1. Fraud and Internal Control
1.1 Fraud is an intentional to misappropriate (steal) assets or misstate financial statements.
• Many high-profile collapses of companies due to fraud
• Examples of misstatements:
– Recording expenses as assets
– Overstating useful lives of assets
– Recording revenues that do not exist
1.2 Internal control: consists of all the related methods and measures adopted within a
company to help it to achieve reliable financial reporting, effective and efficient operation,
and compliance with relevant laws and regulation.
A good internal control has 5 primary components:
1.Control environment: it is the responsibility of the management to make it clear that the
organization values integrity and that unethical activity will not be tolerated.
2.Risk Assessment: companies must identify and analyze the various factor that creat risk
for the business and determine how to manage these risks.
3.Control activities: to reduce the occurrence of fraud, management must design policies
and procedures to address the specific risks faced by the company.
4.Information and communication: the system must capture and communicate all
pertinent info both down and up the org and communicate it to its appropriate external
5.Monitoring: the system must be monitored periodically for their adequacy. Significant
deficiency must the reported to management and the board of directors.
1.3 The importance of internal control is recognized by the Canadian Business Corporations
2.1 Authorization of transactions and activities: transactions and activities must be
undertaken, and approved, by the appropriate individuals or departments. Responsibility
should be assigned to specific individuals. Control is most effective when only one person
is responsible for a given task, (i.e., cash drawer assignment).
2.2 Segregation of duties: the work of one employee should, without a duplication of effort,
provide a reliable basis for evaluating the work of another employee. The responsibility
for related transactions should be assigned to different individuals, and the responsibility
for establishing the accountability for an asset should be separate from the physical
custody of that asset.
2.2.1 Related activities: when one individual is responsible for all of the related activities,
the potential for errors and fraud is increased (e.g., activities related to sales
(selling, shipping, and billing) and activities related to purchasing (ordering,
receiving, and recording payment)).
2.2.2 Accountability for assets: when one employee maintains the record of the asset
that should be on hand, and a different employee has physical custody of the asset,
the custodian of the asset is not likely to convert the asset to personal use.
Segregation of duties means that responsibilities should be divided up so that one person
cannot both commit a fraud and then cover up. If this cannot be fully achieved, supervision by
the owner of the business may be necessary and work of one employee should be verified by
another to ensure the accuracy of accounting records. 2.3 Documentation procedures: documents should provide evidence that transactions and
events have occurred. This control contributes to the accuracy and reliability of the
2.3.1 Documents should be prepared when transactions occur.
2.3.2 Prenumbering documents permits all documents in a related series to be
sequentially accounted (transactions are not counted twice nor omitted).
2.3.3 Source documents for accounting entries should be promptly forwarded to the
2.4 Physical Control: Physical, mechanical, and electronic can control access to, and use of,
assets and records.
2.4.1 Physical controls relate primarily to the safeguarding of assets (safes, bank vaults,
safety deposit boxes, fences, and locked warehouses).
2.4.2 Mechanical and electronic controls enhances accuracy and reliability of the
accounting records. Execution of transactions – cash registers, time clocks, etc.
2.5 Independent checks and performance: the review, comparison, and reconciliation of
2.5.1 Internal auditors review activities of departments and determine compliance with
prescribed policies and make recommendation for improvements. They are
especially useful in comparing accounting records with existing assets to ensure
that nothing has been stolen.
Maximum benefit derived when made on a surprise basis or periodically; made by
independent party of the personal responsible for this info; and exceptions or
discrepancies should reported and corrected.
2.5.3 External auditors do the same as internal auditors but also attest to the fairness of
the financial statements presentation in accordance with generally accepted
accounting principles. They are professional accountant hired by a company to
report on whether or not the company’s financial statements fairly present its
financial position and results of operation.
2.6 Human resource control:
2.6.1 Conducts thorough background checks
2.6.2 Bonding of employees who handle cash: bonding means having insurance
protection against theft of assets by dishonest employees. This insurance is referred
to fidelity insurance, where the insurance company carefully screens all the
employee before adding them to the policy and rejects risky applicants. And bonded
employees have the incentive to act honestly because insurance company will
vigiuresly prosecute any offenders
2.6.3 Rotating employees’ duties and requiring employees to take vacations:
the purpose of this to determine any dishonest activities done by the employee by
their replacement while they are on vacation or in another duty.
Limitations of Internal Control
2.7.1 The concept of reasonable assurance rests on the premise that the costs of
establishing control procedures should not exceed their expected benefit.
2.7.2 It should also be recognized that the human element (fatigue, carelessness, and
indifference) is an important factor as is collusion between two or more individuals
to circumvent prescribed controls.
2.7.3 The size of the business may also impose limitations on internal control.
• Limitations include:
• Cost / benefit • Human element
• Size of business
3. Cash controls
3.1 Cash consists of coins, currency (paper or virtual), cheques, money orders, travellers’
cheques, and money on deposit in a bank. Debit card transactions and bank credit card slips are
cash as well.
Importance of cash:
Most important asset
Vulnerable to theft or misuse
Balancing act needed to ensure sufficient, but not excess, quantity
When a debit card sales occurs the bank automatically pays the sellers by transferring
funds from the customer’s account, but there is an uncertainty that the sellers will receive
the money, so they are willing to pay a bank charge
Debit card expense