Financial Accounting: Fraud, Internal Control, and Cash

11/19/2022
Financial Accounting
IFRS 4th Edition
Weygandt ● Kimmel ● Kieso
Chapter 7
Fraud, Internal Control, and Cash
Chapter Outline
Learning Objectives
LO 1 Define fraud and the principles of internal control.
LO 2 Apply internal control principles to cash.
LO 3 Identify the control features of a bank account.
LO 4 Explain the reporting of cash.
Copyright ©2019 John Wiley & Sons, Inc. 2
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Learning Objective 1
Define Fraud and the Principles of
Internal Control
Fraud and Internal Control (1 of 2)

Fraud
Opportunity
Dishonest act by an
employee that results in
personal benefit to the
employee at a cost to the
employer.
Financial Pressure Rationalization

ILLUSTRATION 7.1 Factors that contribute to fraudulent activity
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Fraud and Internal Control (2 of 2)

Internal Control
Purposes of internal control:
1. Safeguard assets.
2. Enhance accuracy and reliability of accounting
records.
3. Increase efficiency of operations.
4. Ensure compliance with laws and regulations.
Internal Control (1 of 3)
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.
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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.
Five Primary Components:
1. Control environment.
2. Risk assessment.
3. Control activities.
4. Information and communication.
5. Monitoring.
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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

(2 of 6)
Segregation of Duties
• Different individuals should be
responsible for related activities
• Responsibility for record-keeping for
an asset should be separate from
physical custody of that asset
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(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

(4 of 6)
Physical
Controls
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(5 of 6)
Independent Internal
Verification
• Records periodically
verified by an
employee who is
independent
• Discrepancies
reported to
management

(6 of 6)
Human Resource Controls

• Bond employees who
handle cash
• Rotate employees’ duties
and require vacations
• Conduct background
checks
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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:
b. documentation procedures.
c. management responsibility.
d. independent internal verification.
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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 (1 of 3)

Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
1. The person with primary responsibility for reconciling the bank
account and making all bank deposits is also the company’s
accountant.
Solution
• Violates the control activity of segregation of duties
• Recordkeeping should be separate from physical custody
• Employee could embezzle cash and make journal entries to
hide the theft
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Identify which control activity is and explain how the situation
creates an opportunity for a fraud.
2. Wellstone Company’s treasurer received an award for
distinguished service because he had not taken a vacation in 30
years.
Solution
• Violates the control activity of human resource controls
• Key employees must take vacations
• Treasurer, who manages the company’s cash, might embezzle
cash and use his position to conceal the theft

Identify which control activity is violated and explain how the
situation creates an opportunity for a fraud.
3. In order to save money spent on order slips and to reduce time
spent keeping track of order slips, a local bar/restaurant does
not buy prenumbered order slips.
Solution
• Violates the control activity of documentation procedures
• If prenumbered documents are not used, then it is virtually
impossible to account for the documents
• An employee could write up a dinner sale, receive cash from
customer, then throw away order slip and keep the cash
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Apply Internal Control Principles to
Cash
Cash Controls (1 of 2)
Cash Receipts Controls
• Establishment of Responsibility:
 Only designated personnel are authorized to handle
cash receipts
• Segregation of Duties: Different individuals
 Receive cash
 Record cash receipts
 Hold cash
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Cash Receipt Controls (1 of 5)

• Documentation Procedures: Use
 Remittance advice (mail receipts)
 Cash register tapes or computer records
 Deposit slips
• Physical Controls
 Store cash in safes and bank vaults
 Limit access to storage areas
 Use cash registers or point-of-sale terminals

• Independent Internal Verification
 Supervisors count cash receipts daily
 Assistant treasurer compares total receipts to
bank deposits daily
• Human Resource Controls
 Bond personnel who handle cash
 Require employees to take vacations
 Conduct background checks
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Over-the-Counter Receipts
Cash Receipts Controls
Clerk Supervisor
Enters sales, Removes locked
counts cash cash register tape
Sends cash and Sends cash register tape

count to cashier to accounting dept.
Cashier Sends deposit Accounting Department

Counts cash, slip copy to Agrees register tape to
prepares deposit slips accounting dept. deposit slip and
records journal entry
Delivers cash and Bank

deposit slip to bank

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 checks, is sent to
cashier’s department
• Copy of list is sent to accounting department for
recording, clerks keep a copy
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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.

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

Solution
• Each employee should have access to only the assigned
register drawer to enter all sales.
• 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 cash count with 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.
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Cash Disbursement Controls

Generally, internal control over cash disbursements is
more effective when companies pay by check or
electronic funds transfer (EFT) rather than by cash.
One exception is payments for incidental amounts that
are paid out of petty cash.
Cash Controls (2 of 2)
Cash Disbursements Controls
• Establishment of Responsibility
 Only designated personnel are authorized to sign
checks (treasurer) and approve vendors
• Segregation of Duties
 Different individuals approve and make payments
 Check-signers do not record disbursements
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Cash Disbursement Controls (1 of 6)

• Documentation Procedures
 Use prenumbered checks and account for
sequence
 Each check must have an approved invoice
 Require employees to use corporate credit cards
for reimbursable expenses
 Stamp invoices “paid”

• Physical Controls
 Store blank checks in safes, with limited access
 Print check amounts by machine in indelible ink
• Independent Internal Verification

 Compare checks to invoices
 Reconcile bank statement monthly
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• Human Resource Controls:
 Bond personnel who handle cash
 Require employees to take vacations
 Conduct background checks

Review Question
The use of prenumbered checks in disbursing cash is an
application of the principle of:
b. segregation of duties.
c. physical controls.
d. documentation procedures.
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Review Question
The use of prenumbered checks in disbursing cash is an
application of the principle of:
b. segregation of duties.
c. physical controls.
d. documentation procedures.

Voucher System Controls
• 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
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Petty Cash Fund

Petty Cash Fund - Used to pay small amounts.
Involves:
1. establishing the fund
2. making payments from the fund
3. replenishing the fund
Establishing the Petty Cash Fund

Illustration: If Zhū Ltd. decides to establish a NT$3,000 fund
on March 1, the general journal entry is :
March 1 Petty Cash 3,000

Cash 3,000
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Making Payments From Petty Cash (1 of 2)

• Management usually limits the size of expenditures
• Does not permit use of 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 receipt
Making Payments From Petty Cash (2 of 2)

• Custodian keeps receipts in petty cash box until fund
is replenished
• Sum of receipts and money in fund should equal
established total at all times
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Replenishing the Petty Cash Fund (1 of 2)

Illustration: On March 15 Zhū Ltd.’s petty cash custodian
requests a check for NT$2,610. The fund contains NT$390
cash and petty cash receipts for postage NT$1,320, freight-out
NT$1,140, and miscellaneous expenses NT$150. The entry is:
March 15 Postage Expense 1,320
Freight-Out 1,140
Miscellaneous Expense 150
Cash 2,610
Replenishing the Petty Cash Fund (2 of 2)

Illustration: Assume in the preceding example that the
custodian had only NT$360 in cash in the fund plus the
receipts as listed. The request for reimbursement would
therefore be for NT$2,640 and Zhū would make the following
entry.
March 15 Postage Expense 1,320

Supplies 1,140
Miscellaneous Expense 150
Cash Over and Short 30
Cash 2,640
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DO IT! 2b: Petty Cash Fund

Bateer Company established a $50 petty cash fund on July 1. On July
30, the fund had $12 cash remaining and petty cash receipts for
postage $14, office supplies $10, and delivery expense $15. Prepare
journal entries on July 1 and on July 30.
July 1 Petty Cash 50
Cash 50
July 30 Postage Expense 14
Supplies 10
Delivery Expense 15
Cash Over and Short 1
Cash 38
Identify the Control Features of a Bank
Account
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Control Features of a Bank Account

Use of a bank contributes significantly to good internal
control over cash.
• Minimizes 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.
Making Bank Deposits

Authorized
employee should
make deposit.
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Writing Checks
Written order signed by depositor directing bank to pay a
specified sum of money to a designated recipient.
Maker
Payee
Payer
ILLUSTRATION 8.9
Check with remittance advice
Electronic Funds Transfer (EFT) System

• 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
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Bank Statements (1 of 6)
• Prepared from bank’s perspective
• Every deposit bank receives is an increase in bank’s
liabilities (an account payable to the depositor)
• Lists in numerical sequence all paid checks along with
date check was paid and its amount
• Bank includes with bank statement memoranda
explaining other debits and credits it made to
depositor’s account
• A check that is not paid by a bank because of
insufficient funds in a bank account is called an NSF
check (not sufficient funds)
Bank
Statements
(2 of 6)
Each month, the

company receives
from the bank a
bank statement
showing its bank
transactions and
balances.
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Shows the following:
1. Checks paid and other debits that reduce the
balance.
• Debit card transactions
• Electronic funds transfers for bill payments
2. Deposits and other credits that increase the balance.
• Direct deposit
• Automated teller machine
• Electronic funds transfer
Shows the following:
3. Debit Memorandum.
• Bank service charge
• N S F check (not sufficient funds)
4. Credit Memorandum.
• Collection of a notes receivable
• Interest earned
5. The account balance after each day’s transactions.
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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.
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.
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Reconciling the Bank Account

Reconcile balance per books and balance per bank to
their “correct or true” balance.
Reconciling Items:
1. Time Lags
• Deposits in transit
• Outstanding checks
• Bank memoranda
2. Errors
Reconciling the Bank Account

Reconciliation Procedure
Cash Balance Per Bank Cash Balance Per Books
+ Deposits in transit + EFT collections and
- Outstanding checks other deposits
+/- Bank errors - NSF (bounced)
checks
- Service charges and
other Payments
+/- Company errors
Corrected Balance Corrected Balance
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Bank Reconciliation Illustrated (1 of 4)

The bank statement for Cray Gourmet, which the company accessed
online, shows a balance per bank of €15,907.45 on April 30, 2020. On
this date the balance of cash per books is €11,709.45. From the
foregoing steps, Cray determines the following reconciling items for
the bank.
Step 1. Deposits in transit (+): April 30 deposit
(received by bank on May 1). €2,201.40
Step 2. Outstanding checks (−): No. 453, €3,000.00;
No. 457, €1,401.30; No. 460, €1,502.70. 5,904.00
Step 3. Bank errors (+/−): None.
Reconciling items per books are as follows:
Reconciling items per books are as follows:

Step 1. Other deposits (+): Unrecorded electronic
receipt from customer on account on April 9
determined from the bank statement. €1,035.00
Step 2. Other payments (−): The electronic payments
on April 3 and 7 were previously recorded by the
company when they were initiated. Unrecorded charges
determined from the bank statement are as follows:
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
Step 3. Company errors (+): Check No. 443 was correctly
written by Cray for €1,226 and was correctly paid by the
bank on April 12. However, it was recorded as €1,262 on
Cray’s books. 36.00
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Bank Reconciliation
April 30, 2020
Cash balance per bank statement €15,907.45
Add: Deposits in transit 2,201.40
Less: Outstanding checks
No. 453 €3,000.00
No. 457 1,401.30
No. 460 1,502.70 5,904.00
Adjusted cash balance per bank €12,204.85
Cash balance per books €11,709.45

Add: Electronic funds transfer received €1,035.00
Error in recording check No. 443 36.00 1,071.00
Less: NSF check 425.60
Debit and credit card fees 120.00
Bank service charge 30.00 575.60
Adjusted cash balance per books €12,204.85

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
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Book Error: The cash disbursements journal shows that check
no. 443 was a payment on account to Roux Foods, 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 Charges Expense: Fees for processing debit and credit
card transactions (€120) and the bank service charges (€30)
have been combined in a single entry as follows:
Apr. 30 Bank Charge Expense 150.00
Cash 150.00
Cash
Apr. 30 Balance 11,709.45 Apr. 30 425.60
30 1,035.00 30 150.00
30 36.00
Apr. 30 Balance 12,204.85
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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.
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Do It! 3: Bank Reconciliation

Deepika Kann owns Deepika Fine Fabrics. Deepika 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 NSF check, (2) a credit memorandum for an electronic funds
transfer from one of the company’s customers received by the
bank, (3) outstanding checks, and (4) a deposit in transit.
Solution
Sally should treat the reconciling items as follows.
1. NSF check: Deduct from balance per books
2. Electronic funds transfer: Add to balance per books
3. Outstanding checks: Deduct from balance per bank
4. Deposit in transit: Add to balance per bank
Explain the Reporting of Cash
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Reporting of Cash
• Cash consists of coins, currency (paper money),
checks, money orders, and money on hand or deposit
• The statement of financial position reports amount of
cash available at a given point in time
 Listed first in current assets section
• Statement of cash flows shows 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:
1. Readily convertible to known amounts of cash, and
2. 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.
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Reporting Cash
Korean Air Lines, Inc.
Statement of Financial Position
(partial, in millions)
Assets
Current assets
Short-term investments ₩111,988
Cash and cash equivalents 967,481
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.
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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! 4: Reporting Cash

Indicate whether each of the following statements is true or false.
1. Cash and cash equivalents are comprised of coins, currency (paper
money), money orders, and NSF checks.
2. Restricted cash is classified as either a current asset or non-current
asset, depending on the circumstances.
3. A company may have a negative balance in its bank account. In this
case, it should off set this negative balance against cash and cash
equivalents on the statement of financial position.
4. Because cash and cash equivalents often includes short-term
investments, accounts receivable should be reported as the last item
on the statement of financial position.
1. False 2. True 3. False 4. False
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Copyright ©2019 John Wiley & Sons, Inc. 2

Copyright ©2019 John Wiley & Sons, Inc. 3

Fraud and Internal Control (1 of 2)

Financial Pressure Rationalization

Copyright ©2019 John Wiley & Sons, Inc. 4

Fraud and Internal Control (2 of 2)

Copyright ©2019 John Wiley & Sons, Inc. 5

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Copyright ©2019 John Wiley & Sons, Inc. 7

Copyright ©2019 John Wiley & Sons, Inc. 8

Principles of Internal Control Activities

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Principles of Internal Control Activities

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Principles of Internal Control Activities

Principles of Internal Control Activities

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Principles of Internal Control Activities

Principles of Internal Control Activities

Human Resource Controls

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Principles of Internal Control (1 of 2)

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Principles of Internal Control (2 of 2)

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Limitations of Internal Control

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Do It! 1: Control Activities (1 of 3)

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Do It! 1: Control Activities (2 of 3)

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Do It! 1: Control Activities (3 of 3)

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Cash Receipt Controls (1 of 5)

Copyright ©2019 John Wiley & Son, Inc. 23

Cash Receipt Controls (2 of 5)

Copyright ©2019 John Wiley & Son, Inc. 24

Sends cash and Sends cash register tape

Cashier Sends deposit Accounting Department

Delivers cash and Bank

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Cash Receipt Controls (3 of 5)

Cash Receipt Controls (4 of 5)

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Cash Receipt Controls (5 of 5)

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

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

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Cash Disbursement Controls

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Cash Disbursement Controls (1 of 6)

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Cash Disbursement Controls (2 of 6)