Examining The Effectiveness Of Accounting Systems Accounting Essay
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The assignment begins with an attempt to find out the effective of accounting systems within a business and the analysis of management control systems of a business.
I used a mixture of primary and secondary research methods to complete this assignment. I have provided references at the end where necessary and used a variety of books and notes. Along with that I consulted a few websites, details are on the references.
Introduction of accounting
Accounting is all about providing financial and economic information. Accounting information is economic information, it relates to the financial or economic activities of the business.
Accounting information shows the financial position of a business. This is done by the set of accounts, based on a system known as double-entry bookkeeping.
One of the first complete documentation about how to keep books of accounting was written by the professor of mathematics in Rome Luca Pacioli in 1494. This documentation described the double-entry system of accounting. It was adopted and still used today around the world.
Users of Accounting: there are two type of users.
Types of accounting
There are two types of accounting
1: Financial accounting
Financial accounting tells us about the financial position of Business it is used to prepare financial statement. This gives all the finance related information to its users and on the basis of that information a user will be able to do comparison and analyse the position of the company and it takes part in important decision making process.
2: Management accounting
On the other hand management accounts deals with the budgeting, business expenses and cost analysis it is used to make planning and control the business expenses.
Computerised accounting system
Manual accounting system
These days computerised accounting system is widely used in all type of businesses. The result of this system is more convenient and accurate then manual accounting system.
The question arises how this system operates, this system operates by computer software which has to install in the computer. Accounting packages software's which is used in these days it is used to get payroll packages sales ledger purchase ledger and fixed assets. There are lots of accounting software's are available one of the famous software name is off the shelf software it generates the document by getting commands by coding this software is very easy to use because of this software we don't need any professional accountant who set up the account it is very convenient to use one of the example of such software is sage which is very common in these days and easy to operate and it generates the accounts information by its self by coding and another kind of software is called as BESPOKE software it's a customised software most of the bigger size organisations are using this software. It gives them customised entries in the books of accounts.
Computer operates on the bases of dose commands to performs its tasks for the accounting software coding is used to make the software more easy to use
e.g. 05 for purchases
15 for interest
25 for profit and loss accounts
Manual accounting system
Manual accounting systems are the traditional form of maintaining a business's accounts and records this includes different steps like ledgers cash book petty cash book income statement and balance sheet which includes all the day to day transactions and sell purchase accounts this accounting system needs skills and knowledge to full fill its requirements.
1.1 Effectiveness of accounting system within a business:
Information generated from the accounting system can be effective in decision making process sale and purchase of assets and in investments. Quality and benefits of accounting system is evaluated from the performance evaluation, internal control and proper records of transactions.
Effectiveness of accounting information is depend on time management which have a great effect on accounting systems effectiveness, there for the accounting records should be maintain on time and with accuracy of accounting information it have a great impact on the effectiveness of accounting system.
Generally accounting information system provide the information about financial position on daily and weekly basis the effectiveness of accounting system not only depend upon the propose of such system it also depend on the contingency factors ( factors like culture understanding of organisation and outer atmosphere) accounting information is said to be effective when the information is complete and according to the system users effectiveness of accounting system is subject to many researches from a long time.
Accounting information is usually divided into two categories (1) the information that facilitate decision making (2) Information that influence decision making.
1.2: Accounting records
All of the documents and books includes in the preparation of accounting records includes journal, ledger, trial balance, cash books, invoices or any document which help in to make accounts.
In accounting records a cycle is used which is called as accounting cycle it determines the steps of financial statement.
Purpose and use of accounting records:
All accounting records are very useful and had a great value for its respective business without a proper accounting records it is very difficult to run a business successfully.
The purpose of maintaining accounting records to evaluate how much capital and assets a business have and also maintain the records of creditors and debtors or buyers and sellers by the respect of that records a user can have a clear eye on the business and watch the losses and profits in the business whether the business doing well or not and on the basis of that records business can take decisions whether business have to invest or take out all the investments or run the business as it is these record help to make more accurate and satisfied decision making which help to make business more profit and also used for calculating tax liability and give the information to the investors who are willing to buy the shares of that company.
Accounting concepts is very important, it is used to support the application of the "true and fair view", and accounting has adopted certain concepts which help to ensure that accounting information is presented accurately and consistently.
