ACCT - Test 3 (11/9)

fraud

fraud is an intentional act of deception committed to obtain an unfair or illegal financial benefit. (Ex: a bookkeepers transfers company money into their personal bank account)

what are the parts of the fraud triangle

opportunity, rationalization, pressure

opportunity

ability to commit fraud without being caught

raltionalization

justifying dishonest behavior

pressure

financial or personal motivation

what is internal control

are procedures businesses use to:

reduce errors

prevent fraud

protect company assets

promote effective operations

as a company grows, internal controls become more important

because managers cannot supervise every employee or transaction

four primary objectives of internal records

safeguard assets

ensure reliable financial reporting

promote efficient operations

ensure compliance with laws and regulations

safeguard assets

protect company property (i.e. locking cash in register)

ensure reliable financial reporting

keep accurate recording (i.e. monthly bank reconciliation)

promote efficient operations

make work more effectrive (i.e. inventory tracking)

ensure compliance with laws and regulations

follow the law (i.e. following payroll tax regulations)

Sarbanes-Oxley Act of 2022 (SOX)

is a federal law created to improve financial reporting, strengthen corporate accountability, and protect investors

key requirements of the Sarbanes-Oxley Act (SOX)

internal controls

independent audits

executive accountability

six principles of internal control activities

establishment of responsibility

segregation of duties

documentation procedures

physical controls

independent internal verification

human resource controls

establishment of responsibility

assign specific duties to individual employees (i.e. each cashier has their own cash drawer)

it makes employees accountable and helps identify who made an error

segregation of duties

divide related responsibilities among different employees. no single employee should control every part of a transaction (i.e. one employee approves, another receives, and another authorizes purchases).

reduces opportunities for fraud

three functions that should generally be separated:

authorization - approving a transaction

custody - having physical control of assets

recordkeeping - recording transactions in accounting records

documentation procedures

use properly numbered documents and record transactions promptly (i.e. prenumbered invoice, checks, receipts).

keeps tracks of duplicates

physical control

protect company assets and restrict unauthorized access (i.e. safes and locked storage, security camera)

reduces theft, loss, unauthored access, and inaccurate records

independent internal verification

an independent employee reviews accounting records and transactions to verify their accuracy (i.e. an employee who does not handle cash prepares the bank reconciliation)

detects errors and possible frauds

human resource controls

these are procedures involving employees (i.e. bond employees, rotate duties and require vacation, conduct background checks)

limitations of internal controls

human factors:

• human error - employees making mistakes; poor judgment

• collusion - two or more employees work together to approve a fraudulent payment

cost benefit constraint - benefits of I.C. should justify their costs; may not have enough resources to separate every employee’s duties

blockchain

a shared digital ledger that records transactions in a secure, chronological, and tamper-resistant manner

how blockchain supports internal controls:

transaction history

data integrity

auditing

cash controls

an effective system of internal control that protects cash and cash equivalents

3 basic guidelines for cash controls:

handling cash is separate from recordkeeping for cash

cash receipts are promptly deposited in a bank

cash payments are made by check or EFT

what is considered cash

currency

coins

customer, cashier, and certified checks

money orders

cash equivalents

short term, highly liquid investments that are:

readily convertible to a known cash amount

close to maturity date and not sensitive to changes

(i.e. U.S. treasury bills)

liquidity

are assets that can be readily be used to pay current liabilities

EFT

(electronic fluid transfer) the electronic transfer of money from one party to another (i.e. online bill payments)

fast and convenient

check receipts

when checks are received at the point of sale, they are included in the daily cash reconciliation

cash shortages and overages

the difference (-) between actual cash and the amount reported on the cash register tape recorded in the Cash Over and Short account

shortage

actual cash is less than recorded sales (short = missing money)

overage

actual cash is more than recorded sales (over = extra money)

cash dosbusements

payments made by a company

voucher system

system of procedures as a way to control cash payments

the voucher process

authorize the expense (prepare voucher)

record the liability (accts. payable)

issue the check and mark the voucher “paid”

record the payment in the check register

(authorize → record liability → pay → record payment)

petty cash

is a small amount of money kept by a company for minor everyday expenses (i.e. small office purchases, minor supplies)

the imprest system (for petty cash)

a fixed amount is established

money is used for small expenses

receipts are collected for every payment

the fund is replenished back to its original amount

bank accounts (bank service)

provide a secure place for money

signature cards (bank service)

identify authorized signatures

deposit tickets (bank service)

support deposits

check (bank service)

authorize paayments

EFT (bank service)

transfer cash electronically

bank statements (bank service)

help identify unusual unauthorized activity

why use a bank

strengthens internal control over cash

safeguards cash

reduces cash kept on hand

creates two sets of records (company and bank)

bank reconcilication

compares the company’s book balance with the bank statement balance

bank balance (bank side)

the amount shown on the bank statement

book balance (book side)

the amount recorded in the company’s accounting records

bank side adjustments

deposits in transit (+)

outstanding checks (-)

bank errors (-,+)

book side adjustments

interest earned (+)

unrecorded cash receipts (+)

bank fees (-)

