By: 1. Kenneth A. Kim John R. Nofsinger And 2. A. C. Fernando

6 th Lesson

 Last Lecture Review ◦ A & A play very important role in corporations. ◦ Companies are legally bound to hire A & A to have crystal clear financial position of a company because its not their money. ◦ Companies face two types of interactions as far as accounting practices are concerned. Accounting for management and for outside world.

 Normally company keeps two types of records in the shape of Financial Accounting and Managerial accounting- which normally do not match.  A single company always must have single financial position, so how is it possible to have two different accounting records.  Lastly, different accounting records means the element of frauds in the company.

 Lecture Outlines ◦ Financial statement/position explanation. ◦ Accounting records are different for Managers and Public Financial Statement. ◦ Reasons for differences in Financial Accounting and Managerial Accounting. ◦ Problems that may occur in accounting.  Unintentional errors  Problems with receivables  Intentional Errors.  Understated liabilities  Overstated assets.

 Who are Responsible ◦ Accountant or Manager  Audit Role  Types of Auditors ◦ Independent Auditor ◦ Internal Auditor ◦ Government Auditor.  World largest 4 Audit Firms  Summary.

 Financial statement can be explained through ; ◦ Income statement  A financial statement that measures a company's financial performance over a specific accounting period. Also known as the "profit and loss statement" or "statement of revenue and expense. ◦ Balance Sheet  A financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. The balance sheet must follow the following formula: Assets = Liabilities + Shareholders' Equity

◦ Statement of Cash Flow  The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter. ◦ Popular press articles

o And analysts (financial) recommendations o Financial analysts help people decide how to invest their money. They work for banks, insurance companies, mutual funds, and securities firms. They often meet with company officials to learn more about the firms in which they want to invest. After the meetings, the analysts write reports and give talks about what they found out. Then, they suggest buying or selling that firm's stock.

 That’s how outsiders can easily determine the firm’s value, profit and its risk.  However, SEC is looking for the uniform set of standards for public companies i.e. GAAP (Generally Accepted Accounting Principles).  These statements are prepared by the accountants of the firms and reviewed by the auditors.

 Accounting records are different for; ◦ The managers ◦ Public financial statements

 Reasons for Differences in Financial Accounting and Managerial Accounting ◦ If Financial Accounting shows favourable financial position as compared to Managerial Accounting  1. Company’s management is showing fake financial position of the company i.e. company doesn’t have enough financial position ( as managerial accounting shows) but showing the wrong face of the company to the stakeholders.

 If Managerial Accounting shows favourable financial position as compared to Financial Accounting  Company’s management is trying to use the hidden money for their personal interests  i.e. 1. having more perks for themselves 2. using that money for further business, trying to increase the share prices ( trying to gain the maximum benefit from the stocks/shares they hold)

Problems That May Occur In Accounting  Unintentional Errors ◦ An accounting-related item is unintentionally misrepresented or is measured inaccurately.  Problems with receivables ◦ Accounts receivable is money owed to a business by its clients (customers or debtors) and shown on its balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered.

 Intentional Errors ◦ Overstate income statement Impact of Error on Error in InventoryCost of Goods SoldGross ProfitNet Income Ending Inventory =30000 (Actual) Understated Overstated Understated 8000 Understated 7000 Overstated Understated 8000 Overstated Overstated Beginning Inventory= Understated Understated 4000 Overstated Overstated Overstated Overstated Understated 8000 Understated 6000

◦ Understate liabilities  Understated liabilities will automatically show the improves financial position of the company  Assets= Liabilities + Owners’ Equity ◦ Overstate assets (receivables)  Overstated Assets will show the fake financial position of the company.  Assets= Liabilities + Owners’ Equity

 Who are responsible ◦ Accountants ◦ Managers

Auditing  The general definition of an audit is an evaluation of a person, organization, system, process, enterprise, project or product.  Audits are performed to ascertain the validity and reliability of information.

 Types of Auditors ◦ 1. Independent Auditors  Independent auditors are usually CPA’s (Certified Public Accountants) who are either individual practitioners or members of public accounting firms who render professional auditing services to clients. In general, licensing involves passing the uniform CPA examination and obtaining practical experience in auditing.

 2. Internal Auditors Internal auditors are employees of the organization they audit. This type of auditors is involved in an independent evaluation of evidence, called internal auditing, within an organization as a service to the organization. The objectives of internal auditing is to assist the management of organization in the effective discharge of its responsibilities.

 3. Government Auditors Government auditors are employed by various local, state, and federal governmental agencies. Government auditors are specialists in tax and disclosure regulations.

Internal Auditor  Internal auditor is responsible; ◦ To oversee the firm’s financial and operating procedures ◦ To check the accuracy of the financial record- keeping ◦ To implement improvements with internal control ◦ To ensure compliance with accounting regulations ◦ And to detect fraud.

 Firms are not required to have internal auditors but many firms have them to enhance their accounting and internal control efficiency.  In fact, the people who initially detected financial fraud at WorldCom were the company’s own internal auditors.

External Auditor  External auditors are the accountants from outside the firms  They review; ◦ The firm’s financial statements ◦ The fairness of the statement ◦ Assess the system and procedure used by internal auditors

 To conduct external audit, the auditor’s might; ◦ Conduct interviews with the firm’s employees to assess the quality of the internal audit system. ◦ Make their own observations of the firm’s assets. ◦ Check sample balance sheet transactions ◦ Meeting with the firm’s customers and clients to assess the firm’s short-term assets and liabilities. ◦ Conduct their own financial statement analysis such as comparing ratios from one period to the next. ◦ In the end they generate the report.

largest Audit firms are; (BIG FOUR)  Price Waterhouse Coopers (HO in UK)  Deloitte & Touche (HO in US)  Ernst & Young (Ho in UK)  KPMG (HO in Netherland)

 Summary ◦ We have discussed how financial position of a company can be examined through different ways. ◦ Accounting records are different for managers and public financial statement. ◦ Reasons for the difference between financial accounting and managerial accounting are either to show the wrong financial position of the company or to use the company’s money by the management for their personal interests. ◦ Normally, we face different problems that may occur in accounting.

 Here come the role of an auditor to check there errors by the accountants.  There are different types of auditors ◦ Independent auditor ◦ Internal auditor ◦ Government auditor  Big 4. The End