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Financial System And Auditing

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Accounting Concepts and Principles

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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.

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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.

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).

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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 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, 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.

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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 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 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.

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.

REFERENCES

  • 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.
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