Lesson 12 Internal Control and Business Ethnics

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Lesson 12Internal Control and Business Ethnics

• Task Team of
• FUNDAMENTAL ACCOUNTING
• School of Business, Sun Yat-sen University

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Outline

• The Fundamental Principles of Internal Control
• Internal Control to Cash
• Explain and Record Petty Cash Fund Transactions.
• Prepare a Bank Reconciliation
• Exploring the Concept of Accounting Ethics
• Accounting Ethics and Social Responsibilities
• Accounting Ethics and Decision Making

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Opening Story

• The Failure of Firms
• and Internal Control
• Enron
• Worldcom
• CAO

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Opening Story

• China Aviation Oil (Singapore) Corp., an overseas
  arm of China's main jet-fuel supplier, revealed
  the end of 2004 that it has racked up about 550
  million in trading-related losses.

Ranked 29th most transparent company
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Todays organizations are concerned about

• Risk Management
• Governance
• Control
• Assurance (and Consulting)

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Internal Control

• Internal Check
• Internal Control
• Internal Control Structure
• Internal Control-----Integrated Framework
• ERM

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Internal Control

• What is internal control?
• It is the organizational plan and all the related
  measures that an entity adopts to
• safeguard assets,
• encourage adherence to company policies,
• promote operational efficiency, and...
• ensure accurate and reliable accounting records.

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Establishing an Effective System of Internal
Control

• Characteristics of an effective internal control
  system include
• Competent, reliable, and ethical personnel
• Assignment of responsibilities
• Proper authorization
• Separation of duties

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Separation of Duties
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Internal Controls for e-Commerce
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Internal Controls for e-Commerce

• What is an encryption?
• It is the primary method of achieving
  confidentiality in e-commerce.
• Plain-text messages are rearranged by some
  mathematical process.
• The encrypted message cannot be read by anyone
  who does not know the process.

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Internal Controls for e-Commerce
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The Internal Control Integrated Framework
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ERM Defined

• a process, effected by an entity's board of
  directors, management and other personnel,
  applied in strategy setting and across the
  enterprise, designed to identify potential events
  that may affect the entity, and manage risks to
  be within its risk appetite, to provide
  reasonable assurance regarding the achievement of
  entity objectives.
• Source COSO Enterprise Risk Management
  Integrated Framework. 2004. COSO.

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Why ERM Is Important

• Underlying principles
• Every entity, whether for-profit or not, exists
  to realize value for its stakeholders.
• Value is created, preserved, or eroded by
  management decisions in all activities, from
  setting strategy to operating the enterprise
  day-to-day.

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Why ERM Is Important

• ERM supports value creation by enabling
  management to
• Deal effectively with potential future events
  that create uncertainty.
• Respond in a manner that reduces the likelihood
  of downside outcomes and increases the upside.

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Enterprise Risk ManagementIntegrated Framework

• This COSO ERM framework defines essential
  components, suggests a common language, and
  provides clear direction and guidance for
  enterprise risk management.

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The ERM Framework

• Entity objectives can be viewed in the context of
  four categories
• Strategic
• Operations
• Reporting
• Compliance

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The ERM Framework

• ERM considers activities at all levels of the
  organization
• Enterprise-level
• Division or subsidiary
• Business unit processes

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The ERM Framework

• Enterprise risk managementrequires an entity to
  take a portfolio view of risk.

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The ERM Framework

• Management considers how individual risks
  interrelate.
• Management develops a portfolio view from two
  perspectives
• Business unit level
• Entity level

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The ERM Framework

• The eight components of the framework are
  interrelated

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Fundamental Principles of Internal Accounting
Control

• Ensure transactions and activities are
  authorized.
• Maintain adequate records.
• Insure assets.
• Separate recordkeeping and custody of assets.
• Establish a separation of duties.

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Fundamental Principles of Accounting Internal
Control

• Apply technological controls.
• Perform internal and external audits.

Internal controls will vary based on the nature
and size of the organization.
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Limitations of Internal Accounting Control
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Limitations of Internal Control
The costs of internal controls must not exceed
their benefits.
Benefits
Costs
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Cash

• Is an important asset for every company.
• Control of cash on hand and access to it is
  critical.
• Cash includes
• Currency
• Coins
• Deposits in bank accounts
• Other items acceptable for deposit

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The Bank Account as aControl Device

• Documents used to control a bank account include
• signature card
• deposit ticket
• check
• bank statement
• bank reconciliation

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Liquidity

• Refers to how easily an asset can be converted
  into another asset or used in paying for services
  or obligations.
• Examples
• Cash- highly liquid
• A specialized piece of equipment -not very liquid.

