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السبت، 9 أبريل 2016

Summarization chapter 8- FRAUD, INTERNAL CONTROL, AND CASH


Summarization chapter 7- FRAUD, INTERNAL CONTROL, AND CASH


Fraud
A fraud is a dishonest act by an employee that results in personal benefi t to the
employee at a cost to the employer

Why does fraud occur?
The three main factors that contribute to fraudulent activity are depicted by the fraud triangle


opportunity.
For an employee to commit fraud, the workplace environment must provide opportunities that an employee can take advantage of. Opportunities occur when the workplace lacks suffi cient controls to
deter and detect fraud
financial pressure.
Employees sometimes commit fraud because of personal financial problems
caused by too much debt.

rationalization
employees rationalize their dishonest actions. For example, employees sometimes justify fraud because they believe they are underpaid while the employer is making lots of money. Employees feel justified in stealing because they believe they deserve to be paid more.

The Sarbanes-Oxley Act (SOX)
Under SOX, all publicly traded U.S. corporations are required to maintain an adequate system of internal control. Corporate executives and boards of directors must ensure that these controls are reliable and effective. In addition, independent outside auditors must attest to the adequacy of the internal control system. Companies that fail to comply are subject to fi nes, and company
officers can be imprisoned.

Internal Control
Internal control consists of all the related methods and measures adopted within an organization to safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations.
Internal control systems have five primary components as listed 
• A control environment. It is the responsibility of top management to make it clear that the organization values integrity and that unethical activity will not be tolerated. This component is often referred to as the “tone at the top.”
• Risk assessment. Companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks.
• Control activities. To reduce the occurrence of fraud, management must design policies and procedures to address the specifi c risks faced by the company.
• Information and communication. The internal control system must capture and communicate all pertinent information both down and up the organization, as well as communicate information to appropriate external parties.
• Monitoring. Internal control systems must be monitored periodically for their adequacy. Signifi cant deficiencies need to be reported to top management and/or the board of directors.


Principles of Internal Control Activities

control activities الانشطة الرقابية
are the backbone of the company’s efforts to address the risks it faces, such as fraud. 
The specific control activities used by a company will vary, depending on management’s assessment of the risks faced. This assessment is heavily influenced by the size and nature of the company.

The six principles of control activities are as follows.
• Establishment of responsibility تحديد المسئوليات 
• Segregation of duties الفصل بين المهام 
• Documentation procedures اجراءات التوثيق
• Physical controls الرقابه المادية
• Independent internal verification  التفويض الداخلي للصلاحيات
• Human resource controls  رقابه ادارة الموارد البشرية


ESTABLISHMENT OF RESPONSIBILITY
An essential principle of internal control is to assign responsibility to specifi c employees. Control is most effective when only one person is responsible for a given task.

SEGREGATION OF DUTIES
Segregation of duties is indispensable in an internal control system.
There are two common applications of this principle:
1. Different individuals should be responsible for related activities.
2. The responsibility for record-keeping for an asset should be separate
from the physical custody of that asset.
The rationale for segregation of duties is this:
The work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee

DOCUMENTATION PROCEDURES

Documents provide evidence that transactions and events have occurred.
By requiring signatures (or initials) on the documents, the company can identify the individual(s) responsible for the transaction or event. Companies should document transactions when the transaction occurs
Companies should establish procedures for documents. First, whenever possible,
companies should use prenumbered documents, and all documents
should be accounted for. Prenumbering helps to prevent a transaction from
being recorded more than once, or conversely, from not being recorded at all.
Second, the control system should require that employees promptly forward
source documents for accounting entries to the accounting department.
This control measure helps to ensure timely recording of the transaction
and contributes directly to the accuracy and reliability of the accounting records.


PHYSICAL CONTROLS

Use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records.




INDEPENDENT INTERNAL VERIFICATION

INDEPENDENT INTERNAL VERIFICATION
Most internal control systems provide for independent internal verifi cation. This
principle involves the review of data prepared by employees. To obtain maximum
benefit from independent internal verification:
1. Companies should verify records periodically or on a surprise basis.
2. An employee who is independent of the personnel responsible for the information
should make the verification.
3. Discrepancies and exceptions should be reported to a management level that
can take appropriate corrective action



Large companies often assign independent internal verification to internal auditors. Internal auditors are company employees who continuously evaluate the effectiveness of the company’s internal control systems

HUMAN RESOURCE CONTROLS

Human resource control activities include the following.
1. Bond employees who handle cash. Bonding involves obtaining insurance
protection against theft by employees. It contributes to the safeguarding of
cash in two ways. First, the insurance company carefully screens all individuals
before adding them to the policy and may reject risky applicants. Second,
bonded employees know that the insurance company will vigorously prosecute all offenders.
2. Rotate employees’ duties and require employees to take vacations. These
measures deter employees from attempting thefts since they will not be able
to permanently conceal their improper actions. Many banks, for example,
have discovered employee thefts when the employee was on vacation or assigned to a new position.
3. Conduct thorough background checks. Many believe that the most important
and inexpensive measure any business can take to reduce employee theft
and fraud is for the human resources department to conduct thorough background
checks. Two tips: (1) Check to see whether job applicants actually
graduated from the schools they list. (2) Never use telephone numbers for
previous employers provided by the applicant. Always look them up yourself

Limitations of Internal Control

Companies generally design their systems of internal control to provide reasonable assurance of proper safeguarding of assets and reliability of the accounting records. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit.


