I've attached the assignment as a word file, thanks!

JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 304 7 Fraud, Internal Control, and Cash Chapter STUDY OBJECTIVES After studying this chapter, you should be able to: 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 Describe the operation of a petty cash fund. 6 Indicate the control features of a bank account. 7 Prepare a bank reconciliation. 8 Explain the reporting of cash. The Navigator The Navigator Scan Study Objectives Read Feature Story Read Preview Read text and answer p. 316 p. 320 Work Comprehensive Do it! p. 324 Do it! p. 331 p. 334 Review Summary of Study Objectives Answer Self-Study Questions Complete Assignments 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, 304 JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 305 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 low-cost and highvolume, 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 a charge for the cafe's Internet connections. 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 dayone 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.\" The Navigator Inside Chapter 7... How Do Employees Steal? (p. 307) SOX Boosts the Role of Human Resources (p. 316) All About You: Protecting Yourself from Identity Theft (p. 333) 305 JWCL165_c07_304-355.qxd 8/4/09 12:00 PM Page 306 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 assetcash. 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, Internal Control, and Cash Fraud and Internal Control Fraud Sarbanes-Oxley Act Internal control Principles of internal control activities Limitations Cash Receipts Controls Over-the-counter receipts Mail receipts Cash Disbursements Controls Voucher system controls Petty cash fund controls Control Features: Use of a Bank Making deposits Writing checks Bank statements Reconciling the bank account Electronic funds transfer (EFT) system Reporting Cash Cash equivalents Restricted cash Compensating balances The Navigator FRAUD AND INTERNAL CONTROL STUDY OBJECTIVE 1 Define 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. 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: 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 306 JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 307 Fraud and Internal Control Illustration 7-1 Fraud triangle Opportunity Rationalization Financial Pressure that an employee can take advantage of. 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. 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. Employees feel justified in stealing because they believe they deserve to be paid more. E T H I C S I N S I G H T How Do Employees Steal? A recent study by the Association of Certified Fraud Examiners found that two-thirds of all employee thefts involved a fraudulent disbursement by an employee. The most common form (28.3% of cases) was fraudulent billing schemes. In these, the employee causes the company to issue a payment to the employee by submitting a bill for nonexistent goods or services, purchases of personal goods by the employee, or inflated invoices. The following graph shows various types of fraudulent disbursements and the median loss from each. Category (Median Loss) Breakdown of Fraudulent Disbursements Billing ($130,000) 28.3% Expense reimbursement ($25,000) 19.5% Check tampering ($120,000) 17.1% Payroll ($50,000) Wire transfers ($500,000) 0% 13.2% 6.5% 10% 20% 30% 40% 50% 90% Source: 2006 Report to the Nation on Occupational Fraud and Abuse, Association of Certified Fraud Examiners, www.acfe.com/documents/2006_rttn.pdf, p. 14. How can companies reduce the likelihood of fraudulent disbursements? 307 JWCL165_c07_304-355.qxd 308 7/31/09 2:05 PM Page 308 Chapter 7 Fraud, Internal Control, and Cash 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 of 2002 (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 its assets, enhance the reliability of its accounting records, increase efficiency of operations, and ensure compliance with laws and regulations. Internal control systems have five primary components as listed below.2 1 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. 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. \"Corporate Regulation Must Be WorkingThere's a Backlash,\" Wall Street Journal, June 16, 2004, p. C1; and Judith Burns, \"Is Sarbanes-Oxley Working?\" Wall Street Journal, June 21, 2004, pp. R8-R9. 2 The Committee of Sponsoring Organizations of the Treadway Commission, \"Internal Control Integrated Framework,\" www.coso.org/publications/executive_summary_integrated_framework.htm (accessed March 2008). JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 309 Fraud and Internal Control 309 Principles of Internal Control Activities Each of the five components of an internal control system is important. STUDY OBJECTIVE 2 Here, we will focus on one component, the control activities. The Identify the principles of internal reason? These activities are the backbone of the company's efforts to control activities. 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. 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. In the explanations that follow, we have added \"Anatomy of a Fraud\" stories that describe some recent real-world frauds. At the end of each story, we discuss the missing control activity that, had it been in place, is likely to have prevented or uncovered the fraud.3 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 rung up on the cash register. If only one person has operated the register, the shift manager can quickly determine responsibility for the shortage. If two or more individuals have worked the register, it may be impossible to determine who is responsible for the error. In the Feature Story, the principle of establishing responsibility does not appear to be strictly applied by Stephanie's, since three people operate the cash register on any given shift. 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 rang up a sale, or who entered 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. 