CH15 ERRORS AND IRREGULARITIES IN THE

TRANSACTION CYCLES OF THE BUSINESS ENTITY

three basic business 1. Sales and Collections Cycle

transaction cycles 2. Acquisitions and Payments Cycle
3. Payroll and Personnel Cycle

Sales and Collections Cycle 1. Errors in Recording Sales and Collections Transactions
2. Frauds in Sales and Collections

Errors in Recording Sales and Errors in recording sales include mechanical errors, such as using a wrong
Collections Transactions piece or wrong quantity, recording sales in the wrong period (cutoff errors),
a bookkeeper's failure to understand proper accounting for a transaction,
and so on. Internal controls are designed to prevent or detect many of
these kinds of errors.

Frauds in Sales and Collections a.​ Fraudulent Financial Reporting

b.​ Misappropriation of Assets: Withholding Cash Receipts

Misappropriation of Assets: 1.​ Skimming

Withholding Cash Receipts 2.​ Lapping
3.​ Kiting

Frauds in Sales and Collections Frauds in sales generally relate to fraudulent financial reporting.

In contrast, frauds in cash collections relate to misappropriation of assets,

typically accomplished by clerks or management-level employees.

Fraudulent Financial Reporting involving sales typically results in overstated sales or understated sales
returns and allowances Managers under pressure to achieve high profits
may inflate sales to meet target profits established by senior managers, to
obtain bonuses, to retain the respect of senior managers, or even to keep
their jobs.

The following methods can be used to increase sales fraudulently:

-​ Recording fictitious sales (creating fictitious shipping documents,
sales invoices, and so on)
-​ Recording valid transactions twice
-​ Recording in the current period sales that occurred in the
succeeding period (improper cutoff)
-​ Recording operating leases as sales
-​ Recording deposits as sales
-​ Recording consignments as sales
-​ Recording sales when the chance of a return is likely
-​ Following revenue recognition practices that are not in accordance
with PFRS
-​ Recognizing revenue that should be deferred

Skimming act of withholding cash receipts without recording them. An example is

 when a cashier in a retail store does not ring up a transaction and takes
the cash.

Lapping This technique is used to conceal the fact that cash has been abstracted;
the shortage in one customer's account is covered with a subsequent
payment made by another customer.

Kiting This is another technique used to cover cash shortage or to inflate cash
balance. Kiting involves counting the cash twice by using the float in the
banking system. Analyzing and verifying cash transfers during the days
surrounding year-end should reveal this type of fraud.

Float is the gap between the time the check is deposited or added to an account
and the time the check clears or is deducted from the account it was
written on.

Acquisitions and Payments 1. Errors in the Acquisitions and Payments Cycle

Cycle 2. Frauds in the Acquisitions and Payments Cycle

Errors in the Acquisitions and -​ Failing to record a purchase in the proper period (cutoff errors)
Payments Cycle -​ Recording goods accepted on consignment as a purchase
-​ Misclassifying purchases of assets and expenses
-​ Failing to record a cash payment
-​ Recording a payment twice
-​ Failing to record prepaid expenses as assets

Frauds in the Acquisitions and a.​ Paying for Fictitious Purchases

Payments Cycle b.​ Receiving Kickbacks
c.​ Purchasing Goods for Personal Use

Paying for Fictitious Purchases This involves the perpetrator creating a fictitious invoice (and sometimes a
receiving report, purchase order and so forth) and processing the invoice
for payment. Alternatively, the perpetrator can pay the invoice twice.

Receiving Kickbacks In this scheme, a purchasing agent may agree with a vendor to receive a
kickback (refund payable to the purchasing person on goods or services
acquired from the vendor).This is usually done in return for the agent's
ensuring that the particular vendor receives an order from the firm. Often a
check is made payable to the purchasing agent and mailed to the agent at
a location other than his or her place of employment. Sometimes the
purchasing agent splits the kickback with the vendor's employee for
approving and paying it

Purchasing Goods for Personal Goods or services for personal use may be purchased by executive or
Use purchasing agents and charged to the company's account.

Payroll and Personnel Cycle 1. Errors

2. Frauds involving Payroll

Errors in the payroll and a)​ paying employees at the wrong rate,
personnel cycle b)​ paying employees for more hours than they worked,
 c)​ charging payroll expense to the wrong accounts, and
d)​ keeping terminated employees on the payroll.

