Chapter 7: Fraud, Internal Control, and CashChapter 7: Fraud, Internal Control, and Cash- Fraud: dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. o Three Factors: opportunity, financial pressure, and rationalization.- The Sarbanes-Oxley Act:o Applies to publicly traded U.S. corporations. o Required to maintain a system of internal control. o Corporate executives and board of directors must ensure that these controls are reliable and effective. o Independent outside auditors must attest to the adequacy of the internal control system. o SOX created the Public Company Accounting Oversight Board (PCAOB).- Internal Control:o Methods and Measures adopted to:1. Safeguard assets.2. Enhance accuracy and reliability of accounting records.3. Increase efficiency of operations. 4. Ensure compliance with laws and regulations. o Five Primary Components:1. Control environment.2. Risk assessment.3. Control activities.4. Information and communication. 5. Monitoring.- Principles of Internal Control Activities:o 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.o Segregation of Duties:  Different individuals should be responsible for related activities.  The responsibility for record keeping for an asset should be separate from the physical custody of that asset. o Documentation Procedures: Companies should use pre-numbered documents, and all documents should be accounted for.  Employees should promptly forward source documents for accounting entries to the accounting department. o Independent Internal Verification:  Records periodically verified by an employee who is independent.  Discrepancies reported to management. o Human Resource Controls: Bond employees who handle cash. Rotate employees’ duties and require vacations. Conduct background checks.2- Limitations of Internal Control:o Costs should not exceed benefit.o Human element.o Size of the business.- Cash Receipt Controls:o Mail Receipts: Mail receipts should be opened by two people, a list prepared, andeach check endorsed “For Deposit Only.” 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:o Generally, internal control over cash disbursements is more effective when companies pay by check or electronic funds transfer (EFT) rather than by cash.  Applications: Voucher System Controls, and Petty Cash Fund (Appendix 7A).- Voucher System:o A network of approvals by authorized individuals, acting independently, to ensure all disbursements by check are proper. 3o A voucher is an authorization form prepared for each expenditure in a voucher system. - Control Features: Use of a Bank:o The use of a bank contributes significantly to good internal control over cash.  Minimizes the amount of currency at hand.  Creates a double record of bank transactions.  Bank reconciliation. - Bank Statements:o Debit Memorandum:  Bank service charge. NSF (not sufficient funds).o Credit Memorandum: Collect notes receivable.  Interest earned. - Reconciling the Bank Account:o Reconcile balance per books and balance per bank to their “correct or true” balance. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Bank memoranda. 4. Errors. 4- Electronic Funds Transfer (EFT) System:o Disbursement systems that uses wire, telephone, or computers to transfer cash balances between locations. o EFT transfers normally result in better internal control since no cash or checks are handled by company employees. - Cash Equivalents:o Cash equivalents are short-term, highly liquid investments that are both: 1. Readily convertible to known amounts of cash. 2. So near their maturity that their market value is relatively insensitive to changes in interest rates. o Restricted Cash: cash that is not available for general use but rather is restricted for a special purpose. o- Operation of the Petty Cash Fund:o Petty Cash Fund: used to pay small amounts.  Involves: 1. Establishing the fund. 52. Making payments from the fund. 3. Replenishing the fund.