ACCT6172 - Introduction to

Accounting
Week 7 – Fraud, Internal Control and Cash
 Learning Outcome
• Define fraud and internal control
• Identify the principles of internal control activities
• Explain the applications of internal control principles
to cash receipts and cash disbursements
• Describe the operation of a petty cash fund
• Indicate the control features of a bank account
• Prepare a bank reconciliation
• Explain the reporting of cash
 Outline Materi
• Fraud and internal control
• Cash Receipts Control
• Cash Disbursement Controls
• Control Features: Use of a Bank
• Reporting Cash
FRAUD AND INTERNAL CONTROL
 Fraud

Fraud is a dishonest act by an employee that results in

personal benefit to the employee at a cost to the employer.

Three main factors that contribute to fraudulent activity are

depicted by the fraud triangle.
Opportunity

Financial Pressure Rationalization

 Internal Control
Internal control consists of all the related methods and
measures adopted within an organization to:
 safeguard its assets
 enhance the realibility of its accounting records
 increase efficiency of operations
 ensure compliance with law and regulations
 Internal Control

Control Environment

Five primary Risk Assessment

components
of internal Control Activities
control
systems: Information and Communication

Monitoring
 Principles of Internal
Control Activities
The six principles of control activities are as follows:
• Control is most • Related duties • Companies should
effective when should be use prenumbered
only one person assigned to documents and all
documents should
is responsible different be accounted for.
for a given task. individuals.

Establishment Segregation Documentation

of responsibility of duties procedures

• Relate to the • Records periodically •Bonds employees who

safeguarding of assets verified by an handle cash
and enhance the employee who is •Rotate employees’ duties
accuracy and reliability independent. and require employees to
of the accounting take vacations
• Discrepancies reported
records to management. •Conduct thorough
background checks.

Independent
Physical Human resource
Internal controls
Controls Verification
 Limitations of Internal
Control

Costs should not

exceed benefit

Human element

Size of the business.

CASH RECEIPT CONTROL
 Cash Controls

Cash is the one asset that is readily convertible into any other
type of asset. It also is easily concealed and transported, and is
highly desired. Because of these characteristics, cash is the
asset most susceptible to fraudulent activities.
 Cash Receipts Controls
Application of internal control principles to cash receipts

Source: Weygandt,Kimmel,Kieso, (2013)

 Over the Counter Receipts

Important internal
control principle—
segregation of
record-keeping from
physical custody.

Source: Weygandt,Kimmel,Kieso, (2013)

 Mail Receipts

 Mail receipts should be opened by two people, a list

prepared, and each check endorsed.

 Each mail clerk signs the list to establish responsibility for

the data.

 Original copy of the list, along with the checks, is sent to the
cashier’s department.

 Copy of the list is sent to the accounting department for

recording. Clerks also keep a copy.
CASH DISBURSEMENT CONTROLS
 Cash Disbursements
Controls
Application of internal control principles to cash disbursements

Source: Weygandt,Kimmel,Kieso, (2013)

 Cash Disbursements
Controls
Application of internal control principles to cash disbursements

Source: Weygandt,Kimmel,Kieso, (2013)

 Cash Disbursements
Controls
Generally, internal control over cash disbursements is
more effective when companies pay by check, rather
than by cash.

Principles of internal
control apply to cash
disbursements
• Voucher System Controls
• Petty Cash Fund Controls
 Voucher System Controls

A voucher system is a network of approvals by

authorized individuals, acting independently, to
ensure that all disbursements by check are proper.

A voucher is an authorization form prepared for each

expenditure.
 Petty Cash Fund Controls

Used to pay small amounts.

The operation of a petty cash fund, often called an imprest system.

