Financial Accounting

IFRS 4th Edition

Weygandt ● Kimmel ● Kieso

Chapter 7
Fraud, Internal Control, and Cash
Chapter Outline
Learning Objectives
LO 1 Define fraud and the principles of internal control.
LO 2 Apply internal control principles to cash.
LO 3 Identify the control features of a bank account.
LO 4 Explain the reporting of cash.

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Learning Objective 1
Define Fraud and the Principles of
Internal Control

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Fraud and Internal Control (1 of 2)
Fraud
Dishonest act by an Opportunity
employee that results in
personal benefit to the
employee at a cost to the
employer.

Financial Pressure Rationalization

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Fraud and Internal Control (2 of 2)
Internal Control
Purposes of internal control:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records.
3. Increase efficiency of operations.
4. Ensure compliance with laws and regulations.

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Internal Control (3 of 3)
Five Primary Components:
1. Control environment.
2. Risk assessment.
3. Control activities.
4. Information and communication.
5. Monitoring.

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Principles of Internal Control Activities
(1 of 6)

Establishment of Responsibility
• Control is most effective when only
one person is responsible for a
given task
• Establishing responsibility often
requires limiting access only to
authorized personnel, and then
identifying those personnel

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Principles of Internal Control Activities
(2 of 6)

Segregation of Duties
• Different individuals should be
responsible for related activities
• Responsibility for record-keeping for
an asset should be separate from
physical custody of that asset

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Principles of Internal Control Activities
(3 of 6)

Documentation Procedures
• Companies should use
prenumbered documents,
and all documents should
be accounted for
• Employees should promptly
forward source documents
for accounting entries to
the accounting department
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Principles of Internal Control Activities
(4 of 6)

Physical
Controls

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Principles of Internal Control Activities
(5 of 6)

Independent Internal
Verification
• Records periodically
verified by an
employee who is
independent
• Discrepancies
reported to
management
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Principles of Internal Control Activities
(6 of 6)

Human Resource Controls

• Bond employees who
handle cash
• Rotate employees’ duties
and require vacations
• Conduct background
checks

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Limitations of Internal Control
• Costs should not exceed benefit
• Human element
• Size of the business

Helpful Hint
Controls may vary with the risk level of the activity. For example,
management may consider cash to be high risk and maintaining
inventories in the stockroom as lower risk. Thus, management
would have stricter controls for cash.

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Do It! 1: Control Activities (1 of 3)
Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
1. The person with primary responsibility for reconciling the bank
account and making all bank deposits is also the company’s
accountant.
Solution
• Violates the control activity of segregation of duties
• Recordkeeping should be separate from physical custody
• Employee could embezzle cash and make journal entries to
hide the theft

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Do It! 1: Control Activities (2 of 3)
Identify which control activity is and explain how the situation
creates an opportunity for a fraud.
2. Wellstone Company’s treasurer received an award for
distinguished service because he had not taken a vacation in 30
years.
Solution
• Violates the control activity of human resource controls
• Key employees must take vacations
• Treasurer, who manages the company’s cash, might embezzle
cash and use his position to conceal the theft

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Do It! 1: Control Activities (3 of 3)
Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
3. In order to save money spent on order slips and to reduce time
spent keeping track of order slips, a local bar/restaurant does
not buy prenumbered order slips.
Solution
• Violates the control activity of documentation procedures
• If prenumbered documents are not used, then it is virtually
impossible to account for the documents
• An employee could write up a dinner sale, receive cash from
customer, then throw away order slip and keep the cash
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Learning Objective 2
Apply Internal Control Principles to
Cash

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Cash Controls (1 of 2)
Cash Receipts Controls
• Establishment of Responsibility:
▪ Only designated personnel are authorized to handle
cash receipts
• Segregation of Duties: Different individuals
▪ Receive cash
▪ Record cash receipts
▪ Hold cash

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Cash Receipt Controls (1 of 5)
• Documentation Procedures: Use
▪ Remittance advice (mail receipts)
▪ Cash register tapes or computer records
▪ Deposit slips

• Physical Controls
▪ Store cash in safes and bank vaults
▪ Limit access to storage areas
▪ Use cash registers or point-of-sale terminals

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Cash Receipt Controls (2 of 5)
• Independent Internal Verification
▪ Supervisors count cash receipts daily
▪ Assistant treasurer compares total receipts to
bank deposits daily
• Human Resource Controls
▪ Bond personnel who handle cash
▪ Require employees to take vacations
▪ Conduct background checks

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Cash Disbursement Controls
Generally, internal control over cash disbursements is
more effective when companies pay by check or
electronic funds transfer (EFT) rather than by cash.
One exception is payments for incidental amounts that
are paid out of petty cash.

