Ch 4: Financial Accounting: Cash and Internal Controls

Flashcards covering key vocabulary terms related to financial accounting, internal controls, fraud, the Sarbanes-Oxley Act, components and limitations of internal control, cash and cash equivalents, and the statement of cash flows.

Errors

Accidental errors in recording transactions or applying accounting rules.

Fraud

A person intentionally deceives another person for personal gain or to damage that person.

Occupational fraud

The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employer’s resources.

Fraud Triangle

A concept illustrating three elements that lead to fraud: opportunity, motivation, and rationalization.

Opportunity (Fraud Triangle)

The situation allows the fraud to occur.

Motivation (Fraud Triangle)

Someone feels the need to commit fraud, such as the need for money.

Rationalization (Fraud Triangle)

Justification for the deceptive act by the one committing the fraud.

Internal Controls

Plans to safeguard the company’s assets and improve the accuracy and reliability of accounting information, attempting to eliminate the opportunity element of fraud.

Sarbanes-Oxley Act of 2002 (SOX)

Legislation passed by Congress to establish guidelines related to internal control procedures and auditor-client relations, applying to all companies required to file financial statements with the SEC.

Public Company Accounting Oversight Board (PCAOB)

Established by SOX, it has the authority to set standards dealing with auditing, quality control, ethics, independence, and other activities relating to audited financial reports.

Corporate executive accountability (SOX)

A SOX provision requiring corporate executives to personally certify the company’s financial statements and financial disclosures.

Section 404 (SOX)

Requires company management to document and assess the effectiveness of all internal control processes that could affect financial reporting, and company auditors to express an opinion on management’s assessment.

Control environment

Sets the overall ethical tone of the company with respect to internal control, including formal policies related to management’s philosophy, assignment of responsibilities, and organizational structure.

Risk assessment

Identifies and analyzes internal and external risk factors that could prevent a company’s objectives from being achieved.

Control activities

Policies and procedures that help ensure that management’s directives are being carried out, including authorizations, reconciliations, and separation of duties.

Monitoring (Internal Controls)

Continual observation of internal activities and reporting of deficiencies, including formal procedures for reporting control deficiencies.

Information & Communication (Internal Controls)

Methods for collection of relevant information and communication in a timely manner, enabling people to carry out their responsibilities.

Preventative Controls

Control activities designed to prevent fraudulent or erroneous behavior from occurring.

Separation of duties

A set of procedures intended to separate employees’ duties for authorizing transactions, recording transactions, and controlling the related assets.

Physical controls

A set of procedures that ensure assets and accounting records are kept safe.

Proper authorization

A set of procedures designed to prevent improper use of the company’s resources.

Employee management (Control Activity)

Providing employees with appropriate guidance to ensure they have the knowledge necessary to carry out their job duties.

E-commerce controls

A set of procedures specifically designed to ensure only authorized personnel are able to conduct e-commerce transactions.

Detective Controls

Control activities designed to detect fraudulent or erroneous behavior that has already occurred.

Reconciliations

Management periodically determines whether the amount of physical assets agree with the accounting records.

Performance reviews

The actual performance of individuals or processes is checked against their expected performance.

Audits (Detective Control)

Hiring an independent auditor to assess internal control procedures to detect deficiencies or fraudulent behavior.

Collusion

Two or more people acting in coordination to circumvent internal controls.

Cash

Includes coins and currency, checks received, balances in savings and checking accounts, credit card and debit card sales.

Cash equivalents

Investments that mature within three months from the date of purchase, such as money market funds, Treasury bills, and certificates of deposit.

Electronic funds transfers (EFTs)

A method of collections of payments from customers.

Statement of Cash Flows

A financial statement that reports all cash activities for a period, categorizing them into operating, investing, and financing activities.

Operating activities (Cash Flow)

Cash transactions involving revenues and expenses, such as cash received from customers or cash paid for rent and salaries.

Investing activities (Cash Flow)

Cash investments in long-term assets and investment securities, such as the purchase or sale of land, equipment, and buildings for cash.

Financing activities (Cash Flow)

Transactions designed to finance the business through borrowing and owner investment, such as issuing common stock, paying dividends, or borrowing/repaying debt.