Internal Audit and Control and Asset Management

Introduction to Financial Management

  • Overview of Internal Audit and Control & Asset Management

Auditing

  • Definition: The checking of a business's accounting reports to ensure correctness and completeness, as well as the efficiency of its operating systems and policies.

  • Types of Auditing:

    • External Auditing

    • Internal Auditing

External Audit

  • Definition: An independent review of the company’s systems and records conducted by accountants who are not employees, ensuring maintenance accuracy representing the company’s performance and position for a financial period.

  • Objectives:

    • Protect external users of General Purpose Financial Reports (GPFR)

    • Provide investor confidence in financial report accuracy

  • Regulation: Conducted on publicly listed companies under the Corporations Act 2001, mandating account reviews.

  • Auditor's Role: Prepares a formal report expressing the opinion on:

    • True and fair representation of the company

    • Compliance with AASB Accounting Standards

  • Reporting Responsibilities: External auditors must inform the Australian Securities and Investments Commission (ASIC) of breaches of the Corporations Act or AASB Standards.

Internal Audit

  • Definition: An independent and objective review of a business's systems, procedures, and policies to ensure adherence, efficiency, and effectiveness.

  • Functions:

    • Monitor and examine internal controls

    • Detect and correct errors

    • Identify operational deficiencies for improvement

  • Purpose:

    • Protect business assets

    • Ensure the accuracy of business records and reports

    • Encourage efficiency

    • Ensure observance with business policy

    • Guarantee compliance with laws and regulations

  • Note: Purposes align with those of Internal Control.

Internal Control

  • Definition: Procedures, policies, processes, and systems within a business to ensure efficient and effective operations, reliable financial records, and achievement of objectives.

Principles of Internal Control

  • Key Principles:

    • Segregation of duties

    • Established lines of responsibility

    • Authorization processes

    • Employment of competent and reliable staff

    • Appropriate security of assets and records

    • Installation of mechanical and electronic devices

    • Sufficient recording and documentation systems

    • Verification and checking processes

Two Categories of Internal Control

  • Administrative Controls:

    • Procedures ensuring efficient operation and compliance with established policies.

    • Relate to:

      • Segregation of duties

      • Establishing authorization processes

      • Establishing lines of responsibility

      • Employment of competent and reliable staff

  • Accounting Controls:

    • Measures protecting business assets and ensuring record accuracy.

    • Relate to:

      • Security of assets and records

      • Installation of mechanical and electronic devices

      • Verification and checking processes

      • Adequate records and documentation systems

Limitations of Internal Control

  • Human Involvement: Errors made by individuals.

  • Collusion: Conspiracy among individuals to falsify activities and records.

  • Cost-Benefit Ratio: Costs may outweigh benefits of internal controls.

  • Staffing Issues: Insufficient staff to implement controls effectively.

  • Management Override: Risks of management overriding controls, especially in small businesses.

  • Need for Regular Review: Controls must be regularly reviewed to remain effective, adapting to business changes.

Important Financial Principles of Asset Management

  • Significance of Asset Management: Critical to business success; poor asset management leads to business failures.

  • Major Areas to Manage Assets:

    • Appropriate investment in non-current assets

    • Management of accounts receivable, inventory, and cash

    • Management of short-term and long-term debt

    • Management of equity capital

Appropriate Management of Non-Current Assets

  • Definition: Non-current assets are held for longer than 12 months, including:

    • Real assets (property, plant, and equipment)

    • Financial assets (shares)

    • Intangible assets (trademarks)

  • Importance:

    • These assets can be expensive

    • Financing often through long-term debt or equity necessitates adequate cash flow for payment and profitability

    • Balance: Too much investment leads to inefficiency; too little can stifle growth.

  • Strategies for Management: Various strategies can be employed for effective management of non-current assets.

Appropriate Management of Cash

  • Importance of Cash Management:

    • Sufficient cash is necessary for operational needs

    • Excess cash incurs costs (fees, low interest returns)

    • Insufficient cash leads to liquidity problems

    • Cash is vulnerable to theft or loss

  • Strategies for Management: Companies should consider strategies for effective cash management.

Appropriate Management of Accounts Receivable

  • Importance: Credit provision is essential for increasing sales and profitability.

  • Risks:

    • Large accounts receivable may indicate lenient credit policies, leading to bad debts

    • Slow cash collection creates liquidity issues

    • Increased administration costs for managing receivables

    • Excessively strict credit policies might reduce sales and customer retention

  • Strategies for Management: Strategies to ensure effective management of accounts receivable should be discussed.

Appropriate Management of Inventory

  • Importance of Inventory Management: Critical for successful merchandising and wholesale operations.

  • Risks:

    • Significant investment in inventory necessary for operation

    • Must balance inventory levels to avoid overstock or stock-outs

    • Willingness to manage for theft or shrinkage

  • Strategies for Management: Consider strategies for effectively managing inventory.

Appropriate Management of Short-Term Debt

  • Definition: Short-term debt must be repaid within 12 months, including accounts payable, short-term loans, and overdrafts.

  • Importance:

    • Inability to repay can lead to business insolvency

    • Payment timing impacts liquidity; must consider cash availability and supply continuity

    • Early payments could adversely impact liquidity; delays can harm supplier relationships

    • High interest rates may apply.

  • Strategies for Management: Strategies to ensure effective management of short-term debts should be evaluated.

Appropriate Management of Long-Term Debt

  • Definition: Long-term debt includes borrowing due beyond a 12-month period, e.g., mortgages, long-term loans, and debentures.

  • Importance:

    • Used to purchase long-term revenue-generating assets requiring cash flow to ensure repayments

    • Include interest and principal payments necessary to avoid loss of collateral and potential insolvency

    • Excessive debt might inhibit additional capital raising opportunities

    • Underuse of debt financing may hinder growth prospects.

  • Strategies for Management: Businesses should consider various strategies for managing long-term debts.

Appropriate Level of Equity Capital

  • Definition: Equity capital refers to funds invested by owners (shareholders) to finance the business.

  • Importance:

    • Undercapitalization leads to inadequate capital for expansion or investment

    • Overcapitalization may lower investor returns and threaten managerial control over the company.

  • Strategies for Management: Evaluate strategies to manage equity appropriately.