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Financial accounting 1: extensive summary
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Extensive Financial accounting 1 summary.
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FA SUMMARY FINAL EXAMCH7:
L01: define fraud and the principles of internal control
fraud
- Fraud: dishonest act by an employee that results in personal benefit to the employee at a cost
to the employer. Examples: diverting money to personal bank account, shipping merchandise
to yourself, embezzlement, fake rides & bonus receivements
- Fraud occurs because of:
(1) opportunity (most important): occurs when workplace lacks sufficient controls to deter
and detect fraud.
(2) financial pressure: personal problems caused by too much debt, or want to lead lifestyle
they cannot afford.
(3) rationalization: in order to justify their fraud, employees rationalize their dishonest
actions (ex. believe they are underpaid, thus, steal)
internal control
- Internal control: process designed to provide reasonable assurance regarding the achievement
of company objectives related to operations, reporting, and compliance.
- Purpose of internal control is to safeguard assets, enhance reliability of accounting records,
increase efficiency of operations, and ensure compliance with laws and regulations
- 5 primary components of internal control system:
(1) a control environment: responsibility management making clear that organization values
integrity and unethical activity will not be tolerated, also: “tone at the top”.
(2) risk assessment: companies must identify and analyze factors that create risk for business
and must determine how to manage these risks
(3) control activities: to reduce occurrence of fraud, management must design policies and
procedures to address specific risks faced by the company.
(4) information and communication: capture and communate all pertinent information
down/up organization and also to external parties
(5) monitoring: systems must be monitored periodically for their adequacy. Significant
deficiencies need to be reported to top management / of board directors
principles of internal control activities
- Control activities component backbone of company’s efforts to addres the risks it faces
(fraud), they apply to both manual and computerized acc. systems
- Six principles of control activities:
(1) establishment of responsibility:
- control is most effective when only one person is responsible for a given task (quickly
determine responsibility)
- many retailers solve this problem by having registers with multiple drawers (identify)
- requires limiting access only to authorized personnel, and then identifying those personnel.
(2) segregation of duties
- two common applications: 1. Different individuals should be responsible for related
activities, 2. The responsibility for recordkeeping for an asset should be separate from the
physical custody of that asset.
- the work of one employee should, without a duplication of effort, provide a reliable basis for
evaluating the work of another employee.
- making one individual responsible for all related activities increases the potential for errors
and irregularities
Purchasing activities
- Assign related purchasing activities to different individuals. It includes: ordering
merchandise, approving orders, receiving goods, authorizing payment, and paying for goods
or services
- Various frauds are possible when one person handles related purchasing activities, these
abuses are less likely to occur when companies divide the purchasing tasks
, Sales activities
- Assign related sales activities to different individuals. It includes: making a sale, shipping (or
delivering) the goods to customers, billing customer, receiving payment.
- Various frauds are possible when one person handles related sales activities, these abuses are
less likely to occur when companies divide the sales tasks.
- Accountant should have neither physical/access of the asset. custodian not access to
accounting records.
- The custodian of the asset is not likely to convert the asset to personal use when one
employee maintans the record of the asset, and a different employee has physical custody of
the asset (cash and inventory vulnerable to fraud)
(3) documentation procedures
- Documents provide evidence that transactions and events have occurred.
- By requiring signatures on documents, company can identify the idnvidual responsible for the
transaction or event. (DOCUMENT TRANSACTIOSN WHEN THEY OCCUR)
- Companies should establish procedures for documents:
1. use prenumbered documents, and all documents should be accounted for (helps to prevent
transaction to be recorded more than once or not recorded at all)
2. promptly forward source documents for accounting entries to the accounting department.
This control measure helps to ensure timely recording of the transaction + contributes to
accuracy and reliability
(4) physical controls
- They relate to safeguarding of assets and enhance accuracy and reliability of the accounting
records
(5) independent internal verification
- This principle involves the review of data prepared by employees.
