Slide

7-1

Chapter

Fraud, Internal
Control, and Cash
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
Slide
7-2

Study
Study Objectives
Objectives

Slide
7-3

1.

Define fraud and internal control.

2.

Identify the principles of internal control activities.

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.

Fraud,
Fraud, Internal
Internal Control,
Control, and
and Cash
Cash

Fraud and
Internal
Control
Fraud
Internal control
Principles of
internal control
activities
Limitations

Slide
7-4

Cash Receipts
Controls

Over-thecounter
receipts
Mail receipts

Cash
Disbursement
Controls
Voucher
system
controls
Petty cash
fund controls

Control
Features: Use
of a Bank
Making
deposits
Writing checks
Bank
statements
Reconciling
the bank
account
Electronic
funds transfer
(EFT) system

Reporting
Cash

Cash
equivalents
Restricted
cash
Compensating
balances

Fraud
Fraud and
and Internal
Internal Control
Control
Fraud
Dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer.

Illustration 7-1

Why does
fraud occur?

Slide
7-5

SO 1 Define fraud and internal control.

Answer on
notes page
Slide
7-6

Fraud
Fraud and
and Internal
Internal Control
Control
Internal Control
Methods and measures adopted to:

Slide
7-7

1.

Safeguard assets.

2.

Enhance accuracy and reliability of accounting records.

3.

Increase efficiency of operations, and

4.

Ensure compliance with laws and regulations.

SO 1 Define fraud and internal control.

Fraud
Fraud and
and Internal
Internal Control
Control
Internal Control
Internal control systems have five primary components
A control environment
Risk assessment
Control activities
Information and communication
Monitoring

Slide
7-8

SO 1 Define fraud and internal control.

Fraud
Fraud and
and Internal
Internal Control
Control
Principles of Internal Control Activities
Measures vary with
managements assessment of the risks faced.
size and nature of the company.
Six principles of controls activities:

Slide
7-9

Establishment of responsibility
Segregation of duties
Documentation procedures
Physical controls
Independent internal verification
Human resource controls
SO 2 Identify the principles of internal control activities.

Fraud
Fraud and
and Internal
Internal Control
Control
Principles of Internal Control Activities
ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible
for a given task.
SEGREGATON OF DUTIES
Related duties, including physical custody and record keeping,
should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents and all
documents should be accounted for.
Slide
7-10

SO 2 Identify the principles of internal control activities.

Fraud
Fraud and
and Internal
Internal Control
Control

Slide
7-11

SO 2

Fraud
Fraud and
and Internal
Internal Control
Control

Slide
7-12

SO 2 Identify the principles of internal control activities.

Fraud
Fraud and
and Internal
Internal Control
Control

Slide
7-13

SO 2

Fraud
Fraud and
and Internal
Internal Control
Control
Principles of Internal Control Activities
PHYSICAL CONTROLS

Slide
7-14

Illustration 7-2

SO 2 Identify the principles of internal control activities.

Fraud
Fraud and
and Internal
Internal Control
Control
Principles of Internal Control Activities
INDEPENDENT INTERNAL
VERIFICATION

Illustration 7-3

1. Verify records periodically

or on a surprise basis.
2. Verify records by an
employee who is
independent.
3. Discrepancies reported

to management.
Slide
7-15

SO 2 Identify the principles of internal control activities.

Fraud
Fraud and
and Internal
Internal Control
Control
Principles of Internal Control Activities
HUMAN RESOURCE CONTROLS

1. Bond employees.
2. Rotate employees duties and
require vacations.
3. Conduct background checks.

Slide
7-16

SO 2 Identify the principles of internal control activities.

Fraud
Fraud
and
and
Internal
Internal
Control
Control

Slide
7-17

SO 2

Fraud
Fraud and
and Internal
Internal Control
Control

Slide
7-18

SO 2

Fraud
Fraud and
and Internal
Internal Control
Control

Slide
7-19

SO 2

Slide
7-20

Answer on
notes page

Fraud
Fraud and
and Internal
Internal Control
Control
Limitations of Internal Control
Costs should not exceed benefit.
Human element.
Size of the business.

Slide
7-21

SO 2 Identify the principles of internal control activities.

Cash
Cash Receipts
Receipts Controls
Controls
Over-the-Counter Receipts

Slide
7-22

Illustration 7-4

Establishment of
Responsibility

Documentation
Procedures

Independent Internal
Verification

Only designated
personnel are authorized
to handle cash receipts
(cashiers)

Use remittance advice

(mail receipts), cash
register tapes, and
deposit slips

Supervisors count cash

receipts daily; treasurer
compares total receipts
to bank deposits daily

Segregation of Duties

Physical Controls

Different individuals
receive cash, record
cash receipts, and hold
the cash

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 daily

SO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Receipts
Receipts Controls
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 assets
Slide
7-23

SO 3 Explain the applications of internal control principles to cash receipts.

