Financial Accounting and Auditing

This assignment delves into the crucial concepts of financial accounting and auditing. It examines fundamental accounting principles, various types of audits (e.g., internal, external), and their significance in ensuring financial transparency and accountability within organizations. The report also analyzes real-world examples and discusses the influence of audit quality on financing decisions.

FINANCIAL SYSTEM AND AUDITING
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Table of Contents
INTRODUCTION................................................................................................................................3
TASK 1.................................................................................................................................................3
Objectives and uses of different accounting records.......................................................................3
Fundamental accounting concepts and its importance.....................................................................4
Factors affecting accounting system................................................................................................5
TASK 2.................................................................................................................................................5
Different components of business risk.............................................................................................5
Analyse business control system.....................................................................................................6
Risk of fraud and suggesting methods for detecting fraudulent activities.......................................7
TASK 3.................................................................................................................................................8
Plan an audit with scope, materiality and risk.................................................................................8
Appropriate audit test procedure for risky industries......................................................................8
Record an audit process of a proposed plan.....................................................................................9
TASK 4...............................................................................................................................................10
Types of draft report and preparation of unqualified report...........................................................10
Draft a suitable management letter of statutory audit....................................................................11
CONCLUSION..................................................................................................................................12
REFERENCES...................................................................................................................................13
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INTRODUCTION
In every organization regardless their sizes, accountant are responsible to keep a detailed track
record of their financial transactions, known as financial accounting. It must be noted that business
accounts are prepared by using standard set of guidelines which comprises especially income
statement and balance sheet. The purpose of this assignment is to address various accounting
concepts and principles which are the basis of financial accounting and reporting system. Moreover,
it also emphasizes on the causes of fraud and suggests the ways to reduce error and the fraudulent
activities. After preparing financial statement, companies are also required to audit their accounts so
as to make sure their truth and fairness. Therefore, in the report, audit procedure will be explained
along with the auditor report.
TASK 1
Objectives and uses of different accounting records
Scenario states that Minty Cola Co, called Minty produces different kinds of fizzy drinks such
as cola, Lemonade and other kinds of soft drinks to meet the customer nutritional requirement. It
prepares its accounts on a timely basis to determine their operational result and financial strength as
well (Gramling, Johnstone and Rittenberg, 2012). In order to record the transactions, firm needs to
maintain proper records of their functions which are demonstrated underneath:
Prime entry books: As the name implies, it is a book of original entry in which transactions
are recorded initially. For instance, sales book report about delivery of fizzy and other drinks in cash
whereas purchase book record only cash purchase transactions. On the other hand, sales come day
book includes only credit sale whilst purchase come day book reports about the credit purchase. The
main purpose of prime entry books is to maintain proper records of each and every transaction for
preparing the annual accounts in the end of year (Lunt, 2009).
Ledger: It is a complete record of every component such as assets, liabilities, expenditures,
revenue which have been incurred by Minty over an accounting year. These are the classified
statement in which each reported transactions in journal are shown in both debit and the credit side.
It is mainly prepared to consolidate all the operations regarding a specific element And also use as a
basis of trial balance preparation.
Trial balance: It is a summarized statement of all the ledgers and it either can be prepared
by total or balance method. The main objective of the constructing trial balance is to measure
arithmetical accuracy in the reporting (Murthy, 2010).. It is because, if the total of both the credit
and debit side matches with each other than it is a sign of accurate reporting or vice-versa.
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Income statement: This statement includes both the revenues and payments incurred over a
specified duration. For instance, sales, purchase, direct and indirect payments i.e. rent, stationery,
lighting, taxes, dividend etc. are reported in this statement. The main purpose of it is to determine
the net profitability in the terms of profitability or loss.
Balance sheet: It is a summarized statement of the assets (current and fixed) as well as
liabilities (short-term and long-term) together with the owner’s equity. It is prepared by Minty to
determine their financial position by identifying liquidity, solvency and efficiency at the end of
every accounting year (Ramachandran, 2011).
Fundamental accounting concepts and its importance
Minty needs to prepare its income statement and balance sheet by taking into account all the
income, revenues, assets and liabilities as well. Accountant is required to prepare such statement by
complying with several basic concepts that are demonstrated below:
Accrual: This principle states that all the business transactions must be recorded at the time
of their occurrence rather than their actual receipts and payment in cash. Therefore, as per this rule,
Minty’s statement of comprehensive income will include both the cash and credit income and
expenditures occurred during a fixed period (Basu, 2006).
Going concern: Every entrepreneur needs to believe that their business operations will be
continuing for an infinite period. It is important because it allows the Minty Cola Co. to depreciate
and amortize their fixed assets over its useful life.
Business entity: This concept reveals that business transactions must be recorded separately
from such activities and operations which are associated with the owner. It assumes that
entrepreneur and organization both are separate from each other, and therefore, money that is put by
the owner will be reported as capital while their withdrawal for personal use will be presented as the
drawing.
Historical cost: This principle states that Minty Cola must record their non-current assets at
the original cost in the balance sheet. In other words, the price at which fixed assets like property,
building and plant and machinery has been acquired from the market is called as the historical cost
and entity need to record transactions at this value rather than the inflated price (Busch, 2012).
Consistency: According to this, one adopted principle or concept will be followed
continuously in the upcoming years, unless change in the principle brings improvements in the
financial reporting.
Prudence: This concept demonstrates that each and every business operation must be
recognized at their real value without any overestimation or underestimation. So that, Minty’s
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monetary statement can represent true and accurate position of its performance.
Materiality: As per this, Minty’s annual accounts must disclose the information regarding
each and every material fact. In such respect, materiality refers to the detail as well as
appropriateness of information so that decision makers can gather required information for the
decision-making (Cuckston, 2013).
Factors affecting accounting system
There are two types of accounting system that are manual system and enterprise resource
planning, shortened to ERP. Out of these, in the first, companies maintain accounting records and
reports manually whilst the other is related to capture financial information via electronic medium.
There are different factors which influence accounting system of the organization and these are
enumerated hereunder:
Complexity and size of organizational processes: Smaller-sized corporations which deal in
few operations prioritize manual accounting system because they do not need to maintain high
amount of the financial data. However, on the other side, establishments that operate at larger scale
and also deal in wide range of operations such as Minty have to maintain up-to-date and in-depth
information of high volume of data; therefore, they use ERP system so that transactions can be
recorded electronically by using the advanced technology (Sormunen, 2014).
Cost of implementing system: System cost is also an important factor and it is because, all the
corporations’ purpose is to minimize cost and maximize profitability. For instance, if the firm is
financially strong and able to bear the excessive cost of ERP system, than it can adopt computerized
system and however, in the case of lack of funds, business needs to manually record their
operations.
Employee skills: Corporations having skilled and talented personnel can easily use ERP
system. It is because; in order to operate computerized system it is essential for the Minty Cola and
other organization to have skilled and qualified personnel so that they can operate system easily.
However, in the case of unavailability of talented people, business is required to manually record
their financial activities (Dao and Pham, 2014).
TASK 2
Different components of business risk
In the present times, market gives tough competition to each and every commercial
establishment. Therefore, there is a high possibility of risk for Minty Cola Co. due to market
uncertainty and volatility like changes in customer demand, introduction of new technology, new
product and many others (Hassink, Meuwissen and Bollen, 2010). In order to meet the target goals,
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it is important for the managers to identify possible reasons of future risk and thereby take decisions
to overcome it. With regards to the Minty Cola, various components or elements of corporate risk
are discussed below;
Operational risk: Business losses that can arise due to the failure of internal process,
procedure, system and policies are called as operational risk. For instance, loss resulting from
failure in maintaining ethical standards, legal agreements and staff fraud etc.
Compliance risk: Every corporation needs to follow their respective governmental and
political rules and regulations. For instance, Minty needs to comply with legislation and follow
professional code of conduct; otherwise, legal actions can be taken against the business. Suppose, if
Minty did not pay taxes timely to the government than regulatory bodies can charge fines and other
lawsuit (Boolaky and Omoteso, 2016). Such risk may adversely impact the business reputation and
damage their goodwill.
Liquidity risk: Minty and all the other establishments have to maintain proper liquidity to
meet their daily operational requirement. In case of shortage of cash surplus, company will not be
able to dispose-off their short term liabilities timely and effectively and causes risk to the business,
called liquidity risk.
Analyse business control system
It is essential for Minty Cola’s managers to maintain effective control over their daily
business operations; otherwise, it can bring hazards to the business. It is only the duty of
management to prevent the risk of fraudulent activities and adverse results. Therefore, Minty’s top
management has to set rules, regulations and policies which every member are required to follow
while exercising their duties and responsibilities. Corporate governance is the best system of
safeguarding against the possibility of frauds (Danso and Adomako, 2014). It comprises set of
internal business policies, practices and processes by which Minty Cola will be directed and
controlled by the board members. It integrates each and every stakeholder such as employees,
managers, workers, managers, supplier, lenders, shareholders and many others.
It plays an important role in governing regular business operations so that hazards can be
prevented easily. Through complying with the governance principle, Minty Cola can also maintain
strong relationship with all the stakeholders and prevent their rights. For instance, shareholders have
the right to take part in business decisions therefore; it is the responsibility of company to
communicate business information with them (Song, 2016). Moreover, they have to invite
shareholders in annual general meeting. Despite this, they have the authority to recruit external
auditor to examine and analyze the truth and fairness of reported financial statement, so that they
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can make better investment decisions. It is considered as the best technique which helps to identify
the fraudulent activities in the annual accounts. Through this, they can identify the areas where
fraud have taken place by the workers and thereby exert effective managerial control to eliminate it.
In the given case, Minty hired a new credit control to chase its outstanding receivables; however,
finance director did not follow that policy and released the opening allowance of £500,000 to them.
It indicates that financial manager has breached the control system and violated his job
responsibility (Lin, Lin and Yen, 2014).
Along with this, regular monitoring also assists the management to identify the areas where it
is necessary to bring improvements. Furthermore, budgeting is also a better way to examine the
actual business results with the set targets that helps to determine the adverse deviations, which in
turn, qualitative decisions can be taken for the target accomplishment.
Risk of fraud and suggesting methods for detecting fraudulent activities
In the business, there is a great possibility of different kind of frauds; therefore, it is important
for the management to detect fraud and thereby eliminate it. In order to protect corporation itself
from the fraudulent activities, it is important for the management to follow a structured fraud risk
assessment procedure to identify the causes and areas of fraud (Helms, 2006). With reference to
Minty Cola, there are different factors which can cause fraud such as disclosure of material
misstatement, stolen of inventory and improper recording of cash income in the cash book etc.
Along with this, misappropriation of business resources likes telephone, car etc. lead to increase in
total expenditures and adversely impact the business profitability. Furthermore, bribery, conflicts of
interest and violation of employees’ responsibility for their personal benefits also results in business
loss. Therefore, it becomes essential for the Minty Cola’s board members to monitor daily
operations and safeguard and prevent the business itself from the frauds.
There are following ways available to the management to reduce possibility of employee
fraud which is given as under:
Minty Cola Co’s board members can prepare an internal control system and implement it
effectively in the organization to prevent possibility of omission, mistakes and errors. It refers to the
plans and programmes which a business prepares to safeguard itself against fraud and ensure
integrity as well. In such respect, segregation of duty is the most important component in which
each business personnel is responsible to do a specific task. For instance, marketing manager, sales
personnel and financial managers are accountable towards a particular task. Apart from this, proper
documentation of each and every business activity also must be assured for reporting all the
transactions in the Minty Cola’s financial statement (Peters, 2013). It is helpful in detecting fraud
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because every business operation is recorded by different person so that error can be identified
easily. In the given scenario, it has been stated that Minty Cola is suffering from difficulties due to
embezzlement in the cash operations. For instance, segregating responsibility of cash handling to
cashier and its recording to other person helps to identify the fraudulent activities i.e. theft and
stolen of cash. It must be noted that it is the duty of accountant to record only those transactions in
cash book which are authorised by the management. However, on the other hand, inventory fraud
can be eliminated by proper inventory recording and removal must be authorised by the board
members. Furthermore, verification of reported inventory items with the physical stock available in
warehouses is also necessary for Minty (Averkamp, 2016). In addition to this, it is also essential for
the mangers to monitor and revise their internal control programme on the timely basis so as to
eliminate the employee fraud. It enables the managers to take corrective action to remove
difficulties and reach targets.
TASK 3
Plan an audit with scope, materiality and risk
It is important for the Minty Cola Co. to audit its financial statement from an independent
auditor to verify the truth and fairness of the prepared accounts. In this, auditor has to understand
the accounting system, policies and look into the matters in which audit need to be conducted
(Neave, 2009).
Audit scope: It works as guidance to the external auditor while planning to audit Minty
Cola’s accounts. It covers the range of audit activities for which company hired an independent
auditor. In the given case, there is a greater chance of employee fraud regarding cash and inventory
items; therefore, it must be covered by the audit scope.
Materiality: Material information is those which absence or misrepresentation can change
the business condition and bring the company into heavy trouble (Murthy, 2010). For instance,
inaccurately reporting of inventory receipts and removal, inadequate recording of cash receipts,
unauthorized cash payments etc.
Audit Risk: Forming an inaccurate opinion about the financial statement of Minty Cola Co.
is called audit risk. For instance, if auditor became unable to identify the areas of misstatement and
fraudulent activities than he/she will definitely make wrong decisions about the truth and fairness of
the reported statements (Gramling, Johnstone and Rittenberg, 2012).
Appropriate audit test procedure for risky industries
Risk assessment procedure: This test is practiced by auditor to examine the effectiveness of
internal control mechanism in the Minty Cola and Co. It includes the inquiries of managerial
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functions, assessment of preliminary accounting problems and observation and inspection of
business records. The main aim of this procedure is to examine the risk of material misstatement.
Test of control: It is conducted to examine the effectiveness of control system for the
detection and prevention of fraud activities (Hogan and et.al., 2008). It comprises the investigation
of management, supervisor and staff members, application of control system into real practice and
many others.
Substantive procedure: It is mainly prepared to determine the fraud or material
misrepresentation in the financial statement. For instance, improper disclosure of cash receipts,
embezzlement by employees, unauthorized payment to other party, theft of goods for personal use
and misappropriation of business assets etc.
Analytical procedure: In this process, auditor compares the recorded monetary values with
the expected value made by examining the relationship between both the financial as well as non-
financial information. It helps to identify that whether annual accounts require any further
adjustments or not (Lunt, 2009).
Record an audit process of a proposed plan
It is very important for the auditor to follow a specific process in order to identify the errors and
fraudulent acts in the financial statement that is enumerated below:
Document collection: At the initial stage, Minty Cola’s auditor has to prepare a checklist by
noting down the necessary documents which he or she requires to conduct audit. It includes daily
recording books, receipts, payment vouchers, bank statement and many others such as copies of
board meeting and bylaws. Before beginning of the audit, auditor has to communicate to the
management about all the require business document to verify the statement.
Audit plan: After gathering all the necessary documents, auditor has to prepare a plan to
detect fraud. In the given case, as already stated that there is a chance of cash and inventory theft,
therefore, auditor has to pay special attention in this particular area (Ramachandran, 2011).
Scheduling: In this, an open meeting is conducted in which administrative staff is invited by
the auditor to present the scope of audit. Moreover, in this meeting, time frame is decided in which
audit will be completed.
Fieldwork: After the meeting, auditor conducts fieldwork by reviewing the existed internal
control system, policies and procedures as well. Effective and tighter internal control system gives
an assurance to the auditor to some extent that financial statements are free from any material
misstatement (Neave, 2009). However, in case of ineffective control system, Minty’s auditor has to
conduct an in-depth checking of all the business functions.
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Drafting report: After the fieldwork, a final report is constructed by the auditor explaining
all the findings and report about the mathematical errors, posting mistakes, unauthorized payments
and any other discrepancies as well. Moreover, appropriate recommendation is also given by the
auditor about the
Closure meeting: In the end, management give their responses whether they are agrees or
disagree from the audit report. They report about their proposed action plan to resolve their issues
and difficulties (Basu, 2006).
TASK 4
Types of draft report and preparation of unqualified report
After verifying Minty’s financial statement, auditor presents a written opinion to the
management by explaining that whether annual accounts contains any material misstatement or free
of errors. It may be of two types that are qualified and unqualified, enumerated here as under:
Qualified report: If Minty Cola’s auditor founded any misrepresentation in its financial
statement than qualified report will be presented. In other words, if auditor identified any errors,
omissions, mistakes and non-compliance with the accounting principles and laws than he or she will
express qualified opinion to the management (Busch, 2012).
Unqualified report: In case, when auditor is fully satisfied with the truth and fairness of the
financial statement, then unqualified report will be presented to the board members. It states that all
the transactions are reported adequately and by complying with the accounting concepts as well.
AUDIT REPORT
To
Minty Cola’s Board of Directors
Executive summary
We have audited the annual financial statement of Minty Cola Co. set out from pages no.
101 to 107 and comprising income statement, balance sheet, cash flow statement and statement of
changes in equity and retained earnings at the end of 31st December, 2013. Moreover, a summary of
accounting policies and other explanatory notes have been verified in examining the truth and
fairness of the financial accounts.
Scope of audit report
 Verifying the transactions reported in the statement through vouchers, invoices and bills.
 Evaluating internal control mechanism of the Minty Cola Co.
 Analysing the compliance of the financial reporting with necessary accounting principles
and concepts.
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Management committee’s responsibility
 Delivering all the require information and documents to the auditor timely.
 Selecting appropriate accounting policies for the preparation of financial statement.
 Preparation of annual accounts without any fraud and error.
Opinion
In my opinion, the financial statement of Minty Cola Co. at the end of 31st December, 2013
represents true and fair position of its operational performance and financial position as well.
