accounting chapter 4
bank's cash balance: Deposits outstanding
+
company's cash balance: Notes receivable by bank
+
company's cash balance: interest received
+
bank's cash balance: checks outstanding
-
company's cash balance: NSF checks received
-
company's cash balance: bank service fees
-
company's cash balance: unrecorded EFT payments
-
company's cash balance: unrecorded debit card payments
-
how do credit card companies earn revenue?
1) cardholder has a specified grace period before he/she has to pay credit card balance in full- if not paid in grace period then fee (interest) is charged 2) credit card companies charge retailer (NOT customer) for the use of the credit card... charge generally ranges from 2-4% of the amount of the sale
what are the two reasons companies issue incorrect financial statements?
1) companies sometimes make mistakes in recording (or failing to record) transactions or in applying accounting rules 2) fraud- when a person intentionally deceives another person for personal gain or to damage that person
Controls over cash receipts
1) open mail each day and make a list of checks received 2) designate an employee to deposit cash and checks into the company's bank account each day 3) have another employee record cash receipts in the accounting records are soon as possible 4) accept credit and debit cards- to limit amount of cash employees handle
three steps of reconciling the bank account
1) reconcile the BANK's cash balance 2) reconcile the COMPANY'S cash balance 3) Update the company's Cash account by recording items identified in step 2
what are the 2 purposes of internal controls
1) safeguard a company's assets, such as cash 2) improve accuracy and reliability of accounting information
internal controls
A company's plans to (1) safeguard the company's assets and (2) improve the accuracy and reliability of accounting information
Which of the following is an example of a detective control in a company? a) Accounting personnel routinely reconciles the company's cash records with those of its bank to identify discrepancies. b) Only senior managers are authorized to make purchases over a certain amount. c) Electronic records are backed up daily, and require user-ID and password for access. d) Concession supplies are kept in a locked room with access allowed only to authorized personnel.
A) Accounting personnel routinely reconciles the company's cash records with those of its bank to identify discrepancies.
only transactions involving _____ affect a company's cash flows
CASH- not on account, only exchanges of cash
purchase cards
Company-issued debit cards or credit cards that allow authorized employees to make purchases on behalf of the company
banks statement- deposit of cash is a debit or credit?
Credit (opposite of financial accounting) deposit= increase to cash to bank so records a debit to cash account
what are the two highest profile cases of accounting fraud in US history?
Enron and WorldCom
Identify cash equivalents from the listed items Money market funds checked Supplies unchecked Three-month Treasury bills checked Accounts receivable unchecked Prepaid rent
Money market funds checked Three-month Treasury bills checked
Rice Corp. noticed that a check written by the company for utility expense in the amount of $1,000 was incorrectly recorded BY THE BANK as $1,100. What entry needs to be recorded to correct this error?
No entry is required on the company's books... the error was made by the bank so no entry is required in the company's books... the bank must correct its error
Which of the following are preventive controls? Performance reviews Physical controls Reconciliations Separation of duties
Separation of duties Physical controls
dividend policy
The amount of dividends management decides to pay out to shareholders... companies that pay out higher dividends have less cash available
the balance sheet reports what?
a company's total cash balance at the end of the year
Which of the following is a good internal control mechanism for cash disbursements? a) Maximum purchase limits set on debit and credit cards. b) Expenditures above a particular amount do not need authorization. c) All checks need to be signed only by one authorized person. d) All transactions are made using cash with the required documentation.
a) Maximum purchase limits set on debit and credit cards.
