Accounting Chapter 7: Fraud, Internal Control, and Cash

What is fraud in the context of internal control?

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

What are the three factors of the fraud triangle?

Opportunity, Financial Pressure, and Rationalization.

What does 'Opportunity' refer to in the fraud triangle?

When the workplace lacks sufficient controls to deter and detect fraud.

What is 'Financial Pressure' in the context of the fraud triangle?

When employees have personal financial problems or a desire to lead a lifestyle they cannot afford.

How does 'Rationalization' contribute to fraud?

Employees may believe their dishonest actions are justified.

What is the Sarbanes-Oxley Act (SOX)?

A law that requires publicly traded U.S. corporations to maintain a system of internal control.

What is one requirement of corporate executives under SOX?

They must ensure that internal controls are reliable and effective.

What is the purpose of internal control?

To provide reasonable assurance regarding the achievement of company objectives related to operations, reporting, and compliance.

Name one primary component of internal control systems according to COSO.

Control environment, Risk assessment, Control activities, Information and communication, or Monitoring.

What is the purpose of establishing responsibility in internal control?

To assign responsibility to specific employees, ensuring that only authorized personnel handle certain tasks.

What is the principle of segregation of duties?

Different individuals should be responsible for related activities to reduce the risk of errors and fraud.

How does segregation of duties help in purchasing activities?

It decreases the potential for errors and irregularities by assigning related purchasing activities to different individuals.

What was the fraud case involving Maureen Frugali about?

She created fictitious claims for training purposes and received payments for some of them, totaling $11 million.

What was the missing control in Maureen Frugali's case?

The healthcare company did not adequately restrict the responsibility for authorizing and approving claims transactions.

What fraudulent activity did Lawrence Fairbanks commit at Aesop University?

He used university funds to buy personal items by submitting fake vendor invoices.

What was the total amount embezzled by Lawrence Fairbanks?

$475,000.

What was the missing control in Lawrence Fairbanks's case?

The university had not properly segregated related purchasing activities.

What type of fraud did Angela Bauer commit at Aggasiz Construction?

She wrote checks for costs that the company had not incurred and altered the payee line to personal accounts.

How much money did Angela Bauer embezzle?

$570,000.

What was the missing control in Angela Bauer's case?

Aggasiz Construction Company did not properly segregate recordkeeping from physical custody.

What are the principles of internal control activities?

Establishment of responsibility, segregation of duties, documentation procedures, physical controls, independent internal verification, and human resource controls.

What is the role of documentation procedures in internal control?

To ensure that all transactions are properly recorded and can be verified.

What are physical controls in internal control?

Measures to safeguard assets and ensure that access is limited to authorized personnel.

What does independent internal verification involve?

Regularly reviewing and verifying the accuracy of records and transactions by someone not involved in the process.

What are human resource controls?

Controls related to hiring, training, and monitoring employees to prevent fraud and ensure compliance.

What is the significance of the Public Company Accounting Oversight Board (PCAOB)?

It was created by SOX to oversee the audits of public companies and ensure the accuracy of financial reporting.

What is the goal of internal controls in sustainability reporting?

To prevent unauthorized use of data and ensure the accuracy and validity of sustainability information.

What was the main issue with Aggasiz Construction Company's recordkeeping?

They did not properly segregate recordkeeping from physical custody.

Who had physical custody of the checks at Aggasiz Construction Company?

Angela had physical custody of the checks.

What is the purpose of using prenumbered documents in accounting?

To prevent double recording or omission of transactions.

What documentation procedures should Mod Fashions implement to prevent fraud?

Require original, detailed receipts and use corporate credit cards for business expenses.

What fraud scheme was used by employees at Mod Fashions?

They submitted claims for the same expenses using different types of receipts.

How much money did the fraud at Mod Fashions total?

$75,000.

What basic physical controls were lacking at Centerstone Health?

The mailroom should have been locked during nonbusiness hours and access should have been tightly controlled.

What was the total amount embezzled in the fraud at Centerstone Health?

$240,000.

What is the purpose of independent internal verification?

To review data prepared by employees and compare recorded accountability with existing assets.

What human resource control can deter employee theft?

Bonding employees who handle cash and conducting background checks.

What was the fraud scheme at Excelsior Inn?

Ellen provided discounts for cash payments and did not register guests, while Josephine cleaned the rooms.

How much money was taken in the fraud at Excelsior Inn?

$95,000.

What requirement under SOX helps track employee qualifications?

Companies must keep track of employees' degrees and certifications.

What is one benefit of data analytics in internal controls?

It enables continuous monitoring of virtually every transaction.

What is a limitation of internal control?

The human element can affect the effectiveness of internal controls.

What control activity was violated in the Knowledge Check Case 1?

Segregation of duties.

Why is segregation of duties important?

To prevent an employee from embezzling cash and hiding the theft through journal entries.

What should be done to improve documentation procedures?

Documents should be promptly forwarded for accounting entries.

What is the role of physical controls in accounting?

To safeguard assets and enhance the accuracy and reliability of accounting records.

