Financial Management for Business Associations

INTERNAL CONTROLS, FRAUDS AND BUDGETS

Thursday May 23, 2013Secretary General Conference

Islamabad, PakistanBy: Malik Mirza, FCCA, ACA, MBA

www.wisdomfrombooks.com

4/27/2012 www.wisdomfrombooks.com

INTRODUCTION

• Facilitator• Objectives• Format for two hours’ session• Conclusion

Facilitator

Malik Mirza

OBJECTIVES

• UNDERSTAND about internal controls• KNOW budgeting techniques to prepare

effective budget

FORMAT

• Case study • Group discussions• Sharing experience• Power point presentation

Who is this man?• New York money

manager Bernard Madoff's $65 billion Ponzi scheme, the largest fraud ever by an individual, was exposed in December 2008 when Madoff, now doing 150 years in prison, confessed to his sons. The case led the SEC, which missed several opportunities to stop the fraud, to focus on Ponzis and investment advisor fraud.

Who is he?• Shortly after the

company was created by the merger of CUC International and HFS in 1997, a massive, decade long accounting fraud at CUC was uncovered. It was estimated to have cost investors at least $19 billion, and was the largest fraud prosecuted by the SEC to that date. Securities class action lawsuits settled later for more than $3 billion. A judge sentenced former chairman Walter Forbes to 12 years and seven months in federal prison and ordered him to pay $3.275 billion in restitution.

Guess who?• The 2002 fraud-induced

bankruptcy of the telecom company wiped out a firm that once had $103.9 billion in assets on its books. The resulting $6.1 billion securities class action lawsuit payout is the second largest since 1995. Former CEO Worldcom Mr. Bernard Ebbers was convicted of fraud and is doing 25 years in federal prison.

Now: Who is this person• In March of 2003, the SEC

accused CEO Richard M. Scrushy of overstating earnings by at least $1.4 billion over four years. Scrushy was acquitted of all charges but later went to jail on a separate charge of bribing Alabama's governor. Fifteen former executives, including all five of its recent CFOs, pleaded guilty to accounting fraud.

Last guess: A good guy?• Qwest's stock traded as

high as $64 in 2000 before plummeting in 2002 to less than $1 because of a multiyear accounting fraud. The SEC and DOJ probe was prompted by a whistleblower letter. CEO Joseph Nacchio forfeited $44 million for insider trading and went to jail. A class action settlement added $400 million to the pot but investors got back pennies on the dollar.

What’s the conclusion after five guesses?

• Frauds do happen• Can it happen at your organization?• If yes, how?• If no, why not?

Case studyMr. Rahim has recently joined the Business chamber of commerce as chief

accountant. The President and Secretary of Chamber have full faith and trust on Mr. Rahim and as a result, Mr. Rahim is all in all in finance.

The President and Secretary of Chamber have authorized Mr. Rahim to:• Finalize rates of transactions with vendors• Receive invoices• Verify invoices• Prepare cheques• Deliver cheques to vendors• Record transactions in the books of account

Case study• There is no further check on Mr. Rahim except for trust of the President and

Secretary. The only oversight by the President and Secretary of the Business chamber is the signature on cheques.

ASSIGNMENT / GROUP DISCUSSION & PRESENTATION• Please consider the above scenario and after discussion in your group, answer the

following:• How can Mr. Rahim conduct fraud or what are two frauds Mr. Rahim can conduct?• What are three suggested internal controls which will help mitigate chances of

fraud at the Business Chamber of Commerce?• Are there any internal controls at your chamber? Please explain three of them• What one internal control do you consider you will implement once you are back

from this session?

14

COSO Definition of Internal Control

Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

• Effectiveness and efficiency of operations

• Reliability of financial reporting

• Compliance with applicable laws and regulations

What do we mean by ‘internal control’?

15

COSO Internal Controls Key Concepts

– Internal control is a process. It is a means to an end, not an end in itself.

– Internal control is effected by people. It’s not merely policy manuals and forms, but people at every level of an organization.

– Internal control can be expected to provide only reasonable assurance, not absolute assurance, to an entity’s management and board.

– Internal control is geared to the achievement of objectives in one or more separate but overlapping categories.

What do we mean by ‘internal control’?

