Acct Chp 7 book notes

Petty cash funds are authorized and legitimate. In contrast, ... funds are unauthorized and hidden

"Slush"

Two essential steps in establishing a petty cash fund are...

(1) appointing a petty cash custodian who will be responsible for the fund, and (2) determining the size of the fund

The petty cash receipt satisfies two internal control principles:

(1) establishment of responsibility (signature of custodian), and (2) documentation procedures.

The operation of a petty cash fund involves:

(1) establishing the fund, (2) making payments from the fund, and (3) replenishing the fund The company does not make an accounting entry to record a payment when it is made from petty cash. Instead, the company recognizes the accounting effects of each payment when it replenishes (reaches a minimum level) the fund

Internal control over a petty cash fund is strengthened by

(1) having a supervisor make surprise counts of the fund to ascertain whether the paid petty cash receipts and fund cash equal the designated amount, and (2) cancelling or mutilating the paid petty cash receipts so they cannot be resubmitted for reimbursement

Replenishing the petty cash fund involves three internal control procedures:

(1) segregation of duties, (2) documentation procedures, and (3) independent internal verification.

Occupational fraud is one of three types:

1. Asset misappropriation- 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- bribery, illegal gratuities, and economic extortion 3. Financial statement fraud- 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

Human resource control 3 activities:

1. Bond employees who handle cash. Bonding involves obtaining insurance protection against theft by employees. It contributes to the safeguarding of cash in two ways. First, the insurance company carefully screens all individuals before adding them to the policy and may reject risky applicants. Second, bonded employees know that the insurance company will vigorously prosecute all offenders. 2. Rotate employees' duties and require employees to take vacations. These measures deter employees from attempting thefts since they will not be able to permanently conceal their improper actions. 3. Conduct thorough background checks. Many believe that the most important and inexpensive measure for the human resource department to conduct thorough background checks. Two tips: (1) Check to see whether job applicants actually graduated from the schools they list. (2) Never use telephone numbers for previous employers provided by the applicant. Always look them up yourself. if an employee complains of an unfair firing and mentions financial issues at the company, the human resource department must refer the case to the company audit committee and possibly to its legal counsel

Procedures for documents

1. Companies should use prenumbered documents, and all documents should be accounted for. Prenumbering helps to prevent a transaction from being recorded more than once or not at all. 2. Employees promptly forward source documents for accounting entries to the accounting department. Ensures timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records.

To obtain maximum benefit from independent internal verification:

1. Companies should verify records periodically or on a surprise basis. 2. An employee who is independent of the personnel responsible for the information should make the verification. 3. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action.

Segregation of duties two application principles are:

1. Different individuals should be responsible for related activities 2. The responsibility for recordkeeping for an asset should be separate from the physical custody of that asset

5 Basic Principles of cash management

1. Increase the speed of receivables collection- the more quickly customers pay her, the more quickly she can use those funds 2. Keep inventory levels low- maintaining a large inventory of cloth and finished clothing is costly 3. Monitor payment of liabilities- let's say her supplier allows 30 days for payment. If she pays in 10 days, she has lost the use of that cash for 20 days. Therefore, she should use the full payment period. But, she should not pay late. This could damage her credit rating 4. Plan the timing of major expenditures- to maintain operations or to grow, all companies must make major expenditures- make any major expenditure when the company normally has excess cash—usually during the off-season 5. Invest idle cash- cash on hand earns nothing. An important part of the treasurer's job is to ensure that the company invests any excess cash- to avoid a cash crisis, it is very important that investments of idle cash be highly liquid and risk-free.