Cash Controls
cash is the asset most susceptible to fraudulent activities

Cash Receipts Controls


internal control over cash receipts,
we will examine control activities for a retail store with both over-the-counter and mail receipts
OVER-THE-COUNTER RECEIPTS
The customer receives an itemized cash register receipt slip and is expected to count the change received The cash register’s tape is locked in the register until a supervisor removes it. This tape accumulates the daily transactions and totals.
At the end of the clerk’s shift, the clerk counts the cash and sends the cash and
the count to the cashier. The cashier counts the cash, prepares a deposit slip, and
deposits the cash at the bank. The cashier also sends a duplicate of the deposit
slip to the accounting department to indicate cash received. The supervisor
removes the cash register tape and sends it to the accounting department as the
basis for a journal entry to record the cash received


This system for handling cash receipts uses an important internal control
principle—segregation of record-keeping from physical custody. The supervisor
has access to the cash register tape but not to the cash. The clerk and the cashier
have access to the cash but not to the register tape. In addition, the cash register
tape provides documentation and enables independent internal verifi cation. Use
of these three principles of internal control (segregation of record-keeping from
physical custody, documentation, and independent internal verifi cation) provides
an effective system of internal control. Any attempt at fraudulent activity should
be detected unless there is collusion among the employees
In some instances, the amount deposited at the bank will not agree with
the cash recorded in the accounting records based on the cash register tape. These
differences often result because the clerk hands incorrect change back to
the retail customer. In this case, the difference between the actual cash and the
amount reported on the cash register tape is reported in a Cash Over and Short account
Cash 6,946.10
Cash Over and Short 10.10
Sales Revenue 6,956.20
(To record cash shortfall)


MAIL RECEIPTS
All mail receipts should be opened in the presence of at least two mail clerks.
These receipts are generally in the form of checks. A mail clerk should endorse
each check “For Deposit Only.” This restrictive endorsement reduces the likelihood
that someone could divert the check to personal use. Banks will not
give an individual cash when presented with a check that has this type of
endorsement

Cash Disbursements Controls
Companies disburse cash for a variety of reasons, such as to pay expenses and
liabilities or to purchase assets. Generally, internal control over cash disbursements
is more effective when companies pay by check or electronic funds
transfer (EFT) rather than by cash. One exception is payments for incidental
amounts that are paid out of petty cash.

VOUCHER SYSTEM CONTROLS
Most medium and large companies use vouchers as part of their internal control
over cash disbursements. A voucher system is a network of approvals by authorized
individuals, acting independently, to ensure that all disbursements by check
are proper.
The system begins with the authorization to incur a cost or expense. It ends
with the issuance of a check for the liability incurred. A voucher is an authorization
form prepared for each expenditure. Companies require vouchers for all types of
cash disbursements except those from petty cash



Petty Cash Fund
As you just learned, better internal control over cash disbursements is possible
when companies make payments by check. However, using checks to pay small
amounts is both impractical and a nuisance. For instance, a company would
not want to write checks to pay for postage due, working lunches, or taxi fares.
A common way of handling such payments, while maintaining satisfactory
control, is to use a petty cash fund to pay relatively small amounts. The operation
of a petty cash fund, often called an imprest system, involves (1) establishing
the fund, (2) making payments from the fund, and (3) replenishing
the fund


 Petty Cash 100
Cash 100
(To establish a petty cash fund)
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Postage Expense 44
Freight-Out 38
Miscellaneous Expense 5
Cash 87
(To replenish petty cash fund)
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Control Features: Use of a Bank

The use of a bank contributes signifi cantly to good internal control over
cash. A company can safeguard its cash by using a bank as a depository and as a
clearinghouse for checks received and written. Use of a bank minimizes the
amount of currency that a company must keep on hand. Also, use of a bank
facilitates the control of cash because it creates a double record of all bank
transactions—one by the company and the other by the bank. The asset account
Cash maintained by the company should have the same balance as the bank’s
liability account for that company. A bank reconciliation compares the bank’s
balance with the company’s balance and explains any differences to make them agree

Making Bank Deposits


An authorized employee, such as the head cashier, should make a company’s bank deposits



Writing Checks
Most of us write checks without thinking very much about them. A check is a
written order signed by the depositor directing the bank to pay a specifi ed sum of
money to a designated recipient. There are three parties to a check: (1) the maker 
(or drawer) who issues the check, (2) the bank (or payer) on which the check is
drawn, and (3) the payee to whom the check is payable. A check is a negotiable
instrument that one party can transfer to another party by endorsement. Each
check should be accompanied by an explanation of its purpose.


