Chapter 7 Fraud, Internal Control, and Cash ( 舞弊、內部控制與現金 )

1. Chapter 7 Fraud, Internal Control, and Cash(舞弊、內部控制與現金) Instructor: Chih-Liang Julian Liu Department of Industrial and Business Management Chang Gung University

2. Learning Objectives • Define fraud and internal control. • Identify the principles of internal control (內部控制)activities. • Explain the applications of internal control principles to cash receipts (現金收入). • Explain the applications of internal control principles to cash disbursements (現金支出).

3. Describe the operation of a petty cash fund (零用金基金). • Indicate the control features of a bank account (銀行帳戶). • Prepare a bank reconciliation (銀行調節表). • Explain the reporting of cash. Learning Objectives (Cont.)

4. Preview of Chapter 7

5. Fraud Fraud Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer (Examples in text book). Illustration 7-1 Three factors that contribute to fraudulent activity.

6. Internal Control Internal Control • Methods and measures adopted to: • Safeguard assets (保護資產安全). • Enhance accuracy and reliability of accounting records (會計記錄之正確性與可靠性). • Increase efficiency of operations. • Ensure compliance with laws and regulations.

7. Internal Control (Cont.) Internal Control • Five Primary Components: • Control environment. • Risk assessment. • Control activities. • Information and communication. • Monitoring.

8. Principles of Internal Control Activities Establishment of Responsibility (確立責任) Control is most effective when only one person is responsible for a given task. Segregation of Duties (職務分工) Related duties should be assigned to different individuals. Documentation Procedures (憑證處理程序) Companies should use prenumbered documents and all documents should be accounted for.

9. Principles of Internal Control Activities Physical Controls (實體控制) Illustration 7-2

10. Principles of Internal Control Activities Independent Internal Verification (獨立內部驗證) • Records periodically verified by an employee who is independent. • Discrepancies (不一致) reported to management. Illustration 7-3

11. Principles of Internal Control Activities Human Resource Controls (人力資源控制) • Bond employees (投保忠誠險). • Rotate employees’ duties and require vacations. • Conduct background checks.

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

13. Cash Receipts Controls Illustration 7-4

14. Cash Receipts Controls Illustration 7-4

15. Cash Receipts Controls Over-the-Counter Receipts (櫃檯收入) Important internal control principle —segregation of record-keeping from physical custody. Illustration 7-5

16. Cash Receipts Controls • Mail Receipts (郵寄收入) • Mail receipts should be opened by two people, a list prepared, and each checkendorsed “For Deposit Only (僅限存入銀行)”. • 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.

17. Cash Receipts Controls (Cont.) • Mail Receipts (郵寄收入) • Copy of the list is sent to the accounting department for recording. Clerks also keep a copy.

18. Cash Receipts Controls Review Question Permitting only designated personnel to handle cash receipts is an application of the principle of: • segregation of duties. • establishment of responsibility. • independent check. • other controls.

19. Cash Disbursements Controls • Generally,internal control over cash disbursements is more effective when companiespay by check (支票), rather than by cash. • Applications: • Voucher system (憑單制度) • Petty cash fund (零用金基金)

20. Cash Disbursements Controls Illustration 7-6

21. Cash Disbursements Controls Illustration 7-6

22. Cash Disbursements Controls Review Question The use of prenumbered checks in disbursing cash is an application of the principle of: • establishment of responsibility. • segregation of duties. • physical, mechanical, and electronic controls. • documentation procedures.

23. Cash Disbursements Controls • Voucher System Controls • Network of approvals, by authorized individuals, to ensure all disbursements by check are proper. • Avoucheris an authorization form prepared for each expenditure.

24. Cash Disbursements Controls • Petty Cash Fund (零用金基金)- Used to pay small amounts (支付小額款項的現金). • Involves: • establishing the fund (設置零用金基金), • making payments from the fund (由零用金付款), and • replenishing the fund (撥補零用金).

25. Petty Cash (Establish) 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

26. Petty Cash (Record a payment) The company does not make an accounting entry to record a payment when it is made form petty cash. No entry

27. Petty Cash (Replenishing) 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

28. Petty Cash (Replenishing) 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

29. Control Features: Use of a Bank • Contributes to good internal control over cash. • Minimizes the amount of currency (貨幣)on hand. • Creates a double record of bank transactions. • Bank reconciliation (銀行調節表). Company (cash) Bank (statements) Bank reconciliation

30. Use of a Bank (Deposits) Making Bank Deposits Illustration 7-8 Authorized employee should make deposit (存款). Bank Code Numbers Reverse Side Front Side

31. Use of a Bank (Checks) Writing Checks (支票) Written order signed by depositor directing bank to pay a specified sum of money to a designated recipient. Illustration 7-9 Maker Payee Payer

32. Bank Statements (銀行對帳單) Illustration 7-10 • Debit Memorandum • Bank service charge. • NSF (not sufficient funds). • Credit Memorandum • Collect notes receivable. • Interest earned.

33. Company and Bank Deposits 4,276.85 Company (Depositors) Bank Customers (Check) Cash Debits Credits 4,276.85 4,276.85 Pay 644.95 for checks Checks Bank Suppliers Company (Depositors) Debits Credits Cash 644.95 644.95 4,276.85 4,276.85

34. Bank Statements (銀行對帳單) • Debit Memorandum (借項通知單; DM) • Bank service charge (銀行服務費; SC) • NSF (not sufficient funds) (存款不足退票; NSF) DM Company (Depositors) Bank Debits Credits Cash SC 30 NSF 425.6

35. Bank Statements (銀行對帳單) • Debit Memorandum (借項通知單; DM) • Bank service charge (銀行服務費; SC) • NSF (not sufficient funds) (存款不足退票; NSF) DM Company (Depositors) Bank Debits Credits Cash 30 SC 30 NSF 425.6 425.6

36. Bank Statements (銀行對帳單) • Credit Memorandum (貸項通知單; CM) • Collect notes receivable (託收應收票據). • Interest earned (存款帳戶之利息收入; INT). CM Company (Depositors) Bank Debits Credits Cash 1,035

37. Bank Statements (銀行對帳單) • Credit Memorandum (貸項通知單; CM) • Collect notes receivable (託收應收票據). • Interest earned (存款帳戶之利息收入; INT). CM Company (Depositors) Bank Debits Credits Cash 1,035 1,035

38. Bank Statements (銀行對帳單) Illustration 7-10 • Debit Memorandum • Bank service charge. • NSF (not sufficient funds). • Credit Memorandum • Collect notes receivable. • Interest earned.

39. Reconciliation (調節) Reconciling the Bank Account • Reconcile balance per books (company) and balance per bank to their adjusted (corrected) cash balances. • Reconciling Items: • Deposits in transit (在途存款). • Outstanding checks (未兌現支票). • Bank memoranda (銀行通知單). • Errors (錯誤). Time Lags

40. Reconciliation Procedures Illustration 7-11 + Notes collected by bank (CM) - NSF (bounced) checks (DM) - Check printing or other service charges (DM) +/- Book Errors + Deposit in Transit - Outstanding Checks +/- Bank Errors CORRECT BALANCE CORRECT BALANCE

41. Bank Reconciliation illustrated 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

42. A Bank Reconciliation Illustration: Prepare a bank reconciliation at April 30. Cash balance per bank statement ₤15,907.45 Add: Deposit in transit 2,201.40 Less: Outstanding checks (5,904.00) Adjusted cash balance per bank₤12,204.85 Cash balance per books ₤11,589.45 Add: Error in check No. 443 36.00 Less: NSF check (425.60) Less: Bank service charge (30.00) Add: Collection of notes receivable 1,035.00 Adjusted cash balance per books₤12,204.85

43. A Bank Reconciliation: Entries Entries From Bank Reconciliation Collection of Note Receivable: Assuming interest of ₤50 has not been accrued and collection fee is charged to Miscellaneous Expense, the entry is: Apr. 30 Cash 1,035.00 Miscellaneous expense 15.00 Notes receivable 1,000.00 Interest revenue 50.00

44. A Bank Reconciliation: Entries 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

45. A Bank Reconciliation: Entries 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 Illustration 7-13

46. Control Features: Use of a Bank Review Question The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: • outstanding checks. • deposit in transit. • a bank error. • bank service charges.

47. Control Features: Use of a Bank Electronic Funds Transfer (EFT) System (電子資金轉帳制度) • 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.

48. Sally Kist owns Linen Kist Fabrics. Sally asks you to explain how she should treat the following reconciling items when reconciling the company’s bank account: (1) a debit memorandum for an NSF check, (2) a credit memorandum for a note collected by the bank, (3) outstanding checks, and (4) a deposit in transit. Sally should treat the reconciling items as follows. (1) NSF check: Deduct from balance per books. (2) Collection of note: Add to balance per books. (3) Outstanding checks: Deduct from balance per bank. (4) Deposit in transit: Add to balance per bank. Solution:

49. Reporting Cash Cash Equivalents (約當現金) • Cash equivalents are short-term, highly liquid investments that are both: • Readily convertible to cash, and • So near their maturity that their market value is relatively insensitive to changes in interest rates. Restricted Cash (受限制的現金) Should be reported separately on the balance sheet as restricted cash.

50. Reporting Cash Illustration 7-14