Topic 3: Accounting System and Control

Coverage

3.1 Development of Accounting SystemFactorsProcedures: Principles, Phases, Computerised/manualCharts of accounts and accounts classification

3.2 Control in AccountingPurposeCharacteristicsAudit: internal and external

Factors

What are the factors that influenced the development of an accounting system within a business entity?

- Size of business- The volume of transactions- Branches/ subsidiaries- Types of business activities

What are the outputs?

Summary of all the transactions – financial statements

Quality of outputs:

Relevant, reliable, understandable, timely, comparable

Qualitative characteristics

Understandable:Accounting information is produced to fulfill the needs of users. The understanding of the financial statements information is an essential criteria. Therefore, those parties interested in the financial statements should learn how to use it so that information provided is understood and helpful in making decision.

Qualitative characteristics…cont.

Relevant and Reliable

1)Relevant means information that is related to a particular decision, that is it can affect a decision made. For example, information on the net assets and profitability are relevant for bankers to decide whether loan should be approved to a particular business.

Qualitative characteristics…cont.This criterion depends on the following:i. Predictive value – Information must have

predictive value to make it relevant. Taking the previous example (bank), the information provided enable the bank to predict whether the business is capable of paying back the debts.

ii. Feedback value – this means the information that can help decide whether a past decision can be confirmed or altered.

iii. Timeliness – Accounting information is obtained before any decision is made.

Qualitative characteristics…cont.2) Reliability of accounting information

depends on:i. Neutral – the information is prepared

objectively i.e. without any influence.ii. Verifiable – information provided can

be verified by other parties.iii. Give the true picture – the

information must reflect a true picture of the items presented.

Qualitative characteristics…cont.

Comparability: Information that enables users to compare it with the same industry from other entities.

Consistency: The use of accounting method must be consistent from one period to period.

Limitationsi. Cost benefit: The quality of information

issued is constrained by cost. The higher the quality to be attained, the higher its cost.

ii. Materiality: This means information that affects decision making. Immaterial information should be excluded.

iii. Conservatisms: This means, the estimation chosen should have the probability to overstate the assets or profit.

Analysis

Implementation

Evaluation

Design

Phases in the development of accounting

system

Analysis

Planning and identifying information needs of internal and external usersSources of such informationThe records and procedures for collecting and reporting the dataAnalysed present system – strengths and weaknessesProposed new/ revised system

Design

Specify systems requirements more precisely

Where data would be captured

The required processing

Where the output would be used

Implementation

Install new / revised systems (e.g. hardware & software)

Making the system fully operational

User manual

Training users/personnel

Evaluation

Assess the progress and status of new systems

Monitoring effectiveness and correcting any weaknesses.

e.g. General acceptance by users, Cost and benefit

Computerised Accounting Information SystemsBasic Features

Built-in programs performing journalising, posting and preparation of trial balance and reports.

Use of modules: general ledger, inventory, accounts receivable, accounts payable.

Data entered in one module automatically updates information in other modules.

General ledger and accounting reports updated automatically.

Computerised Accounting Information Systems (cont’d)

Advantages

Ability to process large number of transactions quickly.

Automatic posting of transactions.

Error reduction.

Fast response time.

Flexible and fast report production.

Computerised Accounting Information Systems (cont’d)

Disadvantages

Use of inappropriate and/or incompatible software and hardware.

Need for reliable back-up procedures.

Lack of computer system skills.

Computer viruses and hackers.

Fraud.

Chart of Accounts

A listing of all accounts and associated account numbers for a business

WONG PTY LTD – Chart of Accounts Assets Liabilities Equity Revenues Expenses

No. Account title No. Account title No. Account title No. Account title No. Account title 100 Cash 200 Accounts Payable 300 Share Capital 400 Service Revenue 500 Salaries

Expense104 Accounts Receivable 210 Interest Payable 300 Retained Profits 405 Commissions 505 Supplies Expense105 Commissions Receivable 213 Revenue Received 320 Dividends Revenue 510 Rent Expense110 Advertising Supplies in Advance 330 Profit and Loss 515 Insurance

Expense112 Prepaid Insurance 215 Salaries Payable Summary 518 Interest Expense130 Office Equipment 230 Bank Loan 520 Depreciation Expense131 Acc. Depreciation – Office Equipment

Accounts Classification

Accounts are classified according to common characteristics: assets, liabilities, capital, revenue and expenses

Definitions of assets:Things of value which are possessed by a business

Resources that will bring benefits to the organisation

Types of assets

Current assets (short-term) – cash and other assets that may be reasonably be expected to be realised in cash/ sold/ consumed within a year or less through the normal operations of the business

Non-current / long-term / fixed/ property, plant & machinery – tangible assets used in the business that are of a permanent or relatively fixed nature. Usually span of life is more than 1 year.

