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CHAPTER 7
FRAUD, INTERNAL CONTROL, AND CASH
LEARNING OBJECTIVES
1. DEFINE FRAUD AND INTERNAL CONTROL.
2. IDENTIFY THE PRINCIPLES OF INTERNAL CONTROL
ACTIVITIES.
3. EXPLAIN THE APPLICATIONS OF INTERNAL CONTROL
PRINCIPLES TO CASH RECEIPTS.
4. EXPLAIN THE APPLICATIONS OF INTERNAL CONTROL
PRINCIPLES TO CASH DISBURSEMENTS.
5. DESCRIBE THE OPERATION OF A PETTY CASH FUND.
6. INDICATE THE CONTROL FEATURES OF A BANK
ACCOUNT.
7. PREPARE A BANK RECONCILIATION.
8. EXPLAIN THE REPORTING OF CASH.
CHAPTER REVIEW
Fraud and Internal Control
1. (L.O. 1) Fraud is a dishonest act by an employee that results in personal benefit to the employee
2. Internal control consists of all the related methods and measures adopted within an organization
3. (L.O. 2) An essential principle of internal control is to assign responsibility to specific
4. The rationale for segregation of duties is this: The work of one employee should, without a
5. The responsibility for related transactions should be assigned to different individuals, and the respon-
custody of that asset.
7. Physical controls relate to the safeguarding of assets and include such measures as safes for
8. Most internal control systems provide for independent internal verification. This principle
9. In large companies, independent internal verification is often assigned to internal auditors. Internal
auditors are company employees who continuously evaluate the effectiveness of the company’s
internal control systems.
background checks.
Limitations of Internal Control
11. The concept of reasonable assurance rests on the premise that the costs of establishing control
procedures should not exceed their expected benefit.
12. The human element is also an important factor in every system of internal control. A good system
13. Collusion may result when two or more individuals work together to get around prescribed controls
Cash Controls
14. To safeguard cash and to ensure the accuracy of the accounting records for cash, effective
internal control over cash is critical.
Cash Receipts Controls
15. (L.O. 3) The application of internal control principles to cash receipts transactions includes: (1)
register tapes, and deposit slips; (4) cash should be stored in company safes and bank vaults,
16. Control of over-the-counter receipts is centered on cash registers that are visible to customers.
Cash Disbursements Controls
17. (L.O. 4) Generally, internal control over cash disbursements is more effective when companies
18. The application of internal control principles to cash disbursements transactions includes: (1) only
designated individuals should be authorized to sign checks; (2) different individuals should be
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.
Voucher System
19. Companies use a voucher system to enhance the internal control over cash disbursements. A
voucher system is a network of approvals by authorized individuals, acting independently, to
voucher register.
Petty Cash Fund
and (3) the amount of the fund is changed.
Control Features: Use of a Bank
21. (L.O. 6) The use of a bank minimizes the amount of currency that must be kept on hand and
22. A check is a written order signed by the depositor directing the bank to pay a specified sum of
c. The payee to whom the check is payable.
23. A bank statement shows (a) checks paid and other debits charged against the account, (b) deposits
24. A bank debit memorandum is usually included with the bank statement to indicate charges
insufficient funds (NSF check).
25. A bank credit memorandum shows such items as the collection of a note receivable for the
depositor by the bank.
Reconciling the Bank Account
26. (L.O. 7) A reconciliation of a bank account is necessary because the balance per bank and
lags and errors.
27. To obtain maximum benefit from a bank reconciliation, the reconciliation should be prepared by
28. In reconciling the bank statement, it is customary to reconcile the balance per books and balance
a. Determine deposits in transit.
b. Determine outstanding checks.
c. Note any errors discovered.
29. Each reconciling item used in determining the adjusted cash balance per books should be re-
corded by the depositor.
Reporting Cash
30. (L.O. 8) 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 first in the current assets section of the
balance sheet under the title “Cash and cash equivalents.” Cash equivalents are short-term
highly liquid investments that are both readily convertible to known amounts of cash, and so near
their maturity that their market value is relatively insensitive to changes in interest rates. They
include Treasury bills, Commercial paper, and money market funds.
LECTURE OUTLINE
A. Fraud.
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 main factors that contribute to
fraudulent activity by employees:
a. Opportunity—occurs when the workplace lacks sufficient controls to
deter and detect fraud.
b. Financial pressure—employees sometimes commit fraud because
they want to lead a lifestyle that they cannot afford on their current
salary.
c. Rationalization—employees sometimes justify fraud because they
believe they are underpaid and the employer is making lots of
money.
B. Internal Control.
1. Internal control consists of all the related methods and measures adopted
within an organization to:
and regulations.
2. Internal control systems have five primary components: a control environ-
ment, risk assessment, control activities, information and communication,
and monitoring.
C. Principles of Internal Control Activities.
1. Establishment of responsibility: control is most effective when only one
person is responsible for a given task, (i.e., cash register).
2. Segregation of duties: the work of one employee should, without a dupli-
cation of effort, provide a reliable basis for evaluating the work of another
employee.
payment).
(2) Activities related to sales (selling, shipping, and billing).
b. Record keeping separate from physical custody: The custodian of
the asset is not likely to convert the asset to personal use when one
employee maintains the record of the asset, and a different employee
has physical custody of the asset.
3. Documentation procedures: documents provide evidence that transactions
and events have occurred.
department.
4. Physical controls:
a. Physical controls relate to the safeguarding of assets (safes, vaults,
safety deposit boxes, and locked warehouses), and enhance the
accuracy and reliability of the accounting records (alarms, television
monitors, garment sensors, and time clocks).
Copyright © 2014 John Wiley & Sons, Inc. Weygandt, Financial Accounting, 9/e, Instructor’s Manual (For Instructor Use Only) 7-7
5. Independent internal verification: the review of data prepared by
employees.
a. Maximum benefit from independent internal verification is obtained
when:
(1) Companies verify records periodically or on a surprise basis.
(2) An independent employee makes the verification.
(3) Discrepancies and exceptions are reported and corrected.
and recommend improvements when needed.
6. Human resource controls:
a. Bonding employees who handle cash involves obtaining insurance
protection against theft by employees.
b. Rotating employees’ duties and requiring employees to take vaca-
ACCOUNTING ACROSS THE ORGANIZATION
To ensure proper employee supervision and proper separation of duties, companies
represent potential internal control threats?
Answer: An unsupervised employee may have a fraudulent job (or may even be
a fictitious person—e.g., a person drawing a paycheck without working).
Or, if two employees supervise each other, there is no real separation
of duties, and they can conspire to defraud the company.
D. Limitations of Internal Control.
E. Cash Receipts Controls.
1. In retail businesses, control of over-the-counter receipts centers on cash
registers that are visible to customers.
2. All mail receipts should be opened in the presence of at least two mail
clerks and one of the clerks should endorse each check “For Deposit Only.”
F. Cash Disbursements Controls.
1. Generally, internal control over cash disbursements is more effective when
proper.
3. The use of a voucher system, whether done manually or electronically,
improves internal control over cash disbursements and keeps track of the
documents that back up each transaction.
G. Petty Cash Fund.
prenumbered petty cash receipt.
c. Replenishing the fund: debit appropriate expense accounts and
credit Cash.
ETHICS INSIGHT
A recent study by the Association of Certified Fraud Examiners found that two-
