Why the audit function is so important to larger public companies

Why do large companies need auditors?

Author Frank McGivney

Date 20 April 2013

The company structure is the vehicle by which people with resources can invest in different enterprises in order to increase the long term value of these resources (share capital growth) and to obtain some short term income from their investment(annual dividends) .The company structure allows investors to risk some of their resources while availing of the protection of limited liability. This means that the extent of any loss they will incur is limited to their investment. If a company fails then their other  resources and assets will not be affected. This is a vital prerequisite in order to encourage investors to take the risks involved in putting money into any enterprise. Before the advent of the principal of limited liability the investor could lose all of their wealth if an enterprise failed. 

As companies have developed over the centuries there has been a separation of management from the ownership of companies. In the modern world companies are owned by a large number of investors (shareholders) and the company is run by the directors. This means that the people who run the company are different from those who own the company. This has lead to the development of the agency theory. Essentially the directors act as agents for the owners. The objective of directors should be to maximise the return to share holders both in terms of long term growth and in short term revenue, while also protecting the interests of other stake holders, while still operating the business in accordance with company law regulations and requirements. Agency theory contends that directors however will be motivated to maximise their own salary, benefits, bonus and share options. While also maximising the short term share price so as to reflect favourably on their own personal success in operating the business. However the pursuit of these objectives does not necessarily lead to decisions that are in the best interests of shareholders. This conflict of interest is the reason that auditing is so vitally important. Once one man is entrusted with the resources of another for the pursuit of wealth then given the nature of man it is vital that the fidelity of the controller of the resources is checked and verified.

In Ireland and the UK there has developed an option for smaller private companies to claim audit exemption. This is because in a lot of small companies the above separation of ownership and control does not occur because the owners are also the people who run the company. Therefore the need for an audit is diminished. Also it allows small companies to avoid the high costs of audits, However even within these companies there are published guidelines as to how their accounts should be produced so that they still have financial controls to protect other stakeholders such as creditors and the revenue commissioners.

 Of course in most cases auditors and mangers are on the same side as they attempt to protect the assets of a company and identify anyone who is trying to commit fraud. However they can diverge when it is the managers/directors who are the actual ones who are trying to commit fraud or enrich themselves at the expense of the shareholders of the business. At this stage they separate as the auditors are the ones who will attempt to identify any such malpractice or fraud. The effectiveness of external auditors to actually identify such misbehaviour has been justifiably called into question. Most fraud is identified by whistleblowers and by other parties rather than the external auditors. Currently a lot of work is been undertaking in the accountancy field to rectify this situation. Of particular concern in my opionion is the fact that the four big accountancy firms are the only ones who perform audits in public companies quoted on stock exchanges. Also companies don’t change their auditors regularly and therefore a relationship develops which is not consistent with the off hand nature that auditors should operate in. Some suggestions are that public companies will have to change their auditors regularly. It is also suggested that the firms of a size just below the big four accountancy firms should be allowed to develop to order  to compete for public company audits, There are market forces which are an obstacle to these firms growing to the size where they can compete for public company contracts and these need to be removed in my opinion in order to give more credibility to the profession

 The Cadbury report was produced because of Robert Maxwells Mirror group scandal and the BCCI scandals. In 1992 it stated that “The central issue is to ensure that an appropriate relationship exists between the auditors and the management whose financial statements they are auditing.”

Prior to 1844 in the UK and Ireland only the crown could issue Charters of Incorporation. Examples of such charters were The Honourable East India Company and the South Sea company. The south sea Company was the Enron of its day where false claims of potential profits lead to huge investments in the company. The business proposals proved to be fraudulent and the company collapsed leading to the ruination of many of the investors. The industrial revolution lead to a huge increase in the level of trade and manufacturing in the UK and  an Act of Parliament was passed in 1844 that allowed the incorporation of Joint stock Companies. This was followed in 1855 with the passing of the Limited liability Act which allowed for investors to quantify the risk of loss they were taking in their investments. This resulted in the divergence of ownership and control in large public companies as discussed above.

In 1900 the push towards accountability took a big step with an act that required the publication of a audited balance sheet and thus began the steps to the modern situation of producing full audited accounts by large public corporations in a way to ensure transparency and accuracy in the accounts and information presented to the public.

In Summary audits of large companies are necessary in order to protect the interests of all its stakeholders. These stakeholders include the owners of the business. The auditors function is to ensure the owners investment is safe and that the directors aren’t diverting the resources to their own gain. The auditor also protects creditors to ensure that the assets of the business are preserved to allow it to pay its debts. The auditors’ objectives are extremely complex in the modern business environment and hopefully all of the current developments will give confidence back to people in the work of the auditor.  

