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Chapter 8-1
Chapter 8-2
Chapter 8
Fraud, Internal
Control, and Cash
Accounting Principles, Ninth Edition
Chapter 8-3
1. Define fraud and internal control.
2. Identify the principles of internal control.
3. Explain the applications of internal control principles to cash receipts.
4. Explain the applications of internal control principles to cash disbursements.
5. Describe the operation of a petty cash fund.
6. Indicate the control features of a bank account.
7. Prepare a bank reconciliation.
8. Explain the reporting of cash.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives
Chapter 8-4
FraudFraud
The Sarbanes-The Sarbanes-Oxley ActOxley Act
Internal controlInternal control
Principles of Principles of internal controlinternal control
LimitationsLimitations
Cash equivalentsCash equivalents
Restricted cashRestricted cash
Compensating Compensating balancesbalances
Making depositsMaking deposits
Writing checksWriting checks
Bank statementsBank statements
Reconciling the Reconciling the bank accountbank account
Electronic funds Electronic funds transfer (EFT) transfer (EFT) systemsystem
Cash receipts Cash receipts controlscontrols
Cash Cash disbursements disbursements controlscontrols
Fraud and Fraud and Internal ControlInternal Control
Fraud and Fraud and Internal ControlInternal Control Cash ControlsCash ControlsCash ControlsCash Controls
Control Control Features: Use of Features: Use of
a Banka Bank
Control Control Features: Use of Features: Use of
a Banka BankReporting CashReporting CashReporting CashReporting Cash
Fraud, Internal Control, and CashFraud, Internal Control, and CashFraud, Internal Control, and CashFraud, Internal Control, and Cash
Chapter 8-5
Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
FraudFraud
SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.
Why does fraud occur?
Illustration 8-1
Chapter 8-6
Chapter 8-7
Companies must
develop principles of control over financial reporting.
continually verify that controls are working.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
The Sarbanes-Oxley ActThe Sarbanes-Oxley Act
Independent auditors must attest to the adequacy
of internal control.
SOX created the Public Company Accounting Oversight Board (PCAOB).
SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.
Chapter 8-8
Methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting records.
3. Increase efficiency of operations, and
4. Ensure compliance with laws and regulations.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.
Under the Sarbanes-Oxley Act, all publicly traded U.S. corporations are required to maintain an adequate system of
internal control.
Internal ControlInternal Control
Chapter 8-9
Internal control systems have five primary components
1. A control environment
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.
Internal ControlInternal Control
Chapter 8-10
Measures vary with
management’s assessment of the risks faced.
size and nature of the company.
SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
Principles of Internal Control Principles of Internal Control ActivitiesActivities
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Six principles of controls activities:
Establishment of responsibility Segregation of duties Documentation procedures Physical controls Independent internal verification Human resource controls
Chapter 8-11 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
ESTABLISHMENT OF RESPONSIBILITYESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is Control is most effective when only one person is responsible for a given task.responsible for a given task.
SEGREGATON OF DUTIESSEGREGATON OF DUTIES
Related duties, including physical custody and record Related duties, including physical custody and record keeping, should be assigned to different individuals.keeping, should be assigned to different individuals.
DOCUMENTATION PROCEDURESDOCUMENTATION PROCEDURES
Companies should use prenumbered documents for all Companies should use prenumbered documents for all documents should be accounted for.documents should be accounted for.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Principles of Internal Control Principles of Internal Control ActivitiesActivities
Chapter 8-12 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
PHYSICAL CONTROLS Illustration 8-2
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Principles of Internal Control Principles of Internal Control ActivitiesActivities
Chapter 8-13 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
INDEPENDENT INTERNAL VERIFICATION
1. Verify records periodically or on a surprise basis.
2. Records verified by an employee who is independent.
3. Discrepancies reported to management.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Illustration 8-3
Principles of Internal Control Principles of Internal Control ActivitiesActivities
Chapter 8-14 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
HUMAN RESOURCE CONTROLS
1. Bond employees.
2. Rotate employees’ duties and require vacations.
3. Conduct background checks.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Principles of Internal Control Principles of Internal Control ActivitiesActivities
Chapter 8-15
Chapter 8-16 SO 2 Identify the principles of internal control.SO 2 Identify the principles of internal control.
Limitations of Internal ControlLimitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.
Fraud and Internal ControlFraud and Internal ControlFraud and Internal ControlFraud and Internal Control
Chapter 8-17
Cash Receipts ControlsCash Receipts Controls
SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.receipts.
Independent Internal
Verification
Supervisors count cash receipts daily; treasurer compares
total receipts to bank deposits daily
Establishment of Responsibility
Only designated personnel are
authorized to handle cash receipts
(cashiers)
Segregation of Duties
Different individuals receive cash, record cash receipts, and
hold the cash
Documentation Procedures
Use remittance advice (mail
receipts), cash register tapes, and
deposit slips
Physical, Mechanical, and
Electronic Controls
Store cash in safes and bank vaults; limit access to
storage areas; use cash registers
Human Resource Controls
Bond personnel who handle cash; require employees to take
vacations; deposit all cash in bank dailyIllustration 8-4
Cash ControlsCash ControlsCash ControlsCash Controls
Chapter 8-18
Q8-6. At the corner grocery store, all sales clerks make change out of one cash register drawer. Is this a violation of internal control? Why?
