Lecture 05 POST-Lecture Slides

ACCOUNTING
The language of the business world
ACC 1701 / ACC1002

Accounting for Decision Makers/ Financial Accounting
Lecturer: Dr. Hanny Kusnadi
Prior Lecture Refresher
▪ Preparing Financial Statements using Adjusted
Trial Balance
▪ Income Statement
▪ Statement of Changes in Equity
▪ Statement of Financial Position
▪ Closing the books
▪ Close temporary accounts (revenues, expenses,
gains, loss and dividends) to Retained Earnings.
▪ Prepare post-closing Trial Balance
▪ Current Ratio
Refresh your memory!
ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 2

Chapter 07
Cash and Internal Controls

Goals for Today
▪ What is Fraud?
Concepts ▪ Purpose of Internal Control
Accounting ▪ Internal control for cash receipts and

Procedures disbursements
▪ Bank Reconciliation
Financial Analysis ▪ Days' Sales Uncollected

What is Fraud?
Fraud is generally defined as an attempt to deceive others for personal gain.
Corruption Misusing one’s position for inappropriate personal gain.
Asset
Theft (embezzlement) of company resources
Misappropriation
Financial Statement Misreporting amounts in the financial statements

Fraud to portray more favorable financial results.

The Fraud Triangle
• Employee has means to commit • Justification of action as

the fraud unavoidable/necessary.
• Weak internal control presents • Personal feeling of entitlement
opportunities outweighs moral principles
• Pressure to meet financial, personal, societal goals/expectations

• eg. loan covenants, maintain stock price, attract investors
Internal Control System
Internal control refers to policies and procedures designed to:
Properly Ensures Promotes Urge adherence

account for and reliable and efficient to company
safeguard assets accurate operations policies &
financial compliance
records with laws and
regulation

Principles of Internal Control
(1) Establish responsibilities.
• Assign each task to one employee
• Eg. Giving separate cash register to each cashier at the beginning of the shift.
(2) Maintain adequate records.
▪ Good recordkeeping helps protect assets and ensures that employees use
prescribed procedures.
▪ Eg. Paying suppliers using prenumbered checks and digitally documented
electronic fund transfers.
(3) Insure assets and bond key employees.
▪ Insuring assets against casualty and theft
▪ Eg. Independent third party comes to investigate any reported theft or loss and
will be less likely to side with the employee involved in fraud

(4) Separate recordkeeping from custody of assets.
▪ A person who controls or has access to an asset must not keep that asset’s
accounting records.
▪ Eg. Warehouse manager controlling inventory should not have
access to the inventory accounting records
(5) Divide responsibility for related transactions.
▪ Do not make one party responsible for all parts of the process
▪ Eg. Employee in charge of purchasing from supplier do not approve payments to
the suppliers.
(6) Apply technological controls.
▪ Use technology to improve effectiveness of controls
▪ E,g, Electronic cash registers with direct recording of sales transactions, personal
identification scanners to control access.
(7) Perform regular and independent reviews.
▪ Check others’ work.
▪ Frequent reviews of procedures to evaluate effectiveness and promote adherence
▪ Eg. Supervisor reviews subordinate’s work
▪ Eg. Internal auditors not directly involved in the
activities being audited gives impartial perspective and
provides check
▪ Eg. External auditors independent of the company
provides assurance of financial statements

Technology and Internal Control
As long as software and data More Analyzing large
Reduced
entry are correct, mechanical database allows for
Processing and mathematical errors will Extensive Testing more extensive
Errors greatly be reduced. of Records testing.
Technology may cause

Systems can help control Crucial consolidation of job
Digital Evidence access and capture more functions and reduced
Separation of
of Processing information digitally. workforce, make
Duties
separation of duties
more challenging.
Increased Cyber security issues becomes
increasingly important. (eg. data
E-Commerce
theft, computer viruses, hacking)

Limitation of Internal Control
Internal controls can never completely prevent and detect errors
and fraud.
Human error • Human error: negligence, fatigue, mis-judgement,

confusion, carelessness
or • Human fraud: Intent to defeat internal control or collude
Human fraud for person gain
• Companies can only implement internal controls if the

Costs must benefits outweigh the costs
not exceed • Eg. Eliminate shoplifting (benefits) by body searching
benefits every customer, but such an irritating policy would
drive customers away (costs from loss of sales).

