Expert answer:Complete the following problem sets in Ch. 7 and A
Answer & Explanation:Complete the following problem sets in Ch. 7 and Appendix E ofFinancial Accounting:PE-2E7-5E7-6I have attached the chapters for this template. I have also attached the template that you will use to complete this assignment.CHAPTER 7.docxAPPENDIX E.docxWeek 5 Assignment Template.doc
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CHAPTER 7: FRAUD, INTERNAL CONTROL, AND
CASH
© James Pauls/iStockphoto
The Navigator
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Scan Learning Objectives
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Read Text and Answer
p. 346
Work Using the Decision Toolkit
Review Summary of Learning Objectives
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Work Comprehensive
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Answer Self-Test Questions
Complete Assignments
Go to WileyPLUS for practice and tutorials
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p. 370
Read A Look at IFRS p. 393
LEARNING OBJECTIVES
p. 349
p. 358
p. 364
After studying this chapter, you should be able to:
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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.
Feature Story: MINDING THE
MONEY IN MOOSE JAW
If you’re ever looking for a cappuccino in Moose Jaw, Saskatchewan, stop by Stephanie’s
Gourmet Coffee and More, located on Main Street. Staff there serve, on average, 650 cups of
coffee a day, including both regular and specialty coffees, not to mention soups, Italian
sandwiches, and a wide assortment of gourmet cheesecakes.
“We’ve got high school students who come here, and students from the community college,”
says owner/manager Stephanie Mintenko, who has run the place since opening it in 1995. “We
have customers who are retired, and others who are working people and have only 30 minutes
for lunch. We have to be pretty quick.”
That means that the cashiers have to be efficient. Like most businesses where purchases are lowcost and high-volume, cash control has to be simple.
“We have an electronic cash register, but it’s not the fancy new kind where you just punch in the
item,” explains Ms. Mintenko. “You have to punch in the prices.” The machine does keep track
of sales in several categories, however. Cashiers punch a button to indicate whether each item is
a beverage, a meal, or other type of item. An internal tape in the machine keeps a record of all
transactions; the customer receives a receipt only upon request.
There is only one cash register. “Up to three of us might operate it on any given shift, including
myself,” says Ms. Mintenko.
She and her staff do two “cashouts” each day—one with the shift change at 5:00 p.m. and one
when the shop closes at 10:00 p.m. At each cashout, they count the cash in the register drawer.
That amount, minus the cash change carried forward (the float), should match the shift total on
the register tape. If there’s a discrepancy, they do another count. Then, if necessary, “we go
through the whole tape to find the mistake,” she explains. “It usually turns out to be someone
who punched in $18 instead of $1.80, or something like that.”
Ms. Mintenko sends all the cash tapes and float totals to a bookkeeper, who double-checks
everything and provides regular reports. “We try to keep the accounting simple, so we can
concentrate on making great coffee and food.”
INSIDE CHAPTER 7…
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And the Controls Are … (p. 338)
SOX Boosts the Role of Human Resources (p. 345)
How Employees Steal (p. 351)
Madoff’s Ponzi Scheme (p. 358)
PREVIEW OF CHAPTER 7
As the story about recording cash sales at Stephanie’s Gourmet Coffee and More indicates,
control of cash is important to ensure that fraud does not occur. Companies also need controls to
safeguard other types of assets. For example, Stephanie’s undoubtedly has controls to prevent the
theft of food and supplies, and controls to prevent the theft of tableware and dishes from its
kitchen.
In this chapter, we explain the essential features of an internal control system and how it prevents
fraud. We also describe how those controls apply to a specific asset—cash. The applications
include some controls with which you may be already familiar, such as the use of a bank.
The content and organization of Chapter 7 are as follows.
Fraud and Internal Control
The Feature Story describes many of the internal control procedures used by Stephanie’s
Gourmet Coffee and More. These procedures are necessary to discourage employees from
fraudulent activities.
LEARNING OBJECTIVE 1
Define fraud and internal control.
