and then all errors made by the bank must be added or subtracted from the ''---''

"cash balance from company records" and then ''cash balance from the bank statement.'

When attempting to withdraw more money than your account has, you may see a "---" or "---" alert on your bank statement

"non-sufficient funds" or "insufficient funds"

A control environment factor. Is defined as the overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control. Resolving conflicting incentives in an ethical manner that promotes organizational objectives is highly dependent on this

"tone at the top"

(Illustrations from the Internal Control Structure for Revenue and Cash for Hendrickson Theaters Inc. [can be found in the ebook, exhibit 4.3 ] --> **1) The accounting system gives a generalized idea of how entries, documentation, and reports are structured and expected: - As it concerns our entries, "admissions and concessions revenues are recorded daily by increasing both cash and the appropriate revenue accounts." - It too simply explains the process of documentation by stating how the employees working the ticket booth as well as the employees working the concession stand will prepare a detailed list of cash transactions and a daily cash summary report. All of the records and reports will then be transferred to the central office each night and are automatically summarized upon receipt. Each morning, the accountant generates a report and makes revenue entries in the computerized general ledger. - Lastly, the accounting system prefaces reports by saying how a variety of revenue analyses can be prepared on the computer system (including analyses by theater, movie, time of day, day of the week, and month) **2) The control activities (a component from the internal control system) thoroughly relates the actions concerning Hendrickson Theaters Inc by appropriately applying them to the five factors that lie under the control activities topic - It identifies authority and responsibility by explaining how each theatre manager is responsible for the control of cash in his or her theater, but the central office accountant makes all general ledger entries related to cash - Segregation of duties is practiced specifically by having the maintenance of the general ledger segregated from responsibility for local cash control. Maintenance of the general ledger is the responsibility of the manager, who must check and sign deposit documents. Responsibility for local cash control is of ticket sellers and concession operators, who assist in the preparation of daily cash deposits - Documentation is provided by having prenumbered admission tickets dispensed by machine at each theater. The machine also prepares a report of the tickets issued each day - Safeguards over assets and records are present as the company exercises removal of a fixed amount of cash (from the amount accumulated throughout the day) specifically by the manager and has it placed in the theater's safe. - Checks on recorded amounts are exercised when Hendrickson's accountant visits each theater unexpectedly and verifies cash receipts reported against the number of tickets issued. On these same visits, the accountant checks concession revenues against the amounts reported by inventorying concession supplies.

***Relationship between the accounting system and control activities example

EX: You are the CFO of Tolland Gizmo. You sell, on credit, approximately 1,000 Gizmos per month at $10 per unit. In addition to the accounts receivable, you have an inventory of 200 Gizmos that were purchased at a cost of $6 per unit (a total inventory of $1,200) and $1,000 in cash. Currently, Tolland has 1 month's sales in accounts receivable and the following balance sheet: -Assets: 1) Cash= $1,000 2)Inventory= $1,200 3)Accounts Receivable= $10,000 --> Total= $12,200 -Stockholder's Equity= $12,200 & Liability= N/E The salesforce wants to lengthen the collection period of the accounts receivable to 3 months. How would lengthening the collection period of the accounts receivable affect Tolland's financing requirements?

-Operating Cycle and Capital Requirements example: -How lengthening the collection period of the accounts receivable would affect Tolland's financing requirements: Tolland will now have higher financing costs because the collection of the cash is delayed. This may require them to borrow additional money or forego spending the cash as quickly as possible. Presumably, the company would not allow its customers to take 3 months to pay unless compensated for doing so. Thus, Tolland will probably charge a higher price because of the extended payment terms. -Tolland's higher price to cover the increased financing costs it pays for a longer collection period will result in higher revenues.**

