BBA3ACCOUNTANCY

BBA 3 ACCOUNTANCY AUDIT CONTROLLING

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Lead in : What is accounting ? Why is it necessary for companies and organizations ?

Is there one way of doing a bisiness’s accounts, or lots of different possible ways ?

What is auditing and why is it necessary ?

Accountancy vs. Accounting ……………………………… is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in selecting the information that is relevant to the user and is reliable. The principles of accountancy are applied to business entities in three divisions of practical art, named…………………………… (the systematic and comprehensive recording of financial transactions or statements of business that also includes storing, retrieving, summarizing and presenting the information in the form of reports and their analyses), bookkeeping, and auditing.

Accounts ‘Hi I’m Fiona and I’m and accountant. I work in Edinburgh for one of the big accountancy firms. We look at the financial records or accounts o a lot of companies. We work with the accountants of those companies and the book-keepers – the people who work under them. Sometimes we act as auditors – specialist outside accountants who check a business’s accounts at the end of a particular period to see if they give a true and fair view – in other words, that they are accurate and complete.

When a company’s results are presented in a way that makes them look better than they really are, it may be accused of creative accounting or window dressing. Of course, one of our jobs is to spot this and to prevent it happening !

Audits are only part of what accountants do, but it’s a very important part.’

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Results A firm reports its perfromance for a particular period in its results. In Britain, results for a particular year are shown in the company’s annual report. This contains, among other things, a profit and loss account ; in the US, they call this the income statement. In theory, if a company makes more money than it spends, it makes a profit. If it makes less than it spens it makes a loss. But it’s possible for a company to show a profit for a particular period because of the way it presents its activities under the accounting standards or accounting rules of one country, and a loss under the rules of another.

A pre-tax profit or a pre-tax loss is one before tax is calculated. An exceptional profit or loss is for something that is not normally repeated, for example the sale of a subsidiary company or for the costs of restructuring. A company’s gross profit is before charges like these are taken away ; its net profit afterwards. Profits are also referred to as earnings. The final figure for profit or los sis what people call informally the bottom line. If a company makes a profit, it is in the black. If it make a loss, commentators may say that it is in the red. They may also use expressions with red ink, saying for exapmle that a company is bleeding red ink.

Financial reporting A company’s financial results – its balance sheet, profit and loss account, and a lot of other information – is given in its annual report for a particular business year or financial year (not necessarily January to December). US companies also refer to this as their fiscal year. UK companies report their results every six months, and refer to first-half and second-half results. US companies report their results every quarter – every three months. Information given by a company about its financial results is financial reporting.

Ex. 1. Complete the crossword with the correct form of words under Accounts and Results.

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Ex. 2. Read the article and say if the statements are true or false.

Maria Malone is the chief finance officer (CFO) of a large international media company, based in the UK, with activities in television and publishing. She’s talking to new trainees in the finance department : ‘As with all companies, investors and analysts want to know how the company is being run and how their money is being used. Each year we produce an annual report with three key sets of figures :   

profit and loss (P&L) account balance sheet cashflow statement

These are the three key financial statements in financial reporting. They give the basic information about our financial results.’

‘Our financial year ends on 31 March, although othre companies choose other dates. Soon after this, we publish preliminary results or prelims. The full report and accounts are published a few months later. As a Uk company, we also publish interim results or interims after the first six months of our financial year.’

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Maria Malone continues :

‘The accruals principle or accruals method means that events in a particular reporting period, for example sales of goods or purchase of supplies, are recorded in that period, rather than when money is actually received or paid out, which may happen in a later period.’

Profit and loss ‘The profit and loss (P&L) account (UK) or income statement (US) records the profit – the money we make – or the loss – the money we lose – during a particular reporting period, using the accruals principle.

In our case, our accounts show sales from books, magazines, television advertising, etc. during the period. Then we show the cost of goods sold (COGS), for example labour costs – cost of employees’ salaries – and the cost of materials.

Then we take away general expenses – the costs related to making these sales such as salespeople’s salaries, rent for buildings, etc. There is also the cost of depreciation - this is not an actual sum of money paid out, but is shown in the accounts to allow for the way that equipment wears out and declines in value over time and will have to be replaced. This leaves us with our operating profit.

