Why do I Need Accounting? and Sarbanes-Oxley Act of 2002

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Financial Accounting: Tools for Business Decision Making

Eighth Edition

Kimmel ● Weygandt ● Kieso

Chapter 7

Fraud, Internal Control, and Cash

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Financial Accounting: Tools for Business Decision Making

Chapter Outline:

Learning Objectives

Define fraud and the principles of internal control.

Apply internal control principles to cash.

Identify the control features of a bank account.

Explain the reporting of cash and the basic principles of cash management.

L O 1: Define Fraud and the Principles of Internal Control

Fraud

Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer.

Three factors that contribute to fraudulent activity.

The Sarbanes-Oxley Act

Applies to publicly traded U.S. corporations.

Required to maintain a system of internal control.

Corporate executives and boards of directors must ensure that these controls are reliable and effective.

Independent outside auditors must attest to the adequacy of the internal control system.

S O X created the Public Company Accounting Oversight Board (P C A O B).

Internal Control (1 of 4)

Methods and measures adopted to:

Safeguard assets.

Enhance accuracy and reliability of accounting records.

Increase efficiency of operations.

Ensure compliance with laws and regulations.

Internal Control (2 of 4)

Review Question

Internal control is used in a business to enhance the accuracy and reliability of its accounting records and to:

a. safeguard its assets.

b. prevent fraud.

c. produce correct financial statements.

d. deter employee dishonesty.

Internal Control (3 of 4)

Review Question

Internal control is used in a business to enhance the accuracy and reliability of its accounting records and to:

a. safeguard its assets.

b. prevent fraud.

c. produce correct financial statements.

d. deter employee dishonesty.

Internal Control (4 of 4)

Five Primary Components:

Control environment.

Risk assessment.

Control activities.

Information and communication.

Monitoring.

People, Planet, and Profit Insight

And the Controls Are…

Internal controls are important for an effective financial reporting system. The same is true for sustainability reporting. An effective system of internal controls for sustainability reporting will help in the following ways: (1) prevent the unauthorized use of data; (2) provide reasonable assurance that the information is accurate, valid, and complete; and (3) report information that is consistent with overall sustainability accounting policies. With these types of controls, users will have the confidence that they can use the sustainability information effectively.

Some regulators are calling for even more assurance through audits of this information. Companies that potentially can cause environmental damage through greenhouse gases, as well as companies in the mining and extractive industries, are subject to reporting requirements. And, as demand for more information in the sustainability area expands, the need for audits of this information will grow.

Principles of Internal Control Activities (1 of 6)

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.

Principles of Internal Control Activities (2 of 6)

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.

Principles of Internal Control Activities (3 of 6)

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.

Principles of Internal Control Activities (4 of 6)

Physical Controls

Principles of Internal Control Activities (5 of 6)

Independent Internal Verification

Records periodically verified by an employee who is independent.

Discrepancies reported to management.

Principles of Internal Control Activities (6 of 6)

Human Resource Controls

Bond employees who handle cash.

Rotate employees’ duties and require vacations.

Conduct background checks.

Principles of Internal Control (1 of 2)

Review Question

The principles of internal control do not include:

a. establishment of responsibility.

b. documentation procedures.

c. management responsibility.

d. independent internal verification.

Principles of Internal Control (2 of 2)

Review Question

The principles of internal control do not include:

a. establishment of responsibility.

b. documentation procedures.

c. management responsibility.

d. independent internal verification.

Anatomy of a Fraud (1 of 7)

Maureen Frugali was a training supervisor for claims processing at Colossal Healthcare. As a standard part of the claims processing training program, Maureen created fictitious claims for use by trainees. These fictitious claims were then sent to the accounts payable department. After the training claims had been processed, she was to notify Accounts Payable of all fictitious claims, so that they would not be paid. However, she did not inform Accounts Payable about every fictitious claim. She created some fictitious claims for entities that she controlled (that is, she would receive the payment), and she let Accounts Payable pay her.

Total take: $11 million

The Missing Control

Establishment of responsibility. The healthcare company did not adequately restrict the responsibility for authorizing and approving claims transactions. The training supervisor should not have been authorized to create claims in the company’s “live” system.

