KC Lim & Associates Preparation Of Management Accounts Procedures


4.1        Introduction

4.1.1     Aims

The accounts preparation work described in chapter 2 refers specifically to the accounts at the end of an accounting period, which show the actual results of the business since the previous financial statements and its state of affairs as at that date. Such statements are usually prepared for Income Tax Submission purpose, for the partners or proprietor and anyone else required to have an understanding of the business’s performance during the period.

Management accounts’ is a term used to describe other accounts prepared during the financial period on a monthly, quarterly or other basis intended primarily to monitor the performance of the business with a view to exercising control. For such control to be exercised, the accounts need to be prepared quickly so management accounts are usually less accurate than the end of period financial statements, being reliant on estimates and standard costs in many cases.

Broadly, management accounts are used as follows:

(a)        Internal use (within the business)

(i)         to exercise control over business activities;

(ii)         to provide some comfort as to the present financial position;

(iii)        for decision making.

(b)        External use (outside the business)

(i)         for a third party (such as a bank) who has an ongoing interest in the business’s performance/financial position.

Many treat management accounts, cash flow forecasts and business plans as being one single reporting subject but there is a very important difference between management accounts on the one hand and cash flow forecasts and business plans on the other. Management accounts are a historical document, although more recent than those financial statements referred to in chapter 2, whereas business plans and cash flow forecasts are looking forwards and so are wholly reliant upon estimates. This distinction is very important and there is, however, a great deal in common between the control systems for each.

4.1.2     Main risk areas

The main risk to the practice from the preparation of management accounts is that they are normally prepared with the express intention that someone will use them to make a decision. If that decision proves to be incorrect and the user can show that incorrect management accounts were a major influence in that decision and that the preparer owed the user a duty of care, then that user may sue the accountant for negligence.

It is best practice for all accounts prepared by a Chartered Accountant, like us, to carry an accountants’ report and this includes management accounts. This adds extra credibility to the figures when they are seen by a third party, so a review procedure for reasonableness must take place and the accounts must be backed up with an adequate workings file.  When issuing such a report, consideration should also be given to the inclusion of a disclaimer or limitation of liability notice to third party users.

Where management accounts are prepared for a limited company, it is very important that there are no misunderstandings as to the extent to which the figures have been audited. An external user seeing the management accounts may mistake them for audited accounts. On the other hand, figures extracted during the preparation of the management accounts by the auditor’s staff may well be used without further testing during the audit process, so weakening the audit. As with all unaudited accounts, the accountants’ report should clearly state that the figures have not been audited.

4.1.3     Terms of engagement

A4.1 Management Accounts Engagement letter.doc

A4.2 Accountants report and clients declaration.doc

A4.3 Assumptions control sheet.doc

A4.4 Completion questionnaire pre-principal review.doc

A4.5 Completion questionnaire final.doc

A4.6 Client approval letter.doc

A4.7 Client will not sign accounts approval letter.doc

A1.14 Assignment acceptance form.doc

As with any other assignment, there should be evidence in writing of the agreement of the terms of reference. Letters of engagement should be reviewed at regular intervals.

As assignments on preparation of management accounts are a higher risk, so their incorporation into the engagement letter process is essential. The majority of management accounting assignments are regular recurring work for a client for whom we already prepare the final accounts, so it would seem appropriate for this to be treated as recurring work in the engagement letter.

In other cases, management accounts are periodic non-recurring work, although again it is usually for an existing accounts preparation assignment. In these cases, a supplementary engagement letter may be more appropriate, an example of which can be found in the standard documentation at A4.1.

4.1.4     Objectivity, independence and interaction with audit services

Where we have produced management accounts for the client, it is also likely that we will produce the financial statements to be audited. The firm could be subject to the self-review and management threats. Careful consideration needs to be given to these threats to ensure that our 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, we will have to decide whether we wish to continue to provide non-audit services or perform the audit.

In the event of an existing audit client requesting management 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-audited client will be coming into audit.

Irrespective of whether an audit is to be performed or not, the firm still needs to comply with MIA’s ethical guidance on objectivity and independence. An assignment acceptance form, C1, has been included at A1.14. This form should be completed for all assignments to evidence the firm’s consideration of the issues of independence and objectivity and to confirm our firm’s eligibility to perform the work.

4.2        Planning and control

As with any assignment, the work needs to be properly controlled.

All of the processes within the planning and controlling section of chapter 2 (2.2) apply equally to the management accounting process. However, management accounts work will be carried out at the client’s premises more often than will the year end accounts production.

