Chapter 6 Powerpoint

Chapter 6: Cash, Fraud, and Internal Control

Learning Objectives

• CONCEPTUAL

  • C1: Define internal control and identify its purpose and principles.

  • C2: Define cash and cash equivalents, explain how to report them.

• ANALYTICAL

  • A1: Compute days’ sales uncollected ratio and assess liquidity.

• PROCEDURAL

  • P1: Apply internal control to cash receipts and payments.

  • P2: Explain and record petty cash fund transactions.

  • P3: Prepare a bank reconciliation.

  • P4 (Appendix 6A): Describe documentation and verification for cash payments.

Learning Objective C1: Define Internal Control and Identify its Purpose and Principles

Internal Control System

• Monitors and controls business activities:

  • Protects assets

  • Ensures reliable accounting

  • Upholds company policies

  • Promotes efficient operations

Sarbanes-Oxley Act (SOX)

• Requires public companies to document and certify internal controls:

  • Effective internal controls required

  • Auditor evaluation required

  • Harsh penalties for violators (up to 25 years in prison)

  • Oversight by Public Company Accounting Oversight Board (PCAOB)

Committee of Sponsoring Organizations (COSO)

• Five ingredients of internal control:

  1. Control environment

  2. Risk assessment

  3. Control activities

  4. Information & communication

  5. Monitoring

Principles of Internal Control

• Common principles include:

  • Establish responsibilities

  • Maintain adequate records

  • Insure assets and bond key employees

  • Separate recordkeeping from custody of assets

  • Divide responsibility for related transactions

  • Apply technological controls

  • Perform regular and independent reviews

Internal Control Practices

Establish Responsibilities

• Clearly define tasks and assign to one person to pinpoint fault if needed.

Maintain Adequate Records

• Protects assets and helps monitor activities:

  • Detailed records, chart of accounts, preprinted forms, prenumbered sales slips, and computerized systems.

Insure Assets and Bond Key Employees

• Insure assets against losses; bond key employees handling cash.

Separate Recordkeeping from Custody of Assets

• Separate access to assets and accounting records to reduce theft risk.

Divide Responsibility for Related Transactions

• Separation of duties prevents fraud and errors by requiring collaboration between individuals.

Apply Technological Controls

• Use devices like cash registers and time clocks to enhance security and record-keeping.

Perform Regular and Independent Reviews

• Auditors should regularly check efficiency and effectiveness of controls.

Technology and Internal Control

• Use of blockchain for secure accounting that resists modification and maintains records of changes.

Limitations of Internal Control

• Factors impacting internal control efficiency include:

  • Human error

  • Fraud and the fraud triangle (opportunity, pressure, rationalization)

  • Cost-benefit constraint for controls.

Learning Objective C2: Define Cash and Cash Equivalents

Control of Cash

• Three guidelines for effective cash control:

  • Separate handling cash from recordkeeping.

  • Use checks or EFT for cash payments.

  • Deposit cash receipts promptly.

Cash and Cash Equivalents

• Cash: Includes physical currency, coins, and deposits.

• Cash Equivalents: Short-term, highly liquid investments ready for conversion to cash.

Cash Management Goals

• Plan receipts to match payments and maintain minimum operating cash.

• Strategies include:

  • Encourage receivables collection and delay payments.

  • Keep essential assets and plan expenditures.

  • Invest excess cash.

Learning Objective P1: Apply Internal Control to Cash Receipts and Payments

Over-the-Counter Cash Receipts

• Procedures must ensure accuracy in receiving and recording cash to prevent errors.

Cash Over and Short

• Record discrepancies in cash register—overages or shortages affect cash balance.

Cash Receipts by Mail

• Cash must be recorded and deposited by separate individuals to reduce risk of theft.

Control of Cash Payments

• Require checks for payments, limit record access, and maintain a cash budget that estimates receipts and payments.

Voucher System of Control

Procedures for Voucher System

• Verification, approval, and recording of liabilities before payment.

