Prepared by Coby Harmon University of California, Santa Barbara Westmont College

Prepared by
Coby Harmon
4-1 University of California, Santa Barbara
Copyright ©2015 Pearson Education Inc. All rights reserved.
Westmont College
Learning Objective
1. Describe fraud and its impact
4-2 Copyright ©2015 Pearson Education Inc. All rights reserved.

DESCRIBE FRAUD AND ITS IMPACT
Fraud
 Intentional misrepresentation of facts
 Causes injury or damage to another party
 Increased with expansion of e-commerce via the
Internet
 Some common types
■ Insurance fraud ■ Credit card fraud
■ Check forgery ■ Identity theft
■ Medicare fraud

LO 1
Two common types of fraud that impact financial
statements
Misappropriation of Fraudulent Financial

Assets Reporting
 Committed by employees  Committed by managers

 Theft of money or inventory  False and misleading
 Bribery or kickback schemes entries in the books
 Overstate expense
 Deceives investors and
reimbursement creditors

LO 1
Exhibit 4-1 | The Fraud Triangle
Motive Fraud
is the ultimate
unethical act in
business!
Opportunity Rationalization

LO 1
Learning Objective
2. Explain the objectives and components of internal

control

EXPLAIN THE OBJECTIVES AND
COMPONENTS OF INTERNAL CONTROL
Internal Control
 Primary way fraud and errors are:
► Prevented
► Detected or
► Corrected
 Management and Board of Directors implement a:
► Plan of organization
► System of procedures

LO 2
EXPLAIN THE OBJECTIVES AND
COMPONENTS OF INTERNAL CONTROL
Objectives of Internal Control
Encourage Promote
Safeguard
employees to operational
assets
follow policies efficiency
Ensure Comply with

accurate, legal
reliable records requirements

LO 2
The Sarbanes-Oxley Act (SOX)
SOX Provisions
 Public companies must
► maintain a system of internal control
► issue an internal control report
 Auditors must evaluate and report on internal controls

 Created Public Company Accounting Oversight Board
 Limits non-audit services of auditing firms
 Penalties for violators

LO 2
The Sarbanes-Oxley Act (SOX)
Exhibit 4-3 | The Shield of Internal Control
Internal
Controls
Company Assets

LO 2
The Components of Internal Control
Exhibit 4-4 | The Components of Internal Control
RISK ASSESSMENT

LO 2
Control Risk Information

Environment Assessment System
Control Monitoring of
Procedures Controls
 Tone at the top

 Code of ethics

LO 2

Procedures Controls
 Identify business risks

 Establish procedures to deal with risks

LO 2

Procedures Controls
 System to capture, process, and

report transactions

LO 2

Procedures Controls
 Built into the control environment and

information system

LO 2

Procedures Controls
 Controls programmed into a company’s

information technology
 Internal and external auditors
LO 2
Internal Control Procedures
Smart Hiring Practices  Background checks
 Training and supervision
Separation of Duties
 Competitive salaries
Comparison and
 Clear employee
Compliance Monitoring
responsibility
Adequate Records
Limited Access
Proper Approvals

LO 2
Smart Hiring Practices Separates three key duties:
 Asset handling
 Record keeping
Comparison and
 Transaction approval
Adequate Records
Limited Access
Proper Approvals

LO 2
Smart Hiring Practices
Separation of Duties  Operating and cash

budgets
Comparison and
Compliance Monitoring  Exception reporting
 Audits
Adequate Records
Limited Access
Proper Approvals

LO 2
Comparison and
 Details of business
transactions
Adequate Records  Hard copy documents or
electronic
Limited Access
 Prenumbered documents
Proper Approvals

LO 2
Comparison and
Compliance Monitoring  Physical access to assets
Adequate Records  Lock-box system
Limited Access  Lock and key

 Passwords
Proper Approvals
 Encryption
LO 2
Comparison and
 Management’s general or
specific approval
Adequate Records  Credit department
Limited Access  Purchasing department
Proper Approvals  Human resources

department

LO 2
Information Technology
Accounting systems rely
 less on manual procedures and
 more on information technology (IT)
Examples:
► Electronic sensors
► Bar code scanning
Use of computers greatly improves speed and accuracy

LO 2
Safeguard Controls
Job rotation
Fireproof Fidelity
vaults bonds
Security
cameras
Mandatory
vacations Alarms
Loss
prevention
specialists
LO 2
Internal Controls for E-Commerce
E-commerce pitfalls include:
 Stolen credit card numbers
 Computer viruses and Trojan Horses
 Phishing expeditions
Security measures:
 Encryption
 Firewalls

LO 2
The Limitations of Internal Control—
Costs and Benefits
Ways internal control can be circumvented
 Collusion
 Management override
 Fatigue & negligence
Benefits should outweigh the costs