The use of ... contributes significantly to good internal control over cash

A bank For efficiency of operations and better control, national retailers like Walmart and Target often have regional bank accounts

What are the 5 primary components of internal controls? Elaborate

A control environment (tone at the top)- responsibility of top management to make it clear that the organization values integrity and that unethical activity will not be tolerated Risk assessment- identify and analyze various factors that create risk for the business and must determine how to manage these risks Control activities- management must design policies and procedures to address the specific risks (fraud) faced by the company Information and communication- capture and communicate all pertinent information both down and up the organization, as well as communicate information to appropriate external parties Monitoring- monitor periodically for their adequacy

Fraud

A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer A bookkeeper in a small company diverted $750,000 of bill payments to a personal bank account over a three-year period. A shipping clerk with 28 years of service shipped $125,000 of merchandise to himself. A computer operator embezzled $21 million from Wells Fargo Bank over a two-year period. A church treasurer "borrowed" $150,000 of church funds to finance a friend's business dealings

(Limitations of internal control) Human element

A good system can become ineffective as a result of employee fatigue, carelessness, or indifference. For example, a receiving clerk may not bother to count goods received and may just "fudge" the counts. Eliminating the protection offered by segregation of duties

Voucher system

A network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper. The system begins with the authorization to incur a cost or expense. It ends with the issuance of a check for the liability incurred A voucher system involves two journal entries, one to record the liability when the voucher is issued and a second to pay the liability that relates to the voucher. Controls cash disbursement

Internal controls

A process designed to provide reasonable assurance regarding the achievement of company objectives related to operations, reporting, and compliance. Safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations.

Voucher

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

A paid check is sometimes referred to as a...

Cancelled check

Cash on hand, cash in banks, and petty cash are often combined and reported simply as

Cash

The difference between the actual cash and the amount reported on the cash register tape is reported in a ...

Cash Over and Short account Cash Over and Short is an income statement item

One common way to encourage customers to pay more quickly is to offer

Cash discounts for early payment under such terms as 2/10, n/30

The cash budget contains 3 sections: Elaborate on each

Cash receipts- includes expected receipts from the company's principal source(s) of cash, such as cash sales and collections from customers on credit sales, and anticipated receipts of interest and dividends, and proceeds from planned sales of investments, plant assets, and the company's capital stock Cash disbursements- shows expected payments for inventory, labor, overhead, and selling and administrative expenses (not depreciation expense-does not use cash) and projected payments for income taxes, dividends, investments, and plant assets. and Financing- shows expected borrowings and repayments of borrowed funds plus interest. Financing is needed when there is a cash deficiency and the beginning and ending cash balances

Restricted cash

Cash that is not available for general use but rather is restricted for a special purpose. Helps users determine the amount of cash available for a company's general use. For example, 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 useful life

... is the asset most susceptible to fraudulent activities

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

What are the 6 principles to internal control activities?

Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls

Generally, internal control over cash disbursements is more effective when companies pay by ... transfer rather than by ...

Check or electronic funds (EFT) and cash One exception is payments for incidental amounts that are paid out of petty cash

Once a voucher in titled as "paid" the voucher is sent to the accounting department for recording in a journal called

Check register

Internal auditors

Company employees who continuously evaluate the effectiveness of the company's internal control systems

Establishment of responsibility

Control is most effective when only one person is responsible for a given task. Often requires limiting access only to authorized personnel, and then identifying those personnel. Use of identifying passcodes enables the company to establish responsibility by identifying the particular employee who carried out the activity

Occasionally a company will have a net negative balance in its bank account. In this case, the company should report the negative balance among

Current liabilities For example, farm equipment manufacturer Ag-Chem at one time reported "Checks outstanding in excess (more than necessary) of cash balances" of $2,145,000 among its current liabilities

For example, suppose that the cash register tape indicated sales of $6,956.20 but the amount of cash was only $6,946.10. A cash shortfall of $10.10 exists. To account for this cash shortfall and related cash, the company makes the following entry.

Debit Cash 6,946.10 Debit Cash Over and Short 10.10 Credit Sales Revenue 6,956.20 (To record cash shortfall)

Electronic funds transfer (EFT)

Disbursement systems that use wire, telephone, or computers to transfer cash from one location to another For example, many employees receive no formal payroll checks from their employers. Instead, employers send electronic payroll data to the appropriate banks For example, without proper segregation of duties and authorizations, an employee might be able to redirect electronic payments into a personal bank account and conceal the theft with fraudulent accounting entries. EFT transactions normally result in better internal control since no cash or checks are handled by company employees.

