1585085315.pptx fraud, internal control and cash

Accounting Principles
Thirteenth Edition
Weygandt Kimmel Kieso
Chapter 8
Fraud, Internal Control,
and Cash

2
Chapter Outline
Learning Objectives
LO 1 Define fraud and the principles of internal control.
LO 2 Apply internal control principles to cash.
LO 3 Identify the control features of a bank account.
LO 4 Explain the reporting of cash.
Copyright ©2018 John Wiley & Son, Inc.

3
Dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer.
LO 1
Fraud
Three factors that
contribute to
fraudulent activity.
Opportunity
Financial Pressure Rationalization
ILLUSTRATION 8.1
Fraud triangle

4
• Applies to publicly traded U.S. corporations
• Required to maintain a system of internal control
• Corporate executives and boards of directors must
ensure that these controls are reliable and effective
• Independent outside auditors must attest to the
adequacy of the internal control system
• SOX created the Public Company Accounting
Oversight Board (PCAOB)
LO 1
The Sarbanes-Oxley Act

5
Purposes of internal control:
1. Safeguard assets.
2. Enhance the reliability of accounting records.
3. Increase efficiency of operations.
4. Ensure compliance with laws and regulations.
LO 1
Internal Control

6
Five Primary Components:
• A control environment
• Risk assessment
• Control activities
• Information and communication
• Monitoring
LO 1
Internal Control

7
Establishment of Responsibility
• Control is most effective when only
one person is responsible for a given
task
• Establishing responsibility often
requires limiting access only to
authorized personnel, and then
identifying those personnel
LO 1
Principles of Internal Control Activities

8
Segregation of Duties
• Different individuals should be
responsible for related activities
• Responsibility for record-keeping
for an asset should be separate
from physical custody of that asset
LO 1

9
Documentation Procedures
• Companies should use
prenumbered documents, and all
documents should be accounted
for
• Employees should promptly
forward source documents for
accounting entries to the
accounting department
LO 1

10
Physical Controls
• Safes, vaults, and safety deposit boxes
• Locked warehouses and storage cabinets
• Computer facilities with passkey access or fingerprint
or eyeball scans
• Alarms to prevent break-ins
• Television monitors and garment sensors
• Time clocks for recording time worked
LO 1

11
LO 1
Independent Internal Verification
• Records periodically verified by an employee
who is independent
• Discrepancies
reported to
management
ILLUSTRATION 8.3
Comparison of segregation of duties
principle with independent internal
verification principle

12
LO 1
Total take: $275,000
The Missing Control
Independent internal verification. Bobbi Jean’s boss should have verified her
expense reports. When asked what he thought her expenses for a year were,
the boss said about $10,000. At $115,000 per year, her actual expenses were
more than 10 times what would have been expected. However, because he
was “too busy” to verify her expense reports or to review the budget, he
never noticed.

13
LO 1
Human Resource Controls
• Bond employees who
handle cash
• Rotate employees’ duties
and require vacations
• Conduct background checks

14
LO 1
Limitations of Internal Control
• Costs should not exceed benefit
• Human element
• Size of the business
Helpful Hint
Controls may vary with the risk level of the activity. 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.

15
Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
1. The person with primary responsibility for reconciling the bank
account and making all bank deposits is also the company’s
accountant.
Solution
Violates the control activity of segregation of duties
Recordkeeping should be separate from physical custody
Employee could embezzle cash and make journal entries to hide
the theft
LO 1
DO IT! 1 Control Activities

16
Identify which control activity is and explain how the situation
creates an opportunity for a fraud.
2. Wellstone Company’s treasurer received an award for
distinguished service because he had not taken a vacation in 30
years.
Solution
Violates the control activity of human resource controls
Key employees must take vacations
Treasurer, who manages the company’s cash, might embezzle
cash and use his position to conceal the theft
LO 1

17
Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
3. A local restaurant does not buy prenumbered order slips.
Solution
Violates the control activity of documentation procedures
If prenumbered documents are not used, then it is virtually
impossible to account for the documents
An employee could write up a dinner sale, receive cash from the
customer, and then throw away the order slip and keep the
cash.
LO 1

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LO 2
Cash Controls
Cash Receipts Controls
• Establishment of Responsibility:
 Only designated personnel are authorized to handle
cash receipts
• Segregation of Duties: Different individuals
 Receive cash
 Record cash receipts
 Hold cash

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LO 2
Cash Controls
• Documentation Procedures: Use
 Remittance advice (mail receipts)
 Cash register tapes or computer records
 Deposit slips
• Physical Controls
 Store cash in safes and bank vaults
 Limit access to storage areas
 Use cash registers or point-of-sale terminals

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LO 2
Cash Controls
• Independent Internal Verification
 Supervisors count cash receipts daily
 Assistant treasurer compares total receipts to
bank deposits daily
• Human Resource Controls
 Bond personnel who handle cash
 Require employees to take vacations
 Conduct background checks

