CH4- Internal controls, accounting for cash, and ethics

Internal control

Process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with laws and regulations; also safeguards assets

COSO

Committee of Sponsoring Organizations; created the five-component framework for internal control

Control environment

COSO component describing the "tone at the top": management's attitude, integrity, and structure that set the foundation for all controls

Risk assessment

COSO component for identifying potential risks (fraud, data loss, errors) and developing actions to address them

Information and communication

COSO component covering internal and external reporting: sharing the right information with the right people at the right time

Control activities

COSO component made up of the specific policies and procedures that make sure things are done properly ("the internal controls")

Monitoring

COSO component for assessing the quality of a company's controls over time (internal audits, reviews, feedback loops)

Separation of duties

Control activity where different people handle authorization, recordkeeping, and custody of assets

Quality of employees

Control activity requiring employees to be properly trained to perform their tasks

Bonded employees

Employees in positions of trust covered by a fidelity bond; applicants are screened with interviews, background checks, and recommendations

Fidelity bond

Insurance that protects a company from losses caused by employee dishonesty

Required absences

Control activity requiring regular vacations and periodic rotation of duties

Procedures manual

Written documentation of the proper accounting procedures employees must follow

Authority and responsibility

Control activity establishing a definitive chain of command

Specific authorization

Separate approval required for individual, nonroutine transactions

General authorization

Management policies that authorize routine transactions within specified limits

Prenumbered documents

Using numbered forms (checks, purchase orders, receiving reports, invoices) so missing documents are easy to detect

Physical control

Control activity limiting losses by securing valuable assets (locks, safes, restricted access)

Performance evaluations

Control activity providing independent verification of employee performance

Collusion

Two or more employees working together to bypass internal controls

Control environment vs. control activities

Environment is attitude and culture (what you should do); activities are specific procedures that force you to do something

Cash

For financial reporting, includes currency, checks, money orders, bank drafts, and bank account balances

Bankruptcy

What creditors can force a company into when it fails to pay its legal obligations

Bank reconciliation

Regular comparison of the cash balance in the company's records with the bank account balance

Controls over cash receipts

Record collections immediately, count cash regularly, give written receipts, deposit promptly, minimize cash on hand

Controls over cash payments

Use checks or electronic payments, prenumber and lock up checks, separate approval/signing/recording, require approved supporting documents marked paid

AICPA

American Institute of Certified Public Accountants; publishes the Code of Professional Conduct

Responsibilities principle

AICPA principle: exercise sensitive professional and moral judgments in all activities

The public interest principle

AICPA principle: act to serve the public interest, honor the public trust, and show commitment to professionalism

Integrity principle

AICPA principle: perform all professional responsibilities with the highest sense of integrity

Objectivity and independence

AICPA principle: stay objective and free of conflicts of interest; auditors must be independent in fact and appearance

Due care

AICPA principle: follow technical and ethical standards, keep improving competence, and do the job to the best of one's ability

Scope and nature of services

AICPA principle: use the Code to decide what services a CPA in public practice should provide

Fraud triangle

Three common features of misconduct: opportunity, pressure, and rationalization

Opportunity

Fraud triangle element: weak or missing controls that let someone commit fraud

Pressure

Fraud triangle element: an incentive such as debt, addiction, intimidation, or others' expectations

Rationalization

Fraud triangle element: the ability to justify misconduct ("everyone does it," "I deserve it," "I'll pay it back")

Certified public accountant (CPA)

Licensed accountant who conducts independent audits of financial statements

Financial audit

Detailed examination of a company's financial statements and underlying records that also tests the reliability of the accounting system

Materiality

An item important enough to influence the decisions of a reasonable financial statement user

Audit report

Report in which the auditor presents conclusions and an opinion on the financial statements

Unqualified opinion

Most favorable audit opinion: statements comply with GAAP without qualification, reservation, or exception

Qualified opinion

Audit opinion between unqualified and adverse: mostly GAAP-compliant, but the auditor has reservations about something

Adverse opinion

Audit opinion where departures from GAAP are so material the statements do not fairly present the company's position

Internal control is designed to ensure reliable ____ reporting.