Involves three steps:

1. establishing the fund

2. making payments from the fund, and

3. replenishing the fund

 Example:
Establishing the Fund
Illustration: If Zhu Company decides to establish a NT$3,000 fund
on March 1, the journal entry is:

Mar. 1 Petty cash 3,000

Cash 3,000

Source: Weygandt,Kimmel,Kieso, (2013)

 Example: Making Payments
from the Fund
Illustration: Assume that on March 15 Zhu’s petty cash custodian requests
a check for NT$2,610. The fund contains NT$390 cash and petty cash
receipts for postage NT$1,320, freight-out NT$1,140, and miscellaneous
expenses NT$150. The general journal entry to record the check is:

Mar. 15 Postage expense 1,320

Freight-out expense 1,140
Miscellaneous expense 150
Cash 2,610

Source: Weygandt,Kimmel,Kieso, (2013)

 Example: Replenishing the Fund

Illustration: Occasionally, the company may need to recognize a cash

shortage or overage. Assume that Zhu’s petty cash custodian has only
NT$360 in cash in the fund plus the receipts as listed. The request for
reimbursement would, therefore, be for NT$2,640, and Zhu would make the
following entry:

Mar. 15 Postage expense 1,320

Freight-out expense 1,140
Miscellaneous expense 150
Cash over and short 30
Cash 2,640

Source: Weygandt,Kimmel,Kieso, (2013)

CONTROL FEATURES: USE OF A
BANK
 Control Features: Use of a Bank

Contributes to good internal control over cash.

Use of bank:

1. Minimizes the amount of currency on hand.

2. Creates a double record of bank transactions.

The asset account cash maintained by the company should have

the same balance as the bank’s liability account for that company

Bank Reconciliation
(Compares the bank’s balance with the company’s balance and explains any
differences to make them agree)
 Making Bank Deposits

Authorized employee Bank Code

should make Numbers
deposit.

Reverse Side
Front Side
Source: Weygandt,Kimmel,Kieso, (2013)
 Writing Checks
A check is a written order signed by depositor directing bank to pay a
specified sum of money to a designated recipient.
There are three parties to a check:
1. The maker (or drawer) who issues the check
2. The bank (or payer) on which the check is drawn, and
3. The payee to whom the check is payable

Maker

Payee

Payer
 Bank Statements
A bank statement shows the depositor’s bank
transactions and balances.

Debit Memorandum (DM)

 Bank service charge
 NSF (not sufficient funds)

Credit Memorandum (CM or INT)

 Collect notes receivable.
 Interest earned.
 Reconciling the Bank
Account
Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.

The lack of agreement between the two balances has two

causes:
1. Time lags that prevent one of the parties from
recording the transaction in the same period as the
other party (Deposits in transit, Outstanding checks,
Bank memoranda).
2. Errors by either party in recording transactions.
 Reconciliation Procedures

+ Deposit in Transit + Notes collected by bank

- Outstanding Checks - NSF (bounced) checks
+/- Bank Errors - Check printing or other
service charges
+/- Book Errors
CORRECT BALANCE CORRECT BALANCE
 Example
The bank statement for Laird Company, in Illustration 7-10, shows a
balance per bank of £15,907.45 on April 30, 2014. On this date the
balance of cash per books is £11,589.45. Using the four reconciliation
steps, Laird determines the following reconciling items.
Step 1. Deposits in transit:
April 30 deposit (received by bank on May 1). £2,201.40
Step 2. Outstanding checks: No. 453, £3,000.00; no. 457,
£1,401.30; no. 460, £1,502.70. 5,904.00
Step 3. Errors: Laird wrote check no. 443 for £1,226.00
and the bank correctly paid that amount. However,
Laird recorded the check as £1,262.00. 36.00
Step 4. Bank memoranda:
a. Debit—NSF check from J. R. Baron for £425.60 425.60
b. Debit—Charge for printing company checks £30.00 30.00
c. Credit—Collection of note receivable for £1,000
plus interest earned £50, less bank collection fee £15.00 1,035.00

Source: Weygandt,Kimmel,Kieso, (2013)

 Example
Bank reconciliation at April 30
Cash balance per bank statement ₤15,907.45
Deposit in transit 2,201.40
Outstanding checks (5,904.00)
Adjusted cash balance per bank ₤12,204.85

Cash balance per books ₤11,589.45

Error in check No. 443 36.00
NSF check (425.60)
Bank service charge (30.00)
Collection of notes receivable 1,035.00
Adjusted cash balance per books ₤12,204.85
 Example
Journal Entries:
Collection of Note Receivable: Assuming interest of ₤50 has not been
accrued and collection fee is charged to Miscellaneous Expense, the
entry is:

Cash 1,035.00
Miscellaneous expense 15.00
Notes receivable 1,000.00
Interest revenue 50.00
 Example
Book Error: The cash disbursements journal shows that check no.
443 was a payment on account to Andrea Company, a supplier. The
correcting entry is:

Apr. 30 Cash 36.00

Accounts payable 36.00

NSF Check: As indicated earlier, an NSF check becomes an account

receivable to the depositor. The entry is:

Apr. 30 Accounts receivable 425.60

Cash 425.60
 Example

Bank Service Charges: Depositors debit check printing

charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:

Apr. 30 Miscellaneous expense 30.00

Cash 30.00
 Electronic Funds Transfer
(EFT) System
 Disbursement systems that uses wire, telephone, or
computers to transfer cash balances between locations.

 EFT transfers normally result in better internal control

since no cash or checks are handled by company
employees.
REPORTING CASH
 Reporting Cash

Cash Equivalents
Cash equivalents are short-term, highly liquid investments
that are both:
1. Readily convertible to cash, and

2. So near their maturity that their market value is relatively

insensitive to changes in interest rates.

Restricted Cash
Should be reported separately on the balance sheet as
restricted cash.
 Summary
1. A fraud is a dishonest act by an employee that results in
personal benefit to the employee at a cost to the
employer.
2. The fraud triangle refers to the three factors that
contribute to to fraudulent activity by employees:
 Opportunity
 Financial pressure
 Rationalization
3. Internal control consists of all the related methods and
measures adopted within an organization to safeguard
its assets, enhance the reliability of its accounting
records, increase efficiency of operations, and ensure
compliance with laws and regulations.
 Summary
4. The principles of internal control are: establishment of responsibility,
segregation of duties, documentation procedures, physical controls,
independent internal verification, and human resource controls such
as bonding and requiring employees to take vacations.
5. Application of internal control principles to cash receipts: (1) only
designated personnel should be authorized to handle cash receipts
(cashiers); (2) different individuals should be assigned the duties of
receiving cash, recording cash receipt transactions, and having custody
of cash; (3) documents should include remittance advices, cash
register tapes, and deposit slips; (4) cash should be stored in company
safes and bank vaults, access to storage areas should be limited to
authorized personnel, and cash registers should be used in executing
over-the-counter receipts; (5) daily cash counts and daily comparisons
of total receipts should be made; and (6) all personnel who handle
cash receipts should be bonded and required to take vacations.
 Summary
6. The application of internal control principles to cash disbursements
transactions includes: (1) only designated individuals should be authorized to
sign checks; (2) different departments or individuals should be assigned the
duties of approving an item for payment and paying it; (3) prenumbered
checks should be used and each check should be supported by an approved
invoice or other document; (4) blank checks should be stored in a safe and
access should be restricted to authorized personnel, and a machine should be
used to imprint the amount on the check in indelible ink; (5) each check
should be compared with the approved invoice before it is issued; and (6)
bonding personnel who handle cash, requiring employees to take vacations,
and conducting background checks.
7. A petty cash fund is a cash fund used to pay relatively small amounts
8. The operation of the fund, often called an imprest system, involves (1)
establishing the fund, (2) making payments from the fund, and (3)
replenishing the fund
9. The use of a bank minimizes the amount of currency that must be kept on
hand and therefore contributes significantly to good internal control over
cash.
 Summary
10. In reconciling the bank statement, it is customary to reconcile
the balance per books and balance per bank to their adjusted
cash balances. The reconciliation schedule consists of two
sections. The steps in preparing a bank reconciliation are:
a. Determine deposits in transit.
b. Determine outstanding checks.
c. Note any errors discovered.
d. Trace bank memoranda to the depositor’s
records
11. Cash on hand, cash in banks, and petty cash are often combined
and reported simply as Cash. Because it is the most liquid asset,
cash is listed last in the current assets section of the statement
of financial position under the title “cash and cash equivalents”.
 Reference
Weygandt,Kimmel,Kieso, (2013), Financial
Accounting IFRS Edition, 2nd edition, John
Wiley and Sons Inc., New Jersey, chapter 7
Thank You