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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
Control Environment: The foundation of internal control systems set by the management.
Risk Assessment: The identification and analysis of relevant risks.
Control Activities: Policies and procedures to mitigate risks.
Information and Communication: Processes for sharing relevant information.
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.