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FRAUD,FRAUD,

INTERNALINTERNAL

CONTROL, ANDCONTROL, AND

CASHCASH

Financial Accounting, Seventh Edition

7

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After std!in" this #h$%ter, !o sho&d 'e $'&e to(

1. Define fraud and internal control.

2. Identify the principles of internal control activities.

3. Explain the applications of internal control principles to cash receipts.

4. Explain the applications of internal control principles to cash

disbursements.

5. Prepare a ban reconciliation.

!. Explain the reportin" of cash.

#. Discuss the basic principles of cash mana"ement.

$. Identify the primary elements of a cash bud"et.

Le$rnin" O')e#tivesLe$rnin" O')e#tives

Le$rnin" O')e#tivesLe$rnin" O')e#tives

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Preview of Chapter 7

Financial Accounting

Seventh Edition

Kimmel Weygandt Kieso

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Fr$d $nd Intern$& Contro&Fr$d $nd Intern$& Contro&


Dishonest act by an employee that results in personal benefit to

the employee at a cost to the employer.

LO 1 Define fraud and internal control.

Three f$#torsthat

contribute to

fraudulent activity.

I&&str$tion 7-1

Fr$d

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%pplies to%'&i#&! tr$ded&.'. corporations.

(e)uired to maintain as!ste of intern$& #ontro&.

Cor%or$te e.e#tives $nd 'o$rds of dire#torsmust ensurethat these controls are reliable and effective.

Inde%endent otside $ditorsmust attest to the ade)uacy

of the internal control system.

SO/ created the 0'&i# Co%$n! A##ontin" Oversi"ht

o$rd 0CAO3.




The S$r'$nes-O.&e! A#t

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5ethods $nd e$sres $do%ted to(

1. 'afe"uard assets.

2. Enhance accuracy and reliability of accountin" records.

3. Increase efficiency of operations.

4. Ensure compliance *ith la*s and re"ulations.


Intern$& Contro&



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Five 0ri$r! Co%onents(

1. +ontrol environment.

2. (is assessment.

3. +ontrol activities.

4. Information and communication.

5. ,onitorin".


Fr$d $nd Intern$& Contro&Fr$d $nd Intern$& Contro&Fr$d $nd Intern$& Contro&Fr$d $nd Intern$& Contro&

Intern$& Contro&

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Est$'&ishent of Res%onsi'i&it!

+ontrol is most effective *hen

only one person is responsiblefor a "iven tas.

Establishin" responsibility often

re)uires limitin" access only to

authori-ed personnel and then

identifyin" those personnel.

LO 2 Identify the principles of internal control activities.


0rin#i%&es of Intern$& Contro& A#tivities

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7-18

Se"re"$tion of Dties

Different individuals should be

responsible for relatedactivities.

/he responsibility for record0

eepin" for an asset should

be separate from the physical

custody of that asset.




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7-11

Do#ent$tion 0ro#edres

+ompanies should use

prenumbered documents andall documents should be

accounted for.

Employees should promptly

for*ard source documents for

accountin" entries to the

accountin" department.




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7-12 LO 2 Identify the principles of internal control activities.



I&&str$tion 7-2

0h!si#$&

Contro&s

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(ecords periodically

verified by anemployee *ho is

independent.

Discrepancies

reported to

mana"ement.


I&&str$tion 7-*


Inde%endent Intern$& 9erifi#$tion


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7-1+ LO 2 Identify the principles of internal control activities.



H$n Resor#e Contro&s

ond employees *ho handle

cash.

(otate employees duties and

re)uire vacations.

+onduct bac"round checs.

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The 5issin" Contro&

Establishment of responsibility./he healthcare company did not ade)uatelyrestrict the responsibility for authorin" and approvin" claims transactions. /hetrainin" supervisor should not have been authori-ed to create claims in thecompanys live system.

Tot$& t$:e( ;11 i&&ion

ANATO5< OF A FRAUD

,aureen ru"ali *as a trainin" supervisor for claims processin" at +olossal

6ealthcare. %s a standard part of the claims processin" trainin" pro"ram,aureen created fictitious claims for use by trainees. /hese fictitious claims*ere then sent to the accounts payable department. %fter the trainin" claimshad been processed she *as to notify %ccounts Payable of all fictitious claimsso that they *ould not be paid. 6o*ever she did not inform %ccounts Payableabout every fictitious claim. 'he created some fictitious claims for entities that

she controlled 7that is she *ould receive the payment8 and she let %ccountsPayable pay her.

