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## ACCT 101: Control Systems {data-background="../Backgrounds/title.jpg" class="header no-toc-progress" data-state="no-toc-progress"}

<h3 class="date"><br>Session 4</h3>
<h2 class="author"><br>Dr. Richard M. Crowley</h2>

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library(knitr)
library(kableExtra)
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```


# Frontmatter {data-background="../Backgrounds/section.jpg" class="header"}

## Homework 1 Review {data-background="../Backgrounds/reference.jpg" class="default"}

- 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

<img src="../Diagrams/JE_4-0.png" style="max-width:600px">

## Quiz details {data-background="../Backgrounds/studying.jpg" class="default"}

- 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:

<div class="clearfix">
<div class="left">
On the quiz

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

</div>
<div class="right">
Possibly on the final

- Par value accounting for equity

</div>
</div>

> The quiz is to makes sure you have the fundamentals down

## Quiz resources {data-background="../Backgrounds/ending.jpg" class="default"}

- 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 {data-background="../Backgrounds/default.jpg" class="default"}

<div class="left">
<img src="../Course_Diagrams/ACCT_101_course_map_4.png">
</div>
<div class="right">
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

</div>

# Fraud {data-background="../Backgrounds/section.jpg" class="default"}

## Misreporting: A simple definition {data-background="../Backgrounds/default.jpg" class="default"}

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

<img src="../Figures/johnny-automatic-bag-of-money.png" height="150px">

## Traditional accounting fraud {data-background="../Backgrounds/fraud.jpg" class="default"}

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 {data-background="../Backgrounds/fraud.jpg" class="default"}

- <a href="https://www.economist.com/newsbook/2010/07/23/taking-away-dells-cookie-jar">Dell (2002-2007)</a>
    - *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
- <a href="https://www.sec.gov/news/press/2007/2007-70.htm"> Apple (2001)</a>
    - *Options backdating*
- <a href="https://www.sec.gov/litigation/litreleases/2012/lr22552.htm">China North East Petroleum Holdings Limited</a>
    - *Related party transactions* (transferring 59M USD from the firm to family members over 176 transactions)

<div class="fragment">

- <a href="https://www.sec.gov/litigation/admin/2007/33-8815.pdf">CVS (2000)</a>
    - *Improper accounting treatments* (Not using mark-to-market accounting to fair value stuffed animal inventories)
- <a href="https://www.sec.gov/litigation/litreleases/lr16732.htm">Countryland Wellness Resorts, Inc. (1997-2000)</a>
    - Gold reserves were actually... <span class="fragment exclude">dirt</span>

</div>

## Fraud in Singapore {data-background="../Backgrounds/fraud.jpg" class="default"}

- <a href="http://www.straitstimes.com/business/companies-markets/keppel-acts-against-staff-in-bribery-scandal">Keppel O&M</a>
    - \$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
- <a href="http://www.straitstimes.com/singapore/courts-crime/keppel-club-duo-convicted-for-37m-membership-scam">Keppel Club</a>
    - Employees created 1,280 fake memberships, sold them, and retained all profits
    - $37.5M from June 1 to August 1, 2014
- <a href="http://eresources.nlb.gov.sg/infopedia/articles/SIP_422_2005-01-25.html">Asia Pacific Breweries (Chia Teck Leng)</a>
    - Forged documents from 1999 to 2003 to obtain $117M from 4 banks
        - To fund gambling addiction
    - 42 year jail sentence

## Fraud triangle  {data-background="../Backgrounds/default.jpg" class="default"}

<div class="clearfix">
<div class="left">
- Opportunity
    - Hole in the control system
    - Profitably exploitable
- Rationalization
    - Resentment of corporation
    - Poor culture
    - "Borrowing"
- Motivation
    - Family needs
    - Maintaining lifestyle
    - Maintaining performance
</div>
<div class="left">
<img src="../Figures/3legs_fraud.png" style="max-height:350px">
</div>
</div>

> Need all 3 for fraud to happen

# Control Systems {data-background="../Backgrounds/section.jpg" class="default"}

## Systems {data-background="../Backgrounds/neural-net.jpg" class="default"}

- 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 {data-background="../Backgrounds/default.jpg" class="default"}

- 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 {data-background="../Backgrounds/default.jpg" class="default"}

- 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 {data-background="../Backgrounds/default.jpg" class="default"}

- 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 {data-background="../Backgrounds/review.jpg" class="default"}

> - How would we control car quality?
>     - Prevention
>         - <span class="exclude">Purchase materials from trustworthy suppliers</span>
>     - Detection
>         - <span class="exclude">Point inspections on finished cars</span>
>     - Correction
>         - <span class="exclude">Recalls</span>


## Champaign Parking Enforcement {data-background-image="../Backgrounds/case.jpg" class="default present-only"}

<img src="../Figures/Parking_ticket.gif">

## Champaign Parking Enforcement {data-background-image="../Backgrounds/case.jpg" class="default"}

<div class="left">
**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
</div>
<div class="right">
**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?

<img src="../Figures/Parking_Meter.jpg" style="width:30%;margin:0px">
</div>

# Cash reconciliation {data-background="../Backgrounds/section.jpg" class="default"}

## Cash on companies' books {data-background-image="../Backgrounds/coins.jpg" class="default"}

<div class="clearfix">
<div class="left">
Documents:

- Purchase orders
- Invoices for purchases/sales
- Checks
- Payment records
- Petty cash
    - Small amount set aside for **small** purchases
</div>
<div class="right">
<img src="../Diagrams/Cash_post.png" style="max-width:420px">
</div>
</div>

## Cash in the bank {data-background-image="../Backgrounds/coins.jpg" class="default"}

<div class="clearfix">
<div class="left">
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
</div>
<div class="right">
<img src="../Diagrams/Cash_bank.png" style="max-width:420px">
</div>
</div>

## Inconsistencies between cash records {data-background-image="../Backgrounds/default.jpg" class="default"}

- 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 {data-background-image="../Backgrounds/reference.jpg" class="default"}

<img src="../Diagrams/Bank_rec.png" style="max-width:800px">

## Journal entries to record {data-background-image="../Backgrounds/reference.jpg" class="default"}

<div class="clearfix">
<div class="left">
**Cash up**: DR cash, CR...

- Dividends received:
    - *Dividend revenue*
- EFT from customer:
    - *A/R*
- Interest from bank:
    - *Interest revenue*
- Prepayment:
    - *Unearned revenue*
</div>
<div class="right">
**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
</div>
</div>

## Reconciliation example {data-background-image="../Backgrounds/default.jpg" class="default"}

<img src="../Diagrams/Bank_rec_ex.png" style="max-width:800px">

## Practice bank reconciliation {data-background-image="../Backgrounds/group.jpg" class="default"}

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 {data-background="../Backgrounds/section.jpg" class="default"}

## Why have uncollectible accounts? {data-background-image="../Backgrounds/case.jpg" class="default"}

- Case: Hanjin shipping
- Read: <a href="https://www.theguardian.com/business/2016/sep/02/hanjin-shipping-bankruptcy-causes-turmoil-in-global-sea-freight">rmc.link/101class4</a>

<img src="../Figures/Hanjin.png" max-height="200px"/>

## What happened at Hanjin Shipping? {data-background-image="../Backgrounds/case.jpg" class="default exclude"}

- Low on cash
- Ports didn't think they would get paid back by Hanjin
- *Tons of products stuck in ports...*
    - Such as the School of Law's writing boards for class rooms when it opened
- <a href="http://arstechnica.com/gadgets/2016/09/hanjin-bankruptcy-could-mean-price-spikes-for-tvs-cars-other-large-products/" data-preview-link>Shipping rates went up 55%</a>

> In other words, unexpected events happen

## Accounting for unexpected events {data-background-image="../Backgrounds/default.jpg" class="default"}
- Companies can go bankrupt, forget to pay, or breach contracts
- Two approaches:

<div class="clearfix">
<div class="left">
**Allowance method**

- Estimate decrease in asset values beforehand
- *Allowance for uncollectible accounts*
    - Contra asset
- *Bad debt expense*
</div>
<div class="right">
**Direct write-off method**

- Write-off when the loss is guaranteed
- Violates the matching principal
</div>
</div>

> We will use the allowance method (as does IFRS)

## A/R allowance process {data-background-image="../Backgrounds/reference.jpg" class="default"}

<img src="../Diagrams/AR_Allow.png" style="width:80%">

## A/R allowances example {data-background-image="../Backgrounds/default.jpg" class="default"}

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

<img src="../Diagrams/AR_Example_1.png" style="max-width:600px">

- What should our allowance be?

## A/R allowances example {data-background-image="../Backgrounds/default.jpg" class="default"}

<img src="../Diagrams/AR_Example_1-Sol.png" style="width:60%">

## A/R allowances example: Going concern {data-background-image="../Backgrounds/default.jpg" class="default"}

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

<img src="../Diagrams/AR_Example_2.png" style="width:60%">

## A/R allowances example: Going concern {data-background-image="../Backgrounds/default.jpg" class="default"}

<img src="../Diagrams/AR_Example_2-Sol.png" style="width:55%">

## A/R allowances example: Journal entries {data-background-image="../Backgrounds/default.jpg" class="default"}

<img src="../Diagrams/JE_4-1.png" style="width:70%">

<img src="../Diagrams/JE_4-2.png" style="width:70%">

<img src="../Diagrams/JE_4-3.png" style="width:70%">

## A/R allowances example: Bankruptcy {data-background-image="../Backgrounds/default.jpg" class="default"}

- *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.

<img src="../Diagrams/JE_4-4.png" style="max-width:650px">

## Practice for A/R {data-background-image="../Backgrounds/group.jpg" class="default"}

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 {data-background="../Backgrounds/section.jpg" class="default"}

## For next week {data-background="../Backgrounds/ending.jpg" class="default"}

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
- Survey on the class session at <a href="https://docs.google.com/forms/d/e/1FAIpQLSeGLB3VjwvP_sm9jRGOSr74bLey61oNfmxvm0gGyJWbZ8-8DQ/viewform?usp=sf_link">rmc.link/101survey4</a>


## Quiz resources {data-background="../Backgrounds/ending.jpg" class="default"}

- 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

## NOTES {class="never"}

- Consider switching the final activity to have Bad Debt Expense first, and gain on re-estimation second