Frauds involving Payroll a.​ Fictitious Employees

b.​ Excess Payments to Employees
c.​ Failure to Record Payroll
d.​ Inappropriate Assignment of Labor Costs to Inventory

Adding Fictitious Employees to the payroll is one of the most common

defalcations. Detecting Fictitious Employeesonthe payroll is very difficult;
but auditors do sometimes perform a surprise payoff as a deterrent to this
form of defalcation. Alternatively, the auditor may turn the check
distribution over to an official not associated with preparing payroll, signing
checks, or supervising workers. Personnel files and the employees'
completed time cards and time tickets may also be examined to
substantiate the existence of absent employees

Excess Payments to Increasing the rate above that approved or paying employees for more
Employees hours than they worked are the most common ways of paying employees
more than they are entitled to receive.

Failure to Record Payroll Companies having difficulty meeting profit targets or not-for-profit entities
having difficulty managing costs and expenses might fail to record a
payroll. The omission of payroll can be difficult to hide unless a similar
amount of revenues or receipts has been omitted. Analytical procedures
can be performed to test the reasonableness of payroll cost.

Inappropriate Assignment of A company having difficulty meeting profit targets might assign to
Labor Costs to Inventory inventory labor cost that should have been charged to expense. Analytical
procedures such as comparing costs incurred to budgeted cost and
verification of valuation of inventory are some of the useful techniques in
detecting such fraud.

CH16 INTERNAL CONTROL AFFECTING ASSETS

INTERNAL CONTROL OVER Most of the processes relating to cash handling are the responsibility of the
CASH TRANSACTIONS finance department, under the direction of the treasurer. These processes
include handling and depositing cash receipts; signing checks; investing
idle cash; and maintaining custody of cash, marketable securities, and
other negotiable assets. In addition, the finance department must forecast
cash requirements and make both short-term and, long-term financing
arrangements.

Ideally, the functions of the finance department and the accounting

department should be integrated in a manner that provides assurance that:
1. All cash that should have been received was in fact received, recorded
accurately and deposited promptly.
 2. Cash disbursements have been made for authorized purposes only and
have been properly recorded.
3. Cash balances are maintained at adequate, but not excessive, levels by
forecasting expected cash receipts and payments related to normal
operations. The need for obtaining loans for investing excess cash is thus
made known on a timely basis.

guidelines for achieving internal 1.​ Do not permit any one employee to handle a transaction from
control over cash beginning to end.
2.​ Separate cash handling from record keeping.
3.​ Centralize receiving of cash to the extent practical.
4.​ Record cash receipts on a timely basis.
5.​ Encourage customers to obtain receipts and observe cash register
totals.
6.​ Deposit cash receipts daily.
7.​ Make all disbursements by check or electronic funds transfer, with
the exception of small expenditures from petty cash.
8.​ Have monthly bank reconciliation prepared by employees not
responsible for the issuance of checks or custody of cash. The
completed reconciliation should be reviewed promptly by an
appropriate official.
9.​ Monitor cash receipts and disbursements by comparing recorded
amounts to forecasted amounts and investigating variances from
forecasted amounts.

Potential Misstatements - Cash 1. Recording fictitious cash receipts

Receipts 2. Failure to record receipts from cash sales
3. Failure to record cash from collection of accounts receivable
4. Early (late) recognition of cash receipts "cutoff problems"

Examples Internal Control Weakness or

Factors that Increase the Risk of the
Misstatement:

Recording fictitious cash

receipts Fraud: Lack of segregation of duties of the
Overstating cash receipts on the functions of access to cash and
books by transferring cash between record keeping; no effective review
bank accounts without appropriate of bank reconciliations
recording of the transfer to cover up
an embezzlement of cash.

Failure to record receipts from Fraud: Inadequate supervision of cashiers;

cash sales A cashier fails to ring up and record failure to encourage customers to
cash sales and embezzles the cash, obtain cosh receipts.

Error: Inadequate controls for reconciling

A bookkeeper accidentally omits the cash register tapes and accounting
recording of the receipts from one records; inadequate controls for
cash register for the day. reconciling bank accounts.
Failure to record cash from Fraud: Lack of segregation of duties
collection of accounts A čashier embezzles cash between personnel who have
receivable payments by customers on access to cash receipts and those
receivables, without recording the who make entries into the accounts
receipts in the customers' accounts. receivable records.

