Transcript Document

CHAPTER 2
Accounting and accountants
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Contents
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Accounting function
Accounting database
Recording transactions
Organization of data within the general ledger
Control and audit
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Internal control
Internal audit
External audit
Corporate governance
Accounting profession
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Accounting function
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Financial accounting system: objectives
and scope
Uniform accounting procedures
Functional transaction processing
systems
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© 2005 Peter Walton and Walter Aerts
Financial accounting system
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Objectives:
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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
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Highly dependent on the size of the company
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© 2005 Peter Walton and Walter Aerts
Decision
makers
Business
transactions
Information
Data
Tracking and
recording
of data
Processing
of data
Reporting
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Uniform accounting procedures
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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
France
Group
financial
statements
Parent /
holding
company
(Germany)
Uniform
accounting
rules
Italy
Netherlands
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Local tax
accounts
Functional transaction processing
systems
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Functional systems capture different types of
transactions according to their main features, like
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Sales
Purchases
Payroll
Treasury
Investment in long-term capacity
Transaction processing implies interactions between
the accounting function and operating departments
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Accounting database
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General Ledger = central accounting
database
Primary source of information for
internal (management) and external
reporting purposes
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Figure 2.2 The financial accounting
database
Register of
amounts owed
to suppliers
Salaries and
social charges
Goods received
from suppliers
Other business
expenses
Bank account
cash in and out
Register of
debts owed by
clients
Sale of goods
to clients
General Ledger
Finance from
shareholders
and banks
Purchase of
long-term
assets
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© 2005 Peter Walton and Walter Aerts
Reports
to
management and
outsiders
Recording transactions
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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
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© 2005 Peter Walton and Walter Aerts
Fig. 2.3 Building aggregates
(invoices, payments,
receipts, expense
notes, etc.)
Daily
transactions
prepared by week
(or month) and
by type of transaction
total entered into
Summaries
Summaries
General Ledger
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© 2005 Peter Walton and Walter Aerts
Recording transactions (cont.)
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‘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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© 2005 Peter Walton and Walter Aerts
Recording transactions (cont.)
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‘Audit trail’
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‘Chart of accounts’
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Traces the content of aggregates back to transaction details
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)
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Automated, flexible reporting tools
Using specific tags of individual data items, defined and
linked through flexible taxonomies
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© 2005 Peter Walton and Walter Aerts
Organization of data within the
general ledger (G/L)
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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:
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Two columns for figures: debits and credits
Narrative commentary
Cross-referencing details
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© 2005 Peter Walton and Walter Aerts
Control and audit
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Internal control
Internal audit
External audit
Corporate governance
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© 2005 Peter Walton and Walter Aerts
Internal control
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Defining internal control
Components of a system of internal
control
Control activities
 Preventive
controls
 Detective controls
 Corrective controls
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© 2005 Peter Walton and Walter Aerts
Defining internal control
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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.
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© 2005 Peter Walton and Walter Aerts
Internal control objectives (COSO)
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Sustaining the company’s business
operations (efficiency and effectiveness
concerns)
Preparing reliable financial reporting
(including financial statements)
Compliance with applicable laws and
regulations
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© 2005 Peter Walton and Walter Aerts
Components of a system of internal
control (COSO)
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A system of internal control consists of five
interrelated components:
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Control environment
Risk assessment
Control activities
Information and communication
Monitoring
Each component is relevant for each internal
control objective
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Components of a system of
internal control
Monitoring
Information &
Risk
Control
assessment
activities
Communication
Control
environment
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IC system components (COSO
extracts)
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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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IC system components (cont.)
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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.
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© 2005 Peter Walton and Walter Aerts
IC system components (cont.)
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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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IC system components (cont.)
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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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IC system components (cont.)
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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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Control activities
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Control activities usually involve a policy component
and a procedure component
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Policy: establishes what should be done
Procedure: actions necessary to implement a policy
Classification of control activities:
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Separation of functions
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Separation of functions (“segregation of duties”) as a
preventive control measure
It calls for the separation of the four basic functions
of transaction processing
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Authorizing transactions
Executing transactions
Recording transactions
Safeguarding resources resulting from consummating
transactions
The objective is mainly to provide an environment
where fraud becomes difficult
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Internal audit process
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Primary task:
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Independence of internal audit
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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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© 2005 Peter Walton and Walter Aerts
Internal audit – Hierarchical position (1)
CEO
Production manager
Marketing manager
...
Accounting
CFO
Treasury
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© 2005 Peter Walton and Walter Aerts
...
Internal
Audit
Internal audit – Hierarchical position (2)
CEO
Internal
Audit
Production manager
Marketing manager
...
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© 2005 Peter Walton and Walter Aerts
CFO
Internal audit – Hierarchical position (3)
General assembly
Board of directors
Audit committee
Management
committee
CEO
Internal audit
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Institute of Internal Auditors (IIA)
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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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© 2005 Peter Walton and Walter Aerts
Standards for the Professional Practice
of Auditing
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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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© 2005 Peter Walton and Walter Aerts
External audit
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External audit = independent audit of a company’s
financial statements carried out by external auditors
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
External auditors
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Largest four international networks of
external auditors:
 PricewaterhouseCoopers
(PwC)
 KPMG
 Ernst
& Young
 Deloitte
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These “Big Four” dominate the audit
market for multinational companies
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Basic statutory audit tasks
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The basic statutory audit consists of two
tasks:
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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
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© 2005 Peter Walton and Walter Aerts
Report of the external auditor
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The external auditor signs a public report
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a standard attestation regarding the
representational fairness of the financial
statements
The public report may be accompanied by a
‘management letter’
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Directed to company management (not published)
Comments on the audit findings, highlights
potential areas of weakness and makes
recommendations
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© 2005 Peter Walton and Walter Aerts
Corporate governance
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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
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© 2005 Peter Walton and Walter Aerts
Corporate governance
recommendations
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Chairman of the Board of Directors (BOD)
should not be the CEO
Appointment of independent or non-executive
directors
BOD committees with independent directors :
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Compensation committee
Audit committee
Nomination committee
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© 2005 Peter Walton and Walter Aerts
Accounting profession
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Main categories of accounting professionals:
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Independent auditor
Independent accountant
Company accountant
Independent auditor
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Accounting profession (cont.)
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Independent accountant
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External professionals offering accounting services
to (generally small) companies
May also provide tax and general consulting
services, but not statutory audit services
Company accountant
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Internal accounting specialists, but not necessarily
governed by a professional organization
No formal educational prerequisites
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts