KC Lim & Associates Preparation Of Accounts Procedures

3. Preparation of Accounts

3.1 Introduction

Preparation of accounts for businesses carried out by sole proprietors and partnerships are common type of work undertaken by the firm. Some common procedures, which form the foundation for the work is essential both to control risks and to improve efficiency. In particular, the format of the accounts prepared with sufficient breakdown and details of income statement items which is critical for tax computation purposes is an important requirement.

3.1.1 Aims

It is important to consider the aim of this category of work in order to control it adequately and reduce any risks inherent in it.

The intention when carrying out this type of work is to produce a set of meaningful accounts which are likely to be used by the client as a means of reviewing the financial position and financial performance as the business progresses; by the financiers/potential financiers such as banks for loan purposes and also the assets secured for such facilities are safeguarded; by the Inland Revenue Board for income tax purposes.

3.1.2 Risk areas

The major risk is that the accounts prepared are incorrect to a material extent. Materiality in the context of accounts preparation is not the same as materiality in the case of conducting an audit (where true and fair view of the subject of audit is used as the benchmark against which materiality is judged).

In the work of preparing accounts for our client, our firm is acting as the agent for the client and not as the holder of an office defined by the relevant acts such as the Companies Act, 1965 for the case of a company.

Accounts of clients must be prepared with a smaller tolerance in mind if compared with carrying out an audit on financial statements. In fact, most clients have the expectation that the accounts prepared by an accounting firm like ours to be “right” or “correct”.

If the accounts prepared by our firm are found to contain errors of an unacceptable degree, we face the following risks:-

  1. Legal suit initiated by banks who have relied on the information reflected on the accounts in granting banking facilities to our client and suffered losses.
  2. Penalties and/or other action(s) taken by the authorities such as Companies Commission of Malaysia (CCM), Inland Revenue Board (IRB), Malaysian Institute of Accountants (MIA)

Such errors could be due to two main factors:-

  1. The relevant books and records maintained by the client contain such errors
  2. Errors of the staff carrying out the accounts preparation work either due to incorrect understanding of entry recording or pure mistakes/overlook

Such risk of this can be managed by:-

  1. Ensure the staff in charge of preparing client’s accounts have the required experience i.e. competence to carry out such assignment and have gained a proper understanding of the client’s business and significant events occurred during and after the year end
  2. Appropriate review processes in place; and
  3. Obtain proper declarations from the client.
  4. Terms of engagement

Use of letter of engagement that sets out the terms and conditions of work is an important step in reducing risk. It is also the indication that all parties understand what is covered and the respective responsibilities of each party, both the client and the firm. The letter sets out among others, what aspects of the record-keeping will be carried out by the client, what will be performed by the firm and the time-line within which the firm needs to complete the work, and the parties to whom the firm is reporting to and therefore holds a duty of care.

Letter of engagement should be reviewed at least annually to ensure that all the terms and conditions set forth in the letter are still valid and whether additional terms are required. The ideal time to do this would be during the meeting with the client to discuss and finalise current year accounts. This is the right time to formalise following year’s engagement terms as most client is more receptive to discuss and finalise terms of next year’s work while approving current year’s accounts.

3.1.4      Objectivity, independence and interaction with audit services

A1.14 Assignment acceptance form.doc

Common entities that require accounts preparation service include small private companies facing shortage of accounts staff, unincorporated entities such as partnerships and sole proprietorships. For private companies, the accounts prepared are subject to annual statutory audit because of legal requirements (Companies Act 1965 and Income Tax Act 1967), and some of the unincorporated entities that are subject to audit, such as a charity or Friendly Society, due the requirements of law or their own constitution (e.g. Cooperative Societies Act, Articles of Association etc.) or voluntarily.

Where the firm has produced accounts that they are also to audit, careful consideration needs to be given to Ethical Standards to ensure that the firm is in the position to perform the audit and, where applicable, appropriate safeguards have been put in place.

The SP must be made aware of all non-audit services at the beginning of the audit period so that auditor independence can be reviewed and protected. In some cases, firms will have to decide whether they wish to continue to provide non-audit services or perform the audit.

In the event of an existing audit client requesting accounts preparation services for the first time, again this must be cleared through the SP before any work can commence. Conversely, careful consideration and planning will be needed where a previously non-audit client will be coming into audit.

The assignment acceptance form (see A1.14) should be completed prior to commencing all jobs to evidence the firm’s consideration of the objectivity and independence ethical issues and their eligibility to perform the work.

3.2        Planning and control

3.2.1     General planning issues and permanent file documentation

A2.17 Permanent file index.doc

A2.18 Background information.doc

A2.19 Details of professional advisors.doc

A2.20 Register of laws and regulations.doc

A2.21 Details of related parties.doc

As noted above, part of the process of minimising risk to the practice is to ensure that we properly understand the client’s business and that this knowledge is documented for all staff involved in the job to access. This can be done through the use of file notes that can be carried forward year on year, or through the use of permanent files.

Permanent note files

Permanent files are a good tool provided they are maintained and the information contained within them reviewed and updated. An example permanent file index can be found at A2.17.

A background information form has been included at A2.18 to provide a summary of relevant background details on the permanent file. This covers details such as the name and address of the business, the number of business locations, Tax return periods, key personnel etc.. It is useful to have such information summarised at the front of a permanent file and can be used for both unincorporated and incorporated businesses. There is also a schedule which is used to provide details of other professional advisors and this can be found on A2.19.

As a matter of best practice, a file note should be maintained identifying any relevant legislation / regulations / helpsheets that are specific to the client. In addition, industry specific guidance should be identified. Copies of such legislation and guidance should be available at the firm or accessible via the Internet. Similarly, any specific skill requirements for a client should be noted and reviewed annually as part of the planning and staff allocation process. It is advisable that a register of laws and regulations be maintained on the permanent note file; a specimen form has been included at A2.20 for this purpose.

For corporate clients, it is important that details of related party transactions are known to ensure appropriate disclosures are made in the accounts. A form has been provided to be included within the permanent file documentation at A2.21. This information can also be relevant to unincorporated businesses and may also be used to record appropriate details.

Other information per the permanent note file index should be added as thought relevant and of continuing interest to us.

3.2.2     Indices

A2.8 Accounts file index.doc

As has been mentioned above, review is the most important control of all. This control is likely to be carried out by senior members of staff with appropriately high charge-out rates. It is essential, therefore, that every effort is made to facilitate this review, minimising the time taken and maximising its effectiveness. It is, therefore, recommended that all staff within the practice work in broadly similar ways. This can be encouraged by the adoption of a standard index for working papers.

The model standard index, to be found at A2.8, has been drawn up in such a way as to facilitate the review by both the senior and the SP/Manager, bringing all points that are likely to be relevant to the SP/Manager to the front sections of the file.

Where there is a clearly defined structure to the layout of working papers, staff have a much better idea of what is required of them. The system then lends itself to the delegation of work, whilst still allowing full control over it. This can result in improvements in efficiency. Figure 2.1 shows a suggested approach to delegation for a straightforward accounts file.

Section Junior Senior SP/Manager
A Accounts
B File completion Senior prepares file for SP/Manager SP/Manager reviews
C Planning
E to O Balance sheet schedules
P Taxation
Q Income and expense schedules SP/Manager may wish to consult some lead schedules
U Service tax account Work undertaken by junior Senior controls & reviews
W Working papers
X Records received
Y Processing
Note that the missing letters are used only in the audit documentation.

3.2.3     Pre-year end

In order to maximise the efficiency of the assignment, thought should be given to that assignment before the end of the accounting year.

The extent of planning will vary according to the complexity of the entity’s accounting records and accounting procedures and according to the firm’s experience with the business.

The timetable needs to be agreed with the client. The time-scale laid out in the engagement letters referred to in 2.1.3 above has been set with the needs of the practice alone in mind.  The client himself may have certain requirements too, such as to avoid writing up his books and records during a busy period or a need for accounts to be produced early for a reason other than taxation.

The firm needs to ensure that adequate time is planned in for the assignment, particularly now that self-assessment has brought the accounts into the tax return process more rigidly. Even with a phased time-scale, firms will increasingly find themselves under greater pressure as more and more clients switch to accounting year ends late in the tax year as opposed to the present trend for 30 April. Planning the time of the staff will become increasingly important and it will be necessary to consider whether certain pieces of information may be required which are hard to obtain after the year end, such as stock, debtors, creditors etc. Information may be required from third parties close to the year end and pre accounts year end planning for taxation purposes may be required, such as the timing of capital expenditure, etc.

It is also important to plan how the assignment will be delegated to ensure this is carried out in the most cost-effective manner.

One way in which to ensure that clients’ affairs are reviewed prior to the year end would be to enter all accounts year ends into a forward reminder system, bringing each client up for consideration one month before that accounting year end.

The specimen documentation includes a specimen letter requesting accounting records (A2.3).

3.2.4     Booking records in

A2.7 Records received sheet.doc

It must always be remembered that the books and records belong to the client. Whenever you are handling any asset of a client, it is important that proper precautions be taken to safeguard those assets and also to record their movement. Every practice should have a set procedure to be followed when the records arrive and for returning such records to the client.

An example booking-in system may be as follows:

  • As soon as the records arrive in the office, by post or hand, the event should be recorded in a log. Ideally, this should be done by the receptionist to whom the client is likely to speak and should be in the form of an open items ledger with one line per set of records, the final entry on which is the return date. This means that you can easily see what records are present in the office at any one time.
  • The books and records should then immediately be passed to the member of staff likely to be responsible for the accounts production – this should have been decided when the assignment was timetabled.
  • The records should then be listed on a standard form and the list compared to last year’s list to identify any omissions. The client should be requested to send in these omitted items as soon as possible, and in any case before work starts, unless there is a compelling reason to get on with the accounts before the records are complete.
  • Any information in the records that is likely to be required by the tax department (or, if there is no tax department, is tax return related rather than accounts related) should be extracted and passed to the appropriate person.
  • Any building society passbooks etc. should be photocopied and handed back to the client as soon as possible.
  • The ‘jobs in’ log should be updated so that the principal/manager is aware that the job is in the office. Many firms adopt a T-card system for the controlling of jobs within the office.
  • The records should then be placed in a cardboard archive box or strong polythene bag and clearly marked with the client’s name/reference to ensure that they are not mixed up with any other client’s records. The location in the office of the records when not being worked on should be noted in the “jobs in” log.

