Chapter 9 - Aspects of Regulatory Framework for Accounting, the Annual Reports for Accounts for Companies, and Auditing Flashcards
The need for a Regulatory Framework
Financial Statements are not solely for the purpose of keeping accounts internally, but also to communicate to others, as enforced by law:
- by board of directors to owners and shareholders to show how well the organisation is doing, to explain how earnings were distributed and why not all distributable earnings will be handed in, to show why a particular project is feasible and of interest for the company;
- by the company to the HMRC to justify corporation tax, or another tax;
- by a sole trader to justify business activities and expenses, in order to make accurate self-assessment tax returns
The Accounting Profession and a Regulatory Framework
There is a need for consistent principles, and there has been agreement that financial information must be presented in particular formats.
The Regulatory Framework of UK Corporate Accounting - an overview
Legislation
Companies, Partnerships and Groups Regulations 2015. Give details about workability to the law, as well as following European Directive
The Regulatory Framework of UK Corporate Accounting - an overview
Financial Reporting Standards
From January 2016 companies of any size have to follow these standards.
GAAP
Generally Accepted Accounting Principles
Financial Reporting Council
Independent body responsible for representing the UK in corporate reporting standards discussions with others.
International Financial Reporting Standards (IFRS) and The International Accounting Standards (IAS)
Mandatory for listed companies, specially public ones, but can be voluntarily adopted by private limited companies
The London Stock Exchange Rule Book
for publicly listed companies
Company Law - Accounting Legislation
Many accounting rules are incorporated in Company Law, so they are legal and professional requirement.
Companies Act 2006
Keep adequate accounting records to show and explain the company’s financial transaction and to show company’s financial position with reasonable accuracy.
Records must be kept for 6 years by a public company, and 3 by a private company.
Companies Act 2006
Required Financial Statements
- a profit and loss account: the Income Statement, which will show the profit or loss made in a particular reporting period
- balance sheet: Statement of Financial Position, showing assets and liabilities of a company, and overall wealth of the company.
- cash flow statement: showing inflows and outflows of cash and reconciles operating profits
- director’s report: which is scrutinized by auditors to ensure it meets “true and fair view” expectations.
- auditor’s report: independent auditor appointed by shareholders to represent them examine and report on the information in the financial statements and director’s report. Their signed statement of importance for the company, but also for the credit managers.
- Notes to the accounts: explaining the content in further detail, providing justifications and decisions made.
- Group consolidated accounts: when parent company cannot clearly report on activities of all different companies it owns
- other reports and statements: such as Director’s Remuneration, Corporate Governance.
Companies Act 2006
Required Financial Statements
Annual report and accounts need to be shown to shareholders and the Registrar of Companies to the least minimum levels of content required by law, or per shareholders requests.
Companies Act 2006
Required Financial Statements
Not all set of reports and accounts need to be shown to every shareholder, in the following situations:
- parent company may not need to do so for other companies it owns.; subsidiaries can produce accounts to Companies Act
- company that meets the criteria to be qualified as “small”; copy sent to the Companies House must be the same as the one sent to shareholders
- there are exemptions for smaller companies
- dormant companies may ot need to produce details reports
Private Companies Regulations
Private companies are not obliged by statute to hold an AGM, but the shareholders are entitled to receive a copy of the accounts.
And they can submit abridged accounts to the Companies House, depending on their size.
Size Thresholds for medium sized companies
If it doesn’t exceed two or more of the following criteria:
Sales turnover: 36m
Balance Sheet total: 18m
number of employees: 250
Key features of FRS 105 micro-entity financial reporting
- True and fair view
- Preparation of only 2 primary statements required: Statement of Financial Position and Income Statement
- Significantly condensed formats of statements
- Significantly reduced number of disclosures
- Simplified accounting treatment
- Fair value and revaluation accounting not permitted
- no accounting policy choices
- more helpful guidance
Key Features of FRS 102 Section 1 Small Entity Financial Reporting
- True and Fair View is not presumed
- Preparation of only 2 primary statements required: Statement of Financial Position and Income Statement
- Significantly abridged formats of statements
- reduced number of mandatory disclosures as Notes to the Accounts
- Simplified accounting treatment of more complex issues
- Accounting policy choices, including fair value and revaluation accounting, and mandatory disclosure needed
- helpful guidance
- not all company law requirements are reproduced
- FRS 102 consistent terminology
Cash Flow Statement
Not required by small or micro companies.
It reconciles the balance cash recorded in current assets in one year with that shown in the following year
Director’s Report
Can provide additional useful information for the credit manager.
This report is audited and will provide facts about the company’s performance.
Larger companies the report may refer to subsidiary reports prepared by executive directors.