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The 5issin" Contro&

egregation of duties./he university had not properly se"re"ated relatedpurchasin" activities. 9a*rence *as orderin" items receivin" the items andreceivin" the invoice. y receivin" the invoice he had control over thedocuments that *ere used to account for the purchase and thus *as able tosubstitute a fae invoice.

Tot$& t$:e( ;+7,888

ANATO5< OF A FRAUD

9a*rence airbans the assistant vice0chancellor of communications at %esop

&niversity *as allo*ed to mae purchases of under :25;; for his department*ithout external approval. &nfortunately he also sometimes bou"ht items forhimself such as expensive anti)ues and other collectibles. 6o* did he do it

a. se"re"ation of duties.

b. establishment of responsibility.

c. independent chec.

d. other controls.

Revie= >estion

LO # E$plain the applications of internal control principles to cash receipts.

C$sh Contro&sC$sh Contro&sC$sh Contro&sC$sh Contro&s

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?ener$&&! internal control over cash disbursements is more

effective *hen companies %$! '! #he#: or e&e#troni# fnds

tr$nsfer EFT3rather than by cash.

A%%&i#$tions(

9o#her S!ste Contro&s

0ett! C$sh Fnd A%%endi. 7A3

LO % E$plain the applications of internal controlprinciples to cash disbursements.


C$sh Dis'rseent Contro&s

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I&&str$tion 7-4

LO %


C$sh Dis'rseentContro&s

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I&&str$tion 7-4

LO %


C$sh Dis'rseentContro&s

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/he use of prenumbered checs in disbursin" cash is an

application of the principle of>

a. establishment of responsibility.

b. se"re"ation of duties.

c. physical mechanical and electronic controls.

d. documentation procedures.

Revie= >estion



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9o#her S!ste

% net*or of approvals by authori-ed individuals actin"

independently to ensure all disbursements by chec areproper.

% vo#heris an authori-ation form prepared for each

expenditure in a voucher system.



C$sh Dis'rseent Contro&s

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/he use of a ban contributes si"nificantly to "ood internalcontrol over cash.

,inimi-es the amount of currency on hand.

+reates a double record of ban transactions.

an reconciliation.

LO & !repare a ban' reconciliation.

Contro& Fe$tres( Use of $ $n:Contro& Fe$tres( Use of $ $n:Contro& Fe$tres( Use of $ $n:Contro& Fe$tres( Use of $ $n:

He&%f& HintEssentiallythe ban statement is a

copy of the bans recordssent to the customer ormade available online forrevie*.

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De'it 5eor$nd

an service char"e.

' 7not sufficientfunds8.

I&&str$tion 7-7

Credit 5eor$nd

+ollect notesreceivable.

Interest earned.


$n: St$teents


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/he control features of a ban account do not include>

a. havin" ban auditors verify the correctness of the ban

balance per boos.

b. minimi-in" the amount of cash that must be ept on

hand.

c. providin" a double record of all ban transactions.d. safe"uardin" cash by usin" a ban as a depository.

Revie= >estion



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(econcile balance per boos and balance per ban to their

correct or true balance.

Re#on#i&in" Ites>1. Deposits in transit.

2. ?utstandin" checs.

3. an memoranda.

4. Errors.

Tie L$"s


Re#on#i&in" the $n: A##ont


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Re#on#i&i$tion 0ro#edres

@ De%osit in Tr$nsit

- Otst$ndin" Che#:s

@- $n: Errors

@ Notes #o&&e#ted '! '$n:

- NSF 'on#ed3 #he#:s

- Che#: %rintin" or otherservi#e #h$r"es

@- Co%$n! Errors

CORRECT ALANCE CORRECT ALANCE

I&&str$tion 7-6



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7-+1 LO & !repare a ban' reconciliation.


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I&&str$tion( 0re%$re $ '$n: re#on#i&i$tion $t A%ri& *8B


C$sh '$&$n#e %er '$n: st$teent ;1,87B+

De%osit in tr$nsit 2,281B+8

Otst$ndin" #he#:s ,8+B883

Ad)sted #$sh '$&$n#e %er '$n: ;12,28+B6

C$sh '$&$n#e %er 'oo:s ;11,6B+

Co&&e#tion of notes re#eiv$'&e 1,8*B88

Error in #he#: NoB ++* *4B88

NSF #he#: +2B483

$n: servi#e #h$r"e *8B883

Ad)sted #$sh '$&$n#e %er 'oo:s ;12,28+B6


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Co&&e#tion of Note Re#eiv$'&e( %ssumin" interest of :5; has not

been accrued and collection fee is char"ed to ,iscellaneous

Expense the entry is>

+ash 1;35.;;%pr. 3;

,iscellaneous expense 15.;;

otes receivable 1;;;.;;

Interest revenue 5;.;;


Entries Fro $n: Re#on#i&i$tion


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oo: Error( /he cash disbursements =ournal sho*s that chec no.