Sarbanes-Oxley Act of 2002 (Public Company Accounting Reform and Investor Protection Act of 2002 or SOX)
act was created after Enron and WorldCom that established a variety of guidelines related to auditor-client relations and internal control procedures
to adjust the bank's cash balance per bank statement you must do what to deposits outstanding and checks outstanding
add deposits outstanding and subtract checks outstanding
what can be done to minimize fraud?
at least one of the three elements of fraud must be eliminated
Small expenditures from a petty cash fund are normally recorded:
at the end of a specific time period
when are employee purchases captured in the accounting records using debit cards and checks?
at the same time the bank reconciliation is prepared
major provisions of SOX: hiring of auditor
audit firms are hired by the audit committee of the board of directors of the company, not by company management
major provisions of SOX: conflicts of interest
audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company's audit during the preceding year
major provisions of SOX: retention of work papers
auditors of public companies must retain all work papers for seven years or face a prison term for willful violation
Which of the following is an example of a preventive control in a company? a)The management evaluates the overall performance by comparing sales for the current year with sales for the previous year. b) Employees responsible for making cash disbursements are not in charge of cash receipts. c) Management periodically determines whether the amount of physical assets of the company match the accounting records. d) Actual performance of individuals are routinely checked against their expected performance.
b) Employees responsible for making cash disbursements are not in charge of cash receipts.
the final amount in the statement of cash flows should be the same as the cash amount in financial sheet?
balance sheet
what financial statements do companies report cash?
balance sheet and statement of cash flows
do deposits and checks outstanding go under bank or company cash balance?
bank's cash balance
when should employee purchases be included in the accounting records?
by the end of the reporting period
what asset is most commonly involved with fraud?
cash
deposits outstanding
cash receipts of the company that have not been added to the bank's record of the company's balance- increase cash
checks outstanding
checks the company has written that have not been subtracted from the bank's record of the company's balance- decrease cash - cause bank balance to be more than the company's balance of cash
internal controls are especially susceptible to what?
collusion
All forms of cash and cash equivalents are ______ and ____ as a single asset in the balance sheet of most companies
combined, reported
The Sarbanes-Oxley Act applies to
companies that are required to file with the SEC.
Preventative control: employee management
company should provide proper guidance to ensure they have the knowledge necessary to carry out their job duties
what do investors know from a statement of cash flows?
company's cash inflows and outflows related to operating activities, investing activities and financing activities
what are the five components of internal control
control environment, risk assessment, control activities, information and communication, monitoring
major provisions of SOX: Corporate executive accountability
corporate executives must personally certify the company's financial statements and financial disclosures. Severe financial penalties and possible imprisonment are the results of fraud
for reconciliation items that decrease the company's balance of cash, we do what to cash?
credit cash
for reconciliation items that increase the company's balance of cash, we do what to notes receivable?
credit notes receivable - company has collected cash from the note, decreasing the asset account
Who relies on financial statements?
creditors and investors- to accurately portray the activities of the company
what is defined as cash?
currency, coins, and balances in savings and checkings accounts, as well as items acceptable for deposit in these accounts (checks received from customers); also cash equivalents (short term investments that have maturity date no longer than 3 months for the date of purchase)
if theatre uses a credit card to pay $1000 worth of advertising how is the journal entry recorded?
debit $1000- advertising expense credit $1000- accounts payable * credit card allows purchaser to delay payment for several weeks/months= accounts PAYABLE
movie theatre pays $1000 to advertise its showtimes regardless if it pays cash, check or debit card...
debit $1000- advertising expense credit $1000- cash
acceptance of credit cards journal entry (movie theatre accepts payment for $2000 of movie tickets... mastercard charges theatre a 3% service fee)
debit $1940 (2000-fee)- cash debit $60- service fee expense credit $2000- service revenue
journal entry of transfer of cash from the bank to cash on hand in petty cash fund
debit $200- petty cash (on hand) credit $200- cash (checking account)
banks statement- withdrawal of cash is a debit or credit?
debit (Opposite of financial accounting) withdrawal= decrease to the amount owed to the company- debit liability
journal entry of using up petty cash with credit card
debit - expenses credit- accounts payable
acceptance of customer checks journal entry (local theatre sells tickets for the entire day totaling $3000- some use checks, some use cash):
debit 3000- cash credit 3000- service revenue
for reconciliation items that increase the company's balance of cash, we do what to cash?
