Chapter 8: Fraud, Internal Controls, and Cash

Question 1

Cash Equivalent

Answer 1

Highly liquid investments that can be converted to cash in three months or less.

Question 2

Imprest System

Answer 2

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.

Question 3

Electronic Data Interchange

Answer 3

(EDI) Paper docs are bypassed - customer’s computers communicate directly with supplier computers to automate sale/order transactions

Question 4

Evaluated Receipts Settlement

Answer 4

(ERS) A procedure that compresses the payment approval process into a single step by comparing the receiving report to the purchase order.

Question 5

Lock-Box System

Answer 5

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.

Question 6

Remittance Advice

Answer 6

Optional Attachment to a check that tells the business the reason for their payment.

Question 7

Petty Cash Fund Controls

Answer 7

• Surprise counts to confirm receipts+cash=original (imprest) amount
• cancelling or mutilating paid petty cash receipts so that they cannot be re-submitted.

Question 8

Voucher System

Answer 8

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

Question 9

Principles of Internal Controls: Human Resources Controls

Answer 9

• Bond employees
• Conduct background checks
• Rotate duties / require vacations

Question 10

Principles of Internal Controls: Documentation Procedures

Answer 10

• 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

Question 11

Principles of Internal Controls: Independent Internal Verification

Answer 11

• 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

Question 12

Principles of Internal Controls: Physical Controls

Answer 12

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

Question 13

Types of Employee Theft

Answer 13

• Asset misappropriation (this is the most common and least costly)
• Corruption
• Financial Statement Fraud (least common, but the most costly)

Question 14

Principles of Internal Controls: Segregation (separation) of Duties

Answer 14

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

Question 15

Principles of Internal Controls: Establishment (assignment) of Responsibility

Answer 15

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

Question 16

Primary Components of Internal Control

Answer 16

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

Question 17

Sarbanes-Oxley Act Control Regulations

Answer 17

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

Question 18

Committee of Sponsoring Organizations

Answer 18

(COSO) A committee that provides thought leadership related to enterprise risk management, internal control, and fraud deterrence.

Question 19

Electronic Funds Transfer

Answer 19

EFT improves controls as cash and checks are not being handled by an employee. Also adds additional records.

Question 20

Banking Controls

Answer 20

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

Question 21

Six Principles of Controls Activities

Answer 21

• Establishment (assignment) of responsibility
• Segregation (separation) of duties
• Documentation procedures
• Physical controls
• Independent internal verification
• Human resources controls

Question 22

Fraud Triangle

Answer 22

Opportunity, Rationalization and Financial Pressure

Question 23

Journaling: Credit card sales: Net Method

Answer 23

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

Question 24

Journaling: Credit card sales: Gross Method

Answer 24

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

Question 25

Journaling: Recording NSF checks

Answer 25

Debit: Accounts Receivable (increase)
Credit: Cash (decrease)

(occurs when check has already been recorded as deposited to cash)

Question 26

Cash Over/Short Account

Answer 26

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

Question 27

Petty Cash Account

Answer 27

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

Question 28

Internal Control Report

Answer 28

Required by SOA

Report by management describing its responsibility for and the adequacy of internal controls over financial reporting.

Question 29

Bank Reconciliation

Answer 29

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.

Question 30

Reporting Cashing

Answer 30

• 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

Question 31

Cash Ratio

Answer 31

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

Question 32

International Accounting Requirements

Answer 32

Requires high quality accounting standards AND high quality auditing standards

Question 33

IFRS SOX compliance

Answer 33

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