- To obtain max. benefit from independent internal verification:
1. company should verify records periodically or on a surprise basis
2.employee who is independent of personnel responsible for information should make the
verification
3. discrepancies(tegenstrijdig/vershil) should be reported to a management level that can take
appropriate corrective action.
- This verification especially useful in comparing records accountability with existing assets.
- Common examples: reconciliation of company’s cash balance and verification of perpetual
inventory records through a count of physical inventory.
- Internal auditors: company employees who continuously evaluate the effectiveness of the
company’s internal control systems. They review department and indiv. Activities to
determine if internal controls are being followed, also recommend improvements.
, (6) human resource controls
- Includes the following activities:
1. bond employees who handle cash:
- bonding: involves obtaining insurance protection against theft by employees. Contributes to
safeguarding in two ways: screening individuals, bonded employees know that insurance
company will vigorously prosecute all offenders
2. rotate employees’ duties and require employees to take vacations
- deter from attempting theft since they will not be able to permanently conceal their improper
actions.
3. conduct thorough background checks
- important and inexpensive. Two tips: (1): check whether they actually graduated, (2): never use
telephone numbers for previous employers provided by applicant, look up zelf
limitations of internal control
- Reasonable assurance: of proper safeguarding of assets and reliability of acc. Records. It’s the
premise that the costs of establishing control procedures should not exceed their expected
benefit.
- Human element: important factor in every system of internal control. Good system can
become ineffective.
- Collusion: two or more individuals work together to get around prescribed controls. it can
reduce the effectiveness of a system eliminating the protection offered by segregation of
duties.
- Size of business: may impose limiations on internal control. Small companies often find it
difficult to segregate duties
L02: apply internal control principles to cash
- Cash is the asset most susceptible to fraudulent activities, because it is readily convertible into
any other type of asset, easily concealed and transported and highly desired. Numerous errors
can occur due to large volume. Internal control over cash is critical.
cash receipt controls
Over-the-counter receipts
- Cash registers visible to customers prevents sales clerk from entering a lower amount and
pocketing the difference.
- Tape locked in register until supervisor removes it, it accumulates daily transactions/totals
deposit slip to bank and duplicate to acc. Department.
, - System for handling cash receipts uses principle: segregation of recordkeeping from physical
custody. Supervisor only acces to tape, not cash. Clerk and cashier access to cash, but not
tape.
- Three principles provide effective system internal control: segregation recordkeeping physical
custody, documentation, independent internal verification
- Fraud detected unless there is collusion among employees
- Cash over and short account (INCOME STATEMENT): difference between actual cash and
amount reported on cash register tape. Reported as miscellaneous expense when shortfall,
miscellaneous revenue when there is an overage.
- Cash over and short used to record unexplained differences
- USE FOLLOWING ENTRY:
Mail receipts
- Opened in presence of at least two mail clerks (form: checks), reduces fraud
- Endorse each check “for deposit only” to reduce hance personal use
- Mail clerks prepare list of checks each day: name of check issuer, purpose payment, amount
of check.
- Send original copy list and checks to cashier department and accounting
- Cashier access to cash but not records, acc. Department acces to records, not cash
thus neither can engage in undetected fraud
cash disbursements controls
- Internal control over cash disbursements is more effective when companies pay by check or
electronic funds transfer (EFT) rather than by cash (exception: payments for incidental
amounts that are paid out of petty cash)
Voucher system controls
- Voucher system: network of approvals by authorized individuals, acting independently, to
ensure that all disbursements by check are proper
- Begins with authorization to incur a cost or expense and ends with issuance of a check for the
liability incurred.
- Voucher: authorization form prepared for each expenditure.
- Starting point voucher is fill in information about liability, then employee in accounts payable
records the voucher (voucher register). And files it to date which it is to be paid. issues and
sends check on that date and stamps with “paid” send to accounting department for
recording (check register)
- JOURNAL ENTRY VOUCHER: LIABILITY WHEN VOUCHER IS ISSUED AND TO
PAY LIABILITY THAT RELATES TO THE VOUCHER.
- Voucher system provides internal control over cash disbursements: first, establish
responsibility.
petty cash fund
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