INTERNAL CONTROL AFFECTING ASSETS

Internal Control over Cash Transactions

- Responsibility of the finance department, under the direction of the treasurer

The functions of the finance department and the accounting department should be integrated in
a manner that provides assurance that:

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

GUIDELINES FOR ACHIEVING INTERNAL CONTROL OVER CASH

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

Description of Examples Internal Control

Misstatement Weakness or Factors that
Increase the Risk of the
Misstatement

Recording fictitious cash Fraud ● Lack of segregation

receipts ● Overstating cash of duties of the
receipts on the books functions of access to
- Transfering cash and record
cash between keeping: no
bank accounts effective review of
without bank reconciliation
appropriate
recording the
transfer to
cover an
embezzlement
of cash

Failure to Record receipts Fraud ● Inadequate

from cash sales ● A cashiers fails to supervision of
ring up and record cashiers; failure to
sales and embezzles encourage customers
the cash to obtain cash
receipts
Error
● A bookkeeper
accidentally omits the ● Inadequate
recording of the cash controls for
receipts from one reconciling cash
cash register for the register tapes and
day accounting records;
inadequate controls
for reconciling bank
accounts

Failure to record cash Fraud ● Lack of segregation

from collection of ● A cashier embezzle of duties between
accounts receivable cash payments by personnel who have
customers on access to cash
receivables, without receipts and those
recording the receipts who make entries into
in the customer’s the accounts
accounts receivable records

● A bookkeeper
 accidentally who has
access to cash
receipts embezzles
cash collected from
customers and writes
off the related
receivables

● Inadequate
Error reconciliations of
● A bookkeeper subsidiary records of
accidentally fails to accounts receivable
record payment on a with the general
receivables ledger control account

Early (late) recognition of Fraud ● Ineffective board

cash receipts — “cutoff ● Holding the cash of directors, audit
problems” receipts journal open committee or
to record next year’s internal audit
cash receipts as function; “top at the
having occurred in top” not conductive to
this year ethical conduct;
undue pressure to
Error show improved
● Recording cash financial position
receipts based on bad
information about ● Failure to list and
date of receipts deposit cash
receipts on a timely
basis
POTENTIAL MISSTATEMENTS — CASH DISBURSEMENTS

Description of Example Internal Control Weakness

Misstatement or Factors that Increase the
Risk of the Misstatement

Inaccurate recording of a Fraud ● Inadequate

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

Duplicate recording and Error ● Ineffective controls

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

Unrecorded Fraud ● Ineffective control

disbursements ● In conjunction with over record keeping
recorded (but for and access to cash
deposited) cash
receipts, an employee
writes and chases an
unrecorded check for
 identical amount
INTERNAL CONTROL OVER FINANCIAL INVESTMENTS
- Consists of marketable stocks and bonds because they are found more frequently and
usually are greater pero value than the other kinds of investment holdings.
- OTHER TYPES: Commercial paper issued by corporations, mortgages and trust deeds,
and the cash surrender value of life insurance policies
- Derivatives are financial instruments that “derive” their value from other financial
instruments, underlying assets, or indexes.

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

- In many concerns, segregation of the function of custody and record keeping is achieved
by the use of an independent safekeeping agent, such as a stockholder, bank or trust
company
POTENTIAL MISSTATEMENTS — FINANCIAL INVESTMENTS

Description of Examples Internal Control

Misstatement Weakness or Factors that
Increase the Risk of the
Misstatement

Misstatement of recorded Error ● Inadequate

value of investments ● Failure to record accounting manual;
changes in market incompetent
values of investments accounting personnel

Fraud ● Ineffective BOD,

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

Unauthorized investment Fraud ● Inadequate

transactions ● An employee with segregation of
access to securities duties of record
coverts them for keeping for and
personal use custody of securities

Incomplete recording of Error ● Inadequate

investments ● Failure to record accounting manual;
derivative agreements incompetent
which are embedded accounting personnel
in other agreements ● Inadequate
monitoring by
internal auditors
POTENTIAL MISSTATEMENTS — REVENUE/RECEIVABLES

Description of Examples Internal Control

Misstatement Weakness or Factors that
Increase the Risk of the
Misstatement

Recording unearned Fraud ● Ineffective BOD,

revenue ● Recording fictitious audit committee, or
sales without internal audit
receiving a customer function; undue
order or shipping the pressure to meet
goods earnings targets. “Top
● Intentional over management action”
shipment of goods not conductive to
ethical conduct