Moreover, cash flow statement is prepared by complying with the accounting principles and as per
financial reporting standard. Thus, its annual accounts are free from material misstatement and
represent accurate and fair position of business performance.
From: Name of Certified Public Accountant
Membership No. __________________
Signature: _________________
Date: 3rd October, 2016
Draft a suitable management letter of statutory audit
MANAGEMENT LETTER
To,
Minty Cola Co. for the attention of board members
After reviewing the unqualified report of the auditor, it has been identified that Minty Cola’s
financial statement are constructed by following the accounting laws, principles (GAAP) and
reporting standards (IFRS) as well. In such respect, income statement, balance sheet and cash flow
statement are constructed adequately and free from any material misstatement, enumerated
hereunder:
 No irregularity and omission have been founded in the annual accounts ended on 31st
December, 2013.
 Each and every inventory receipts and payments are authorized and recorded properly in the
financial statement.
 Fixed business assets like plant and machinery and building are depreciated at an
appropriate rate and disclosed in the statement to report non-current assets at written down
value.
 Third party transactions are recorded very clearly and without any discrepancies.
 All the necessary accounts and documents have been prepared as per the legislation and
regulatory norms.
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 Loans and liabilities are recorded at an accurate value and free from overstated or
understated value.
 All the accounting principles have been followed consistently throughout the years.
Sincerely
Certified Independent Audit Company
CONCLUSION
In conclusion of the above project report, it can be concluded that it is the responsibility of
every accountant to prepare their financial statement using the principles and laws and thereby
examine their business performance at the end of the year. Moreover, companies face number of
risk due in their operations, therefore, it is important for the managers to examine the risk and
thereby take decisions to mitigate it. In the end, it has been inferred that auditing plays a crucial role
in reporting accurate and true performance to all the stakeholders for making viable and strategic
decisions.
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REFERENCES
Books and Journals
Basu, K., 2006. Auditing:Principles and Techniques. Pearson Education India.
Boolaky, P. and Omoteso, K., 2016. International standards on auditing in the international financial
services centres: What matters? Managerial Auditing Journal. 31(6/7). pp. 727-747.
Busch, S. R., 2012. Healthcare Fraud;Auditing and detection guide. John Wiley and Sons.
Cuckston, T., 2013. Bringing tropical forest biodiversity conservation into financial accounting
calculation. Accounting , Auditing and Accountability Journal. 26(5). pp. 688-714.
Danso, A. and Adomako, S., 2014. The financing behaviour of firms and financial crisis.
Managerial Finance. 40(12). pp. 1159-1174.
Dao, M and Pham, T., 2014. Audit tenure, auditor specialization and audit report lag. Managerial
Auditing journal. 29(6). pp. 490-512.
Gramling, A. A., Johnstone, M. K and Rittenberg, E. L., 2012. Auditing. Cengage Learning.
Hassink, H., Meuwissen, R. and Bollen, L., 2010. Fraud detection, redress and reporting by
auditors. Managerial Auditing Journal. 25(9), pp. 861–881.
Helms, B., 2006. Access for all: building inclusive financial systems. World Bank Publications.
Hogan, C. E. and et.al., 2008. Financial statement fraud: Insights from the academic literature.
Auditing: A Journal of Practice & Theory. 27(2). pp. 231-252.
Lin, J. C., Lin, L. H. and Yen, R. A., 2014 .Dual audit, audit firm independence, and auditor
conservatism. Review of Accounting and Finance. 13(1). pp. 65-87.
Lunt, H., 2009. Fundamentals of financial accounting. Elsevier.
Murthy, K. D., 2010. Indian financial system. I. K. International Pvt Ltd.
Neave, H. E., 2009. Modern financial system. John Wiley & Sons.
Ramachandran, D., 2011. Financial accounting for management. Tata McGraw-Hill Education.
Song, L., 2016. Accounting quality and financing arrangements in emerging economies.
International Journal of Accounting and Information Managemenet. 24(1). pp. 2-19.
Sormunen, N., 2014. Bank officers’ perceptions and uses of qualified audit reports. Qualitative
Research in Accounting and Management. 11(3). pp. 215-237.
Online
Averkamp, H.,2016. Financial Accounting. [Online]. Available through:
<http://www.accountingcoach.com/financial-accounting/explanation>. [Accessed on 3rd
October 2016].
Peters, I., 2013. Effective Internal Audit in the Financial Sector [pdf] . Available
through:https://www.iia.org.uk/media/354788/0758_effective_internal_audit_financial_webf
inal.pdf. [Accessed on 3rd October 2016].
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