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Financial Systems and Auditing

INTRODUCTION

The report is based on numerous scenarios relating to financial systems and auditing. The report first discusses the importance of maintaining accurate and effective accounting records within a business. The different purposes of accounting records, importance of accounting concepts and influential factors of accounting systems within an organisation are discussed in detail. The next section of the report discusses the impact of negligence and non-compliance of financial regulations and business risk management. The planning process of an audit is evaluated, in terms of the scope, materiality and risk of an audit. The final section of the report discusses the various purposes and types of audit reports and presents a draft template of an audit report and a management letter.

TASK 1: IMPORTANCE OF KEEPING EFFECTIVE ACCOUNTING SYSTEMS WITHIN A BUSINESS

REPORT

To: Mr. Andrew Keller

From: Accountant

Subject: Importance of Accounting Systems

Date: 14th April 2014

INTRODUCTION

The report discusses the importance of maintaining effective accounting systems within an organisation. The issue is discussed under three main sections; purpose of different accounting records, importance of accounting concepts and influential factors of accounting structures within a business.

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DESCRIPTION AND PURPOSE OF DIFFERENT ACCOUNTING RECORDS

Accounting records refer to the documentation relating to the generation and maintenance of financial statements which are used in financial reviews and audits. Accounting records comprise of records of assets, liabilities in ledgers, journals and invoices to name a few (Richardson, 2012).

Prime entry book is one main type of accounting record which should be maintained within an organisation. Prime entry books are where transactions are first recorded, therefore these records are also referred to as original entry books. Examples for prime entry book are; cash book, sales day book and purchase day book (Marshall, 2011).

Ledgers are compulsory accounting records which should be maintained in every business. Ledgers provide information to create final financial statements. Ledgers further display the arithmetic accuracy of the accounting books (Rajasekaran, 2011).

Accounting records are extremely useful to evaluate the current financial position of the business, compare the business over different time periods and competitors. Accounting records are useful for all stakeholders of the business including; shareholders, investors, employees, customers, suppliers and the government, to obtain a comprehensive understanding regarding the business. Maintaining accurate and precise accounting records will act as evidence in a court of law. As businesses develop, the number of transactions involved increase too. Therefore accounting records would assist in summarizing this large number of transactions. Due to the plethora of benefits, maintaining effective accounting records is vital to the smooth flow of business operations (Moore, 2006).

IMPORTANCE OF ACCOUNTING CONCEPTS

Accounting concepts are basic underlying assumptions used in generating financial statements in business and organisations. Accounting concepts include; accruals, going concern, consistency, prudence and business entity concept to name a few. The importance of accounting concepts lies in the application of various concepts in real business environments (Greig & MacKay, 2009).

The business entity concept states that the business should be treated as a separate entity from the owner/investor. Thus, transactions relating to the business should be recorded separately. This would help the owners to identify their individual assets and liabilities and understand that they aren’t liable for risks faced by the business (Warren, Reeve & Duchac, 2013).

The accruals basis will include the non-cash transactions, thus helping the users of the financial statements to understand the financial position of the organisation. The concept of going concern is based on the fact that the accounts have been prepared with the assumption of the business operating for the foreseeable future (Ramlochan & Lalla, 2002).

The consistency concept provides reliability and uniformity to financial statement. As per the consistency concept, a particular item will be treated in the same manner repeatedly. The financial statements should be based on the prudent concept, where when in doubt the worst possible outcome should be recorded (Vickerstaff & Johal, 2014).

Thus it is evident that accounting concepts provide consistency and reliability to accounting records and financial statements. Accounting concepts design financial records to match the dynamic business environment, and as per the requirements of the users of the financial statements.

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INFLUENTIAL FACTORS OF THE STRUCTURE OF ACCOUNTING SYSTEMS

There are various accounting systems that could be implemented within a business. However there are two main accounting systems namely; manual accounting systems and computerised accounting systems. Manual accounting systems are traditional and well-crafted systems which usually include; cash books, sales and purchase day books and petty-cash books. Manual accounting systems are based on fundamental accounting concepts and are labour intensive and require a large amount of paperwork. On the contrary, computerized accounting systems are machine intensive, thus are faster and more accurate than manual accounting systems, However the initial investment required for computer accounting systems are quite high (Hall, 2012).

