ch07-1 cash & reconciliation

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Chapter 7

Fraud, Internal Control, and Cash

Financial Accounting, IFRS EditionWeygandt Kimmel Kieso

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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.

Study ObjectivesStudy Objectives

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FraudFraudInternal controlInternal controlPrinciples of Principles of internal control internal control activitiesactivitiesLimitationsLimitations

Cash Cash equivalentsequivalentsRestricted Restricted cashcashCompensating Compensating balancesbalances

Making Making depositsdepositsWriting checksWriting checksBank Bank statementsstatementsReconciling Reconciling the bank the bank accountaccountElectronic Electronic funds transfer funds transfer (EFT) system(EFT) system

Over-the-Over-the-counter counter receipts receipts Mail receiptsMail receipts

Fraud and Fraud and Internal Internal ControlControl

Cash Receipts Cash Receipts ControlsControls

Control Control Features: Use Features: Use

of a Bankof a BankReporting Reporting

CashCashCash Cash

Disbursement Disbursement ControlsControls

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

Voucher Voucher system system controlscontrolsPetty cash Petty cash fund controlsfund controls

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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 Control

Fraud

SO 1 Define fraud and internal control.SO 1 Define fraud and internal control.

Why does fraud occur?

Illustration 7-1

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Answer on notes page

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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.



Internal Control

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Internal control systems have five primary components

A control environment

Risk assessment

Control activities

Information and communication

Monitoring



Internal Control

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Measures vary withmanagement’s assessment of the risks faced.

size and nature of the company.

SO 2 Identify the principles of internal control activities.SO 2 Identify the principles of internal control activities.

Principles of Internal Control Activities


Six principles of controls activities:

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

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ESTABLISHMENT OF RESPONSIBILITYESTABLISHMENT OF RESPONSIBILITY

Control is most effective when only one person is responsible Control is most effective when only one person is responsible for a given task.for a given task.

SEGREGATON OF DUTIESSEGREGATON OF DUTIES

Related duties, including physical custody and record keeping, Related duties, including physical custody and record keeping, should be assigned to different individuals.should be assigned to different individuals.

DOCUMENTATION PROCEDURESDOCUMENTATION PROCEDURES

Companies should use prenumbered documents and all Companies should use prenumbered documents and all documents should be accounted for.documents should be accounted for.




11 SO 2SO 2


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13 SO 2SO 2


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PHYSICAL CONTROLS Illustration 7-2




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INDEPENDENT INTERNAL VERIFICATION

1. Verify records periodically or on a surprise basis.

2. Verify records by an employee who is independent.

3. Discrepancies reported to management.


Illustration 7-3



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HUMAN RESOURCE CONTROLS

1. Bond employees.

2. Rotate employees’ duties and require vacations.

3. Conduct background checks.




17 SO 2SO 2

Fraud Fraud and and Internal Internal ControlControl

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SO 2SO 2

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SO 2SO 2

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Answer on notes page

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Limitations of Internal Control

Costs should not exceed benefit.

Human element.

Size of the business.



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

Independent Internal Verification

Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily

Establishment of ResponsibilityOnly designated

personnel are authorized to handle cash receipts

(cashiers)

Segregation of DutiesDifferent individuals receive cash, record

cash receipts, and hold the cash

Documentation Procedures

Use remittance advice (mail receipts), cash register tapes, and

deposit slips

Physical ControlsStore 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

Illustration 7-4

Cash Receipts ControlsCash Receipts Controls

Over-the-Counter Receipts

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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

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


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Over-the-Counter Receipts


Illustration 7-5

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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, 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.



Mail Receipts

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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 Question



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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 Disbursement ControlsCash Disbursement Controls

SO 4 Explain the applications of internal control SO 4 Explain the applications of internal control principles to cash disbursements.principles to cash disbursements.

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Independent Internal Verification

Compare checks to invoices; reconcile bank

statement monthly

Establishment of ResponsibilityOnly designated

personnel are authorized to sign checks

(treasurer) and approve vendors

Segregation of DutiesDifferent 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 ControlsStore blank checks in

safes, with limited access; print check

amounts by machine in indelible ink

Illustration 7-6

Human Resource Controls

Bond personnelwho handle cash;require employeesto take vacations;

conduct backgroundchecks


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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 Question



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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.


Voucher System Controls


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Petty Cash Fund - Used to pay small amounts.

Involves:

1. establishing the fund,

2. making payments from the fund, and

3. replenishing the fund.

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

Petty Cash Fund Controls


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


Petty cash 100Mar. 1

Cash 100


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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:


Postage expense 44Mar. 15

Cash 87

Freight-out 38

Miscellaneous expense 5


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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:


Postage expense 44Mar. 15

Cash 88

Freight-out 38

Miscellaneous expense 5

Cash over and short 1


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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 Bank

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

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Making Bank DepositsAuthorized employee should make deposit.


Bank Code Numbers

Front Side Reverse Side

Illustration 7-8


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Writing ChecksWritten order signed by depositor directing bank to pay a specified sum of money to a designated recipient.


Maker

Payee

Illustration 7-9

Payer


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Bank Statements

Debit MemorandumBank service chargeNSF (not sufficient funds)


Illustration 7-10

Credit MemorandumCollect notes receivable.Interest earned.


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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 Question



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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.


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Reconciliation Procedures


+ Deposit in Transit

- Outstanding Checks

+- Bank Errors

+ Notes collected by bank

- NSF (bounced) checks

- Check printing or other service charges

+- Company ErrorsCORRECT BALANCE CORRECT BALANCE

Illustration 7-11


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Illustration: Illustration: The bank statement for Laird Company (Illustration 7-12), 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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Illustration: Illustration: a) Prepare a bank reconciliation at April 30.


Cash balance per bank statement $15,907.45Add: Deposit in transit 2,201.40Less: 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 1,035.00Add: 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


Illustration 7-12

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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:

Cash 1,035.00Apr. 30

Miscellaneous expense 15.00

Notes receivable1,000.00Interest revenue

50.00



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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:

Cash 36.00Apr. 30

Accounts payable36.00



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NSF Check: As indicated earlier, an NSF check becomes an account receivable to the depositor. The entry is:

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 expense 30.00Apr. 30

Cash30.00



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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 Question



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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.



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Reporting 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 7-14

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.

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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 Question

Reporting CashReporting Cash

SO 8 Explain the reporting of cash.SO 8 Explain the reporting of cash.

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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.

Understanding U.S. GAAP

Key DifferencesKey Differences Fraud, Internal Control, and Cash

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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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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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Looking to the FutureLooking to the Future


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 high-quality 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.

Fraud, Internal Control, and Cash

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