Learning Objective P2: Explain and Record Petty Cash Fund Transactions

Petty Cash System

• Used for small expenses like shipping fees & supplies.

Establishing and Operating a Petty Cash Fund

• Debit petty cash to establish; operational receipts must match with remaining cash.

Learning Objective P3: Prepare a Bank Reconciliation

Purpose of Bank Reconciliation

• Adjust discrepancies between bank statement and company records to determine actual cash balance.

Bank Reconciliation Steps

• Includes step-by-step reconciliation to address outstanding checks, deposits in transit, and errors.

Learning Objective A1: Compute Days’ Sales Uncollected Ratio

Days’ Sales Uncollected Calculation

• Formula: Accounts Receivable / Net Sales x 365

• Indicates time frame for collecting cash from credit sales.

Appendix 6A: Documentation and Verification for Cash Payments

Key Documents for Verification

• Receiving reports, purchase requisitions, purchase orders, and invoices are needed to approve payments accurately.

Conclusion

• The principles of internal control and effective cash management are essential for ensuring financial integrity and operational efficiency.

Chapter 6: Cash, Fraud, and Internal Control

Learning Objectives

CONCEPTUAL

• C1: Define internal control and identify its purpose and principles.

• C2: Define cash and cash equivalents; explain how to report them.

ANALYTICAL

• A1: Compute days’ sales uncollected ratio and assess liquidity.

PROCEDURAL

• P1: Apply internal control to cash receipts and payments.

• P2: Explain and record petty cash fund transactions.

• P3: Prepare a bank reconciliation.

• P4 (Appendix 6A): Describe documentation and verification for cash payments.

Learning Objective C1: Define Internal Control and Identify its Purpose and Principles

Internal Control System

An internal control system is essential for the operation of a business as it monitors and controls various business activities. The key purposes include:

• Protecting assets from theft, loss, or misuse.

• Ensuring the accuracy and reliability of accounting information.

• Upholding corporate policies and compliance with laws and regulations.

• Promoting efficient operations that enhance productivity and reduce waste.

Sarbanes-Oxley Act (SOX)

The Sarbanes-Oxley Act was enacted to enhance corporate governance and accountability, particularly for publicly traded companies. Key provisions include:

• Requiring companies to document internal controls and certify their effectiveness annually.

• Mandatory audits of these controls by independent auditors.

• Imposing stringent penalties, including up to 25 years in prison, for corporate fraud and non-compliance.

• Oversight by the Public Company Accounting Oversight Board (PCAOB) to maintain the integrity of financial reporting.

Committee of Sponsoring Organizations (COSO)

COSO developed a framework for designing and implementing effective internal control systems, which comprises five critical components:

1. Control Environment: Sets the foundation for all other components, focusing on integrity, ethical values, and organizational structure.

2. Risk Assessment: Identifying risks that could impede the achievement of objectives and devising measures to mitigate those risks.

3. Control Activities: Policies and procedures that help ensure that management directives are carried out effectively.

4. Information and Communication: Ensuring relevant information is communicated timely and effectively across the organization.

5. Monitoring: Ongoing evaluation of the internal control system's performance to identify improvements.

Principles of Internal Control

Common principles that guide the development of an effective internal control system include:

• Establish Responsibilities: Clearly define job tasks and responsibilities to increase accountability.

• Maintain Adequate Records: Create detailed documentation that aids in tracking transactions, making audits easier and protecting assets.

• Insure Assets and Bond Key Employees: Effectively manage risk by insuring valuable assets against potential losses and ensuring fidelity bonding for employees handling cash.

• Separate Recordkeeping from Custody of Assets: Limit access to accounting records and physical assets to reduce the risk of embezzlement or fraud.

• Divide Responsibility for Related Transactions: Ensure that no single employee has control over all aspects of a financial transaction to prevent fraud.

• Apply Technological Controls: Utilize technology such as automated systems and biometric security to enhance monitoring.

