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CHAPTER 2 Accounting and accountants

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1 CHAPTER 2 Accounting and accountants

2 Contents Accounting function Accounting database
Recording transactions Organization of data within the general ledger Control and audit Internal control Internal audit External audit Corporate governance Accounting profession

3 Accounting function Financial accounting system: objectives and scope
Uniform accounting procedures Functional transaction processing systems

4 Financial accounting system
Objectives: Track all economic transactions of the enterprise Record and process them logically in a database Provide reporting tools and formats to communicate information useful to decision makers Scope Highly dependent on the size of the company

5 Financial accounting system
Business transactions Decision makers Information Data Financial accounting system Tracking and recording of data Processing of data Reporting It is also useful to present ‘Accounting’ as an information system which measures, processes and communicates financial info about a company. Accounting measures activities by recording data on these activities for future use. The data are stored until they are retrieved and used so that they get transformed into useful information. This information will be communicated to decision makers via different kinds of reports. Note: Bookkeeping is normally used for the recording of transactions phase. So, essentially, Accounting is the liaison between corporate activities and decision makers. We could say that the input of the info system are data and the output information useful in making decisions.

6 Uniform accounting procedures
Uniform accounting systems are central to the coordination and management of an international group Internal accounting manuals to standardize procedures and interpretation of data Uniform accounting rules (like IFRS) versus national accounting rules

7 Fig. 2.1 Group reporting flows
Subsidiaries Local tax accounts France Group financial statements Parent / holding company Uniform accounting rules Italy (Germany) Nether- lands

8 Functional transaction processing systems
Functional systems capture different types of transactions according to their main features, like Sales Purchases Payroll Treasury Investment in long-term capacity Transaction processing implies interactions between the accounting function and operating departments

9 Accounting database General Ledger = central accounting database
Primary source of information for internal (management) and external reporting purposes

10 Figure 2.2 The financial accounting database
Register of amounts owed to suppliers Salaries and social charges Goods received from suppliers Other business expenses Reports to manage-ment and outsiders General Ledger Bank account cash in and out Finance from shareholders and banks Register of debts owed by clients Purchase of long-term assets Sale of goods to clients

11 Recording transactions
Information flows into the general ledger through several layers of processing Individual (daily) transactions are summarized by period and by type Through summarization aggregates are buit up for the year’s activities

12 Fig. 2.3 Building aggregates
(invoices, payments, receipts, expense notes, etc.) Daily transactions Summaries prepared by week (or month) and by type of transaction General Ledger total entered into

13 Recording transactions (cont.)
‘Journals’ Capture details of individual transactions Used to build up periodic summaries and feed aggregated data into the general ledger May be organized according to functional transaction processing systems ‘General ledger’ Collection of summarized, aggregated transaction data Source for the preparation of periodic income statements and balance sheets

14 Recording transactions (cont.)
‘Audit trail’ Traces the content of aggregates back to transaction details ‘Chart of accounts’ Used to categorize and record transactions within the accounting database according to the double-entry accounting logic State-mandated or voluntary ‘XBRL’ (eXtensible Business Reporting Language) Automated, flexible reporting tools Using specific tags of individual data items, defined and linked through flexible taxonomies

15 Organization of data within the general ledger (G/L)
In the G/L, data are stored according to the ‘double-entry’ system The G/L is organized into a series of ‘accounts’ (cfr. ‘chart of accounts’): data files to record transactions of a particular type Specifics of an account: Two columns for figures: debits and credits Narrative commentary Cross-referencing details

16 Control and audit Internal control Internal audit External audit
Corporate governance

17 Internal control Defining internal control
Components of a system of internal control Control activities Preventive controls Detective controls Corrective controls

18 Defining internal control
Definition of COSO (Committee of Sponsoring Organizations) Internal control is a process, established, operated and monitored by those charged with governance and management of a company, to provide reasonable assurance regarding the achievement of objectives in the following categories: a) The effectiveness and efficiency of the company’s operations; b) The reliability of its financial reporting; c) Its compliance with applicable laws and regulations.