Control of CASH
Cash is the most susceptible to theft and fraud.
Internal control of cash is essential, and an effective system that protects cash should
meet these guidelines:
(1) Separation of duties
▪ Complete separation of cash receipts functions and cash
disbursement function.
▪ E.g. person receiving cash should be different from person
disbursing cash
(2) Effective prescribed policies & procedures
▪ Proper cash handling procedure - Cash receipts are promptly
deposited in the bank
▪ Separate approval of purchases & actual cash payments
▪ Cash disbursement by check with different individuals for
approval and check-signing
Cash, Cash Equivalents, and Liquidity
Cash and similar assets are called liquid assets because
they can be readily used to settle near-term obligations.
Cash
Currency, coins and amounts on deposit in bank accounts, checking
accounts, and some savings accounts. Also includes items such as
customer checks, cashier checks, certified checks, and money
orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to known amounts of cash.
2. Subject to an insignificant risk of changes in value.

Cash Management
The goals of cash management are twofold:
1. Plan cash receipts to meet cash payments when due.
2. Keep a minimum level of cash necessary to operate.
Effective cash management involves applying the following

cash management principles:
▪ Encourage collection of receivables.
▪ Delay payment of liabilities.
▪ Keep only necessary levels of assets.
▪ Plan expenditures.
▪ Invest excess cash.

Controls for Cash Receipts
Business can receive cash in two different ways:
Receive cash in Receive cash

person at remotely
time of sale • mail
• Electronically
The primary internal control goal for cash receipts is to ensure

that the business receives the appropriate amount of cash and
safely deposits it in the bank.

Cash Receipts from Over-the-Counter
SEGREGATION OF DUTIES
Sales Clerk Supervisor Accounting

• Scan items and record • Verify cash in register • Verify bank deposit slip
sales on cash register. with cash count sheet with register records
• Collect payment from • Store cash (before bank • Prepare journal entries
customer and provide deposit) into the accounting
receipt to customer. system
• Complete bank deposit
• Prepare cash count sheet of cash.
at the end of shift

Over-the-Counter Cash Receipts
P1
Cash Over and Short
Difference between the cash in the cash register and the record of cash receipts.
Cash Short: According to the sales register records, total sales = $1,000. But cash
deposit slip is for $980. There is a shortage of $20.
Cash $ 980
Cash Over & Short $ 20
Sales Revenue $1,000
Cash Over: According to the sales register records, total sales = $1,000. But cash
deposit slip is for $1,050. Cash is over by $50.
Cash $ 1,050
Cash Over & Short $ 50
Sales Revenue $1,000
▪ Unless the discrepancy is material, “Cash Over & Short” will typically be reported as
Miscellaneous Revenue/Expense on the Income Statement.
Cash Receipts Remotely
(Mail / Electronically)
SEGREGATION OF DUTIES
Clerk Cashier/Supervisor Accounting

• Receive checks in mail • Verify cash/checks • Verify bank deposit with list
from clerk
• Prepare list of • Deposit to bank
cash/checks received • For electronic remittance,
(one copy to Cashier, verify amount with bank
one to Accounting, one records.
for Clerk record)
• Prepare journal entries into
the accounting system

Controls for Cash Payments
Control of cash disbursements is especially important as most large thefts
occur from payment of fictitious invoices.
Require all expenditures to be made by check
Limit access to checks except for those who have the

authority to sign checks.
The primary goal of internal controls for all cash payments is to

ensure that the business pays only for properly authorized
transactions.

Control of Cash Disbursements
Voucher System
Voucher System establishes procedures for:
. ▪ Verifying, approving, and recording obligations for eventual cash disbursements.
▪ Issuing checks for payment of verified, approved, and recorded obligations.

Control of Cash Disbursements
Voucher System (continued)
.
EFT = Electronic Funds Transfer

Controls from Bank Procedures
Banks provide important services that help businesses to control cash:
• Restricting access
• Documenting procedures
• Independently verifying
Basic Bank Services:
Bank Accounts Signature Cards Deposit Tickets
Electronic Bank
Checks
Funds Transfer Statements

C2
Bank Statement
Usually once a month, the bank sends
each depositor a bank statement
showing the activity in the account:
(A) Summarize changed in the account
(B) Summarize checks paid and other

debits (withdrawals)
(C) Summarize deposits and other

credits
(D) Summarize the daily account

balance

Bank Reconciliation
A bank reconciliation is an internal report prepared
to verify the accuracy of both the bank statement and
the cash accounts of a business or individual.

Bank Reconciliation
Your Bank May Not Know About You May Not Know About
1. Errors made by the bank 3. Interest that the bank has put into
2. Time lags your account (interest income)
a) Deposits that you made 4. Service charges taken out of your
recently (deposit in transit) account (fees and charges)
b) Checks that you wrote recently 5. Electronic funds transfers (EFTs)
(outstanding checks) 6. Customer checks you deposited
for which the customer did not
have sufficient funds (NSF)
7. Errors made by you

Bank Reconciliation Example
Adjusting the Bank side
We follow 9 step in preparing a bank reconciliation:
(1) Cash Balance per Bank
(2) + Deposits in Transit
(3) - Outstanding Checks
+/- Errors
(4) Adjusted Cash Balance

Adjusting the Book side
(5) Cash Balance per Book
(6) + Collections & Interest
(7) - Uncollectible items & fees
+/- Errors
(8) Adjusted Cash Balance

Adjusted Bank = Adjusted Book
(9) Adjusted Bank Balance = Adjusted Book Balance

Bank Reconciliation
Adjusting Entries for the Books
After performing your bank reconciliation, you need to record adjusting entries
for the reconciling items on the book side of the reconciliation:
EFT received from customer
and related bank service
charge:
Interest Revenue:
Miscellaneous bank charges:
Customer (T.Woods) check

rejected as NSF plus the
service fee of $10:

Financial Analysis
▪ What is Fraud?
Concepts ▪ Purpose of Internal Control
Accounting ▪ Internal control for cash receipts and

Procedures disbursements
Financial Analysis ▪ Days’ Sales Uncollected

Assessing Liquidity & Efficiency
Days’ Sales Uncollected
Days’ Sales = Average Accounts Receivable*

x 365
Uncollected Net Sales
▪ Measures how many days on average it takes the company to collect on its accounts
receivables and convert it to cash.
▪ Recall that liquidity refers to how easily an asset can be converted to cash.
▪ Also known as “Days to Collect AR”
▪ Useful to assess how efficient a company is in collecting is receivables
▪ Shorter days is preferred: indicate faster conversion to cash
*Note: sometimes this ratio is calculated using only Ending AR balance instead of average.
An example: ComfortDelGro
ComfortDelGro 2019 2018

Average Trade Receivables 297.1 263.0
Net Sales 3,905.7 3,805.2
Days’ Sales Uncollected 27.76 25.23

ComfortDelGro vs Uber
Let’s compare ComfortDelGro with its competitor Uber:
ComfortDelGro 2019 2018 Uber 2019 2018

Average Trade Receivables 297.1 263.0 Average Trade Receivables 1,066.5 919
Net Sales 3,905.7 3,805.2 Net Sales 14,147 11,270
Days’ Sales Uncollected 27.76 25.23 Days’ Sales Uncollected 27.52 29.76
▪ Uber’s Days Sales Uncollected is comparable to ComfortDelGro.

▪ Both are within a month (30 days).

Take Away for Lecture 05
▪ Purpose of Internal Control
▪ Internal Control
▪ Cash Receipts Over-the-Counter
▪ Cash Receipts Remotely
▪ Cash Disbursements
▪ Days’ Sales Uncollected

Supplementary General Business Knowledge
Note:
The information in the following slides are general business
knowledge to broaden your horizon on accounting issues.
If time permits, I will cover them in the lecture.
They are not from the textbook and will not be examinable.

Accounting Scandals
Depending on how much time we have, we might discuss the following
(but not limited to) issues:
▪ Ways that companies can manipulate the books
▪ Cash Flow Hocus Pocus
▪ Interesting cases of cash flow manipulation
▪ Infamous Accounting Frauds Case Studies
▪ Enron (2001)
▪ Satyam (2009)
▪ Wirecard (2020)

Why companies “cook” the books?
▪Firms and individuals have incentives to manage reported financial
statement in a variety of settings:
▪ To look good to investors & other stakeholders (e.g. customers,
suppliers)
▪ To reach management bonus thresholds
▪ To meet financial analysts’ expectations
▪ To look good for an IPO or a bank loan
▪ To avoid reporting a loss
▪ To appear less risky
▪ To cover up mistakes

How do companies “cook” the books?
Common ways companies manipulate the books:
▪ Manipulating revenues
▪ Improper recognition
▪ Fake/fictitious revenues
▪ Through improper transactions, typically with related parties
▪ Channel stuffing
▪ Manipulating estimates
▪ Inappropriate methodologies (eg. depreciation, write-offs)
▪ Manipulating expenses
▪ Improper capitalization of expenses
▪ Manipulating cash flow
▪ Manipulating weak internal controls
To recognize or not to recognize:
Cases of revenue recognition gimmicks
Xerox (2002): fined $10m by SEC
▪ Improperly classify short-term equipment rentals as long term leases , resulting in
accelerated revenue recognition. Also stored revenue off the balance sheet in a
“cookie jar” and released it strategically to boost earnings.
Nortel Networks (2007): fined $35m by SEC
▪ Fraudulently accelerated revenue in 2000 to meet targets. Also maintained a “cookie
jar” and used it to turn 2003 loss into profit, allowing large bonuses to be paid to
senior executives.
GROUPON (2011): SEC forced it to restate earnings for years 2009-2011 before IPO
▪ Groupon recognizes revenue from the entire price of a deal, then report cost of
goods sold for the portion it pays to the supplier. E.g. If a deal is sold for $100, even
though Groupon only keeps $10 of it as commission, it reports the full $100 as its
revenue, thus inflating its sales revenue! (And $90 as cost of sales)

Cash Flow Hocus Pocus
Interesting Cases of Cash Flow Manipulation
▪ Cash is tangible, so surely it cannot be manipulated?
Think again!
▪ CASE 1: Netflix (Misclassifying Inventory Purchases)
▪ When Netflix first started, its business was in renting out DVDs to customers by
mail.
▪ For years, Netflix has treated its purchase of DVDs -- the essential inventory of its
business -- as an investing outflow, rather than an operating outflow.
▪ This is especially curious, because most of Netflix's new DVDs are amortized over
a period of just one year.
▪ Netflix's accounting treatment provides a big boost for its operating cash flows.
▪ Red Flag: Always question large investing outflows when they appear to be part of
a company's normal cost of operations.

Cash Flow Hocus Pocus
Interesting Cases of Cash Flow Manipulation
▪ CASE 2: Oxford Industries (Securitizations)
▪ Oxford Industries, an Atlanta apparel company, doubled its CFO in 2001 from the
year before to $74.4 million.
▪ Biggest boost to CFO came from a massive decline in Accounts Receivable.
▪ Did its customers all suddenly pay up? NO! Oxford actually sold $80.5 million of its
receivables, or what we call “securitization” of receivables, to third parties.
▪ Red Flag: Watch out for companies that starts or steps up securitization programs! It
can create the impression that CFO that year is really better than it is.

The poster child of accounting scandal:
ENRON
▪ Houston-based energy giant – 7th largest company in the U.S in 2001.
Largest seller/buyer of natural gas and electricity with reported $100
billion revenues.
▪ Investigated in 2001 by SEC. Went bankrupt with US$74 billion in
losses. All its employee retirement accounts wiped out!
▪ Major Perpetrators:
▪ Ken Lay (Chairman/CEO) – died before sentencing in 2006.
▪ Jeff Skilling (CEO) – served 12 years in federal prison,
recently released in Feb 2019.
▪ Andrew Fastow (CFO) – served 6 years in prison
▪ Arthur Anderson (Auditors) – the accounting firm collapsed
following Enron scandal.
▪ Stock analysts? – who kept pushing Enron stock up
The poster child of accounting scandal:
ENRON
Through various complex and dubious accounting schemes, Enron managed to:
▪ Inflate income and profit
▪ Using long –term energy contracts to recognize future inflow as revenues causing
massive inflation in non-existent revenues
▪ Hide losses and debts in off-balance sheet subsidiaries
▪ Using complex SPEs (special purpose entities) to engage in fraudulent transactions
and hide debts and losses from Enron’s Balance Sheet.
▪ It created more than 500 SPEs and thousands of dubious partnerships.
▪ Inflate stock price and credit ratings (maintaining its credit rating is vital in keeping
stock price high)
▪ Funnel funds to personal parties (themselves, family, friends)
▪ Fraudulently misrepresent Enron’s financial performance in public reports
▪ Reduce tax payments
A tangled web of lies and deceit:
ENRON
SPEs Illustration: • $$ / Note (Assets up)
• Bad Assets removed from books
• $$$$$ (Assets up)
Other • Report INCOME from sales of “assets”
Investor $$ / Note • NO DEBT on Enron books!
(min 3%)
$$$$$
Enron $$ / Note
Enron
stock $$$$$ stock
SPE#3 SPE#4
Bad Assets
$$$$$
SPE#1 SPE#2
Enron stock $$$$$ $$ $$
as collateral $$$$$
• Enron stock as equity
• DEBT
• Cash funneled to Enron
“Outside”
Enron stock Investor
as collateral (min 3%)
And it goes on and on….

