Accountancy, accounts and auditors

1 Cost schedules

A cost schedule collects and analyses the direct materials, direct labour and overhead costs of a product, service, job or department. It supports pricing, budgeting, cost control and management decisions.Influence of the accountancy profession

YouTube videoPlay video

The accounting profession has the very wide-ranging influence.

• Financial accounting. The accountancy profession deals with how items should be shown in the accounts. In other words, the profession establishes the accounting standards.
  

• Auditing. Once companies get to a particular size they have to be audited. An audit is an independent gathering of evidence that allows the accountants to report whether or not the accounts produced by the company show a true and fair view.
  

• Management accounting. Within companies there needs to be management accounting. This will be looking at budgets, future estimates and will be recording on a month-to-month basis how the company is doing, and investigating why it might not be on track to hit the required profits.
  

• Consulting. Many accountants also provide consultancy. For example relating to the IT system, particularly for the accounts function, and in setting up remuneration schemes and systems of internal control.
  

• Taxation. Accountants have a very important role in helping organisations to calculate their tax liabilities and reporting this to the government revenue authorities.
  

• Government. Within the public sector, that is government organisations, accountants are very important in tracking and recording the expenditure of public funds that have been raised by taxation.
  

Accountants are usually regarded as professionals.

• Competence (specialist knowledge is worthless if it is wrong, out-of date or a mystery)
  

• Honesty and integrity (to apply knowledge and competence properly)
  

• Reliability (clients expect to have their requirements met on time)
  

• Flexibility (for example, staying late, working weekends to meet deadlines)
  

• Respect for others (for example, recognising that others might have valid but different views)
  

• Self-control (no matter how much provoked, professionals should remain calm and business-like).
  

2 Professional ethical codes

The International Federation of Accountants is the global organisation of the accountancy profession. It works in over 120 countries and jurisdictions to protect the public interest by encouraging high-quality practices by the world’s accountants. Through its independent standard-setting boards, IFAC develops international standards on ethics, auditing and assurance, education and public sector accounting standards. It also issues guidance to support professional accountants in business, small and medium practices and developing nations.

The IFAC Code of Ethics is a good illustration of a professional ethical guide. The code states that the accountancy profession has a responsibility to act in the public interest and it then goes on to establish detailed guidance on fundamental principles and ethics. You will shortly see what the fundamental principles refer to.

Having identified the fundamental principles, the framework then requires accountants to identify, evaluate, and address the threats to compliance, applying safeguards to eliminate the threats or to reduce them to an acceptable level. For example, independence is especially important in audit and supports the fundamental principle of objectivity. But how can an auditor be independent if the auditor receives an audit fee from the client? So there we have a fundamental principle and we have identified a potential threat to that fundamental principle. The safeguard applied is to put a limit on the amount of fees coming from any one client so that that the auditor would not feel unduly threatened if that client were to leave after a dispute about the financial statements.

3 ACCA Code of Ethics and Conduct.

The ACCA’s fundamental principles are as follows:

• Integrity. Basically, this means that the members should be honest and straightforward. If they see something is amiss, they should say so. They shouldn’t try to conceal, they shouldn’t try to be ambiguous. They should state things plainly.
  

• Objectivity. Members should be influenced by the facts and the facts only. They must avoid bias, conflict of interest, and undue influence.
  

• Professional competence and due care. Accountants must keep themselves up to date with legislation and recent developments. They shouldn’t take on work which they are not qualified for or for which they have no skills. They must be diligent, they must be careful.
  

• Confidentiality. Members, particularly perhaps auditors, have access to information which is highly confidential and which is price-sensitive. That information must be held confidentially. Members should not disclose confidential information unless they have a legal or professional duty to do so. An example of the legal duty to disclose information can arise if a member thinks that a client or the person that they are working for is involved in money laundering. Many countries have very strong regulations nowadays stating that money laundering suspects should be reported to the authorities.
  

• Professional behaviour. Accountants should comply with the law and they should avoid any action which discredits the profession. So, for example, when they are trying to advertise their services, they shouldn’t say that other members are bad or poor. They should confine themselves to promoting what they are good at. They shouldn’t rubbish other professionals.

4 Users of accounting information

The potential uses of accounting information include:

• Managers of the company.
  

• Shareholders of the company.
  

• Trade contacts: suppliers and customers.
  