Anatomy of a Fraud (2 of 7)

Lawrence Fairbanks, the assistant vice-chancellor of communications at Aesop University, was allowed to make purchases of under $2,500 for his department without external approval. Unfortunately, he also sometimes bought items for himself, such as expensive antiques and other collectibles. How did he do it? He replaced the vendor invoices he received with fake vendor invoices that he created. The fake invoices had descriptions that were more consistent with the communications department’s purchases. He submitted these fake invoices to the accounting department as the basis for their journal entries and to the accounts payable department as the basis for payment.

Total take: $475,000

The Missing Control

Segregation of duties. The university had not properly segregated related purchasing activities. Lawrence was ordering items, receiving the items, and receiving the invoice. By receiving the invoice, he had control over the documents that were used to account for the purchase and thus was able to substitute a fake invoice.

Anatomy of a Fraud (3 of 7)

Angela Bauer was an accounts payable clerk for Aggasiz Construction Company. She prepared and issued checks to vendors and reconciled bank statements. She perpetrated a fraud in this way: She wrote checks for costs that the company had not actually incurred (e.g., fake taxes). A supervisor then approved and signed the checks. Before issuing the check, though, she would “white-out” the payee line on the check and change it to personal accounts that she controlled. She was able to conceal the theft because she also reconciled the bank account. That is, nobody else ever saw that the checks had been altered.

Total take: $570,000

The Missing Control

Segregation of duties. Aggasiz Construction Company did not properly segregate record-keeping from physical custody. Angela had physical custody of the blank checks, which essentially was control of the cash. She also had record-keeping responsibility because she prepared the bank reconciliation.

Anatomy of a Fraud (4 of 7)

To support their reimbursement requests for travel costs incurred, employees at Mod Fashions Corporation’s design center were required to submit receipts. The receipts could include the detailed bill provided for a meal, or the credit card receipt provided when the credit card payment is made, or a copy of the employee’s monthly credit card bill that listed the item. A number of the designers who frequently traveled together came up with a fraud scheme: They submitted claims for the same expenses. For example, if they had a meal together that cost $200, one person submitted the detailed meal bill, another submitted the credit card receipt, and a third submitted a monthly credit card bill showing the meal as a line item. Thus, all three received a $200 reimbursement.

Total take: $75,000

The Missing Control

Documentation procedures. Mod Fashions should require the original, detailed receipt. It should not accept photocopies, and it should not accept credit card statements. In addition, documentation procedures could be further improved by requiring the use of a corporate credit card (rather than a personal credit card) for all business expenses.

Anatomy of a Fraud (5 of 7)

At Centerstone Health, a large insurance company, the mailroom each day received insurance applications from prospective customers. Mailroom employees scanned the applications into electronic documents before the applications were processed. Once the applications are scanned they can be accessed online by authorized employees. Insurance agents at Centerstone Health earn commissions based upon successful applications. The sales agent’s name is listed on the application. However, roughly 15% of the applications are from customers who did not work with a sales agent. Two friends—Alex, an employee in record keeping, and Parviz, a sales agent—thought up a way to perpetrate a fraud. Alex identified scanned applications that did not list a sales agent. After business hours, he entered the mailroom and found the hardcopy applications that did not show a sales agent. He wrote in Parviz’s name as the sales agent and then rescanned the application for processing. Parviz received the commission, which the friends then split.

Total take: $240,000

The Missing Control

Physical controls. Centerstone Health lacked two basic physical controls that could have prevented this fraud. First, the mailroom should have been locked during nonbusiness hours, and access during business hours should have been tightly controlled. Second, the scanned applications supposedly could be accessed only by authorized employees using their passwords. However, the password for each employee was the same as the employee’s user ID. Since employee user-ID numbers were available to all other employees, all employees knew all other employees’ passwords. Unauthorized employees could access the scanned applications. Thus, Alex could enter the system using another employee’s password and access the scanned applications.

Anatomy of a Fraud (6 of 7)

Bobbi Jean Donnelly, the office manager for Mod Fashions Corporations design center, was responsible for preparing the design center budget and reviewing expense reports submitted by design center employees. Her desire to upgrade her wardrobe got the better of her, and she enacted a fraud that involved filing expense-reimbursement requests for her own personal clothing purchases. She was able to conceal the fraud because she was responsible for reviewing all expense reports, including her own. In addition, she sometimes was given ultimate responsibility for signing off on the expense reports when her boss was “too busy.” Also, because she controlled the budget, when she submitted her expenses, she coded them to budget items that she knew were running under budget, so that they would not catch anyone’s attention.

