Chapter 7 concepts

Question 1

what are the three main factors that contribute to fraudulent activity

Answer 1

opportunity, financial pressure, rationalization

Question 2

what is the Sarbanes-Oxley Act (SOX)

Answer 2

Law that requires publicly traded companies to maintain adequate systems of internal control.

Question 3

what is the Public Company Accounting Oversight Board (PCAOB)

Answer 3

establishes auditing standards and regulates auditor activity.

Question 4

what is Internal control

Answer 4

A process designed to provide reasonable assurance regarding the achievement of company objectives related to operations, reporting, and compliance.

Question 5

what are the 5 components of internal control?

Answer 5

A control environment
Risk assessment
control activities
information and communication
monitoring

Question 6

what are the six principles of control activities

Answer 6

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

Question 7

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

Answer 7

True

Question 8

Segregation of duties is indispensable in an internal control system. There are two common applications of this principle:

Answer 8

1. Different individuals should be responsible for related activities.
2. The responsibility for recordkeeping for an asset should be separate from the physical custody of that asset.

Question 9

Independent internal verification. This principle involves the review of data prepared by employees. To obtain maximum benefit from independent internal verification:

Answer 9

1. Companies should verify records periodically or on a surprise basis.
2. An employee who is independent of the personnel responsible for the information should make the verification.
3. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action.

Question 10

Internal auditors

Answer 10

Company employees who continuously evaluate the effectiveness of the company’s internal control systems.

Question 11

Human resource control activities include the following.

Answer 11

1.Bond employees who handle cash.
2.Rotate employees’ duties and require employees to take vacations.
3.Conduct thorough background checks.
Two tips: (1) Check to see whether job applicants actually graduated from the schools they list. (2) Never use telephone numbers for previous employers provided by the applicant; always look them up yourself.

Question 12

Voucher system

Answer 12

A network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper.

Question 13

Voucher

Answer 13

An authorization form prepared for each expenditure in a voucher system.

Question 14

Asset misappropriation

Answer 14

such as theft of cash on hand, fraudulent disbursements, false refunds, ghost employees, personal purchases, and fictitious employees. This fraud is the most common but the least costly.

Question 15

Corruption

Answer 15

such as bribery, illegal gratuities, and economic extortion. This fraud generally falls in the middle between asset misappropriation and financial statement fraud as regards frequency and cost.

Question 16

Financial statement fraud

Answer 16

such as fictitious revenues, concealed liabilities and expenses, improper disclosures, and improper asset values. This fraud occurs less frequently than other types of fraud but it is the most costly.

Question 17

Companies report cash in two different statements:

Answer 17

the balance sheet and the statement of cash flows.

Question 18

Cash equivalents are:

Answer 18

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. (Generally only investments with maturities of three months or less qualify under this definition.) Examples of cash equivalents are Treasury bills, commercial paper (short-term corporate notes), and money market funds.

Question 19

Restricted cash

Answer 19

Cash that is not available for general use but instead is restricted for a particular purpose.