Study Guide for Test 3 CHAPTER 7 FRAUD INTERNAL CONTROL AND CASH Know the three main factors that contribute to fraud Fraud Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer 1 Opportunity For an employee to commit fraud the workplace environment must provide opportunities that an employee can exploit Opportunities occur when the workplace lacks sufficient controls to deter and detect fraud WHICH IS WHY INTERNAL CONTROL IS SO IMPORTANT 2 Financial Pressure Employees sometimes commit fraud because of personal financial problems caused by too much debt or because they want to lead a lifestyle that they cannot afford on their current salary 3 Rationalization In order to justify their fraud employees rationalize their dishonest actions For example they justify fraud because they are underpaid while the employer is making lots of money They feel justified in stealing because they believe they deserve to be paid more Know the objectives of internal control Internal control All the related methods and measures adopted within an organization to safeguard assets and enhance the reliability of accounting records increase efficiency of operations and ensure compliance with laws and regulations Internal control systems have five primary components 1 Control environment it is to be made clear that the organization values integrity and that unethical activity will not be tolerated 2 Risk Assessment companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks 3 Control Activities to reduce the occurrence of fraud management must design policies and procedures to address the specific risks faced by the company 4 Information and communication the internal control system must capture and communicate all pertinent information both down and up the organization as well as communicate information to appropriate external parties 5 Monitoring internal control systems must be monitored periodically for their adequacy significant deficiencies need to be reported to top management and or the board of directors Know the principles of control activities Study Guide for Test 3 Six principles of control activities they apply to most companies and are relevant to both manual and computerized accounting systems 1 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 EX identifying passwords that keep track of who entered a sale 612680 2 Segregation of duties Different individuals should be responsible for related activities The responsibility for record keeping for an asset should be separate from physical custody of that asset The rationale for segregation of duties is the work of one employee should without a duplication of effort provide a basis for evaluating the work of another employee EX the personnel that design and program computerized systems should not be assigned duties related to day to day use of the system Otherwise they could design the system to benefit them personally and conceal the fraud through day to day use 3 Documentation procedures Companies should use prenumbered documents and all documents should be accounted for Employees should promptly forward source documents for accounting entries to the accounting department This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records 4 Physical controls Relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records Examples of the controls include safes vaults and safety deposit boxes for cash and business papers locked warehouses and storage cabinets for inventories and records computer facilities with pass key access or fingerprint or eyeball scans alarms to prevent break ins television monitors and garnet sensors to deter theft time clocks for recording time worked 5 Independent internal verification To obtain maximum benefit from independent internal verification companies should verify records periodically or on a surprise basis an employee who is independent of the personnel responsible for the information should make the verification and discrepancies and exceptions should be reported to a management level that can take appropriate corrective action This internal control is especially useful in comparing recorded transactions with existing assets EX the reconciliation of the cash register tape with the cash in the register 6 Human resource HR controls Bond Bonding involves obtaining insurance protection against theft by employees It contributes to the safeguarding of cash because the insurance company carefully screens all individuals before adding them to the policy and may reject risky applications and bonded employees know that the insurance company will vigorously prosecute all offenders employees who handle cash rotate employees duties and require vacations and conduct background checks THE BOOK AND POWERPOINT PROVIDE GREAT EXAMPLES TO AID IN FURTHER UNDERSTANDING OF CONTROLS If it is a small business the control would be have an owner or their family member participating to mitigate fraud Know the bank reconciliation process including the related journal entries Bank reconciliation the process of comparing the bank s balance with the company s balance and explaining the differences to make them agree The need for reconciliation has two causes 1 Time lags that prevent one of the parties from recording the transaction in the same period Time lags occur frequently It can occur when a bank uses night depository to make its deposits there will be a difference of one day between the company records and receipts and the bank 2 Errors by either party in recording transactions You might think that if a company never writes checks it does not Study Guide for Test 3 need to reconcile its accounts however the possibility of errors or fraud still necessitates periodic reconciliation The incidence of errors or fraud depends on the effectiveness of the internal controls maintained by the company and the bank Bank errors are infrequent but still any party could accidentally record a check as the wrong amount or the bank might mistakenly charge a check drawn by C D Berg to the account of C D Burg The use of a
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