Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 2Accounting and accountants
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting function
Financial accounting system: objectives and scope
Uniform accounting procedures Functional transaction processing
systems
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Tracking and recordingof data
Tracking and recordingof data
Processing of data
Processing of data ReportingReporting
Decision makers
Decision makers
Businesstransactions
Businesstransactions
Financial accounting system
Data Information
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 2.1 Group reporting flows
Group financial
statements
Uniform accounting
rules
Parent /holding
company
Subsidiaries Local tax accounts
FranceFrance
ItalyItaly
Nether-lands
Nether-lands(Germany)
(Germany)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting database
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
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 LedgerGeneral Ledger
Sale of goods to clients
Goods received
from suppliers
Reports to
manage-ment and
outsiders
Reports to
manage-ment and
outsiders
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 2.3 Building aggregates
General LedgerGeneral Ledger
prepared by week (or month) and by type of transaction
(invoices, payments, receipts, expense notes, etc.)
SummariesSummaries
Daily transactions
total entered into
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Control and audit
Internal control Internal audit External audit Corporate governance
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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 company’s operations;b) The reliability of its financial reporting;c) Its compliance with applicable laws and regulations.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
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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
Monitoring
Risk
assessment
Control activities
Information &
Communication
Control environment
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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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
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
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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)
CEO
Production manager Marketing manager ... CFO
Accounting Treasury ...Internal
Audit
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Internal audit – Hierarchical position (2)
CEO
InternalAudit
Production manager Marketing manager ... CFO
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Internal audit – Hierarchical position (3)
General assembly
Board of directors
Management committee
Audit 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)
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”
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
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