Chapter 6: Cash, Fraud, and Internal Control

internal control system

helps monitor and control business procedures to

• protect assets

• promote efficient operations

• ensure reliable accounting

• uphold company policies

sarbanes-oxley (SOX) act

requires managers and auditors of public companies to document and verify internal controls, here are some requirements:

• company must have effective internal controls

• auditors must evaluate internal controls

• violators receive harsh penalties - up to 25 yrs in prison w/ fines

• auditors’ work is overseen by the Public Company Accounting Oversight Board (PCAOB)

committee of sponsoring organizations (COSO) lists 5 ingredients of internal control said to add to the quality of accounting information

• control environment: company structure, ethics, and integrity

• risk assessment - identify, analyze, and manage risk factors

• control activities - policies and proceudres to reduce risk of loss

• information and communication - reports to internal and external parties

• monitoring - regular review of internal control effectiveness

principles of internal control

(1) establish responsibilites

(2) maintain adequate records

(3) insure assets and bond key employees

(4) separate recordkeeping from custody of assets

(5) divide responsibility for related transactions

(6) apply technological controls

(7) perform regular and independent reviews

blockchain

new, more secure type of accounting ledger that is continuously and simultaneously updated and verified - makes it difficult for the ledger to be modified without a detailed record of changes. records cannot be hidden or destroyed as the record is shared and stored by multiple users

limitations of internal control

(1) human error or fraud

(2) cost-benefit constraint

human error

a mistake from carelessness, misjudgement, or confusion

human fraud

intentionally defeating internal controls for personal gain

cash internal controls

(1) handling cash separate from recordkeeping of cash

(2) cash receipts are promptly deposited in a bank

(3) cash payments are made by check or EFT

cash

currency, coins, deposits in bank accounts

cash equivalents

shot-term, highly liquid investment assets meeting 2 criteria:

(1) readily convertible to a known cash amount

(2) close enough to their due date that their market value won’t greatly change

goals of cash management

(1) plan cash receipts to meet cash payments when due

(2) keep a minimum level of cash necessary to operate

effective cash management strategies

(1) encourage collection of receivables

(2) delay payment of liabilities

(3) keep only necessary assets

(4) plan expenditures

(5) invest excess cash

cash over and short account

income statement account recording income effects of cash overages and shortages due to mistakes w/ giving change

**customers more likely to dispute being shortchanged so typically has a DB balance, reflecting an expense, reflected on income statement as SG&A expense

cash receipts by mail

two people assigned to open mail —> theft requires collusion

3 receipts made:

(1) person opening mail keeps

(2) goes to accountant/recordkeeper

(3) goes to cashier with the money

control of cash payments

(1) cash budget

(2) voucher system

(3) petty cash system

cash budget

companies wish to minimize cash bc of its risk of theft and low return compared to other assets

voucher system

set of procedures and approvals designed to control cash payments and acceptance of liabilities:

• verify, approve, record liabilities for cash payment

• issuing checks for those approved liabilities

voucher

internal document / file used to collect info to control cash payments and to ensure that a transaction is properly recorded

**voucher system applied to all payments except petty cash

petty cash payments

payments for small items i.e. shipping, minor repairs, low-cost supplies

when do you debit/credit petty cash

ONLY when you are establishing the fund or changing the amount, not when reimbursing it

deposit ticket

lists items deposited in bank, receipt of deposit

bank statement includes

(1) beginning of period account balance

(2) withdrawals and other decreases to the account during the period

(3) deposits and other increases to the account during the period

(4) end of period account balance

canceled checks

checks bank has paid and deducted from customer’s account

bank reconciliation

explains differences between checking acount balance in depositor’s records and balance on bank statement

bank balance adjustments

+ deposits in transit: deposits made and recorded in depositor’s books but not yet listed on bank statement

- outstanding checks: checks written by depositor, subtracted on depositor’s books but not yet turned in for payment on bank statement

± bank errors

book balance adjustments

+ interest earned and unrecorded cash receipts

- bank fees and NSF checks

± book errors

journal entries from a bank reconciliation

ONLY items impacting the book balance need entries:
(1) collection of note (DB cash, CR, notes receivable)

(2) interest earned (DB cash, CR interest revenue)

(3) check printing (DB misc expenses, CR cash)

(4) NSF check (DB AR, CR cash)

days’ sales uncollected

measure of how quickly a company can convert its accounts receivable into cash, use it to estimate how much time is likely to pass before current amount of accounts receivable is received in cash, used to determine if cash is being collected quickly enough to pay upcoming obligations

= AR / net sales *365

smaller = better