Chapter 4 - internal control and cash
Lockbox system - to receive cheques by mail and then deposited to bank immediately.
Fraud is an intentional misrepresentation of facts, made for the purpose of persuading another party to act in a way that causes injury
or damage to that party.
Types of fraud
• Misappropriation of assets: this type of fraud is committed by employees of an entity who steal money from the company and cover
it up through erroneous entries in the books.
• Fraudulent financial reporting: committed by company managers who make false and misleading entries in the books, making
financial results of the company appear to be better than they actually are. The purpose of this is deceive investors and creditors
into investing or loaning money to the company.
• Most common form of fraudulent financial reporting is earnings management. For example, the company's earnings are $1.12 a
share, but analysts predicted $1.18 a share. The fraud would be that the management reverses bad debt write-downs, reducing
expenses to increase earnings to $1.18
Fraud Triangle: Motive
• Motive: usually results from greed.
• Opportunity: from weak internal controls. Improper segregation of duties or improper access to assets.
• Rationalization: "I deserve this", "no one will know".
Internal control - a plan of organization and system of procedures designed, implemented, and maintained by company management
and the board of directors to deal with risks to the business that have been identified and that relate to the company's financial records,
company's ability to operate effectively/efficiently (everyone in the company should work towards the same goal and assets should be
protected), company's compliance with legal requirements.
Internal control has five objectives: safeguard assets including records against waste, inefficiency, and fraud. Encourage all employees,
managers, and staff to follow company policy. Promote operational efficiency to minimize waste. Ensure accurate, reliable accounting
records. Comply with legal and regulatory requirements.
A public company offers its securities, such as shares or debt, for sale to the public. They would tell you their internal control, disclosure
controls and procedures, and management discussion and analysis.
Components of internal control:
• Control environment: owners and top managers must behave honourably to set a good example. Code of conduct. Show
• Risk managements: a company faces business risks. The company must be able to identify its business risks and establish
procedures for dealing with these risks.
• Information systems: need accurate information
• Control procedures: built to control environment and information system are the means by which companies gain access to the five
objectives of internal controls. Like proper separation of duties, comparison and other checks, adequate records, proper approvals,
and physical safeguards to protect assets from theft.
• Monitoring of controls: computer systems can do this. You can also hire auditors to monitor their controls. Internal auditors monitor
company controls from the inside to safeguard the company's assets. External auditors test the controls from the outside to ensure
that the accounting records are accurate and reliable. Internal control procedures
• Smart hiring practices and separation of duties: background checks should be performed. Proper training and supervision, paying
competitive salaries, helps ensure that all employees are sufficiently competent for their jobs.
o Management must always separate three key duties: asset handling, record keeping, and transaction approval.
• Comparisons and compliance monitoring: no person or department should be able to completely process a transaction from
beginning to end without being cross-checked by another person or department.
o Like the controller's department should be responsible for recording customer collections to individual customer A/R.
Another employee should compare the treasurer's (responsible for depositing daily cash receipts to bank) daily records of
cash deposited with totals of collections posted to individual accounts by the controller's department
o Operating and cash budgets help monitor compliance with management's policies.
o Exception reporting: computer systems that are programmed to prepare exception reports that are out of line with
expectations. Like with the budgets.
o Auditing also helps monitor.
• Adequate records: accounting records should provide details of business transactions. Like sales invoices, receiving reports, and
cheques. Documents should be pre-numbered to assure completeness of processing and proper transaction cut off, and to prevent
theft and inefficiency. A gap in the numbered document sequence draws attenti