CHAPTER%202%20Accounting%20and%20accountants

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CHAPTER 2Accounting and accountants
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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

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Accounting function

• Financial accounting system objectives and scope
• Uniform accounting procedures
• Functional transaction processing systems

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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

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Decision makers
Business transactions
Information
Data
Financial accounting system
Tracking and recording of data
Processing of data
Reporting
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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

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

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Accounting database

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

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Figure 2.2 The financial accounting database
Register of amounts owed to suppliers
Salaries and social charges
Goods received from suppliers
Reports to manage-ment and outsiders
Other business expenses
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
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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 years activities

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

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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

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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

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Control and audit

• Internal control
• Internal audit
• External audit
• Corporate governance

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Internal control

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

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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
  companys operations
• b) The reliability of its financial reporting
• c) Its compliance with applicable laws and
  regulations.

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Internal control objectives (COSO)

• Sustaining the companys business operations
  (efficiency and effectiveness concerns)
• Preparing reliable financial reporting (including
  financial statements)
• Compliance with applicable laws and regulations

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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

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Components of a system of internal control
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IC system components (COSO extracts)

• Control EnvironmentThe 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.

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IC system components (cont.)

• Risk AssessmentEvery 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.

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IC system components (cont.)

• Control ActivitiesControl 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.

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IC system components (cont.)

• Information and CommunicationPertinent
  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.

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IC system components (cont.)

• MonitoringInternal 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.

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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 PP designed to prevent an
  error or fraud from occurring
• Detective controls PP designed to detect an
  error or fraud as soon as posible
• Corrective controls PP to correct problems in a
  timely manner

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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

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Defining internal audit

• Internal auditing is an independent, objective
  assurance and consulting activity designed to add
  value and improve an organisations 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

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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

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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

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Internal audit Hierarchical position (1)
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Internal audit Hierarchical position (2)
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Internal audit Hierarchical position (3)
General assembly
Board of directors
Audit committee
Management committee
CEO
Internal audit
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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

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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

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External audit

• External audit independent audit of a companys
  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 companys financial position and
  performance

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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

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Basic statutory audit tasks

• The basic statutory audit consists of two tasks
• To check that the accounting database effectively
  picks up all the companys 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 companys
  real state

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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

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Corporate governance

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

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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

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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

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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