Total take: $275,000

The Missing Control

Independent internal verification. Bobbi Jean’s boss should have verified her expense reports. When asked what he thought her expenses were, the boss said about $10,000. At $115,000 per year, her actual expenses were more than ten times what would have been expected. However, because he was “too busy” to verify her expense reports or to review the budget, he never noticed.

Anatomy of a Fraud (7 of 7)

Ellen Lowry was the desk manager and Josephine Rodriquez was the head of housekeeping at the Excelsior Inn, a luxury hotel. The two best friends were so dedicated to their jobs that they never took vacations, and they frequently filled in for other employees. In fact, Ms. Rodriquez, whose job as head of housekeeping did not include cleaning rooms, often cleaned rooms herself, “just to help the staff keep up.” Ellen, the desk manager, provided significant discounts to guests who paid with cash. She kept the cash and did not register the guest in the hotel’s computerized system. Instead, she took the room out of circulation “due to routine maintenance.” Because the room did not show up as being used, it did not receive a normal housekeeping assignment. Instead, Josephine, the head of housekeeping, cleaned the rooms during the guests’ stay.

Total take: $95,000

The Missing Control

Human resource controls. Ellen, the desk manager, had been fired by a previous employer. If the Excelsior Inn had conducted a background check, it would not have hired her. The fraud was detected when Ellen missed work due to illness. A system of mandatory vacations and rotating days off would have increased the chances of detecting the fraud before it became so large.

Accounting Across the Organization

SOX Boosts the Role of Human Resources

Under SOX, a company needs to keep track of employees’ degrees and certifications to ensure that employees continue to meet the specified requirements of a job. Also, to ensure proper employee supervision and proper separation of duties, companies must develop and monitor an organizational chart. When one corporation went through this exercise it found that out of 17,000 employees, there were 400 people who did not report to anyone. The corporation had 35 people who reported to each other. In addition, SOX also mandates that, if an employee complains of an unfair firing and mentions financial issues at the company, the human resources department must refer the case to the company audit committee and possibly to its legal counsel.

Limitations of Internal Control

Costs should not exceed benefit.

Human element.

Size of the business.

▼ Helpful Hint

Controls may vary with the risk level of the activity. For example, management may consider cash to be high risk and maintaining inventories in the stockroom as lower risk. Thus, management would have stricter controls for cash.

Do It! 1: Control Activities

Identify which control activity is violated in each of the following situations.

Solution

The person with primary responsibility for reconciling the bank account and making all bank deposits is also the company’s accountant.

Segregation of duties

Wellstone Company’s treasurer received an award for distinguished service because he had not taken a vacation in 30 years.

Human resource controls

In order to save money on order slips and to reduce time spent keeping track of order slips, a local bar/restaurant does not buy prenumbered order slips.

Documentation procedures

L O 2: Apply Internal Control Principles to Cash

Cash Receipt Controls

Cash Receipt Controls (1 of 5)

Cash Receipt Controls (2 of 5)

Over-the-Counter Receipts

Important internal control principle—segregation of record-keeping from physical custody.

Cash Receipt Controls (3 of 5)

Mail Receipts

Mail receipts should be opened by two people, a list prepared, and each 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 Receipt Controls (4 of 5)

Review Question

Permitting only designated personnel such as cashiers to handle cash receipts is an application of the principle of:

a. segregation of duties.

b. establishment of responsibility.

c. independent internal verification.

d. human resource controls.

Cash Receipt Controls (5 of 5)

Review Question

Permitting only designated personnel such as cashiers to handle cash receipts is an application of the principle of:

a. segregation of duties.

b. establishment of responsibility.

c. independent internal verification.

d. human resource controls.

Cash Disbursement Controls (1 of 6)

Generally, internal control over cash disbursements is more effective when companies pay by check or electronic funds transfer (E F T) rather than by cash.

Applications:

Voucher System Controls

Petty Cash Fund (Appendix 7A)

Cash Disbursement Controls (2 of 6)

Cash Disbursement Controls (3 of 6)

Cash Disbursement Controls (4 of 6)

Review Question

The use of prenumbered checks in disbursing cash is an application of the principle of:

a. establishment of responsibility.

b. segregation of duties.

c. physical controls.

d. documentation procedures.

Cash Disbursement Controls (5 of 6)

Review Question

The use of prenumbered checks in disbursing cash is an application of the principle of:

a. establishment of responsibility.

b. segregation of duties.

c. physical controls.

d. documentation procedures.

Cash Disbursement Controls (6 of 6)

Voucher System

A network of approvals by authorized individuals, acting independently, to ensure all disbursements by check are proper.

A voucher is an authorization form prepared for each expenditure in a voucher system.

Ethics Insight How Employees Steal (1 of 2)

Occupational fraud is using your own occupation for personal gain through the misuse or misapplication of the company’s resources or assets. This type of fraud is one of three types:

Asset misappropriation, such as theft of cash on hand, fraudulent disbursements, false refunds, ghost employees, personal purchases, and fictitious employees. This fraud is the most common but the least costly.

Corruption, such as bribery, illegal gratuities, and economic extortion. This fraud generally falls in the middle between asset misappropriation and financial statement fraud as regards frequency and cost.

Financial statement fraud, such as fictitious revenues, concealed liabilities and expenses, improper disclosures, and improper asset values. This fraud occurs less frequently than other types of fraud but it is the most costly.

Ethics Insight How Employees Steal (2 of 2)

The graph below shows the frequency and the median loss for each type of occupational fraud. (Note that the sum of percentages exceeds 100% because some cases of fraud involved more than one type.)

Source: 2014 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners, pp. 10–12.

Do It! 2: Control over Cash Receipts (1 of 2)

L. R. Cortez is concerned about the control over cash receipts in his fast-food restaurant, Big Cheese. The restaurant has two cash registers. At no time do more than two employees take customer orders and enter sales. Work shifts for employees range from 4 to 8 hours. Cortez asks your help in installing a good system of internal control over cash receipts.

Solution

A separate cash register drawer should be assigned to each employee at the start of each work shift, with register totals set at zero.

Each employee should have access to only the assigned register drawer to enter all sales.

Do It! 2: Control over Cash Receipts (2 of 2)

Solution

Each customer should be given a receipt.

At the end of the shift, the employee should do a cash count. A separate employee should compare the cash count with the register tape (or point-of-sale records) to be sure they agree.

Cortez should install an automated point-of-sale system that would enable the company to compare orders entered in the register to orders processed by the kitchen.

L O 3: Identify the Control Features of a Bank Account

The use of a bank contributes significantly to good internal control over cash.

Minimizes the amount of currency on hand.

Creates a double record of bank transactions.

Bank reconciliation.

▼ Helpful Hint

Essentially, the bank statement is a copy of the bank’s records sent to the customer or made available online for review.

Electronic Funds Transfer (E F T) System

E F T s

Are disbursement systems that use wire, telephone, or computers to transfer cash from one location to another.

Use is quite common.

Normally result in better internal control since no cash or checks are handled by company employees.

Bank Statements (1 of 5)

Each month, the company receives from the bank a bank statement showing its bank transactions and balances.

Bank Statements (2 of 5)

Shows the following:

Checks paid and other debits that reduce the balance.

Debit card transactions

Electronic funds transfers for bill payments

Deposits and other credits that increase the balance.

Direct deposit

Automated teller machine

Electronic funds transfer

Bank Statements (3 of 5)

Shows the following:

Debit Memorandum.

Bank service charge

N S F check (not sufficient funds)

Credit Memorandum.

Collection of a notes receivable

Interest earned

The account balance after each day’s transactions.

Bank Statements (4 of 5)

Review Question

The control features of a bank account do not include:

a. having bank auditors verify the correctness of the bank balance per books.

b. minimizing the amount of cash that must be kept on hand.

c. providing a double record of all bank transactions.

d. safeguarding cash by using a bank as a depository.

Bank Statements (5 of 5)

Review Question

The control features of a bank account do not include:

a. having bank auditors verify the correctness of the bank balance per books.

b. minimizing the amount of cash that must be kept on hand.

c. providing a double record of all bank transactions.

d. safeguarding cash by using a bank as a depository.

Reconciling the Bank Account

Reconcile balance per books and balance per bank to their “correct or true” balance.

Reconciling Items:

Time Lags

Deposits in transit.

Outstanding checks.

Bank memoranda.

Errors.