A bookkeeper accidentally who has Lack of segregation of duties

access to cash receipts embezzles between personnel who have
cash collected from customers and access to cash receipts and those
writes off the related receivables. who make entries into the accounts
receivable records.

Error: Inadequate reconciliations of

A bookkeeper accidentally fails to subsidiary records of accounts
record payment on a receivable. receivable with the general ledger
control account.

Early (late) recognition of cash Fraud: Ineffective board of directors, audit

receipts "cutoff problems" Holding the cash receipts. journal committee, or internal audit
open to record next year's cash function; "tone at the top" not
receipts as having occurred in this conductive to ethical conduct;
year. undue pressure to show improved
financial position.

Error:
Recording cash receipts based on Failure to list and deposit cash
bad information about date of receipts on a timely basis.
receipt.

Potential Misstatements - Cash 1.​ Inaccurate recording of a purchase or disbursement

Disbursements 2.​ Duplicate recording and payment of purchases
3.​ Unrecorded disbursements

Inaccurate recording of a Fraud: Inadequate segregation of duties of

purchase or disbursement A bookkeeper prepares a check to record keeping and preparing cash
himself and records it as having disbursements, or check signer
been issued to a major supplier. does not review and cancel
supporting documents.
Error:
A disbursement is made to pay an Ineffective control for matching
invoice for goods that have not invoices with receiving documents
been received. before disbursements are
Disbursements for travel and authorized.
entertainment are improperly
included with merchandise Ineffective accounting coding
purchases. procedures may result from
incompetent accounting personnel,
inadequate chart of accounts, or no
 controls over the posting process.

Duplicate recording and Error:

payment of purchases A purchase is recorded when on Ineffective controls for review and
invoice is received from a vendor cancellation of supporting
and recorded again when a documents by the check signer.
duplicate invoice is sent by the
vendor.

Unrecorded disbursements Fraud:

In conjunction with recorded (but Ineffective control over record
deposited) cash receipts, an keeping for and access to cash.
employee writes and chases on
unrecorded check for the identical
amount,

INTERNAL CONTROL OVER The most important group of financial investments, consists of marketable
FINANCIAL INVESTMENTS stocks and bonds because peso value than the other kinds of investment
holdings. Other types of investments often encountered include
commercial paper issued by corporations, mortgages and trust deeds, and
the cash surrender value of life insurance policies.

Derivatives are financial instruments that "derive" their value from other financial
instruments, underlying assets, or indexes. For example, a simple
derivative would involve a commitment by a company to purchase a
commodity at a certain price at some point in the future.Other derivatives
are much more complex, involving, for example, relationships between
fluctuations in European interest rates and the price of copper.

The major elements of 1. Formal investment policies that limit the nature if investments in
adequate internal control over securities and other financial instruments.
financial investments include 2. An investment committee of the board of directors that authorizes and
the following: reviews financial investment activities for compliance with investment
policies.
3. Separation of duties between the executive authorizing purchases and
sales of securities and derivative instruments, the custodian of the
securities, and the person maintaining the records of investments.
4. Complete detailed records of all securities and derivative instruments
owned and the related provisions and terms.
5. Registration of securities in the name of the company.
6. Periodic physical inspection of securities on hand by an internal auditor
or an official having no responsibility for the authorization, custody, or
record keeping of investments.
7. Determination of appropriate accounting for complex financial
instruments by competent personnel.

In many concerns, segregation of the functions of custody and record

keeping is achieved by the use of an independent safekeeping agent, such
as a stockholder, bank or trust company.

If securities are not placed in the custody of an independent agent, they

 should be kept in a bank safe-deposit box under the joint control of two or
more of the company's officials.

Joint control means that neither of the two custodians may have access to the
securities except in the presence of the other. A list of securities in the box
should be maintained in the box, and the deposit or withdrawal of
securities should be recorded on this list along with the date and
signatures of all persons present.The safe-deposit box rental should be in
the name of the company, not in the name of an officer having custody of
securities.

Complete detailed records of all securities and derivative instruments

owned are essential to satisfactory control These records frequently
consist of a subsidiary record for each security and derivative instrument,
with such identifying data as the exact name, face amount or par value,
certificate number, number of shares, date of acquisition, name of broker,
cost, terms and any interest or dividend payments received.

