Chapter 8

FRAUD, INTERNAL
CONTROL, AND
CASH
Chapter
8-1
 Fraud and Internal Control

Fraud
Dishonest act by an employee that results in personal
benefit to the employee at a cost to the employer.

Illustration 8-1

Why does
fraud occur?

Chapter
8-2 SO 1 Define fraud and internal control.
Chapter
8-3
 Fraud and Internal Control

The Sarbanes-Oxley Act

Companies must
develop principles of control over financial
reporting.
continually verify that controls are working.

Independent auditors must attest to the adequacy

of internal control.
SOX created the Public Company Accounting
Oversight Board (PCAOB).
Chapter
8-4 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Internal Control:
Related methods and measures adopted to:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records.
3. Increase efficiency of operations, and
4. Ensure compliance with laws and regulations.

Chapter
8-5 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Internal Control
Internal control systems have five primary components
1. A control environment
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring

Chapter
8-6 SO 1 Define fraud and internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

Measures vary with
management’s assessment of the risks faced.
size and nature of the company.

Six principles of controls activities:

 Establishment of responsibility
 Segregation of duties
 Documentation procedures
 Physical controls
 Independent internal verification
 Human resource controls
Chapter
8-7 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

ESTABLISHMENT OF RESPONSIBILITY
Control is most effective when only one person is responsible
for a given task.
SEGREGATON OF DUTIES
Related duties, including physical custody and record
keeping, should be assigned to different individuals.
DOCUMENTATION PROCEDURES
Companies should use prenumbered documents for all
documents should be accounted for.
Chapter
8-8 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

PHYSICAL CONTROLS Illustration 8-2

Chapter
8-9 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

INDEPENDENT INTERNAL Illustration 8-3

VERIFICATION
1. Verify records
periodically or on a
surprise basis.
2. Records verified by an
employee who is
independent.
3. Discrepancies reported
to management.

Chapter
8-10 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Principles of Internal Control Activities

HUMAN RESOURCE CONTROLS
1. Bond employees.
2. Rotate employees’ duties and
require vacations.
3. Conduct background checks.

Chapter
8-11 SO 2 Identify the principles of internal control.
 Fraud and Internal Control

Limitations of Internal Control

Costs should not exceed benefit.
Human element.
Size of the business.

Chapter
8-12 SO 2 Identify the principles of internal control.
 Cash Controls

Cash consists of coins, currency, checks, money

orders, and money on hand or on deposit in a bank.
Cash receipts come from:
cash sales
collections on account from customers
receipt of interest, rent, and dividends
investments by owners
bank loans
proceeds from the sale of noncurrent assets

Chapter
8-13 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Cash Receipts Controls

Establishment of Documentation Independent Internal
Responsibility Procedures Verification
Only designated Use remittance Supervisors count cash
personnel are advice (mail receipts daily;
authorized to handle receipts), cash treasurer compares
cash receipts register tapes, and total receipts to bank
(cashiers) deposit slips deposits daily

Segregation of Duties Physical, Human Resource

Different individuals Mechanical, and Controls
receive cash, record Electronic Controls Bond personnel who
cash receipts, and hold Store cash in safes handle cash; require
the cash and bank vaults; limit employees to take
access to storage vacations; deposit all
Illustration 8-4 areas; use cash cash in bank daily
registers
Chapter
8-14 SO 3 Explain the applications of internal control principles to cash receipts.
 Over-the-
Counter
Receipts

Illustration 8-4

Chapter
8-15 SO 3 Explain the applications of internal control principles to cash receipts.
 Mail Receipts

Control Procedures:
Mail receipts should be opened by two people, a list
prepared, and each check endorsed.

Copy of the list, along with the checks and

remittance advices, sent to cashier’s department.

Cashier adds the checks to the over-the-counter

receipts and prepares a daily cash summary and
makes the daily bank deposit.

Copy of list sent to treasurer’s office for

comparison with total shown on daily cash summary.
Chapter
8-16 SO 3 Explain the applications of internal control principles to cash receipts.
 Cash Controls

Cash Disbursements Controls

Generally, internal control over cash disbursements
is more effective when companies pay by check,
rather than by cash.
Applications:
Voucher system
Petty cash fund

Chapter SO 4 Explain the applications of internal

control principles to cash disbursements.
8-17
 Cash Controls

Cash Disbursements Controls Illustration 8-6

Documentation
Establishment of Procedures Independent Internal
Responsibility Use prenumbered Verification
Only designated checks; checks must Compare checks to
personnel are have an approved invoices; reconcile bank
authorized to sign invoice; require statement monthly
checks (treasurer) and employees to use
approve vendors corporate credit cards
Human Resource
for reimbursable
Controls
Segregation of Duties expenses
Bond personnel
Different individuals who handle cash;
Physical Controls require employees
approve and make
payments; check Store blank checks in to take vacations;
signers do not record safes, with limited conduct background
disbursements access; print check checks
amounts by machine in
Chapter
indelible ink
8-18
 Cash Controls

Cash Disbursements Controls

Voucher System
Network of approvals, by authorized
individuals, to ensure all disbursements by
check are proper.
A voucher is an authorization form prepared
for each expenditure.