3 The \"Anatomy of a Fraud\" stories on pages 310-315 are adapted from Fraud Casebook: Lessons from the Bad Side of Business, edited by Joseph T. Wells (Hoboken, NJ: John Wiley & Sons, Inc., 2007). Used by permission. The names of some of the people and organizations in the stories are fictitious, but the facts in the stories are true. It's your shift now. I'm turning in my cash drawer and heading home. Transfer of cash drawers JWCL165_c07_304-355.qxd 310 7/31/09 2:05 PM Page 310 Chapter 7 Fraud, Internal Control, and Cash A N AT O M Y O F A F R A U D 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 Accounts Payable. After the training claims had been processed, she was to notify the accounts payable department 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 healthcare company did not adequately restrict the responsibility for authoring 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: 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. For example, companies should 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. For example: If a purchasing agent can order goods without obtaining supervisory approval, the likelihood of the purchasing 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 transactions. For example: 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 receipt could understate the amount billed for sales made to friends and relatives. JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 311 Fraud and Internal Control 311 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. A N AT O M Y O F A F R A U D Lawrence Fairbanks, the assistant vice-chancellor of communications at Aesop University was allowed to make purchases for his department of under $2,500 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 the communications department's operations. He submitted these fake invoices to the accounting department as the basis for their journal entries and to Accounts Payable 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 fraudulent activities. A N AT O M Y O F A F R A U D Angela Bauer was an accounts payable clerk for Aggasiz Construction Company. She 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, she 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 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. Accounting Employee A Maintains cash balances per books Segregation of Duties (Accountability for assets) Assistant Cashier B Maintains custody of cash on hand JWCL165_c07_304-355.qxd 312 7/31/09 No. 0126 No. 0125 No. 0124 No. 0123 Chelsea Video 125 Main Street Chelsea, IL 60915 S O L D Firm Name Highpoint Electronic Attention of Susan Malone, Sales Representative T O Address 27 Circle Drive Harding MI City Catalogue No. A2547Z45 Page 312 Chapter 7 Fraud, Internal Control, and Cash No. 0127 Date 5/8/99 2:05 PM 48281 State Salesperson Malone Invoice No. 731 Description Production Model Circuits (Inoperative) Zip Invoice Date 5/4/99 Quantity 1 Approved Reid Price 300 Amount $300 Prenumbered invoices 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. 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 requiring signatures (or initials) on the documents, the company can identify the individual(s) responsible for the transaction or event. Companies should document transactions when the transaction occurs. Companies should establish procedures for documents. First, whenever possible, companies should use prenumbered documents, and all documents should be accounted for. Prenumbering helps to prevent a transaction from being recorded more than once, or conversely, from not being recorded at all. Second, the control system should require that employees promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records. A N AT O M Y O F A F R A U D To support their reimbursement requests for travel costs incurred, employees at Mod Fashions Corporation's design center were required to submit receipts. The receipts could include the detailed bill provided for a meal, or the credit card receipt provided when the credit card payment is made, or a copy of the employee's monthly credit card bill that listed the item. A number of the designers who frequently traveled together came up with a fraud scheme: They submitted claims for the same expenses. For example, if they had a meal together that cost $200, one person submitted the detailed meal bill, another submitted the credit card receipt, and a third submitted a monthly credit card bill showing the meal as a line item. Thus, all three received a $200 reimbursement. Total take: $75,000 THE MISSING CONTROL Documentation procedures. Mod Fashions should require the original, detailed receipt. It should not accept photocopies, and it should not accept credit card statements. In addition, documentation procedures could be further improved by requiring the use of a corporate credit card (rather than a personal credit card) for all business expenses. Source: Adapted from Wells, Fraud Casebook (2007), pp. 79-90. PHYSICAL CONTROLS Use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. Illustration 7-2 (page 313) shows examples of these controls. A N AT O M Y O F A F R A U D At Centerstone Health, a large insurance company, the mailroom each day received insurance applications from prospective customers. Mailroom employees scanned the applications into electronic documents before the applications were processed. Once the applications are scanned they can be accessed online by authorized employees. Insurance agents at Centerstone Health earn commissions based upon successful applications. The sales agent's name is listed on the application. However, roughly 15% JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 313 Fraud and Internal Control Physical Controls Safes, vaults, and safety deposit boxes for cash and business papers Alarms to prevent break-ins Locked warehouses and storage cabinets for inventories and records Computer facilities with pass key access or fingerprint or eyeball scans Television monitors and garment sensors to deter theft Time clocks for recording time worked Illustration 7-2 Physical controls of the applications are from customers who did not work with a sales agent. Two friendsAlex, an employee in record-keeping, and Parviz, a sales agentthought up a way to perpetrate a fraud. Alex identified scanned applications that did not list a sales agent. After business hours, he entered the mailroom and found the hardcopy applications that did not show a sales agent. He wrote in Parviz's name as the sales agent and then rescanned the application for processing. Parviz received the commission, which the friends then split. Total take: $240,000 THE MISSING CONTROL Physical controls. Centerstone Health lacked two basic physical controls that could have prevented this fraud. First, the mailroom should have been locked during nonbusiness hours, and access during business hours should have been tightly controlled. Second, the scanned applications supposedly could be accessed only by authorized employees using their passwords. However, the password for each employee was the same as the employee's user ID. Since employee user-ID numbers were available to all other employees, all employees knew all other employees' passwords. Unauthorized employees could access the scanned applications. Thus, Alex could enter the system pretending to be any other employee. Source: Adapted from Wells, Fraud Casebook (2007), pp. 316-326. INDEPENDENT INTERNAL VERIFICATION Most internal control systems provide for independent internal verification. This principle involves the review of data prepared by employees. To obtain maximum benefit from independent internal verification: 1. Companies should verify records periodically or on a surprise basis. 