Director’s report must include:
- business review of the year’s activities, its developments; with the main risks and uncertainties, as well as key performance indicators
- financial review including taxation and capital. Financial info for the benefit of shareholders and other interested entities.
- review of operations
- company’s financial performance during and financial position at the end of the year including proposed dividends, changes in equity
- details of shareholders and shareholding
- principal activities that have impacted the results
- major developments
- post statement of financial statement events
- research and development
- changes to non-current assets
- details of political and charitable activities
- overview of employees and employment policy
- names of directors
- changes to the board of directors
- acquisitions
- supplier payment policy (credit terms)
- auditors appointed by the board
Chairman’s Statement
Subjective review of the major activities and events of the past year. It’s not mandatory to the Annual Reports and it’s not scrutinised by the auditors.
Internal Auditing
Either employees of the company, or can be outsourced.
Appointed by management to provide an independent appraisal of the company
Work of the internal auditing
- review the design and functioning of the accounting system
- examining the information provided to see if it’s reliable and complete
- reviewing implementation of management policies
It is important where a it’s difficult for management to supervise and control all activities of the business.
An internal audit is a non-statutory audit, i.e. not required by law
External Auditing
Employees or partners of an independent professional accountancy firm and are engaged by the management of public and private companies.
- They form an opinion of the company’s annual accounts, as if they were properly prepared in accordance to the Companies Act and with the correct framework and standards
- that accounts give a true and fair view of the company’s state and its profit and loss for the year
- report their findings to shareholders in a formal report
External auditing
Submitting accounts to shareholders and to the Registrar of Companies is a legal requirement for private and public company, unless they qualify for audit exemption.
Annual Report
For companies that are subject to audit, it must contain the auditor’s report.
Financial Statements and a report are to be submitted to the Shareholders at the at AGM.
Statutory Audit
Independent auditor needs to report financial statements to shareholders; and this is required by law.
Financial Statements (production, who for and analysis)
Directors are responsible for producing the financial statements.
These are then examined by an independent auditor appointed by the shareholders, and they will providing their opinion as to whether it is a ‘true and fair view’
Auditor’s report to the Directors - non-statutory report
It communicates points that have arisen during the audit, such as:
- design and operation of accounting and internal control system and improvement suggestions;
- offer constructive advice on potential economies or improvements in efficiency
- specific comments of the financial statements and the particular use of accounting policies and practices
Auditor’s Report to company members/shareholders - statutory report
True and Fair View
It is the auditor’s responsibility to include an opinion as to whether accounts show a true and fair view, and if they have been prepared in accordance with the Companies Act 2006 within the the acceptable bases and conventions.
This opinion is, however, not a guarantee that the accounts are free from errors or fraud.
Because there are a certain amount of ways and policies that are acceptable, but each will come to different results, the auditor doesn’t have to certify that the accounts are correctly prepared.
‘True and Fair view’ is a subjective concept, but all is all it means that the company complies with the best professional practices.
That means this concept will change, as the policies change.
Statutory Auditors’ Report (Companies Act 2006)
Most reports will be unqualified/clean and will include:
- general statement on the preparation of the report
- distinction between the directors’ and auditors’ responsibilities
- basis used to carry out the audit (i.e. in accordance with Auditing Standards)
- an express opinion of a true and fair view
Statutory Auditors’ Report
it is implied that
- proper records have been kept
- the financial statements agree with the accounting records
- all information for the audit has been obtained
- information in the directors’ report is consistent with the accounts
Auditors’ Report
Qualified opinion
- When auditors disagree with the treatment of the disclosure of an item in the financial statements, and the auditor doesn’t think it provides a true fair view. This may be due to the use of inappropriate, accounting treatment or disclosure, the actual accounts or facts, or failure to comply with the accounting requirements.
- there is a limitation on the scope of the auditor’s examination: type or quality of evidence provided, or insufficient evidence. Not all accounting records being made, or directors’ preventing the ‘testing’ procedure requested by the auditor.
When giving a qualified opinion, auditors must consider uncertainties about the outcome of future events and their potential financial effect.
The importance of a clean audit report to the organisation
If the auditor doesn’t give a clean report, than it is said to be qualified.
The negative points for the company are:
- less reliance on the business for potential lenders, even possibly affecting the share price
- may reflect badly on the directors of the company
- may cause legal restrictions in the amount of dividend the company is able to pay
The importance of a clean audit to the credit manager
Shareholders and potential lenders use the Financial Statements to see how much reliance they can have in the company, therefore if there is a clean audit report, it means they can trust those Financial Statement for decision making.
It means there is a true and fair view and of its profit for the year.
It also means that accounts have been kept correctly.
A qualified report should warn the credit manager there areas that need to be looked into and improved.
