Cash, Fraud, and Internal Control

Chapter 6

Wild and Shaw

Financial and Managerial Accounting
9th Edition

Copyright ©2022 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 6 Learning Objectives
CONCEPTUAL
C1 Define internal control and identify its purpose and principles.
C2 Define cash and cash equivalents and explain how to report them.

ANALYTICAL
A1 Compute the days’ sales uncollected ratio and use it to assess liquidity.

PROCEDURAL
P1 Apply internal control to cash receipts and payments.
P2 Explain and record petty cash fund transactions.
P3 Prepare a bank reconciliation.
P4 Appendix 6A – Describe use of documentation and verification to control cash payments.

© McGraw-Hill Education 6-2

 Learning Objective C1

Define internal control and

identify its purpose and
principles.

© McGraw-Hill Education 6-3

 Internal Control System
An internal control system is used to
monitor and control business activities. It
includes the policies and procedures used
to:
– Protect assets.
– Ensure reliable accounting.
– Uphold company policies.
– Promote efficient operations.

© McGraw-Hill Education 6-4

Learning Objective C1: Define internal control and identify its purpose and principles.
 Sarbanes-Oxley Act (SOX)

The Sarbanes-Oxley Act requires managers and auditors of

public companies to document and certify the system of
internal controls.

Requirements include:
• The company must have effective internal controls.
• Auditors must evaluate internal controls.
• Violators receive harsh penalties up to 25 years in prison with fines.
• Auditors’ work is overseen by Public Company Accounting Oversight Board
(PCAOB).

© McGraw-Hill Education 6-5

Learning Objective C1: Define internal control and identify its purpose and principles.
 Committee of Sponsoring
Organizations (COSO)
Committee of Sponsoring Organizations (COSO) lists five
ingredients of internal control which add quality to
accounting information:

1. Control environment
2. Risk assessment
3. Control activities
4. Information & communication
5. Monitoring

© McGraw-Hill Education 6-6

Learning Objective C1: Define internal control and identify its purpose and principles.
 Principles of Internal Control
Internal control principles common to all
companies:
1. Establish responsibilities.
2. Maintain adequate records.
3. Insure assets and bond key employees.
4. Separate recordkeeping from custody of assets.
5. Divide responsibility for related transactions.
6. Apply technological controls.
7. Perform regular and independent reviews.

© McGraw-Hill Education 6-7

Learning Objective C1: Define internal control and identify its purpose and principles.
 Internal Control:
Establish Responsibilities

1. Tasks should be clearly established.

2. Tasks should be assigned to one person.
3. Can then determine who is at fault.

© McGraw-Hill Education 6-8

Learning Objective C1: Define internal control and identify its purpose and principles.
 Internal Control:
Maintain Adequate Records
1. Protects assets.
2. Helps managers monitor company activities.
3. Includes:
1. Detailed records.
2. Use of chart of accounts.
3. Preprinted forms.
4. Prenumbered sales slips.
5. Computerized point-of-sale systems.
© McGraw-Hill Education 6-9
Learning Objective C1: Define internal control and identify its purpose and principles.
 Internal Control: Insure Assets
and Bond Key Employees

1. Assets should be insured against losses.

2. Employees handling a lot of cash and other
assets should be bonded.
3. Bonding means the company has purchased
an insurance policy against theft by that
employee.

© McGraw-Hill Education 6-10

Learning Objective C1: Define internal control and identify its purpose and principles.
 Internal Control: Separate
Recordkeeping from Custody
of Assets
1. Person who controls or has access to assets
must not have access to that asset’s
accounting records.
2. Reduces risk of theft or waste of an asset.
3. Employees would need to collude, agree in
secret, to commit fraud under this control.
© McGraw-Hill Education 6-11
Learning Objective C1: Define internal control and identify its purpose and principles.
Internal Control: Divide Responsibility
for Related Transactions

1. Responsibility for a transaction should be

divided between two or more individuals.
2. Ensures work of one person acts as a check
on the other to prevent fraud or errors.
3. Called separation of duties.