2. An employee who is independent of the personnel responsible for the information should make the verification. 313 JWCL165_c07_304-355.qxd 314 7/31/09 2:05 PM Page 314 Chapter 7 Fraud, Internal Control, and Cash 3. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action. Independent internal verification is especially useful in comparing recorded accountability with existing assets.The reconciliation of the cash register tape with the cash in the register at Stephanie's Gourmet Coffee and More is an example of this internal control principle. Another common example is the reconciliation of a company's cash balance per books with the cash balance per bank and the verification of the perpetual inventory records through a count of physical inventory. Illustration 7-3 shows the relationship between this principle and the segregation of duties principle. Illustration 7-3 Comparison of segregation of duties principle with independent internal verification principle Segregation of Duties Accounting Employee Maintains cash balances per books Assistant Cashier Maintains custody of cash on hand Independent Internal Verication Assistant Treasurer Makes monthly comparisons; reports any unreconcilable differences to treasurer A N AT O M Y O F A F R A U D Bobbi Jean Donnelly, the office manager for Mod Fashions Corporations design center, was responsible for preparing the design center budget and reviewing expense reports submitted by design center employees. Her desire to upgrade her wardrobe got the better of her, and she enacted a fraud that involved filing expense-reimbursement requests for her own personal clothing purchases. She was able to conceal the fraud because she was responsible for reviewing all expense reports, including her own. In addition, she sometimes was given ultimate responsibility for signing off on the expense reports when her boss was \"too busy.\" Also, because she controlled the budget, when she submitted her expenses, she coded them to budget items that she knew were running under budget, so that they would not catch anyone's attention. Total take: $275,000 THE MISSING CONTROL Independent internal verification. Bobbi Jean's boss should have verified her expense reports. When asked what he thought her expenses for a year were, the boss said about $10,000. At $115,000 per year, her actual expenses were more than ten times what would have been expected. However, because he was \"too busy\" to verify her expense reports or to review the budget, he never noticed. Source: Adapted from Wells, Fraud Casebook (2007), pp. 79-90. JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 315 Fraud and Internal Control 315 Large companies often assign independent internal verification to internal auditors. Internal auditors are company employees who continuously evaluate the effectiveness of the company's internal control systems. They review the activities of departments and individuals to determine whether prescribed internal controls are being followed. They also recommend improvements when needed. In fact, most fraud is discovered by the company through internal mechanisms such as existing internal controls and internal audits. For example, the alleged fraud at WorldCom, involving billions of dollars, was uncovered by an internal auditor. HUMAN RESOURCE CONTROLS Human resource control activities include the following. 1. Bond employees who handle cash. Bonding involves obtaining insurance protection against theft by employees. It contributes to the safeguarding of cash in two ways: First, the insurance company carefully screens all individuals before adding them to the policy and may reject risky applicants. Second, bonded employees know that the insurance company will vigorously prosecute all offenders. 2. Rotate employees' duties and require employees to take vacations. These measures deter employees from attempting thefts since they will not be able to permanently conceal their improper actions. Many banks, for example, have discovered employee thefts when the employee was on vacation or assigned to a new position. 3. Conduct thorough background checks. Many believe that the most important and inexpensive measure any business can take to reduce employee theft and fraud is for the human resources department to conduct thorough background checks. Two tips: (1) Check to see whether job applicants actually graduated from the schools they list. (2) Never use the telephone numbers for previous employers given on the reference sheet; always look them up yourself. A N AT O M Y O F A F R A U D Ellen Lowry was the desk manager and Josephine Rodriquez was the head of housekeeping at the Excelsior Inn, a luxury hotel. The two best friends were so dedicated to their jobs that they never took vacations, and they frequently filled in for other employees. In fact, Ms. Rodriquez, whose job as head of housekeeping did not include cleaning rooms, often cleaned rooms herself, \"just to help the staff keep up.\" These two \"dedicated\" employees, working as a team, found a way to earn a little more cash. Ellen, the desk manager, provided significant discounts to guests who paid with cash. She kept the cash and did not register the guest in the hotel's computerized system. Instead, she took the room out of circulation \"due to routine maintenance.