(1) Going concern: it is assumed that the business entity for which accounts are being prepared is solvent and variable, and the business will continue its operations for the foreseeable future. This has important implications for the valuation of assets and liabilities.
(2) Accruals concept: revenue and expenses are taken account of when they occur and not when the cash is received or paid out.
(3) Prudence concept: revenue and profits are included in the balance sheet only when they are realized and liabilities are included when there is a reasonable 'possibility' of incurring them it is also called conservation concept. Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (they are "provided for" in the accounts" as soon as there is a reasonable chance that such costs will be incurred in the future.
(4) Consistency concept: once an entity has chosen an accounting method, it should continue to use the same method, except for a solid reason to change. Any change in the accounting method must be disclosed. Transactions and valuation methods are treated the same way from year to year, or period to period. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.
(5) Entity concept: accounting records reflect the financial activities of a specific business or organization, and not of its owners or employees.
(6) Matching concept: transactions affecting both revenues and expenses should be recognized in the same accounting period.
(7) Materiality concept: relatively minor events may be ignored, but the major ones should be fully disclosed.
(8) Realization concept: any change in the market value of an asset or liability is not recognized as a profit or loss until the asset is sold or the liability is paid off (discharged).
(9) Money measurement concept: accounting process records only those activities that can be expressed in monetary terms (with some exceptions, as in cost-accounting).
(10) Separate entity concept: Business is the separate entity from its owner.
(11)Relevance concept: This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
1.3: Factors Affecting Accounting System
There are lots of factors which affect the accounting system the major factor are which affect the organisation is the (1) nature of business and (2)size of organisation and 3the structure of the organization if the organization is a multinational company then the accounting system of that organisation is on a very high level and very complex and they have separate department for all the accounting related work if a small company going to increase its size then they should have to change the accounting method and adopt the new method because of large amount of transactions are also taken place in the business on which the old method can no longer apply, and the other factor which affect the accounting system the change in IAS if in IAS some new rules are coming in then the business have to adopt that rule and adopt in the business and make there strategy according to it.
2.1: Business risk:
Business risk cannot be eliminated but must be managed by companies. There are several ways to minimize the business risk by proper planning.
Determining Business Risk: Developing the Business Risk Model
It is important for an organization to identify the business risks that exist in the environment in which it operates. To identify those risks, organizations must look at their external environments. External business risks are economic, political, social, environmental, technological, and other external conditions.
An organization cannot fully understand its business risks unless it also understands its business objectives, strategies, and processes.
Interrelationships between business objectives, strategies, processes, and business risk
Types of risk:
Operational risks are associated with your business' operational and administrative procedures. These include:
Business should examine these operations, prioritise the risks and make necessary provisions.
Financial risk is the risk made by equity holders by using of firms debt. If the company raises capital by borrowing money, I t must pay back with the interest charges. This increases the degree of uncertainty about the company and it must have enough income to pay back that amount in the future
Compliance risk is the possibility that the business will not comply with laws and regulations in the jurisdictions where it operates or that the organization will break any legally contract. Noncompliance can be dangerous, or it can result from being unaware or local legal requirements.
Response to risk:
A business can take any given risk.
Accept risk: if the risk of loss is minimum then only accept the risk and carry on business according to it.
Reduce risk: reducing the risk by better planning and strategies
Avoid risk: do not enter into that kind of business in which there is some bigger risk
Transfer risk: companies can also transfer the risk by taking insurance policy.
2.2: Describe and evaluate the control system
The environment in which business operates and the system it adopts is a process, affected by an entity's board of directors, management and other personnel, designed to provide assurance regarding to the success of objectives in the following areas:
effectiveness and efficiency of operations,
reliability of financial reporting, and
Compliance with applicable laws and regulations.
IAS315 gives us an understanding of the entity and its environment and assessing the risk of business and control system of business.
ISA identify the five elements of control system,
The control environment
Information and communication
Control environment is that in which control system operates. Control environment is defined by the business management. Control environment forming a base for control activities, risk assessment, monitoring, awareness and action of those changed with governance and management. The control environment is the most important component because it sets the tone for the organization. Factors of the control environment include employees' integrity, the organization's commitment to competence, management's philosophy and operating style, and the attention and direction of the board of directors and its audit committee.