© McGraw-Hill Education 6-12

Learning Objective C1: Define internal control and identify its purpose and principles.
 Internal Control: Apply Technological
Controls
1. Cash registers make an electronic file/record
of each sale.
2. Time clock records exact time employee
works.
3. ID scanners limit access to authorized
individuals.

© McGraw-Hill Education 6-13

Learning Objective C1: Define internal control and identify its purpose and principles.
Internal Control: Perform Regular and
Independent Reviews

1. Helps ensure that procedures are followed.

2. Preferably done by auditors not directly
involved in the activities.
3. Auditors evaluate the efficiency and
effectiveness of internal controls.

© McGraw-Hill Education 6-14

Learning Objective C1: Define internal control and identify its purpose and principles.
Technology, Fraud, and Internal Control
Reduced More
Processing Extensive Testing
Errors of Records

New Separation of
Evidence of Duties
Processing

Increased
E-Commerce

© McGraw-Hill Education 6-15

Learning Objective C1: Define internal control and identify its purpose and principles.
 Blockchain as a Control
Blockchain is a more secure type of accounting
ledger which continuously and simultaneously
updates and verifies the ledger.
1. Prevents modification without detailed
record of changes.
2. Changes cannot be destroyed or hidden.
3. Auditors focus on testing the effectiveness of
company’s blockchain processes and
technology.
© McGraw-Hill Education 6-16
Learning Objective C1: Define internal control and identify its purpose and principles.
 Limitations of Internal Control
Human Error Human Fraud
Intentionally
Carelessness
defeating internal
Misjudgment
controls for
Confusion
personal gain

Fraud Triangle:
Opportunity, Pressure & Rationalization
Cost-benefit constraint: costs of internal controls
must not exceed their benefits.
© McGraw-Hill Education 6-17
Learning Objective C1: Define internal control and identify its purpose and principles.
 Learning Objective C2

Define cash and cash

equivalents and explain how to
report them.

© McGraw-Hill Education 6-18

 Control of Cash
An effective system of internal control that
protects cash and cash equivalents should meet
three basic guidelines:

Handling cash Cash receipts

is separate from are promptly
recordkeeping for deposited in a
cash. bank.
Cash payments
are made by
check or EFT.
© McGraw-Hill Education 6-19
Learning Objective C2: Define cash and cash equivalents and explain how to report them.
 Cash, Cash Equivalents, and Liquidity
Cash and similar assets are called liquid assets because
they can be readily used to pay liabilities.
Cash
Currency, coins, and deposits in bank accounts. Also
includes items such as customer checks, cashier checks,
certified checks, and money orders.

Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
changes.
© McGraw-Hill Education 6-20
Learning Objective C2: Define cash and cash equivalents and explain how to report them.
 Cash Management
The goals of cash management are twofold:
1. Plan cash receipts to meet cash payments when due.
2. Keep a minimum level of cash necessary to operate.

Effective cash management involves applying

the following cash management strategies:
 Encourage collection of receivables.
 Delay payment of liabilities.
 Keep only necessary assets.
 Plan expenditures.
 Invest excess cash.

© McGraw-Hill Education 6-21

Learning Objective C2: Define cash and cash equivalents and explain how to report them.
 Learning Objective P1

Apply internal control to cash

receipts and payments.

© McGraw-Hill Education 6-22

 Over-the-Counter Cash Receipts
This graphic illustrates that none of the people
involved can make a mistake or divert cash
without the difference being revealed.

© McGraw-Hill Education 6-23

Learning Objective P1: Apply internal control to cash receipts and payments.
 Cash Over and Short: Overage
Sometimes errors in making change are discovered from
differences between the cash in the cash register and the
record of the amount of cash receipts.