Then we subtract the interest payable on money we have borrowed in the form of bonds and bank loans. This gives the profit on ordinary activities before tax or pre-tax profit.

Of course, we pay tax on our profits and in the UK this is called corporation tax.’

Earnings ‘From the profit after tax, we usually pay dividend to shareholder, and you can see the figure for dividends per share. However, when business is bad, we may not do this – we may pass, omit or skip the dividend. Profit after tax is also referred to as earnings.

Naturally, we don’t pay out all our profit in dividends. We keep retained earnings- some of the profit to invest in our future activities.

You can look at profitability in terms of earnings per share (EPS), even if some of these earnings are retained – kept by the company and not paid out in dividends.’

Ex. 3. Match words from the box to make expressions.

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accruals account earnings

exceptional expenses general

interest

payable items

operating

profit period

principle

retained profit and loss reporting

Ex. 4. Now complete each sentence with the correct expression from ex. 1 above.

1) Our ……………………………………………… runs from 1 April to 31 March.

2) The company’s ……………………………………………… before exceptional items has increased by 10 per cent this year.

3) We have decided to keep £250,000 from our profits as ……………………………………………… and not distribute this to the shareholders.

4) One of the ……………………………………………… in the profit and loss account this year related to the restructuring costs of our operations in Korea.

5) With the ………………………………………………, of course, postponing or bringing forward cash payments has no effect.

6) During the early months of the loan, the amount of ……………………………………………… each month on this type of loan is relatively high.

7) The ……………………………………………… ecentually arrives at a figure for profit to shareholders, after the deduction of all expenses including debt interest and taxes.

8) The cost of new operations in Argentina caused ……………………………………………… to increase to £60.5 million from £51.9 million.

Ex. 5. Are the statements true or false in the context of a company’s profit and loss account ?

A. B. C. D. E.

The cost of goods sold is the total cost related to selling something.

Selling and general expenses include the salaries of the salesforce.

Depreciation represents an actual amount of money paid out to suppliers of equipment.

Operating profit is the same as pre-tax profit.

If a company has a bank loan and/or has borrowed money in the form of bonds, it has to show interest payable in its accounts.

F. Exceptional items are paid out every year and relate to the normal operations of the business.

G. A figure for profit after tax relates to what is left after corporation tax has been paid.

H. If a company shows a figure for retained earnings from a particular period, it has paid out all the profit from the period to shareholders.

I. EPS and dividends per share are the same thing.

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Assets A company’s balance sheet gives a ‘snapshot photo’ of its assets and liabilities at the end of a particular period, usually the 12-month period of its financial year. But the snapshot could be taken on any day of the year.

An asset is something that has value or the power to earn moneyfor a business. These include : 1. CURRENT ASSETS  cash at the bank  securities – investments in other companies  stocks or inventories (US) of raw materials, unfinished goods, finished goods that are going to be sold, etc.  debtors or accounts receivable or receivables (US) – money owed to the company by customers, not including bad debts that will probably never be paid.

2. FIXED, TANGIBLE or PHYSICAL ASSETS : equipment, machinery, buildings and land 3. INTANGIBLE ASSETS : for example goodwill – the value that the company thinks it has as a functioning organization with its existing customers – and in some cases brands because established brands have the power to earn money, and would have a value for any potential buyer of the company Items are carried – shown – on the balance sheet at particular amounts. However, there are some things of value that are never shown on a balance sheet, for example the knowledge and skills of the company’s employees.

Depreciation Of course, some assets such as machinery and equipment lose their value over time because they wear out and become obsolete. Amounts relating to this are shown as depreciation or amortization in the accounts. For example, some computer equipment is depreciated or amortized over a very short period, perhaps as short as three years, and a charge for this is shown in the accounts. The value of the equipment is written down or reduced each year over that period and written off completely at the end.

The amount that is shown as the value of an asset at a particular time is its book value. This may or may not be its market value – the amount that it could be sold for at that time. For example, land and buildings may be worth more than shown in the accounts bacause they have increased in value.

Equipment may be worth less than shown in the accounts because its value has not been depreciated by a realistic amount.

