Lecture 4 - Internal Control, Cash and Receivables Flashcards
Define Fraud
-An intentional misrepresentation of facts, made for the purpose of persuading another party to act in a certain way that causes injury or damage to that party
Mention 2 common types of fraud and examples of each
1) Misappropriation of assets
-Committed by employees. E.g. Theft, bribery, kick-back schemes, overstatement of expense reimbursements
2) Fraudulent financial reporting
-. E.g. false and misleading financial reporting which deceives investors and creditors and brings damage to the general public
Mention and explain the 3 elements of the Fraud Triangle
1) Pressure
-On a person - e.g. need-based
2) Opportunity - e.g. weak internal control
3) Rationalization - made by the person
Internal control is the primary way to prevent, detect and correct fraud:
Mention 5 objectives of Internal Control
1) Safeguard assets
2) Encourage employees to follow company policy
3) Promote operational efficiency
4) Ensure accurate, reliable accounting records
5) Comply with legal requirements
Mention 2 internal control procedures
1) Separation of duties
-Asset handling, record keeping and transaction approval should be done by different people
2) Monitoring of control
-Both internal and external auditors
Mention 3 limitations of internal control
1) Collusion
2) Management can override the procedures/controls
3) Human limitations: Fatigue and negligence
*Benefits of the system should always outweigh the cost
Explain Bank Reconciliation
-Explains the differences in cash balances between the book (cash account in the general ledger) and the bank statement
-Differences are due to time lag in recording transactions between the company and the bank
Preparing the Bank Reconciliation
What should be posted on the bank side (3) and what should be posted on the book side (7)? and is it + or -?
*Note that the company only has to prepare the book side and this is typically done before the trial balance and every month when the bank statement is received
Bank Side Reconciliation:
-Deposits in transit +
-Outstanding checks -
-Bank errors -/+
Book Side Reconciliation:
-Bank collections +
-Electronic funds transfer EFT +
-Service charge -
-Interest revenue +
-NSF (bounced) checks -
-EFT payments -
-Correction of book errors +/-
Describe Receivables:
How liquid are they?
What do they signify?
How are they acquired?
-3rd most liquid asset (after cash and short-term investments)
-Monetary claims against others
-Acquired by:
1) Selling goods and services on account
2) Lending money
Describe Accounts Receivables
-Current assets converted to cash within the financial period
-Serves as a control account:
1) Summarizes total receivable from all costumers
2) Subsidiary ledger with separate accounts for each costumer
What are the 2 methods for accounting for uncollectible receivables (bad debt)?
1) Allowance Method: Estimate bad debts in advance
2) Direct Write-off Method: Recognize bad debts expense at the point the AR becomes uncollectible = when the costumer goes bankrupt.
Describe the Allowance Method:
1) What does it do?
2) Based on what?
3) What is it recorded as?
4) Which contra account is set up to AR and what does it show?
5) When is the uncollectible accounts written off?
1) Records expected collection losses from failure to collect receivables
2) Is based on the company’s past experiences
3) Is recorded as ‘Uncollectible account expense’ = decrease in assets and increase in expenses
4) ‘Allowance for uncollectable (doubtful) accounts’ and shows the amount the company expects to not collect - it is an estimation
5) At the end of the year
Describe the Direct Write-off Method
1) When does it record an expense?
2) Mention 2 issues with this method
1) When specific costumer’s account proves to be uncollectable
2) 2 issues
-No allowance for uncollectables = overstates assets at the balance sheet date
-Fails to recognize the expense in the same period in which the related revenue is earned = violation of the matching principle
What is a Note Receivable?
And define the following elements
1) Creditor
2) Debitor
3) Interest
4) Maturity date
5) Maturity value
6) Principal
7) Term
-More formal than AR
-Company lends out money to another company that at the maturity date pays the principal + interest.
-Uses a promissory note
1) The lender
2) The borrower
3) Cost of borrowing the money
4) Date at which the note must be paid
5) The sum of principal + interest
6) The amount of money borrowed
7) The length of time from when the note was signed to when payment must be made
How to speed up cash flow from receivables:
1) Mention 2 ways to shorten credit cycle and collect cash more quickly
2) What does selling/factoring receivables entail - what is a benefit and a disadvantage? And which companies is this method used by?
1) Use credit card or bank card sales instead or selling/factoring receivables
2) Companies sell receivables to another company (factor) for a discounted price. The factor then tries to collect the debt to earn revenue.
-Benefit: Companies get an immediate receipt of cash
-Disadvantage: It’s expensive and the company looses control over the collection
-It is used by companies with 1) weak or insufficient credit history (start-ups) or 2) companies with a significant amount of debt