Now you see it , now you don’t! Where did the $$ go?
SATYAM
▪ Indian IT services company – World Economic Forum named it one of
the 100 most pioneering tech company in 2000
▪ Listed in NYSE in 2001, with over 50k employees by 2008
▪ In Dec 2008, a botched acquisition attempt of Maytas triggered chain of
events that led to Founder-Chairman Raju confessing in Jan 2009 that the
company’s accounts were falsified for many years.
▪ Major Perpetrators:
▪ B. Ramalinga Raju (Founder/Chairman)
▪ B. Rama Raju (Brother/ Managing Dir.)
▪ V Srinivas (CFO)
▪ PWC (Auditor)
▪ Most of the perpetrators only got 7 years imprisonment!
Now you see it , now you don’t! Where did the $$ go?
SATYAM
Accounting scam of US$1.5 billion:
▪ Inflating revenues through false sales invoices
▪ Forging bank documents to show non-existent cash deposits.
▪ Funds funneled to Raju and his family members:
▪ Family-controlled firms Maytas Properties and Maytas
Infrastructures bought massive land and property
▪ 356 investment companies controlled by Raju family members
were allegedly used to divert funds
▪ 13,000 fake non-existent employees used to embezzle funds
▪ In Dec 2008, Satyam tried to acquire Maytas (in an attempt to fill the gap in “fake”
assets) but investors reacted negatively to the announced deal, questioned the nature
of the related party transaction and its stocks plummeted.

Fresh off the stove: WireCard (June 2020)
€3.5 billion Accounting Scam
▪ WireCard – German payments provider founded in 1999, and once hailed as “Germany
paypal”, declared insolvency in June 2020, owing creditors €3.5 billion.
What do we know so far about the accounting scam:
▪ Fraudulently inflated sales and profits.
▪ €1.9 billion cash “missing” - this is ¼ of its whole balance sheet!
▪ WireCard tried to acquire Deutsche Bank in an attempt to plug its massive fraud. (subject to
clean bill of health by special audit to be performed by KPMG)
▪ For many years, it lied to its auditors EY of large sums of money held in Singapore’s OCBC.
▪ During special audit, it told KPMG that money were transferred out of OCBC to two
Phillippines banks – In its April report, KPMG stated it could not verify the funds.
▪ In June 2020, EY refused to sign off on the annual audit stating €1.9 b cash was “spurious”
▪ WireCard filed for insolvency at the end of June 2020. Investigation is still on-going…
That’s all folks!
See you next week!

(Next week we will be covering Chapter 08 – Receivables)
Post any questions/discussion in the LumiNUS Discussion Forum for Lecture 04.
My email: bizhann@nus.edu.sg

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ACCOUNTING

The language of the business world

ACC 1701 / ACC1002

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 2

Cash and Internal Controls

Accounting ▪ Internal control for cash receipts and

Financial Analysis ▪ Days' Sales Uncollected

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 4

Corruption Misusing one’s position for inappropriate personal gain.

Financial Statement Misreporting amounts in the financial statements

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 5

• Employee has means to commit • Justification of action as

• Pressure to meet financial, personal, societal goals/expectations

Properly Ensures Promotes Urge adherence

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 7

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 8

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 10

Technology may cause

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 11

Human error • Human error: negligence, fatigue, mis-judgement,

• Companies can only implement internal controls if the

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 12

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 14

Effective cash management involves applying the following

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 15

Receive cash in Receive cash

The primary internal control goal for cash receipts is to ensure

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 16

Sales Clerk Supervisor Accounting

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 17

Clerk Cashier/Supervisor Accounting

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 19

Limit access to checks except for those who have the

The primary goal of internal controls for all cash payments is to

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 20

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 21

EFT = Electronic Funds Transfer

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 22

Basic Bank Services:

Bank Accounts Signature Cards Deposit Tickets

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 23

(A) Summarize changed in the account

(B) Summarize checks paid and other

(C) Summarize deposits and other

(D) Summarize the daily account

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 24

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 25

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 26

(1) Cash Balance per Bank

(2) + Deposits in Transit

(3) - Outstanding Checks

(4) Adjusted Cash Balance

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 27

(5) Cash Balance per Book

(6) + Collections & Interest

(7) - Uncollectible items & fees

(8) Adjusted Cash Balance

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 28

(9) Adjusted Bank Balance = Adjusted Book Balance

Miscellaneous bank charges:

Customer (T.Woods) check

ACC 1701/1002 (AY2021S1) LECTURE 05 Post-Slides 30

Accounting ▪ Internal control for cash receipts and