Chapter 5: Fraud, Internal Control, and Cash

internal accounting report

an _____________________ is prepared to compare the company's cash records with the bank's

Fraud

an attempt to deceive others for personal gain

bank reconciliation

an internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual -provides independent verification of all cash transactions that the bank has processed for the company -done monthly

establish responsibility

assign each task to only one employee; ex) give a separate cash register drawer to each cashier at the beginning of a shift

information and communication

communicates information about activities effecting the organization to support sound decision making

independently verifying

company accountants can use the statement of account prepared by the bank to double-check the accuracy of the cash records

5 control components

control environment, risk assessment, control activities, information and communication, and monitoring activities

3 Categories of employee fraud

corruption, asset misappropriation, financial statement fraud

requirements introduced by SOX:

counteract incentives, reduce opportunities, encourage honesty

restrict access

do not provide access to assets or information unless it is needed to fulfill assigned responsibilities ex) use passwords and firewalls. restrict access to cash

incentive

employee has reason for committing fraud. ex) personal financial pressure

rationalization

employee perceives the misdeed as unavoidable or justified

sox requires all public companies to:

establish an audit committee of independent directors; evaluate and report the effectiveness of internal control over financial reporting

5 key principles of internal control

establish responsibility, segregation of duties, restrict access, document procedures, independently verify

monitoring activities

evaluated often to determine if working as intended

2 ways businesses can receive cash:

in person at time of sale or on account

3 components of fraud triangle

incentive, opportunity, rationalization

control activities

include various work responsibilities and duties completed by employees to reduce risks to an acceptable level

reduce opportunities

internal control evaluation, independent audit committee

financial statement fraud

involves misrepresenting amounts in the financial statements, usually to portray more favorable financial results than what actual exist

corruption

involves misusing one's position for inappropriate personal gain

restricting access

keep limited amount of cash on hand to prevent stolen or misplaced cash

document procedures

prepare documents to show activities that have occurred; ex) pay suppliers using prenumbered checks

cash equivalents

short term, highly liquid investments purchased within 3 months of maturity

imprest system

-a process that is controls the amount paid to others by limiting the total amount of money available for making payments to others -reduces risk of under/over payment -it is correct if net balance at the end is equal to zero

to prepare bank reconciliation

1. identify the deposits in transit 2. identify outstanding checks 3. record other transactions on the bank statement and correct your errors a. interest received b. EFT c. NSF check d. service charges e. Your company errors

2 reasons you can never completely prevent or detect fraud

1. organization will implement internal controls only to the extent that their benefits exceed their cost 2. internal controls can fail as a result of human error or fraud

Cash received in person: Cashier

1. scans items sold 2. collects customer payment 3. prepares cash count sheet

most cash payments involve:

1. writing a check or completing EFT to supplier 2. paying employees via EFT 3. a petty cash system (only in rare cases)

Cash received in person: supervisor

4. compares cash in register with cash count sheet 5. stores cash in vault box 6. completes bank deposit

Cash received in person: accounting department

7. compares cash register records with cash count sheet and bank deposit slip 8. prepares journal entry

eliminates

EFT _____________ for some internal controls

debit, credit

EFT--> ______ cash and __________ accounts receivable for each customer

voucher system:

a process for approving and documenting all purchases and payments on account

Petty Cash System

a set of policies, procedures, controls, and forms that a company uses to dispense cash for various miscellaneous needs, such as office supplies and services

The Sarbanes-Oxley Act (SOX)

a set of regulations passed by congress in 2002 in an attempt to improve financial reporting and restore investor confidence

petty cash funds

a system used to reimburse employees for expenditures on behalf of the organization

internal control

actions taken to promote efficient and effective operations, protect assets, enhance accounting information, and adhere to laws and regulations

banks point of view

bank statement is presented from ______________

documenting procedures

by processing payments, banks facilitate and document business transactions

cleared the bank

check has ___________ when one bank contacts another and the withdrawal and transfer is complete

independently verify

check others work; ex) compare the cash balance in the companies accounting records to the cash balance reported by the bank and accounting for any differences.

segregate duties

designed into the accounting system to prevent an employee from making a mistake or committing a dishonest act as part of one assigned duty and then also covering it up through another assigned duty; ex) inventory suppliers do not also approve payments to suppliers

risk assessment

managers should continuously assess the potential for fraud

restricted cash

not available for general use but rather restricted for a specific purpose

control environment

refers to the attitude that people in the organization hold regarding internal control

3 controls from bank procedures

restricting access, documenting procedures, independently verifying

loan covenant

terms of a loan agreement that if broken, entitle the lender to renegotiate loan terms or force repayment

asset misappropriation

theft (embezzlement); cash is usually the target, but other assets can be misappropriated

counteract incentives

those who willfully misrepresent financial results face stiff penalties (fines) ad prison terms

the primary goal for cash receipts

to endure that the business receives the appropriate amount of cash and safely deposits it in the bank

the primary goal of internal controls for all cash payments

to ensure that the business pays only for properly authorized transactions

opportunity

usually steam from weak external controls

electronic funds transfer (EFT)

when customer electronically transfers funds from his or her bank account to the company's bank account

direct deposit

when employees are paid salaries and wages through EFT