Accounting and reporting cash

-When cash is received, a cash account is increased by a debit; and when cash is paid out, a cash account is decreased by a credit. -From a personal perspective: the receipt of either a check or currency is recorded by a debit to cash. Conversely, either the issue of a check or the payment of currency is recorded by a credit to cash. -Cash is reported on both the balance sheet (reports the amount of cash and equivalents available at the balance sheet date) and the statement of cash flows (shows the sources and uses of cash during the year) -**Despite the fact that there may be a time lag between the issuance of a check and the actual transfer of funds, the accounting system treats payment by check in exactly the same way that it treats the transfer of currency --> this is a reason as to why we have the cash control: bank reconciliation

The five components of an internal control system

1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication 5. Monitoring Activities

The Internal Control System's three objectives

1. Operation objective 2. Reporting objective 3. Compliance objective

Differences between the cash account balance and the bank statement balance develop from three sources:

1. transactions recorded by the business, but not recorded by the bank in time to appear on the current bank statement, 2. transactions recorded by the bank, but not yet recorded by the business, 3. errors in recording transactions on either set of records

- ''all highly liquid (liquid= how easily it is to be converted into cash) investments with an original maturity of 3 months or less at the date of inception.'' This statement ensures that they are both: 1) easily convertible into known amounts of cash and 2) close enough to maturity that they are relatively insensitive to changes in interest rates (In other words: are the most liquid current asset [along with cash itself] found on a business's balance sheet. They are short-term commitments "with temporarily idle cash and easily convertible into a known cash amount". - Companies bother to invest their cash in such short-term investments because: such investments earn a greater rate of return than cash sitting in a bank account.

Accounting and reporting cash: cash equivalents

One of the three areas that are used to strengthen cash controls (cash being an asset that is protected by the internal control system, but needs further security due to its level of liquidity). This strategy was invented due to the often disagreement between the bank's accounting records and the company's accounting records (which is an occurrence because the transactions are not recorded at the same time [ex: a company writes a check on January 18 and credits cash immediately; however, the bank will not debit your account until the check is presented to the bank—typically many days later]). Therefore, this is the process of reconciling any differences between a company's accounting records and the bank's accounting records.

Bank reconciliation

Shows the beginning and ending account balance and the individual deposits and withdrawals recorded by the bank during the period. Basically, it is a copy of the bank's accounting records showing each customer the increases and decreases in their balances

Bank statement

If a debit increases an asset and decreases a liability and a credit decreases an asset and increases a liability, why does the bank "credit" your account when you make a deposit and "debit" your account when you make a withdrawal?

Because the "credit" and "debit" are from the bank's point of view. When you make a deposit, it actually increases the bank's liability to you—the bank now owes you more (EX: checking account is a liability for the bank since the bank owes you the balance). When you make a withdrawal, it decreases the bank's liability to you.

One of the two risks that are identified, analyzed, and managed by our risk assessment component of internal control. These risks are how the company allocates its resources to meet its objectives. They are INTERNAL processes of the company. Some of the processes used for the company to apply its resources include: materials acquisition, production, logistics and distribution, branding and marketing, and human resources.

Business process risks

This is the first step of the operating cycle. An important aspect of cash management is to keep this idea low because this decreases the need for cash

Buying Inventory... Keeping inventory levels low= spending less cash= less need for cash

One of the three areas that are used to strengthen cash controls (cash being an asset that is protected by the internal control system, but needs further security due to its level of liquidity). It is defined as an account that records the discrepancies between deposited amounts of actual cash received and the total of the cash register tape. -In other words: at the end of each day, the amount of cash received during the day is debited to the cash accounts to which it has been deposited. The amount deposited should equal the total of cash register tapes. If it does not, the discrepancy is recorded in this account - (Cash over and short is usually treated as an income statement account and is reported as a part of other expenses or other revenue)

Cash Over and Short

- A methodology that is crucial to have because although internal controls are designed to protect all assets, the more liquid an asset is= the more likely it is to be stolen. Therefore, this idea uses different strategies which are all structured in order to further ensure the control of the placement of cash (as the internal control system is originally operated to do so as well) - As mentioned, it consists of three strategies ^^

