Presentation on theme: "CHAPTER 2 Accounting and accountants. Contents Accounting function Accounting database Recording transactions Organization of data within the."— Presentation transcript:
CHAPTER 2 Accounting and accountants
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
Accounting function Financial accounting system: objectives and scope Uniform accounting procedures Functional transaction processing systems
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
Tracking and recording of data Processing of data Reporting Decision makers Business transactions Financial accounting system Data Information
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
Fig. 2.1 Group reporting flows Group financial statements Uniform accounting rules Parent / holding company SubsidiariesLocal tax accounts France Italy Nether- lands (Germany)
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
Accounting database General Ledger = central accounting database Primary source of information for internal (management) and external reporting purposes
Figure 2.2 The financial accounting database Other business expenses Register of amounts owed to suppliers Salaries and social charges Finance from shareholders and banks Bank account cash in and out Register of debts owed by clients Purchase of long-term assets General Ledger Sale of goods to clients Goods received from suppliers Reports to manage- ment and outsiders
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
Fig. 2.3 Building aggregates General Ledger prepared by week (or month) and by type of transaction (invoices, payments, receipts, expense notes, etc.) Summaries Daily transactions total entered into
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
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
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
Control and audit Internal control Internal audit External audit Corporate governance
Internal control Defining internal control Components of a system of internal control Control activities Preventive controls Detective controls Corrective controls
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.
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
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
Components of a system of internal control
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.
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.
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.
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.
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.
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
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
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
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
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
Internal audit – Hierarchical position (1) CEO Production manager Marketing manager...CFO AccountingTreasury... Internal Audit
Internal audit – Hierarchical position (2) CEO Production manager Marketing manager...CFO Internal Audit
Internal audit – Hierarchical position (3) General assembly Board of directors Management committee Audit committee CEOInternal audit
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”
Standards for the Professional Practice of Auditing Attribute standards 1000 - Purpose, Authority, and Responsibility 1100 - Independence and Objectivity 1200 - Proficiency and Due Professional Care 1300 - 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
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
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
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
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
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
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
Accounting profession Main categories of accounting professionals: Independent auditor Independent accountant Company accountant Independent auditor 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
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