Documentation procedures

Documents provide evidence that transactions and events have occurred. By requiring signatures (or initials) on the documents, the company can identify the individual(s) responsible for the transaction or event. Companies should document transactions when they occur.

Making payments from the petty cash fund

Each payment from the fund must be documented on a prenumbered petty cash receipt (or petty cash voucher). The signatures of both the fund custodian and the person receiving payment are required on the receipt

Financial pressure is when

Employees sometimes commit fraud because of personal financial problems caused by too much debt or, they want to lead a lifestyle that they cannot afford on their current salary

Segregation of duties is...

For example, the personnel that design and program computerized systems should not be assigned duties related to day-to-day use of the system. Otherwise, they could design the system to benefit them personally and conceal the fraud through day-to-day use. Increases the potential for errors and irregularities

To obtain maximum benefit from a bank reconciliation, an employee...

Who has no other responsibilities related to cash should prepare the reconciliation

What entries does the bank make?

If the company discovers any bank errors in preparing the reconciliation, it should notify the bank so the bank can make the necessary corrections on its records. The bank does not make any entries for deposits in transit or outstanding checks

Rationalization is when

In order to justify their fraud, employees rationalize their dishonest actions. For example, employees sometimes justify fraud because they believe they are underpaid while the employer is making lots of money. They believe they deserve to be paid more

Sale invoice indicates

Indicates that the company has billed the customer for the goods

The most common form of liquid investments is

Interest-paying U.S. government securities

Sarbanes- Oxley Act (SOX)

Law that requires publicly traded companies to maintain adequate systems of internal control. In addition, independent outside auditors must attest to the adequacy of the internal control system. SOX also created the Public Company Accounting Oversight Board (PCAOB) to establish auditing standards and regulate auditor activity. Is time and money well spent? Under SOX, a company needs to keep track of employees' degrees and certifications to ensure that employees continue to meet the specified requirements of a job. Companies must develop and monitor an organizational chart.

Every deposit the bank receives is an increase in the bank's ...

Liabilities (an account payable to the depositor) Payment (from the bank for a check) reduces the bank's liability and is therefore debited

Stock of small companies is often

Liquid

International note Corporate treasurers make investments known as hedges

Lock in an exchange rate to reduce the company's exposure to exchange-rate fluctuation

Cash over and short situations result from

Mathematical errors or from failure to keep accurate records.

Risk free investment

Means there is no concern that the party will default on its promise to pay its principal and interest

Independent internal verification

Most internal control systems provide for independent internal verification. Involves the review of data prepared by employees. Useful in comparing recorded accountability with existing assets Examples are the reconciliation of a company's cash balance per books with the cash balance per bank, and the verification of the perpetual inventory records through a count of physical inventory. Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily. Other controls - Bond personnel who handle cash; require vacations; deposit all cash in bank daily

A check that is not paid by a bank because of insufficient funds in a bank account is called an...

NSF check (not sufficient funds) The NSF check creates an account receivable (debits because the people planned to pay the bank so much money, but it was not valid, still owe acct receiv. goes up because we owe the bank the money) for the depositor and reduces cash in the bank account

Liquid investment

One with a market in which someone is always willing to buy or sell the investment

The most important element of the fraud triangle is ...? Elaborate

Opportunity For an employee to commit fraud, the workplace environment must provide opportunities that an employee can take advantage of. Opportunities occur when the workplace lacks sufficient controls to deter and detect fraud. They believe they will not be caught

What are the three main factors that contribute to fraudulent activity?

Opportunity, financial pressure, rationalization

The two type of activities company should assign to certain workers are? How is fraud taken into place within these activities?