Reconciliation Procedures

Bank Reconciliation Illustrated (1 of 5)

The bank statement for Laird Company shows a balance per bank of $15,907.45 on April 30, 2017. On this date the balance of cash per books is $11,709.45. Laird determines the following reconciling items.

Deposits in transit: April 30 deposit (received by bank on May 1).	$2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457, $1, 401.30; No. 460, $1,502.70.	5,904.00
Other deposits: Unrecorded electronic receipt from customer on account on April 9 determined from bank statement.	1,035.00
Other payments: Unrecorded charges determined from the bank statement are as follows:	Blank
Returned NSF check on April 29	425.60
Debit and credit card fees on April 30	120.00
Bank service charges on April 30	30.00
Company errors: Check No. 443 was correctly written by Laird for $1,226 and was correctly paid by the bank on April 12. However, it was recorded as $1,262 on Laird’s books.	36.00

Bank Reconciliation Illustrated (2 of 5)

Illustration: Prepare a bank reconciliation at April 30.

Cash balance per bank statement	$15,907.45
Deposit in transit	2,201.40
Outstanding checks	(5,904.00)
Adjusted cash balance per bank	$12,204.85 Double underline

Cash balance per books	$11,709.45
Electronic funds transfer received	$1,035.00
Error in recording check No. 443	36.00
N S F check	(425.60)
Debit and credit card fees	(120.00)
Bank service charge	(30.00)
Adjusted cash balance per books	$12,204.85 double underline

Bank Reconciliation Illustrated (3 of 5)

Entries From Bank Reconciliation

Collection of Electronic Funds Transfer: Payment of account by customer. The entry is:

Apr. 30

Cash

1,035.00

Accounts Receivable

1,035.00

Bank Reconciliation Illustrated (4 of 5)

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

N S F 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

Bank Reconciliation Illustrated (5 of 5)

Bank Charges Expense: Fees for processing debit and credit card transactions are normally debited to the Bank Charges Expense account, as are bank service charges. The entry is:

Apr. 30

Bank Charge Expense

150.00

Cash

150.00

Bank Reconciliation (1 of 2)

Review Question

The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:

a. outstanding checks.

b. deposit in transit.

c. a bank error.

d. bank service charges.

Bank Reconciliation (2 of 2)

Review Question

The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is:

a. outstanding checks.

b. deposit in transit.

c. a bank error.

d. bank service charges.

Investor Insight Madoff’s Ponzi Scheme

No recent fraud has generated more interest and rage than the one perpetrated by Bernard Madoff. Madoff was an elite New York investment fund manager who was highly regarded by securities regulators. Investors flocked to him because he delivered steady returns of between 10% and 15%, no matter whether the market was going up or going down. However, for many years, Madoff did not actually invest the cash that people gave to him. Instead, he was running a Ponzi scheme: He paid returns to existing investors using cash received from new investors. As long as the size of his investment fund continued to grow from new investments at a rate that exceeded the amounts that he needed to pay out in returns, Madoff was able to operate his fraud smoothly. To conceal his misdeeds, Madoff fabricated false investment statements that were provided to investors. In addition, Madoff hired an auditor that never verified the accuracy of the investment records but automatically issued unqualified opinions each year. A competing fund manager warned the S E C a number of times over a nearly 10-year period that he thought Madoff was engaged in fraud. The S E C never aggressively investigated the allegations. Investors, many of which were charitable organizations, lost more than $18 billion. Madoff was sentenced to a jail term of 150 years.

Do It! 3: Bank Reconciliation

Sally Kist, owner of Linen Kist Fabrics, 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 N S F check, (2) a credit memorandum for an electronic funds transfer from a customer, (3) outstanding checks, and (4) a deposit in transit.

Solution

Sally should treat the reconciling items as follows.

N S F check:

Deduct from balance per books.

Electronic funds transfer:

Add to balance per books.

Outstanding checks:

Deduct from balance per bank.

Deposit in transit:

Add to balance per bank.

L O 4: Explain the Reporting of Cash and the Basic Principles of Cash Management

Reporting Cash

Cash consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit.

Balance sheet reports the amount of cash available at a given point in time.

Listed first in the current assets section.

Includes cash on hand, cash in banks, and petty cash.

Statement of cash flows shows the sources and uses of cash during a period of time.

Reporting Cash (1 of 4)

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.

Restricted Cash

Cash that is not available for general use but rather is restricted for a special purpose.