19 Internal control objectives (COSO)
Sustaining the company’s business operations (efficiency and effectiveness concerns) Preparing reliable financial reporting (including financial statements) Compliance with applicable laws and regulations

20 Components of a system of internal control (COSO)
A system of internal control consists of five interrelated components: Control environment Risk assessment Control activities Information and communication Monitoring Each component is relevant for each internal control objective

21 Components of a system of internal control

22 IC system components (COSO extracts)
Control Environment The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. Control environment factors include the integrity, ethical values and competence of the entity's people; management's philosophy and operating style; the way management assigns authority and responsibility, and organizes and develops its people; and the attention and direction provided by the board of directors.

23 IC system components (cont.)
Risk Assessment Every entity faces a variety of risks from external and internal sources that must be assessed. A precondition to risk assessment is establishment of objectives, linked at different levels and internally consistent. Risk assessment is the identification and analysis of relevant risks to achievement of the objectives, forming a basis for determining how the risks should be managed. Because economic, industry, regulatory and operating conditions will continue to change, mechanisms are needed to identify and deal with the special risks associated with change.

24 IC system components (cont.)
Control Activities Control activities are the policies and procedures that help ensure management directives are carried out. They help ensure that necessary actions are taken to address risks to achievement of the entity's objectives. Control activities occur throughout the organization, at all levels and in all functions. They include a range of activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of operating performance, security of assets and segregation of duties.

25 IC system components (cont.)
Information and Communication Pertinent information must be identified, captured and communicated in a form and timeframe that enables people to carry out their responsibilities. Information systems produce reports, containing operational, financial and compliance-related information, that make it possible to run and control the business. They deal not only with internally generated data, but also information about external events, activities and conditions necessary to informed business decision-making and external reporting. Effective communication also must occur in a broader sense, flowing down, across and up the organization. All personnel must receive a clear message from top management that control responsibilities must be taken seriously. They must understand their own role in the internal control system, as well as how individual activities relate to the work of others. They must have a means of communicating significant information upstream. There also needs to be effective communication with external parties, such as customers, suppliers, regulators and shareholders.

26 IC system components (cont.)
Monitoring Internal control systems need to be monitored--a process that assesses the quality of the system's performance over time. This is accomplished through ongoing monitoring activities, separate evaluations or a combination of the two. Ongoing monitoring occurs in the course of operations. It includes regular management and supervisory activities, and other actions personnel take in performing their duties. The scope and frequency of separate evaluations will depend primarily on an assessment of risks and the effectiveness of ongoing monitoring procedures. Internal control deficiencies should be reported upstream, with serious matters reported to top management and the board.

27 Control activities Control activities usually involve a policy component and a procedure component Policy: establishes what should be done Procedure: actions necessary to implement a policy Classification of control activities: Preventive controls: P&P designed to prevent an error or fraud from occurring Detective controls: P&P designed to detect an error or fraud as soon as posible Corrective controls: P&P to correct problems in a timely manner

28 Separation of functions
Separation of functions (“segregation of duties”) as a preventive control measure It calls for the separation of the four basic functions of transaction processing Authorizing transactions Executing transactions Recording transactions Safeguarding resources resulting from consummating transactions The objective is mainly to provide an environment where fraud becomes difficult

29 Defining internal audit
“Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.” Institute of Internal Auditors

30 Internal audit process
Primary task: Examine and evaluate the adequacy and effectiveness of the internal control system Evaluate the quality of performance in carrying out assigned responsibilities Can be considered to be part of the monitoring component of a IC system Its scope potentially covers all activities within the company

31 Independence of internal audit
Independence with regard to the acitivities they audit, is essential for the internal audit function Independence should be assured through: Organizational position and authority within the company Recognition of professional objectivity

32 Internal audit – Hierarchical position (1)
De hiërarchische positie van de interne auditor is zeer belangrijk voor zijn onafhankelijkheid .  1° Onder de directeur administratie en financiën -> deontologische problemen!!  !! De controlebevoegdheid stopt op het niveau waaraan door de interne auditor wordt gerapporteerd !!  Directeur A&F = controleur + gecontroleerde -> conflicten !! Bijvoorbeeld: wanneer er zich een probleem voordoet bij de boekhouding, is het mogelijk dat de directeur een begrijpende, vergoelijkende houding aanneemt !bij problemen bij verantwoordelijken op hetzelfde hiërarchische niveau kan dit leiden tot een vorm van politiek gedrag in functie van doelstellingen die niet noodzakelijk de ondernemingsdoelstellingen zijn. 2° Rechtstreeks bij de directeur-generaal ->staffunctie bij de directeur-generaal  3° Audit-comité bij de Raad van Bestuur = meerdere leden van de Raad van Bestuur zonder operationele bevoegdheden, eventueel aangevuld met externe auditors !noot: alle ondernemingen genoteerd op de New York Stock Exchange moeten een audit-comité hebben, bestaande uit 'outside directors'.  

33 Internal audit – Hierarchical position (2)

34 Internal audit – Hierarchical position (3)
General assembly Board of directors Audit committee Management committee AGFA: zie passages omtrent Corporate Governance Board of Directors Board of Management CEO = Chairman of BoM = Klaus Seeger = CEA of Agfa-Gevaert NV Audit Committee: bestaat uit 2 non-executive directors (Chaffart & Wenning) CEO Internal audit

35 Institute of Internal Auditors (IIA)
As an international professional body, the IIA provides authoritative guidance “Standards for the Professional Practice of Internal Auditing” establish ethical (attribute standards) and practice (performance standards) guidelines Certification programme leading to the designation of “Certified Internal Auditor”

36 Standards for the Professional Practice of Auditing
Attribute standards Purpose, Authority, and Responsibility Independence and Objectivity Proficiency and Due Professional Care Quality Assurance and Improvement Program Performance Standards 2000 Managing the Internal Audit Activity 2100 Nature of Work 2200 Engagement Planning. 2300 Performing the Engagement 2400 Communicating Results 2500 Monitoring Progress 2600 Management's Acceptance of Risks

37 External audit External audit = independent audit of a company’s financial statements carried out by external auditors Also referred to as “statutory audit” The external auditor expresses an opinion on the representational fairness of the financial statements in conformity with generally accepted accounting principles Reassurance for outside stakeholders that the financial statements are a valid representation of the company’s financial position and performance

38 External auditors Largest four international networks of external auditors: PricewaterhouseCoopers (PwC) KPMG Ernst & Young Deloitte These “Big Four” dominate the audit market for multinational companies

39 Basic statutory audit tasks
The basic statutory audit consists of two tasks: To check that the accounting database effectively picks up all the company’s activities and is correct To check that the financial statements are a correct representation of the accounting database, use appropriate accounting policies and are a reasonable representation of the company’s real state

40 Report of the external auditor
The external auditor signs a public report a standard attestation regarding the representational fairness of the financial statements The public report may be accompanied by a ‘management letter’ Directed to company management (not published) Comments on the audit findings, highlights potential areas of weakness and makes recommendations

41 Corporate governance Corporate governance issues arise whenever ownership of a company is separated from its management Central concern = how management’s freedom of action may be limited by outside interests Many countries have specific rules, regulations and guidance on corporate governance

42 Corporate governance recommendations
Chairman of the Board of Directors (BOD) should not be the CEO Appointment of independent or non-executive directors BOD committees with independent directors : Compensation committee Audit committee Nomination committee

43 Accounting profession
Main categories of accounting professionals: Independent auditor Independent accountant Company accountant Specialists licensed to carry out the independent audit required by company law University degree + professional examinations + at least three years as a student in a public auditing firm International variation in nature of scope of statutory audit and in constraints on auditor/client relationship

44 Accounting profession (cont.)
Independent accountant External professionals offering accounting services to (generally small) companies May also provide tax and general consulting services, but not statutory audit services Company accountant Internal accounting specialists, but not necessarily governed by a professional organization No formal educational prerequisites

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