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Purpose, Use and Importance of Different Accounting Records

An accounting record is defined as the all of the documentations involved in the preparation of financial statements, records which are relevant to financial review, and audits which include the recording of assets and liabilities, ledgers, journals, and any other supporting documents like invoices.

Ledger: - Maintaining a ledger is a must in all accounting systems. Ledgers are used for preparing trial balances; which check the arithmetical accuracy of the accounting books. Ledgers are the store-house of all kinds of information; which are used for preparing final accounts and financial statements.

Prime entry books: - A prime entry book is also known as a book of original entry. These are the books where transactions are first recorded. The main  prime entry books are Sales day book, Purchase day book, Sales Return day book, Purchase Return day book, General Journal and Cash Book (Ducha, 2008).

Accounting plays an important role. It provides information such as how good or bad the financial condition of the business is, and which activities or products have been profitable. Accounting is important for a business entity for the following reasons:

  • Accounting records, set on the base of even practices, will assist a business to compare results of one period with another period.
  • Insulating records, backed up by proper and genuine vouchers are good evidence in a court of law.
  • Increased volume of business results in a large number of transactions, accounting records avoid the necessity of remembering various transactions.

Fundamental concepts of accounting:

Accruals concept of accounting: The accruals basis of accounting involves the non-cash of transactions to be mirrored in the financial statements (for the period in which those effects are experienced and not in the period in which cash is actually received or paid) (Open University Course Team, 2006).

Going concern: This  further clears that the accounts have been prepared on the assumption that the authority will continue to operate for the foreseeable future. The Avenue Account and Balance Sheet assume no intention to significantly curtail the City Council’s operations (Open University Course Team, 2006).

Consistency concept: There are a number of different ways in which some concepts can be applied. Each business must choose the approach that gives the most reliable picture of the business, not just for this period, but over time also. According to the consistency convention, when a method has been adopted for the accounting treatments of an item, the same method will be adopted for all subsequent occurrences of similar items. However, in saying this, it does not mean that the firm has to follow the method until the firm closes down (Open University Course Team, 2006).

Prudence concept: The account should be prudent when preparing financial statements. In other words, if something is in doubt then always plan for the worst, and if a transaction has not yet been completed ignore any possible benefits that may arise from it (Open University Course Team, 2006).

Business entity concept: One of the main principles of accounting; this concept says that a business should be treated separately from the property owner or investor. In simple words, we can say that the owner of the business should be treated separately from the business. Whatever profits come into the business should be taken in a company account. Under the business entity concept, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses (Ducha, 2008).

Different factors of accounting system:

Computerised Accounting System: Keeping accurate accounting records is a vital part of managing an organisation. Apart from helping to keep it afloat financially and legally, it is also a requirement of funding bodies. Smaller groups can usually manage with simple book-keeping procedures but bigger groups juggling with larger sums of money and more complex financial transactions may find their workload eased by using a computerised accounting system. The good news is that they are easy to use and reasonably priced computerised accounting packages on the market that are either aimed at, or can be adapted to, voluntary sector organisations (Ducha, 2008).

Manual Accounting Systems: Accounting systems are manual or comprised. Understanding a manual accounting system is useful in identifying relationships between accounting data and reports. Also, most computerised systems use principles from manual systems. In other words, manual accounting and bookkeeping systems are the traditional form for maintaining a business's accounts and records. They involve keeping various ledgers and files which typically include a cash book, sales and purchase day books and petty cash sheets. Although the use of basic manual bookkeeping systems require little knowledge or skill in accounting, they are still the preferred method of accounting for those who have used them in the past (Drew, 2000).

Considering factors when using computerised or manual accounting systems:

There are many factors to consider when using a computerised or manual accounting system, such as:

  • The capacity to generate sales/ increase invoices
  • The necessity to compute/include VAT in accounting
  • The cost of software, updates and support
  • The capability to process payroll and stock control

Business risk:

Business risks are associated with the uncertainty of a company's future cash flows, which are affected by the operations of the company and the environment in which it operates. It is the variation in cash flow from one period to another that causes greater uncertainty and leads to the need for greater compensation for investors. Companies that have a long history of stable cash flows require less compensation for business risk than companies whose cash flows vary from one quarter to the next (Fabozzi et al, 2007).

Components of business risks:

Operational risks: This can be understood as the risk of loss resulting from insufficient internal processes, people and systems, or from external events, which include legal risk. In other words, the risk of loss resulting from failure to comply with laws, prudent ethical standards and contractual obligations, which include the exposure to litigation from all aspects of an institution’s activities.

Compliance risks: This can be defined as the current and potential risk to earnings or money arising from violations of, or non-conformance with, laws, rules, approved practices, internal policies, methods, or moral standards. These arise in situations where there are laws or rules prevailing certain bank products, or where the activities of the bank’s clients may be unclear or unverified. This risk exposes the institution to fines, civil money punishments, payment of damages, and the voiding of contracts (Fabozzi et al, 200).

Liquidity risks: This can be explained as the current and approaching risk to earnings or capital arising from a bank’s incapability to meet its obligations without incurring unacceptable losses. Liquidity risk include the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognise or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value (Neu and Malz, 2007).

Risk management: There are various ways in which risks can be managed, including preventing risks from happening, lessening the risk’s negative effects, and recognising all the consequences that a specific risk might bring (Blokdijk, 2007).

Corporate governance:

Corporate governance is the system by which companies are directed and controlled. The role of the shareholders is to appoint the directors and the external auditors, and to satisfy themselves that an appropriate governance structure is in place. It is also where directors are responsible for setting the company’s strategic aims, providing the leadership to put these into effect, supervising the management of the business and reporting to shareholders on their stewardship. Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined (Gupta, 2005).

Fraud risk assessment:

To protect itself and its stakeholders efficiently and effectively from fraud, an organisation should recognise potential fraud risks and the specific risks that directly or indirectly relate to the organisation. A structured fraud risk assessment, tailored to the organisation’s size, complexity, industry, and goals, should be performed and updated periodically. The assessment may be integrated with an overall organisational risk assessment or performed as a stand-alone exercise, but should, at a minimum, include risk identification, risk likelihood, significance assessment, and risk response (ACFE).

Managing the risk of fraud- the risk based approach:

A risk-based approach enables organisations to target their resources, both for improving controls and for pro-active detection in problem areas. Developments in corporate governance, including the requirement for statements on internal control, create the atmosphere in which fraud can be considered as a set of risks to be managed alongside other business risks. Managing the risk of fraud should be embedded in the entirety of an organisation’s risk, control and governance procedures. In a wider sense, assessing and managing the risk of fraud involves assessing the organisation’s overall exposure to fraud, recognising the areas most vulnerable to the risk of fraud, assigning ownership, calculating the scale of fraud risk, responding to the risk of fraud, and determining the success of the fraud-risk strategy (ACFE).

Assessing the organisation’s overall vulnerability to fraud:

Vulnerability to fraud can be assessed at different levels in an organisation. A quick assessment of the overall level of risk an organisation is exposed to is often a good starting point and may highlight particular vulnerabilities (where some action needs to be taken immediately rather than waiting for the results of a more in-depth risk assessment to be completed). A fraud risk assessment should additionally be carried out during the development of any new policies, activities or operations to ascertain whether any new risks arise that need to be managed. The risk assessment should also be reviewed and re-assessed whenever a change in policy occurs or when changes are made to the way in which a policy is to be implemented (ACFE).

Fraud risk identification may include gathering external information from regulatory bodies, industry sources, key guidance setting groups, and professional organisations such as the American Institute of Certified Public Accountants (AICPA), the Association of Certified Fraud Examiners (ACFE), the Canadian Institute of Chartered Accountants (CICA) or the CICA Alliance for Excellence in Investigative and Forensic Accounting. Internal sources for identifying fraud risks should include interviews and brainstorming, with personnel, a broad spectrum of activities within the organisation, the review of whistle-blower complaints, and analytical procedures. A proper and working fraud risk identification process includes a calculation of the incentives, pressures and chances to commit fraud. Employee incentive programs and the metrics on which they are based can provide a map to where fraud is most likely to occur. Fraud risk assessments should consider the potential override of controls by management; as well as areas where controls are weak or there is a lack in segregation of duties (Vallabhaneni, 2008).

The speed, functionality and accessibility that created the enormous benefits of the information age have also increased an organisation’s exposure to fraud. Therefore, any fraud risk assessment should consider the access and overriding of system controls, as well as other internal and external threats to data integrity, system security, and theft of financial and sensitive business information (Costa Lewis, 2004).