COSO’S FRAMEWORK – THREE DIMENSIONS OF INTERNAL

CONTROL

MONITORING

INFORMATION AND COMMUNICATION

CONTROL ACTIVITIES

RISK ASSESSMENT

CONTROL ENVIRONMENTOPERATIO

NSFIN

ANCIAL

REPORTING

COMPLIA

NCE

UN

IT A

UN

IT B

AC

TIV

ITY

1A

CT

IVIT

Y 2

AC

TIV

ITY

3

1. Consists of three objectives:

– Effectiveness and efficiency of operations – Reliability of financial reporting – Compliance with applicable laws and

regulations

2. Consists of five components:– Control environment– Risk assessment– Control activities– Information/Communication– Monitoring

3. Requires an entity level focus and an activity level focus

17

Control Environment

CONTROL ENVIRONMENTOPERATIO

NSFIN

ANCIAL

REPORTIN

GCO

MPLIA

NCE

The control environment sets the tone of the 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:

• Integrity and ethical values

• Commitment to competence

• Board of Directors or Audit Committee

• Management philosophy and operating style

• Organizational structure

• Assignment of authority and responsibility

• Human resource policies and procedures

CONTROL ENVIRONMENT

18

Risk Assessment

RISK ASSESSMENT

OPERATIO

NSFIN

ANCIAL

REPORTIN

GCO

MPLIA

NCE

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.

RISK ASSESSMENT

19

Risk Assessment

RISK ASSESSMENT

OPERATIO

NSFIN

ANCIAL

REPORTIN

GCO

MPLIA

NCE

Objectives (i.e. assertions) must be established prior to the identification of risks to their achievement and to take necessary actions to manage the risks.

By setting objectives, both at entity and activity levels, prior to a risk assessment, a company can determine the critical success factors; then determine the risks to the critical success factors.

A risk assessment usually includes:

a. Estimating the significance of a risk

b. Assessing the likelihood (or frequency) of the risk occurring

c. Consideration of how the risk should be managed

RISK ASSESSMENT

20

Control Activities

CONTROL ACTIVITIES

OPERATIO

NSFIN

ANCIAL

REPORTIN

GCO

MPLIA

NCE

Control activities are the policies and procedures that help ensure management directives are carried out. They help to 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.

Control activities include:

•Approvals

•Authorizations

•Verifications

•Reconciliations

•Reviews of operating performance

•Security of assets

•Segregation duties

CONTROL ACTIVITIES

21

Control Classification

Preventive controls focus on preventing errors or exceptions. Such preventive controls are

– Standard policies and procedures– Proper segregation of duties– Authorization levels/approvals

Detective controls are designed to identify an error or exception after it has occurred. Such detective controls are:

– Exception reports– Reconciliations– Periodic audits

Internal controls can be classified as either Preventive or Detective.

CONTROL ACTIVITIES

OPERATIO

NSFIN

ANCIAL

REPORTIN

GCO

MPLIA

NCE

CONTROL ACTIVITIES

CONCLUDING INTERNAL CONTROLS: SHARING EXPERIENCE

Let’s review the environment of chambers and provide feedback on:1. Control environment2. Risk assessment3. Control activities4. Information/Communication5. Monitoring

Budget Preparation: Best Practice & Strategy

WHAT IS A BUDGET

• A budget is a detailed plan of income and expenses.

WHY WE NEED BUDGETI’ ve got a great training course Have u done

a budget

CRITICISMS OF TRADITIONAL BUDGETING

• Rarely strategically focused• Time consuming and costly• Reinforces departmental barriers rather than

encouraging knowledge sharing• Sometimes based on unsupported

assumptions and guesswork as opposed to well-constructed performance data

• Infrequently updated (budget amendment)

Two Questions

1. Why Do We Budget and Forecast?

– Budget and Forecast Timeline

2. How Do We Budget and Forecast

BUDGET PREPRATION AND STRATEGY

Bankrupt Waah!

What’s wrong with

him?

He didn’t prepare a budget

Why Budget and Forecast?Budgets and Forecasts

A Budget is a formal expression of the plans for the operation for a specific period

A forecast is a projection of activity based upon the information

A budget and forecast is your best estimate of the department’s/ function’s financial result for a fiscal year


Measure actual and forecasts against the budget throughout the planning process

Analyze anticipated versus actual results

Predict future performance and anticipate changes


Assist in monitoring control of current performance

Provide early warning of deviations from plans

Internal financial control by department


Impact decisions at higher levelsReporting responsibility to Board of DirectorsQuarterly meeting plus executive sessions

Importance of good budgets and good forecasts


FINANCIAL BUDGET PREPARATION

I need to prepare a training budget.