\" Because the room did not show up as being used, it did not receive a normal housekeeping assignment. Instead, Josephine, the head of housekeeping, cleaned the rooms during the guests' stay. Total take: $95,000 THE MISSING CONTROL Human resource controls. Ellen, the desk manager, had been fired by a previous employer after being accused of fraud. If the Excelsior Inn had conducted a thorough background check, it would not have hired her. The hotel fraud was detected when Ellen missed work for a few days due to illness. A system of mandatory vacations and rotating days off would have increased the chances of detecting the fraud before it became so large. Source: Adapted from Wells, Fraud Casebook (2007), pp. 145-155. If I take a vacation, they will know that I've been stealing. JWCL165_c07_304-355.qxd 316 8/4/09 12:00 PM Page 316 Chapter 7 Fraud, Internal Control, and Cash ACCOUNTING ACROSS THE ORGANIZATION SOX Boosts the Role of Human Resources Under SOX, a company needs to keep track of employees' degrees and certifications to ensure that employees continue to meet the specified requirements of a job. Also, to ensure proper employee supervision and proper separation of duties, companies must develop and monitor an organizational chart. When one corporation went through this exercise it found that out of 17,000 employees, there were 400 people who did not report to anyone, and they had 35 people who reported to each other. In addition, if an employee complains of an unfair firing and mentions financial issues at the company, HR must refer the case to the company audit committee and possibly to its legal counsel. Why would unsupervised employees or employees who report to each other represent potential internal control threats? Limitations of Internal Control HELPFUL HINT Controls may vary with the risk level of the activity. For example, management may consider cash to be high risk and maintaining inventories in the stockroom as low risk. Thus management would have stricter controls for cash. Companies generally design their systems of internal control to provide reasonable assurance of proper safeguarding of assets and reliability of the accounting records. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit. To illustrate, consider shoplifting losses in retail stores. Stores could eliminate such losses by having a security guard stop and search customers as they leave the store. But store managers have concluded that the negative effects of such a procedure cannot be justified. Instead, stores have attempted to control shoplifting losses by less costly procedures: They post signs saying, \"We reserve the right to inspect all packages\" and \"All shoplifters will be prosecuted.\" They use hidden TV cameras and store detectives to monitor customer activity, and they install sensor equipment at exits. The human element is an important factor in every system of internal control. A good system can become ineffective as a result of employee fatigue, carelessness, or indifference. For example, a receiving clerk may not bother to count goods received and may just \"fudge\" the counts. Occasionally, two or more individuals may work together to get around prescribed controls. Such collusion can significantly reduce the effectiveness of a system, eliminating the protection offered by segregation of duties. No system of internal control is perfect. The size of the business also may impose limitations on internal control. A small company, for example, may find it difficult to segregate duties or to provide for independent internal verification. before you go on... Control Activities Do it! Identify which control activity is violated in each of the following situations, and explain how the situation creates an opportunity for a fraud. 1. The person with primary responsibility for reconciling the bank account is also the company's accountant and makes all bank deposits. 2. Wellstone Company's treasurer received an award for distinguished service because he had not taken a vacation in 30 years. 3. In order to save money spent on order slips, and to reduce time spent keeping track of order slips, a local bar/restaurant does not buy prenumbered order slips. JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 317 Cash Receipts Controls Solution 1. Violates the control activity of segregation of duties. Record-keeping should be separate from physical custody. As a consequence, the employee could embezzle cash and make journal entries to hide the theft. 2. Violates the control activity of human resource controls. Key employees must take vacations. Otherwise, the treasurer, who manages the company's cash, might embezzle cash and use his position to conceal the theft. 317 Action Plan Familiarize yourself with each of the control activities summarized on page 309. Understand the nature of the frauds that each control activity is intended to address. 3. Violates the control activity of documentation procedures. If pre-numbered documents are not used, then it is virtually impossible to account for the documents. As a consequence, an employee could write up a dinner sale, receive the cash from the customer, and then throw away the order slip and keep the cash. Related exercise material: BE7-1, BE7-2, BE7-3, BE7-4, E7-1, and Do it! 7-1. The Navigator CASH RECEIPTS CONTROLS Cash is the one asset that is readily convertible into any other type of STUDY OBJECTIVE 3 asset. It also is easily concealed and transported, and is highly desired. Explain the applications of internal Because of these characteristics, cash is the asset most susceptible to control principles to cash receipts. fraudulent activities. In addition, because of the large volume of cash transactions, numerous errors may occur in executing and recording them. To safeguard cash and to ensure the accuracy of the accounting records for cash, effective internal control over cash is critical. Illustration 7-4 (page 318) shows how the internal control principles explained earlier apply to cash receipts transactions. As you might expect, companies vary considerably in how they apply these principles. To illustrate internal control over cash receipts, we will examine control activities for a retail store with both overthe-counter and mail receipts. Over-the-Counter Receipts In retail businesses, control of over-the-counter receipts centers on cash registers that are visible to customers. A cash sale is rung up on a cash register, with the amount clearly visible to the customer. This activity prevents the cashier from ringing up a lower amount and pocketing the difference. The customer receives an itemized cash register receipt slip and is expected to count the change received.The cash register's tape is locked in the register until a supervisor removes it. This tape accumulates