• Providers of finance to the company.
  

• The Inland Revenue (tax authorities).
  

• Employees of the company.
  

• Financial analysts and advisers.
  

• Government and their agencies.
  

• The public.
  

5 Management accounts and financial accounts

Accounting information is usually divided between management accounts and financial accounts.

5.1 Management accounts are:

• Internal.
  

• They can be in any format.
  

• They look to the future, for example setting budgets; and back, for example looking at performance to date.
  

• They are often what’s known as ‘ad hoc’. That means they can contain non-routine special reports.
  

• Their form and content is not governed by statute. Management accounts are governed simply by the need for information and how that can be best provided.
  

• Finally, they are not subject to audit or independent checking of any sort.
  

• Management accounting deals primarily with setting budgets (a financial plan), budgetary control, planning and recording costs and providing information for decision making., for example, which products are the most profitable. When budgets are compared to actual results, the differences are known as variances. These van be favourable (costs less than budget costs, sales higher than budget sales) or unfavourable/adverse (costs higher than budgeted, sales lower than budgeted). Large variances imply that something unexpected happened and management can focus their attention on investigating their cause.

5.2 Financial accounts are:

• The published accounts of a company, particularly provided for the members or shareholders of the company.
  

• The format and content is tightly regulated by statute.
  

• They always look back, what the balance sheet at a particular date was at what the profit and loss account for a period was.
  

• They are absolutely routine, normally appearing annually.
  

• They must comply with statutory and other accounting rules
  

• Often they are subject to audit and certainly are once a company becomes a significant size.
  

• Financial accounting deals primarily with recording financial transactions and producing financial statements. Financial statements consist of:
  

  • Statement of financial position
    

  • Statement of profit or loss
    

  • Statement of cash flows
    

  • Notes to the financial statements
    

• Statement of changes in equity.
  

• It is becoming increasingly common for companies to publish, as part of their annual reports, sustainability and integrated reports. These widen the information given to shareholders and will, for example, indicate human capital (the skills of employees) and resource capital as well as financial capital and steps the company is taking to achieve long-term sustainability (for example, using renewable energy sources and reducing waste).
  

6 External audit

We have made several references to the term “audit” and we were referring to external audit. So let’s just cover a little bit more about what that might entail.

If you remember back to the problems of corporate governance, these arose from the fact that the owners of the company, the shareholders, appointed directors to run the company on a day-to-day basis. But how do the owners know that the directors are running the company properly? Originally the only real check was that once a year the directors had to produce a set of financial statements (accounts). To try to ensure that the financial statements are what’s known as “true and fair,” independent, external auditors are appointed by the members to check them.

If the directors do not file financial statements on time there are severe penalties because this information is required for the public record. In the UK, all companies - private or public, large or small, trading or non-trading - must send their accounts and reports to Companies House every year. If you submit company accounts and reports late, the law imposes an automatic penalty. Failure to file annual accounts is a criminal offence which can result in directors being fined personally in the criminal courts.

The financial statements comprise the:

• Statement of profit or loss.
  

• The statement of financial position (often colloquially called the balance sheet).
  

• Cash flow statement
  

• Notes to these documents.
  

• Statement of changes in equity.
  

The external auditors look at these financial statements, do many checks, look for supporting evidence about the figures in them, and come to a conclusion about them. The conclusion is given in the Audit Report, which is attached to the financial statements.

• ‘True’ means that the financial statements are more or less arithmetically accurate.
  

• ‘Fair’ is a slightly more difficult concept and means they are not misleading. Something can be arithmetically accurate, yet still give an incorrect impression.
  

Additionally, the auditors examine the system of internal control of the company and transactions that happened during the year and they then produce reports to management about the company’s accounting procedures. So if the auditors find, for example, that invoices are not being priced up properly, they will report this to management, and management can then take action to try to ensure that and errors or problems do not occur again in the future.

If the auditors conclude that there are material misstatements in the financial statements (ie significant errors) then they will be unable to state that the financial statements show a true and fair view and will modify their audit report appropriately to explain the issue: thus warning the shareholders about the problem.

It is important to note what external auditors do NOT do:

• They do not prepare the financial statements: management does.
  

• They do not check every transaction: this would not be economically viable in all but the smallest companies. Instead, they look at a sample of transactions.
  

