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Flashcards in Chapter 7 powerpoint Deck (68):
1

Fraud

A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer

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Fraud triangle

Opportunity

Pressure

Rationalization

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Opportunity

Lack of sufficient controls, inadequate employee monitoring, a belief that they will not be caught

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Pressure

Employee has debt or a desire to lead to a lifestyle they cannot afford

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Rationalization

Justification by the employee as to why they commited fraud

ex. deserve more

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SOX - internal controls

All publicly traded corporations are required to maintian adequate internal control

Requires disclosure of material weakness

 

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Material Weakness

A significant deficiency or combination of significant deficiencies, that results in more than a remote liklihood that a material misstatement of the annual or interim financial statements will not be prevented or detected

*will we catch a deficiency

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Purpose of Internal Control

Safeguard Assets

Ensure Compliance with Laws and Regulations

Increase Financial Statement Reliability

Increase Operational Efficiency

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Primary Components of Internal Control System

Control Environment

Risk Assesment

Control Activities

Information & Communication

Monitoring

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Control Environment

"Tone at the top"

Management's message to the employees that the organization values integrity and will not tolerate unethical activity

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Risk Assesment

Consists in two places:

1. Identification and analysis of potential sources of risk for the company

2. Strategic management of those risks

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Control Activities

Polices and procedures designed and implemented by management to address specific risks identified in the risk assesment phase

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Information and Communication

Internal control system should do two systems:

1. Capture pertinent information for employees at all levels of the company

2. Communicate this information to approriate parties

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Monitoring

Employees and the internal control system should be continually monitored to asses its adequacy and any significant deficiencies should be communicated to management

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6 principles of Control Activities

Establishment of Responsibility

Segregation of duties

Documentation procedures

Physical Controls

Idependent Internal Verification

Human Resource Controls

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Establishment of Responsibility

Assign responsibility to specific employees

Most effective when only one person is responsibile for a given task

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Segregation of Duties

Different individuals are responsibile for related activities

ex. one person orders goods, another approves, another pays

Responsibility for record-keeping of an asset should be seperate from physical control of the asset

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Documentation procedures

Provide evidence that transactions & events have occurred

*prenumbered documents to ensure all accounted for

* Promptly forward source documents for accounting department to ensure timely recording of transaction

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Physical Controls

The safeguarding of assets, enhancement of accuracy and reliability of accounting records

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Independent Internal Verification

Review records and transactions periodically or on a surprise basis

Employee that reviews should be indepndent of personnel responsible for the information *internal auditor*

Discrepancies should be reported to management

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Human Resource Controls

Bonding Employees: Insurance protetion against theft by employees

Employee Rotations/required vacations: Deters employees because not able to permanently conceal theft, fraud, etc.

Background checks

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Limitations of Internal Control

Reasonable Assurance (Not total) - Costs should not exceed Benefits

Human element - employee fatigue or carelessness or Mistakes

- collusion 

Size of the Business: Usually a larger company will have internal auditors

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Collusion

Two or more individuals who work together to get around prescribed controls

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The asset most suceptible to fraudulent activities

CASH

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Nontimely deposit of cash receipts

Physical controls

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Excessive past due accounts receivable

Establishment of responsibility 

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Disregard of advantages offered by vendors for prompt payment of invoice

Establishment of responsibility

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Absence of segregation of duties

Segregation of duties

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Inadequate procedures for applying accounting principles

Documentation procedures

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Lack of qualified management personel

Establishment of responsibility

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Lack of supervision by outside board of directors

Establishment of responsibility

Independent internal verification

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Overall poor record keeping

Documentation procedure

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Checks are not prenumberd

Documentation procedures

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The purchasing agent signs checks

Establishment of responsibility

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Unissued checks are stored in unlocked file cabinet

Physical controls

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Purchasing agent approves and pays for goods purchased

segregation of duties

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After payment, the invoice is filed

Documentation procedures

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The purchasing agent records payments in cash disbursements journal

Segregation of duties

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The treasurer records the checks in cash disbusements journal

segregation of duties

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The treasurer reconciles the bank statement

Independent internal verification

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Debit Memorandum

Bank service Charge

NSF (Not sufficient Funds)

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Credit Memorandum

Collect Notes Receivable

Interest Earned

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Deposits in Transit

Deposits recorded by the depositor that have not been recorded by the bank

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Outstanding Checks

Checks issued and recorded by the company that have not been paid by the bank

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NSF check

A check that is not paid by the bank because of insufficient funds in the customer's bank account

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Adjusted Balance

Same as true cash balance, correct cash balance

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Who performs bank reconciliations?

Employee who is responsible for NON-cash related activities

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Reasons for bank reconciliations

Value as a Control

Time Lags

Errors

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Always start with outstanding items on the _________________ bank reconcilatioin

previous

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Neither record________________________

is 100% complete in all respects, neither bank nor company

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Adjustments to bank balance

+ Deposits in Transit

- Outstanding Checks

+/- bank errors

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Adjustments to the book balance

+ notes collected by banks

- NSF (bounced) checks

- Check Printing or other service charges

+/- Book errors

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Electronic Funds Transfer (EFT)

Disbursement systems that use wire, telephone, or computers to transfer cash from one location to another

Better internal control because  no cash or checks handled by employees

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Cash is:

Recorded in both balance sheet and statement of cash flows

Most liquid asset, so reported first on balance sheet

The balance sheet shows the amount of cash available at a given point in time

The statement of cash flows shows the sources and uses of cash during a period of time

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Cash Equivalents are:

Readily convertible to known amounts of cash

So near maturity that their value is relatively insensitive to interest rate changes

Examples: treasury bills, commercial paper, and money market funds

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Restricted Cash

Cash that is not available for general use

Set aside for special purpose

Reported spereately on balance sheet

IF not to be used within next year, report as noncurrent asset on the balance sheet

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Objective of Managing Cash

Ensure that the company has sufficient cash to meet payments, yet

Minimize the amount of idle cash on hand

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Basic Principles of Cash Management

Increase the Speed of Receivables Collection

Keep Inventory Levels Low

monitor Payment of Liabilities

Plan Timing of Major Expenditures

Invest Idle Cash

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Increase Speed of Receivables collection

Offer 2/10 discount instead of only N/30

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Keep inventory levels low

Remember just-in-time inventory

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Monitor payment of liabilities

Pay at the end of allowed period (without being late)

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Invest idle cash

Liquid investment: Someone always willing to buy or sell the investment

Risk-free investment: No concern that the party will default on its promise to pay the principal and interest

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Cash Budget

Cash is vital

Planning the company's cash needs is a key business activity

Shows anticipated cash flows, usually for a one to two year period

Contributes to more effective cash management

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Where we classify restricted cash impacts:

Liquidity analysis:

Working capital

Current ratio

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Prpoer completion of the bank reconciliation affects

liquidity analysis

solvency analysis

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Internal Controls effect

Affects: Auditor's report, thus shares prices

Profitability and Productivity

Market as a whole - if a graud were to occur due to a lack of internal controls it could cause a ripple effect in the stock market

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