the daily transactions and totals. At the end of the clerk's shift, the clerk counts the cash and sends the cash and the count to the cashier. The cashier counts the cash, prepares a deposit slip, and deposits the cash at the bank. The cashier also sends a duplicate of the deposit slip to the accounting department to indicate cash received. The supervisor removes the cash register tape and sends it to the accounting department as the basis for a journal entry to record the cash received. Illustration 7-5 (page 319) summarizes this process. This system for handling cash receipts uses an important internal control principlesegregation of record-keeping from physical custody. The supervisor has access to the cash register tape, but not to the cash. The clerk and the cashier have access to the cash, but not to the register tape. In addition, the cash register tape provides documentation and enables independent internal verification. Use of these three principles of internal control (segregation of record-keeping from JWCL165_c07_304-355.qxd 318 7/31/09 2:05 PM Page 318 Chapter 7 Fraud, Internal Control, and Cash Cash Receipts Controls Establishment of Responsibility Only designated personnel are authorized to handle cash receipts (cashiers) Physical Controls Store cash in safes and bank vaults; limit access to storage areas; use cash registers Segregation of Duties Different individuals receive cash, record cash receipts, and hold the cash Independent Internal Verification Supervisors count cash receipts daily; treasurer compares total receipts to bank deposits daily No. 0127 No. 0126 No. 0125 Documentation Procedures Use remittance advice (mail receipts), cash register tapes, and deposit slips Illustration 7-4 Application of internal control principles to cash receipts A L SE 6,946.10 10.10 6,956.20 Cash Flows 6,946.10 No. 0124 No. 0123 Beyer Video 125 Main Street Chelsea, IL 60915 S O L D Firm Name Sellers Attention of Susan Malone, Sales Representative T O Address 27 Circle Drive Harding MI City Date 5/8/99 Catalogue No. A2547Z45 48281 State Salesperson Malone Zip Invoice No. 731 Invoice Date 5/4/99 Description Production Model Circuits (Inoperative) Quantity 1 z Price 300 Reid Amount $300 Human Resource Controls Bond personnel who handle cash; require employees to take vacations; conduct background checks physical custody, documentation, and independent internal verification) provides an effective system of internal control. Any attempt at fraudulent activity should be detected unless there is collusion among the employees. In some instances, the amount deposited at the bank will not agree with the cash recorded in the accounting records based on the cash register tape. These differences often result because the clerk hands incorrect change back to the retail customer. In this case, the difference between the actual cash and the amount reported on the cash register tape is reported in a Cash Over and Short account. For example, suppose that the cash register tape indicated sales of $6,956.20 but the amount of cash was only $6,946.10. A cash shortfall of $10.10 exists. To account for this cash shortfall and related cash, the company makes the following entry. Cash Cash Over and Short Sales Revenue (To record cash shortfall) 6,946.10 10.10 6,956.20 Cash Over and Short is an income statement item. It is reported as miscellaneous expense when there is a cash shortfall, and as miscellaneous revenue when JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 319 Cash Receipts Controls Clerk Rings up sales, counts cash Supervisor Removes locked cash register tape Sends cash Sends cash register tape Accounting Department Records journal entry Cashier Counts cash, prepares deposit slips Deposit slip Sends deposit slip Sends cash and deposit slip Deposit slip Bank there is an overage. Clearly, the amount should be small. Any material amounts in this account should be investigated. Mail Receipts All mail receipts should be opened in the presence of at least two mail clerks.These receipts are generally in the form of checks. A mail clerk should endorse each check \"For Deposit Only.\" This restrictive endorsement reduces the likelihood that someone could divert the check to personal use. Banks will not give an individual cash when presented with a check that has this type of endorsement. The mail-receipt clerks prepare, in triplicate, a list of the checks received each day. This list shows the name of the check issuer, the purpose of the payment, and the amount of the check. Each mail clerk signs the list to establish responsibility for the data. The original copy of the list, along with the checks, is then sent to the cashier's department. A copy of the list is sent to the accounting department for recording in the accounting records. The clerks also keep a copy. 319 Illustration 7-5 Control of over-the-counter receipts HELPFUL HINT Flowcharts such as this one enhance the understanding of the flow of documents, the processing steps, and the internal control procedures. JWCL165_c07_304-355.qxd 320 8/4/09 12:00 PM Page 320 Chapter 7 Fraud, Internal Control, and Cash This process provides excellent internal control for the company. By employing two clerks, the chance of fraud is reduced; each clerk knows he or she is being observed by the other clerk(s). To engage in fraud, they would have to collude. The customers who submit payments also provide control, because they will contact the company with a complaint if they are not properly credited for payment. Because the cashier has access to cash but not the records, and the accounting department has access to records but not cash, neither can engage in undetected fraud. before you go on... Control Over Cash Receipts Action Plan Differentiate among the internal control principles of (1) establishing responsibility, (2) using physical controls, and (3) independent internal verification. Design an effective system of internal control over cash receipts. Do it! L. R. Cortez is concerned about the control over cash receipts in his fastfood restaurant, Big Cheese. The restaurant has two cash registers. At no time do more than two employees take customer orders and ring up sales. Work shifts for employees range from 4 to 8 hours. Cortez asks your help in installing a good system of internal control over cash receipts. Solution Cortez should assign a cash register to each employee at the start of each work shift, with register totals set at zero. Each