Cash controls

As discussed, the activities of the operating cycle transform cash into goods and services and then back, through sales, into cash. This sequence of activities includes a continual process of paying and receiving cash. A company can significantly increase its net income through its cash management policies. At a high level, cash management principles entail the following: 1) delaying payments to suppliers, so a company can earn as much interest on their cash as possible, 2) speeding up a collection from customers in order to invest the cash sooner or reduce the need for additional financing, 3)earning the greatest return on any excess cash

Cash management

One of the five categories that identify control activities. Is defined as having recorded amounts checked by an independent person to determine that amounts are correct and that they correspond to properly authorized activities *EX) accounting records of a business/company should be checked (or reconciled) to the bank statement and any discrepancies should be resolved immediately.

Checks on recorded amounts

One of the five categories that identify control activities. Is defined in two objectives: 1) the authority to perform important duties is delegated to specific individuals, and 2) those individuals should be held responsible for the performance of those duties in the evaluation of their performance

Clearly defined authority and responsibility

When two or more parties decide to work together to gain an advantage. This is an exercise of the segregation of duties

Collusion

One of the three objectives that the internal control system accounts for. It is defined as compliance with applicable laws and regulations.

Compliance Objective

One of the five components of the internal control system, which is also classified under one of the three objectives of internal control (is the component most directly related to the accounting system and the financial statement). It is defined as the policies and procedures that top management establishes to help ensure that its objectives are met. The clear delegation of authority and responsibility motivates individuals to perform well because they know they are accountable for their actions. This factor is designed/determined by the possible risk assessments that are present in a company. This factor also can be identified by one of five categories: clearly defined authority and responsibility, segregation of duties, adequate documents and records, safeguards over assets and records, and checks on recorded amounts

Control Activities

One of the five components of internal control (that too is a factor of one of our three objectives) and is the foundation of the internal control system. It is defined as the collection of environmental factors that influence the effectiveness of control procedures. The collection of environmental factors includes the following: philosophy and operating style of management, personnel policies and practices of the business, and "tone at the top," also known as the overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control

Control Environment

One of the several types of transactions that can be recorded by the bank, but not yet recorded by the business. An example of this scenario involves: if the bank collected a note receivable for the business and deposited the funds in the business's account

Credit memo

One of the several types of transactions that can be recorded by the bank, but not yet recorded by the business. An example of this scenario includes: the bank makes a prearranged deduction from the business's account to pay a utility bill

Debit memo

One of the two types of transactions that can be recorded by the business, but not recorded by the bank in time to appear on the current statement. It is defined as an amount received and recorded by a company, but which has not been recorded by the bank in time to appear on the current bank statement. Deposits in transit cause the bank balance to be smaller than the business's cash account balance (meaning, these will be added to the **bank statement)

Deposits in transit

- Overall, these issues occur in both scenarios that either the bank records before the business or the business records before the bank/ they represent another source of difference between a business's cash account balance and the bank balance. - Errors are inevitable in any accounting system and should be corrected as soon as discovered. In addition, an effort should be made to determine the cause of any error as a basis for corrective action.

Errors

One of the five categories that identify control activities. It is defined as the requirement of summary records and their underlying documentation must provide information about specific activities and help in the evaluation of individual performance. This idea is the basis for the financial statements and other reports prepared for managers, owners, and others both inside and outside the business