Chapter SO 4 Explain the applications of internal

control principles to cash disbursements.
8-19
 Cash Controls

Cash Disbursements Controls

Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund,

2. making payments from the fund, and

3. replenishing the fund.

Chapter
8-20 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

Illustration: If Laird Company decides to establish a $100

fund on March 1, the journal entry is:

Mar. 1 Petty cash 100

Cash 100

Chapter
8-21 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

Illustration: Assume that on March 15 Laird’s petty cash

custodian requests a check for $87. The fund contains $13
cash and petty cash receipts for postage $44, freight-out $38,
and miscellaneous expenses $5. The general journal entry to
record the check is:

Mar. 15 Postage expense 44

Freight-out 38
Miscellaneous expense 5
Cash 87

Chapter
8-22 SO 5 Describe the operation of a petty cash fund.
 Cash Controls

Illustration: Occasionally, the company may need to recognize

a cash shortage or overage. Assume that Laird’s petty cash
custodian has only $12 in cash in the fund plus the receipts as
listed. The request for reimbursement would, therefore, be for
$88, and Laird would make the following entry:

Mar. 15 Postage expense 44

Freight-out 38
Miscellaneous expense 5
Cash over and short 1
Cash 88

Chapter
8-23 SO 5 Describe the operation of a petty cash fund.
 Control Features: Use of a Bank

Contributes to good internal control over cash.

Minimizes the amount of currency on hand.
Creates a double record of bank transactions.
Bank reconciliation.

Chapter
8-24 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank
Illustration 8-8
Making Bank Deposits
Authorized employee Bank Code
Numbers
should make deposit.

Reverse Side
Front Side
Chapter
8-25 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank

Writing Checks Illustration 8-9

Written order signed by depositor directing bank to pay

a specified sum of money to a designated recipient.

Maker

Payee

Payer

Chapter
8-26 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank
Illustration 8-10
Bank Statements
Debit Memorandum
Bank service charge
NSF (not sufficient
funds)

Credit Memorandum
Collect notes
receivable.
Interest earned.

Chapter
8-27 SO 6 Indicate the control features of a bank account.
 Control Features: Use of a Bank

Reconciling the Bank Account

Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.

2. Outstanding checks.

3. Errors.

4. Bank memoranda (service charges).

Chapter
8-28 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

Reconciliation Procedures
Illustration 8-11

+ Deposit in Transit + Notes collected by bank

- Outstanding Checks
+- Bank Errors
CORRECT BALANCE
- NSF (bounced) checks
- Check printing or other
service charges
+- Company Errors
CORRECT BALANCE

Chapter
8-29 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

Illustration: The bank statement for Laird Company (Illustration

8-10), shows a balance per bank of $15,907.45 on April 30, 2010.
On this date the balance of cash per books is $11,589.45. Using
the four reconciliation steps, Laird determines the following
reconciling items.

Chapter
8-30
 Control Features: Use of a Bank
Illustration: a) Prepare a bank reconciliation at April 30.

Cash balance per bank statement $15,907.45

Add: Deposit in transit 2,201.40
Less: Outstanding checks (5,904.00)
Adjusted cash balance per bank $12,204.85

Cash balance per books $11,589.45

Add: Error in recording check no. 443 36.00
Collection of notes + interest - fee 1,035.00
Less: NSF check (425.60)
Bank service charge (30.00)
Adjusted cash balance per books $12,204.85
Chapter Illustration 8-12
8-31 SO 7 Prepare a bank reconciliation.
 Control Features: Use of a Bank

The company records each reconciling item used to determine

the adjusted cash balance per books.
Collection of Note Receivable: Assuming interest of $50 has
not been accrued and collection fee is charged to
Miscellaneous Expense, the entry is:

Apr. 30 Cash 1,035.00

Miscellaneous expense 15.00
Notes receivable 1,000.00
Interest revenue 50.00

Chapter
8-32 SO 5 Describe the operation of a petty cash fund.
 Control Features: Use of a Bank

Book Error: The cash disbursements journal shows that

check no. 443 was a payment on account to Andrea Company,
a supplier. The correcting entry is:

Apr. 30 Cash 36.00

Accounts payable 36.00

Chapter
8-33 SO 5 Describe the operation of a petty cash fund.
 Control Features: Use of a Bank

NSF Check: As indicated earlier, an NSF check becomes an

account receivable to the depositor. The entry is:

Apr. 30 Accounts receivable 425.60

Cash 425.60

Bank Service Charges: Depositors debit check printing

charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:

Apr. 30 Miscellaneous 30.00

Cash 30.00
Chapter
8-34 SO 5 Describe the operation of a petty cash fund.
 Control Features: Use of a Bank

Electronic Funds Transfers (EFT)

Disbursement systems that uses wire,
telephone, or computers to transfer cash
balances between locations.
EFT transfers normally result in better
internal control since no cash or checks are
handled by company employees.

Chapter
8-35 SO 7 Prepare a bank reconciliation.