443 *as a payment on account to %ndrea +ompany a supplier.

/he correctin" entry is>

+ash 3!.;;%pr. 3;

%ccounts payable 3!.;;


NSF Che#:( %s indicated earlier an ' chec becomes an

account receivable to the depositor. /he entry is>

%ccounts receivable 425.!;%pr. 3;

+ash 425.!;


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$n: Servi#e Ch$r"es( Depositors debit chec printin" char"es

7D,8 and other ban service char"es 7'+8 to ,iscellaneous

Expense. /he entry is>

,iscellaneous expense 3;.;;%pr. 3;

+ash 3;.;;



I&&str$tion 7-18

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/he reconcilin" item in a ban reconciliation that *ill result in

an ad=ustin" entry by the depositor is>

a. outstandin" checs.

b. deposit in transit.

c. a ban error.

d. ban service char"es.

Revie= >estion



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Disbursement systems that uses =ire, te&e%hone, or

#o%tersto transfer cash balances bet*een locations.

EFTtransfers normally result in 'etter intern$& #ontro&since no cash or checs are handled by company

employees.



E&e#troni# Fnds Tr$nsfer EFT3 S!ste

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'ally ist o*ns 9inen ist abrics. 'ally ass you

to explain ho* she should treat the follo*in" reconcilin" items *hen

reconcilin" the companys ban account> 718 a debit memorandum foran ' chec 728 a credit memorandum for a note collected by the

ban 738 outstandin" checs and 748 a deposit in transit.

'ally should treat the reconcilin" items as follo*s.

718 ' chec> Deduct from balance per boos.

728 +ollection of note> %dd to balance per boos.

738 ?utstandin" checs> Deduct from balance per ban.

748 Deposit in transit> %dd to balance per ban.

LO &

So&tion

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C$sh eiv$&entsare short0term hi"hly li)uid investments

that are both>

1. (eadily convertible to no*n amounts of cash and

2. 'o near their maturity that their maret value is relatively

insensitive to chan"es in interest rates.

LO ( E$plain the reporting of cash.

Re%ortin" C$shRe%ortin" C$shRe%ortin" C$shRe%ortin" C$sh

C$sh Eiv$&ents

+ash that is not available for "eneral use but rather is

restricted for a special purpose.

Restri#ted C$sh

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I&&str$tion 7-11

LO ( E$plain the reporting of cash.


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7-2

Chich of the follo*in" statements correctly describes the

reportin" of cashestion


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I&&str$tion 7-12

O%er$tin" C!#&e of $5er#h$ndisin" Co%$n!

LO ) Discuss the basic principles of cash management.

5$n$"in" $nd 5onitorin" C$sh5$n$"in" $nd 5onitorin" C$sh5$n$"in" $nd 5onitorin" C$sh5$n$"in" $nd 5onitorin" C$sh

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I&&str$tion 7-1*$si# 0rin#i%&es of C$sh 5$n$"eent

LO )


C

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C$sh d"et

F 'ho*s anticipated

cash flo*s usually

over a one0 to t*o0

year period.

F +ontributes to

more effective cash

mana"ement.

LO * Identify the primary elements of a cash budget.


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Invo&ves(

1. establishin" the fund

2. main" payments from the

fund and

3. replenishin" the fund.

0ett! C$sh Fnd0 &sed to pay small amounts.

LO + E$plain the operation of a petty cash fund.

O%er$tion of the 0ett! C$sh Fnd

A%%endi. 7AA%%endi. 7AA%%endi. 7AA%%endi. 7A

Ethi#s NoteInternal control

over a petty cash fund isstren"thened by> 718 havin"a supervisor mae surprisecounts of the fund to confirm*hether the paid petty cashreceipts and fund cash e)ualthe fund amount and

728 cancelin" or mutilatin" thepaid petty cash receipts sothey cannot be resubmittedfor reimbursement.

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I&&str$tion( If 9aird +ompany decides to establish a :1;; fundon ,arch 1 the entry is>

Petty cash 1;;,arch 1

+ash 1;;


O%er$tion of the 0ett! C$sh FndO%er$tion of the 0ett! C$sh FndO%er$tion of the 0ett! C$sh FndO%er$tion of the 0ett! C$sh Fnd

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I&&str$tion( ?n ,arch 15 the petty cash custodian re)uests achec for :$#. /he fund contains :13 cash and petty cash

receipts for posta"e :44 supplies :3$ and miscellaneous

expenses :5. /he entry is>

Posta"e expense 44,arch 15

+ash $#

'upplies 3$

,iscellaneous expense 5



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I&&str$tion( %ssume in the precedin" example that thecustodian had on&! ;12 in #$shin the fund plus the receipts as

listed. /he re)uest for reimbursement *ould therefore be for

:$$. /he entry is>

+ash over and short 1

+ash $$



Posta"e expense 44,arch 15

'upplies 3$

,iscellaneous expense 5

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e! 0oints

/he fraud trian"le discussed in this chapter is applicable to all

international companies. 'ome of the ma=or frauds on an

international basis are Parmalat 7Italy8 (oyal %hold 7the

etherlands8 and 'atyam +omputer 'ervices 7India8.