If a cash register’s record shows $550 but the count of cash

in the register is $555, we would prepare the following
journal entry:

© McGraw-Hill Education 6-24

Learning Objective P1: Apply internal control to cash receipts and payments.
 Cash Over and Short: Shortage
Sometimes errors in making change are discovered from
differences between the cash in the cash register and the
record of the amount of cash receipts.

On the other hand, if a cash register’s record shows $625 but

the count of cash in the register is
$621, the entry to record cash sales and its shortage is:

© McGraw-Hill Education 6-25

Learning Objective P1: Apply internal control to cash receipts and payments.
 Cash Receipts by Mail

The
recordkeeper
Two people are
The cashier records
assigned the
deposits the amounts
task of opening
cash in a bank. received in the
the mail.
accounting
records.

© McGraw-Hill Education 6-26

Learning Objective P1: Apply internal control to cash receipts and payments.
 Control of Cash Payments
Control of cash payments is important as most
large thefts are from payment of fictitious
invoices.
Keys to Controlling Cash Payments:
• Require all payments to be made by check.
• Limit access to accounting records except for
those who have the authority to sign checks.
Cash Budget:
• Includes projected cash receipts and cash payments.
© McGraw-Hill Education 6-27
Learning Objective P1: Apply internal control to cash receipts and payments.
 Voucher System of Control (1 of 2)
A voucher system establishes procedures for:
1.
1. Verifying,
Verifying, approving,
approving, and
and recording
recording liabilities
liabilities
for
for eventual
eventual cash
cash payments.
payments.
2.
2. Issuing
Issuing checks
checks for
for payment
payment ofof verified,
verified,
approved,
approved, and
and recorded
recorded liabilities.
liabilities.

© McGraw-Hill Education 6-28

Learning Objective P1: Apply internal control to cash receipts and payments.
 Voucher System of Control (2 of 2)
Exhibi
t 6.1

© McGraw-Hill Education 6-29

Learning Objective P1: Apply internal control to cash receipts and payments.
 Learning Objective P2

Explain and record petty cash

fund transactions.

© McGraw-Hill Education 6-30

 Petty Cash System of Control
Small payments for items such as:
• Shipping fees,
• Minor repairs, and
• Low-cost supplies.

© McGraw-Hill Education 6-31

Learning Objective P2: Explain and record petty cash fund transactions.
 Establishing a Petty Cash Fund
To establish a petty cash fund:
Petty Cash is debited to increase
Cash is credited to decrease

© McGraw-Hill Education 6-32

Learning Objective P2: Explain and record petty cash fund transactions.
 Operating a Petty Cash Fund
Summary of petty cash receipts:
Exhibit
6.3

© McGraw-Hill Education 6-33

Learning Objective P2: Explain and record petty cash fund transactions.
 Reimbursement of Petty Cash Fund
The petty cash payments report is used in making
the journal entry to reimburse the fund.
Debit each of the expenses, Merchandise Inventory
and credit Cash.

© McGraw-Hill Education 6-34

Learning Objective P2: Explain and record petty cash fund transactions.
 Increasing or Decreasing a Petty
Cash Fund
To increase, debit Petty Cash and credit Cash.

To decrease, debit Cash and credit Petty Cash.

© McGraw-Hill Education 6-35

Learning Objective P2: Explain and record petty cash fund transactions.
 Cash Over and Short
• If petty cashier fails to obtain a receipt for payment or
overpays an amount, cash over or short will result.
• Petty cash payments report plus cash left in account will
not total to the fund balance.
• Shortage: difference is debited to Cash Over and Short.
• Overage: difference is credited to Cash Over and Short.

© McGraw-Hill Education 6-36

Learning Objective P2: Explain and record petty cash fund transactions.
 Basic Bank Services
Signature
Signature Cards
Cards

Bank
Bank Accounts
Accounts Deposit
Deposit Tickets
Tickets

Bank
Bank
Checks
Checks Statements
Statements

Electronic
Electronic
Funds
Funds Transfer
Transfer
(EFT)
(EFT)

© McGraw-Hill Education 6-37

Learning Objective P2: Explain and record petty cash fund transactions.
 Deposit Ticket
1. Used to deposit money in the bank.
2. Lists cash and checks along with the amounts.
3. Serves as proof of deposit.