Errors
● Recording sales based ● Ineffective billing
on the receipt of process in which
orders from billing is not tied to
customers rather than shipping information
the shipment of goods ● Ineffective controls
● Inaccurate billing and for testing invoices, or
recording of sales ineffective input
● Recording cash that validation checks and
represents a liability computer
(e.g., receipt of a reconciliations to
customer’s deposit) as ensure the accuracy
revenue of databases
● Inadequate
accounting manual;
incompetent
accounting personnel

Early (late) recognition of Fraud ● Ineffective BOD,

revenue – “cutoff error” ● Holding the sales audit committee, or
journal open to record internal audit
next year’s sales as function; not
having occurred in the conductive to ethical
current year conduct; undue
pressure to meet
 sales targets
Error
● Recording sales in the ● Ineffective cutoff
wrong period based procedures in the
on incorrect shipping shipping department
information

Recording revenue when Fraud ● Ineffective BOD,

significant uncertainties ● Recording sales when audit committee, or
exist the customer is likely internal audit
to return the goods function; not
conductive to ethical
conduct; undue
pressure to meet
sales targets

Error
● Recording sales when ● Aggressive attitude of
the customer’s management toward
payment is contingent financial reporting;
upon the customer incompetent chief
receiving financing or accounting officer
selling the goods to
another party (e.g.,
consignment sales)

Recording revenue when Fraud ● Ineffective BOD,

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

Error ● Aggressive attitude of

● Amount of revenue management toward
earned on franchises financial reporting;
is miscalculated incompetent chief
accounting officer

Overestimation of the Fraud ● Ineffective BOD,

amount of revenue ● Misstating the audit committee, or
earned percentage of internal audit
completion of several function; not
projects by a conductive to ethical
construction company conduct’ incompetent
using the individuals involved in
 percentage-of the estimation process
completion method
revenue recognition ● Aggressive attitude of
management toward
financial reporting;
● Overestimating the incompetent
percentage of personnel involved in
completion on the
projects by a estimation/accounting
construction company process.
using the percentage
of completion method
of revenue recognition
Internal Control over Notes Receivables

Principles requires that:

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

POTENTIAL MISSTATEMENTS - INVENTORY/COGS

Description of Examples Internal Control

Misstatement Weakness or Factors that
Increase the Risk of the
Misstatement

Misstatement of inventory Fraud ● Ineffective BOD,

costs ● Intentional audit committee or
misstatement of internal audit
production costs function; “tone at
assigned to inventory the top” not
● Intentional conductive to ethical
misstatement of conduct; undue
inventory prices pressure to meet
earnings targets

Errors
● The assignment of ● Ineffective cost
direct labor costs, accounting system;
 direct material costs, failure to update
or factory overhead to standard on a timely
inventory item is basis
inaccurate ● Ineffective input
● Erroneous pricing of validation controls
inventory on the database of
inventory costs;
ineffective supervision
of the personnel that
enter the costs on the
final inventory
schedule

Misstatement of inventory Fraud ● Ineffective physical

quantities ● Items are stolen with controls over
no journal entry inventories
reflecting the theft ● Ineffective BOD,
● Inventory quantities in audit committee or
locations not visited internal audit
by auditors are function; “tone at
systematically the top” not
overstated conductive to ethical
conduct; undue
pressure to meet
earnings targets

Errors
● Miscounting of ● Ineffective controls or
inventory by supervision of physical
personnel involved in inventory
physical inventory

Early (late) recognition of Fraud ● Ineffective BOD,

purchases — “cutoff ● Intentional recording audit committee or
problems” of purchases in the internal audit
subsequent period function; “tone at
the top” not
conductive to ethical
conduct; undue
pressure to meet
earnings targets

Error
● Recording purchases ● Ineffective
of the current period accounting
in the subsequent procedures that do
period not tie recorded
purchases to receiving
 data

POTENTIAL MISSTATEMENTS – INVESTMENTS IN PROPERTY, PLANT AND

EQUIPMENT

Description of Examples Internal Control

Misstatement Weakness or Factors that
Increase the Risk of the
Misstatement

Misstatement of Fraud ● Undue pressure to

acquisition of PPE ● Expenditures for meet earnings
repairs and targets
maintenance
expenses recorded as
PPE acquisitions to
overstate income

Error
● Purchases of ● Inadequate
equipment accounting manual;
erroneously reported incompetent
in maintenance and accounting personnel
repairs expense
account

Failure to record Error ● Inadequate

retirements of PPE ● An asset that has accounting policies,
been replaced is e.g., failure to use
discarded due to its retirement work
lack of value, without orders
an accounting entry

Improper reporting of Error ● Inadequate

unusual transactions ● A “gain” recorded on accounting manual;
an exchange of incompetent
nonmonetary assets accounting
that lacks commercial personnel
substance