FRAUD
A fraud is a dishonest act by an employee that results in personal benefit to the employee at a
cost to the employer. Examples of fraud reported in the financial press include:
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• A bookkeeper in a small company diverted $750,000 of bill payments to a personal bank
account over a three-year period.
• A shipping clerk with 28 years of service shipped $125,000 of merchandise to himself.
• A computer operator embezzled $21 million from Wells Fargo Bank over a two-year period.
• A church treasurer “borrowed” $150,000 of church funds to finance a friend’s business
dealings.
Why does fraud occur? The three main factors that contribute to fraudulent activity are depicted
by the fraud triangle in Illustration 7-1.
The most important element of the fraud triangle is opportunity. For an employee to commit
fraud, the workplace environment must provide opportunities that an employee can exploit.
Opportunities occur when the workplace lacks sufficient controls to deter and detect fraud. For
example, inadequate monitoring of employee actions can create opportunities for theft and can
embolden employees because they believe they will not be caught.
Illustration 7-1: Fraud triangle
A second factor that contributes to fraud is financial pressure. Employees sometimes commit
fraud because of personal financial problems caused by too much debt. Or they might commit
fraud because they want to lead a lifestyle that they cannot afford on their current salary.
The third factor that contributes to fraud is rationalization. In order to justify their fraud,
employees rationalize their dishonest actions. For example, employees sometimes justify fraud
because they believe they are underpaid while the employer is making lots of money. These
employees feel justified in stealing because they believe they deserve to be paid more.
THE SARBANES-OXLEY ACT
What can be done to prevent or to detect fraud? After numerous corporate scandals came to light
in the early 2000s, Congress addressed this issue by passing the Sarbanes-Oxley Act (SOX).
Under SOX, all publicly traded U.S. corporations are required to maintain an adequate system of
internal control. Corporate executives and boards of directors must ensure that these controls are
reliable and effective. In addition, independent outside auditors must attest to the adequacy of the
internal control system. Companies that fail to comply are subject to fines, and company officers
can be imprisoned. SOX also created the Public Company Accounting Oversight Board
(PCAOB) to establish auditing standards and regulate auditor activity.
One poll found that 60% of investors believe that SOX helps safeguard their stock investments.
Many say they would be unlikely to invest in a company that fails to follow SOX requirements.
Although some corporate executives have criticized the time and expense involved in following
the SOX requirements, SOX appears to be working well. For example, the chief accounting
officer of Eli Lily noted that SOX triggered a comprehensive review of how the company
documents controls. This review uncovered redundancies and pointed out controls that needed to
be added. In short, it added up to time and money well spent. And the finance chief at General
Electric noted, “We have seen value in SOX. It helps build investors’ trust and gives them more
confidence.”1
INTERNAL CONTROL
Internal control consists of all the related methods and measures adopted within an organization
to safeguard assets, enhance the reliability of accounting records, increase efficiency of
operations, and ensure compliance with laws and regulations. Internal control systems have five
primary components as listed below.2
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• A control environment. It is the responsibility of top management to make it clear that the
organization values integrity and that unethical activity will not be tolerated. This component
is often referred to as the “tone at the top.”
• Risk assessment. Companies must identify and analyze the various factors that create risk
for the business and must determine how to manage these risks.
• Control activities. To reduce the occurrence of fraud, management must design policies
and procedures to address the specific risks faced by the company.
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• Information and communication. The internal control system must capture and
communicate all pertinent information both down and up the organization, as well as
communicate information to appropriate external parties.
• Monitoring. Internal control systems must be monitored periodically for their adequacy.
Significant deficiencies need to be reported to top management and/or the board of directors.
PEOPLE, PLANET, AND PROFIT INSIGHT:
And the Controls Are …
Internal controls are important for an effective financial reporting system. The same is true for
sustainability reporting. An effective system of internal controls for sustainability reporting will
help in the following ways: (1) prevent the unauthorized use of data; (2) provide reasonable
assurance that the information is accurate, valid, and complete; and (3) report information that is
consistent with overall sustainability accounting policies. With these types of controls, users will
have the confidence that they can use the sustainability information effectively.