debit cash
journal entry of using up petty cash with petty cash fund
debit- expenses credit- cash
COSO (Committee of Sponsoring Organizations)
dedicated to improving the quality of financial reporting through, among other things, effective internal controls
In a bank reconciliation, the bank's charge of $10 for checking account fees is
deducted from the company's cash balance.
five components of internal control: information and communication
depends on the reliability of the accounting information system... there must always be some sort of system in place anonymous tip hotline should be in place to encourage communication about unethical activities EX: if accountant's office has papers scattered everywhere or they refuse to do accounting with a computer rather then hand... then you should be worried
preventative controls
designed to detect errors or fraud that already have occured
Detective Controls
designed to detect errors or fraud that already have occurred
Preventative control: separation of duties
employee selling the movie ticket should not also be the one in charge of collecting the tickets
what is the second source of occupational fraud?
financial statement manipulation- those in charge of financial accounting information falsify reports "cooking the books"
ISSUANCE of common stock is what kind of cash flow activity
financing activity
Preventative control: proper authorization
formal guidelines should be put in place on how to handle cash receipts and purchases EX: only management should be allowed to make purchases over a certain amount
growth
growth companies have less cash available because of their higher capital spending on new opportunities
what is the ideal cash balance of a company?
high enough to be able to pay debts that become due but not so high that cash is idle and not being used effectively to grow the company
five components of internal control: risk assessment
identifies and analyzes internal and external risk factors that could prevent a company's objectives from being achieved EX: internal risks (unsafe lighting, unsanitary bathrooms, etc) and external risks (vendor supplying low quality popcorn, decline in customer demand to go to the movies because of Netflix)... put the company's objectives in jeopardy
five components of internal control: monitoring
internal activities and reporting of deficiencies is required on an ongoing basis. Monitoring includes formal procedures for reporting control deficiencies
major provisions of SOX: non- audit services
it's unlawful for the auditors of public companies to also perform certain non-audit services, such as investment advising, for their clients
three elements of fraud: rationalization
justification for the deceptive act by the one committing the fraud
major provisions of SOX: auditor rotation
lead auditor in charge of auditing a particular company must rotate off that company within 5 years and allow a new audit partner to take lead
Detective controls: reconcilliations
management should periodically determine the amount of physical assets of the company (cash, supplies, inventory, and other property) agree with accounting records
Detective control: audits
many companies are required to have an independent auditor attest the adequacy of their internal control procedures, other companies can voluntarily have an auditor come in to detect deficiencies or fraudulent behavior of employees
bank reconciliation
matches the balance of cash in the bank account with the balance of cash in the company's own records... differences in these two balances can occur because of timing differences or errors
WorldCom fraud scandal
misclassified certain expenditures to overstate assets and profitability by $11 billion- hoped to fool investors into overvaluing the company's stock
what is the first source of occupational fraud?
misuse of company resources
Preventative control: physical controls over assets and liabilities
money from sales of the day should be placed in a safe at the end of the day, important documents should be kept in fireproof files, etc
example of a timing difference in cash
movie theatre pays its popcorn supplier $2000 by check, the company records a decrease in cash immediately, but the bank doesn't record a decrease in cash until the popcorn supplier deposits the check
what cash flow is most directly related to the company's profitability?
net cash flows from operating activities
are notes payable included in statement of cash flows?
no, because no cash is involved in the transaction
what is one way of preventing fraud
not allowing the same person to be responsible for both CONTROLLING the asset and ACCOUNTING the asset
bank collection
occurred when First Bank received $3000
accidental error
occurs if the company mistakenly records a check being written for $117 as a $171 in its records
collusion
occurs when two or more people act in coordination to circumvent internal controls
what are the three elements of fraud
opportunity, motivation, rationalization
what element of the fraud triangle do companies have the greatest ability to eliminate?
opportunity- by implementing internal controls
what are manager motives to cooking the books?