We specialise in producing audit exempt accounts for small and medium size companies in Ireland to the high standard required by the Companies acts 1963 to 2013 and accounting standards.
Frank McGivney & Co. Chartered Management Accountants Kells, Co Meath

Fraud Prevention in SME's

Fraud in Small and Medium size enterprises

Author Frank McGivney BA ACMA CGMA

Date: 14 April 2013

Every business owner should be aware of the risks that their business can face in relation to fraud by any party that is involved with the business. The biggest risk of been subject to fraud is the complacency that it will not happen to your firm. This complacency allows fraudsters to operate with ease. A lot of people start their business in good faith and it is easy for them to be unaware of all of the risks involved in running a business as they strive to build a fledging business idea into a success. Historically the following enterprises are most at risk:

(1)   Where the business owners are not aware of the dangers of fraud.

(2)   Where staff are not managed properly

(3)   Where members of staff have unresolved personal issues such as gambling problems, who suffer from alcoholism etc

(4)   Industries which have traditionally been subject to corruption

(5)   Industries which are in decline or which are subject to poor trading conditions.

(6)   Business where proper control and risk assessment systems are not implemented

Of course no matter what controls you put in place there is always a risk of someone committing a fraud on you.

There are three costs associated with fraud

(1) The cost of the fraud itself. This can add up to a significant amount. Take for instance an employee in a retail outlet who pockets Euro100 a week from the till every week. Even a small retail shop may have a turnover of over a million euro a year and so 100 a week out of a turnover of 19000 a week may seem nothing to the fraudster but it adds up to 5000 a year and given the low percentage profit on many retail outlets and the high rental costs this adds up to a high   percentage of the firms overall profit. If the overall profit margin is 15% then the gross profit of the business on a million is 150,000. If you take away rental costs of say 30000 a year and electricity costs of 12000 and staff wages of 50000 a year then the profit is down to 58000. Then take away rates and other expenses and the profit on a million euro turnover is soon down to 30,000 a year and then the 5000 of defrauded money can clearly be seen as a huge percentage of the firms profit

(2) The cost of discovering and quantifying the loss. Forensic accountants may have to hired or an investigator and these all add to the cost of the firm

(3) The cost of putting in place systems to prevent the fraud from reoccurring.

Internally to a firm there are two forms of fraud

(1)   employee fraud this is where an employee defrauds the firm of money

(2)   Financial statement fraud This is here a firm produces financial statements which reflect a better position than reality in order to influence external stakeholders. I will have a future article exploring this area.

Externally other parties can also commit fraud on a firm. This can be done by external contractors, customers and suppliers. This can include double billing for supplies or services. Supplying goods of a quality or value much lower than invoiced, looking for refunds on high value sales with fake sales invoices, etc. Some of the frauds from external parties rely on collusion with employees of the firm. Controls need to be put in place to prevent as much as possible of such collusion. One of the most fundamental controls is ensuring segregation of duties to ensure no one person is in full control of any area of a business on their own. Also managers should not be capable of overriding internal controls on their own

 Fraud prevention and detestation has a lot to do with the culture of the firm. An attitude that fraud is not acceptable and will be fully and firmly dealt with should permeate from the business owners down to every level of the firm. All employees should be aware that fraud is not acceptable and a whistleblowing policy should be established and implemented in a way that will protect the whistleblower.

While every one in an organisation can prevent and detect fraud there are specific people who should be utilised to minimise the risk of fraud been committed. Internal and external auditors should always perform there duties with an awareness of the need to detect and investigate any potential instance of fraud. Auditors can use various tools and analysis to highlight potential areas of risk. Often times analysis which shows skewed results are the pointers to fraud, Simple indications such as employees who never take holidays or staff who will not delegate responsibilities or duties are suspicious. In my experience when employees who go missing when you try to audit them or who can’t explain the operation of their jobs in clear terms are areas to investigate. Of course this can also just be due to factors such as incompetence or resistance to having their work assessed. While doing investigative work for one of the Irish semi-state bodies I found a lot of resistance from older employees as there seemed to be a culture of resistance to change in the company and really a resistance to management in general that I haven’t experienced to such a level in private industry. However I overcame this with proper communication of the objectives of the investigation which was purely commercial in nature. It did highlight areas of concern and lead to a lot of improvements beyond the core work I was contracted to work on.

On occasions where there is suspicion of a fraud then a specialist such as a forensic accountant may have to be used. The forensic accountant’s functions are to

(1)   Determine if a fraud has been committed by using various different techniques and methods of analysis

(2)   Determine the scope of the fraud and how much of a loss has been incurred

(3)   Determine who is responsible for the fraud. In larger firms there is often more than one employee involved and often times there are outside parties also involved

(4)   Determine how the fraud operated and then put in place controls that will prevent it been repeated.