When determining the structure of accounting systems to be implemented within the organisation, there are a plethora of factors that should be examined. For small businesses with a small amount of transactions, investing in costly computerized systems would be unnecessary. A manual system would be sufficient. However for large organisations, implementing a computerized accounting system would be extremely important due to their voluminous transactions. Therefore, the size of the business is a major deciding factor of the structure of the accounting systems. The level of accuracy and precision required, capability, capacity and requirement of the business are few other factors that should be considered when determining the structure of the accounting system within the business (Hansen & Mowen, 2005).

CONCLUSION

The reports discussed the various types and purposes of accounting records and the numerous accounting concepts that govern them. It was evident through the discussion that organised, precise and accurate accounting records should be maintained within the business to ensure the stability of the business.

TASK 2: ANALYSING MANAGEMENT CONTROL SYSTEMS
IMPORTANCE AND IMPLICATIONS OF BUSINESS RISK MANAGEMENT

REPORT

To: Board of Directors

From: Business Analyst

Date: 13th April 2014

Subject: Evaluating importance of business risk management and implications of non-compliance with financial regulations and negligence on business risk management.

Introduction

Business risk management is a systematic process carried out to identify, prioritize, and draw plausible actions to mitigate unforeseen future risk facing entities beforehand; to ensure the possible penalties are minimized facilitating continuous business operation. There are internal and external risk factors. Financial, employee, strategic, and innovation risk are commonly faced internal risk factors whereas external risk factors are governed by factors such as health and safety, political environment, and degree of compliance. This report analyses the importance of business risk management and the impacts of weak risk management practices to a business operation.

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Importance of business risk management

Risk management is of growing importance due to number of reasons. Local and global legislation is continuously becoming stringent implying the need for strategic risk management processes and practices for an entity to succeed. In the past companies simply tend to mitigate their financial and nom-financial losses due to unforeseen events via insurance schemes which is no longer the cheapest option. Even the insurance companies expect effective risk management in the end of the clients which has made insurance claiming quite challenging often leading the clients to bear the losses (Hampton, 2009, p.18). The business environment is dynamic and the attitudes of customers, management, employees, and general public are changing drastically. Globalization and professionalism adapted by the entities enhancing competition in local and global markets excessively demand for effective and efficient risk management practices to preserve their market share mitigating future risks.

Impacts of neglecting business risk management

Avoidance is not the best way to deal with risks facing entity, but to manage them responsibly. Neglecting business risk management brings about adverse impacts not only to the company, but also to the internal and external environment and stakeholders related to it via financial and economic damages, loss of opportunities, environmental damages, job and income losses, and even life losses due to health and safety risks (Hampton, 2009).

Impacts of non-compliance with financial regulation

Non-compliance with financial regulations and legislations exposes the entity to a greater amount of regulatory risks which often leads to fines and litigations which brings about major financial losses to the entity (Chey, 2014, p.15). Material impacts are imposed on financial statements due to non-compliance which subsequently leads to loss of faith on the company among the investors and other stakeholders and often lead to the business to collapse in the long term.

Conclusion

Businesses are facing a number of risks on a daily basis. It is vital to maintain effective and efficient risk management processes in place to mitigate the impacts of unforeseen future risks which otherwise would lead to severe financial and non-financial losses to the business and its stakeholders.

CONTROL PROCEDURES TO DETECT FRAUD RISK FACING BUSINESS OPERATIONS.

In order to assess likelihood and exposure to fraud risks facing business operations, various risk assessment internal control procedures are in place. Fraud risk matrix is a commonly used tool which links internal controls to unforeseen fraud risks subsequently developing an audit procedure which links fraud risks facing entity (Vona, 2012, p.96). Creative accounting and deliberate misrepresentations are commonly employed fraud by entities. Clear separation of duties, systematic and up to date documentation, effective sanctions, and physical control of assets and information systems are preventive control procedures to detect fraud risks. Proactive fraud detection, reconciliations, and effective performance appraisal procedures are detective internal controls.

