Chapter 7 - Lecture notes 7 PDF

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Lecture Notes - ACCTG 241 - Danny Erickson...

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Chapter 7 Friday, October 15, 2021 11:36 AM

1. Fraud a. A fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. b. The fraud triangle refers to the three main factors that contribute to fraudulent activity by employees: i. Opportunity - occurs when the workforce lacks sufficient controls to deter and detect fraud. ii. Financial pressure - employees sometimes commit fraud because they want to lead a lifestyle that they cannot afford on their current salary. iii. Rationalization - employees sometimes commit fraud because they believe they are underpaid and the employer is making lots of money. 2. Internal Control a. The purposes of internal control are: i. Safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations b. Internal control systems have five primary components: a control environment, risk assessment, control activities, information and communication, and monitoring c. Principles of Internal Control i. Establishment of responsibility: control is most effective when only one person is responsible for a given task, (i.e., cash register) ii. Segregation of duties: the work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee *Record keeping separate from physical custody (the person recording the records never has access to the assets)… iii. Documentation procedures: documents provide evidence that transactions and events have occurred *Prenumbered documents… iv. Physical controls relate to the safeguarding of assets (safes, vaults, safety deposit boxes, and locked warehouses), and enhance the accuracy and reliability of the accounting records (alarms, television monitors, garment sensors, and time clocks) v. Independent internal verification: the review of data prepared by employees vi. Human resource controls: 1. Bonding employees who handle cash involves obtaining insurance protection against theft by employees 2. Rotating employees' duties and requiring employees to take vacations deters employees from attempting thefts since they will not be able to permanently conceal their improper actions. 3. Conducting thorough background checks is considered by many to be the most important and inexpensive measure any business can take to reduce employee theft and fraud d. Limitations of Internal Control i. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit

ii.

b.

b.

b.

3.

4.

c. 5.

It should also be recognized that the human element (employee fatigue, carelessness, or indifference) is an important factor as is collusion between two or more individuals to get around prescribed controls Cash Receipts Controls i. Checks - Stamp on the Checks => "For Deposit Only" ii. Rotate Duties on the receipt of cash (rotate employees)… Cash Disbursements Controls i. Rotate Duties in the payment process (employees) ii. Use prenumbered checks iii. Use electronic payment systems Use a bank… i. Remove physical control of cash (cash is then in the bank)… ii. A bank creates another record of the cash events… Reporting of Cash a. On the balance sheet, companies often combine cash on hand, cash in bank, and petty cash and report the total as Cash b. Cash equivalents are short-term, highly liquid investments that are both: i. Securities with a maturity under 90 days ii. Readily convertible to known amounts of cash Restricted Cash should NOT be reported as cash a. Restricted cash is cash that is not available for general use but is restricted for a special purpose b. Example #1 - Compensating Balance (required by a bank) A bank might require a business to keep an amount in the bank as a requirement to continue with a banking relationship between the business and the bank Example #2 - Building Fraud A business might be building a cash fund to build a new building Petty Cash Account (or Petty Cash Fund) A business might need cash to pay for small items around the office A Petty Cash account can be used for this type of situation Establish Petty Cash account… Petty Cash

200

Cash

200

The business buys a few items over the month. The receipts are kept in a folder. At the end of the month the purchased items are recorded. The business adds up to the receipts and the business is missing 2 dollars (not a big deal). Postage Expense

15

Office Supplies Expense

100

Entertainment Expense

20

Cash Over and Short

2

Cash

137

The business gets cash from the bank and replenishes the Petty Cash account (see the above journal entry) The business wants to increase the Petty Cash account Petty Cash

100 Cash

100

Bank Balance

15

Subtract: Outstanding Checks Add or Subtract: Any Bank Errors Add: Outstanding Deposits

-2 3 1

Correct Balance => Banks

17

Business Entity / Book Balance

20

Subtract: Bank Fees & Other Bank Expenses Add: Interest Revenue Add: Cash Received by the Bank (unknown to the business) Subtract: NSF Checks (from Customers) Add or Subtract: Errors

-1 2 5 -6 -3

Correct Business Entity Balance (Book Balance)

17

Notes: Outstanding Checks - Checks written by the business that have not been cleared through the banking system Outstanding Deposits - Deposits made by the business that have not cleared through the banking system NSF Checks - These items are checks that the business thought it had received money from customers. The checks were deposited and the banking system reported back to the business that the customers' bank accounts were empty (the checks "bounced"). *NSF = Non-Sufficient Funds...