See notes page for discussion
Discussion QuestionDiscussion Question
SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.receipts.
Cash ControlsCash ControlsCash ControlsCash Controls
Chapter 8-19
Q8-11. The management of Sewell Company asks you, as the company accountant, to explain (a) the concept of reasonable assurance in internal control and (b) the importance of the human factor in internal control.
See notes page for discussion
Discussion QuestionDiscussion Question
Cash ControlsCash ControlsCash ControlsCash Controls
SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.receipts.
Chapter 8-20
Cash ControlsCash ControlsCash ControlsCash Controls
Cash consists of coins, currency, checks, money orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assetsSO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash
receipts.receipts.
Chapter 8-21
Over-the-Over-the-Counter Counter ReceiptsReceipts
Over-the-Over-the-Counter Counter ReceiptsReceipts
SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.receipts.
Illustration 8-4
Chapter 8-22
Mail ReceiptsMail ReceiptsMail ReceiptsMail Receipts
Control Procedures:
Mail receipts should be opened by two people, a list prepared, and each check endorsed.
Copy of the list, along with the checks and remittance advices, sent to cashier’s department.
Cashier adds the checks to the over-the-counter receipts and prepares a daily cash summary and makes the daily bank deposit.
Copy of list sent to treasurer’s office for comparison with total shown on daily cash summary.SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash
receipts.receipts.
Chapter 8-23
Permitting only designated personnel to handle cash receipts is an application of the principle of:
a. segregation of duties.
b. establishment of responsibility.
c. independent check.
d. Human resource controls.
Review QuestionReview Question
Cash ControlsCash ControlsCash ControlsCash Controls
SO 3 Explain the applications of internal control principles to cash SO 3 Explain the applications of internal control principles to cash receipts.receipts.
Chapter 8-24
Generally, internal control over cash disbursements is more effective when companies pay by check, rather than by cash.
Applications:
Voucher system
Petty cash fund
Cash ControlsCash ControlsCash ControlsCash Controls
SO 4 Explain the applications of internal SO 4 Explain the applications of internal control principles to cash control principles to cash disbursements.disbursements.
Cash Disbursements ControlsCash Disbursements Controls
Chapter 8-25
Cash ControlsCash ControlsCash ControlsCash Controls
Independent Internal
Verification
Compare checks to invoices; reconcile
bank statement monthly
Establishment of Responsibility
Only designated personnel are
authorized to sign checks (treasurer)
and approve vendors
Segregation of Duties
Different individuals approve and make payments; check
signers do not record disbursements
Documentation Procedures
Use prenumbered checks; checks must
have an approved invoice; require
employees to use corporate credit cards
for reimbursableexpenses
Physical Controls
Store blank checks in safes, with limited access; print check
amounts by machine in indelible ink
Illustration 8-6Cash Disbursements ControlsCash Disbursements Controls
Human Resource Controls
Bond personnelwho handle cash;require employeesto take vacations;
conduct backgroundchecks
Chapter 8-26
Q8-17 Joe Griswold Company’s internal controls over cash disbursements provide for the treasurer to sign checks imprinted by a checkwriting machine in indelible ink after comparing the check with the approved invoice. Identify the internal control principles that are present in these controls.
See notes page for discussion
Discussion QuestionDiscussion Question
Cash ControlsCash ControlsCash ControlsCash Controls
SO 4 Explain the applications of internal SO 4 Explain the applications of internal control principles to cash control principles to cash disbursements.disbursements.
Chapter 8-27
The use of prenumbered checks in disbursing cash is an application of the principle of:
a. establishment of responsibility.
b. segregation of duties.
c. physical, mechanical, and electronic controls.
d. documentation procedures.
Review QuestionReview Question
Cash ControlsCash ControlsCash ControlsCash Controls
SO 4 Explain the applications of internal SO 4 Explain the applications of internal control principles to cash control principles to cash disbursements.disbursements.
Chapter 8-28
Voucher System
Network of approvals, by authorized individuals, to ensure all disbursements by check are proper.
A voucher is an authorization form prepared for each expenditure.
Cash ControlsCash ControlsCash ControlsCash Controls
SO 4 Explain the applications of internal SO 4 Explain the applications of internal control principles to cash control principles to cash disbursements.disbursements.
Cash Disbursements ControlsCash Disbursements Controls
Chapter 8-29
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,
2. making payments from the fund, and
3. replenishing the fund.