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Cash Controls (2 of 2)
Cash Disbursements Controls
• Establishment of Responsibility
▪ Only designated personnel are authorized to sign
checks (treasurer) and approve vendors
• Segregation of Duties
▪ Different individuals approve and make payments
▪ Check-signers do not record disbursements

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Cash Disbursement Controls (1 of 6)
• Documentation Procedures
▪ Use prenumbered checks and account for
sequence
▪ Each check must have an approved invoice
▪ Require employees to use corporate credit cards
for reimbursable expenses
▪ Stamp invoices “paid”

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Cash Disbursement Controls (2 of 6)
• Physical Controls
▪ Store blank checks in safes, with limited access
▪ Print check amounts by machine in indelible ink

• Independent Internal Verification

▪ Compare checks to invoices
▪ Reconcile bank statement monthly

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Cash Disbursement Controls (3 of 6)
• Human Resource Controls:
▪ Bond personnel who handle cash
▪ Require employees to take vacations
▪ Conduct background checks

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Cash Disbursement Controls (6 of 6)
Voucher System Controls
• A network of approvals by authorized individuals,
acting independently, to ensure all disbursements by
check are proper
• A voucher is an authorization form prepared for each
expenditure in a voucher system

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Petty Cash Fund
Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund
2. making payments from the fund
3. replenishing the fund

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Making Payments From Petty Cash (1 of 2)
• Management usually limits the size of expenditures
• Does not permit use of fund for certain types of
transactions
• Payments are documented on a prenumbered receipt
• Signatures of both the custodian and the individual
receiving payment are required on the receipt
• Supporting documents should be attached to receipt

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Making Payments From Petty Cash (2 of 2)
• Custodian keeps receipts in petty cash box until fund
is replenished
• Sum of receipts and money in fund should equal
established total at all times

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Learning Objective 3
Identify the Control Features of a Bank
Account

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Control Features of a Bank Account
Use of a bank contributes significantly to good internal
control over cash.
• Minimizes amount of currency on hand
• Creates a double record of bank transactions
• Bank reconciliation

Helpful Hint
Essentially, the bank statement is a copy of the bank’s records sent
to the customer or made available online for review.

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Electronic Funds Transfer (EFT) System
• Disbursement systems that use wire, telephone, or
computers to transfer cash from one location to
another
• Use is quite common
• Normally result in better internal control since no
cash or checks are handled by company employees

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Bank Statements (1 of 6)
• Prepared from bank’s perspective
• Every deposit bank receives is an increase in bank’s
liabilities (an account payable to the depositor)
• Lists in numerical sequence all paid checks along with
date check was paid and its amount
• Bank includes with bank statement memoranda
explaining other debits and credits it made to
depositor’s account
• A check that is not paid by a bank because of
insufficient funds in a bank account is called an NSF
check (not sufficient funds)
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Bank
Statements
(2 of 6)

Each month, the

company receives
from the bank a
bank statement
showing its bank
transactions and
balances.

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Learning Objective 4
Explain the Reporting of Cash

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Reporting of Cash
• Cash consists of coins, currency (paper money),
checks, money orders, and money on hand or deposit
• The statement of financial position reports amount of
cash available at a given point in time
▪ Listed first in current assets section
• Statement of cash flows shows sources and uses of
cash during a period of time

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Reporting Cash (1 of 4)
Cash Equivalents
Cash equivalents are short-term, highly liquid
investments that are both:
1. Readily convertible to known amounts of cash, and
2. So near their maturity that their market value is
relatively insensitive to changes in interest rates.
Restricted Cash
Cash that is not available for general use.

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Reporting Cash
Korean Air Lines, Inc.
Statement of Financial Position
(partial, in millions)
Assets
Current assets
Short-term investments ₩111,988
Cash and cash equivalents 967,481

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Copyright
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