The purchase and sale of investments often is entrusted to a responsible

financial executive, subject to frequent review by an investment committee
of the board of directors.

Potential Misstatements 1.​ Misstatement of recorded value of investments

Financial Investments 2.​ Unauthorized investment transactions
3.​ Incomplete recording of investments

Misstatement of recorded value Error: Inadequate accounting manual;

of investments Failure to record changes in market incompetent accounting personnel.
values of investments.

Fraud: Ineffective board of directors, audit

Misstatement of the value of closely committee, or internal audit
held investment. function; not conducive to ethical
conduct; undue pressure to meet
earnings targets.

Unauthorized investment Fraud: An employee with access to Inadequate segregation of duties of

transactions securities coverts them for personal record keeping for and custody of
use. securities.

Incomplete recording of Error: a. Inadequate accounting manual;

investments Foilure to record derivative incompetent accounting. personnel.
agreements which are embedded in b. Inadequate monitoring by internal
ather agreements. auditors.

INTERNAL CONTROL OVER Accounts receivable include not only claims against customers arising
RECEIVABLES from the sale of goods or services, but also a variety of miscellaneous
claims such as loans to officers or employees, loans to subsidiaries, claims
against various other films, claims for tax refunds and advantages to
suppliers.
Notes receivable are written promises to pay certain amounts at future dates. Typically used
for handling transactions of substantial amount; these negotiable
documents are widely used.

Internal Control of Accounts To understand internal control over accounts receivable and revenue, one
Receivable and Revenue must consider the various components, including the control environment,
risk assessment, monitoring, the (accounting) information and
communication system, and control activities.

Because of the risk of intentional misstatement of revenues, the control

environmentis very important to effective internal control over revenue and
receivables. Of particular importance is an independent audit committee of
the board of directors that monitors management's judgments about
revenue recognition principles and estimates, as well as an effective
internal audit function.

Management should establish a tone at the top of the organization

thatencouragesintegrity and ethical financial reporting. These ethical
standards should be communicated and observed throughout the
organization. Also, incentives for dishonest reporting, such as undue
emphasis on meeting unrealistic sales or earnings targets, should be
eliminated.

Potential Misstatements 1.​ Recording unearned revenue

Revenue / Receivables 2.​ Early (late) recognition of revenue: "cutoff error"
3.​ Recording revenue when significant uncertainties exist
4.​ Recording revenue when significant services still must be
performed by seller
5.​ Overestimation of the amount of revenue earned.

Recording unearned revenue Fraud: Ineffective board of directors, audit

Recording fictitious sales without committee, or internal audit
receiving a customer order or function; undue pressure to meet
shipping the goods. earnings targets. "top management
Intentional overshipment of goods. action" not conductive to ethical
conduct.
Errors:
Recording sales based on the Ineffective billing process in which
receipt of orders from customers billing is not tied to shipping
rather than the shipment of goods. information.
Inaccurate billing and recording of
sales. Ineffective controls for testing
invoices, or ineffective input
validation checks and computer
reconciliations to ensure the
accuracy of databases.

Recording cash that represents a Inadequate accounting manual;

liability (e.g.. receipt of a customer's incompetent accounting personnel.
 deposit) as revenue.

Early (late) recognition of Fraud: Ineffective board of directors, audit

revenue: "cutoff error" Holding the sales journal open to committee, or internal audit
record next year's sales as having function; not conducive to ethical
occurred in the current year. conduct; undue pressure to meet
sales targets.
Error:
Recording soles in the wrong period Ineffective cutoff procedures in the
based on incorrect shipping shipping department.
information.

Recording revenue when Fraud: Ineffective board of directors, audit

significant uncertainties exist Recording sales when the customer committee, or internal audit
is likely to return the goods. function; not conducive to ethical
conduct; undue pressure to meet
sales targets.
Error:
Recording sales when the Aggressive attitude of management
customer's payment is contingent toward financial reporting;
upon the customer receiving incompetent chief accounting
financing or selling the goods to officer.
another party (e.g., consignment
sales).

Recording revenue when Fraud: Ineffective board of directors, audit

significant services still must be Recording franchise revenue when committee, or internal audit
performed by seller the franchises are sold even though function; not conducive to ethical
an obligation to perform significant conduct; undue pressure to meet
services still exists. sales targets.