• Perform Regular and Independent Reviews: Ensure regular audits and reviews are conducted by external reviewers to maintain objectivity.

Internal Control Practices

Internal controls are actual operational practices that support the principles mentioned:

• Establish Responsibilities: Assign clear and specific tasks to prevent ambiguity and promote accountability.

• Maintain Adequate Records: Utilize preprinted forms and digital inventory management tools to ensure comprehensive and organized recordkeeping.

• Insure Assets and Bond Key Employees: Prevent losses through effective insurance policies and ensure that all employees handling cash are bonded.

• Separate Recordkeeping from Custody of Assets: Implement checks and balances such as segregating procurement from payment processes.

• Divide Responsibility for Related Transactions: Mandate that different individuals approve and execute transactions.

• Apply Technological Controls: Incorporate advanced security measures, such as encrypting sensitive data and using ERP systems for integrated management.

• Perform Regular and Independent Reviews: Schedule periodic audits to assess compliance with internal controls and overall financial integrity.

Technology and Internal Control

Advanced technologies like blockchain are increasingly being integrated into internal control systems to enhance transparency and data integrity. Blockchain facilitates secure accounting that resists modifications and maintains an accurate, unalterable record of transactions.

Limitations of Internal Control

Despite their importance, internal control systems are not infallible. Factors that can impact their effectiveness include:

• Human Error: Mistakes made inadvertently can lead to misreporting.

• Fraud and the Fraud Triangle: Vulnerability due to the interrelation of opportunity, pressure, and rationalization.

• Cost-Benefit Constraint for Controls: Sometimes, the costs associated with implementing controls can outweigh the benefits, leading to an inadequate system.

Learning Objective C2: Define Cash and Cash Equivalents

Control of Cash

Effective cash control is critical for ongoing business operations. Three primary guidelines include:

• Separate Handling Cash from Recordkeeping: Establish stringent routines to avoid mishandling funds.

• Use Checks or EFT for Cash Payments: Eliminate cash transactions where possible to simplify tracking and reduce risk.

• Deposit Cash Receipts Promptly: Speedy deposits help maintain accurate financial records and reduce the risk of theft.

Cash and Cash Equivalents

• Cash: This encompasses physical currency & coins as well as demand deposits held at financial institutions.

• Cash Equivalents: These are short-term investments that are readily convertible into cash, typically with a maturity of three months or less, such as Treasury bills and money market funds.

Cash Management Goals

Effective cash management aims to:

• Plan Receipts to Match Payments: Ensure liquidity by aligning the timing of cash inflows with outflows.

• Maintain Minimum Operating Cash: Retain the least amount of cash necessary for daily operations while maximizing investments.

• Strategies: Implement policies to encourage prompt collection of accounts receivable, delaying payments strategically, retaining necessary assets, and investing surplus cash wisely.

Learning Objective P1: Apply Internal Control to Cash Receipts and Payments

Over-the-Counter Cash Receipts

• Designs procedures to ensure security and accuracy during cash handling and recording to mitigate errors and fraud.

Cash Over and Short

• It is vital to record any discrepancies between cash in the register and actual cash, either overages or shortages, to maintain an accurate cash balance.

Cash Receipts by Mail

• When cash receipts are handled, it should involve multiple individuals to reduce the risk of theft or misappropriation.

Control of Cash Payments

• Mandate the use of checks for all business payments, restrict access to sensitive financial records, and maintain a budget to predict cash requirements accurately.

Voucher System of Control

The voucher system ensures:

• Verification, approval, and appropriate record-keeping of liabilities are carried out before any payments are authorized.

Learning Objective P2: Explain and Record Petty Cash Fund Transactions

Petty Cash System

Utilized to cover minor expenses, such as office supplies or postage, this system must be carefully monitored.

Establishing and Operating a Petty Cash Fund

• The initial fund must be established through proper debiting, and all operational receipts must reconcile with the cash remaining in the fund at all times.

