 Internal control is defined as the procedures and
processes used by a company to:
1. Safeguard its assets.
2. Process information accurately.
3. Ensure compliance with laws and regulations.
 Internal Control—Integrated Framework is the
standard by which companies design, analyze, and
evaluate internal control.
 Employee fraud is the intentional act of deceiving an
employer for personal gain.
 The three internal control objectives can be achieved
by applying the Five Elements of Internal Control
set forth by the Integrated Framework. 5 These
elements are as follows:
1. Control environment – overall attitude of
management and employees about the
importance of controls. Three factors
influencing a company’s control
environment are as follows:
o Management’s philosophy and
operating style - relates to whether
management emphasizes the
importance of internal controls.
o The company’s organizational
structure – framework for planning and
controlling operations.
o The company’s personnel policies –
involve the hiring, training, evaluation,
compensation, and promotion of
employees.
2. Risk assessment
3. Control procedures – provide reasonable
assurance that business goals will be
achieved, including the prevention of fraud.
Control procedures, which constitute one of
the most important elements of internal
control, include the following:
o Competent personnel, rotating duties,
and mandatory vacations
o Separating responsibilities for related
operations
o Separating operations, custody of
assets, and accounting
o Proofs and security measures – used to
safeguard assets and ensure reliable
accounting data.
4. Monitoring – locate weaknesses and improve
controls. Includes observing employee
behavior and the accounting system for
indicators of control problems.
o Internal auditors, who are
independent of operations, usually
perform such evaluations. Internal
auditors are also responsible for day-
to-day monitoring of controls.
o External auditors evaluate and report
on internal control as part of their
annual financial statement audit.
5. Information and communication – essential
element of internal control.
Limitations of Internal Control
1. The human element of controls –
recognizes that controls are applied and
used by humans.
2. Cost-benefit considerations –
recognize that the cost of internal
controls should not exceed their benefits.
Cash Controls Over Receipts and Payments
 Cash includes coins, currency (paper money),
checks, and money orders.
Control of Cash Receipts
 Businesses normally receive cash from two
main sources:
o Customers purchasing products or
services
o Customers making payments on
account
 Cash Received from Cash Sales – An
important control to protect cash received in
over-the-counter sales is a cash register.
 Cash Received in the Mail – Cash is received
in the mail when customers pay their bills. This
cash is usually in the form of checks and
money orders. Most companies design their
invoices so that customers return a portion of
the invoice, called a remittance advice, with
their payment.
 Cash Received by EFT – Cash may also be
received from customers through electronic
funds transfer (EFT).
Control of Cash Payments
 The control of cash payments should provide
reasonable assurance that:
o Payments are made for only authorized
transactions.
o Cash is used effectively and efficiently.
For example, controls should ensure
that all available purchase discounts
are taken.
 Voucher system is a set of procedures for
authorizing and recording liabilities and cash
payments.
 A voucher is any document that serves as proof
of authority to pay cash or issue an electronic
funds transfer.
 A voucher is normally prepared after all
necessary supporting documents have been
 received. For the purchase of goods, a voucher
is supported by the supplier’s invoice, a
purchase order, and a receiving report.
 Cash Paid by EFT – Cash can also be paid by
electronic funds transfer (EFT) systems.

Bank Accounts
 Major reason that companies use bank accounts is
for internal control.
 Banks usually maintain a record of all checking
account transactions. A summary of all
transactions, called a bank statement, is mailed,
usually each month, to the company (depositor) or
made available online.
 Bank statement shows the beginning balance,
additions, deductions, and the ending balance.
 Bank makes credit entries (issues credit
memos):
o Deposits made by electronic funds transfer
(EFT)
o Collections of notes receivable for the
company
o Proceeds for a loan made to the company
by the bank
o Interest earned on the company’s account
o Correction (if any) of bank errors
 Bank makes debit entries (issues debit memos):
o Payments made by electronic funds transfer
(EFT)
o Service charges
o Customer checks returned for not sufficient
funds
o Correction (if any) of bank errors
 ACH (Automated Clearing House) is a network for
clearing electronic funds transfers among
individuals, companies, and banks.

Bank Reconciliation
 Bank reconciliation is an analysis of the items and
amounts that result in the cash balance reported in
the bank statement to differ from the balance of the
cash account in the ledger.
 A company may temporarily have excess cash. In
such cases, the company normally invests in highly
liquid investments in order to earn interest. These
investments are called cash equivalents.
 Banks may require that companies maintain
minimum cash balances in their bank accounts.
Such a balance is called a compensating
balance. This is often required by the bank as part
of a loan agreement or line of credit.
 A line of credit is a preapproved amount the bank is
willing to lend to a customer upon request.
Compensating balance requirements are normally
disclosed in notes to the financial statements.
 Ratio of cash to monthly cash expenses is useful
for assessing how long a company can continue to
operate without: 1. Additional financing, or 2.
Generating positive cash flows from operations