Where possible, it is often useful to go through the records with the client so highlighting any omissions at an early stage, enabling the client to bring any important matters to the clerk’s attention.

The returning of records is obviously a simple process. However, the records should be reviewed before they are returned to ensure that any information required next year is copied or retained and the receptionist should log out the records.

A specimen records received sheet is included at A2.7.

3.2.5     Controlling the assignment

It has always been important that work within the office be controlled. This is doubly important now that self assessment has imposed such rigid deadlines on the process.

Work in progress levels can only be controlled if you are aware what jobs are in the office and at what stage. A useful control can revolve around the T-card system, often known as a ‘squash ladder’, an example of which is shown at A2.2.

Alternatively, a card file system or computer database can be used, but the T-card system has one overwhelming advantage, which is visibility. Having the cards in a rack in the main working office makes it absolutely clear which jobs are hanging around and which member of staff has a backlog.

Whatever system is operated, it must be applied by everyone, including the principals. Wherever a job moves from one stage to another, that person must annotate the card or request that the database be updated.

Despite this requirement, it is inevitable that items will be missed and the system should be regularly reviewed to ensure that it is up to date and that any potential problems are considered before they become actual problems. Ideally, this should be done weekly, maybe at a Monday morning planning meeting within each section. This continual monitoring of the progress of jobs reduces ‘fire fighting’ which is where someone, rather than doing the job that should be done, does the job that needs to be done most urgently. This results in jobs being picked up and put down too frequently, reducing efficiency. It also results in those clients who shout the loudest getting the best service, although they may not be the best clients.

Excessive stress, reduced work satisfaction, increased staff turnover, and lower profits can also arise from this approach.

A typical T-card system may work as follows:

  • T-cards are colour-coded to identify the job type e.g. accounts, audit, tax return etc. or the principal or department group responsible. Both can be achieved by having a colour-coded card with a coloured spot in the corner so the card may indicate the job type and the spot the department.
  • The T-cards are placed in panels for each stage of the accounts preparation process. The cards in each column at any particular time give a ‘snapshot’ of the present position. It is useful to know how long a job has been at each particular stage, hence the card can have places to insert the date at which each stage is reached. The group of panels together then gives a global view of the work in progress whilst each card gives the history of that particular job.
  • The first panel can be jobs that are expected to arrive soon based on the timetable, with further panels for jobs in but not started, jobs in progress, ready for senior review, waiting for response to queries, waiting for principal review and waiting for signature by the client.
  • Additional panels can be inserted for books received but incomplete and ‘in progress’ panels can be added for each member of staff.
  • When the card has reached the end of the system, the next stage is for the information to be incorporated into the tax return. The card may, therefore, be passed to the tax department as a prompt, filed for future reference or stapled to the accounts file.

3.2.6     Timetabling

A2.1 Assignment control sheet.doc

Timetabling has always been important to ensure that junior staff are kept fully occupied and that the appropriate member of staff is involved with each job. This timetabling process is worsening, with accounting year ends gradually concentrating on 31 December, resulting in a distinct peak of work passing through the office from January to July.

The only way in which this will be controllable is to consider the situation in advance, agreeing the time-scale for the accounts production process for each client as mentioned in pre year end at section 2.2.3 above and fitting that timetable into an overall scheme within the practice or each section.

Inevitably, this timetable will eventually prove to be the one scenario that will not take place. However, the setting of a timetable ensures that problem periods are identified and that action is taken, either by discussing and revising agreed time-scales with the client or by drafting staff in from other departments etc. The timetable clearly needs to be reviewed frequently, preferably weekly.

The effective deadline of 7 months for 31 December year ends is in practice substantially reduced, since the client will need some notice of his eventual tax liability in order to raise the funds. 31 July is suggested as the effective deadline for the majority of clients, with only dilatory clients being worked on to a material extent beyond that date.

Some clients will inevitably ignore the agreed or proposed timetable and bring their records in at the last minute. Others will want their work done very quickly for a particular reason. Both of these are effectively jumping the queue, so this represents premium work which should only be done for a good price.  It is clearly not wise for us to put ourselves out for these clients, to the detriment of other clients, and then be beaten down on the fee.

There is an accounts assignment control sheet at A2.1 that provides a schedule on which all clients with a particular year end are listed.  The schedule then shows the various actions that are required to take place on certain dates, with each box being ticked to indicate when this is done for each particular client. Miscreant clients can then be seen at a glance and the appropriate action taken.

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