personal gain... maximizing their compensation, increasing the company's stock price, and preserving their jobs
after the bank reconciliation is performed, what is the next step?
prepare entries to update the balance of cash in the company's records (adjusting entries for company's cash balance)
major provisions of SOX: oversight board
public company accounting oversight board has the authority to establish standards dealing with auditing, quality control, ethics, independence, and other activities relating to the preparation of audited financial reports- board includes 5 members (elected by Securities and Exchange Commission- SEC)
Dividends _____ are classified as operating activities cash flows, while dividends ____ are classified as financing activities cash flows.
received, paid
restricted cash
represents cash that is not available for current operations EX: repaying debt, purchasing equipment, making investments in the future
The key provisions of the Sarbanes-Oxley Act include
requiring that corporate executives certify financial statements. requiring documentation and assessing effectiveness of internal controls. restricting activities of auditors to prevent conflicts of interest.
major provisions of SOX: internal control
section 404 of the act requires (a) that company management document and assess the effectiveness of all internal control processes that could affect financial reporting and (b) that company auditors express an opinion on whether managements assessment of the effectiveness of internal control is fairly stated
Important internal control procedures for employee purchases include:
separation of duties reconciliation of credit card statements clear rules for purchase authorization predetermined spending limits for employees
five components of internal control: control environment
sets the overall ethical tone of the company with respect to internal control. It includes formal policies related to management's philosophy, assignment of responsibilities, and organizational structure EX: if employees notice unethical behavior or comments by management they are more likely to behave similarly
cash equivalents
short term investments that have maturity date no longer than 3 months for the date of purchase EX: money market funds, treasury bills, certificates of deposit
petty cash fund
small amount of cash kept on hand to pay for minor purchases
three elements of fraud: motivation
someone feels the need to commit fraud, such as the need for money
managers act as what?
stewards/caretakers of the company's assets
what does "cooking the books" mean?
the accounting record (books) have been presented in an altered form (cooked)
Detective control: performance reviews
the actual performance of individuals or processes should be checked against their expected performance EX: amount of concession sales should be compared to number of tickets sold over a period
balance sheet provides what information about cash?
the final balance for cash does NOT provide details regarding cash receipts and cash payments
credit card
the issuer (Visa, Mastercard) extends credit (lends money) to the cardholder each time the cardholder uses the card... meanwhile credit card company deposits cash in the company's bank for the amount of the sale
the statement of cash flows reports what?
the net cash flows during the year by type of activity
five components of internal control: control activities
the policies and procedures that help ensure that management's directives are being carried out. these activities include authorizations, reconciliations, and separation of duties
intentional error
the result of theft EX: company records a daily deposit of $5000 but an employee only deposits $500 into the bank account and pockets the rest, the bank reconciliation will reveal the missing $4500
a check and cash are treated...
the same
three elements of fraud: opportunity
the situation allows the fraud to occur
what happened to stock prices of these companies as a result to the fraud
the stock prices plummeted... investors lost billions, employees suffered, etc
occupational fraud
the use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employer's resources
Who takes final responsibility for establishment and success
top executives- CEO and CFO
who has the ability to override internal control features and commit fraud?
top-level employees
when a company sells products or services to customers who use a credit/debit card the cash collected from those sales is included where?
total cash balance immediately because cash from those transactions will be deposited electronically into the company's bank account within a few days
true or false? effective internal controls and ethical employees alone cannot ensure a company's success or even survival
true
when are employee purchases captured in the accounting records using credit cards and petty cash funds?
typically not recorded immediately in accounting records
Enron fraud scandal
used questionable accounting practices to avoid reporting billions in debt and losses in its financial statements- hoped to fool investors into overvaluing the company's stock
when do timing differences occur in cash?
when the company records transactions either before or after the bank records the same transactions
debit cards
work just like a check and withdraw funds directly from cardholder's bank account at the time of use... using a debit card decreases cash in your cash account ALSO results in fee being charged to retailer... usually much lower recorded much like a credit card journal entry