4.2.1     Overlap with accounts production

It is not uncommon for the firm like ours producing the management accounts to produce the year end accounts as well. There is a great deal of scope for a reduction in the cost of those year end accounts by relying on the work done at various intermediate stages. This fact should be carefully borne in mind at the planning stage of the management accounts’ production; in particular, we should consider any overlap between the management accounts work and work on the annual accounts. In preparing the monthly/quarterly analysis and posting, it may not take much extra effort to extract the information that will be required at the year end, and, in so doing, dispense with the necessity to return to those client books and records at the year end, in turn greatly improving the overall efficiency.

We should also consider the layout of the accounts. Management accounts do not have to adhere to any layout as they would not normally be submitted to the Inland Revenue Board under the self-assessment tax system adopted in our country now. However the client may have their own specific requirements as to the layout of the management accounts and generally go into far greater depth in certain circumstances and miss out other areas altogether, depending upon the use to which the information is going to be put. However, in the case of computerised accounts production, if the same coding list can be used with different formats for the production of the management accounts and the annual accounts, then a great deal of work can be saved

Given the separate functions to which the different accounts are going to be used, careful planning can save a great deal of time turning two separate assignments into one larger hybrid assignment.

4.2.2     Assignments in the office

If the accounts production process is taking place within the office, then the assignments should be brought into the control system described in chapter 2. The books and records should be booked in, an entry made in the appropriate T-card or equivalent system and then the progress of the job properly monitored throughout the office. The time-scale is likely to be much shorter than for the year end accounts’ production and, given this lack of flexibility, one would expect the management accounts to be given priority in the timetabling process.

Staff undertaking management accounts’ work should be sufficiently competent, as with any work. However, since there will be less information available from which to prepare the accounts, due to the lack of a delay between the end of the relevant period and the preparation process, the staff need to be particularly competent. They need to be sufficiently aware to be able to spot discrepancies in trends and variances and to at least make some attempt to determine the reasons for any unusual figures. Staff in this position are likely to be heavily dependent upon management representations and need to be sufficiently competent to be able to assess those representations for reasonableness.

As with an audit, such representations need to be recorded since, if the accounts do eventually prove to be incorrect, the extent to which the fault lies with the client needs to be evidenced as a defensive procedure.

4.2.3     Assignments at the client’s premises

In many cases, the management accounts will be prepared from the client’s own accounting records and, since these records are frequently in constant use, it is often less disruptive and more efficient for the accounts preparation process to take place at the client’s premises.

Again, the control system is very much as for year end accounts’ production, but particular care needs to be taken over the supervisory and review processes. The figures should not be released before the completion process at 4.4 below has been undertaken. In particular, junior staff should not normally let the client see the results without at least a cursory review by a more senior member of staff since the client may well place reliance on those interim, and unreviewed, figures.

4.3        Detailed work

4.3.1     Working papers

The standard of preparation of working papers for management accounts should be no less than that for the final accounts. All such schedules should clearly indicate what client and what period is involved, who prepared and reviewed the schedule, and when.

Where a number of sets of management accounts are drawn up during the year, it may be beneficial for the lead schedules to be cumulative, with a column for each quarter or month. This enables trends to be clearly seen and saves time with the schedules being brought forward month by month. Computerised spreadsheets are ideal for this approach, provided that appropriate hard copies are obtained. In such a case, evidence of review becomes clouded. Each review occasion, i.e. each period, needs to be separately initialled and dated.

In many cases, working papers for management accounts will be computer-produced e.g. printouts from the client’s computer. It is important that these are headed up and that a trail exists from the final accounts to the lead schedules and then to those supporting computer-produced schedules. One must always consider that this is a higher risk area, so it is more likely at some stage that someone will want to recreate what was done.

4.3.2     Assumptions

By their very nature, management accounts are less accurate than annual accounts due to the necessity for certain items to be estimated. This is either due to the speed at which the accounts are prepared, preventing the use of hindsight (such as with accruals schedules), or cost consideration (such as not being able to carry out a detailed stock take for every accounting period). These problems are dealt with by the use of estimates and assumptions.

It is imperative that all such estimates be clearly identified so that they may be properly reported to the user of the accounts. The user can then temper his judgement in the light of those assumptions, so reducing the risk to the practice.

4.4        Completion

4.4.1     Casting

Calling and casting of management accounts is very rarely carried out. The necessity for such procedures depends upon the way in which the accounts are prepared.

Whilst ideally one would hope that everything leaving the practice can be properly called and cast, in practice such procedures are not so often carried out on computer-produced documents. Management accounts that are to be used internally are ephemeral in nature, will not be on record for any particular length of time and are frequently not subject to the calling process. However, all documents should be cast.

If any part of the management accounts process is on a spreadsheet rather than a bespoke or commercially produced accounting package, then casting is crucial. Anyone who has used a spreadsheet will be aware that the accuracy of the total is dependent wholly upon the accuracy of the various formulae within the spreadsheet, all of which are user written and are particularly susceptible to accidental damage or hidden logical flaws.