LO 2
Learning Objective
3. Design and use a bank reconciliation

DESIGN AND USE A BANK RECONCILIATION
Documents used to control a bank account
Signature Deposit
Check
Card Ticket
Bank Bank
Statement Reconciliation
 Protects against forgery

LO 3
Signature Deposit
Check
Card Ticket
Bank Bank
 Proof of deposit transaction

LO 3
Signature Deposit
Check
Card Ticket
Bank Bank
 Maker, payee, and bank

LO 3
Check Three parties
Exhibit 4-5 | Check with Remittance Advice
to a check
Maker Payee
Bank

LO 3
Signature Deposit
Check
Card Ticket
Bank Bank
 Report of customer’s cash activity

LO 3
Exhibit 4-6 | Bank Statement
4-33
Signature Deposit
Check
Card Ticket
Bank Bank
 Differences between company’s cash records

and bank balance
LO 3
Bank Reconciliation
Two records of a business’s cash
1. Cash account in company’s general ledger
2. Bank statement
Differences because of time lag in recording transactions

LO 3
Bank Reconciliation
Bank Side Book Side
 Deposits in transit  Bank collections

 Outstanding checks  Electronic funds transfers
 Bank errors  Service charge
 Interest revenue
 Nonsufficient funds (NSF)
checks
 Cost of printed checks
 Book errors
LO 3
Bank Reconciliation Illustrated
The December 31 bank balance of Mid-Atlantic Manufacturing is $5,900. The
company’s Cash account has a balance of $3,340. Additional information
related to the cash account at December 31 is as follows:
1. Deposit in transit, $1,600.
2. Bank error: The bank deducted $100 for a check written by another
company. Add $100 to the bank balance.
3. Outstanding checks—total of $1,340.
4. EFT receipt of your dividend revenue earned on an investment, $900.
5. Bank collection of your account receivable, $2,100.
6. Interest revenue earned on your bank balance, $30.
7. Book error: You recorded check no. 333 for $510. The amount you actually
paid on account was $150. Add $360 to your book balance.
8. Bank service charge, $20.
9. NSF check from a customer, $50. Subtract $50 from your book balance.
10. EFT payment of insurance expense, $400.

LO 3
Bank Reconciliation Illustrated
Bank reconciliation for Mid-Atlantic at December 31
Cash balance per bank statement $ 5,900
Add: Deposit in transit 1,600
Correction of bank error 100
Less: Outstanding checks (1,340)
Adjusted bank balance $ 6,260
Cash balance per books $ 3,340

Add: EFT receipt of dividends 900
Bank collection of accounts receivable 2,100
Interest revenue 30
Correction of book error (Check no. 333) 360
Less: Service charge (20)
NSF check (50)
EFT payment of insurance expense (400)
Adjusted book balance $ 6,260
LO 3
Journalizing transactions from Bank reconciliation
Interest revenue 30
NSF check (50)
Account Debit Credit

Cash 900
Dividend Revenue 900
Receipt of dividend earned

LO 3
Interest revenue 30
NSF check (50)

Cash 2,100
Accounts Receivable 2,100
Receivables collected by bank

LO 3
Interest revenue 30
NSF check (50)

Cash 30
Interest Revenue 30
Interest earned on bank balance

LO 3
Interest revenue 30
NSF check (50)

Cash 360
Accounts Payable 360
Correction of check no. 333

LO 3
Interest revenue 30
NSF check (50)

Miscellaneous Expense 20
Cash 20
Bank service charge

LO 3
Interest revenue 30
NSF check (50)

Accounts Receivable 50
Cash 50
NSF check returned by bank
4-44 LO 3
Interest revenue 30
NSF check (50)

Insurance Expense 400
Cash 400
Payment of monthly insurance

LO 3
Summary of the various reconciling items:
BANK BALANCE—ALWAYS
■ Add deposits in transit
■ Subtract outstanding checks
■ Add or subtract corrections of bank errors
BOOK BALANCE—ALWAYS
■ Add bank collections, interest revenue, and EFT receipts
■ Subtract service charges, NSF checks, and EFT
payments
■ Add or subtract corrections of book errors

LO 3
The bank statement balance is $4,500 and shows a service charge of
$15, interest earned of $5, and an NSF check for $300. Deposits in
transit total $1,200; outstanding checks are $575. The bookkeeper
recorded as $152 a check of $125 in payment of an account payable.
This created a book error of $27 (positive amount to correct the error).
(1) What is the adjusted bank balance?
(2) What was the book balance of cash before the reconciliation?
Answer:
(1) $5,125 ($4,500 + $1,200 – $575).
(2) $5,408 ($5,125 + $15 – $5 + $300 – $27). The adjusted book and
bank balances are the same.
4-47 Advance slide in presentation mode to reveal answers LO 3