Intangible assets – do not have any physical features. They present legal rights and relationships beneficial to their owners. E.g. patents, copyrights, trademark and goodwill.Liabilities – debts owned (in term of cash, goods or services) to outsiders (creditors) and are frequently described on balance sheet by titles that include the word “payable”

Current liabilities (short-term) – liabilities that will due within short time (usually one year or less) and that are to be paid out of the current assets

Long-term liabilities (fixed) – liabilities that will not be due for a comparatively long time (usually more than one year)

Capital - the owner’s equity in the business

Revenue – the gross increase in capital attributable to business activities

Expense – cost that have been consumed in the process of producing revenue

Drawing – money taken from the business for personal use

Control in Accounting

Detailed procedures adopted by the management to control the operation of a business

Means of controlling the entity’s activities to help ensure that they accomplish the desired objectives

PurposesTo control the operation of businessTo provide reasonable assurance those specific objectives will be achievedTo provide physical security and management control over an entity’s cash, inventories and other assetsTo ensure management policies are adhered toTo prevent errors and fraudsTo ensure the record and reports are accurate and meeting the standards

Types of Internal Control

Administrative ControlProcedures and records that assist management in achieving business objectives

Accounting ControlSet of procedures and records that are primarily concerned with the reliability of financial records and reports and safeguarding of assets

Internal ControlInternal control consists all the processes used by management to achieve effective and efficient operations, compliance with laws, etc.

It includes policies to:safeguard assets

enhance accuracy and reliability of accounting records

It is an essential part of risk management.

Principles of Internal Control

1. Establishment of responsibility.

2. Segregation of duties.

3. Documentation procedures.

4. Physical, mechanical and electronic controls.

5. Independent internal verification.

Principles of Internal Control (cont’d)

1. Establishment of responsibilityAssignment of responsibility to specific individuals.

Monitoring of compliance with procedures

2. Segregation of dutiesResponsibility for related activities assigned to different people

Separation of responsibility for recording and physical custody of the asset

Principles of Internal Control (cont’d)

3. Documentation proceduresAll documents generated by the business to be pre-numbered

Documents to be initialled

Provides a audit trail for checking of transactions

Principles of Internal Control (cont’d)

4. Physical, mechanical and electronic controls

Use of safes and safety deposit boxesLocked cabinets and warehousesAlarmsMonitors and sensorsPasswords to computer systems and programsTime clocks

Principles of Internal Control (cont’d)

5. Independent internal verificationChecking procedures to ensure segregation of duties

Monitoring by supervisors

Verification by internal auditor

Rotation of duties

Internal Audit

An independent appraisal activity established within an organisation as a service to the organisation

It is a control that functions by examining and evaluating the adequacy and effectiveness of other controls

Internal Audit: Objective

To assists members of the organisation in the effective discharge of their responsibilitiesTo accomplish this objective, the internal audit staff is expected to furnish the organisation with “analyses, appraisals, recommendations, counsel and information concerning the activities reviewed”.

Responsibilities

Encompassing the examination and evaluation of the adequacy and effectiveness of the organisation’s system of internal control and the quality of performance in carrying out assigned responsibilities

Scopes

Reviewing the reliability and integrity of financial and operating information and the means used to identify, measure, classify and report such information

Reviewing the systems established to ensure compliance with those policies, plan, procedures, laws and regulations that have a significant impact on operations and reports, and determining whether the organisation is in compliance

Reviewing the means of safeguarding assets as appropriate, verifying the existence of such assets

Appraising the economy and efficiency with which resources are employed

Reviewing operations and programs to ascertain whether results are consistent with established objectives and goals and whether the operations or programs are being carried out as planned

Internal audit vs external auditInternal External

Auditor Full-time employees of an entity

Independent practitioner

Employer Companies, governmental unit, non profit entities

CPA Firms

Perform Compliance & operational audit

Financial audit

Responsible to

Senior management & BOD

3rd parties -investors

Licensing No Yes (CPA)