As with everything in life the experience of someone committing a fraud against your firm can be used in a positive manner to learn lessons and to allow the business owner to improve the business. Often times during the forensic accountants work other information and data comes to light. This may relate to how tasks are perfumed and these can lead to more effective and efficient systems bee put in place, as in my example of the semi state body above.

If you feel you have been the subject of a fraud or you want to analysis the ability of your firm to detect or prevent fraud then you can contact Frank McGivney & Co. Ltd on 0469293891 or fmcgivney@live.com. I have experience of forensic analysis for any number of small firms. I have also experience of preparing fraud investigations for the High Court involving cases against among others the banks. I have also produced forensic reports for criminal cases which have been provided to the Criminal Assets Bureau. I also work extensively in forensic reports for divorce cases.

Brief summary of some tax rates in Ireland in 2012 and 2013

Brief summary of some tax rates in Ireland in 2012 and 2013

(A) Corporation Tax is the taxed charged on the profits of a company. They are calculated on an annual basis on the taxable profits of the business

Trading Profit and foreign dividends derived from trading income are taxed at 12.5%.

Start up Relief: if you start a company and it is not set up to replace a former trade (i.e. you not switching an existing trade to a new company whether sole trade or another company) then  the first 40000 of corporation tax over the first three years is not collectable by the Revenue. This is linked to employers prsi at a limit of 5000 per employee.

Non trading income such as interest, foreign rental income, miscellaneous income and rental income are all taxed at 25%.

If you have investment or estate income and do not distribute it to shareholders by the end of 18 months then any of this income not distributed is subject to a surcharge of 20%

The same is true for a service company at the end of 18 months but at a rate of 15%.

Company chargeable gains are taxed at 25%.

Vat

The Vat rates are

0%

5.2% Farmers flat rate

13.5% reduced rate which for certain industries is 9% until December 2013

23% standard rate

The rate you charge depends on your product or service. There is a list on www.revenue.ie .

Some business such as in the education and medical fields are exempt from vat.

Capital acquisitions tax is charged at 30% on all amounts over the relevant thresholds. If you receive the following amounts from these people then you are exempt from the tax. However the amount is cumulative so if you get 100,000 of your mother in 2010 and 200,000 from your father in 2012 then the 50,000 over the 250,000 limit is taxable

(1)   parent to son or daughter 250,000

(2)   Brother or sister, nephew or niece 33,500

(3)   Cousin or stranger 16,750

Stamp Duty

Stamp duty on transfers or conveyance of land or buildings is at the following rates

(1)   non residential property 2&

(2)   Residential: first 1,000,000 is at 1% and balance is at 2%

Advice for setting up your new business

Frank McGivney & Co. Ltd

Chartered Management Accountants

Useful steps for when you set up your new business

Written by Frank McGivney BA ACMA CGMA

Before you decide to set up your new business

(1)   Market Research Carry out market research and investigate the business you are proposing to start

(2)   Pick the right name which will reflect the service or product you want to sell

(3)   Prepare projections to forecasts to determine whether the business is likely to make money

(4)   Decide what structure is most appropriate, i.e should you operate as  company or  sole trader/ Partnership

When you are setting up business

(1)   incorporate a company with the companies registration office if you have decided to operate as a company

(2)   or register a sole trader business name with the companies registration office if you are going to be a sole trader or partnership

(3)   register with revenue commissioners for relevant taxes such as corporation tax, income tax, vat, paye employer and relevant contract tax

(4)   set up bank account, this may take up to ten days

(5)   advertise and market your product or service to your target market

Once you have set up your business you need to establish

(1)   Sales control this involves having an invoice book , setting up a system for sending out monthly statements, setting credit limits for customers and having a system for collecting money

(2)   Purchase Control: this involves choosing suppliers of goods and services, putting in place payment schedules for paying your bills, setting up direct debits for some bills such as electricity, telephone etc

(3)   Financial management. This involves controlling your finances, you need to ensure you get in all the money that is owed to you in a timely manner and then controlling your spending so that you can pay important bills when they fall due

(4)   Control expenses you need to find the best value for the goods and services you purchase that gives you the quality you need at the best price

(5)   Keep records. You need to establish a system to record purchases and sales. You have to keep all your invoices. You should file your bank statements. Make sure you fill out all your cheque stubs legibly

(6)   Do your tax returns on time. Make sure you meet all relevant deadlines for filing returns and pay all taxes as they fall due

I have more detailed articles on most of these subjects on http://frankmcgivney.blogspot.ie/ or you can ring me Frank McGivney on 0469293891 or email me on fmcgivney@live.com for more detailed advice on any of the above. I offer  full accountancy and tax service. 

 Frank McGivney & Co. Chartered Management Accountants Kells, Co Meath