Risk assessment analyse the identification, analysis, and management of uncertainty in business facing the organization. Risk assessment is relevant to the financial reporting and organization operational objectives. The management have to carry out a risk assessment from auditor which provides information with confidence that company system will not have any error in them.
Information system is the system that processes the information within an organization it includes processing the information and the procedure to initiate record and report on financial statement both manual and computerised.
Control activities include the policies and procedures maintained by the management of an organization to find risk. E.g. Control activity is a policy requiring the approval by the board of directors for all purchases exceeded from an estimating amount. Control activities are the important element of internal control, this provide satisfaction to prevent wrong decision from occurring.
Monitoring refers to the assessment of the quality of internal control. Monitoring activities provide information about potential and actual breakdowns in a control system that could make it difficult for an organization to achieve its goals.
Fraud is an intentional mistake by the management, employs or third parties for illegal financial advantages. Or if we talk about an error it's an unintentional mistake.
Fraud is difficult to be identifying because it is done by complete planning and care so the internal audit is conduct to detect the fraud.
THE DIFFERENCE BETWEEN FRAUDS
The distinguishing factor between fraud and error is that action which results in a misstatement of the financial statements it is intentional or unintentional. The term 'fraud' is a broad legal concept, but the auditor is concerned with fraud that causes a material mistake in the financial statements. ISA 240 (Redrafted) defines fraud as: 'An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. And
"SAS 99 defines fraud as an intentional act that results in a material misstatement in financial statements"
Types of fraud:
There are many types of fraud which relates to a business.
Miscasting of payrolls,
Stealing unclaimed wages,
Collusion external parties
Teeming and leading
Altering cheques and inflating expense claim
Issuing false creditor notes
Failing to record all sales
Prevention of Fraud:
Fraud is preventing by implementing the rules and laws in the business some of the points are written below which is very useful for the business to prevent the business from fraud.
A good internal control system
Continuous supervision of all employees
Surprise audit visits
Through personal procedure
Detection of fraud in the business:
Maintaining key control procedure reduce the risk of fraud occurring and increases the risk of detection control over cash transaction are more important this is the main area in which mostly frauds are happen.
Keep eye on all transactions which are placing in the business. Divide the duties between different functions, in other words more than a person. There are following point which is very useful to detect the fraud.
Receipts by post:
Safeguard to prevent interception of mail between receipts and opening.
Appoint person to supervise mails
Protection of cash and cheques
Control over cash sales and collection:
Restriction of receipts received
Clearance of cash officer and register
Investigation of cash storage and surpluses
Paying into bank
Make up and comparison of paying in slips and receipts
Banking receipts record
Condition and events:
Particular financial reporting pressure in an entity;
Inadequate working capital due to declining profit or too rapid expansion
Increases sales on credit this area should be check to find out if anything is going wrong is that department.
If unusual transaction is take place especially at year end that give's any significant effect on earnings.
Complex transaction or accounting treatment.
Duties, rights and liability;
What is an audit?
An audit is an examination of a company's financial statements prepared by the directors of the company. Its purpose is to give the company shareholders an independent, professional and informed opinion on the financial statements:
â€¢ It has been prepared according to the Companies Acts, any other relevant legislation and relevant accounting standards.
â€¢ It gives a true and fair view of the condition of the company on financial statement.
Who is an auditor?
An auditor is an independent professional person who is qualified to audit a company's financial statements.
What does an audit involve?
In carrying out an audit, an auditor will usually:
â€¢ Identify the data of the financial statements that have some errors.
â€¢ check the transactions record, account balances and disclosures.
â€¢ Give suggestions on company's accounting policies are reasonable.
â€¢ Test that the company's internal controls are effective.
â€¢ write management letter if any problems discovered during the audit and advise on how to deal with that.
â€¢ write and issue the auditor's report to the members of the company.
What are the duties of auditors?
Duty to provide an audit report:
The main duty of auditors is to report to the shareholders on whether in their opinion the company's financial statements give a true and fair view. They may give:
â€¢ A qualified opinion - this says that the financial statements give a true and fair view of the company's state of affairs except for certain stated circumstances.
â€¢ A disclaimer of opinion - this shows that the auditor is unable to give an opinion whether the financial statements gives a true and fair view or not.
â€¢ An adverse opinion - it says that the financial statements do not give a true and fair view.
What are the rights of auditors?
Auditors have the right to:
â€¢ Access the books and accounts of the company and its subsidiaries;
â€¢ Access information and explanations from the company's directors and employees.