Learning Objective P3: Prepare a Bank Reconciliation

Purpose of Bank Reconciliation

The reconciliation process aims to address any discrepancies that exist between the bank's records and the company's financial records, facilitating an accurate assessment of the actual cash balance available.

Bank Reconciliation Steps

This includes a detailed process for:

• Identifying outstanding checks.

• Tracking deposits in transit.

• Correcting any bookkeeping errors to the financial records.

Learning Objective A1: Compute Days’ Sales Uncollected Ratio

Days’ Sales Uncollected Calculation

The formula for computation is:Days’ Sales Uncollected = (Accounts Receivable / Net Sales) x 365This ratio provides insight into the effectiveness of the company’s credit policies and the speed of cash collection from accounts receivable.

Appendix 6A: Documentation and Verification for Cash Payments

Key Documents for Verification

Essential documents such as receiving reports, purchase requisitions, purchase orders, and vendor invoices are necessary to accurately approve and document cash payments.

Conclusion

The principles of internal control and effective cash management are critical for maintaining financial integrity and operational efficiency within an organization.

Recommended Internal Control Procedures:

1. Establish Responsibilities: Assign a separate individual to oversee inventory supply and cash management, preventing the single employee from being responsible for both sales and inventory.

2. Perform Regular Independent Reviews: Implement a system where supervisors or managers conduct regular checks of inventory and cash on hand at the end of each day to ensure that amounts align with sales records.

3. Limit Cash Handling: Utilize a cash register or a locked cash box with a key only accessible to a supervisor, instead of allowing the employee to carry cash in a simple box.

4. Separate Recordkeeping from Custody of Assets: Introduce a daily sales report that the employee must complete, which is then verified by a supervisor when the cash and inventory are counted.

5. Implement a Petty Cash Management System: If small purchases are necessary (like for replenishing items), set up a petty cash fund that is also monitored and reconciled by an independent party.

Recommended Internal Control Procedures:

1. Establish Responsibilities: Assign a separate individual to oversee inventory supply and cash management, preventing the single employee from being responsible for both sales and inventory.

2. Perform Regular Independent Reviews: Implement a system where supervisors or managers conduct regular checks of inventory and cash on hand at the end of each day to ensure that amounts align with sales records.

3. Limit Cash Handling: Utilize a cash register or a locked cash box with a key only accessible to a supervisor, instead of allowing the employee to carry cash in a simple box.

4. Separate Recordkeeping from Custody of Assets: Introduce a daily sales report that the employee must complete, which is then verified by a supervisor when the cash and inventory are counted.

5. Implement a Petty Cash Management System: If small purchases are necessary (like for replenishing items), set up a petty cash fund that is also monitored and reconciled by an independent party.

Being 'bonded' means that an employee is covered by a fidelity bond, which is a type of insurance that protects a business from losses due to theft or fraud by that employee. Bonding provides a financial guarantee that, in the event the bonded employee commits theft or fraud, the business will be compensated for the losses incurred. This is particularly important for employees who handle cash or have access to sensitive financial information, as it adds an extra layer of security and trust for the employer.

Yes, this statement is true for the scenario. Establishing responsibilities among employees in the concession company is a critical internal control procedure. By clearly defining roles—such as assigning one employee to manage inventory, another to handle sales, and a third to oversee cash management—a business can ensure accountability. Should any discrepancies or issues arise, it will be easier to identify the source of the problem and take corrective action, thus enhancing overall operational efficiency and security.

Recommended Internal Control Procedures:

1. Establish Responsibilities: Assign a separate individual to oversee the cash management and purchasing activities, ensuring that the employee in charge of buying merchandise does not have sole control over both cash and inventory buying decisions.

2. Set Purchase Limits: Implement a policy that establishes a maximum dollar amount that the employee can spend without prior approval, so larger purchases require authorization from a manager before the employee heads to sales.

3. Maintain Documentation: Require the employee to provide receipts for every purchase made at garage sales. All receipts should be collected and uploaded to a centralized system for transparency.