employee should be instructed to use only the assigned register and to ring up all sales. Each customer should be given a receipt. At the end of the shift, the employee should do a cash count. A separate employee should compare the cash count with the register tape, to be sure they agree. In addition, Cortez should install an automated system that would enable the company to compare orders rung up on the register to orders processed by the kitchen. Related exercise material: BE7-5, E7-2, and Do it! 7-2. The Navigator CASH DISBURSEMENTS CONTROLS Companies disburse cash for a variety of reasons, such as to pay expenses and liabilities or to purchase assets. Generally, internal control over cash Explain the applications of disbursements is more effective when companies pay by check, rather internal control principles to cash than by cash. One exception is for incidental amounts that are paid out of disbursements. petty cash.4 Companies generally issue checks only after following specified control procedures. Illustration 7-6 (page 321) shows how principles of internal control apply to cash disbursements. STUDY OBJECTIVE 4 Voucher System Controls Most medium and large companies use vouchers as part of their internal control over cash disbursements.A voucher system is a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper. The system begins with the authorization to incur a cost or expense. It ends with the issuance of a check for the liability incurred. A voucher is an authorization form prepared for each expenditure. Companies require vouchers for all types of cash disbursements except those from petty cash. 4 We explain the operation of a petty cash fund on pages 322-324. JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 321 Cash Disbursements Controls 321 Cash Disbursements Controls Establishment of Responsibility Only designated personnel are authorized to sign checks (treasurer) and approve vendors Payments Due S M Tu W Th 1 4 5 6 7 8 11 12 13 14 15 18 19 20 21 22 25 26 27 28 29 F 2 9 16 23 30 S 3 10 17 24 ER UR S EA TR Physical Controls Store blank checks in safes, with limited access; print check amounts by machine in indelible ink Payments Due S M Tu W Th F S 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Segregation of Duties Different individuals approve and make payments; check signers do not record disbursements Independent Internal Verification Compare checks to invoices; reconcile bank statement monthly R RE SU EA TR Documentation Procedures Use prenumbered checks and account for them in sequence; each check must have an approved invoice; require employees to use corporate credit cards for reimbursable expenses; stamp invoices "paid" Smith Company No. 408 123 Cherry Lane Anytown, Montana Smith Company 123 PAY to Cherry Lane Anytown, Montana Smith Company 123 PAY to Cherry Lane Anytown, Montana Smith Company 385700991 6489 00032 123 PAY to Cherry Lane No. 407 No. 406 No. 405 Anytown, Montana Smith Company 385700991 6489 00032 123 PAY to Cherry Lane Anytown, Montana PAY6489 00032 385700991 to 6489 00032 385700991 6489 00032 385700991 No. 404 Human Resource Controls Bond personnel who handle cash; require employees to take vacations; conduct background checks The starting point in preparing a voucher is to fill in the appropriate information about the liability on the face of the voucher. The vendor's invoice provides most of the needed information. Then, an employee in accounts payable records the voucher (in a journal called a voucher register) and files it according to the date on which it is to be paid. The company issues and sends a check on that date, and stamps the voucher \"paid.\" The paid voucher is sent to the accounting department for recording (in a journal called the check register). A voucher system involves two journal entries, one to issue the voucher and a second to pay the voucher. The use of a voucher system improves internal control over cash disbursements. First, the authorization process inherent in a voucher system establishes responsibility. Each individual has responsibility to review the underlying documentation to ensure that it is correct. In addition, the voucher system keeps track of the documents that back up each transaction. By keeping these documents in one place, a supervisor can independently verify the authenticity of each transaction. Consider, for example, the case of Aesop University presented on page 311. Aesop did not use a voucher system for transactions under $2,500. As a consequence, there was no independent verification of the documents, which enabled the employee to submit fake invoices to hide his unauthorized purchases. Illustration 7-6 Application of internal control principles to cash disbursements JWCL165_c07_304-355.qxd 322 7/31/09 2:05 PM Page 322 Chapter 7 Fraud, Internal Control, and Cash Petty Cash Fund Controls As you learned earlier in the chapter, better internal control over cash disbursements is possible when companies make payments by check. Describe the operation of a petty However, using checks to pay small amounts is both impractical and a cash fund. nuisance. For instance, a company would not want to write checks to pay for postage due, working lunches, or taxi fares. A common way of handling such payments, while maintaining satisfactory control, is to use a petty cash fund to pay relatively small amounts. The operation of a petty cash fund, often called an imprest system, involves three steps: (1) establishing the fund, (2) making payments from the fund, and (3) replenishing the fund.5 STUDY OBJECTIVE 5 A L ESTABLISHING THE FUND In establishing a petty cash fund, a company appoints a petty cash custodian who will be responsible for the fund. Next it determines the size of the fund. Ordinarily, a company expects the amount in the fund to cover anticipated disbursements for a three- to four-week period. To establish the fund, a company issues a check payable to the petty cash custodian for the stipulated amount. For example, if Laird Company decides to establish a $100 fund on March 1, the journal entry is: SE 100 100 Mar. 1 Cash Flows no effect Petty Cash Cash (To establish a petty cash fund) 100 100 The fund custodian cashes the check and places the proceeds in a locked petty cash box or drawer. Most petty cash funds are established on a fixed-amount basis. The company will make no additional entries to the Petty Cash account unless management changes the stipulated amount of the