Having adequate documents and records

- The petty cash fund is overseen by a petty cash custodian, who both pays for small dollar amounts directly from the fund and reimburses employees who have receipts for items they've bought with their own money. At the end of the month, the custodian submits all receipts (and other supporting documentation) to the company. - After company personnel (other than the petty cash custodian) determine that the documents are authentic and that each transaction is supported by appropriate documentation, the custodian is given an amount to replenish the petty cash fund. - The company then records the amounts spent in the accounting records. Because the custodian replenishes petty cash at the end of the month, the accounting records are appropriately updated each month** (Replenishment of petty cash may also occur during the month if the amount of petty cash available gets too low. However, to assure that all expenses are recorded in the appropriate accounting period, replenishment should occur at the end of the month or accounting period. As an additional control measure, a company should periodically verify its petty cash balances by counting the cash in the hands of custodians and comparing it to the custodian's petty cash record)

How a petty cash fund works

One of the five components of the internal control system, which is also classified under one of the three objectives of internal control. It is defined as adequate information being identified and gathered (to the company) on a timely basis. Further, this information must be communicated to the appropriate employees in the organization

Information and Communication

Credit memos recorded by the bank but not recorded by the business cause the bank balance to be --- than the cash account balance.

Larger. Cash account balance< bank statement balance because the bank went ahead and deposited funds into the business's account when the business itself has yet to do so. Therefore, there is an additional amount in the bank balance that isn't in the cash balance

Outstanding check example: when a check is written during December, but not cashed until January, the business's December 31 cash balance will be ---- than its account balance on the December 31 bank statement.

Lower. Cash account balance < bank statement balance because the bank has yet to have recorded the outstanding check the company was charged with

Once the bank reconciliation is completed, some adjustments to the accounting records may be necessary. No adjustments are necessary for outstanding checks or deposits in transit because the accounting records have correctly recorded these amounts. However, adjustments are necessary for any company errors or items such as bank charges or interest that the company does not find out about until receiving the bank statement.

Making Adjusting Entries as a Result of the Bank Reconciliation

One of the five components of the internal control system, which is also classified under one of the three objectives of internal control. It is defined as the process of tracking potential and actual problems in the internal control system (which is done by staying up to date on the activity that has occurred and resulted from our previous components of internal control) Monitoring is accomplished through normal supervising activities such as when a manager asks a subordinate how things are going. However, best practices for larger organizations suggest that an internal audit group helps monitor the effectiveness of the internal control system.

Monitoring

-One of the several types of transactions that can be recorded by the bank, but not yet recorded by the business. It is defined as "a check that has been returned to the depositor because funds in the issuer's account are not sufficient to pay the check" (also called a bounced check). In other words, this term refers to the status of a checking account that does not have enough money to cover transactions. -The amount of the check was added to the depositor's account when the check was received; however, when the bank discovers the check cannot be paid, the amount of the check is deducted from the account. This deduction is recorded by the bank before it is not yet recorded by the business.

Non-sufficient funds (NSF) check

- The elapsed time between the purchase of goods for resale (or the purchase of materials to produce salable goods or services) and the collection of cash from customers (presumably a larger amount of cash than was invested in the goods sold). -Although typically a year or less, the operating cycle can be as short as a few days for perishable goods or as long as many years for the production and sale of products (such as timber or wine). -***The length of the operating cycle influences the classification of assets and liabilities on balance sheets. In addition, the operating cycle plays an important role in the measurement of income. The length of the operating cycle also affects the amount of capital a business needs and the policies that govern its sales of goods and services

Operating Cycle

One of the three objectives that the internal control system accounts for. It is defined as the effectiveness and efficiency of the entity's operations, including financial performance goals and safeguarding assets against loss.

Operation Objective

One of the two types of transactions that can be recorded by the business, but not recorded by the bank in time to appear on the current statement. It is defined as a check that has been issued and recorded by the business but that has not been "cashed" by the recipient of the check. The business has (properly) recorded the check as lowering its cash balance and the bank has (properly) not recorded the check as lowering the business's account balance because it has not been cashed (therefore, these will be subtracted from the **bank statement)

Outstanding checks

This is the second step of the operating cycle. As with all payments, a good cash management principle is to delay payments as long as possible while maintaining a good relationship with the payee. Therefore, this idea is favored to be not a constant occurance. Plus, the longer a company keeps cash, the more interest it can collect (which means more $ the business earns)