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Ex. 6. Complete the assets table for a UK company with one of the underlined expressions above, and the figures, using the information below.

Paradigm has goodwill – in the form of hundreds of satisfied customers – worth an estimated £30 million. This is its only intangible asset.

It has investments of £12 million in other companies.

It has raw materials, unfinished goods and finished goods together worth £7 million.

It owns equipment and machinery with a book value of £18 million.

It owns land with a book value of £62 million.

The company has £22 million in its accounts at the bank.

The company owns offices and factories with a book value of £188 million.

Various people and organization, including customers, owe £15 million.

Ex. 7. Using the information under Depreciation and in the table above, decide if these statements about Paradigm’s assets are true or false.

1.

2.

3.

4.

5.

6.

cash relates only to banknotes in the safe on the company’s premises equipment and machinery is the price it was bought for, minus amounts for depreciations stocks relates only to finished goods waiting to be sold land and buildings is the exact amount they could definitely be sold for goodwill is an estimated value that a buyer or the company might or might not agree to pay debtors is a reasonable estimate of how much i twill receive from them

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Liabilities A company’s liabilities – everything it owes – are its debts to suppliers, lenders, bondholders, the tax authorities, etc.

1. CURRENT LIABILITIES are debts that have to be paid within a year, for example :     2.

creditors – money owed to suppliers, etc. overdrafts – when the company spends more money than it has in its bank accounts interest payments that have to be paid in the short term tax payable – money owed to the tax authorities LONG-TERM LIABILITIES are debts that have to be paid further into the future, for example long-term bank loand and bonds.

Shareholders’ equity When you deduct a company’s liabilities from its assets – everything it owns – you are left with shareholders’ equity, owners’ equity or shareholders’ funds.

In theory, this is what would be left for shareholders if the business stopped operating, paid all its debts, obtained ecerything that was owed to it, sold all the buildings and equipment that it owns, etc.

Shareholders’ equity as shown in a company’s accounts includes :  

the capital that shareholders have invested the profits that have not been paid out in dividends to shareholders over the years, but that have been kept by the company as reserves or retained earnings

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Ex. 8. This is the other half of the balance sheet of Paradigm. Complete the assets table with the underlined expressions above and the relevant figures, using the information below.

Paradigm has a bank loan of £40 million to be repaid in five years.

It has issued £200 million worth of shares.

It has issued bonds for £60 million that i twill have to repay in seven years.

It has retained earnings of £21 million.$ It has to pay £7 million in interest on its bank borrowings and bonds.

It owes £10 million in tax.

It owes £12 million to suppliers and others.

On one of its bank accounts, Paradigm has spent £4 million more than it had in the account.

Ex. 9. Using the information under Shareholders’ equity and in the table above, decide if these statements about Paradigm’s liabilities are true or false.

1. The item for creditors includes debts that will have to be paid relatively soon.

2. Overdrafts are a form of short-term loan.

3. In the coming year, Paradigm will have to pay more tax than it pays out in interest on its loans.

4. The figure of £12 million for creditors relates to money that it paid out to them in the previous period.

5. Shareholders’ equity of £200 million is the current value of Paradigm’s shares held by shareholders.

6. Retained earnings is the total of all the dividends that have been paid out to shareholders over the years.

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Ex. 10. Use correct forms of expressions related to assets and liabilities to complete the sentences. a. A bank lent money to people who did not repay the loans, and decided to show that they would never be repaid : it …………………………. them …………………………. . b. An iol company reported a reduction of $118 million in the value of its oil reserves : it showed an amount for …………………………. In its accounts, which meant an equivalent reduction in the …………………………. of its oil reserves. c. A firm owes $500,000 to the tax authorities, payable at the end of this month. These are one of its …………………………. . d. A manufacturing company bought a machine and decreased the value shown in its accounts by 20% per yearfor five years : it …………………………. the machine’s value over 5 years. e. A company showed a charge of $1.5 million in the value of its spare parts inventory in its accounts, reducing its estimated value from $6 million to $4.5 million : it …………………………. the value of its inventory. f. A company pays pensions to retired employees and will have to go on doing so indefinitely ; these are …………………………. .