financial

Internal control promotes effective and ____ operations.

efficient

Internal control promotes ____ with applicable laws and regulations.

compliance

Internal controls ____ assets against theft and unauthorized use.

safeguard

The COSO framework for internal control has ____ components.

five

The control environment is often called the "tone at the ____."

top

Internal audits and reviews are examples of the ____ component of COSO.

monitoring

Segregation of duties and account reconciliations are examples of control ____.

activities

Separation of duties keeps authorization, recordkeeping, and ____ of assets with different people.

custody

A fidelity ____ protects a company from losses caused by employee dishonesty.

bond

Requiring employees to take regular vacations is called required ____.

absences

Nonroutine transactions require ____ authorization.

specific

Routine transactions within set limits are covered by ____ authorization.

general

Using ____ documents makes it easier to detect missing checks or invoices.

prenumbered

Locking expensive merchandise in display cases is an example of ____ control.

physical

Two or more employees working together to bypass controls is called ____.

collusion

No system of internal control can prevent all ____.

fraud

Companies should invest ____ cash to avoid reducing potential profitability.

excess

If a company fails to pay its obligations, creditors can force it into ____.

bankruptcy

A bank ____ compares the company's cash records to the bank balance.

reconciliation

Cash collections should be recorded ____ upon receipt.

immediately

Customers who pay cash should receive a written ____.

receipt

Disbursements should be made by check or electronic payment rather than ____.

cash

Unused checks should be ____ up.

locked

Supporting documents should be marked ____ when the check is signed.

paid

The AICPA publishes the Code of Professional ____.

Conduct

Auditors must be independent in fact and in ____.

appearance

The fraud triangle element involving weak controls is ____.

opportunity

Personal debt that creates an incentive to steal is an example of ____.

pressure

Saying "everyone does it" is an example of ____.

rationalization

A financial audit tests the ____ of the accounting system.

reliability

An item important enough to influence a reasonable user's decisions is ____.

material

The most favorable audit opinion is the ____ opinion.

unqualified

When departures from GAAP are severe, the auditor issues an ____ opinion.

adverse

When statements are mostly GAAP-compliant but the auditor has reservations, the opinion is ____.

qualified

Which COSO component represents management's attitude and integrity, or the "tone at the top"?

Control environment

Which COSO component involves identifying potential risks and planning actions to address them?

Risk assessment

Which COSO component involves assessing the quality of controls over time through internal audits?

Monitoring

Which COSO component includes reports, meetings, dashboards, and accounting systems?

Information and communication

Segregation of duties, reconciliations, and approvals belong to which COSO component?

Control activities

A cafe manager rotates which employee closes out the register each week and requires everyone to take vacation. Which control activity is this?

Required absences

A warehouse limits access to its inventory room to employees with keycards. Which control activity is this?

Physical control

A company buys insurance that covers losses if its cashier steals money. What is this insurance called?

Fidelity bond

A store manager must personally approve any refund over $300. What type of authorization is this?

Specific authorization

Store policy allows any cashier to process refunds under $50 without approval. What type of authorization is this?

General authorization

An office uses checks numbered in sequence so a missing check is noticed right away. Which control activity is this?

Prenumbered documents

At a nonprofit, one volunteer collects donations, a second records them, and a third deposits them. Which control activity is this?

Separation of duties

An internal auditor independently checks the work of the payroll clerk. Which control activity is this?

Performance evaluations

A cashier and a bookkeeper work together to hide stolen cash. What limitation of internal control does this show?

Collusion

Which of the following is a control over cash receipts?

Deposit cash in the bank on a timely basis

Which of the following is a control over cash payments?

Keep unused checks locked up

Which of the following is included in cash for financial reporting?

Money orders

An employee with gambling debts feels desperate for money. Which fraud triangle element is this?

Pressure

A bookkeeper can add new vendors and pay them with no one reviewing the changes. Which fraud triangle element is this?

Opportunity

An employee says, "I'll put it back before anyone notices." Which fraud triangle element is this?

Rationalization

Which AICPA principle requires auditors to be independent in fact and appearance?

Objectivity and independence