What is the risk associated with collusion among employees?

It can reduce the effectiveness of internal controls.

What should a company do to ensure proper employee supervision?

Develop and monitor an organizational chart.

What type of controls can help prevent fraud in a small business?

Implementing basic physical controls and independent internal verification.

What could have prevented the fraud at Excelsior Inn?

Conducting thorough background checks and implementing mandatory vacations.

What is the significance of employee rotations in fraud prevention?

It deters employees from attempting theft since they cannot permanently conceal their actions.

What should be done to ensure timely recording of transactions?

Documents should be promptly forwarded for accounting entries to the accounting department.

What is the total take from the fraud at Mod Fashions?

$75,000.

What is one method to identify potential fraud through data analytics?

Flagging recipients of large dollar amounts in risky areas.

What could be a consequence of employee fatigue on internal controls?

It can lead to carelessness or indifference, reducing control effectiveness.

What principle is violated when recordkeeping is not separate from physical custody?

Segregation of duties

How can an employee embezzle cash while hiding the theft?

By making journal entries to conceal the theft

What control activity is violated when key employees do not take vacations?

Human resource controls

Why is it important for key employees to take vacations?

To prevent opportunities for fraud, such as embezzlement

What control activity is violated by not using prenumbered order slips?

Documentation procedures

What risk arises from failing to use prenumbered documents?

It makes it difficult to account for transactions, leading to potential theft

What is the primary asset that is highly susceptible to fraud?

Cash

What are cash receipts controls focused on?

Over-the-counter receipts through cash registers

What must be restricted to prevent cashiers from adjusting sales amounts?

Access to the point-of-sale (POS) system

What is a common cause of cash register shortages?

Incorrect change given back to customers

What is the cash shortfall if the cash register tape indicates $6,956.20 but cash is only $6,946.10?

$10.10

What are electronic receipts?

Transactions that occur with electronic funds transfer (EFT)

What is an example of an electronic receipt?

Direct deposit of payroll amounts to employees

What is the purpose of a voucher system?

To ensure all disbursements by check are properly authorized

What does the voucher system improve in internal control?

Establishes responsibility and keeps track of transaction documentation

What is a petty cash fund used for?

To pay small amounts without using checks

What type of fraud involves the misuse of company resources for personal gain?

Occupational fraud

What are the three types of occupational fraud?

Asset misappropriation, corruption, and financial statement fraud

What is the most common type of occupational fraud?

Asset misappropriation

What principle is applied when only designated personnel handle cash receipts?

Establishment of responsibility

What is the risk of not having prenumbered checks in cash disbursement?

It violates documentation procedures

What should be done with blank checks to ensure security?

Store them in a safe

What is the role of the treasurer in cash disbursement controls?

Only the treasurer may sign checks

What is the importance of reconciling the bank statement monthly?

To verify that cash records match bank records

What are the key control features of a bank account?

Use of a bank, safeguarding cash, minimizing currency on hand, and creating a double record of transactions.

What is the purpose of bank reconciliation?

To compare the bank's balance with the company's balance and explain differences.

What does electronic banking enable for companies?

Secure access to account information and internal controls for transactions.

What is remote deposit capture?

A mobile banking feature that allows users to deposit checks remotely using a smartphone.

What information do bank statements provide?

Bank transactions, balances, deposits, checks paid, and account balance after transactions.

What is a deposit in transit?

Items recorded by the depositor that have not yet been recorded by the bank.

What are outstanding checks?

Issued checks recorded by the company that have not been paid by the bank.

What does NSF stand for in banking?

Non-Sufficient Funds, indicating a check not paid due to insufficient funds in the account.

What is the role of independent internal verification in bank reconciliation?

To ensure that reconciliations are prepared by an employee with no other cash responsibilities.

What are the steps to reconcile items per bank?

1. Add deposits in transit; 2. Deduct outstanding checks; 3. Adjust for bank errors.

What are the steps to reconcile items per books?

1. Add other deposits; 2. Deduct other payments; 3. Adjust for book errors.

What is the adjusted cash balance?

The cash balance after posting all reconciliation entries to the cash account.

What is the significance of bank service charges in reconciliation?

They are reconciling items that require an adjusting entry by the depositor.

What was Bernard Madoff's fraudulent scheme?

A Ponzi scheme where he paid returns to existing investors using funds from new investors.

How did Madoff conceal his fraudulent activities?

By fabricating false investment statements and hiring an unqualified auditor.

What was the outcome of Madoff's Ponzi scheme for investors?

Investors lost more than $18 billion.

What does the term 'bank charge' refer to?

Fees for processing debit and credit card transactions.

What is the purpose of documentation procedures in internal control?

To ensure accurate and complete records of transactions.

What is the importance of safeguarding checks?

To prevent theft or misuse of checks.

What is the role of segregation of duties in internal control?

To reduce the risk of errors or fraud by dividing responsibilities among different individuals.

What is the definition of independent internal verification?

A process where an employee with no cash handling responsibilities prepares reconciliations.