Assessing the likelihood and significance of each potential fraud risk is a subjective process that should consider not only monetary significance, but also the significance to an organisation’s financial reporting, operations, and reputation, as well as the legal and regulatory compliance requirements. An initial assessment of fraud risk should consider the inherent risk of a particular fraud in the absence of any known controls that may address the risk.

The COSO Model:

In the United States many firms have adopted the internal control concepts existing in the report of the Committee Of Sponsoring Organisations (COSO) of the Tread Way Commission. Published in 1992, the COSO report describes internal control as a process affected by an entity's board of directors, management and other personnel, that is 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

COSO describes internal control as consisting of five essential components. These components, which are subdivided into seventeen factors, include:

  • The control environment
  • Risk assessment
  • Control activities
  • Information and communication
  • Monitoring

Duties and responsibilities of the auditor:

In most countries the auditor has a statutory duty to report to the entity’s members the truth and fairness of the business’s annual accounts. This report must state the auditor’s opinion on whether the statements have been prepared in accordance with the relevant legislation, whether they give a true and fair view of the profit/ loss for the year, and the state of affairs at the year end. The duty to report on the truth and fairness of the financial statements is the primary duty associated with the external audit. The auditor has a duty to form an opinion on certain other matters and to report any reservations.

The auditor must consider whether:

1. The entity has kept proper accounting records.

2. The entity’s balance sheet and income statement agree with the underlying accounting records.

3. All the information and explanations that the auditor considers necessary for the purposes of the audit have been obtained, and whether adequate returns for their audit have been received from branches not visited during the audit.

4. The entity has complied with the relevant legislation’s requirements in respect of the necessary disclosures. If the entity has not made all the disclosures required the audit report should, if possible, contain a statement of the required particulars (Vallabhaneni, 2008).

Relationship between internal and external audit:

The coordination of internal audit activity with external audit activity is very important for both parties. From the external audit’s point of view it is important as external auditors have the possibility to raise the efficiency of the financial statements audit.

The role of internal auditing is determined by management. Its objectives differ from those of the external auditor, who is appointed to report independently on the financial statements. The internal audit’s objectives vary according to the management’s requirements. The external auditor’s primary concern is whether the financial statements are correct. The external auditor should obtain a sufficient understanding of the internal audit activities to identify and assess the risks of material misstatement. The external auditor should also perform an assessment of the internal audit's function (when internal auditing is relevant to the external auditor’s risk assessments that is).

Liaising with internal auditing is more effective when meetings are held at appropriate intervals during the period. The external auditor would need to be advised of, and have access to. relevant internal auditing reports, and be kept informed of any significant matters that come to the internal auditor’s attention (where they affect the work of the external auditor). Similarly, the external auditor would ordinarily inform the internal auditor of any significant matters which may affect internal auditing (Diamond, 2002).

Appropriate audit tests:

An audit test is a procedure performed by either an external or internal auditor in order to assess the accuracy of various financial statement assertions. The two common categorisations of audit tests are 'substantive tests' and 'tests of internal controls'. Both types of tests are used in external and internal audits in order to reach established audit objectives, as can be outlined in audit checklists or determined based on the results of audit questionnaires. Audit tests are typically performed on a sample basis over an existing group of similar transactions. Sampling approaches can either be statistical or non-statistical, with the ultimate goal being to obtain the most representative sample of the population before testing begins (Diamond, 2002).

Types of audit tests:

It is essential for internal auditors to understand how this method works, as well as its purpose. Also, given the variety of testing methods that may be used during the audit process, it helps to distinguish sampling from other types of examination. During an operational audit, an internal auditor might use observation as an aid in evaluating a unit's procedures (Diamond, 2002).

Simple Random Sampling: This method practices sampling without replacement. That is, once an item has been selected for testing it is not included in population and is not subject to re-selection. An auditor can implement simple random sampling through computer programs or random number tables (Beasley et al, 2005).

Systematic (Interval) Sampling: This method describes the choice of sample items in such a way that there is an unchanging interval between each sample item. In this method, every "Nth" item is selected with a random start (Beasley et al, 2005).