Reporting Cash (2 of 4)

Reporting Cash (3 of 4)

Review Question

Which of the following statements correctly describes the reporting of cash?

a. Cash cannot be combined with cash equivalents.

b. Restricted cash funds may be combined with Cash.

c. Cash is listed first in the current assets section.

d. Restricted cash funds cannot be reported as a current asset.

Reporting Cash (4 of 4)

Review Question

Which of the following statements correctly describes the reporting of cash?

a. Cash cannot be combined with cash equivalents.

b. Restricted cash funds may be combined with Cash.

c. Cash is listed first in the current assets section.

d. Restricted cash funds cannot be reported as a current asset.

Do It! 4a: Reporting Cash

Indicate whether each of the following statements is true or false.

Cash and cash equivalents are comprised of coins, currency (paper money), money orders, and N S F checks.

False

Restricted cash is classified as either a current asset or noncurrent asset, depending on the circumstances.

True

A company may have a negative balance in its bank account. In this case, it should offset this negative balance against cash and cash equivalents on the balance sheet.

False

Because cash and cash equivalents often includes short-term investments, accounts receivable should be reported as the first item on the balance sheet.

False

Managing and Monitoring Cash (1 of 2)

Operating Cycle of a Merchandising Company

Managing and Monitoring Cash (2 of 2)

Basic Principles of Cash Management

Cash Budgeting (1 of 2)

Shows anticipated cash flows, usually over a one- to two-year period.

Cash receipts

Cash disbursements

Financing activities

Enables the company to plan ahead to cover possible cash shortfalls and to make investments of idle funds.

Contributes to more effective cash management.

Cash Budgeting (2 of 2)

Do It! 4b: Cash Budget

Martian Company’s management wants to maintain a minimum monthly cash balance of $15,000. At the beginning of March, the cash balance is $16,500, expected cash receipts for March are $210,000, and cash disbursements are expected to be $220,000. How much cash, if any, must Martian borrow to maintain the desired minimum monthly balance?

Beginning cash balance	$ 16,500
Add: Cash receipts for March	210,000
Total available cash	226,500
Less: Cash disbursements for March	220,000
Excess of available cash over cash disbursements Financing	6,500
Add: Borrowings	8,500
Ending cash balance	$ 15,000 Double line

L O 5a: Appendix 7A: Explain the Operation of a Petty Cash Fund

Petty Cash Fund - Used to pay small amounts.

Involves:

establishing the fund,

making payments from the fund, and

replenishing the fund.

▼ Ethics Note

Petty cash funds are authorized and legitimate. In contrast, “slush” funds are unauthorized and hidden (under the table).

Establishing the Petty Cash Fund

Illustration: If Laird Company decides to establish a $100 fund on March 1, the entry is:

March 1

Petty Cash

100

Cash

100

Making Payments From Petty Cash

Management usually limits the size of expenditures.

Does not permit use of the fund for certain types of transactions.

Payments are documented on a prenumbered receipt.

Signatures of both the custodian and the individual receiving payment are required on the receipt.

Supporting documents should be attached to the receipt.

Custodian keeps the receipts in the petty cash box until the fund is replenished.

Sum of the receipts and money in the fund should equal the established total at all times.

Replenishing the Petty Cash Fund (1 of 2)

Illustration: On March 15 the petty cash custodian requests a check for $87. The fund contains $13 cash and petty cash receipts for postage $44, supplies $38, and miscellaneous expenses $5. The entry is:

March 15

Postage Expense

Supplies

Miscellaneous Expense

Cash

Replenishing the Petty Cash Fund (2 of 2)

Illustration: Assume in the preceding example that the custodian had only $12 in cash in the fund plus the receipts as listed. The request for reimbursement would therefore be for $88. The entry is:

March 15

Postage Expense

Supplies

Miscellaneous Expense

Cash Over and Short

Cash

A Look at I F R S-L O-6: Compare the Accounting Procedures for Fraud, Internal Control, and Cash Under G A A P and I F R S

Relevant Facts

Similarities

The fraud triangle is applicable to all international companies. Some of the major frauds on an international basis are Parmalat (Italy), Royal Ahold (the Netherlands), and Satyam Computer Services (India).

A Look at I F R S (1 of 13)

Similarities

Rising economic crime poses a growing threat to companies, with 34% of all organizations worldwide being victims of fraud in a recent 12-month period.