TASK 3: PLANNING AND CONDUCT OF AN AUDIT ASSIGNMENT

REPORT

To: The Manager

From: Auditor

Subject: Audit Assignment

Date: 14th April 2014

INTRODUCTION

The report discusses the importance of auditing and provides a detailed description of the elements relating to planning and conducting an audit assignment. A plethora of audit tests and tools that could be used in audit reporting and recording are evaluated in the report.

FINANCIAL AUDITS

Audits are measures of internal control, which establishes the monetary and operational efficiency and diminishes the organisational risk. Auditors have a statutory duty of ensuring the reliability, true and fair view of the financial statements and financial controls used in a business (Russel, 2003).

PLANNING AND CONDUCTING AN AUDIT ASSIGNMENT

An audit plan is designed by the auditor taking into consideration factors such as; time, cost, scope, nature and degree of the audit work to be carried out. The objective of an audit plan is to conduct the audit in the most effective way, in order to identify the reliability of the financial statements and to pay significant attention to numerous areas in an audit. Through a carefully structured audit plan, the commercial aspects of an audit process can be identified and limitations of the procedures could be observed (Kumar & Sharma, 2006).

The scope of the audit is a major factor that should be considered when designing an audit plan. The scope of the audit should examine the adequacy of the financial controls implemented within the organisation. It should consider the effectiveness of operations, safeguarding of assets and compliance with rules and regulations. The scope of the audit plays a key role in an audit, thus is of utmost importance in audit planning. All other factors should evolve around the scope of the audit. Both time and cost are integral factors in meeting the expectations of the organisation. Any audit procedure should be completed on time and within budget. Depending on the organisations, the audit time frame will differ. As most organisations conduct annual audits, there are businesses which conduct semi-annual and quarterly audits. Therefore the audit process should be limited to certain time frame. The audit process should also not exceed the budget set by the organisation. If any issues arise during the planning procedure, it should be conveyed to the management and the audit plan should be amended as appropriate (Johnstone, Gramling & Ritternberg, 2013).

AUDIT TESTS AND AUDIT TOOLS

Audit tests can be performed by both internal and external auditors and are used to evaluate the accuracy and reliability of financial statements prepared by an organisation. Audit tests are mainly of two types; substantive tests and tests of internal control. Audit tests are usually conducted on a sample extracted from a population of similar transactions. The samples of transactions are chosen using simple random sampling, systematic sampling or stratified sampling, so that the most representative sample is chosen to conduct the test (Puncel, 2007). The various types of audit tests that can be used during the audit process are shown in table 1 below.

Table 1: Audit Tests

Audit Test Description
Test of Effectiveness Test to determine the effectiveness of controls over cash disbursements.
Dual Purpose Test of Controls and Account Balances Test to determine the effectiveness of plans relating to other audit tests and test the accuracy of related transactions.
Substantive Analytical Test Test to determine if the account relationships meet expectations.
Direct Test of Account Balances Test to examine the existence and accuracy of account balances at historical costs.
Direct Test of Transactions Test to examine the existence of sales transactions.

In addition to the above tests a number of tools are utilized by auditors in audit recording, which includes; process mapping analysis, survey techniques, analytical review and inquiry through facilitated groups (Johnstone, Gramling & Ritternberg, 2013).

CONCLUSION

The report discussed a plethora of factors that should be considered when planning and conducting an audit assignment. The inter-relationships of these factors were discussed in the context of executing an effective and efficient audit. The purpose of conducting audit tests, the various audit tests utilized by auditors and audit tools used in audit recording were evaluated in the report.

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TASK 4: AUDIT REPORT PREPARATION
PURPOSE, TYPES, AND CONTENTS OF AUDIT REPORTS

Audit reports demonstrates a formal opinion or else a disclaimer prepared and issued as a result of an internal or external audit carried out for a legal business operation by an independent external auditor or an internal auditor (Moeller, 2009, p.121). The main purpose served by the auditor’s report is to provide information on financial position and the future of business entities reliably to interested stakeholders to facilitate operational, financial, and investment decision making. Publishing audit reports is demanded by law especially for entities regulated by SEC (Securities and Exchange Commission) or otherwise publically traded.