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Remember that under the accruals method events in a particular reporting period are recorded in that period, rather than when the money is actually received or paid out, which may happen in a later period. And depreciation represents reductions in the values of the firm’s equipment, etc. although no actual cash leaves the company, of course.

However, the cashflow statement shows cash inflows and outflows – money actually coming into and going out of a company in a particular period.

A company can have cashflow problems even if it is profitable, for example if it is paying suppliers more quickly than it is being paid by customers. This is related to the credit terms that businesses have. In the UK, there is usually an agreed credit period of 30 days or more in which invoices must be paid. In some countries, this period is much longer.

Types of cashflow

Net cashflow from operations is the money generated by the sales of the company’s goods or services, minus the money spent on supplies, staff salaries, etc. in the period.

Net cashflow from investment activities is the overall result of the following :  

inflows – loans repaid and loan interest paid by borrowers ; money received from sales of securities in other companies ; sales of land, buildings and equipment outflows – loans made to borrowers; purchases of securities in other companies, purchases of land, buildings and equipment

Net cashflow from financing activities is the result of the following :  

inflows – money received through issuing new shares and bonds in the company ; money received through short-term borrowing outflows – moeny repaid in short-term borrowing; dividends paid to shareholders

Adding and subtracting the figures above, the company calculates its net cash position at the end of the year. Investors check the cashflow statement to see how the company has obtained and used cash – how much it has made from its operations, raised through new share issues, etc.

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Ex. 11. Use the information under Cashflow statement and Types of cashflow plus the facts from the presentation below to complete the table about a fictional UK company called SBC.

Last year SBC had a net cashflow from its operations of £10.1 million. It bought a new office building for £8 million and new equipment for £1 million. The company lant £1 million to one of its directors so that she could buy a new house. SBC paid £10 million to buy shares in Company A and obtained £6 million for shares that it sold in Company B. It received interest of £500,000 on a loan it had made to another director and sold its old office building for £5 million.

SBC obtained a bank loan for £500,000 that i twill have to repay next year. It paid out £1 million in dividends to shareholder. It raised £1.25 million by issuing new bonds and £1.75 million by issuing new share capital. It also repaid a loan of £1.5 million that it obtained last year.

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Profit and profitability The profit made by a company in a particular period is also referred to as its earnings – profits after tax – or net income – money produced minus everything spent to produce it. There are different indicators of profitability – level of profit in relation to what is required to produce it. One measure is EBITDA – earnings before interest, tax, depreciation and amortization. Comparing the EBITDA of different companies is a good way of comparing their fundamentl operating perfromance before other financial and tax considerations are taken into account. It may be used to see if a company is good at generating cash or cashflow.

Ex. 12. Complete the extract with these expressions (use one of the expressions twice) : amortization and depreciation

cashflow

EBITDA

net income

Sequola has received investor inquiries as to why our cashflow has been so much better than reported net income. This is partly accounter for by non-cash factors such as (1) …………………………… .

If we look at Sequola’s (2) ……………………………………, our excellent (3) ………………………………………………… is more understandable. Our (4) ……………………………………… in the quarter was $93,000, but our (5) …………………………………. were $253,000 for the same period, or $160,000 higher.

Accounting standards Audits and their transparency

Every company appoints auditors – specialist external accountants – who audit its accounts. The auditors approve the accounts if they think thay give a true and fair view of the company’s situation.

If not, they specify the qualifications thay have about the accounts. If auditors do this, it certainly gets investors worried !

Companies that give misleading – false – information in their accounts are said to cook the books.

They may overstate or understate particular amounts – indicating that they are more or less than they really are. Companies that do this are guilty of fraud.

But auditors complain that there may be an expectation gap between what they are required by law to do and what clients and investors sometimes expect them to do ; auditors say that they should not be expected to pick up every problem.

Following the scandal of Enron and other corporate collapses in the US, investors became increasingly worried about accounting irregularities or false accounting, and they are demanding that auditors should be more strictly regulated – the authorities should supervise them more closely.

Regulators – government agencies checking that the law is applied – are demanding more transparency ; they say audits should ensure that the company’s accounts should give a clear picture of its true financial situation.

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They are particularly concerned with :  auditor rotation – the principle that companies should be obliged to change their auditors regularly  conflict of interests – some say that a company’s auditors should not be allowed to do its consultancy work, for example, for giving tax advive or doing management consultancy

International standards

In the UK, the way accounts are presented is governed by regulators such as the Financial Reporting Council (FRC).

In the US, they have the Generally Accepted Accounting Principles (GAAP), promoted by the Financial Accounting Standards Board (FASB).

People and institutions invest in companies worldwide. Thereforeit is important for financial reporting to be in a form that means the same thing to people all over the world. This is why accountants worldwide are moving towards International Accounting Standards (IAS) – standards or rules that companies all over the world will, ideally, end up using.

These standards will eventually be accepted by bodies – organizations – such as the International Oranization of Securities Commissions (IOSCO) representing stock markets all over the world, including the all-important Securities and Exchange Commission (SEC) in the US. This acceptance will facilitate investment by allowing investors from every continent to understand and trust the accounts of companies, wherever they are based.

The SEC has come under attack for not using its regulatory powers – its right to control financial activities – to prevent the excesses that led to the banking crisis of the year 2007-9. Critics said that its oversight – control – of the financial services industry was not strict enough.

Ex. 13. Look at the vocabulary under International standards and answer the questions using abbreviations. Which body or set of rules would be most involved with, or relate mainly to the following : I. a company whose shares are listed on the New York Stock Exchange and that is accused of accounting fraud II.

the way that someting is presented in a UK company’s accounts

III.

discussions between stock exchanges around the world on standardizing procedures

IV.

the way multinationals around the world account for profits from overseas subsidiaries

V.

the way that something is presented in a US company’s accounts

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Ex. 14. Complete the article with the following expressions (use one expression twice) : audits

fraud cooked the books

overstated understated irregularities regulators

Ex. 15. Now answer these questions about the article in ex. 10.

1.

2.

3.

4.

5.

Has the fraud been proved in a court of law ?

How much have shareholders lost ?

Are cash reserves assets or liabilities ?

Why had shareholders felt confident ?

Does Mr Raju feel bad about what has happened ?

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Ex.16. Two colleagues from an auditing firm are discussing the latest financial scandal.

Listen to part1 of the dialogue and anser the following questions :

   

What is Heidi worried about ?

What does Phillip think ?

What does Heidi think investors should get ?

What example of inaccurate information does she give ?

Now listen to part2 of the dialogue and complete the gaps.

Phillip

We don’t (1) ………………………………… anything.

Heidi

But we’re expected to find these things. That’s what we’re paid to do.

Phillip Hang on a minute. Our job is to (2) ………………………………… the information provided to us by the management of a company. We have to assume that they’re being (3) ………………………………… .

We’re not police officers.

Heidi

But…

Phillip Let me finish. Look, there are (4) ………………………………… mechanisms to deal with people who commit (5) ………………………………… . The auditing profession has its own (6) ………………………………… and investors trust this. It’s tried and tested.

Heidi All I’m saying is that investors have a right to (7) ………………………………… on the financial information thay read, and we’re paid to (8) ………………………………… exactly that. (9) ………………………………… may not be enough. And the trend is…

Phillip I agree that it’s strange that we’re paid by the same people who we (10) …………………………………, but it’s always been this way and I don’t see how that can be changed, do you ?

Whose opinion do you agree with ?

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Ex. 17. What does an auditor do ? Look at the following activities and decide which ones are normally done internally or externally ?

An auditor : A. spends time getting to know the business as well as the environment and the industry in which it operates B. analyses the internal business and financial systems used to make and record transactions C. gathers evidence on the financial controm systems and the figures in the financial statements D. gives advice on the business methods and transactions of the company E. examines financial statements to determine whether they conform to generally accepted accounting principles F. prepares the financial statements in accordance with the generally accepted accounting principles of the country where the enterprise operates G. guarantees the correctness of the figures presented in the accounts H. provides consulting services I. presents a written report to the management of the company, decribing whether the accounting records and financial statements conform to legal reqquirements J. maintains confidentiality and independence

Ex. 18. Janet Hendley, a partner in an audit firm, calls Claude Bernaud, the CFO of a French company. Listen to the dialogue, and then decide if the statements which follow are true or false.