It is important to know the balance in the checking account at all times. To
keep the balance current, the depositor should enter each deposit and check on
running-balance memo forms (or online statements) provided by the bank or on
the check stubs in the checkbook.

Bank Statements
If you have a personal checking account, you are probably familiar with bank statements.
A bank statement shows the depositor’s bank transactions and balances.5
Each month, a depositor receives a statement from the bank.

The bank credits to the customer’saccount every deposit it receives. The reverse occurs when the bank “pays” a check issued by a company on its checking account balance. Payment reduces the bank’s liability. Thus, the bank debits check payments to the customer’s account with the bank.


DEBIT MEMORANDUM
Some banks charge a monthly fee for their services. Often, they charge this fee
only when the average monthly balance in a checking account falls below a specifi
ed amount. They identify the fee, called a bank service charge, on the bank
statement by a symbol such as SC. The bank also sends with the statement a debit
memorandum explaining the charge noted on the statement

CREDIT MEMORANDUM
Sometimes a depositor asks the bank to collect its notes receivable. In such a
case, the bank will credit the depositor’s account for the cash proceeds of the note


Reconciling the Bank Account

The bank and the depositor maintain independent records of the depositor’s
checking account. People tend to assume that the respective balances will always
agree. In fact, the two balances are seldom the same at any given time, and both
balances differ from the “correct” or “true” balance. Therefore, it is necessary to
make the balance per books and the balance per bank agree with the correct or
true amount—a process called reconciling the bank account

The bank reconciliation should be prepared by an employee who has no
other responsibilities pertaining to cash

The following steps reveal all the reconciling items that cause the difference 
Step 1. Deposits in transit.
 Compare the individual deposits listed on the bank
statement with deposits in transit from the preceding bank reconciliation
and with the deposits per company records or duplicate deposit
slips. Deposits recorded by the depositor that have not been recorded by
the bank are the deposits in transit. Add these deposits to the balance per bank. Step
 2. Outstanding checks.
Compare the paid checks shown on the bank statement with
(a) checks outstanding from the previous bank reconciliation
 (b) checks issued by the company as recorded in the cash
payments journal (or in the check register in your personal checkbook).
Issued checks recorded by the company but that have not yet been paid
by the bank are outstanding checks. Deduct outstanding checks from
the balance per the bank. Step 
3. Errors. Note any errors discovered in the foregoing steps and list them
in the appropriate section of the reconciliation schedule. For example, if
the company mistakenly recorded as $169 a paid check correctly written
for $196, it would deduct the error of $27 from the balance per books.
All errors made by the depositor are reconciling items in determining
the adjusted cash balance per books. In contrast, all errors made by the
bank are reconciling items in determining the adjusted cash balance per the bank.
Step 4. Bank memoranda.
 Trace bank memoranda to the depositor’s records.
List in the appropriate section of the reconciliation schedule
any unrecorded memoranda. For example, the company would deduct
from the balance per books a $5 debit memorandum for bank
service charges. Similarly, it would add to the balance per books $32 of interest earned.


Electronic Funds Transfer (EFT) System
EFT transactions normally result in better internal control since no cash or
checks are handled by company employees. This does not mean that opportunities
for fraud are eliminated. In fact, the same basic principles related to internal
control apply to EFT transfers. For example, without proper segregation of duties
and authorizations, an employee might be able to redirect electronic payments into
a personal bank account and conceal the theft with fraudulent accounting entries.

Reporting Cash
Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository.
 Companies report cash in two different statements:
the balance sheet and the statement of cash flows.

The balance sheet reports the amount of cash available at a given point intime.
 The statement of cash fl ows shows the sources and uses of cash during a period of time
Cash Equivalents

Many companies use the designation “Cash and cash equivalents” in reportingcash.

Cash equivalents are short-term, highly liquid investments that are both:
1. Readily convertible to known amounts of cash, and
2. So near their maturity that their market value is relatively insensitive to changes in interest rates.




Restricted Cash


A company may have restricted cash, cash that is not available for
general use but rather is restricted for a special purpose. For example, landfi ll
companies are often required to maintain a fund of restricted cash to ensure
they will have adequate resources to cover closing and clean-up costs at the end
of a landfill site’s useful life

Cash restricted in use should be reported separately on the balance sheet asrestricted cash.





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