NSF checks (-)

book errors (-,+)

NSF

(not sufficient funds) a customer writes a check, but their bank returns it because they do not have enough money

a receivable

is an amount of money owed to a company’s by a customer or another party

are expected to be collected in cash

among a company’s most liquid assets

each customer has separate purchases, payments, and the balance owed

types of receivables

accounts

notes

other

accounts receivables (A/R)

amounts customers owe for goods or services sold on account

usually collected within 30-60 days

most common type of receivable

(i.e. a business sells 2,000 of merchandise to a customer on credit)

notes receivable

a formal written promise to pay a specific amount

generally includes interest, specified maturity date, and can be long or short term

(i.e. a customer signs a 90-day, 6% note promising to pay 5,000)

other receivables

amounts owed that do not come formal normal business operations

interest, employees advances, and tax refunds - reported separately

(i.e. an employee owes the company 500 for an advance)

trade receivables

result from normal business operations

bad debts

are amounts customers owe that are unlikely to be collected

are a normal risk of selling goods and services on credit

why do bad debts happen

may run out of money

may refuse to pay

may go out of business

simply fail to pay their bills

accts. receivable is a current asset, but..

companies should not overstate the amount they expect to collect

requirement for the direct write off method

timing - when account is written off

matching - does NOT match expense with revenue

GAAP - not allowed

focus - actual losses

requirements for the allowance method

timing - when sale occurs

matching - DOES match expense with revenue

GAAP - required

focus - estimated losses

direct write off method

the company records bad debt expense only when it determines that a customer’s account cannot be collected

allowance method

this method estimates how much money the company will not collect; instead of waiting until a customer fails to pay, the company estimates bad debts each accounting period

NRV

(net realizable value) is the the amount of accounts receivable the company expects to actually collect

= accounts receivable - allowance for doubtful accounts

write-off

happens when the company determines that a customer’s account is no longer collectible

a write off under the allowance method affects only…

balance sheet accounts. it does not create another bad debt expense because the expense was already estimated and recorded earlier

internal controls for uncollectible accounts.. why

prevent fraud and ensure write-offs are legitimate

management approval requires

segregation of duties - person approving write-offs should NOT handle cash or accounts receivable

percentage of receivables method

management estimates bad debts based on a % of accounts receivable

two approaches:

• single % of total receivables

• aging of receivables (different % to older accounts)

single % method

calculate desired balance = A/R x estimated uncollected %

determine adjustment = desired balance - existing credit

aging of accounts receivable method

separates customer balances based on how long they have been outstanding

older accounts are more likely to become uncollectable

the older the account..

the higher the estimated % of uncollectible accounts

promissory note (notes receivable)

a written promise to pay a specific amount at a specific time

key features of a promissory note (N/R)

formal credit instrument

stronger legal claim than A/R

negotiable (can be transferred)

when are notes receivable used

lending or borrowing money

large or long term credit

replacing accounts receivable

what is the difference between accts. receivable and notes receivable

A/R = informal; N/R = formal, written document with interest

maker (party to a notes)

the party making promise to pay

refers to the note as a note payable

THINK: makes the promise

payee (party to a notes)

the party receiving the payment

refers to the note as a note receivable

THINK: gets paid

computing interest

interest = face value of note x annual interest rate x time in terms of 1 year

days = fraction of 360

months = fraction of 12

initial note/entry

journal entry: note is recorded at face value

interest is earned over time

notes receivable honored at maturity

calculate interest = principal x rate x time

determine total cash received = principal + interest

accrual of interest receivable

interest is earned over time, even if the company has not received the cash yet

companies must record accrue interest earned by the end of the accounting period. from note date → financial statement date

disposal of receivables

companies sometimes need cash immediately instead of waiting for customers to pay, so… you do..

selling receivables (factoring) - form of disposal

occurs when a company sells its receivables to a factor, usually a bank or finance company

pledging receivables - form of disposal

means a company borrows money using its receivables as collateral

A/R turnover

ratio measures how quickly a company collects its receivables

= net credit sales / average net accounts receivable

higher turnover =

faster collection of cash

lower turnover =

slower collection of cash

plant assets

tangible assets used in a company’s operations that have a useful like of more than one accounting period

plant assets generally lose service potential except…

for land

historical cost principle

requires that companies record plant assets at cost

acquisition cost

includes all expenditures necessary to get the asset in place and ready for use

= purchase price + all necessary costs to get the asset ready for use

land

includes all necessary costs incurred to make the land ready for its intended use

Land is NOT depreciated because it has an indefinite useful life

true

land improvements

structural additions made to land that have limited useful like (I.e. parking lots, fences, driveways, sidewalks, etc.)

land improvements ARE depreciated because they eventually need replacement

true

costs included in land

purchase price

accrued property taxes paid by purchaser

title insurance premiums

real estate commissions

legal, surveying fees

clearing, grading, and draining

removing unwanted structures ( - salvage proceeds)

cost included in land improvements

purchase or construction fees

title, architecture, attorney, brokerage fees

building permits

remodeling costs

taxes

interest costs on construction loans (during construction)