ACCT 101: Control Systems


Session 4


Dr. Richard M. Crowley

Frontmatter

Homework 1 Review

  • Closing entries
    • Accounts are: Revenues, Expenses, Gains, Losses, Dividends
  • Depreciation
    • (Price paid - salvage value) / [life length from purchase]
    • In homework: (100,000 - 20,000) / 5 = 16,000
  • Accrual entries:
    1. Bring an expense or revenue forward
    2. Create a payable or receivable as well
    3. Payable or receivable reversed upon payment

Quiz details

  • Like the practice quizzes on eLearn, except 60 minutes
    • You will have 60 minutes to complete it
  • What can be covered:
    • Everything in the session 1 to 4 slides, except:

On the quiz

  • Par value accounting
  • Concept names and definitions
    • Matching principle, periodicity, etc.

Possibly on the final

  • Par value accounting for equity

The quiz is to makes sure you have the fundamentals down

Quiz resources

  • TA-led review session
    • Thursday, Sept 9 at 7:00pm on Zoom.
  • Practices provided on eLearn:
    • A full practice Quiz 1
    • A set of extra Quiz 1 practice questions
    • Select textbook problems (with answers)
  • There is an account glossary on eLearn
    • Lists and defines every account we’ve seen so far

Learning objectives

Control Systems (Chapter 4)

  1. Understand the drivers of fraud
  2. Be able to identify weaknesses in firms’ systems and suggest improvements
  3. Be able to reconcile book and bank cash

A/R (Chapter 5)

  1. Understand how to write off uncollectible A/R

Fraud

Misreporting: A simple definition

Errors that affect firms’ accounting statements or disclosures which were done seemingly intentionally by management or other employees at the firm.

Traditional accounting fraud

  1. A company is underperforming
  2. Management cooks up some scheme to increase earnings
    • Wells Fargo (2011-2018?)
      • Fake/duplicate customers and transactions
  3. Create accounting statements using the fake information

Other accounting fraud types

  • Dell (2002-2007)
    • Cookie jar reserve (secret payments by Intel of up to 76% of quarterly income)
      1. The company is overperforming
      2. “Save up” excess performance for a rainy day
      3. Recognize revenue/earnings when needed to hit future targets
  • Apple (2001)
    • Options backdating
  • China North East Petroleum Holdings Limited
    • Related party transactions (transferring 59M USD from the firm to family members over 176 transactions)

Fraud in Singapore

  • Keppel O&M
    • $55M USD bribery in Brazil for contracts
    • Highly profitable, until fines rolled in
      • Profit of $351.8M USD
      • Fines of $422M USD (to US, Brazil, Singapore) [so far]
    • 6 employees implicated
    • 1 Keppel lawyer pleaded guilty in USA for drafting bribery contracts
  • Keppel Club
    • Employees created 1,280 fake memberships, sold them, and retained all profits
    • $37.5M from June 1 to August 1, 2014
  • Asia Pacific Breweries (Chia Teck Leng)
    • Forged documents from 1999 to 2003 to obtain $117M from 4 banks
      • To fund gambling addiction
    • 42 year jail sentence

Fraud triangle

  • Opportunity
    • Hole in the control system
    • Profitably exploitable
  • Rationalization
    • Resentment of corporation
    • Poor culture
    • “Borrowing”
  • Motivation
    • Family needs
    • Maintaining lifestyle
    • Maintaining performance

Need all 3 for fraud to happen

Control Systems

Systems

  • Each part of the company is dependent on other parts
  • Consider how all parts work together

Simplest case is a linear assembly line

  • Pass the product from one stop to the next until it’s done
  • Except for…
    • Maintenance
    • Input selection
    • Product mix
    • Quality control
    • …
  • Where does information flow?

Basic goals of control systems

  • Prevention
    • Make sure something doesn’t go wrong
      • Ex.: Inspect raw materials before assembly
  • Detection
    • Check if something went wrong
      • Ex.: Check products randomly after assembly
  • Correction
    • Something went wrong, so we need to fix it
      • Ex.: Determine cause of defects & learn from problems

Basic mechanisms/solutions

  • Separation of duties
    • Different parts of a system are handled by different employees
      • Ex.: Inspection not done by assembly line worker
  • Monitoring
    • Check if things are normal
      • Ex.: Boss stops by every now and then
  • Limited access
    • Employees only have access to what they need
      • Ex.: Line workers can’t access inventory records
      • Ex.: Raw material purchasers can’t access salary records
  • Approvals
    • Require oversight for some actions
      • Ex.: Buying from a new vendor may require boss’s signature