Don’t forget to develop your training

plan first.

PLAN

FINANCIAL BUDGET PREPARATIONBUSINESS PLAN

EXECUTIVE SUMMARY

MAJOR ASSUMPTIONS

SWOT ANALYSIS

MARKETING AND SALES PLAN

FINANCIAL BUDGET

GANTT CHART – NEW COMPANY

Launch Date

Company Setup

Application of License

Office Renovation

Staff Recruitment

System Installation

System Readiness

GANTT CHARTQ1 Q2 Q3 Q4


FINANCIAL BUDGET PREPARATIONBUSINESS PLANGANTT CHART

MARKETING PLAN

FINANCIAL BUDGET


MARKETING OBJECTIVES

PRODUCTS AND SERVICES

CURRENT MARKET SITUATIONa.Target Marketsb.Business Opportunitiesc.Competition

SALES AND MARKETING PLAN

FINANCIAL BUDGET PREPARATIONMASTER BUDGET

OPERATING BUDGET FINANCIAL BUDGET

CAPITAL BUDGET

BUDGETED P&L

CASHFLOW BUDGET

REVENUE BUDGET

COST OF SALES BUDGET

OPERATING EXPENSE BUDGET

ADVERTISING BUDGET

BUDGETED P&L

FINANCIAL BUDGET PREPARATIONREVENUE BUDGET

Rs 100 out So I need at

least Rs 100 to cover expenses

Where I will find this money

FINANCIAL BUDGET PREPARATIONREVENUE BUDGET

OPERATING BUDGETProvide Business Statistics

Provide breakdown of revenue by type

Explain how these revenue are achieved (Business mode)

Provide calculation of revenue numbers together with related direct costs

Specify when the revenue targets will be achieved

Specify when the related direct costs are incurred

REVENUE BUDGET



ADVERTISING BUDGET

BUDGETED P&L

FINANCIAL BUDGET PREPARATIONOPERATING EXPENSE BUDGET

OPERATING BUDGETCategorise the expenses

Personnel CostsOffice PremisesTravel and EntertainmentPostage and CouriersPrinting and Stationery

Provide justification and calculation for each type of expenses

When to incur the expense??

REVENUE BUDGET



ADVERTISING BUDGET

BUDGETED P&L

FINANCIAL BUDGET PREPARATIONADVERTISING BUDGET

OPERATING BUDGETProvide Marketing and Sales Plan

Provide justification and calculation for each type of costs

How the expense will be incurred??

When to incur the expense??

REVENUE BUDGET



ADVERTISING BUDGET

BUDGETED P&L

FINANCIAL BUDGET PREPARATIONPROFIT AND LOSS BUDGET

Income Rs 100

Expenses Rs 80

Great! I will make profit of

Rs 20

FINANCIAL BUDGET PREPARATIONPROFIT AND LOSS BUDGET

Income Rs 80, Expenses Rs 100,

What will I do??


• IN CASE OF LOSS

– Increase income

– Reduce expenses

DOWNSIZING

FINANCIAL BUDGET PREPARATIONBREAK EVEN

Ohwell at least I

didn’tlose anything.


• To break even means

Income is equal to expenses

Income Rs 100 – Expenses Rs 100 = Profit Rs 0


FINANCIAL BUDGET PREPARATIONCAPITAL BUDGET


CAPITAL BUDGET

BUDGETED P&L

CASHFLOW BUDGET

Description of Expenditure

Provide Justification

Provide Costing

When to Purchase

How to Finance

FINANCIAL BUDGET PREPARATIONCASHFLOW BUDGET


CAPITAL BUDGET

BUDGETED P&L

CASHFLOW BUDGET

From Operating Activities

From Investing Activities

From Financing Activities

Budgeted Cash Requirements

FINANCIAL BUDGET PREPARATIONBUDGET AND PROJECTION TEMPLATE

OPERATING BUDGETHistorical Year 1 to Current

Year

Budget Current

Year

Projection Next 4 Years

Provide Yearly

Analysis

Provide Yearly

Analysis

Provide Monthly Analysis

KEY PERFORMANCE INDICATORS

• Abbreviated KPIs• Quantitative Measure• Derived from Key Success Factors• Base vs Stretch targetFor Forecast• YTD actual and FY Forecast• Comments on expected variance




TOP DOWN VS BOTTOM UP A top down budget is a budget that is set

without allowing the ultimate budget holder to have the opportunity to participate in the budgeting process

A bottom up budget is a system of budgeting in which budget holders have the opportunity to participate in setting their own budgets.