4. Perform Regular Reconciliations: Conduct regular reconciliations between cash spent on purchases and the inventory received to ensure that all cash transactions are accounted for and matched with acquired merchandise.

5. Independent Review of Purchases: Schedule periodic reviews of the purchasing decisions made by the employee, where management evaluates the quality and appropriateness of the acquired merchandise to ensure that purchases align with the store's inventory and pricing strategy.

Recommended Internal Control Procedures:

1. Establish Responsibilities: Assign a separate individual to oversee the cash management and purchasing activities, ensuring that the employee in charge of buying merchandise does not have sole control over both cash and inventory buying decisions.

2. Set Purchase Limits: Implement a policy that establishes a maximum dollar amount that the employee can spend without prior approval, so larger purchases require authorization from a manager before the employee heads to sales.

3. Maintain Documentation: Require the employee to provide receipts for every purchase made at garage sales. All receipts should be collected and uploaded to a centralized system for transparency.

4. Perform Regular Reconciliations: Conduct regular reconciliations between cash spent on purchases and the inventory received to ensure that all cash transactions are accounted for and matched with acquired merchandise.

5. Independent Review of Purchases: Schedule periodic reviews of the purchasing decisions made by the employee, where management evaluates the quality and appropriateness of the acquired merchandise to ensure that purchases align with the store's inventory and pricing strategy.

Yes, the question "Recommend an internal control procedure for each situation below:" is asking for recommendations based on the principles of internal control. These principles guide the development of effective internal control systems aimed at ensuring the integrity of financial reporting, safeguarding assets, and preventing errors and fraud. In providing recommendations, it's important to reference these principles and apply them to the specific situations described.

Yes, this statement is true for the scenario about the antique store. Performing regular and independent reviews is an essential procedure of internal controls. Regularly reviewing the purchases of the employee helps ensure that business transactions are operating smoothly and efficiently. The manager can assess whether the employee is making wise and quality purchases at the garage sales and examine if the financial statements align with the store's new and current inventory. Additionally, the manager could implement the following measures to enhance this control: 1. Establish specific criteria for evaluating the purchases to ensure that they meet the store's resale standards and align with the inventory strategy. 2. Conduct surprise audits of the cash and inventory to confirm the physical presence of the items purchased. 3. Create a formalized reporting process where the employee submits weekly reports detailing purchases made, accompanied by receipts and justifications for the purchases. This makes tracking easier and strengthens accountability.

Recommended Internal Control Procedures for Concession Company:

1. Establish Responsibilities: Assign separate individuals for cash management and inventory supply. This ensures that the employee who sells the items doesn’t have sole control over inventory management.

2. Limit Cash Handling: Instead of keeping cash in a simple box, utilize a cash register or locked cash box with restricted access to keep the cash secure. Only the supervisor should have the key.

3. Perform Regular Independent Reviews: Schedule daily or weekly checks of inventory and cash by a manager or supervisor at the end of each day to ensure that sales records align with the cash on hand and inventory levels.

4. Implement a Daily Sales Report: Require the employee to complete a daily sales report detailing the number of items sold and the cash taken in, which should be reviewed by a supervisor.

5. Separate Recordkeeping from Custody of Assets: Ensure that different individuals handle sales and recordkeeping, such as a daily inventory count that is verified against sales to prevent theft and errors.

Recommended Internal Control Procedures for Concession Company:

1. Establish Responsibilities: Assign separate individuals for cash management and inventory supply. This ensures that the employee who sells the items doesn’t have sole control over inventory management.

2. Limit Cash Handling: Instead of keeping cash in a simple box, utilize a cash register or locked cash box with restricted access to keep the cash secure. Only the supervisor should have the key.

3. Perform Regular Independent Reviews: Schedule daily or weekly checks of inventory and cash by a manager or supervisor at the end of each day to ensure that sales records align with the cash on hand and inventory levels.