Over-theCounter
Receipts

Illustration 7-5

Slide
7-24

SO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Receipts
Receipts Controls
Controls
Mail Receipts
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 cashiers department.
Cashier adds the checks to the over-the-counter receipts,
prepares a daily cash summary and makes the daily bank
deposit.
Copy of list sent to treasurers office for comparison with
total shown on daily cash summary.
Slide
7-25

SO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Receipts
Receipts Controls
Controls
Review Question
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.

Slide
7-26

SO 3 Explain the applications of internal control principles to cash receipts.

Cash
Cash Disbursement
Disbursement Controls
Controls
Generally, internal control over cash disbursements is
more effective when companies pay by check, rather
than by cash.
Applications:
Voucher system
Petty cash fund

Slide
7-27

SO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Disbursement
Disbursement Controls
Controls
Illustration 7-6

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

Slide
7-28

Documentation
Procedures
Use prenumbered
checks; checks must
have an approved
invoice; require
employees to use
corporate credit cards for
reimbursable
expenses
Physical Controls
Store blank checks in
safes, with limited
access; print check
amounts by machine in
indelible ink

Independent Internal
Verification
Compare checks to
invoices; reconcile bank
statement monthly
Human Resource
Controls
Bond personnel
who handle cash;
require employees
to take vacations;
conduct background
checks

Cash
Cash Disbursement
Disbursement Controls
Controls

Review Question
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.

Slide
7-29

SO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Disbursement
Disbursement Controls
Controls
Voucher System Controls
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.

Slide
7-30

SO 4 Explain the applications of internal control

principles to cash disbursements.

Cash
Cash Disbursement
Disbursement Controls
Controls
Petty Cash Fund Controls
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,
2. making payments from the fund, and
3. replenishing the fund.

Slide
7-31

SO 5 Describe the operation of a petty cash fund.

Cash
Cash Disbursement
Disbursement Controls
Controls
Illustration: If Laird Company decides to establish a $100 fund on
March 1, the journal entry is:
Mar. 1

Petty cash
Cash

Slide
7-32

100
100

SO 5 Describe the operation of a petty cash fund.

Cash
Cash Disbursement
Disbursement Controls
Controls
Illustration: Assume that on March 15 Lairds 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:
Mar. 15

Postage expense

44

Freight-out

38

Miscellaneous expense
Cash

Slide
7-33

5
87

SO 5 Describe the operation of a petty cash fund.

Cash
Cash Disbursement
Disbursement Controls
Controls
Illustration: Occasionally, the company may need to recognize a
cash shortage or overage. Assume that Lairds 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:
Mar. 15

Postage expense

44

Freight-out

38

Miscellaneous expense

Cash over and short

Cash
Slide
7-34

88
SO 5 Describe the operation of a petty cash fund.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Contributes to good internal control over cash.
Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.

Slide
7-35

SO 6 Indicate the control features of a bank account.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Making Bank Deposits
Authorized employee should
make deposit.

Front Side
Slide
7-36

Illustration 7-8

Bank Code
Numbers

Reverse Side
SO 6 Indicate the control features of a bank account.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Writing Checks
Written order signed by depositor directing bank to pay a
specified sum of money to a designated recipient.
Illustration 7-9

Maker
Payee
Payer

Slide
7-37

SO 6 Indicate the control features of a bank account.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Illustration 7-10

Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)

Credit Memorandum
Collect notes
receivable.
Interest earned.

Slide
7-38

SO 6 Indicate the control features of a bank account.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank

Review Question
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.

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7-39

SO 6 Indicate the control features of a bank account.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Reconciling the Bank Account
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.
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7-40

SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Reconciliation Procedures

Illustration 7-11

+ Deposit in Transit

+ Notes collected by bank

NSF (bounced) checks

Check printing or other

service charges

Outstanding Checks

+- Bank Errors

+- Company Errors
CORRECT BALANCE
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7-41

CORRECT BALANCE
SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Illustration: The bank statement for Laird Company (Illustration 712), shows a balance per bank of $15,907.45 on April 30, 2011. On
this date the balance of cash per books is $11,589.45. Using the four
reconciliation steps, Laird determines the following reconciling items.

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7-42

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Illustration: a) Prepare a bank reconciliation at April 30.
Cash balance per bank statement
Add:

$15,907.45

Deposit in transit

2,201.40

Less:
Outstanding checks
Adjusted cash balance per bank

(5,904.00)
$12,204.85

Cash balance per books

$11,589.45

Add:

Error in recording check no. 443

Collection of notes + interest - fee

Less:

NSF check
Bank service charge

Adjusted cash balance per books

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7-43

Illustration 7-12

36.00
1,035.00
(425.60)
(30.00)
$12,204.85

SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
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:
Apr. 30

Cash
Miscellaneous expense

Slide
7-44

1,035.00
15.00

Notes receivable

1,000.00

Interest revenue

50.00

SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
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:
Apr. 30

Cash
Accounts payable

Slide
7-45

36.00
36.00

SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
NSF Check: As indicated earlier, an NSF check becomes an
account receivable to the depositor. The entry is:
Apr. 30

Accounts receivable

425.60

Cash

425.60

Bank Service Charges: Depositors debit check printing

charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:
Apr. 30

Miscellaneous expense
Cash

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7-46

30.00
30.00
SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank

Review Question
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.

