PREVIEW OF CHAPTER 7

Financial Accounting
IFRS 3rd Edition
Weygandt ● Kimmel ● Kieso
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 CHAPTER

7 Fraud, Internal Control,

and Cash
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

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. Describe the operation of a petty cash fund.
6. Indicate the control features of a bank account.
7. Prepare a bank reconciliation.
8. Explain the reporting of cash.
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 Fraud and Internal Control
Learning
Objective 1
Fraud Define fraud and
internal control.
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.

Illustration 7-1
Fraud triangle

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 Internal Control

 Internal control is a process designed to provide reasonable

assurance regarding the achievement of company
objectives related to operations, reporting, and compliance.
 In more detail, the purposes of internal control are to
safeguard assets, enhance the reliability of accounting
records, increase efficiency of operations, and ensure
compliance with laws and regulations.
 Internal control systems have five primary components as
listed below.

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 Internal Control

Methods and measures adopted to:

1. Safeguard assets.

2. Enhance accuracy and reliability of accounting records.

3. Increase efficiency of operations.

4. Ensure compliance with laws and regulations.

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 Internal Control

Five Primary Components:

● Control environment.
● Risk assessment.
● Control activities.
● Information and communication.
● Monitoring.

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  A control environment. It is the responsibility of top management to make it
clear that the organization values integrity and that unethical activity will not
be tolerated. This component is often referred to as the “tone at the top.”
 Risk assessment. Companies must identify and analyze the various factors
that create risk for the business and must determine how to manage these
risks.
 Control activities. To reduce the occurrence of fraud, management must
design policies and procedures to address the specific risks faced by the
company.
 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.
 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.
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 The six principles of control activities

 • Establishment of responsibility
 • Segregation of duties
 • Documentation procedures
 • Physical controls
 • Independent internal verification
 • Human resource controls

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 Principles of Internal Control Activities
Learning Objective 2
Identify the principles of
ESTABLISHMENT OF internal control activities.

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.

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 Principles of Internal Control Activities

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.

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 Principles of Internal Control Activities

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.

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 Principles of Internal Control Activities

PHYSICAL Illustration 7-2

Physical controls
CONTROLS

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 Principles of Internal Control Activities

INDEPENDENT INTERNAL VERIFICATION

 Records periodically
verified by an
employee who is
independent.
 Discrepancies
reported to
management.

Illustration 7-3
Comparison of segregation of duties principle with
independent internal verification principle
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 Principles of Internal Control Activities

HUMAN RESOURCE CONTROLS

 Bond employees who handle cash.

 Rotate employees’ duties and require

vacations.
 Conduct background checks.

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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.

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 > DO IT!

Identify which control activity is violated in each of the

following situations. SOLUTION
1. The person with primary responsibility for
reconciling the bank account and making all Segregation
bank deposits is also the company’s of duties
accountant.
2. Wellstone Company’s treasurer received an Human
award for distinguished service because he had resource
not taken a vacation in 30 years. controls
3. In order to save money on order slips and to
Documentation
reduce time spent keeping track of order slips, a
procedures
local bar/restaurant does not buy prenumbered
order slips.
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 Cash Controls
Learning
Objective 3
Cash Receipt Controls Explain the
applications of
internal control
principles to cash
receipts.

Illustration 7-4
Application of internal control
principles to cash receipts

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 Cash Receipt Controls

Illustration 7-4
Application of internal control
principles to cash receipts

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 Cash Receipt Controls

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.

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 Cash Disbursement Controls
Learning
Objective 4
Generally, internal control over cash Explain the
applications of
disbursements is more effective when internal control
principles to cash
companies pay by check or electronic funds disbursements.

transfer (EFT) rather than by cash.

Applications:
 Voucher System Controls
 Petty Cash Fund

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 Cash Disbursement Controls

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 Controls
Learning
Objective 5
Petty Cash Fund - Used to pay small amounts. Describe the
operation of a
petty cash fund.
Involves:

1. establishing the fund,

2. making payments from the fund, and

3. replenishing the fund.

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 ESTABLISHING THE PETTY CASH FUND

Illustration: If Zhu Ltd. decides to establish a NT$3,000 fund

on March 1, the journal entry is:

Mar. 1 Petty Cash 3,000

Cash
3,000

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 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.
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 REPLENISHING THE PETTY CASH FUND

Illustration: Assume that on March 15 Zhu’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
general journal entry to record the check is:

Mar. 15 Postage Expense 1,320

Freight-Out 1,140
Miscellaneous Expense 150
Cash
2,610

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 REPLENISHING THE PETTY CASH FUND

Illustration: Occasionally, the company may need to recognize

a cash shortage or overage. Assume that Zhu’s petty cash
custodian has 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 Zhu would make the following entry:

Mar. 15 Postage Expense 1,320

Freight-Out 1,140
Miscellaneous Expense 150
Cash Over and Short 30
Cash
2,640
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 > DO IT!

Bateer SA established a R$50 petty cash fund on July 1. On

July 30, the fund had R$12 cash remaining and petty cash
receipts for postage R$14, office supplies R$10, and delivery
expense R$15. Prepare journal entries to establish the fund on
July 1 and to replenish the fund 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 (R$50 – R$12) 38
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