Also called PARTICIPATIVE BUDGET

BUDGETARY SLACK• Difference between minimum necessary costs

and the costs built into budget or actually incurred.

• Managers set targets that are too easy to achieve.

• Managers must ensure that their spending rises to meet their budget.

• Waste money on non-essential expenses.

SOLUTION ZBB

BUDGET TYPES Firm/ Sanctioned

Unfirm/ Contingent/ Unsanactioned

In most of the organisations contingent budget is also approved by board.

The movement from contingent to firm is considered as memorandum amendment

INCREMENTAL BUDGETING Starts with previous year budget or actual

results and +/ - an incremental amount to cover inflation and other known changes

Have advantages and disadvantages

INCREMENTAL BUDGETING Suitable for stable businesses Costs are not expected to change significantly Good cost control Limited discretionary costs Quick & easy to prepare Builds inefficiency Uneconomic activities may be continued Budgetary Slack

ZERO BASED BUDGETINGRequires each cost element to be specifically justified through the activities to which the budget relates

Managers should specify those activities that can be individually evaluated

Decision is evaluated and ranked using cost/ benefit analysis

Resources are then allocated

ZERO BASED BUDGETING Inefficient operations can be discontinued Increased staff involvement Responds to change in business environment Efficient allocation of resources Enhanced knowledge of cost behaviour patterns Emphasis short term benefits Demotivation due to large amount of time Ranking can be difficult for different type of

activities

ROLLING BUDGETSKept continuously up to date by adding another accounting period (month or quarter) when the earliest accounting period has expired

Suitable in fast moving environment where accurate forecasts cannot be made

Suitable if business needs tight control

Q1 Y1 Q2 Y1 Q3 Y1 Q4 Y1 Q1 Y2

Budget

Actual

Add

ZERO BASED BUDGETING Planning will be based on most accurate budget Reduce element of uncertainty Always a budget that extends into future Forces management to reassess the budget

regularly Costly and time consuming Danger Budget = last budget +/- Demotivate employees = budgetary targets

constantly changing

ACTIVITY BASED BUDGETINGBased on budgeting based on an activity framework and utilising cost driver data

Use for overhead costs determination

Constructed by preparing activity matrix

Good tool for variance feedback processes

HOW DO I MONITOR THE BUDGET

COMPARISON ACTUAL VS

BUDGET

FEED FORWARD CONTROLComparing budgeted results against a forecasted results

Feed back simply compare historical results with the budgeted results

Feed forward is the acceptable system over the world for control action

FEED FORWARD CONTROLS

ales

Rs

Budget 2011

Sales to date used to forecast results to end

of the year

Control action can be taken now to close

the gap

Time

Current date

Sales to date

FEED FORWARD CONTROL

Feedback Report

Sales report for April 2011

Month YTD

Budget Actual Variance Budget Actual Variance

Product Rs'000 Rs'000 Rs'000 Rs'000 Rs'000 Rs'000

X 35 38 3 (F) 90 94 4 (F)

Y 20 14 (6) (A) 50 39 (11) (A)

Z 25 23 (2) (A) 50 45 (5) (A)

Total 80 75 (5) (A) 190 178 (12) (A)

FEED FORWARD CONTROLFeedforward Report

Sales report for April 2011

Full Year

Budget Forecast Variance

Product Rs'000 Rs'000 Rs'000

X 240 250 10 (F)

Y 150 120 (30) (A)

Z 210 194 (16) (A)

Total 600 564 (36) (A)

REPORTING ON VARIANCESThere are different reports being prepared for

reporting of variances.

There is a link between numbers and words.

Numbers are represented by different names like Flash Report, Summary Analysis, Variance Analysis, Snapshots, etc.

REPORTING ON VARIANCESWithout descriptive, textual and narrative part

numbers are considered to be meaningless

In large organisations, a weekly CEO report or for small organisations, a monthly commentary.

These documents embed with numbers (flash report) along with narratives.

THANK YOU