Limitations

  • Collusion
    • Multiple people can jointly subvert systems
  • Fatigue
    • People are not perfect
  • Negligence
    • Not every employee does what they are supposed to

Example: Car manufacturer

  • How would we control car quality?
    • Prevention
    • Detection
    • Correction

Champaign Parking Enforcement

Their Objectives

  1. Validity: All recorded transactions ocurred
  2. Completeness: All valid transactions have been recorded
  3. Valuation: Amounts measured properly
  4. Security: Information system protected from unauthorized access or destruction

Discussion questions

  • What are some risks that threaten these objectives?
    • How frequent is the risk?
    • How serious is the risk?
  • How could they be addressed?

Cash reconciliation

Cash on companies’ books

Documents:

  • Purchase orders
  • Invoices for purchases/sales
  • Checks
  • Payment records
  • Petty cash
    • Small amount set aside for small purchases

Cash in the bank

Documents:

  • Cash deposits, withdrawals
  • Checks
  • Electronic checks
    • EFT, ACH, GIRO, etc.
  • Bank interest and fees
  • Nonsufficient funds
    • Customer’s check is rejected
    • Check writer didn’t have enough cash in the bank

Inconsistencies between cash records

  • The two records come from different sources
    • We can use this to verify the records!…
      • But they likely won’t be exactly the same
  • Why are the records different?
    • Time lags
      • We receive cash and checks first
        • These may still be in transit to the bank
      • Banks receive electronic checks first
      • Banks know about fees and interest first
  • Time lags are shorter these days with internet banking

Reconciliation process

Journal entries to record

Cash up: DR cash, CR…

  • Dividends received:
    • Dividend revenue
  • EFT from customer:
    • A/R
  • Interest from bank:
    • Interest revenue
  • Prepayment:
    • Unearned revenue

Cash down: CR cash, DR…

  • Charges from the bank:
    • Bank service charges
      • This is an expense account
  • Check failed (NSF):
    • Receivable the check was for (A/R)
  • Charged expenses:
    • The expense

Reconciliation example

Practice bank reconciliation

  1. Get the in class activity spreadsheet
    • Session_4_Activity_Cash.xlsx
  2. Do the bank reconciliation
    1. Figure out what needs to be reconciled from bank and book
    2. Record these in the reconciliation tab
    3. Make sure cash reconciles (it will in this case)
    4. Record the needed journal entries (3)

A/R tracking

Why have uncollectible accounts?

Accounting for unexpected events

  • Companies can go bankrupt, forget to pay, or breach contracts
  • Two approaches:

Allowance method

  • Estimate decrease in asset values beforehand
  • Allowance for uncollectible accounts
    • Contra asset
  • Bad debt expense

Direct write-off method

  • Write-off when the loss is guaranteed
  • Violates the matching principal

We will use the allowance method (as does IFRS)

A/R allowance process

A/R allowances example

  • Suppose we have the following allowance schedule and accounts receivables outstanding at year end

  • What should our allowance be?

A/R allowances example

A/R allowances example: Going concern

  • What about GC Corp?
    • The auditor issued a going concern opinion
    • High chance of bankruptcy
    • Let’s update the allowance schedule for that:

A/R allowances example: Going concern

A/R allowances example: Journal entries

A/R allowances example: Bankruptcy

  • Bankruptcy follows the direct write-off method
    • We record it when it happens
    • Use up some of the allowance (DR), decrease our A/R (CR)
  • If the firm recovers, we reverse this transaction
  • Example: PGUS goes bankrupt. During bankruptcy they pay us $300, and we expect no further payments from them.

Practice for A/R

  1. Get the in class activity spreadsheet
    • Session_4_Activity_AR.xlsx
  2. Complete the activity in groups of 3-4
    1. Use the allowance schedule to determine the amount of uncollectible A/R needed
    2. Use the T-account to determine the adjustment needed
    3. Record the adjustment in the journal

End Matter

For next week

  1. Quiz 1
  2. Read the pages for next week
    • Chapter 5 (Part A)
    • Chapter 6 (Inventory)
  3. No homework
  4. Practice on eLearn
    • Covers bank reconciliation and A/R
    • Automatic feedback provided

Quiz resources

  • TA-led review session
    • Thursday, Sept 9 at 7:00pm on Zoom.
  • Practices provided on eLearn:
    • A full practice Quiz 1
    • A set of extra Quiz 1 practice questions
    • Select textbook problems (with answers)
  • There is an account glossary on eLearn
    • Lists and defines every account we’ve seen so far