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7-47

SO 7 Prepare a bank reconciliation.

Control
Control Features:
Features: Use
Use of
of aa Bank
Bank
Electronic Funds Transfers (EFT) System
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.

Slide
7-48

SO 7 Prepare a bank reconciliation.

Reporting
Reporting Cash
Cash
Cash consists of coins, currency (paper money), checks,
money orders, and money on hand or on deposit in a bank
or similar depository.
Illustration 7-14

Cash equivalents
Restricted cash
Compensating balances
Slide
7-49

SO 8 Explain the reporting of cash.

While cash equivalents are now frequently

reported with cash, it appears likely that the
IASB will end this practice in the future.
Instead, items now referred to as cash
equivalents will be reported as short-term
investments.

Reporting
Reporting Cash
Cash

Review Question
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.

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7-50

SO 8 Explain the reporting of cash.

Q. The following information pertains to Teresina Video Company.

1.Cash balance per bank, July 31, R$7,293.
2.July bank service charge not recorded by the depositor R$28.
3.Cash balance per books, July 31, R$7,384.
4.Deposits in transit, July 31, R$1,500.
5.Bank collected R$800 note for Teresina in July, plus interest R$36, less
fee R$20. The collection has not been recorded by Teresina, and no interest
has been accrued.
6.Outstanding checks, July 31, R$621.
Instructions
(a)Prepare a bank reconciliation at July 31.
(b)Journalize the adjusting entries at July 31 on the books of Teresina Video
Company.

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7-51

Q. The information below relates to the Cash account in the ledger of Wasson
Company.
Balance September 1 - $17,150;
Cash Deposited - $64,000
Balance September 30 - $17,404; Checks written - $63,746
The September bank statement shows a balance of $16,122 on September 30 and the
following memoranda.
Credit
Collection of $1,500 note plus
interest $30
Interest earned on checking
account

Debit
$1,530
$45

NSF check: Violet Jones

Safety deposit box rent

$725
$65

At September 30, deposits in transit were $4,450, and outstanding checks totaled
$2,383.
Instructions
(a)Prepare the bank reconciliation at September 30.
(b)Prepare the adjusting entries at September 30, assuming (1) the NSF check was
from a customer on account, and (2) no interest had been accrued on the note.

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7-52

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Fraud, Internal Control,

and Cash

The fraud triangle discussed in this chapter is applicable to U.S.

companies as well. Some of the most infamous U.S. fraud scandals
are Enron, Worldcom, and, more recently, the Bernie Madoff ponzi
scheme.
After numerous corporate scandals, the U.S. Congress passed the
Sarbanes-Oxley Act of 2002 (SOX). Under SOX, all publicly traded
U.S. corporations are required to maintain an adequate system of
internal control.
As a result of SOX, corporate executives and boards of directors
must ensure that internal controls are reliable and effective. In
addition, independent outside auditors must attest to the adequacy
of the internal control system.
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7-53

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Fraud, Internal Control,

and Cash

SOX created the Public Company Oversight Board (PCAOB), to

establish auditing standards and regulate auditor activity.
One study estimates the cost of compliance for U.S. companies at
over $35 billion, with audit fees doubling in the first year of
compliance. At the same time, examination of internal controls
indicates lingering problems in the way companies operate. One
study of first compliance with the internal-control testing
provisions documented material weaknesses for about 13% of
companies reporting in 2004 and 2005 (PricewaterhouseCoopers
Global Economic Crime Survey, 2005).

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7-54

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Fraud, Internal Control,

and Cash

The enhanced internal control standards apply only to large public

companies listed on U.S. exchanges. There is continuing debate
over whether foreign issuers should have to comply with this extra
layer of regulation.
Most companies report cash and cash equivalents together under
IFRS and GAAP, as shown in this textbook. In addition, GAAP
follows the same accounting policies related to the reporting of
restricted cash.

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7-55

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Looking to the Future

Fraud, Internal Control,

and Cash

High-quality international accounting requires both high-quality

accounting standards and high-quality auditing. Similar to the
convergence of GAAP and IFRS, there is a movement to improve
both U.S. and international auditing standards.The International
Auditing and Assurance Standards Board (IAASB) functions as an
independent standard-setting body. It works to establish highquality auditing and assurance and quality-control standards
throughout the world. Whether the IAASB adopts internal control
provisions similar to those in SOX remains to be seen. Also, under
proposed new standards being developed jointly by the FASB and
IASB for financial statement presentation, cash equivalents cannot
be combined with cash.
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7-56

Copyright
Copyright
Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
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Request for further information should be addressed to the
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programs or from the use of the information contained herein.

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