8-1 Fraud, Internal Control, and Cash

Learning Objectives

• Discuss fraud and the principles of internal control.

• Apply internal control principles to cash.

• Identify control features of a bank account.

• Explain the reporting of cash.

8-2 Understanding Fraud

• Definition of Fraud: A dishonest act by an employee resulting in personal gain at the employer’s expense.

• Fraud Triangle Factors:

  • Incentive: A motivator for committing fraud (e.g., financial issues).

  • Opportunity: Circumstances that allow fraud to occur (e.g., weak internal controls).

  • Rationalization: The process by which fraud is justified by the perpetrator.

8-3 Sarbanes-Oxley Act (SOX)

• Applicability: Publicly traded U.S. corporations must maintain a system of internal controls.

• Responsibilities: Corporate executives must ensure reliability and effectiveness of controls; boards of directors oversee compliance.

• Independent Auditors: Required to verify the adequacy of internal controls.

• PCAOB: Established to oversee the audits of public companies in the U.S.

8-4 Internal Control Objectives

• Purpose:

  • Safeguard assets.

  • Enhance reliability of accounting records.

  • Improve operational efficiency.

  • Ensure compliance with laws and regulations.

8-5 Primary Components of Internal Control

1. Control Environment: The foundation of internal control systems set by the management.

2. Risk Assessment: The identification and analysis of relevant risks.

3. Control Activities: Policies and procedures to mitigate risks.

4. Information and Communication: Processes for sharing relevant information.

5. Monitoring: Regular evaluations of the effectiveness of controls.

8-6 Effectiveness of Internal Controls

• Importance: Internal controls play a crucial role in effective financial and sustainability reporting by preventing data misuse and ensuring accurate reporting.

• Sustainability Control Needs: Increasing demand for audits in sustainability due to growing environmental concerns.

8-7 Establishment of Responsibility

• Control Principle: Assign specific responsibilities to individuals to minimize fraud risk.

• Access Limitation: Restrict access to authorized personnel only.

8-8-8 Fraud Cases**

Anatomy of a Fraud: Healthcare Industry

• Case: Maureen Frugali created fictitious claims totaling $11 million.

• Failure in Control: Lack of restriction in authorizing claim transactions.

8-9 Segregation of Duties

• Principle: Different individuals should manage related activities to prevent conflict of interest and fraud risk.

• Controls Needed: The responsibility for recording assets must be separate from their physical custody.

8-10 Further Segregation Failures**

University Fraud Case

• Lawrence's Case: No proper segregation of purchasing duties led to a $475,000 fraud involving fake invoices by the assistant vice-chancellor.

8-11 Additional Segregation Issues**

Construction Company Fraud Case

• Angela's Case: She misappropriated $570,000 by writing unauthorized checks while having access to both cash and records.

8-12 Documentation Procedures

• Best Practices: Use prenumbered documents and ensure prompt forwarding of documents for accounting.

8-13 Missing Control in Documentation**

Mod Fashions Fraud Case

• Total Loss: $75,000 due to designers submitting the same expense claims using various documents.

8-14 Physical Controls

• Examples: Use of safes, vaults, locked storage, and surveillance to deter theft.

8-15 Independent Internal Verification

• Control Principle: Periodically have records checked by an independent employee to detect discrepancies promptly.

8-16 Missing Control in Verification**

Bobbi Jean's Case

• Fraud Total: $275,000 due to unverified expense reports.

8-17 Human Resource Controls

• Principles: Bond employees handling cash, enforce mandatory vacations, and conduct background checks.

8-18 Missing Controls in HR**

Excelsior Inn Fraud Case

• Loss: $95,000 due to failure in conducting a background check on the manager.

8-19 SOX Implications for HR

• Employee Oversight & Compliance: SOX requires continuous employee monitoring and proper job supervision.

8-20 Limitations of Internal Control

• Key Considerations: Cost, human elements, and business size impact the effectiveness of internal controls.

8-21-23 Control Activity Violations**

• Examples of control violations and their potential fraud opportunities, such as lack of segregation, no vacations for key personnel, and lack of prenumbered documentation.

8-24 Cash Receipt Controls

• Physical Controls: Secure storage, limit access to cash, and regularly supervise cash handling.

8-25 Cash Disbursement Controls

• Best Practices: Audit cash disbursements with prenumbered checks and separation of duties between authorization and record-keeping.

8-26 Using EFT for Payments

• Benefits: Better internal control with electronic fund transfers since they reduce the handling of cash.

8-27-53 Bank Account Controls and Reconciliation**

• Processes: Detailed steps for reconciling bank accounts, identifying discrepancies, and correcting errors.

8-54 Reporting Cash and Cash Equivalents

• Definition: Cash equivalents are highly liquid investments with minimal risk. Restricted cash is noted for specific purposes.

8-55 Occupational Fraud Types**

• Fraud Varieties: 1) Asset Misappropriation. 2) Corruption. 3) Financial Statement Fraud — differing in frequency and financial impact.

8-56 Internal Control and Ethical Considerations**

• The importance of high-quality auditing and accounting standards in preventing international fraud.

8-57 Sarbanes-Oxley Act Implications for Non-U.S. Companies

• Compliance Issues: SOX requirements apply primarily to U.S. companies, sparking discussions about foreign compliance.

8-58 Conclusion on Internal Controls in Today's Business Environment**

• Understanding the importance of robust internal control systems to mitigate risks of fraud and ensure compliance.