21
LO 2
Over-the-Counter Receipts
Clerk
Enters sales,
counts cash
Supervisor
Removes locked
cash register tape
Sends cash and
count to cashier
Sends cash register tape
to accounting dept.
Cashier
Counts cash,
prepares deposit slips
Sends deposit
slip copy to
accounting dept.
Accounting Department
Agrees register tape to
deposit slip and
records journal entry
Delivers cash and
deposit slip to bank
Bank
ILLUSTRATION 8.5
Control of over-the-counter
receipts

22
Mail Receipts
• Mail receipts should be opened by two clerks, a list
prepared, each check endorsed “For Deposit Only”
• Each clerk signs the list to establish responsibility
• Original copy of list, along with checks, is sent to
cashier’s department
• Copy of list is sent to accounting department for
recording. Clerks also keep a copy.
LO 2

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 internal verification
d. human resource controls
LO 2

24
Generally, internal control over cash disbursements is
more effective when companies pay by check or
electronic funds transfer (EFT) rather than by cash.
One exception is payments for incidental amounts that
are paid out of petty cash.
LO 2
Cash Disbursement Controls

25
LO 2
Cash Controls
Cash Disbursements Controls
• 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

26
LO 2
Cash Controls
• Documentation Procedures
 Use prenumbered checks and account for
sequence
 Each check must have an approved invoice
 Require employees to use corporate credit cards
for reimbursable expenses
 Stamp invoices “paid”

27
LO 2
Cash Controls
• 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

28
LO 2
Cash Controls
• Human Resource Controls:
 Bond personnel who handle cash
 Require employees to take vacations
 Conduct background checks

29
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 controls
d. documentation procedures
LO 2

30
LO 2
Cash Disbursement Controls
Voucher System Controls
• A network of approvals by authorized individuals,
acting independently, to ensure all disbursements by
check are proper
• A voucher is an authorization form prepared for each
expenditure in a voucher system

31
LO 2
Petty Cash Fund
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund
2. making payments from the fund
3. replenishing the fund

32
LO 2
Petty Cash Fund
Establishing the Petty Cash Fund
Illustration: If Laird Company decides to establish a $100 fund
on March 1, the general journal entry is:
Mar. 1 Petty Cash 100
Cash 100

33
LO 2
Petty Cash Fund
Replenishing the Petty Cash Fund
Illustration: 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 journal entry is:
Mar. 15 Postage Expense 44
Freight-Out 38
Miscellaneous Expense 5
Cash 87

34
LO 2
Petty Cash Fund
Replenishing the Petty Cash Fund
Illustration: Assume in the preceding example that the
custodian had 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 5
Cash Over and Short1
Cash 88

35
LO 2
DO IT! 2b Petty Cash Fund
Bateer Company established a $50 petty cash fund on July 1. On
July 30, the fund had $12 cash remaining and petty cash receipts
for postage $14, office supplies $10, and delivery expense $15.
Prepare journal entries on July 1 and on July 30.
July 1 Petty Cash 50
Cash 50
July 30 Postage Expense 14
Supplies 10
Delivery Expense 15
Cash Over and Short 1
Cash 38

36
The use of a bank contributes significantly to good
internal control over cash.
• Minimizes the amount of currency on hand
• Creates a double record of bank transactions
• Bank reconciliation
LO 3
Control Features of a Bank Account

37
Authorized
employee should
make deposit.
LO 3
Making Bank Deposits
ILLUSTRATION 8.8

38
LO 3
Written order signed by depositor directing bank to pay a
specified sum of money to a designated recipient.
Writing Checks
Maker
Payee
Payer
ILLUSTRATION 8.9
Check with remittance advice

39
• Disbursement systems that use wire, telephone, or
computers to transfer cash from one location to
another
• Use is quite common
• EFT transactions normally result in better internal
control since no cash or checks are handled by
company employees
LO 3
Electronic Funds Transfer (EFT) System

40
• Prepared from bank’s perspective
• Every deposit bank receives is an increase in bank’s
liabilities (an account payable to the depositor)
• Lists in numerical sequence all paid checks along with
date check was paid and its amount
• Bank includes with bank statement memoranda
explaining other debits and credits it made to
depositor’s account
• 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)
LO 3
Bank Statements

41
LO 3
Bank
Statements
ILLUSTRATION 8.10
Bank statement

42
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
LO 3

43
Reconcile balance per books and balance per bank
to their “correct” or “true” balance.
Reconciling Items:
1. Deposits in transit
2. Outstanding checks
3. Bank memorandum
4. Errors
LO 3
Reconciling the Bank Account
Time Lags

44
Reconciliation Procedure
LO 3
Cash Balance Per Bank Cash Balance Per Books
+ Deposits in transit + EFT collections and
other deposits
- Outstanding checks
+/- Bank errors - NSF (bounced)
checks
- Service charges and
other Payments
+/- Company errors
Corrected Balance Corrected Balance

45
LO 3
Bank Reconciliation Illustrated
Illustration 8.10 presented the bank statement for Laird Company
which the company accessed online. It shows a balance per bank of
$15,907.45 on April 30, 2020. On this date the balance of cash per
books is $11,709.45. From the foregoing steps, Laird determines the
following reconciling items for the bank.
Step 1. Deposits in transit (+): April 30 deposit
(received by bank on May 1). $2,201.40
Step 2. Outstanding checks (−): No. 453, $3,000.00;
No. 457, $1,401.30; No. 460, $1,502.70. 5,904.00
Step 3. Bank errors (+/−): None.
Reconciling items per books are as follows:

46
LO 3
Reconciling items per books are as follows:
Step 1. Other deposits (+): Unrecorded electronic
receipt from customer on account on April 9
determined from the bank statement. $1,035.00
Step 2. Other payments (−): The electronic payments
on April 3 and 7 were previously recorded by the
company when they were initiated. Unrecorded charges
determined from the bank statement are as follows:
Returned NSF check on April 29 425.60
Debit and credit card fees on April 30 120.00
Bank service charges on April 30 30.00
Step 3. Company errors (+): Check No. 443 was correctly
written by Laird for $1,226 and was correctly paid by the
bank on April 12. However, it was recorded as $1,262 on
Laird’s books. 36.00

47
Bank Reconciliation
April 30, 2020
Cash balance per bank statement $15,907.45
Add: Deposits in transit 2,201.40
Less: Outstanding checks
No. 453 $3,000.00
No. 457 1,401.30
No. 460 1,502.70 5,904.00
Adjusted cash balance per bank $12,204.85
Cash balance per books $11,709.45
Add: Electronic funds transfer received 1,035.00
Error in recording check No. 443 36.00 1,071.00
Less: NSF check 425.60
Debit and credit card fees 120.00
Bank service charge 30.00 575.60
Adjusted cash balance per books $12,204.85
LO 3

48
LO 3
Entries for Bank Reconciliation
Collection of Electronic Funds Transfer: A payment of an
account by a customer is recorded in the same way, whether
the cash is received through the mail or electronically. The
entry is as follows.
Apr. 30 Cash 1,035.00
Accounts Receivable 1,035.00

49
LO 3
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 36.00
Accounts Payable 36.00
NSF Check: As indicated earlier, an NSF check becomes an
account receivable to the depositor. The entry is:
Apr. 30 Accounts Receivable425.60
Cash 425.60

50
LO 3
Bank Charge Expense: Fees for processing debit and credit
card transactions ($120) and the bank service charges ($30)
have been combined in a single entry as follows:
Apr. 30 Bank Charge Expense 150.00
Cash 150.00
Cash
Apr. 30 Balance 11,709.45 Apr. 30 425.60
30 1,035.00 30 150.00
30 36.00
Apr. 30 Balance 12,204.85
ILLUSTRATION 8.13
Adjusted balance in cash account

51
The reconciling item in a bank reconciliation that will
result in an adjusting entry by the depositor is:
a. outstanding checks
b. a bank error
c. deposit in transit
d. bank service charges
LO 3

52
LO 3
DO IT! 3 Bank Reconciliation
Sally Kist owns Linen Kist Fabrics. Sally asks you to explain how she
should treat the following reconciling items when reconciling the
company’s bank account: (1) a debit memorandum for an NSF
check, (2) a credit memorandum for an electronic funds transfer
from one of the company’s customers received by the bank, (3)
outstanding checks, and (4) a deposit in transit.
Sally should treat the reconciling items as follows.
1. Deduct from balance per books
2. Add to balance per books
3. Deduct from balance per bank
4. Add to balance per bank

53
Cash Equivalents
Cash equivalents are short-term, highly liquid
investments that are both:
1. Readily convertible to known amounts of cash, and
2. So near their maturity that their market value is
relatively insensitive to changes in interest rates
Restricted Cash
Cash that is not available for general use but rather is
restricted for a special purpose.
LO 4
Reporting Cash

54
LO 4
Reporting Cash
Delta Air Lines, Inc.
Balance Sheet
(partial, in millions)
Assets
Current assets
Cash and cash equivalents $2,844
Short-term investments 959
Restricted cash 122
ILLUSTRATION 8.14
Balance sheet presentation of cash

55
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.
LO 4
Reporting Cash

56
LO 4
DO IT! 4 Reporting Cash
Indicate whether each of the following statements is true or false.
1. Cash and cash equivalents are comprised of coins, currency (paper
money), money orders, and NSF checks.
2. Restricted cash is classified as either a current asset or noncurrent
asset, depending on the circumstances.
3. A company may have a negative balance in its bank account. In this
case, it should off set this negative balance against cash and cash
equivalents on the balance sheet.
4. Because cash and cash equivalents often includes short-term
investments, accounts receivable should be reported as the first item
on the balance sheet.
1. False 2. True 3. False 4. False

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