Illustration
Logan Harmon operates an ice skating rink. He has just received
the monthly bank statement at July 31 from Valley National
Bank, and the statement shows an ending balance of $1,500.
Listed on the statement are a bank collection of accounts
receivable of $818, a service charge of $14, two NSF checks
totaling $240, and a $20 charge for printed checks. In reviewing
his cash records, Logan identifies outstanding checks totaling
$1,220 and a July 31 deposit in transit of $3,530. During July, he
recorded a $540 check for the salary of a part-time employee as
$54. Logan’s Cash account shows a July 31 cash balance of
$3,752.
How much cash does Logan actually have at July 31, 2014?
LO 3
Illustration
The monthly bank statement at July 31 from Valley National
Bank shows an ending balance of $1,500.
Bank Books
Balance, July 31 $1,500 Balance, July 31
Adjusted bank balance Adjusted book balance

LO 3
Illustration
Logan’s Cash account shows a July 31 cash balance of $3,752.
Bank Books
Balance, July 31 $1,500 Balance, July 31 $3,752

LO 3
Illustration Listed on the bank statement are a bank
collection of an accounts receivable of $818, a service charge of $14,
two NSF checks totaling $240, and a $20 charge for printed checks.
Bank Books

Add: Collection on account 818
Less:
Service charge (14)
NSF checks (240)
Printed check charge (20)

LO 3
Illustration
In reviewing his cash records, Logan identifies a July 31 deposit in
transit of $3,530 and outstanding checks totaling $1,220.
Bank Books

Add: Deposit in transit 3,530 Add: Collection on account 818
Less: Outstanding checks (1,220) Less:
Service charge (14)
NSF checks (240)

LO 3
Illustration
During July, Logan recorded a $540 check for the salary of a part-
time employee as $54.
Bank Books

Service charge (14)
NSF checks (240)
Correction of book error (486)

LO 3
Illustration
How much cash does Logan actually have at July 31, 2014?
Bank Books

Service charge (14)
NSF checks (240)
Adjusted bank balance $3,810 Adjusted book balance $3,810

LO 3
Illustration
Prepare the journal entries that Logan should record on July 31 to
update his Cash account.
Journal Entries Books
Cash 818 Balance, July 31 $3,752

Accounts Receivable 818 Add: Collection on account 818
Miscellaneous Expense 34 Less:

Cash 34 Service charge (14)
NSF checks (240)
Accounts Receivable 240
Cash 240
Salary Expense 486
Adjusted book balance $3,810
Cash 486
LO 3
Learning Objective
4. Evaluate internal controls over cash receipts and

cash payments

EVALUATE INTERNAL CONTROLS OVER
CASH RECEIPTS AND CASH PAYMENTS
Cash requires specific internal controls because
 Cash is easy to steal
 All transactions ultimately affect cash
 Cash receipts should be deposited quickly
 Companies can receive cash
■ Over the counter
■ Through the mail

LO 4
Cash Receipts Over the Counter
 Point-of-sale terminals
■ provide control over cash receipts
■ record sale, cost of item sold, and reduction to
inventory
 Customer issued a receipt as proof of purchase
 Sales associate turns in cash drawer at end of shift
■ Combined with other cash and deposited
 Accounting department reconciles sales per terminal
to cash in drawer

LO 4
Cash Receipts Deposit
by Mail ticket
Checks
Remittance
advices
Debit to
Exhibit 4-11 | Cash Receipts by Mail
Cash

LO 4
Controls over Payment by Check
Payment by check or electronic funds transfer (EFT) is an
important internal control
 Provides record of the payment
 Check must be signed by an authorized official
 EFT must be approved by an authorized official
 Should be supported by evidence

LO 4
Controls over Purchase and Payment
 Fax or e-mail purchase order
 Receive goods and prepare a receiving report
 Receive invoice
 Approve and agree all documents
 Sends check or authorizes an electronic funds transfer
(EFT)

LO 4
Exhibit 4-12 | Cash Payments by Check or EFT

LO 4
Controls over Purchase and Payment
Before signing the check

or approving the EFT, the
treasurer’s department
should examine the
packet to prove that all
the documents agree.
Exhibit 4-13 | Payment Packet

LO 4
Petty Cash
 Small fund to make minor purchases
 Custodian solely responsible for the accounting
 Set amount of cash
 Voucher prepared for each payment
 Imprest system
► Sum of fund plus paid vouchers should equal set
amount