Paying for Inventory

Start with the ''cash balance from the bank statement'' and the ''cash balance from company records.'' These two balances are then adjusted as necessary to produce identical ''adjusted cash balances'' by following these steps: Step 1) Compare the deposits on the bank statement to the deposits debited to the cash account. Any deposits debited to the cash account but not on the bank statement are likely deposits in transit, so look at a deposit slip to ensure that these amounts were actually deposited. Deposits in transit should be added to the ''cash balance from the bank statement.'' Step 2) Compare the paid (often called canceled) checks. Any checks credited to the cash account but not on the bank statement are likely outstanding checks. These amounts should be subtracted from the ''cash balance from the bank statement.'' Step 3) Look for items on the bank statement that have not been debited or credited to the cash account. These include bank service charges, interest payments, NSF checks, automatic payments (debit memos), and bank collections on behalf of the company (credit memos). Bank debits should be subtracted from the ''cash balance from company records,'' while bank credits should be added to the ''cash balance from company records.'' Step 4)If the ''adjusted cash balances'' are still not the same, search for errors. The most common error is a ''transposition'' error in which, for example, a check is written for $823, but recorded as $283 (the 8 and 2 are transposed). In this case, the accounting records will show a $283 credit to the cash account, but the bank will show an $823 debit to the company's account (BC the different values determine whether or note there are non-sufficient funds--> whether the check can be covered or not).

Performing a bank reconciliation

One of the three areas that are used to strengthen cash controls (cash being an asset that is protected by the internal control system, but needs further security due to its level of liquidity). It is defined as a fund used to pay for small dollar amounts (since issuing checks to pay small amounts is usually more costly than paying cash)

Petty Cash

Importance of bank reconciliation

Reconciliation of the separately maintained records (company's accounting records and the bank's accounting records) serves two purposes: 1. It serves a control function by identifying errors and providing an inspection of detailed records that deters theft, 2. It serves a transaction detection function by identifying transactions performed by the bank, so the business can make the necessary entries in its records

Although we distinguish between the accounting system and the internal control system, the two are really one integrated system designed to meet the needs of a particular business. It is difficult to generalize the relationship between internal control activities and accounting systems because it directly depends on the objectives of a particular business, so it's important that we deeply analyze the contrast (say, with actual records and statements) --> **Look into the example flashcard in this Quizlet

Relationship between the accounting system and control activities

One of the three objectives that the internal control system accounts for. It is defined as the reliability of reporting. They include internal and external financial and non-financial reporting.

Reporting Objective

One of the five components of the internal control system, which is also classified under one of the three objectives of internal control. It is defined as procedures that are designed to identify, analyze, and manage strategic risks and business process risks. It is also known as Enterprise Risk Management or ERM

Risk Assessment

The idea of securing the physical protection of something. In the accounting world, this refers to the physical protection over assets and records. This may be accomplished through, for example, fireproof vaults, locked storage facilities, keycard access, and anti-theft tags on merchandise. A large concern in physically securing assets and records includes access controls for computers

Safeguarding

One of the five categories that identify control activities. It is defined as securing assets and records against theft and destruction

Safeguards over Assets and Records

Requires publicly traded corporations to establish formal procedures to receive, retain, and address any information that may affect the company's accounting or auditing. Companies must also have procedures in place to make sure such information is never destroyed and that it is communicated to those with the power to resolve any issues, such as the board of directors and upper management. This act too requires that all publicly traded corporations have an internal audit function that reports to the audit committee of the board of directors (exercise of another internal control component: monitoring)

