Fraud, Internal Control and Cash - Principles of Accounting - Lecture Notes, Study notes for Principles of Accounting. Aliah University

Principles of Accounting

Description: Fraud, Internal Control and Cash, Fraud and Internal Control, Internal Control, Control Environment, Risk Assessment, Control Activities, Information and Communication, Principles of Internal Control, Establishment of Responsibility, Segregation of Duties are some points from lectures of Principles of Accounting.
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Fraud, Internal Control and Cash
Study 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. Prepare a bank reconciliation.
6. Explain the reporting of cash.
7. Discuss the basic principles of cash management.
8. Identify the primary elements of a cash budget.
9. (Appendix) Explain the operation of a petty cash fund.
Study Objective 1 Define Fraud and Internal Control
Fraud is a dishonest act by employee that results in personal benefit to the
employee at a cost to the employer
Three main factors contribute to fraudulent activity. They are: (1) opportunity,
which are usually due to a lack of sufficient controls; (2) financial pressure,
which usually is related to too much personal debt or a desire for a better
lifestyle; and (3) rationalization, which is justification for why the employee
deserves the compensation from fraudulent acts.
Sarbanes-Oxley Act of 2002 (SOX) requires all publicly traded U.S. corporations to
maintain an adequate system of internal controls. SOX imposes more
responsibilities on corporate executives and boards of directors to ensure that
companies’ internal controls are reliable and effective
Companies must develop sound principles of control over financial
reporting and continually assess that the controls are working.
Independent outside auditors must attest to the level of internal controls.
Internal control consists of all of the related methods and measures adopted
within a business to:
Safeguard assets
Enhance the reliability of its accounting records
Increase efficiency of operations, and
Ensure compliance with laws and regulations.
There are five primary components of internal control systems:
Control environment, or “tone at the top.”
Risk assessment, or identifying and analyzing factors that create risk.
Control activities, or policies and procedures to address risk.
Information and communication, which allow for both down and up
organizational information flow and appropriate external communication.
Monitoring, which allow for reporting of significant deficiencies
Study Objective 2 - Identify the Principles of Internal Control
To safeguard assets and enhance the accuracy and reliability of its accounting
records, companies follow internal control principles. The following six internal
control principles apply to most enterprises:
1. Establishment of Responsibility
An essential characteristic of internal control is the assignment of responsibility to
specific individuals.
Control is most effective when only one person is responsible for a given task.
Establishing responsibility includes the authorization and approval of transactions.
2. Segregation of Duties
Segregation of duties is indispensable in a system of internal control.
The rationale for segregation of duties is that the work of one employee should,
without a duplication of effort, provide a reliable basis for evaluating the work of
another employee.
There are two common applications of this principle:
I. The responsibility for related activities should be assigned to different
Related Activities:
When one individual is responsible for all of the related activities,
the potential for errors and irregularities is increased.
Related purchasing activities should be assigned to different
individuals. Related purchasing activities include ordering
merchandise, receiving goods, and paying (or authorizing
payment) for merchandise.
Related sales activities also should be assigned to different
individuals. Related sales activities include making a sale,
shipping (or delivering) the goods to the customer, and billing the
II.The responsibility for record keeping for an asset should be separate from the
physical custody of the asset.
Separate Record Keeping from Physical Custody
The custodian of the asset is not likely to convert the assets to
personal use if one employee maintains the record of the assets
that should be on hand and a different employee has physical
custody of the assets.
3. Documentation Procedures
Documents provide evidence that transactions and events have occurred.
Documents should be prenumbered and all documents should be
accounted for.
Source documents for accounting entries should be promptly forwarded to
the accounting department to help ensure timely recording of the
transaction and event.
4. Physical Electronic Controls Physical controls relate primarily to the
safeguarding of assets. Mechanical and electronic controls safeguard assets and
enhance the accuracy and reliability of the accounting records. Use of physical
controls is essential. Examples of these controls include:
Safes, vaults, and safety deposit boxes for cash and business papers.
Locked warehouses and storage cabinets for inventory and records.
Computer facilities with pass key access or fingerprint or eyeball scans.
Alarms to prevent break-ins.
Television monitors and garment sensors to deter theft.
Time clocks for recording time worked.
5. Independent Internal Verification
Independent internal verification involves the review, comparison, and
reconciliation of data prepared by employees.
For Maximum benefit:
Verification should be made periodically or on a surprise basis.
Verification should be done by an employee independent of the personnel
responsible for the information.
Discrepancies and exceptions should be reported to a management level
that can take appropriate corrective action.
In large companies, independent internal verification is often assigned to internal
Internal auditors are employees of the company who evaluate on a
continuous basis the effectiveness of the company’s system of internal
They periodically review the activities of departments and individuals to
determine whether prescribed internal controls are being followed.
6. Human Resource Controls
Bonding of employees who handle cash.
Rotating employees' duties and requiring employees to take vacations.
Conducting thorough background checks, checking on school graduations and
verified telephone number of previous employers.
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