Error: Aggressive attitude of management

Amount of revenue corned on toward financial reporting:
franchises is miscalculated incompetent chief accounting
officer.

Overestimation of the amount Fraud: Ineffective board of directors, audit

of revenue earned Misstating the percentage of committee, or internal audit
completion of several projects by a function; not conducive to ethical
construction company using the conduct; incompetent individuals
percentage-of completion method involved in the estimation process.
revenue recognition.

Overestimating the percentage of Aggressive attitude of management

completion on projects by a toward financial reporting;
construction company using the incompetent personnel involved in
percentage-of-completion method of the estimation /accounting process.
revenue recognition.
Internal Control over Notes As previously stated, a basic characteristic of effective control consists of
Receivable the subdivision of duties.

As applied to notes receivable, this principle requires that:

1. The custodian of notes receivable not have access to cash or to general
accounting records.
2. The acceptance and renewal of notes be authorized in writing by a
responsible official who does not have custody of the notes.
3. The write-off of defaulted notes be approved in writing by responsible
officials and effective procedures adopted for subsequent follow-up of such
defaulted notes.

The controls that assure the fair valuation of inventories are found in the
INTERNAL CONTROL OVER purchases (or acquisition) cycle. These controls include procedures for
INVENTORIES & COST OF selecting vendors, ordering merchandise or materials, inspecting goods
GOODS SOLD received, recording the liability to the vendor, and authorizing and making
cash disbursements. In a manufacturing business, the valuation of
inventories also is affected by the production (or conversion) cycle, in
which various manufacturing costs are assigned to inventories, and the
cost of inventories is then transferred to the cost of goods sold.

The term inventories is used in 1. goods on hand ready for sale, whether the merchandise of a trading
this chapter to include: concern or the finished goods of a manufacturer;
2. goods in the process of production; and
3. good to be consumed directly or indirectly in production, such as raw
materials, purchased parts, and supplies.

Internal Control over The importance of adequate internal control over inventories and cost of
Inventories and Cost of Goods goods sold from the viewpoint of both management and the auditors can
Sold scarcely be overemphasized.

In some companies, management stresses controls over cash and

securities but pays little attention to control over inventories. Since many
types of inventories are composed of items not particularly susceptible to
theft, management may consider controls to be unnecessary in this area.
Such thinking ignores the fact that controls for inventories affect nearly all
the functions involved in producing and disposing of the company's
products.

Potential Misstatements - 1.​ Misstatement of inventory costs

Inventory/Cost of Goods Sold 2.​ Misstatement of inventory quantities
3.​ Early (late) recognition of purchases "cutoff problems",

Misstatement of inventory costs Fraud: Ineffective board of directors, audit

Intentional misstatement of committee, or internal audit
production costs assigned. to function; "tone at the top" not
inventory. conductive to ethical conduct;
undue pressure to meet earnings
Intentional misstatement of targets.
inventory prices.
 Errors: Ineffective cost accounting system;
The assignment of direct labor failure to update standard costs on
costs, direct material costs, or a timely basis.
factory overhead to inventory items
is inaccurate. Ineffective input validation controls
on the database of inventory costs;
Erroneous pricing of inventory. ineffective supervision of the
personnel that enter the costs on
the final inventory schedule.

Misstatement of inventory Fraud: Ineffective physical controls over

quantities Items are stolen with no journal inventories.
entry reflecting the theft,
Ineffective board of directors, audit
Inventory quantities in locations not committee, or internal audit
visited by auditors are function; "tone at the top" not
systematically overstated. conducive to ethical conduct; undue
pressure to meet earnings targets.
Errors:
Miscounting of inventory by Ineffective controls or supervision of
personnel involved in physical physical inventory.
inventory

Early (late) recognition of Fraud: Ineffective board of directors, audit

purchases "cutoff problems", Intentional recording of purchases committee, or internal audit
in the subsequent period. function; "tone at the top" not
conducive to ethical conduct; undue
pressure to meet earnings targets.
Error:
Recording purchases of the current Ineffective accounting procedures
period in the subsequent period. that do not tie recorded purchases
to receiving data.

properly, plant and equipment INTERNAL CONTROL OVER PROPERTY, PLANT AND EQUIPMENT
The term ___ includes all tangible assets with a service life of more than
one year that are used in the operation of the business and are not
acquired for the purpose of resale.