If the management accounts are typed, then all the calling and casting procedures outlined in chapter 2 need to be implemented in every case.

4.4.2     Review

As mentioned above, review is imperative for management accounts. The fact that the staff need to be particularly on the ball, looking for variances and flaws in explanations given, has already been identified, as has the need for multiple review boxes in composite schedules. In fact, the whole review process outlined for the accounts needs to be considered for management accounts, with the exception of the statutory disclosure consideration.

A matter of considerable concern is where junior or middle-ranking staff are sent out to a client to do management accounts, complete them on site and leave them with the client without those accounts being reviewed by a manager, let alone a principal. These documents are still a product of the practice and full review procedures are essential. If necessary, the principal or senior manager should visit the client at the end of the particular assignment and be responsible for signing off the file and handing over the management accounts, having given them a reasonable review.

4.4.3     Quality control

As with other areas of the practice, consideration should be given to the performance of hot or cold file reviews to ensure the firm’s standards and procedures are being adhered to. Particular consideration should be given to those assignments identified as high risk. This may be a part of a cyclical review programme. As mentioned previously, it is essential that, where reviews are performed, action is taken to remedy findings and there is a follow-up review to ensure this has been done.

4.4.4     Disclaimers and restrictions on use

The risk inherent in management accounts is greater than that for year end accounts, so the accountants’ report should be worded accordingly.

Management accounts should always contain an approval statement from the client, approving the figures, confirming that all information requested has been supplied and that the assumptions are reasonable. Once this has been obtained, the accountants’ report can be signed. This report should have a similar wording to a normal accountants’ report for year end accounts, together with a disclaimer in respect of any assumptions and a clear restriction on the use of the accounts.

The majority of management accounts are prepared for the internal use of the business, so the restriction should clearly state that the accounts have been prepared with the express purpose of their use by the management internally and they are not to be shown to any third parties without the permission of the accountant.

If the accounts have been prepared for internal use and for submission to the bank, with us being informed by the client of that from the outset, then the restriction can be rephrased, naming the bank. In this situation it is likely that the firm will also owe a duty of care to that third party i.e. the bank. It is vital therefore that the firm considers the potential risks involved and acts accordingly.

This is not to say that management accounts cannot be used by the management for other purposes but if they do wish to show the accounts to another party, we should be notified and a new accountants’ report printed changing the restriction to permit that new purpose. If we are not happy for this other person to see them, or feels that the work done was insufficient bearing in mind the new use to which the accounts are to be put, then at least he has an opportunity to refuse permission or require further work to be done before granting such permission.

The accountants’ report should be one of the first pages in the management accounts, with all pages clearly numbered and preferably with the report referring to the precise pages in those accounts. A user of the accounts could then spot the missing page if the report were to be removed.

On occasion, our involvement in the management accounts production consists of a review of the nominal ledger, the processing of some journals and the printing of accounts from the client’s own computer system. In such circumstances, it may not be practicable for an accountants’ report to be appended. This is acceptable, although not ideal, provided that there is no indication of our involvement, i.e. the accounts are not printed on the practice’s letterhead, and it is made clear to the client that he/she must not represent to third parties that the accounts have been prepared by us. The specimen engagement letter at A4.1 contains an optional clause to this effect.

4.4.5     Completion questionnaires

As for the year end accounts production process, completion questionnaires can ensure that important procedures and controls are not omitted, particularly when there is pressure to complete the accounts for the client. A completion questionnaire (pre-principal review) is included at A4.4 and a completion questionnaire (final) at A4.5.

The questionnaires can be simpler since the majority of the tax related questions will not be an issue. However, it is important not to ignore taxation altogether since problems should always be addressed earlier rather than later, particularly when the tax authorities are involved. The questionnaires also retain the cross selling and staff development questions.

There is an additional checklist, the assumptions control sheet (see A4.3). This is intended to ensure that the SP/principal/manager is aware of all such assumptions, so can make an informed decision on the necessity for their disclosure.

4.4.6     If the client will not sign the accounts

When accounts are being prepared monthly, particularly when they are to be sent to the client’s bank, there may not be time to get the accounts formally approved, or the client may be resistant, not seeing the need for the inconvenience and delay. In those circumstances, an alternative approach may be to notify the client that approval will be assumed unless you hear otherwise. An alternative approval letter can be found at A4.7.

Ft is imperative that an accountants’ report still be attached, and that the client is made aware that passing the accounts on will be considered to be evidence of his approval of the accounts. The accountant should also have some proof of delivery to the client.

This alternative approach is most definitely the second choice approach as far as we are concerned. Every effort should be made to obtain written approval wherever possible.

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