A dishonest act by an employee that results in personal benefit at the company's expense.

What are the three legs of the fraud triangle?

Opportunity, financial pressure, and rationalization.

Which leg of the fraud triangle does a company control most?

Opportunity — internal control is aimed at removing the openings that let fraud happen.

What did the Sarbanes-Oxley Act (SOX) require?

Public companies must maintain and document adequate internal controls, and top management is responsible for them.

What is internal control?

The methods a company uses to safeguard assets, keep records accurate and reliable, promote efficiency, and ensure compliance with policy and law.

Name the six principles of internal control.

Establishment of responsibility, segregation of duties, documentation procedures, physical controls, independent internal verification, and human resource controls.

Principle — establishment of responsibility?

Assign each task to one specific person; control is most effective when only one person is responsible for a given job.

Principle — segregation of duties?

The person who has custody of an asset should not keep its records, and related duties should be divided among different people.

Principle — documentation procedures?

Use prenumbered documents and record transactions promptly so nothing is missed, lost, or recorded twice.

Principle — physical controls?

Safes, locked storage, alarms, passwords, and time clocks that physically protect assets and records.

Principle — independent internal verification?

Have someone review, compare, and reconcile the work of others — ideally on a surprise basis and by someone independent.

Principle — human resource controls?

Bond employees who handle cash, rotate duties, require vacations, and run background checks.

What are the limitations of internal control?

Cost-benefit (controls must be worth their cost), collusion (employees working together can defeat them), and the human element/small size.

Why is collusion dangerous to internal control?

Two or more employees working together can circumvent segregation of duties, which assumes people act independently.

A key control over CASH RECEIPTS?

Separate the person who handles cash from the person who records it; use registers; deposit receipts intact daily; have a supervisor reconcile the count to the record.

Why open mail receipts with two people present?

It reduces the chance one person removes cash before it is recorded — segregation of duties applied to incoming mail.

A key control over CASH DISBURSEMENTS?

Pay by check or EFT (each leaves a record), have authorized signers separate from record-keepers, use prenumbered checks, and compare supporting documents before paying.

Why stamp invoices PAID?

So the same invoice cannot be submitted and paid a second time.

What is a petty cash fund?

A small imprest fund of cash kept on hand to pay for minor expenditures where writing a check is impractical.

What does 'imprest' mean?

The fund is set at a fixed amount and periodically restored to that amount when replenished.

Journal entry to ESTABLISH petty cash?

Debit Petty Cash, credit Cash — made only once, for the fund amount.

Is an entry made each time petty cash pays a bill?

No. The custodian just keeps a receipt; no accounting entry is made until the fund is replenished.

Journal entry to REPLENISH petty cash?

Debit the various expenses shown by the receipts and credit Cash. Petty Cash is NOT touched.

What is Cash Over and Short?

An account for petty cash discrepancies: a shortage is a DEBIT, an overage is a CREDIT. It appears in the replenishing entry when receipts + cash ≠ the fund.

Petty cash example — $150 fund, $131 receipts, $17 cash. Short or over?

Expected cash = 150 − 131 = 19; actual = 17, so it's $2 SHORT (a debit to Cash Over and Short). Credit Cash 150 − 17 = 133.

Journal entry to INCREASE the petty cash fund?

Debit Petty Cash, credit Cash for the increase (e.g., $150 to $250 → debit Petty Cash 100).

How does a bank account help control cash?

Depositing all receipts and paying by check gives an independent, second record of every cash transaction to check the company's own against.

What is a bank reconciliation?

A schedule that explains the difference between the bank balance and the book balance, adjusting each to the correct true cash balance.

Reconciliation — what happens to deposits in transit?

ADD them to the bank balance — the company recorded them but the bank hasn't yet.

Reconciliation — what happens to outstanding checks?

SUBTRACT them from the bank balance — written by the company but not yet cleared by the bank.

Reconciliation — a note collected by the bank?

ADD it (and any interest) to the book balance — the bank knew first; it requires a book entry.

Reconciliation — an NSF (bounced) customer check?

SUBTRACT it from the book balance and re-establish the receivable; the customer still owes you.

Reconciliation — a bank service charge?

SUBTRACT it from the book balance; it requires a book entry (debit an expense, credit Cash).

Which reconciling items require journal entries?

Only the BOOK-side items (collections, interest, NSF checks, charges, book errors). Bank-side items clear on their own.

Entry for a note the bank collected ($800, incl. $50 interest)?

Debit Cash 800; credit Notes Receivable 750 and Interest Revenue 50.

Entry for an NSF check of $150 from a customer?

Debit Accounts Receivable 150; credit Cash 150.

Entry for a $50 bank service charge?

Debit Bank Charge (Miscellaneous) Expense 50; credit Cash 50.

Where is cash reported on the balance sheet?

As a current asset, usually listed first because it is the most liquid.

What are cash equivalents?

Short-term, highly liquid investments maturing within three months of purchase (e.g., Treasury bills, money-market funds), reported with cash.

What is restricted cash?

Cash set aside for a specific purpose (e.g., a plant-expansion fund). It is reported separately from cash and cash equivalents.

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Accounting 1 · Chapter 8 · Free

Chapter 8 — Fraud, Internal Control & Cash

Fraud, internal control, and cash — the fraud triangle, control principles, bank reconciliations, petty cash, and controls over cash.

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What you'll learn

Explain the fraud triangle and the principles of internal control
Apply controls over cash receipts and disbursements
Prepare a bank reconciliation and account for petty cash

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Part 1 — Petty Cash Journal Entries

Part 2 — How To Do a Bank Reconciliation Step by Step

Part 3 — Cash and Cash Equivalents: What Counts as Cash

Part 4 — Internal Controls & the Fraud Triangle

Part 5 — Internal Control Over Cash

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Chapter 8 — Fraud, Internal Control & Cash

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