©Karl Dolenc/iStockphoto
Some regulators are calling for even more assurance through audits of this information.
Companies that potentially can cause environmental damage through greenhouse gases are
subject to reporting requirements as well as companies in the mining and extractive industries.
And, as demand for more information in the sustainability area expands, the need for audits of
this information will grow.
Why is sustainability information important to investors? (See page 393.)
PRINCIPLES OF INTERNAL CONTROL ACTIVITIES
LEARNING OBJECTIVE 2
Identify the principles of internal control activities.
Each of the five components of an internal control system is important. Here, we will focus on
one component, the control activities. The reason? These activities are the backbone of the
company’s efforts to address the risks it faces, such as fraud. The specific control activities used
by a company will vary, depending on management’s assessment of the risks faced. This
assessment is heavily influenced by the size and nature of the company.
The six principles of control activities are as follows.
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• Establishment of responsibility
• Segregation of duties
• Documentation procedures
• Physical controls
• Independent internal verification
• Human resource controls
We explain these principles in the following sections. You should recognize that they apply to
most companies and are relevant to both manual and computerized accounting systems.
Establishment of Responsibility
An essential principle of internal control is to assign responsibility to specific
employees. Control is most effective when only one person is responsible for a given task.
To illustrate, assume that the cash on hand at the end of the day in a Safeway supermarket is $10
short of the cash entered in the cash register. If only one person has operated the register, the
shift manager can quickly determine responsibility for the shortage. What happens, though, if
two or more individuals work the register? For example, in the Feature Story, the principle of
establishing responsibility does not appear to be strictly applied by Stephanie’s Gourmet Coffee
and More since three people operate the cash register on any given shift. Many retailers solve
this problem by having registers with multiple drawers. This makes it possible for more than one
person to operate a register but still allows identification of a particular employee with a specific
drawer. Only the signed-in cashier has access to his or her drawer.
Establishing responsibility often requires limiting access only to authorized personnel, and then
identifying those personnel. For example, the automated systems used by many companies have
mechanisms such as identifying passcodes that keep track of who made a journal entry, who
entered a sale, or who went into an inventory storeroom at a particular time. Use of identifying
passcodes enables the company to establish responsibility by identifying the particular employee
who carried out the activity.
ANATOMY OF A FRAUD
Maureen Frugali was a training supervisor for claims processing at Colossal Healthcare. As a
standard part of the claims-processing training program, Maureen created fictitious claims for
use by trainees. These fictitious claims were then sent to the accounts payable department. After
the training claims had been processed, she was to notify Accounts Payable of all fictitious
claims, so that they would not be paid. However, she did not inform Accounts Payable about
every fictitious claim. She created some fictitious claims for entities that she controlled (that is,
she would receive the payment), and she let Accounts Payable pay her.
Total take: $11 million
THE MISSING CONTROL
Establishment of responsibility. The health-care company did not adequately restrict the
responsibility for authorizing and approving claims transactions. The training supervisor should
not have been authorized to create claims in the company’s “live” system.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 61–70.
Segregation of Duties
Segregation of duties is indispensable in an internal control system. There are two common
applications of this principle:
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1. Different individuals should be responsible for related activities.
2. The responsibility for record-keeping for an asset should be separate from the physical
custody of that asset.
The rationale for segregation of duties is this: The work of one employee should, without a
duplication of effort, provide a reliable basis for evaluating the work of another employee.
For example, the personnel that design and program computerized systems should not be
assigned duties related to day-to-day use of the system. Otherwise, they could design the system
to benefit them personally and conceal the fraud through day-to-day use.
SEGREGATION OF RELATED ACTIVITIES.
