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Chapter 7 Notes

by: Amelia Cassidy

Chapter 7 Notes BA 210

Amelia Cassidy
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About this Document

Chapter 7 - Fraud, Internal Control, and Cash
Financial Accounting
Dr. Greenman
Class Notes
Accounting, business, financial accounting




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This 12 page Class Notes was uploaded by Amelia Cassidy on Tuesday March 8, 2016. The Class Notes belongs to BA 210 at Embry-Riddle Aeronautical University - Daytona Beach taught by Dr. Greenman in Spring 2016. Since its upload, it has received 56 views. For similar materials see Financial Accounting in Business at Embry-Riddle Aeronautical University - Daytona Beach.


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Date Created: 03/08/16
Chapter 7 ­ Fraud, Internal Control, and Cash      ● Fraud and Internal Control  ○ Fraud  ■ Fraud Definition  ● Dishonest act by an employee that results in personal benefit to  him/her at the cost to employer  ■ Fraud Triangle Definition  ● Three factors that contribute to fraudulent activity by employees:  opportunity, financial pressure, and rationalization    ● Opportunity  ○ Occur when workplace lacks sufficient controls to  deter/detect fraud  ● Financial Pressure  ○ Personal financial problems caused by too much debt  ○ Want to lead lifestyle they can’t afford on current salary  ● Rationalization  ○ Justify fraud because they believe they are underpaid  while employer is making lots of money  ○ Sarbanes­Oxley Act  ■ Sarbanes­Oxley Act Definition  ● Regulations passed by Congress to try to reduce unethical  corporate behaviour  ○ Internal Control  ■ Internal Control Definition  ● All related methods/activities adopted within an organization to  safeguard its assets and enhance the accuracy/reliability of its  accounting records  ● Control Environment  ○ Tone at the top  ○ Organization values integrity ­ unethical activity is not  tolerated  ● Risk Assessment  ○ Companies identify/analyze various factors that create risk  for the business and must determine how to manage them  ● Control Activities  ○ Reduce occurrence of fraud, management must design  policies/procedures to address risks faced by the company  ● Information and Communication  ○ Capture/Communicate all pertinent info both up & down  the organization, as well as communicate info to  appropriate external parties  ● Monitoring  ○ Monitored periodically for adequacy  ○ Significant deficiencies need to be reported to top mgmt  and/or board of directors  ○ Principles of Internal Control Activities    ■ Establishment of Responsibility  ● Control is most effective when only one person is responsible for  given task   ■ Segregation of Duties  ● Two common applications  ○ Different individuals should be responsible for related  activities  ○ Responsibility for record­keeping for an asset should be  separate from physical custody of that asset  ● The work of one employee should, without duplication of effort,  provide a reliable basis for evaluating the work of another  employee  ● Segregation of Related Activities  ○ Making one individual responsible for related activities  increases potential for errors/irregularities  ● Segregation of Record­Keeping From Physical Custody  ○ Custodian of the asset is not likely to convert asset to  personal use when one employee maintains the record of  the asset, and a different employee has physical custody  of the asset    ■ Documentation Procedures    ● Companies should use prenumbered documents, and all should  be accounted for  ● Control system should require that employees promptly forward  source documents for accounting entries to the accounting  department  ○ Helps ensure timely recording of transaction      ■ Physical Controls    ● Safeguarding of assets and enhancing accuracy/reliability of  accounting records  ■ Independent Internal Verification  ● Review of data prepared by employees  ● Verify records periodically or on surprise basis  ● An employee who is independent of personnel responsible for  information should make verification  ● Discrepancies/Exceptions should be reported to management  level that can take appropriate corrective action    ● Internal Auditors Definition  ○ Company employees who continuously evaluate the  effectiveness of the company’s internal control system  ■ Human Resource Controls  ● Bond employees who handle cash  ○ Bonding Definition  ■ Obtaining insurance protection against  misappropriation of assets by employees  ● Rotate employees’ duties and require employees to take vacations  ● Conduct thorough background checks    ○ Limitations of Internal Control  ■ Reasonable Assurance  ● Costs of establishing control procedures should not exceed  expected benefit  ■ Human Element  ● Employee fatigue, carelessness, indifference  ■ Collusion  ● Reduce effectiveness