• As a consequence of the above, the auditors do not guarantee that the financial statements are correct. They can only give reasonable assurance that the financial statements are free from material misstatement.
  

• They do not specifically look for fraud. Many incidents of fraud are relatively small and fraudsters often cover their tracks very cleverly. There is a reasonable chance of large frauds being detected but it is not the auditors’ duty to guarantee that no frauds have occurred.
  

• They do not give guidance as to whether the company is a good one to invest in.
  

• They are not responsible for establishing the system of internal control: management is. However, they will inform management if any internal control deficiencies are discovered during their audit.

Note: most countries’ legislation allows audit exemptions for very small companies (such as family companies) because in such companies the owners are usually involved with the day-to-day activities of management so an independent audit is unnecessary.

7 The regulatory system

In the UK, financial statements are regulated as follows:

• Company law. This, for example, insists that companies produce accounts roughly every year. Although there are certain statutory disclosures set out in company law, by and large company law doesn’t go into huge amounts of detail about exactly how different elements of the financial statements must be shown. That’s really too complex a matter to have in law because frequent changes and great expertise is needed to decide how things should best be shown.
  

• Accounting standards. The detailed regulations about disclosure and presentation are usually found in the accounting standards. The major bodies of accountants must subscribe to the accounting standards. The system for establishing accounting standards in the UK is headed up by the Financial Reporting Council. Internationally this function is carried out by the IASB (International Accounting Standards Board). The IASB works towards harmonising accounting standards throughout the world by issuing International Accounting Financial Reporting Standards (IRFRs). The FRC usually adopts IASB standards. In general, all sets of financial statements should comply with the financial reporting standards.
  

• Auditing standards are governed by IFAC, the International Federation of Accountants and, in particular one of its sub-committees the IAASB (International Auditing and Assurance Standards Board). Auditing standards set out how audits should be conducted and how audit evidence should be obtained.
  

• IESBA (International Ethical Standards Board for Accountants). This is part of IFAC and sets out the ethical framework for accountants (eg integrity, objectivity, professional competence and due care, confidentiality and professional behaviour). By and large, ACCA adopts the IESBA’s code as its Code of Ethics and Conduct. From time to time urgent issues arise, for example, the recent banking crisis could potentially have given rise to issues which had to be dealt with very quickly. Rather than going through the full and perhaps rather slow process of establishing financial reporting standards in the normal way, the Urgent Issues Task Force can deal with these urgent matters quickly.
  

• Financial Reporting Review Panel. Sometimes companies depart from the financial reporting standards and the Financial Reporting Review Panel is concerned with examining and questioning why that has taken place. Occasionally they may conclude the departure is justified, but this tends to be a relatively rare occurrence.
  

• Public Interest Oversight Board. Oversees IFAC and concentrates on audit, education and ethics. It has representatives from a wide range of users of financial statements. It widens the range of opinions taken into account when accounting and auditing standards are being formulated.
  

• EU Law. Listed companies in the European Union have to adopt IFRSs.
  

• GAAP
  

GAAP stands for Generally Accepted Accounting Practice (UK) or Generally Accepted Accounting Principles (in any parts of the world).. This is a common set of accounting principles, standards and procedures that companies use to compile their financial statements.

GAAP is a combination of statute, accounting standards, international accounting standards, stock exchange rules, and convention. GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analysing companies for investment purposes. Companies are expected to follow GAAP rules in reporting their financial data through their financial statements.

8 Internal audit

The role of internal audit is:

..to provide independent assurance that an organisation's risk management, governance and internal control processes are operating effectively (Chartered Institute of Internal Auditors).

Internal auditors should be independent from the company’s operations and, in particular, independent from the company’s accounting operations. They should have access to the board, usually through the audit committee if there is one.

Internal audit should consist of qualified, skilled and experienced staff. The members of the internal audit department should comply with ethical and professional standards.

Although internal audit can be assigned a number of tasks, most of their regular work is examining the design and practical operation of the company’s system of internal control. Internal auditors obtain very detailed skills and knowledge about their company’s operations and this can provide very useful information and recommendations for the board to consider.

External auditors sometime liaise with internal audit, for example, to avoid audit work being duplicated. However, the external auditor is sole responsible for the opinion expressed in the audit report attached to the financial statements.

9 Internal audit compared to external audit