â€¢ be notified of company general meetings and address the meetings.
â€¢ explain in general meeting the circumstances of any condition to remove them as auditor.
Liabilities of auditor:
Give a true and fair view on financial statement and deliver the right information to the general public and shareholders to prevent them from loss
3.2: Internal and external audit:
The External Auditor:
the external auditor tests the transactions record that takes part in the financial statements.
The internal Auditor:
The internal auditor, on the other hand, deals with its major operations, risk management and internal controls.
The Main Differences
There are many key differences between internal and external audit.
The external auditor is an external contractor how does not belongs to the organization, company hire the he auditor for auditing firms. The external auditor seeks to provide an opinion on whether the accounts show a true and fair view.
Whereas internal audit forms an opinion on the adequacy and effectiveness of systems of risk management and internal control, many of which are outside the main accounting systems.
The 3 Key Models of Organization Activities Involves Internal and External Audit
3 Key Models of Organization Activities involves Internal Vs External Auditor
Here is a list of "Internal Audit Versus External Audit "in detail:
Internal Auditor Vs External Auditor
3.3: Planning of auditing
In auditing of any organisation, auditor has to consider certain things before audit.
First is scope
In any audit should be to determine its scope and the auditor's general approach.
Auditor has to make some strategy for the auditing and place it with auditing documents which defines the major areas on which auditor has to take extra care and the difficulties associate with audit and the auditing clients points of concerns.
Documents accounting system:
Auditor has to collect all those documents associated with audit e.g. financial statement, transactions record, receipts, and other related documents. Auditor need these documents to analyse it and find all the aspects of transactions to find out whether the financial statement have any error or not or is there any possibility of fraud is there or not and whether it gives a true and fair view or not.
System and internal controls:
At this stage the objective is to determine the flow of documents and the facts related to the documents and the operational system in the organisation. At this level auditor has to find the facts related to documents and the documents flow in the departments including sales, purchases, cash and stock and accounts personal. This is the good way to find out the rough estimate of system, after that which will be converted into formal record.
Just like risks in business some risks are also relates with the auditing.
Audit risk is defined as:
"Audit risk is the risk that that auditor may give an inappropriate opinion on the financial statement"
Components of audit risk:
Audit risk has three components:
Inherent risk is the risk that auditor may be misstated because of lack of knowledge and insufficient information available for it. Auditor has to use their professional practice and available knowledge about the item to asses' inherent risk if no such information is available then the inherent risk is high.
Control risk is the risk that organisation control system fails to detect the material misstatement. And the financial statement do not prepare according to the IAS.
Detection risk is the risk that auditor will fail to detect the material misstatement of accounting system. Detection risk relates to the knowledge, practice and the experience of the auditor.
Materiality is relates to the financial statement, it is an expression of the relative importance of a particular matter on the mean of financial statement as a whole or as an individual. A matter is material if its omission or misstatement could influence the economic decision of the users which basis on that financial statement. Materiality depends on the size operations of organization.
ISA 320 tells the auditor to consider materiality and its relation with risk at the time of conducting an audit.
3.4: Audit testing and uses
In developing overall audit plan, auditors uses five types of audit tests to find out whether financial statement are truly stated or not.
Procedures to Obtain an Understanding
Auditors perform this by a system called walkthrough to obtain understanding it applies on the transactions and entire process is operated like this.
Tests of Controls
procedure used to obtaining an understanding about internal control, it contains followings evidences
Make inquires of client personal
Examine documents, records and reports
Observe control activities
Reform client procedure
Test of Control is used to determine whether the control system is effective or not and usually involves a testing of transaction.
Substantive Tests of Transactions
Procedures designed to test for dollar misstatements of financial statement balances.
To indicate possible misstatements
To reduce tests of details of balances
Tests of Details of Balances
Focus on ending G/L balances
It is used to find out whether the balance of the financial statement is accurate.
3.5 Records Auditing process
In the large company with sophisticated internal control and low inherent risk therefore auditor perform extensive test and it relies on the client internal control to reduce substitutive test because of the emphasis on test of control and analytical procedure, this audit can be done comparable in inexpensive. This audit likely represents the mix of evidences used in integrated audit of public company financial statements and internal control over financial reporting.
