chapter 7 Flashcards
what is an internal control?
to protect a companies assets, ensure reliable financial reporting and comply with gvt regulations→ use them to make sure we can achieve these objectives
what are the two types of internal controls?
Can either be preventative (stop something from happening) or detective (to determine if something did happen)
what are the five components of the internal control system?
control environment, risk assessment, control activities, information and communication and monitoring activities
what is the control environment? (components)
environment inside an org, high level management, leading by good example to influence rest of employees
what is risk assessment?
management should identify and analyze factors that could create risks for the company and decide how to best mitigate them → process where management analyze and identify risks and how to mitigate them
what is control activities
to reduce intentional and unintentional errors, management should design policies/ procedures to address the risks→ once we have identified the risks, we can design controls to reduce the risks of happening
what is information and communication?
all pertinent information should be communicated to appropriate internal/ external users → once we have designed the controls,mw e have to communicate them to external and internal users, have to make sure the employees know they are in place
what are monitoring activities ?
on a periodic basis, we have to monitor the controls and make sure they are working properly, identify any deficiencies and communicate them to the management team
what are the five control activities/
assignment of respsonibiltu, segregation of duties, documentation, physical controls, review and reconciliation
what is assignment of responsibility?
we have to be careful when designing employee rules to make sure employees or employee levels are only assigned tasks that make sense and can be traced (can make sure employees are being helped accountable for their actions)
what is segregation of duties?
Cant give one employee too much responsibility→ can lead to higher risk of fraud or theft of companies assets
segregation of duties for purchases?
we should have different employees for ordering goods, approving the order, receiving the goods and authorizing payment
segregation of duties for sales?
make sure that we have different employees responsible for approving credit for customers, shipping goods and preparing invoices
in a smaller org, how would segregation of duties happen?
might need owner of company to take on some of those roles
what is documentation?
Important for us to have evidence of the transactions that have happened→ prove timing and amount
what are examples of documentation?
receipts→ proof that sale has happened and amount
Shipping documents→ goods have actually been shipped
what should every document have?
Signatures should be included on documents and all documents should be sequentially numbered
what are physical controls?
Are used to safeguard assets and enhance reliability of financial records
what are examples of physical controls?
safes, access systems with passwords, locked warehouses, alarm systems and cameras
what is review and reconciliation?
Reviews→ a review of data prepared by employees. The review can be carried out by other employees (internal review) or third parties (external review)
Reconciliation→ comparisons between two or more documents to ensure our records match up, includes bank reconciliations
what is a bank reconciliation?
important control over cash where we compare cash in our accounting system versus what the bank actually has on hand
what are internal reviews for review and reconciliation?
should be performed by internal auditors (hired by the company to audit whats happening inside the same company),
what are external reviews for review and reconciliatipn>
performed by external auditors to make sure the financial statametns do not have any material error
for reviews to be useful, what should they have?
perform in regular basis, reviewer should be independent, discrepancies should be reported to management
what are the four limitations of internal controls?
1) cost/ benefit considerations
2) human error
3) collusion
4) management overide
what is cost/ benefit considerations?
companies are often limited in their budget for controls → physical controls may be expensive, if we have a limited budget we have to suggest controls that will provide important benefits
what is human error (limitations of internal control)
lack of training, fatigue, even if we have controls in place, if our employees arent properly trained or overworked, wont be good
what is collusion (limitations of internal control?
if we properly segregate our duties to make sure that tasks are being performed by dif people, this should be good. However, if employees decide to work together, the control may not be effective
what is management override (limitations of internal control)?
quite often, management is given broad access to the accounting and control systems, might have the possibility and potential for manipulating a companies systems, use for personal gain
what is fraud?
When individuals purposefully misappropriate (steal) assets or misstate financial info
what are the three factors present when fraud happens?
1) Opportunity
2) pressure
3) rationalization
what is opportunity and fraud?
this could happen when insufficient internal controls are in palace or employees can work around them
what is pressure and fraud?
this could include personal financial problems, pressure to succeed or other motivation
what is rationalization and fraud?
occurs when individuals make excuses for their actions, could be when an employee feels they are underpaid and tehy deserve more, they say the fraud they are commiting is okay
what is cash?
Cash will include physical cash (coins, paper money, cheques) and cash deposited with a financial institution
what does cash not include?
postdated cheques (cheques payable in the future), stale-dated cheques (cheques that will not be honoured because they are more than six months old), or returned cheques (cheques received from customers but returned by the bank because the customer’s account lacked sufficient funds)
what are cash receipts?
at the register, electronic and cheque
what are cash payments?
electronic and cheque
when are controls of receipts most effective?
when cash is deposited at the bank daily and when a company increases the proportion of cash received via electronic transfer.
controls of cash payments will be most effective when?
when payments are made electronically or by cheque.
