Accounting and Accountants

CHAPTER 2
Accounting 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

Accounting function
Financial accounting system:

objectives and scope
Uniform accounting procedures
Functional transaction processing
systems

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

Decision
makers
Business
transactions
Information
Data
Financial accounting system

Tracking and
recording
of data
Processing
of data
Reporting

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

Fig. 2.1 Group reporting flows

Subsidiaries
France
France
Group
financial
statements
Parent /
holding
company
(Germany)
(Germany)
Uniform
accounting
rules
Italy
Italy
NetherNetherlands
lands

Local tax
accounts
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

Accounting database
General Ledger = central

accounting database
Primary source of information for
internal (management) and
external reporting purposes

Register of
amounts
owed to
suppliers
Goods
received from
suppliers
Bank account
cash in and
out
Register of
debts owed
by clients
Sale of goods
to clients
Figure 2.2 The financial

accounting database
Salaries and
social
charges
Other
business
expenses
General Ledger
General Ledger
Finance from
shareholders
and banks
Purchase of
long-term
assets

Reports
Reports
to
to
manage
manage
-ment
-ment
and
and
outsider
outsider
ss
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 years activities

Fig. 2.3 Building aggregates

(invoices,
payments,
receipts, expense
notes, etc.)
Daily
transactions
prepared by week
(or month) and
by type of
transaction
total entered
into
Summaries
Summaries
General Ledger
General Ledger

(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

Recording transactions (cont.)
Audit trail
Chart of accounts
Traces the content of aggregates back to transaction

details
Used to categorize and record transactions within the
accounting database according to the double-entry
accounting logic
State-mandated or voluntary
XBRL (eXtensible Business Reporting Language)
Automated, flexible reporting tools

Using specific tags of individual data items, defined and
linked through flexible taxonomies

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

Control and audit
Internal control
Internal audit
External audit

Internal control
Defining internal control

Components of a system of
internal control
Control activities
Preventive
controls
Detective controls
Corrective controls

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 companys
operations;
b) The reliability of its financial reporting;
c) Its compliance with applicable laws and regulations.

Internal control objectives

(COSO)
Sustaining the companys business

operations (efficiency and
effectiveness concerns)
Preparing reliable financial reporting
(including financial statements)
Compliance with applicable laws and
regulations

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

internal control

IC system components (COSO

extracts)
Control Environment
The control environment sets the tone of an organization,
influencing the control consciousness of its people. It is the
foundation for all other components of internal control,
providing discipline and structure. Control environment
factors include the integrity, ethical values and
competence of the entity's people; management's
philosophy and operating style; the way management
assigns authority and responsibility, and organizes and
develops its people; and the attention and direction
provided by the board of directors.

IC system components (cont.)
Risk Assessment
Every entity faces a variety of risks from external and
internal sources that must be assessed. A precondition to
risk assessment is establishment of objectives, linked at
different levels and internally consistent. Risk assessment
is the identification and analysis of relevant risks to
achievement of the objectives, forming a basis for
determining how the risks should be managed. Because
economic, industry, regulatory and operating conditions
will continue to change, mechanisms are needed to
identify and deal with the special risks associated with
change.
Control Activities
Control activities are the policies and procedures

that help ensure management directives are
carried out. They help ensure that necessary
actions are taken to address risks to achievement
of the entity's objectives. Control activities occur
throughout the organization, at all levels and in all
functions. They include a range of activities as
diverse as approvals, authorizations, verifications,
reconciliations, reviews of operating performance,
security of assets and segregation of duties.
Information and Communication
Pertinent information must be identified, captured and communicated

in a form and timeframe that enables people to carry out their
responsibilities. Information systems produce reports, containing
operational, financial and compliance-related information, that make it
possible to run and control the business. They deal not only with
internally generated data, but also information about external events,
activities and conditions necessary to informed business decisionmaking 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.

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.

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

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
Safeguarding resources resulting from consummating
transactions
The objective is mainly to provide

environment where fraud becomes difficult

an
Defining internal audit

Internal auditing is an independent,
objective assurance and consulting activity
designed to add value and improve an
organisations 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

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

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

Internal audit Hierarchical position

(1)
CEO
Production manager
Marketing manager
...
Accounting
CFO
Treasury

...
Internal
Audit

(2)
CEO
Internal
Audit
Production manager
Marketing manager
...

CFO

(3)
General assembly
Board of directors
Audit committee
Management
committee
CEO
Internal audit

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

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
External audit
External audit = independent audit of a

companys 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 companys financial position and performance

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

Basic statutory audit tasks
The basic statutory audit consists of two

tasks:
To check that the accounting database
effectively picks up all the companys
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
companys real state

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

Corporate governance issues arise

whenever ownership of a company is
separated from its management
Central concern = how managements
freedom of action may be limited by
outside interests
Many countries have specific rules,
regulations and guidance on corporate
governance

recommendations
Chairman of the Board of Directors (BOD)

should not be the CEO
Appointment of independent or nonexecutive directors
BOD committees with independent
directors :
Compensation committee
Audit committee
Nomination committee

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

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


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CHAPTER 2

Accounting and accountants

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Financial accounting system:

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Financial accounting system

Track all economic transactions of the enterprise

Highly dependent on the size of the company

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Financial accounting system

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Uniform accounting procedures

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Fig. 2.1 Group reporting flows

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Functional systems capture different types of

Transaction processing implies interactions

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

General Ledger = central

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Figure 2.2 The financial

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Information flows into the general

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Fig. 2.3 Building aggregates

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Recording transactions (cont.)

Traces the content of aggregates back to transaction

XBRL (eXtensible Business Reporting Language)

Automated, flexible reporting tools

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Organization of data within the

In the G/L, data are stored according to the

Two columns for figures: debits and credits

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Control and audit

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Defining internal control

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Defining internal control

Definition of COSO (Committee of Sponsoring

Internal control is a process, established, operated and

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Internal control objectives

Sustaining the companys business

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

A system of internal control consists of

Each component is relevant for each

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

IC system components (COSO

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

IC system components (cont.)

IC system components (cont.)

Control activities are the policies and procedures

IC system components (cont.)

Information and Communication

Pertinent information must be identified, captured and communicated

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

IC system components (cont.)