Sarbanes-Oxley Act

One of the five categories that identify control activities. It is defined as the idea that accounting and administrative duties should be performed by different individuals so that no one person has access to the asset and prepares all the documents and records for an activity. This factor reduces the likelihood that records could be used to conceal irregularities (intentional misstatements, theft, or fraud) and increases the likelihood that such irregularities will be discovered (this idea also stands true for unintentional record-keeping errors). Perhaps the most important aspect is separating the record-keeping responsibility from the physical control of the assets

Segregation of duties (also called separation of duties)

This is the third step of the operating cycle. This step often produces receivables. This is something the company ought to do since good cash management suggests increasing the speed of receivable collections. Many times, many companies sell their receivables rather than wait for their customers to pay. Of course, they sell the receivables for less than they will receive (which represents interest and return for the buyer), but it also allows the company to receive the cash sooner and avoid hiring employees to service the receivables.

Selling inventory.

One of the several types of transactions that can be recorded by the bank, but not yet recorded by the business. It is defined as fees charged by the bank for services provided. Examples include annual maintenance, minimum balance, and foreign transaction fees. The amount of the fee is not known to the business (and therefore cannot be recorded) until the bank statement is received.

Service charges

As it concerns the operating cycle, these are financial investments that can easily be converted to cash. A reason behind this idea could be because beyond delaying payments and speeding up collections, businesses try to keep their bank cash balances to a minimum because most bank accounts earn relatively small amounts of interest. However, the value and composition of short-term investment portfolios change continually in response to seasonal factors and other shifts in the business environment.

Short-term investments

Service charges example: Bank service charges unrecorded by the business at the end of a month cause the bank balance to be --- than the business's cash account balance.

Smaller. Cash account balance > bank statement balance because the business has not yet recorded the deduction from the service charge (but the bank has)

Debit memo example: Debit memos recorded by the bank but not yet recorded by the business cause the bank balance to be --- than the cash account balance

Smaller. Cash account balance> bank statement balance because the bank records a charge from the business earlier than the business itself would have recorded it

NSF checks fund example: NSF checks cause the bank balance to be --- than the cash account balance.

Smaller. Cash account balance> bank statement balance because the business has already recorded the deposit of the amount written on the check. However, since the check that was written to the business is no good- does not have enough "sufficient funds"- the bank does not record the addition to the bank statement for that company.

One of the two risks that are identified, analyzed, and managed by our risk assessment component of internal control. These risks are possible threats to the organizations' success in accomplishing its objectives. They are EXTERNAL to the organization (risks outside of the company which, for example, may concern --> 1. industry forces: competitors, customers, substitute products or services, suppliers, and the threat of new competitors and/or 2. macro factors: political, economic, social, and technological risks)

Strategic risks

The policies and procedures established by top management and the board of directors to provide reasonable assurance that the company's objectives are being met in three areas: (1) effectiveness and efficiency of operations, (2) reliability of financial reporting, and (3) compliance with applicable laws and regulations. Internal controls are too used to protect all assets

The Internal Control System

The methods and records used to identify, measure, record, and communicate financial information about a business

The accounting system

1. Clearly defined authority and responsibility 2. Segregation of duties 3. Adequate documents and records 4. Safeguards over assets and records 5. Checks on recorded amounts

The five categories that identify control activities (which are effective at reducing intentional or unintentional error, theft, and fraud)

1. philosophy and operating style of management 2. personnel policies and practices of the business 3. "tone at the top" --> the overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control

The three environmental factors of the control environment (which determines the effectiveness of control policies and procedures)

1. Bank reconciliation 2. Cash over and short 3. Petty cash

Three important areas where the accounting system interacts with the internal control system to strengthen cash controls

There are generally two types of transactions recorded by the business, but not recorded by the bank in time to appear on the current statement:

outstanding checks and deposits in transit

The several types of transactions that are recorded by the bank, but not yet recorded by the business: **After the reconciliation process, the business must make *adjusting journal entries to record all the transactions that have been recorded by the bank but not yet recorded in the business's ledger cash account.

service charges, non-sufficient funds checks and overdraft charges, and debit and credit memos