The vast majority of companies will use bank accounts and online banking to manage their cash. This will have the following advantages:
- The use of a bank account safeguards the company’s cash and provides a second set of records for cash transactions (bank statement) that can be reconciled with the accounting records.
- Easily transfer funds between accounts and make/receive online payments.
- Easily view transactions and download transactions into accounting software.
When the company receives cash, what happens on bank statements?
this will be a credit for the bank as their liability increases.
when the company pays cash, what happens on the bank statement?
this will be a debit for the bank as they liability decreases.
what info do we find on the bank statement?
Amounts that will be deducted from a bank account include: payments (EFT, cheque), NSF cheques (non-sufficient cheques) written by customers, NSF service charge and other bank service fees.
Amounts that will be added to a bank account include: EFT and other deposits, interest earned and other transfers.
It’s normal for these balances to be different - possible reasons for the difference includes:
Timing differences: due to outstanding cheques (cheques written that have not yet been deposited), deposits in transit or amounts recorded by the bank that the company isn’t yet aware of (ex. Service charges).
Errors: errors made by employees entering transactions in accounting software or errors made by the bank.
who makes a bank reconciliation?
This reconciliation should be prepared by an employee with no other cash responsibilities (for segregation of duties).
what are the two sections of a bank reconciliation?
1) Cash balance per bank: amount per bank statement + deposits in transit – outstanding cheques +/- bank errors = reconciled cash per bank.
2) Cash balance per books: amount per books + unrecorded receipts + interest – unrecorded payments – NSF cheques – service charges +/- company errors = adjusted book balance.
if the adjusting balances of a bank reconciliation are not equal, what could this to be a sign of?
this could be a sign of missing cash, mistakes or further investigation is required (ex. Did we find all the adjustments needed?).
after the bank reconciliation has been prepared, what do we need to do next?
we need to prepare journal entries to adjust the book balance.
what are journal entries that may be required ro adjust the cash balance in the books
EFT payments received and not yet recorded (Dr. Cash / Cr. Accounts receivable)
Book error (not bank errors – we need to notify the bank if we find they made a mistake)
NSF cheque (Dr. Accounts receivable / Cr. Cash – include amount of service charge)
Bank charge expense (Dr. Bank charge expense / Cr. Cash)
wehre do companies report cash?
both on their Statement of Financial Position (ending balance) and the Statement of Cash Flows (shows beginning, ending and changes for the period).
what should be presented together?
Cash and cash equivalents should be combined and presented together
when a company has a negative bank balance, what happens?
they will present the amount as a current lability called bank indebtedness.
when can cash equivalents and cash be grouped together?
cash equivalents must be readily converted into known amount of cash and near enough to maturity that there is an insignificant risk of change in value (generally – less than 3 months).
The following basic principles can help companies ensure they have sufficient cash:
- Increase speed of collection on receivables (ex. Offer discounts)
- Keep inventory levels low
- Take advantage of credit periods
- Plan timing of major expenditures
- Invest idle cash
- Prepare cash budget
should companies have a lot of extra cash
no, could indicate lost opportunity
what is an electronic funds transfer?
involve transferring money electronically from one bank account to another
for control activities over cash receipts, what does assignment of responsibility look like?
authorize only designated personnel to handle cash receipts
for control activities over cash receipts, what does segregation of duties look like?
have different incidviudald recording cash receipts and handling cash
for control activities over cash receipts, what does documentation look like?
use remittance advices, cash register tapes,
for control activities over cash receipts, what does physical control look like?
store cash in safes with limited access, use cash rexsietrd and repost all cash In bank daily
for control activities over cash receipts, what does review and reconciliation look like?
have supervisors count cash recpoets daily, have an accountant compare total receipts with bank deposits daily
for control activities over cash payments, what does assignment of repsonsibkuty look like?
specific employees should be authorized to approve EFT payments
for control activities over cash payments, what does segregation of duties look like?
have Dif employees prepare, approve and record EFT payments
for control activities over cash payments, what does documentation look like
ensure that each EFT payment is supported by an approved invoice
for control activities over cash payments, what does phsycao; controls look like?
require mrultifactor authentication to log into the EFT payment system
for control activities over cash payments, what does review and reconliiayion look like?
reconcile the tittle autrhouzed EFT payments with the actual payments processed from the bank account on a daily basis