LO 4
Learning Objective
5. Construct and use a cash budget

CONSTRUCT AND USE A CASH BUDGET
 Budget
► Financial plan to coordinate business activities
 Cash budget
► Planned receipts and payments
► Steps:
■ Start with beginning cash balance
■ Add budgeted receipts and subtract budgeted
payments
■ Equals cash available before new financing
■ Compare cash available to budgeted cash balance

LO 5
CONSTRUCT AND USE A CASH BUDGET
Exhibit 4-14 | Cash Budget

LO 5
Illustration
Kachina Corporation is preparing its cash budget for 2015. Kachina ended
2014 with cash of $68 million and managers need to keep a cash balance
of at least $70 million for operations.
Collections from customers are expected to total $11,925 million during
2015, and payments for inventory should reach $6,210 million. Kachina
also expects to receive interest payments in the amount of $15 million.
Operating expense payments are budgeted at $2,653 million. During 2015,
Kachina expects to invest $1,922 million in new equipment. Debt payments
scheduled for 2015 will total $683 million. The company forecasts net
income of $893 million for 2015 and plans to pay dividends of $448 million.
Prepare Kachina Corporations’ cash budget for 2015. Will the
budgeted level of cash receipts leave Kachina with the desired ending cash
balance of $70 million, or will the company need additional financing? If so,
how much?

LO 5
Illustration Kachina Corporation Cash Budget
Cash balance, December 31, 2014 $ 68

Budgeted cash receipts:
Collections from customers 11,925
Receipt of interest 15
12,008
Budgeted cash payments:
Purchase of inventory $ 6,210
Operating expenses 2,653
Investment in equipment 1,922
Debt payments 683
Dividends 448 11,916
Cash available (needed) before financing 92
Budgeted cash balance, December 31, 2015 (70)
Cash available for additional investments $ 22
4-69 Advance slide in presentation mode to reveal answers LO 5
Learning Objective
6. Report cash on the balance sheet

REPORT CASH ON THE BALANCE SHEET
 All cash accounts combined into a single total
► Cash & Cash Equivalents
■ Time deposits
■ Certificates of deposit
■ High-grade government securities (3 months or less)

LO 6
Compensating Balance Agreements
 Cash balance should not include cash that is
restricted
 Company that borrows agrees to maintain a minimum
cash balance
► Compensating balance agreement

LO 6
Copyright
This work is protected by United States copyright law and is

provided solely for the use of instructors in teaching their courses
and assessing student learning. Dissemination or sale of any part of
this work (including on the World Wide Web) will destroy the integrity
of the work and is not permitted. The work and materials from it
should never be made available to students except by instructors
using the accompanying text in their classes. All recipients of this
work are expected to abide by these restrictions and to honor the
intended pedagogical purposes and the needs of other instructors
who rely on these materials.

Prepared by Coby Harmon University of California, Santa Barbara Westmont College

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1. Describe fraud and its impact

4-2 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Misappropriation of Fraudulent Financial

 Committed by employees  Committed by managers

4-4 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-5 Copyright ©2015 Pearson Education Inc. All rights reserved.

2. Explain the objectives and components of internal

4-6 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-7 Copyright ©2015 Pearson Education Inc. All rights reserved.

Objectives of Internal Control

Ensure Comply with

4-8 Copyright ©2015 Pearson Education Inc. All rights reserved.

 Auditors must evaluate and report on internal controls

4-9 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-10 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-11 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Risk Information

 Tone at the top

4-12 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Risk Information

 Identify business risks

4-13 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Risk Information

 System to capture, process, and

4-14 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Risk Information

 Built into the control environment and

4-15 Copyright ©2015 Pearson Education Inc. All rights reserved.

Control Risk Information

 Controls programmed into a company’s

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4-18 Copyright ©2015 Pearson Education Inc. All rights reserved.

Separation of Duties  Operating and cash

4-19 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-20 Copyright ©2015 Pearson Education Inc. All rights reserved.

Adequate Records  Lock-box system

Limited Access  Lock and key

Proper Approvals  Human resources

4-22 Copyright ©2015 Pearson Education Inc. All rights reserved.

Use of computers greatly improves speed and accuracy

4-23 Copyright ©2015 Pearson Education Inc. All rights reserved.

4-25 Copyright ©2015 Pearson Education Inc. All rights reserved.

Benefits should outweigh the costs

4-26 Copyright ©2015 Pearson Education Inc. All rights reserved.

3. Design and use a bank reconciliation

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 Protects against forgery

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 Proof of deposit transaction

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 Maker, payee, and bank

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 Report of customer’s cash activity

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 Differences between company’s cash records

Differences because of time lag in recording transactions

4-35 Copyright ©2015 Pearson Education Inc. All rights reserved.

Bank Side Book Side

 Deposits in transit  Bank collections

4-37 Copyright ©2015 Pearson Education Inc. All rights reserved.