(isin" economic crime poses a "ro*in" threat to companies *ith

nearly half of all or"ani-ations *orld*ide bein" victims of fraud in a

recent t*o0year period 7Price*aterhouse+oopersGlobal

Economic +rime 'urvey 2;;58. 'pecifically 44@ of (omaniancompanies surveyed experienced fraud in the past t*o years.

LO 1, -ompare the accounting procedures for fraud

internal control and cash under /AA! and IF0.

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e! 0oints

Globally the number of companies reportin" fraud increased from

3#@ to 45@ since 2;;3 a 22@ increase. /he cost to companies

*as an avera"e :1.# million in losses from tan"ible fraudsthat

is those that result in an immediate and direct financial loss./hese include asset misappropriation false pretenses and

counterfeitin" 7Price*aterhouse+oopersGlobal Economic +rime

'urvey 2;;58.



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e! 0oints

%ccountin" scandals both in the &nited 'tates and internationally

have re0i"nited the debate over the relative merits of G%%P *hich

taes a rules0basedapproach to accountin" versus I(' *hich

taes a principles0basedapproach. /he %' announced that itintends to introduce more principles0based standards.

Internal controls are a system of checs and balances desi"ned to

prevent and detect fraud and errors. Chile most companies have

these systems in place many have never completely documentedthem nor had an independent auditor attest to their effectiveness.

oth of these actions are re)uired under '?H.



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e! 0oints

+ompanies find that internal control revie* is a costly process but

badly needed. ?ne study estimates the cost of '?H compliance

for &.'. companies at over :35 billion *ith audit fees doublin" in

the first year of compliance. %t the same time examination ofinternal controls indicates lin"erin" problems in the *ay companies

operate. ?ne study of first compliance *ith the internal control

testin" provisions documented material *eanesses for about

13@ of companies reportin" in a t*o0year period

7Price*aterhouse+oopersGlobal Economic +rime 'urvey 2;;58.



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e! 0oints

/he '?H internal control standards apply only to companies listed

on &.'. exchan"es. /here is continuin" debate over *hether

forei"n issuers should have to comply *ith this extra layer of

re"ulation.

/he accountin" and internal control procedures related to cash are

essentially the same under both I(' and this textboo. In

addition the definition used for cash e)uivalents is the same.

,ost companies report cash and cash e)uivalents to"ether under

I(' as sho*n in this textboo. In addition I(' follo*s the

same accountin" policies related to the reportin" of restricted

cash.



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e! 0oints

I(' defines cash and cash e)uivalents as follo*s.

F +ash is comprised of cash on hand and demand deposits.

F +ash e)uivalents are short0term hi"hly li)uid investmentsthat are readily convertible to no*n amounts of cash and

*hich are sub=ect to an insi"nificant ris of chan"es in value.

&nder I(' cash and cash e)uivalents are often sho*n last in the

statement of financial position.



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Loo:in" to the Ftre

Different cultures have different perspectives on bribery and other

)uestionable activities and conse)uently penalties for en"a"in" in such

activities vary considerably across countries. 6i"h0)uality international

accountin" re)uires both hi"h0)uality accountin" standards and hi"h0)uality auditin". 'imilar to the conver"ence of G%%P and I(' there is

movement to improve international auditin" standards. /he International

%uditin" and %ssurance 'tandards oard 7I%%'8 *ors to establish hi"h

)uality auditin" and assurance and )uality0control standards throu"hout

the *orld. Chether the I%%' adopts internal control provisions similar to

those in '?H remains to be seen. ou can follo* developments in the

international audit arena at http>JJ***.ifac.or"JiaasbJ.



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IFRS 0r$#ti#e



on0&.' companies that follo* I('>

a8 do not normally use the principles of internal control activities

used in this textboo.

b8 often offset cash *ith accounts payable on the balance sheet.

c8 are not re)uired to follo* '?H.

d8 one of the above.

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IFRS 0r$#ti#e



Chich of the follo*in" is the correct accountin" under I(' for

cash

ch07

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