Three major subgroups of such assets are generally recognized: L B N

1.​ Land, such as properly used in the operation of the business, has
the significant characteristic of not being subject to depreciation.
2.​ Buildings, machinery, equipment and land improvements, such as
fences and parking lots, have limited service lives and are subject
to depreciation.
3.​ Natural resources (wasting assets), such as oil wells, coal mines,
and tracts of timber, are subject to depletion as the natural
resources are extracted or removed.
 Acquisitions and disposals of property, plant and equipment are usually
large in dollar amount, but concentrated in only a few transactions.
Individual items of plant and equipment may remain unchanged in the
accounts for many years.

Internal Control over Plant and The amounts invested in plant and equipment represents a large portion of
Equipment the total assets of many industrial concerns.

Maintenance, rearrangement and depreciation of these assets are major

expenses in the income statement. The total expenditures for the assets
and related expenses make strong internal control essential to the
preparation of reliable financial statements.

Errors in measurement of income may be material if assets are scrapped

without their cost being removed from the accounts, or if the distinction
between capital and revenue expenditures is not maintained consistently.

The losses that inevitably arise from uncontrolled methods of acquiring,

maintaining, and retiring plant and equipment are often greater than the
losses from fraud in cash handling.

In large enterprises, the auditors may expect to find an annual plant

budget used to forecast and control acquisitions and retirements of plant
and equipment. Many small companies also forecast expenditures for
plant assets. Successful utilization of a plant budget presupposes the
existence of reliable and detailed accounting records for plant and
equipment. A detailed knowledge of the kinds, quantities and condition of
existing equipment is an essential basis for intelligent forecasting of the
need for replacements and additions to the plant.

Other key controls applicable to 1. A subsidiary ledger consisting of a separate record for each unit of
plant and equipment are as property. An adequate plant and equipment ledger facilitate the auditor's
follows: work in analyzing additions and retirements, in verifying the depreciation
provision and maintenance expenses, and in comparing authorizations
with actual expenditures.
2. A system of authorization requiring advance executive approval of all
plant and equipment acquisitions, whether by purchase, lease or
construction. Serially numbered capital work orders are a convenient
means of recording authorizations.
3. A reporting procedure assuring prompt disclosure and analysis of
variances between authorized expenditures and actual costs.
4. An authoritative written statement of company policy distinguishing
between capital expenditures and revenue expenditures. A dollar minimum
ordinarily will be established for capitalization; any expenditures of a lesser
amount automatically classified as charges against current revenue.
5. A policy requiring all purchases of plant and equipment to be handled
through the purchasing department and subjected to a standard routine for
receiving, inspection and payment.
6. Periodic physical inventories designed to verify the existence, location
and condition of all property listed in the accounts and to disclose the
 existence of any unrecorded units.
7. A system of retirement procedures, including serially numbered
retirement work orders (bottom), stating reasons for retirement and bearing
appropriate approvals.

Potential Misstatements - 1.​ Misstatement of acquisitions of property, plant and equipment

Investments in Property, Plant 2.​ Failure to record retirements of property, plant and equipment.
and Equipment 3.​ Improper reporting of unusual transactions.​ ​

Misstatement of acquisitions of Fraud: Undue pressure to meet earnings

property, plant and equipment Expenditures for repairs and targets.
maintenance expenses recorded as
property, plant and equipment
acquisitions to overstate income.

Error:
Purchases of equipment Inadequate accounting manual,
erroneously reported in incompetent accounting personnel.
maintenance and repairs expense
account

Failure to record retirements of Error: Inadequate accounting policies,

property, plant and equipment An asset that hos been replaced is e.g., failure to use retirement work
discorded due to its lack of value, orders.
without an accounting entry.

Improper reporting of unusual Error: Inadequate accounting manual;

transaction A"gain" recorded on an exchange of incompetent accounting personnel.
nonmonetary assets that locks
commercial substance

CH17 INTERNAL CONTROL AFFECTING LIABILITIES AND

EQUITY

INTERNAL CONTROL OVER ACCOUNTS PAYABLE

accounts payable often referred to as vouchers payable for a voucher system

accounts payable is used to describe short-term obligations arising from the

purchase of goods and services in the ordinary course of
business.