Purchasing activities- ordering merchandise, approving orders, receiving goods, authorizing payment, and paying for goods or services. 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 If a purchasing agent is allowed to order goods without obtaining supervisory approval, the likelihood of the purchasing agent receiving kickbacks from suppliers increases Sale activities- making a sale, shipping (or delivering) the goods to the customer, billing the customer, and receiving payment 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 relatives

Physical controls

Relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records

Cash restricted in use should be reported separately on the balance sheet as

Restricted cash If the company expects to use the restricted cash within the next year, it reports the amount as a current asset. When this is not the case, it reports the restricted funds as a noncurrent asset If the company has access to these funds for general use, reported as part of cash and cash equivalents, if not report them separately FASB requires that restricted cash be included with cash and cash equivalents when reconciling the beginning and ending amounts on a statement of cash flows

Reasonable assurance

Rests on the premise that the costs of establishing control procedures should not exceed their expected benefit

Controls may vary with the ... level of the activity

Risk. For example, management may consider cash to be high risk and maintaining inventories in the stockroom as low risk. Thus, management would have stricter controls for cash

Cash equivalents

Short-term, highly -liquid (easily convertible to cash)- investments that are both: 1. Readily convertible to known amounts of cash. 2. So near their maturity that their market value is relatively insensitive to changes in interest rates. (Generally, only investments with maturities of three months or less qualify under this definition.) Treasury bills, commercial paper (short-term corporate notes), and money market funds

A merchandising company's operating cycle is generally ... than that of a manufacturing company.

Shorter In a manufacturing operation, there may be a significant lag between the original purchase of raw materials and the ultimate receipt of cash from customers.

Cash budget

Shows anticipated cash flows, usually over a one- to two-year period. Helps users determine if the company will be able to meet its projected cash needs

Bank statement

Shows its bank transactions and balances. Essentially, the bank statement is a copy of the bank's records (from a banks perspective) sent to the customer or made available online for review. Lists in numerical sequence all paid checks along with the date the check was paid and its amount.

(Limitations of internal control) Size of business

Small companies often find it difficult to segregate duties or to provide for independent internal verification. Businesses with fewer than 100 employees are most at risk for employee theft. In fact, 29% of frauds occurred at companies with fewer than 100 employees

Companies report cash in two different statements:

The balance sheet- the balance sheet and the statement of cash flows and the statement of cash flows- the sources and uses of cash during a period of time

Bank reconciliation

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

Why do we focus so much on the factor control activities?

These activities are the backbone of the company's efforts to address the risks it faces, such as fraud

Mail receipts

These receipts are generally in the form of checks. A mail clerk should endorse each check "For Deposit Only." Banks will not give an individual cash when presented with a check that has this type of endorsement. The mail clerks prepare, in triplicate, a list of the checks received each day (one for the clerk, other for cashiers departments and the accounting department)

Over the counter receipts

This system for handling cash receipts uses an important internal control principle—segregation of recordkeeping from physical custody Segregation of recordkeeping from physical custody, documentation (cash register tape), and independent internal verification (cash register tape), provides an effective system of internal control

The need for reconciliation has two causes:

Time lags- prevent one of the parties from recording the transaction in the same period. For example, several days may elapse between the time a company pays by check and the date the bank pays the check. Also whenever the bank mails a debit or credit memorandum (a document issued by the seller of goods or services to the buyer) to the company Errors- by either party recording transactions. The incidence of errors or fraud depends on the effectiveness of the internal controls maintained by the company and the bank.

Reconciling the bank

To make the balance per books and the balance per bank agree with the correct or true amount

Petty cash fund (imprest system)

To pay relatively small amounts (to pay for postage due, working lunches, or taxi fares). the operation involves: (1) establishing the fund, (2) making payments from the fund, and (3) replenishing the fund

Management of cash is the responsibility of the company

Treasurer

All mail receipts should be opened in the presence of at least ... mail clerks

Two

Occupational fraud

Using your own occupation for personal gain through the misuse or misapplication of the company's resources or assets

Record a voucher in a journal called

Voucher register

Which of the following was not a result of the Sarbanes-Oxley Act? Companies must file financial statements with the Internal Revenue Service. All publicly traded companies must maintain adequate internal controls. The Public Company Accounting Oversight Board was created to establish auditing standards and regulate auditor activity. Corporate executives and boards of directors must ensure that controls are reliable and effective, and they can be fined or imprisoned for failure to do so.

a. Filing financial statements with the IRS is not a result of the Sarbanes-Oxley Act (SOX); SOX focuses on the prevention or detection of fraud.