Stratified (Cluster) Sampling: This method describes the selection of sample items by breaking the population down into strata’s, or groups. Each stratum is then treated separately. For this strategy to be effective, distribution within clusters should be greater than distribution among clusters. An example of cluster sampling is the inclusion of the sample of all payments or cash disbursements for a particular month. If blocks of homogeneous samples are selected, the sample will be subjective (Beasley et al, 2005).

Audit tests:

Process mapping analysis: This analysis develops process maps of the supplier delivery and accounts payable/ approval processes. These maps are then analysed to identify the potential for suppliers to refuse to deliver supply.

Survey techniques: this technique is used to perform a supplier satisfaction survey. To identify details, magnitude and an external perspective of supplier concerns over the accounts payable process.

Analytical review: This review is used to perform benchmarking analytical tests to compare key processes operating statistics with industry best practices, and compare specific processes with best practice procedure.

Inquiry through facilitated groups: This inquiry is used to conduct a focus group involving several major suppliers, key members of the accounts payable process and major departments required to authorise invoices (Beasley et al, 2005).

Differences between management and auditor’s responsibilities:

The management's responsibility is to create internal control. Internal control includes a whole system of controls and procedures, both monetary and operational, which are established to lessen risks and their impact. To safeguard assets, ensure efficiency and inspire devotion to college policies and directives. It is the internal audit's role to carry out an independent evaluation of the efficiency of these controls.

Audit planning: Initial audit planning takes place before the thorough audit work begins. In planning for a specific audit assignment, an auditor must take on a plan with regard to the timing, nature and degree of the audit work to be carried out. The aims of the plan are to ensure proper attention is dedicated to different areas of the audit, and potential problems are identified. Audit plans have to be observed as a organised plan of action; plotting out the audit processes to be carried out with the aim of reporting on whether a stated set of accounts show a factual and fair-minded view. However, the fact that the audit assignment is the commercial motion of the audit firm should be recognised, and if the costs of carrying out the planned procedures are likely to exceed the client entities budgeted fee then this unevenness should be informed at the planning stage (by discussing with the management of the entity) (Gupta, 2009).

Scope of audit planning: It is important to keep in mind the formal scope of audit work when considering an audit’s role in risk management. Based on the results of the risk assessment, the internal audit activity should evaluate the adequacy and effectiveness of controls encompassing the organisation’s governance, operations, and information systems, which should include reliability and integrity of financial and operational information. Effectiveness and efficiency of operation, safeguarding of assets, compliance with laws, regulations, and contracts are the scope of audit planning (Spencer-Pickett, 2006).

Audit testing: Direct tests of account balances and transactions are designed by determining the most efficient manner to substantiate the assertions embodied in the account or transactions. There are many alternatives open to the auditor in planning audit tests. The following are the types of audit tests.

  • Tests of effectiveness: Used to determine whether the controls are effective over cash disbursements.
  • Dual-purpose tests of controls and account balances: Used to determine whether the controls are effective to help plan the nature, timing, and extent of other audit tests, and test the accuracy of recording the related transactions.
  • Substantive analytical tests: Used determine whether account relationships meet expectations, including the possibility that some of the receivables are not collectable.
  • Direct tests of account balances: Used to test the existence and dollar accuracy of account balances as stated at historical cost.
  • Direct tests of transactions: Used to test the existence of sales transactions (Gramling, 2009,  Gupta, 2009).

Evidence that auditors collect from audit files and working papers: There are 7 broad categories of evidence from which the auditor can choose: physical examination, confirmations, documentation, analytical evidence, written representations, mathematical evidence, oral evidence, and electronic evidence.

Audit files and testing papers:

Working papers provide evidence that an effective, efficient and economic audit has been carried out. They should therefore be prepared with care and skill. Working papers are important because they are necessary for audit quality control purposes. They provide assurance that the work delegated by the audit partner has been properly completed and that an effective audit has been carried out.

Statutory Audit:

Statutory Audit is the checking of accounts required by law. The Law may require the audit to be conducted, the manner in which it should be conducted, and to whom the report of auditors should be presented (Stittle, 2003).

Statutory Audit Reports are prepared in accordance with Article L(225-235) of the French Commercial Code. The purpose of a Statutory Audit Report is to present the fair presentation and consistency of financial statements. It includes the auditor's view of the financial statement, given without any reservations, and comments on whether the  auditor feels the company followed all of the accounting rules properly i.e. that the financial reports are an accurate demonstration of the company's financial condition (Stittle, 2003).

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