fund. For example, if Laird Company decides on July 1 to increase the size of the fund to $250, it would debit Petty Cash $150 and credit Cash $150. MAKING PAYMENTS FROM THE FUND The petty cash fund custodian has the authority to make payments from the fund that conform to prescribed management policies. Usually, management limits the size of expenditures that come from petty cash. Likewise, it may not permit use of the fund for certain types of transactions (such as making short-term loans to employees). Each payment from the fund must be documented on a prenumbered petty cash receipt (or petty cash voucher), as shown in Illustration 7-7 (page 323). Note that the signatures of both the fund custodian and the person receiving payment are required on the receipt. If other supporting documents such as a freight bill or invoice are available, they should be attached to the petty cash receipt. The fund custodian keeps the receipts in the petty cash box until the fund is replenished. The sum of the petty cash receipts and the money in the fund should equal the established total at all times. Management can (and should) make surprise counts at any time to determine whether the fund is being maintained correctly. The company does not make an accounting entry to record a payment when it is made from petty cash. Instead, the company recognizes the accounting effects of each payment when it replenishes the fund. 5 The term \"imprest\" means an advance of money for a designated purpose. JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 323 323 Cash Disbursements Controls Illustration 7-7 Petty cash receipt No. 7 LAIRD COMPANY Petty Cash Receipt 3/6/11 Date__________ Acme Express Agency Paid to_________________________ $18.00 Amount________ Collect Express Charges For____________________________ Freight-in CHARGE TO____________________ Approved Received Payment Custodian REPLENISHING THE FUND When the money in the petty cash fund reaches a minimum level, the company replenishes the fund. The petty cash custodian initiates a request for reimbursement. He or she prepares a schedule (or summary) of the payments that have been made and sends the schedule, supported by petty cash receipts and other documentation, to the treasurer's office. Someone in the treasurer's office examines the receipts and supporting documents to verify that they were proper payments from the fund. The treasurer then approves the request and issues a check to restore the fund to its established amount. At the same time, all supporting documentation is stamped \"paid\" so that it cannot be submitted again for payment. To illustrate, assume that on March 15 Laird's petty cash custodian requests a check for $87. The fund contains $13 cash and petty cash receipts for postage $44, freight-out $38, and miscellaneous expenses $5. The general journal entry to record the check is: Mar. 15 Postage Expense Freight-out Miscellaneous Expense Cash (To replenish petty cash fund) Postage Expense Freight-out Miscellaneous Expense Cash Over and Short Cash (To replenish petty cash fund) ETHICS NOTE L 44 38 5 87 SE 44 Exp 38 Exp 5 Exp 87 Cash Flows Note that the reimbursement entry does not affect the Petty Cash account. Replenishment changes the composition of the fund by replacing the petty cash receipts with cash. It does not change the balance in the fund. Occasionally, in replenishing a petty cash fund, the company may need to recognize a cash shortage or overage. This results when the total of the cash plus receipts in the petty cash box does not equal the established amount of the petty cash fund. To illustrate, assume that Laird's petty cash custodian has only $12 in cash in the fund plus the receipts as listed. The request for reimbursement would, therefore, be for $88, and Laird would make the following entry: Mar. 15 A 87 HELPFUL HINT Cash over and short situations result from mathematical errors or from failure to keep accurate records. A L SE 44 38 5 1 44 38 5 1 88 88 Cash Flows 88 Exp Exp Exp Exp JWCL165_c07_304-355.qxd 324 8/4/09 12:00 PM Page 324 Chapter 7 Fraud, Internal Control, and Cash ETHICS NOTE Internal control over a petty cash fund is strengthened by: (1) having a supervisor make surprise counts of the fund to confirm whether the paid vouchers and fund cash equal the imprest amount, and (2) canceling or mutilating the paid vouchers so they cannot be resubmitted for reimbursement. Conversely, if the custodian has $14 in cash, the reimbursement request would be for $86, and the company would credit Cash Over and Short for $1 (overage). A company reports a debit balance in Cash Over and Short in the income statement as miscellaneous expense. It reports a credit balance in the account as miscellaneous revenue. The company closes Cash Over and Short to Income Summary at the end of the year. Companies should replenish a petty cash fund at the end of the accounting period, regardless of the cash in the fund. Replenishment at this time is necessary in order to recognize the effects of the petty cash payments on the financial statements. before you go on... Petty Cash Fund Action Plan To establish the fund, set up a separate general ledger account. Determine how much cash is needed to replenish the fund: subtract the cash remaining from the petty cash fund balance. Total the petty cash receipts. Determine any cash over or shortthe difference between the cash needed to replenish the fund and the total of the petty cash receipts. Record the expenses incurred according to the petty cash receipts when replenishing the fund. Do it! Bateer Company established a $50 petty cash fund on July 1. On July 30, the fund had $12 cash remaining and petty cash receipts for postage $14, office supplies $10, and delivery expense $15. Prepare journal entries to establish the fund on July 1 and to replenish the fund on July 30. Solution July 1 30 Petty Cash Cash (To establish petty cash fund) 50 Postage Expense Office Supplies Delivery Expense Cash Over and Short Cash ($50 - $12) (To replenish petty cash) 14 10 15 50 1 38 Related exercise material: BE7-9, E7-7, E7-8, and Do it! 7-3. The Navigator CONTROL FEATURES: USE OF A BANK The use of a bank contributes significantly to good internal control over cash. A company can safeguard its cash by using a bank as a depository and Indicate the control features of a as a clearing house for checks received and written. Use of a bank minibank account. mizes the amount of currency that a company must keep