The control features of a bank account do not include: having bank auditors verify the correctness of the bank balance per books. minimizing the amount of cash that must be kept on hand. providing a double record of all bank transactions. safeguarding cash by using a bank as a depository.

a. Having bank auditors verify the correctness of the bank balance per books is not one of the control features of a bank account.

A check is written to replenish a $100 petty cash fund when the fund contains receipts of $94 and $4 in cash. In recording the check: debit Cash Over and Short for $2. debit Petty Cash for $94. credit Cash for $94. credit Petty Cash for $2.

a. When this check is recorded, the company should debit Cash Over and Short for the shortage of $2 (total of the receipts plus cash in the drawer ($98) versus $100)

Physical controls do not include: safes and vaults to store cash. independent bank reconciliations. locked warehouses for inventories. bank safety deposit boxes for important papers.

b. Independent bank reconciliations are not a physical control.

Which of the following would not be an example of good cash management? Provide discounts to customers to encourage early payment. Invest temporary excess cash in stock of a small company. Carefully monitor payments so that payments are not made early. Employ just-in-time inventory methods to keep inventory low.

b. Investing excess cash to purchase stock in a small company is inappropriate because the stock of small companies is often not easily converted to cash.

Permitting only designated personnel such as cashiers to handle cash receipts is an application of the principle of: segregation of duties. establishment of responsibility. independent internal verification. human resource controls.

b. Permitting only designated personnel to handle cash receipts is an application of the principle of establishment of responsibility

Which statement correctly describes the reporting of cash? Cash cannot be combined with cash equivalents. Restricted cash funds may be combined with cash. Cash is listed first in the current assets section. Restricted cash funds cannot be reported as a current asset.

c. Cash is listed first in the current assets section. The other choices are incorrect because (a) cash and cash equivalents can be appropriately combined when reporting cash on the balance sheet, (b) restricted cash is not to be combined with cash when reporting cash on the balance sheet, and (d) restricted funds can be reported as current assets if they will be used within one year.

In a bank reconciliation, deposits in transit are: deducted from the book balance. added to the book balance. added to the bank balance. deducted from the bank balance.

c. Deposits in transit are added to the bank balance on a bank reconciliation

The principles of internal control do not include: establishment of responsibility. documentation procedures. management responsibility. independent internal verification.

c. Management responsibility is not one of the principles of internal control.

Which of the following is not an element of the fraud triangle? Rationalization. Financial pressure. Segregation of duties. Opportunity.

c. Segregation of duties is not an element of the fraud triangle.

The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: outstanding checks. deposit in transit. a bank error. bank service charges.

d. Because the depositor does not know the amount of the bank service charges until the bank statement is received, an adjusting entry must be made when the statement is received.

Which of the following items in a cash drawer at November 30 is not cash? Money orders. Coins and currency. An NSF check. A customer check dated November 28.

d. Because the depositor does not know the amount of the bank service charges until the bank statement is received, an adjusting entry must be made when the statement is received.

Which of the following is not one of the sections of a cash budget? Cash receipts section. Cash disbursements section. Financing section. Cash from operations section.

d. Cash from operations is not a section of a cash budget.

Which of the following control activities is not relevant when a company uses a computerized (rather than manual) accounting system? Establishment of responsibility. Segregation of duties. Independent internal verification. All of these control activities are relevant to a computerized system.

d. Establishment of responsibility, segregation of duties, and independent internal verification are all relevant to a computerized system.

Internal control is used in a business to: safeguard its assets. enhance the accuracy and reliability of its accounting records. ensure compliance with laws and regulations. All of these answer choices are correct.

d. Safeguarding a company's assets, enhancing the accuracy and reliability of its accounting records, and ensuring compliance with laws and regulations are all aspects of internal control.