Cash ControlsCash ControlsCash ControlsCash Controls
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Cash Disbursements ControlsCash Disbursements Controls
Chapter 8-30
Illustration: If Laird Company decides to establish a $100 fund on March 1, the journal entry is:
Cash ControlsCash ControlsCash ControlsCash Controls
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Petty cash 100Mar. 1
Cash 100
Chapter 8-31
Illustration: Assume that on March 15 Laird’s petty cash custodian requests a check for $87. The fund contains $13 cash and petty cash receipts for postage $44, freight-out $38, and miscellaneous expenses $5. The general journal entry to record the check is:
Cash ControlsCash ControlsCash ControlsCash Controls
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Postage expense 44Mar. 15
Cash 87
Freight-out 38
Miscellaneous expense 5
Chapter 8-32
Illustration: Occasionally, the company may need to recognize a cash shortage or overage. Assume that Laird’s petty cash custodian has only $12 in cash in the fund plus the receipts as listed. The request for reimbursement would, therefore, be for $88, and Laird would make the following entry:
Cash ControlsCash ControlsCash ControlsCash Controls
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Postage expense 44Mar. 15
Cash 88
Freight-out 38
Miscellaneous expense 5
Cash over and short 1
Chapter 8-33
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.
Chapter 8-34
Making Bank DepositsAuthorized employee should make deposit.
SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.
Bank Code
Numbers
Front Side Reverse Side
Illustration 8-8
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-35
Writing ChecksWritten order signed by depositor directing bank to pay a specified sum of money to a designated recipient.
SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.
Maker
Payee
Illustration 8-9
Payer
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-36
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient funds)
SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.
Illustration 8-10
Credit Memorandum
Collect notes receivable.
Interest earned.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-37
The control features of a bank account do not include:
a. having bank auditors verify the correctness of the bank balance per books.
b. minimizing the amount of cash that must be kept on hand.
c. providing a double record of all bank transactions.
d. safeguarding cash by using a bank as a depository.
Review QuestionReview Question
SO 6 Indicate the control features of a bank account.SO 6 Indicate the control features of a bank account.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-38
Reconciling the Bank Account
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
Reconcile balance per books and balance per bank to their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Errors.
4. Bank memoranda.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-39
Reconciliation Procedures
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
+ Deposit in Transit
- Outstanding Checks
+- Bank Errors
+ Notes collected by bank
- NSF (bounced) checks
- Check printing or other service charges
+- Company Errors
CORRECT BALANCE CORRECT BALANCE
Illustration 8-11
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-40
Illustration: Illustration: The bank statement for Laird Company (Illustration 8-10), shows a balance per bank of $15,907.45 on April 30, 2010. On this date the balance of cash per books is $11,589.45. Using the four reconciliation steps, Laird determines the following reconciling items.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-41
Illustration: Illustration: a) Prepare a bank reconciliation at April 30.
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
Cash balance per bank statement $15,907.45
Add: Deposit in transit 2,201.40
Less: Outstanding checks (5,904.00)
Adjusted cash balance per bank $12,204.85
Cash balance per books $11,589.45
Collection of notes + interest - fee 1,035.00
Add: Error in recording check no. 443 36.00
Less: NSF check (425.60)
Bank service charge (30.00)
Adjusted cash balance per books $12,204.85
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Illustration 8-12
Chapter 8-42
The company records each reconciling item used to determine the adjusted cash balance per books.
Collection of Note Receivable: Assuming interest of $50 has not been accrued and collection fee is charged to Miscellaneous Expense, the entry is:
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Cash 1,035.00Apr. 30
Miscellaneous expense 15.00
Notes receivable1,000.00Interest revenue
50.00
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-43
Book Error: The cash disbursements journal shows that check no. 443 was a payment on account to Andrea Company, a supplier. The correcting entry is:
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Cash 36.00Apr. 30
Accounts payable36.00
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-44
NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is:
SO 5 Describe the operation of a petty cash fund.SO 5 Describe the operation of a petty cash fund.
Accounts receivable 425.60Apr. 30
Cash425.60
Bank Service Charges: Depositors debit check printing charges (DM) and other bank service charges (SC) to Miscellaneous Expense. The entry is:
Miscellaneous 30.00Apr. 30
Cash30.00
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-45
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
Review QuestionReview Question
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-46
Electronic Funds Transfers (EFT)
Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations.
EFT transfers normally result in better internal control since no cash or checks are handled by company employees.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
Chapter 8-47
Q8-23. Lori Figgs is confused about the lack of agreement between the cash balance per books and the balance per the bank. Explain the causes for the lack of agreement to Lori, and give an example of each cause.
See notes page for discussion
Discussion QuestionDiscussion Question
SO 7 Prepare a bank reconciliation.SO 7 Prepare a bank reconciliation.
Control Features: Use of a BankControl Features: Use of a BankControl Features: Use of a BankControl Features: Use of a Bank
Chapter 8-48
Reporting CashReporting CashReporting CashReporting Cash
SO 8 Explain the reporting of cash.SO 8 Explain the reporting of cash.
Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository.
Cash equivalents
Restricted cash
Compensating balances
Illustration 8-14
Chapter 8-49
Which of the following statements correctly describes the reporting of cash?
a. Cash cannot be combined with cash equivalents.
b. Restricted cash funds may be combined with Cash.
c. Cash is listed first in the current assets section.
d. Restricted cash funds cannot be reported as a current asset.
Review QuestionReview Question
Reporting CashReporting CashReporting CashReporting Cash
SO 8 Explain the reporting of cash.SO 8 Explain the reporting of cash.
Chapter 8-50
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