4. Implement a Daily Sales Report: Require the employee to complete a daily sales report detailing the number of items sold and the cash taken in, which should be reviewed by a supervisor.

5. Separate Recordkeeping from Custody of Assets: Ensure that different individuals handle sales and recordkeeping, such as a daily inventory count that is verified against sales to prevent theft and errors.

Applying Technological Controls in the Concession Company Scenario:

1. Point of Sale (POS) System: Implement a POS system for processing sales. This system would not only record cash transactions securely but also automatically track inventory levels in real time, ensuring accurate sales data and reducing the potential for theft or data entry errors.

2. Digital Inventory Management: Utilize software to manage inventory that includes features for tracking sales and stock levels. This allows for better planning and reduces the risk of overstocking or stockouts. The software could provide alerts when inventory reaches a certain threshold.

3. Biometric Security Systems: Use biometric devices, such as fingerprint scanners, to limit access to cash registers or locked cash boxes. This ensures that only authorized personnel can access monetary assets.

4. Mobile Payment Solutions: Introduce mobile payment options to reduce the need for cash handling, making transactions more efficient and secure while promoting customer convenience.

5. Surveillance Systems: Implement security cameras at the concession stand to monitor transactions and deter theft. This can provide an additional layer of security and accountability for the employee handling sales.

6. Monitoring and Reporting Software: Use software that tracks sales and cash flow, generating reports for review by supervisors. This provides ongoing visibility into cash management practices and aids in audits.

Recommended Internal Control Procedures for Antique Store:

1. Establish Responsibilities: Assign separate individuals for cash management and purchasing activities. Ensure that the employee handling cash is not solely responsible for making purchasing decisions, which promotes accountability and reduces the risk of fraud.

2. Set Purchase Limits: Implement a policy that establishes a maximum dollar amount the employee can spend without prior approval from a manager. Larger purchases should require authorization before implementation.

3. Maintain Documentation: Require the employee to provide receipts for every purchase made at garage sales. All receipts should be collected and uploaded to a centralized system for transparency and accountability.

4. Perform Regular Reconciliations: Conduct regular reconciliations between cash spent and the inventory received to ensure all cash transactions are accounted for and matched with acquired merchandise.

5. Independent Review of Purchases: Schedule periodic reviews of the purchasing decisions made by the employee, where management evaluates the quality and appropriateness of the acquired merchandise to ensure alignment with the store's inventory and pricing strategy.

In general terms, 'less incline' refers to a decrease in the slope or angle of an object or surface. It means that the angle of ascent or descent is shallower, making the surface less steep. This can be applied in various contexts, such as in geography (referring to the slope of land), fitness (indicating a treadmill or hill with a lower gradient), or engineering (referring to the angle of a ramp or path). In summary, 'less incline' suggests a gentler slope.

Using Maintain Adequate Records Procedure in the Antique Store:

1. Detailed Documentation of Purchases: Require the employee to keep comprehensive records of all purchases made at garage sales, including dates, items acquired, prices paid, and the source of the purchase. This documentation helps in tracking expenses and inventory levels.

2. Utilize Inventory Management Systems: Implement software tools to manage inventory that can track items from purchase through resale. Keeping detailed records of item descriptions, costs, and sales prices enhances transparency and accountability.

3. Regular Reconciliation Reports: Schedule regular reconciliations of cash spent and inventory on hand, ensuring that purchases align with inventory recorded and highlighting discrepancies early on.

Using Divide Responsibility for Related Transactions Procedure in the Antique Store:

1. Segregate Duties: Assign different employees to handle cash management, purchasing, and inventory management. For example, one employee could handle purchasing at garage sales, while another manages the cash register and sales documentation.

2. Approval Process: Institute an approval process where purchases made by the employee require verification and authorization from a manager or another employee before cash transactions are completed.

3. Periodic Audits: Conduct periodic audits where inventory and cash balances are checked against purchase records to confirm accuracy, improve accountability, and mitigate risks of misappropriation.