Typical transactions creating the acquisition on credit of merchandise, raw materials,

accounts payable include: plant assets and office supplies.
 Other sources of accounts payable include
the receipt of services, such as legal and accounting
services, advertising, repairs and utilities. Interest-bearing
obligations should not be included in accounts payable but
shown separately as bonds, notes, mortgages, or
installment contracts
Invoices and statements from supplies usually evidence
accounts payable arising from the purchase of goods or
services and most other liabilities.

accrued liabilities sometimes called accrued expenses. generally accumulate

over time, and management must make accounting
estimates of the year-end liability.
Such estimates are often necessary for salaries, pensions,
interest, rent, taxes and similar items

Some companies, therefore, may choose to minimize their

record keeping of liabilities and to rely on creditors to call
attention to any delay in making payment. This viewpoint is
not an endorsement of inaccurate or incomplete records of
accounts payable, but merely recognition that the
self-interest of creditors constitutes an effective control in
accounting for payables that is not present in the case of
accounts receivable.

Potential Misstatements 1.​ Inaccurate recording of a purchase or disbursement

Accounts Payable 2.​ Misappropriation of purchases
3.​ Duplicate recording of purchases
4.​ Late (early) recording of cost of purchase "cutoff
problems"​

Inaccurate recording of a Fraud: Inadequate

purchase or disbursement A bookkeeper prepores o check to segregation of duties
himself and records it as having of record keeping
been issued to a major supplier. and preparing cash
disbursements, or
Error: check signer does
A disbursement is made to pay an not review and
invoice for goods that have not cancel supporting
been received. documents,

Ineffective controls
for matching invoices
with receiving
documents before
disbursements are
authorized.

Misappropriation of purchases Fraud: Ineffective controls

 Goods are ordered but delivered to for matching invoices
an inappropriate address and with receiving
stolen. documents before
disbursements are
authorized.

Duplicate recording of Error: A purchase is recorded when Ineffective controls

purchases an invoice is received from a vendor for review and
and recorded again when a concellation of
duplicate invoice is sent by the supporting
vendor. documents by the
check signer.

Late (early) recording of cost of Fraud: Purchases journal "closely Ineffettive board of
purchase "cutoff problems" early" with this period's purchases directors, audit
recorded as having occurred in committee, or
subsequent period. internal audit
function: "tone at the
top" not conducive to
ethical conduct;
undue pressure to
meet earnings target.

INTERNAL CONTROL OVER Business corporations obtain substantial amounts of their

OTHER DEBTS financial resources by incurring debt and issuing capital
stock.

financing cycle The acquisition and repayment of capital is sometimes

referred to as the__ This transaction cycle includes the
sequence of procedures for authorizing, executing, and
recording transactions that involve bank loans, mortgages,
bonds payable, and capital stock as well as the payment of
interest and dividends

Internal Control over Debt ●​ Authorization by the Board of Directors

●​ Use of an Independent Trustee
●​ Interest Payments on Bonds and Notes Payable

Authorization by the Board of Effective internal control over debt begins with the
Directors authorization to incur the debt. The bylaws of a corporation
usually require that the board of directors approve
borrowing. The treasurer of the corporation will prepare a
report on any proposed financing, explaining the need for
funds, the estimated effect of borrowing upon future
earnings, the estimated financial position of the company in
comparison with others in the industry both before and after
the borrowing, and alternative methods of raising the funds.
Authorization by the board of directors will include review
and approval of such matters as the choice of a bank or
trustee, the type of security, registration with the SEC,
 agreements with investment bankers, compliance with
requirements of the state of incorporation, and listing of
bonds on a securities exchange. After the issuance of
long-term debt, the board of directors should receive a
report stating the net amount received and its disposition
as, for example, acquisition of plant assets, addition to
working capital, or other purposes.

Use of an Independent Trustee Bond issues are always for large amounts usually many
millions of pesos. Therefore, only relatively large companies
issue bonds: small companies obtain long-term capital
through mortgage loans or other sources. Any company
large enough to issue bonds and able to find a ready
market for the securities will almost always utilize the
services of a large bank as an independent trustee.

Use of an Independent Trustee largely solves the problem of internal control over bonds
payable. Internal control is strengthened by the fact that the
trustee does not have access to the issuing company's
assets or accounting records and the fact that the trustee is
a large financial institution with legal responsibility for its
actions.

trustee is charged with the protection of the creditors' interests and

with monitoring the issuing company's compliance with the
provisions of the indenture.

also maintains detailed records of the names and

addresses of the registered owners of the bonds, cancels
old bond certificates and issues new ones when bonds
change ownership, follows procedures to prevent over
issuance of bond certificates, distribute interest payments,
and distributes principal payments when then bonds
mature.