Exhibit
6.4

© McGraw-Hill Education 8-38

Learning Objective P2: Explain and record petty cash fund transactions.
 Check
1. Used to withdraw money from the bank.
2. Includes maker, signor of check; payee; and payer.

Exhibit
6.5

© McGraw-Hill Education 8-39

Learning Objective P2: Explain and record petty cash fund transactions.
 Bank Statement Exhibit
6.6

Usually once a
month, the bank
sends each
depositor a
bank statement
showing the
activity in the
account.

© McGraw-Hill Education 8-40

Learning Objective P2: Explain and record petty cash fund transactions.
 Learning Objective P3

Prepare a bank reconciliation.

© McGraw-Hill Education 6-41

 Bank Reconciliation
A bank reconciliation is prepared periodically to explain
the difference between cash reported on the bank
statement and the cash balance on company’s books.

© McGraw-Hill Education 6-42

Learning Objective P3: Prepare a bank reconciliation.
 Purpose of Bank Reconciliation
The balance of a checking account reported on the bank statement
rarely equals the balance in the depositor’s accounting records.

Cash Balance per Bank Cash Balance per Book

+ Deposits in Transit + Collections & Interest

- Outstanding Checks - Bank fees and NSF Checks

+/- Bank Errors +/- Book Errors

Adjusted Cash Balance = Adjusted Cash Balance

Adjusting entries are recorded for the reconciling items on the book
side of the reconciliation.

© McGraw-Hill Education 6-43

Learning Objective P3: Prepare a bank reconciliation.
 Bank Reconciliation Demonstration:
Steps 1-4 Exhibit
6.7

© McGraw-Hill Education 8-44

Learning Objective P3: Prepare a bank reconciliation.
 Bank Reconciliation Demonstration:
Steps 5-8 Exhibit
6.7

© McGraw-Hill Education 6-45

Learning Objective P3: Prepare a bank reconciliation.
 Entries from a Bank Reconciliation
Only items reconciling the book balance require
adjustment.

© McGraw-Hill Education 6-46

Learning Objective P3: Prepare a bank reconciliation.
 Learning Objective A1

Compute the days’ sales

uncollected ratio and use it to
assess liquidity.

© McGraw-Hill Education 6-47

 Days’ Sales Uncollected
Indicates
Indicates how
how much
much time
time is
is likely
likely to
to pass
pass before
before
we
we receive
receive cash
cash receipts
receipts from
from credit
credit sales.
sales.

Days’ Exhibit
Accounts receivable 6.8
sales = × 365
Net sales
uncollected

Exhibit
6.9

© McGraw-Hill Education 8-48

Learning Objective A1: Compute the days’ sales uncollected ratio and use it to assess liquidity.
 Learning Objective P4
Appendix 6A
Describe use of documentation
and verification to control cash
payments.

© McGraw-Hill Education 6-49

 Documentation and Verification
Purchase Requisition

Purchase Order

Invoice

Receiving Report

Learning Objective P4: Describe use of documentation and verification to control cash payments.
© McGraw-Hill Education 6-50
 Invoice Approval
• Accounting department will record
purchase and approve payment after
all documents are in order.
• Information across all documents are
verified.
• Invoice approval also called check
authorization.
• Checklist of steps necessary for
approving invoice and payment.
© McGraw-Hill Education 6-51
Learning Objective P4: Describe use of documentation and verification to control cash payments.
 Voucher
• Voucher is complete after invoice has
been checked and approved.
• Used to authorize recording
obligation.
• Certain information is required on the
inside of a voucher.
• Certain information is also required
on the outside of a voucher.

© McGraw-Hill Education 6-52

Learning Objective P4: Describe use of documentation and verification to control cash payments.
End of Chapter 6

© McGraw-Hill Education 6-53