of system, eliminating protection offered by  segregation of duties  ● Cash Controls  ○ Cash is the asset most susceptible to fraudulent activities  ○ Cash Receipts Controls      ■ Over­the­Counter Receipts    ● Supervisor has access to register tape but not cash  ● Clerk/Cashier have access to cash but not register tape  ■ Mail Receipts  ● Opened in presence of two + mail clerks  ● In form of checks  ● Excellent internal control  ○ Cash Disbursement Controls  ■ Generally, internal control over cash disbursements is more effective  when companies pay by check rather than by cash  ● Exception = incidental amounts paid out of petty cash    ■ Voucher System Controls  ● Voucher System Definition  ○ Network of approvals by authorized individuals acting  independently to ensure that all disbursements by check  are proper  ● Voucher Definition  ○ An authorization form prepared for each payment in a  voucher system  ● Improves internal control over cash disbursements  ● Keeps track of documents that back up each transaction  ■ Petty Cash Fund Controls  ● Petty Cash Fund Definition  ○ A cash fund used to pay relatively small amounts  ● Operations  ○ Called​mprest System  ■ Establish fund  ■ Make payments from fund  ■ Replenish fund  ● Establishing the Petty Cash Fund  ○ Appoint petty cash custodian  ○ Determine size of fund    ● Making Payments from the Petty Cash Fund    ○ Company does not make accounting entries to record  payments from petty cash  ■ Recognize accounting effects of each payment  when replenishing fund  ● Replenishing the Petty Cash Fund  ○ Prepares schedule/summary of payments, support them  w/receipts    ● Control Features: Use of a Bank  ○ Use of a bank contributes significantly to good internal control over cash  ○ Bank Reconciliation Definition  ■ Process of comparing the bank’s balance of an account with the  company’s balance and explaining any difference to make them agree  ○ Making Bank Deposits    ○ Writing Checks  ■ Check Definition  ● Written order signed by a bank depositor, directing the bank to pay  a specified sum of money to a designated recipient  ■ 3 parties:  ● The maker/drawer ­ issues the check  ● Bank/payer ­ the check is drawn  ● Payee ­ to whom the check is payable  ■ A check is a negotiable instrument one party can transfer to another by  endorsement    ○ Bank Statements  ■ Bank Statement Definition  ● Monthly statement from the bank that shows the depositor’s bank  transactions and balances  ■ Shows:  ● Checks paid/other debits that reduce the balance in the  depositor’s account  ● Deposits/Other credits that increase that balance in account  ● Account balance after each day’s transactions    ■ Paid check =Canceled check  ■ Debit Memorandum  ● Bank Service Charge Definition  ○ Fee charged by a bank for use of its services  ● Not Sufficient Funds (NSF) Definition  ○ Check that is not paid by a bank because of insufficient  funds in a customer’s bank account  ■ Credit Memorandum  ● Collect notes receivable  ● Interest earned  ○ Reconciling the Bank Account  ■ Make the balance per books and balance per bank agree with the  correct/true amount  ■ Two Causes  ● Time Lags ­ prevent one party from recording transaction in the  same period as other party  ● Errors ­ by either party in recording transactions  ■ Reconciliation Procedure  ● Bank reconciliation should be prepared by an employee who has  no other responsibilities pertaining to cash    ● Deposits in Transit Definition  ○ Deposits recorded by depositor but not yet recorded by the  bank  ● Outstanding Checks Definition  ○ Checks issued and recorded by a company but not yet  paid by the bank  ● Errors  ○ All errors made by depositor are reconciling items in  determining adjusted cash balance per books  ● Bank Memoranda  ■ Bank Reconciliation Illustrated    ■ Entries from Bank Reconciliation  ● If company does not journalize/post items, Cash account will not  show correct balance  ○ Electronic Funds Transfer (EFT) System  ■ EFT Definition  ● Disbursement system that uses wire, telephone, or computers to  transfer funds from one location to another  ■ Better internal control since no cash.checks are handled by company  employees  ● Reporting Cash  ○ Cash Definition  ■ Resources that consist of coins, currency, checks, money, orders, and  money on hand or on deposit in a bank or similar depository  ■ Reported in Balance Sheet and Statement of Cash Flows  ○ Cash Equivalents  ■ Cash Equivalents Definition  ● Short­Term, highly liquid investments that can be converted to a  specific amount of cash  ● So near to maturity that market value is relatively insensitive to  interest rate changes    ○ Restricted Cash  ■ Restricted Cash Definition  ● Cash that must be used for a special purpose  ■ If company wants to use restricted cash within next year, must be  reported a​ urrent Asset   


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