Chapter 7 Outline

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CHAPTER 7

Fraud, Internal Control, and Cash

Study Objectives

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. Prepare a bank reconciliation.

6. Explain the reporting of cash.

7. Discuss the basic principles of cash management.

8. Identify the primary elements of a cash budget.

*9.Explain the operation of a petty cash fund.

Chapter Outline

Study Objective 1 – Define Fraud and Internal Control

* Fraud is a dishonest act by employee that results in personal benefit to the employee at a cost to the employer

* The fraud triangle refers to the three factors that contribute to fraudulent activity. They are: (1) opportunity, which is usually due to a lack of sufficient controls; (2) financial pressure, which usually is related to too much personal debt or a desire for a better lifestyle; and (3) rationalization, which is justification for why the employee deserves the compensation from fraudulent acts.

* Sarbanes-Oxley Act of 2002 (SOX) requires all publicly traded U.S. corporations to maintain an adequate system of internal controls. SOX imposes more responsibilities on corporate executives and boards of directors to ensure that companies’ internal controls are reliable and effective * Companies must develop sound principles of control over financial reporting and continually assess that the controls are working. * Independent outside auditors must attest to the level of internal controls.

* Internal control consists of all of the related methods and measures adopted within an organization to: * Safeguard its assets
* Enhance the reliability of its accounting records
* Increase efficiency of operations, and
* Ensure compliance with laws and regulations.

* There are five primary components of internal control systems: * Control environment, or “tone at the top.”
* Risk assessment, or identifying and analyzing factors that create risk. * Control activities, or policies and procedures to address risk. * Information and communication, which allow for both down and up organizational information flow and appropriate external communication. * Monitoring, which allows for reporting of significant deficiencies.

Study Objective 2 - Identify the Principles of Internal Control Activities

To safeguard assets and enhance the accuracy and reliability of its accounting records, companies follow internal control principles. The following six internal control principles apply to most enterprises:

1. Establishment of Responsibility
* An essential principle of internal control is to assign responsibility to specific individuals. * Control is most effective when only one person is responsible for a given task. * Establishing responsibility includes the authorization and approval of transactions. 2. Segregation of Duties

* Segregation of duties is indispensable in an internal control system. * The rationale for segregation of duties is that the work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee. * There are two common applications of this principle:

I. The responsibility for related activities should be assigned to different individuals. * Related Activities:
* When one individual is responsible for all of the related activities, the potential for errors and irregularities is increased. * Related purchasing activities should be assigned to different individuals. Related purchasing activities include ordering merchandise, receiving goods, and paying (or authorizing payment) for merchandise....
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