on hand.Also, use of a bank facilitates the control of cash because it creates a double record of all bank transactionsone by the company and the other by the bank. The asset account Cash maintained by the company should have the same balance as the bank's liability account for that company. A bank reconciliation compares the bank's balance with the company's balance and explains any differences to make them agree. Many companies have more than one bank account. For efficiency of operations and better control, national retailers like Wal-Mart and Target may have regional bank accounts. Large companies, with tens of thousands of employees, may have a payroll bank account, as well as one or more general bank accounts. Also, a company may maintain several bank accounts in order to have more than one source for short-term loans when needed. STUDY OBJECTIVE 6 JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 325 Control Features: Use of a Bank Making Bank Deposits An authorized employee, such as the head cashier, should make a company's bank deposits. Each deposit must be documented by a deposit slip (ticket), as shown in Illustration 7-8. CHECKS LIST SINGLY DOLLARS CENTS 1 Bank code numbers 2 3 4 5 6 7 8 DEPOSIT TICKET LAIRD COMPANY CASH CURRENCY 77 West Central Avenue, Midland, Michigan 48654 74102/724 TOTAL FROM OTHER SIDE TOTAL DATE 9 COIN LIST CHECKS SINGLY TOTAL FROM OTHER SIDE NET DEPOSIT USE OTHER SIDE FOR ADDITIONAL LISTINGS BE SURE EACH ITEM IS PROPERLY ENDORSED 10 11 12 13 14 National Bank & Trust 15 Midland, Michigan 48654 16 CHECKS AND OTHER ITEMS ARE RECEIVED FOR DEPOSIT SUBJECT TO THE PROVISIONS OF THE UNIFORM COMMERCIAL CODE OR ANY APPLICABLE COLLECTION AGREEMENT 17 18 19 Front side Reverse side TOTAL ENTER TOTAL ON THE FRONT OF THIS TICKET Deposit slips are prepared in duplicate.The bank retains the original; the depositor keeps the duplicate, machine-stamped by the bank to establish its authenticity. Writing Checks Most of us write checks, without thinking very much about them. A check is a written order signed by the depositor directing the bank to pay a specified sum of money to a designated recipient. There are three parties to a check: (1) the maker (or drawer) who issues the check, (2) the bank (or payer) on which the check is drawn, and (3) the payee to whom the check is payable. A check is a negotiable instrument that one party can transfer to another party by endorsement. Each check should be accompanied by an explanation of its purpose. In many companies, a remittance advice attached to the check, as shown in Illustration 7-9 (page 326) explains the check's purpose. It is important to know the balance in the checking account at all times.To keep the balance current, the depositor should enter each deposit and check on runningbalance memo forms provided by the bank or on the check stubs in the checkbook. Bank Statements If you have a personal checking account, you are probably familiar with bank statements. A bank statement shows the depositor's bank transactions and balances.6 6 Our presentation assumes that the depositor makes all adjustments at the end of the month. In practice, a company may also make journal entries during the month as it receives information from the bank regarding its account. Illustration 7-8 Deposit slip 325 JWCL165_c07_304-355.qxd 326 7/31/09 2:05 PM Page 326 Chapter 7 Fraud, Internal Control, and Cash Illustration 7-9 Check with remittance advice Check Maker No. 448 LAIRD COMPANY 77 West Central Avenue, Midland, Michigan 48654 Payee 74102/724 Pay to the order of $ Dollars National Bank & Trust Payer Midland, Michigan 48654 Memo Remittance Advice Detach this portion before cashing. Date 4-16-11 Description Invoice No. 27662 Gross Amount Discount Net Amount 1525.00 ---- 1525.00 W. A. Laird Company, Midland, MI HELPFUL HINT Essentially, the bank statement is a copy of the bank's records sent to the customer for periodic review. Each month, a depositor receives a statement from the bank. Illustration 7-10 (page 327) presents a typical bank statement. It shows: (1) checks paid and other debits that reduce the balance in the depositor's account, (2) deposits and other credits that increase the balance in the account, and (3) the account balance after each day's transactions. The bank statement lists in numerical sequence all \"paid\" checks, along with the date the check was paid and its amount. Upon paying a check, the bank stamps the check \"paid\"; a paid check is sometimes referred to as a canceled check. On the statement the bank also includes memoranda explaining other debits and credits it made to the depositor's account. DEBIT MEMORANDUM Some banks charge a monthly fee for their services. Often they charge this fee only when the average monthly balance in a checking account falls below a specified amount. They identify the fee, called a bank service charge, on the bank statement by a symbol such as SC. The bank also sends with the statement a debit memorandum explaining the charge noted on the statement. Other debit memoranda may also be issued for other bank services such as the cost of printing checks, issuing traveler's checks, and wiring funds to other locations. The symbol DM is often used for such charges. Banks also use a debit memorandum when a deposited check from a customer \"bounces\" because of insufficient funds. For example, assume that Scott Company, a customer of Laird Company, sends a check for $800 to Laird Company for services provided. Unfortunately, Scott does not have sufficient funds at its bank to pay for these services. In such a case, Scott's bank marks the check NSF (not sufficient funds) and returns it to Laird's (the depositor's) bank. Laird's bank then debits JWCL165_c07_304-355.qxd 7/31/09 2:05 PM Page 327 Control Features: Use of a Bank 327 Illustration 7-10 Bank Statement National Bank & Trust Midland, Michigan 48654 ACCOUNT STATEMENT Member FDIC LAIRD COMPANY 77 WEST CENTRAL AVENUE MIDLAND, MICHIGAN 48654 Statement Date/Credit Line Closing Date April 30, 2011 457923 ACCOUNT NUMBER Balance Last Statement Deposits and Credits Checks and Debits Total Amount No. 34,805.10 26 Balance This Statement Total Amount 20 13,256.90 No. 32,154.55 CHECKS AND DEBITS DEPOSITS AND CREDITS Date No. Amount 4-2 4-5 4-4 4-3 4-8 4-7 4-8 4-11 4-12 435 436 437 438 439 440 441 442 443 644.95 3,260.00 1,185.79 776.65 1,781.70 1,487.90 2,420.00 1,585.60 1,226.00 4-29 4-29 4-30 4-30 NSF 459 DM 461 425.60 1,080.30 30