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The Bank Reconciliation

• What are two records of a businesss cash?
• Cash account in the businesss own general
  ledger.
• The bank statement which tells the actual amount
  of cash the business has in the bank.

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The Bank Reconciliation

• Items recorded by a company not on the bank
  statement
• deposit in transit
• outstanding checks

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The Bank Reconciliation

• Items on a bank statement and not recorded by the
  business
• bank collections
• bank fees
• interest earned on account
• NSF checks

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The Paths That Two Checks Take (Good Check)
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The Paths That Two Checks Take (NFS Check)
Makers bank balance is not sufficient to pay the
check.
Makers bank sends the worthless check back
to payees bank.
Payee holds worthless check.
Payees bank decreases payees balance.
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The Bank Reconciliation Example

• At the beginning of July, Sahita, Inc. received
  the Junes bank statement.
• It indicated the following
• The bank balance was 63,275.
• The bank had collected a note receivable from one
  of Sahitas customers in the amount of 1,325.

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The Bank Reconciliation Example

• The bank paid the electric bill of 1,500.
• There was a 200 check returned for NSF.
• Interest earned on the account was 265.
• Bank service charges were 12.

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The Bank Reconciliation Example

• Sahitas books indicates a cash balance of
  66,647.
• A deposit of 11,250 was mailed to the bank on
  June 30.
• Checks issued in June for 8,000 have not yet
  been paid by the bank.

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The Bank Reconciliation Example
Balance per bank, June 30 63,275 Add deposit in
transit 11,250 74,525 Less
outstanding check 8,000 Adjusted
bank balance 66,525
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The Bank Reconciliation Example
Balance per books, June 30 66,647 Add Note
receivable collected by the bank
1,325 Interest income
265 68,237 Less Payment of electric
bill 1,500 NSF check 200 Service
charge 12 Adjusted book
balance 66,525
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The Bank Reconciliation Example
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Record Reconciling Items
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Record Reconciling Items
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Record Reconciling Items

• June 30, 200x
• Bank Service Fees 12
• Cash
  12
• Bank service charges

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Internal Controls for Cash

• Guidelines
• Separate handling of cash from recordkeeping of
  cash.
• Deposit cash receipts daily.
• Make cash disbursements by cheque.

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Cash ReceiptsOver the Counter

• The terminal should be positioned so that
  customers can see the amount the cashier enters
  into the cash register.
• The cash drawer should open only when the sales
  clerk enters an amount on the keypad.
• The roll of tape locked inside the machine
  records each sale and cash transaction.
• Pricing merchandise at uneven amounts means
  that the clerk has to open the cash drawer.
• This requires entering the amount of the sale on
  the keypad and so onto the register tape.

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Cash ReceiptsOver the Counter

• At the end of the day, the cashier deposits the
  cash in the bank.
• The tape goes to accounting.

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Cash Receipts by Mail

• All incoming mail should be opened by a mailroom
  employee.
• This person should compare the check received
  with the remittance advice.
• Cash receipts should be given to the cashier.
• The mailroom employee forwards the remittance
  advice to accounting.
• Many companies use a lock-box system.
• Customers send their checks directly to an
  address that is a bank account.
• Company personnel do not handle the cash.

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Cash Short and Over

• Assume that the cash register tapes indicate
  sales revenue of 25,000.
• However, the cash received was 24,980.
• What entry would record the days sales?

Cash 24,980 Cash Short
and Over 20
Sales Revenue 25,000 Daily cash
sales
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Petty Cash System of Control

• Good internal control procedures require cash
  disbursements be made by cheque.
• The exception
• Small payments requiredin most companies for
  items such as postage, courier fees, repairs and
  supplies.

This is an example of the cost-benefit limitation
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Control of Cash Disbursements

• All expenditures should be made by cheque. The
  only exception is for small payments from petty
  cash.
• Separate authorization, cheque signing and
  recordkeeping duties.
• Apply a voucher system.

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Control OverApproval of Payments

• The accounting department...
• combines all of these documents,
• checks them for accuracy, and...
• forwards this disbursement packet to designated
  officers for approval and payment.

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Controlling Petty Cash Payments

• On June 15, Sahita Inc. manager decided to
  establish a 250 petty cash fund.
• What is the entry?

June 15, 200x Petty Cash
250 Cash in Bank 250 To
open the petty cash fund
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Controlling Petty Cash Payments

• Jose is the petty cash custodian responsible for
  the fund.
• On June 20, he purchased supplies in the amount
  of 70.
• For each disbursement, he prepares a petty cash
  ticket.
• At all times the amount of cash in the petty cash
  fund plus the petty cash tickets must equal 250.

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Controlling Petty Cash Payments

• Jose also spent 20 for delivery charges and 60
  for coffee and other miscellaneous expenses.
• What is the journal entry to record the
  replenishment of the fund?

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Controlling Petty Cash Payments
June 30, 200x Supplies 70 Delivery
Expense 20 Miscellaneous Expense 60 Cash in
Bank 150 To replenish the petty cash fund
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Ethical Values Do Matter!

• In making judgment, the Early Kings were perfect,
  because they made more principles the starting
  point of all their undertaking and the root of
  everything that was beneficial. This principle,
  however, is something that persons of mediocre
  intellect never grasp. Not grasping it, they lack
  awareness, and lacking awareness, they pursue
  profit. But while they pursue profit, it is
  absolutely impossible for them to be certain of
  attaining it.
• --Lv Bu-wei 246BC,
• The Annals of Lv
  Bu-wei, Lu Shi Chun Qiu

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Ethical Values

• Ethical values have been changed immensely in the
  last century.
• Ethical and moral values provide a foundation to
  society on how to function, live, and work within
  the society.
• Ethical values provide the foundation on which a
  civilized society exists. Without the foundation,
  civilization collapses.

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Enron Cartoon
There are two levers to set a man in motion, fear
and self-interest.

Napoleon Bonaparte
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Economic Boom and Ethics

• The boom of the 1990's -- changing the business
  environment, reshaping corporate leadership.
• Financial scandals and out-of-hand executive
  compensation -- a lapse of ethics and
  unprecedented greed, a disdain for the rule of
  law.
• The most pressing leadership issue for today
  ---ensure that corporate officers behave in an
  ethical manner.

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Ethical Issues in Accounting

• CEO ---- daily share price v.s. long-term
  corporate value
• Current compensation practicesoverstate
  earnings to boost pay
• short-term behavior
• excessive risk-taking
• aggressive accounting methods
• Legislation ---- tackle the accountingirregularit
  ies issues caused byunethical executives.
• (G.Bush signed into law Sarbanes-Oxley Act of
  2002)

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Purposes of Ethics

• Direct business men and women to abide by a code
  of conduct that facilitates, if not encourages,
  public confidence in their products and services.
• In the accounting field, professional
  organizations such as the AICPA, IMA, maintain
  and enforce a code of professional conduct for
  public accountants
• They recognize the accounting profession's
  responsibility to provide ethical guidelines to
  its members.

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Can One Person Make A Difference in Business
Ethics?

• I am only one.
• But still I am one.
• I cannot do everything,
• But still I can do something
• And because I cannot do everything
• I will not refuse to do the something that I can
  do.
• ---Edward
  Everett Hale

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Who Takes the Lead?

• At this moment, Americas highest economic need
  is higher ethical standards --- standards
  enforced by strict laws and upheld by responsible
  business leaders.
• George W. Bush,
  Corporate Responsibility speech
• July 9,2002

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Ethics and Social Responsibility
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Social Responsibility

• Donations to not-for-profit organizations
• Programs to reduce pollution and better use
  natural resources
• Programs to improve worker and consumer safety
• Paid time off for workers

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Guidelines for Ethical Decision Making
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Professional Code of Ethics

• Accountants are held to very high standards of
  conduct.
• There is no compromising.
• Would you hire an accountant who is almost
  always honest?
• Internal controls rely upon basic honesty and
  integrity.

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Summary

• The Fundamental Principles of Internal Control
• Internal Check Internal Control Internal
  Control Structure Internal Control Integrated
  Framework ERM.
• The Internal Accounting Control
• The Purposes and Principles of Internal Control.
  
• Internal Control to Cash
• Record Petty Cash Fund Transactions.
• Prepare a Bank Reconciliation.
• Ethical values have been changed immensely in the
  last century
• Ethics are closely related to social
  responsibility
• Ethics influence peoples decision making

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Case for Discussion

• This connection will direct you to the complete
  case
• HOW DO YOU MEASURE SUCCESS?
• (Click on the title of case)

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Case for Discussion

• This connection will direct you to the complete
  case
• Ethics and Enron?
• http//www.businessethics.ca/enron/

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Case for Discussion

• CCC company is a young business that has grown
  rapidly.The companys bookkeeper,who was hired
  two years ago,left town suddenly after suddenly
  after the company s manager discovered that a
  great deal of money had disappeared over the past
  18 months.An audit disclosed that the bookkeeper
  had written and signed several cheques made
  payable to the bookkeepers sister,and then
  recorded the cheques as salaries expense.The
  sister,who cashed the cheques but had never
  worked for the company,left town with the
  bookkeeper.As a result,the company incurred an
  uninsured loss of 600,000.

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Case for Discussion

• Evaluate CCC companys internal accounting
  control appear to have been ignored in this
  situation.

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The End of Lesson 12