Making one individual responsible for related activities increases the potential for errors
and irregularities. Instead, companies should, for example, assign related purchasing
activities to different individuals. Related purchasing activities include ordering merchandise,
order approval, receiving goods, authorizing payment, and paying for goods or services. Various
frauds are possible when one person handles related purchasing activities:
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• If a purchasing agent is allowed to order goods without supervisory approval, the likelihood
of the agent receiving kickbacks from suppliers increases.
• If an employee who orders goods also handles receipt of the goods and invoice, as well as
payment authorization, he or she might authorize payment for a fictitious invoice.
These abuses are less likely to occur when companies divide the purchasing tasks.
Similarly, companies should assign related sales activities to different individuals. Related
selling activities include making a sale, shipping (or delivering) the goods to the customer,
billing the customer, and receiving payment. Various frauds are possible when one person
handles related sales activities. For example:
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• If a salesperson can make a sale without obtaining supervisory approval, he or she might
make sales at unauthorized prices to increase sales commissions.
• A shipping clerk who also has access to accounting records could ship goods to himself.
• A billing clerk who handles billing and cash receipts could understate the amount billed for
sales made to friends and relatives.
These abuses are less likely to occur when companies divide the sales tasks: the salespeople
make the sale; the shipping department ships the goods on the basis of the sales order; and the
billing department prepares the sales invoice after comparing the sales order with the report of
goods shipped.
ANATOMY OF A FRAUD
Lawrence Fairbanks, the assistant vice-chancellor of communications at Aesop University, was
allowed to make purchases of under $2,500 for his department without external approval.
Unfortunately, he also sometimes bought items for himself, such as expensive antiques and other
collectibles. How did he do it? He replaced the vendor invoices he received with fake vendor
invoices that he created. The fake invoices had descriptions that were more consistent with
communications department purchases. He submitted these fake invoices to the accounting
department as the basis for their journal entries and to the accounts payable department as the
basis for payment.
Total take: $475,000
THE MISSING CONTROL
Segregation of duties. The university had not properly segregated related purchasing activities.
Lawrence was ordering items, receiving the items, and receiving the invoice. By receiving the
invoice, he had control over the documents that were used to account for the purchase and thus
was able to substitute a fake invoice.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 3-15.
SEGREGATION OF RECORD-KEEPING FROM
PHYSICAL CUSTODY.
The accountant should have neither physical custody of the asset nor access to it. Likewise, the
custodian of the asset should not maintain or have access to the accounting records. The
custodian of the asset is not likely to convert the asset to personal use when one employee
maintains the record of the asset, and a different employee has physical custody of the
asset. The separation of accounting responsibility from the custody of assets is especially
important for cash and inventories because these assets are very vulnerable to fraud.
ANATOMY OF A FRAUD
Angela Bauer was an accounts payable clerk for Aggasiz Construction Company. Angela
prepared and issued checks to vendors and reconciled bank statements. She perpetrated a fraud in
this way: She wrote checks for costs that the company had not actually incurred (e.g., fake
taxes). A supervisor then approved and signed the checks. Before issuing the check, though,
Angela would “white-out” the payee line on the check and change it to personal accounts that
she controlled. She was able to conceal the theft because she also reconciled the bank account.
That is, nobody else ever saw that the checks had been altered.
Total take: $570,000
THE MISSING CONTROL
Segregation of duties. Aggasiz Construction Company did not properly segregate record-keeping
from physical custody. Angela had physical custody of the blank checks, which essentially was
control of the cash. She also had record-keeping responsibility because she prepared the bank
reconciliation.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 100-107.
Documentation Procedures
Documents provide evidence that transactions and events have occurred. At Stephanie’s
Gourmet Coffee and More, the cash register tape is the restaurant’s documentation for the sale
and the amount of cash received. More sophisticated registers, called point-of-sale terminals, do
not rely on tapes. Rather, they are networked with the company’s computing and accounting
records, which results in direct documentation. Similarly, a shipping document indicates that the
goods have been shipped, and a sales invoice indicates that the company has billed the customer
for the goods. By req …
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