Accounting scandals both in the United States and internationally have re-ignited the debate over the relative merits of G A A P, which takes a “rules-based” approach to accounting, versus I F R S, which takes a “principles-based” approach. The F A S B announced that it intends to introduce more principles-based standards.

A Look at I F R S (2 of 13)

Similarities

On a lighter note, at one time the Ig Nobel Prize in Economics went to the C E O s of those companies involved in the corporate accounting scandals of that year for “adapting the mathematical concept of imaginary numbers for use in the business world.” A parody of the Nobel Prizes, the Ig Nobel Prizes (read Ignoble, as not noble) are given each year in early October for 10 achievements that “first make people laugh, and then make them think” (see en.wikipedia.org).

A Look at I F R S (3 of 13)

Similarities

Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. While most companies have these systems in place, many have never completely documented them, nor had an independent auditor attest to their effectiveness. Both of these actions are required under S O X.

A Look at I F R S (4 of 13)

Similarities

Companies find that internal control review is a costly process but badly needed. One study estimates the cost of S O X compliance for U.S. companies at over $35 billion, with audit fees doubling in the first year of compliance. At the same time, examination of internal controls indicates lingering problems in the way companies operate. One study of first compliance with the internal-control testing provisions documented material weaknesses for about 13% of companies reporting in a two-year period (PricewaterhouseCoopers’ Global Economic Crime Survey, 2005).

A Look at I F R S (5 of 13)

Similarities

The accounting and internal control procedures related to cash are essentially the same under both I F R S and this textbook. In addition, the definition used for cash equivalents is the same.

Most companies report cash and cash equivalents together under I F R S, as shown in this textbook. In addition, I F R S follows the same accounting policies related to the reporting of restricted cash.

A Look at I F R S (6 of 13)

Differences

The S O X internal control standards apply only to companies listed on U.S. exchanges. There is continuing debate over whether foreign issuers should have to comply with this extra layer of regulation.

A Look at I F R S (7 of 13)

Looking to the Future

Ethics has become a very important aspect of reporting. Different cultures have different perspectives on bribery and other questionable activities, and consequently penalties for engaging in such activities vary considerably across countries. High-quality international accounting requires both high-quality accounting standards and high-quality auditing. Similar to the convergence of G A A P and I F R S, there is movement to improve international auditing standards. The International Auditing and Assurance Standards Board (I A A S B) functions as an independent standard-setting body. It works to establish high-quality auditing and assurance and quality-control standards throughout the world. Whether the I A A S B adopts internal control provisions similar to those in S O X remains to be seen. You can follow developments in the international audit arena at www.ifac.org.

A Look at I F R S (8 of 13)

I F R S Practice

Non-U.S companies that follow I F R S:

a. do not normally use the principles of internal control activities described in this textbook.

b. often offset cash with accounts payable on the balance sheet.

c. are not required to follow S O X.

d. None of the above.

A Look at I F R S (9 of 13)

I F R S Practice

Non-U.S companies that follow I F R S:

a. do not normally use the principles of internal control activities described in this textbook.

b. often offset cash with accounts payable on the balance sheet.

c. are not required to follow S O X.

d. None of the above.

A Look at I F R S (10 of 13)

I F R S Practice

The Sarbanes-Oxley Act applies to:

a. all U.S. companies listed on U.S. exchanges.

b. all companies that list stock on any stock exchange in any country.

c. all European companies listed on European exchanges.

d. Both (a) and (c).

A Look at I F R S (11 of 13)

I F R S Practice

The Sarbanes-Oxley Act applies to:

a. all U.S. companies listed on U.S. exchanges.

b. all companies that list stock on any stock exchange in any country.

c. all European companies listed on European exchanges.

d. Both (a) and (c).

A Look at I F R S (12 of 13)

I F R S Practice

High-quality international accounting requires both high-quality accounting standards and:

a. a reconsideration of S O X to make it less onerous.

b. high-quality auditing standards.

c. government intervention to ensure that the public interest is protected.

d. the development of new principles of internal control activities.

A Look at I F R S (13 of 13)

I F R S Practice

High-quality international accounting requires both high-quality accounting standards and:

a. a reconsideration of S O X to make it less onerous.

b. high-quality auditing standards.

c. government intervention to ensure that the public interest is protected.

d. the development of new principles of internal control activities.

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