Interest Payments on Bonds Many corporations assign the entire task of paying interest
and Notes Payable to the trustee for either bearer bonds or registered bonds.
Highly effective control is then achieved, since the company
will issue a single check for the full amount of the
semiannual interest payment on the entire bond issue.

INTERNAL CONTROL OVER OWNERS' EQUITY

The three principal elements of 1.​ the proper authorization of transactions by the board
strong internal control over of directors and corporate office,
share capital and dividends: 2.​ the segregation of duties in handling these
transactions (preferably the use payments), and
3.​ the maintenance of adequate records.

Internal Control on Equity ●​ Control of Share Capital Transactions by the Board

of Directors
 ●​ Independent Registrar and Stock Transfer Agent

Control of Share Capital All changes in share capital accounts should receive formal
Transactions by the Board of advance approval by the board of directors. The board of
Directors directors must determine the number of shares to be issued
and the price per share; if an installment plan of payment is
to be used, the board must prescribe the terms. If plant and
equipment, services, or any consideration other than cash
is to be accepted in payment for shares, the board of
directors must establish the valuation on the noncash
assets received. Transfers from retained earnings to the
Share Capital and Paid-in Capital accounts, as in the case
of stock dividends, are initiated by action of the board. In
addition, stock splits and changes in par or stated value of
shares require formal authorization by the board.
Authority for all dividend actions rests with the directors.
The declaration of a dividend must specify not only the
amount per share but also the date of record and the date
of payment.

Independent Registrar and In appraising internal control over share capital, the first
Stock Transfer Agent question that the auditors consider is whether the
corporation employs the services of an independent share
registrar and a share transfer agent or handles its own
capital share transactions. Internal control is far stronger
when the services of an independent share registrar and a
stock transfer agent are utilized because the banks or trust
companies acting in these capacities will have the
experience, the specialized facilities, and the trained
personnel to perform the work in an expert manner.
Moreover, by placing the responsibility for handling share
capital certificates in separate and independent
organizations, the corporation achieves to the fullest extent
the internal control concept of separation of duties.

Internal Control over Dividends The nature of internal control over the payment of tof
dividends, as in the case of stock issuance, depends
primarily upon whether the company performs the function
of dividend payment itself or utilizes the services of an
independent dividend-paying agent. If an independent
dividend-paying agent is used, the corporation will provide
the agent with certified copy the dividend declaration and a
check for the full amount of the dividend. The bank or trust
company serving as stock transfer is usually appointed to
distribute the dividend, since it maintains the detailed
records of shareholders. The agent issues dividend checks
to the individual shareholders and sends the corporation a
list of the payments made. The use of an independent fiscal
agent is to be recommended payments made. The use of
from the stand-point of internal ternal control, for it
materially reduces the possibility of fraud or error arising in
connection with the distribution of dividends. case of
In a small corporation that does not use the services of a
dividend-paying agent, the responsibility for payment of
dividends is usually lodged with the treasurer and the
secretary. After declaration of a dividend by the board of
directors, the secretary prepares a list of shareholders as of
the date of record, the number of shares held by each, and
the amount of the dividend each is to receive. The total of
these individual amounts is proved by multiplying the
dividend per share by the total number of outstanding
shares.
Dividend checks controlled by serial numbers are dawn
payable to individual stockholders in the amount shown on
the list described above. If the shareholders ledger is
maintained on a computer master file, the dividend checks
may be prepared by the computer directly from this record.
The stockholder list and dividend checks are submitted to
the treasurer for approval and signature. The checks should
be reconciled by the treasurer with the total of shares
outstanding and mailed without again coming under control
of the officer who prepared them.
Cash in the amount of the total dividend is then transferred
from the general bank account to a separate dividend bank
account. As the individual dividend checks are paid from
this account and returned by the bank, they should be
matched with the check stubs or marked paid in the
dividend check register. A list of outstanding checks be
prepared monthly from the open stubs or open items in the
checks register. This list should agree in total with the
balance remaining in the dividend bank account.
Companies with numerous shareholders prepare dividend
checks in machine-readable form, so that the computer
may perform the reconciliation of outstanding checks.