Audit reports could be classified under four types according to situational encounters during the audit process namely; unqualified opinion, qualified opinion, adverse opinion, and disclaimer of opinion (Henderson, 2014). Unqualified opinion is the best audit report an entity is entitled to which demonstrates that financial records and statements are maintained as per the accounting standards (IFRS or GAAP) in compliance with local regulatory requirements, pertinent material matters are essentially disclosed, and changes in the applicability of accounting principles and practices are determined and clearly disclosed. Qualified opinion is almost similar to an unqualified opinion which is issued for an entity which has not maintained the financial records systematically, however does not reveal any misrepresentations. The qualified audit report in a special paragraph illustrates the reason for the qualified opinion instead of an unqualified opinion. Poorest audit report an entity can obtain is an adverse opinion (Henderson, 2014) which is issued due to lack of compliance with accounting standards, regulatory requirements, and degree of misrepresentation involved. It is vital to reconstruct the financial statements get them audited in such a situation. Disclaimer of opinion is issued when the auditor is not in a position to determine an accurate audit opinion on entity’s financial position due to reasons such as lack of information availability and lack of financial records.

The format of the audit report may differ from one company to another. However the basic elements and contents consists of; the title of the audit report, addressee, paragraph of introduction, management’s responsibility for the financial statements, responsibility of the auditor, auditor’s opinion, other reporting responsibilities, signature of the auditor, date of the report, and the address of the auditor (Moeller, 2009)

PURPOSE AND CONTENT OF MANAGEMENT LETTERS

Management letters which is also known as the internal controls letter or letter of weakness is a component of the auditor’s report demonstrates a report prepared addressing the management of the entity which illustrates recommendations and corrective actions suggested for the drawbacks in financial statements and disclosed by the auditors (Kumar and Sharma, 2006). Apart from that management letters provides a platform to enhance future financial reporting, recording, and evidence gathering process, allowing auditors to direct the attention of the management towards the areas of weaknesses which may incur severe material errors. The contents of management letters are not required to be disclosed in the annual statements of financial position or performance. Contents of a management letter often includes the weaknesses identified during the audit process, weaknesses in applicability of controls, significant errors, deviations from accounting standards and local regulatory requirements, and inappropriate accounting policies and practices involved in financial reporting (Gray and Manson, 2008, p.277).

REFERENCES

Chey, H. K. (2014), International Harmonization of Financial Regulation, Routledge Publishing, pp.13-17

Gray, I. and Manson, S. (2008), The Audit Process: Principles, Practice and Cases, Second Edition, Van Nostrand Reinhold (International), p.277

Greig, P. and MacKay, J. (2009), Accounting Concepts and Applications, Macmillan Education, United States

Hall, J. (2012), Accounting Information Systems, South-Western Cengage Learning, United States.

Hampton, J. J. (2009), Fundamentals of Enterprise Risk Management: How Top Companies Assess Risk, AMACOM Publishing, p.18

Hansen, .D and Mowen, M. (2005), Cost Management: Accounting and Control, South-Western Cengage Learning, United States, p. 4

Henderson, K. J. (2014). What Are the 4 Types of Audit Reports? [Online], Available from:

http://smallbusiness.chron.com/4-types-audit-reports-3794.html[accessed 16/04/2014]

Johnstone, K., Gramling, A. and Ritterberg, L. (2013), Auditing: A Risk Based Approach to Conducting a Quality Audit, South-Western Cengage Learning, United States, p. 207

Kumar, R. and Sharma, V. (2006), Auditing: Principles and Practice, PHI Learning Pvt. Ltd., India, p. 54

Marshall, P. (2011), Mastering Book-Keeping, Constable and Robinson, United Kingdom

Moeller, R. R. (2009), Brink’s Modern Internal Auditing: A Common Body of Knowledge, Wiley publishing, United States, p.121

Moore, R. (2006), Small Business ManagementAn Entrepreneurial Emphasis, South-Western Cengage Learning, United States.

Puncel, L. (2007), Audit Procedures, CCH, United States.

Rajasekaran, V. (2011), Financial Accounting, Pearson Education, India, p. 118

Ramlochan, D. and Lalla, C. (2002), Principles Accounts, Pearson Education, India, p. 30

Vona, L. W. (2012), Fraud Risk Assessment: Building a Fraud Audit Program, Wiley Publishing, United States, p.96

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