Chapter 8: Fraud, Internal Controls, and Cash Flashcards
Cash Equivalent
Highly liquid investments that can be converted to cash in three months or less.
Imprest System
A way to account for petty cash by maintaining a constant balance in the petty cash account.
At any time cash + petty cash tickets/ receipts must total the amount allocated to the petty cash fund.
Electronic Data Interchange
(EDI) Paper docs are bypassed - customer’s computers communicate directly with supplier computers to automate sale/order transactions
Evaluated Receipts Settlement
(ERS) A procedure that compresses the payment approval process into a single step by comparing the receiving report to the purchase order.
Lock-Box System
System where customers send their checks to a P.O. Box that belongs to a bank. A bank employee empties the box daily and records the deposits into the company’s bank account.
Remittance Advice
Optional Attachment to a check that tells the business the reason for their payment.
Petty Cash Fund Controls
- Surprise counts to confirm receipts+cash=original (imprest) amount
- cancelling or mutilating paid petty cash receipts so that they cannot be re-submitted.
Voucher System
A form of cash disbursement control.
- A Network of approvals to ensure all disbursements are authorized.
- A voucher is an authorization form prepared for each expenditure
Principles of Internal Controls: Human Resources Controls
- Bond employees
- Conduct background checks
- Rotate duties / require vacations
Principles of Internal Controls: Documentation Procedures
- Pre-numbered documents = easier to account for all documents
ex: sales slips, register tapes etc
- match checks to invoices
- track which invoices have been paid by stamping
Principles of Internal Controls: Independent Internal Verification
- Records verified periodically (or by surprise)
- Verified by an independent employee (not someone in the same chain of command)
- Discrepancies reported to management
- Multiple people verifying the same math
- Comparing cash to register tapes
- Reconciling bank statements
Principles of Internal Controls: Physical Controls
Limiting access to secured items and cash Such as: Safes, vaults, safety deposit boxes, locking warehouses / cabinets. Computer security (password, biometrics) Video monitoring sensor tags on inventory time clocks alarm systems use of indelible inks and watermarks
Types of Employee Theft
- Asset misappropriation (this is the most common and least costly)
- Corruption
- Financial Statement Fraud (least common, but the most costly)
Principles of Internal Controls: Segregation (separation) of Duties
Related duties (physical custody and record keeping) should be assigned to different individuals.
Ex: different individuals receive cash vs. record the receipts vs. hold the cash
- check signers do not record disbursements
- different individuals make vs record payments
Operations vs. accounting
Custody of assets vs. accounting
Principles of Internal Controls: Establishment (assignment) of Responsibility
About accountability. Most effective when:
- one person is responsible for a given task.
Ex:
- only certain personnel can handle cash
- only designated personnel can approve vendors and sign checks
- each individual cashier has their own drawer = known responsibility
Primary Components of Internal Control
C: Control Activities (procedures) R: Risk Assessment I: Information systems and communication M: Monitoring of controls E: Environment (controlled)
- Costs should not exceed benefits
- Controls vary on size/type of business
Sarbanes-Oxley Act Control Regulations
Controls apply to publicly traded companies on US exchanges. Companies must:
- Develop principles of control over financial reporting
- Continually verify that the controls are working
- Issue internal control reports
- Ensure employee supervision/ maintain required certificates
- Independent auditors attest to the adequacy of internal controls
- PCAOB oversees auditors
- Auditing firms cannot supply auditing and certain consulting services to the same client
Committee of Sponsoring Organizations
(COSO) A committee that provides thought leadership related to enterprise risk management, internal control, and fraud deterrence.
Electronic Funds Transfer
EFT improves controls as cash and checks are not being handled by an employee. Also adds additional records.
Banking Controls
Banking minimizes currency on hand and creates additional records for tracking.
Debit and Credit memorandums record:
- Bank charges (debit)
- Interest earned, notes collected (credit)
Reconciling balance per books & balance per bank shows time lag items (like deposits in transit and check outstanding)
Note: use bank code numbers, not check numbers on the deposit slips
Six Principles of Controls Activities
- Establishment (assignment) of responsibility
- Segregation (separation) of duties
- Documentation procedures
- Physical controls
- Independent internal verification
- Human resources controls
Fraud Triangle
Opportunity, Rationalization and Financial Pressure
Journaling: Credit card sales: Net Method
Net method: total sale less assessed fee = cash deposited by the processor (aka “net of fee”)
Debit: Cash (cash received)
Debit: Credit Card Expense (fee amount)
Credit: Sales Revenue
Journaling: Credit card sales: Gross Method
Sale amount deposited when sales occur, fee charged on a regular basis (monthly)
When sale happens:
Debit: Cash (full amt of sale)
Credit: Sales Revenue
When Fee is charged:
Debit: Credit Card Expense
Credit: Cash
Journaling: Recording NSF checks
Debit: Accounts Receivable (increase)
Credit: Cash (decrease)
(occurs when check has already been recorded as deposited to cash)
Cash Over/Short Account
Income Statement account (misc. revenue/expenses)
Misc revenue if credit balance
Misc Expense if debit balance
Journal cash short:
Debit: Cash
Debit: cash over/short: short amount
Credit: Sales
Journal cash over:
Debit: Cash
Credit: Sales
Credit: Cash over/short: over amount
Petty Cash Account
Asset Account
To establish:
Debit: Petty Cash
Credit: Cash
Then only record receipts to journal when replenishing the cash
Debit: Various expenses from receipts
Credit: Cash (balance amount to bring petty cash to imprest amount)
Any missing or extra petty cash goes to over/short account
Internal Control Report
Required by SOA
Report by management describing its responsibility for and the adequacy of internal controls over financial reporting.
Bank Reconciliation
Cash Balance per statement: \+ deposit transit - outstanding checks \+/- bank errors = adjusted balance
Cash balance per books: \+ Notes collected by bank \+ Interest earned - NSF/ bounced checks - bank service charges \+/- company errors = adjusted balance
adjusted balance on each side should be the same. Any company errors must be fixed via adjusting entries.
Reporting Cashing
- Cash + cash equivalents (short term liquid investments easily converted into cash or so near maturity that market fluctuations do not matter.
- Restricted cash - cash not available for general use, earmarked. Still considered a current asset.
Can technically all be combined under cash+cash equivalents
Cash Ratio
Measures the company’s ability to pay its current liabilities from cash + cash equivalents
= (cash + cash equivalents) / total current liabilities
Cash equivalents can be converted to cash in 3 months or less
International Accounting Requirements
Requires high quality accounting standards AND high quality auditing standards
IFRS SOX compliance
Internal control standards ONLY apply to companies listed on U.S. Exchanges
There is debate over foreign issuer compliance
IFRS does not require an audit of internal controls