1.

2.

3.

4.

5.

6.

Janet wants to talk to Claude about a report.

Janet thinks that capitalization of costs should be expenses in the P&L. Claude agrees with Janet on this point.

Claude thinks capitalization of costs should be classes under machine upgrades.

Claude’s reasoning is that the upgrades are really investments in the future.

Janet agrees to reconsider her opinion.

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Ex. 19. Read this example of an extract from an independent auditor’s report in the USA and answer the questions.

To Share Owners and Board of Directors of Megatrap Corp

We have audited the accompanying statement of financial position of Megatrap Corp and consolidated affiliates as of December 31, 2015 and 2014, and the statements of earning changes in share owners’ equity and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of the company’s management. We have to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Under these standards we have to plan and perform the audit to obatain reasonable assurance that the financial statements do not have any material misstatement. We examined on a test basis the evidence supporting the figures and disclosures in the financial statements. We also assessed the accounting principles used and significant estimates made by management, and we evaluated the presentation of the statements.

In our opinion, the aforementioned financial statements present fairly, in all material respects, the financial position of Megatrap Corp and consolidated affiliates at December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

According to the report, an audit does several things. What is mentioned ?

What documents did the auditors look at ?

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Ex. 20. Before you read the e-mail, talk about these questions :  

Why do businesses get audited ?

What are some of the problems that show up in audits ?

Mr. Riley, I have completed my audit of Endless Magic Toy Company. Unfortunately, I cannot give a clean opinion of this company without material adjustments to the financial statements. I found a few anomalous entries in its books that shoul be attended to.

First, I noticed that the reported sales figures do not match the actual revenue. At first, I thought it could have been a simple clerical error. But then I irecalled something I had read earlier about bonuses for sales people. Sure enough, it appears the sales people reported erroneous sales figues – sales that won’t actually occur until next quarter. I believe thay did this in order to surpass the bonus cutoff point.

The secon impropriety that I found had to do with some new manufacturing equipment. As you know, these assets should have been capitalized and depreciated over their useful life. But someone chose to write the entire purchase price off as an expense. Any government tax department employee would see this immediately in an audit.

I am surprised by the lack of professional skepticism on the part of Endless Magic Toy Company’s internal auditor. I have a meeting with the Chief Operating Officer tomorro, and I plan to discuss these issues with her.

Regards, Patrick Stevens

Choose the correct answers : 1.

2.

3.

What is the text mainly about ? a) the results of an audit b) how to make material adjustments c) the results of a meeting with the COO d) problems with Thomas and Riley’s books What did Endless Magic’s salespeople do ? a) They made a clerical error. b) They falsified sales information. c) They made material adjustments. d) They showed professional skepticism.

What did the company do when it purchased new equipment ? a) It depreciated the equipment. b) It capitalized its old equipment. c) It wrote off the purchase as an expense. d) It got advice from a government employee.

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Vocab : Match the words (1-5) with their definitions (A-E) : 1.

2.

3.

4.

5.

A. B. C. D. E.

Anomalous Cutoff point Chief Operating Officer Impropriety Professional skepticism

a corporate executive in charge of operations the level that must be reached to receive some reward the critical attitude an auditor must have any activity that is unethical out of the ordinary

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Ex. 21. First read the job ad below, and then, with a partner, act out the roles of an interviewer and an applicant.

Wanted : CONTROLLER The accounting firm of West, Kennedy, and Wilson is seeking a well-qualified controller. This position is available immediately.

Requirements : • A bachelor’s or master’s degree in Accounting • Must be a Certified Public Accountant (CPA) • At least seven years’ experience with accounting systems • Management experience is preferred, but not necessary • Honesty • Attention to detail • Willingness to travel • Willingness to work some nights and weekends, as needed Responsibilities include : • Ensuring that financial records are kept up to date • Preparing and distributing all final internal and external financial reports • Reporting directly to the CFO • Oversight and quality assurance of all bookkeeping activities • Training of new hires and development of standardized training materials

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