4.1: Purpose of Audit Report
Audit report is that report in which external auditor express their opinion about the true and fair view of the financial statement of the organisation.
The audit report is published for the shareholders, management or directors and also for general public. There are two key differences between the report to shareholders and to report for the management.
The shareholders report is to show whether the financial statement shows a true and fair view
And the private report for the management and directors which contain comments and recommendations on the financial statement
Contents of audit report:
Auditor report on financial statement contains clear opinion based on the assessment of record. Audit report draw on a complete pattern which gives the clear view to its users. The main contents of audit report as follow.
4.2: Different qualifications in report:
There are two types of reports one is unqualified or unmodified report and the second is qualified or modified report.
1: An unqualified audit report gives assurance to its users and gives true and fair of the financial statement and there is no material mistakes are in it. An unqualified report extract by laws and rule under companies act 1985. Which contain followings?
Proper accounting records
All information and explanations
Details of director's benefits
Particulars of loans and other transactions
2: Qualified report:
On the qualified report auditor give two types of opinions.
Matters that affect the auditor's opinion
Matter that do not affect the auditor's opinion
Matters that affect the auditor's opinion
Auditor may not be give appropriate opinion because of some circumstances like insufficient material of financial statement. And others factors are as follow.
There is any limitation of scope in auditors work. It may be material or pervasive
Disagreement with management it may be material or pervasive
These two factors farther divide into two branches.
A limitation of scope may lead to disclaimer of opinion. A disclaimer opinion should be expressed when the limitation of scope is so material or pervasive when auditor do not obtain any evidence related to that to express his opinion on the financial statement.
Disagreement may leads to adverse opinion. It should be expressed when effect of disagreement is material and pervasive when some misleading or incomplete information in the financial statement.
Matters that do not affect the auditor's opinion
In some circumstances auditor may give unqualified opinion because of the uncompleted information in the financial statement in this case auditor write a paragraph is called as emphasis of matter describing a fundamental uncertainty and then give an opinion on that.
4.3: Management letter:
The Board of Directors, ABC & CO
Alpha Co Limited, certified accountants
15 Essex Road 29 High Street,
London, EC1N 2HB London, E15 5SG
1 April 200X
Members of the board,
Financial statement for the year ended 31 May 200X
In accordance with our normal practice we set out certain matters which arose as a result of our review of the accounting system and procedure operated by your company during our recent interim audit.
We would point out that matters dealt with in this letter came to our notice during the conduct of our normal audit procedure which are designed to expressing our opinion on the financial statement of your company in consequence our work did not encompass a detailed view of all the aspects of the system and cannot be relied to necessarily to disclose defalcation or other irregularities or to include all possible improvement in internal control.
1: Purchases system: debit control
During the assessment of our work we find that the goods orders from company ABC on 1 MAR 200X order orally it do not contain any purchase receipts or purchase accounts.
There is a possibility of over payment or liability being set up.
We recommend that the purchase department is responsible of such order and if the order is purchase orally then an official permission should be obtain as conformation.
2: Dividend pays account: Shareholder account
We asses that the dividend pay to the shareholder of the year 2010 does not have any entry in the
It will lead to show more balance in the profit and chances to pay double to the shareholders
We recommend that the accounts department is responsible for such matters so when the dividend is pays to the shareholders pass the entry to balance sheet after the profi and loss accounts preparation.
3: admin Expenses: expense account
During our audit check we found that there are no proper records of admin expenses
It will lead to more expenses in admin and any employ can take any amount from company account which is a loss for the company.
We recommend that this is the responsibility of the accounts department in this area responsible person should be appointed who have the authority to issue the funds for the admin.
Our comments have been discussed with your finance department and the chief accountant and these matters consider by us again during further audit. We are happy to receive comments on or points made. If you require any further information please do not hesitate to contact with us.
This letter has been produce for the sole use of your company. It must be not discussed with third party. No responsibility if it assumed by us to any person.
We like to say thanking to your staff for their co-operation and support during the course of audit.
ABC & Co
This assignment in a nutshell has helped me understand what various types of accounting systems are within a business and how factors like nature and size of a business changes the way auditing is done in each organization.
Along with that, it has given me a good understanding of the types of risks involved in a business and how they can be reduced by proper auditing checks, etc. Finally, it elaborated how to actually write an audit report, what are the contents we need to follow and how effective it is.
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