Accounting Grade 10: Ethics and Internal Control

• Study notes for Accounting Grade 10, focusing on ethics and internal control.
• Covering key principles, IFRS/GAAP, ethics, and fraud in accounting.

Accounting Principles

• In grades 10, 11 and 12, students should aim to define and explain IFRS and GAAP.
• Students should also explain and identify basic concepts of IFRS and GAAP.
• The ultimate goal of recording transactions is to prepare financial statements.
• IFRS dictates that financial statements should be prepared with the following fundamental assumptions.

Accrual Basis/Matching

• Record transactions when they occur, not when cash changes hands.
• Focus on the expected movement of transactions, not just cash flow.

Going Concern

• Assume the business will continue operating in the foreseeable future.
• Preparing financial statements is pointless if the business is expected to close.

Desirable Characteristics of Financial Statements

• Financial statements should be understandable, reliable, material, and comparable.

Understandable

• Financial information should be easily understood by individuals with business knowledge.

Reliability

• Users should trust financial statements as a fair representation of the business.

Materiality

• Include relevant information that could impact decisions made by users of financial statements.
• The nature and relevance of the information determines its materiality.

Comparability (Consistency)

• Financial policies and formats should stay consistent for year-to-year and business-to-business comparisons.

GAAP

• GAAP stands for Generally Accepted Accounting Practice

Prudence

• Record financial results conservatively, avoid overstating or understating to favor a particular outcome.

Business Entity Rule

• Keep business finances separate from the owners' finances.
• Separate financials should be prepared for each business if a single person owns multiple businesses.

Historical Cost Rule

• Assets like land, buildings, and equipment should be recorded at their original purchase price.

Ethics

• The study of moral beliefs about right and wrong, governing a person's behavior.
• Many businesses develop a Code of Ethics or Conduct to address potential ethical issues.

Code of Ethics

• A set of rules for employees to guide conduct within the organization.
• It reflects the norms and beliefs of the company and sets expectations for behavior.
• Explains the values, ethics, and beliefs that guide organizational policies and behavior.
• Establishes standards for personal and business conduct.
• Boosts external confidence in the organization.
• Prevents undesirable behaviors and practices.

Professional Bodies

• Accountants in South Africa often belong to SAICA or SAIPA.
• South African Institute of Chartered Accountants (SAICA)
• South African Institute of Professional Accountants (SAIPA).
• SAICA members can prepare books, give business advice, and audit books.
• SAIPA members can prepare books and give business advice, but cannot perform audits.

Professional Codes of Conduct

• Organizations provide guidance to members through training, news, and updates to IFRS rules and standards.
• Accountants sign these codes and may lose their qualifications if they are violated.
• Objectivity: Accountants should be impartial, fair, and not influenced by personal feelings.
• Integrity: Honest behavior is critical for establishing trust between accountants and businesses.
• Confidentiality: Financial information should only be disclosed with proper permission.
• Professional Competence: Accountants should be skilled, diligent and attentive in providing services.
• Professional Behavior: Accountants should act in a way that maintains a good reputation and avoids discrediting the profession.
• Technical Standards: Accountants should have the necessary skills, achieved through training, and stay updated on accounting changes.

Ethics in Tests and Exams

• You should be able to explain "ethics" and "code of ethics".
• Expected to analyze appropriate behavior (with reasons) and suggest improvements for future situations.

Internal Control

• Involves defining, explaining, and identifying basic internal control processes.
• Integrated with other topics to ensure comprehensive understanding.

Definition of Internal Control

• Policies and procedures put in place to safeguard assets and ensure the organization reaches its goals.
• A broad term encompassing any rules that ensure smooth business operations, prevent fraud, limit adverse events, or provide safety nets.

Categories of Internal Control

• Physical safeguards: Includes security guards, cameras and alarms.
• Separation of duties: Assigning tasks to multiple people reduces fraud.
• Authorizations: Requiring approval before a task is carried out.
• Documentation: Supporting all transactions with source documents.

Preventative Controls

• Deter or prevent undesirable events like burglar-proof buildings, security cameras, and access control.

Detective Controls

• Assist in detecting undesirable events that have already occurred, such as alarm systems, physical stock-taking and anti-virus software.

Corrective Controls

• Normalize a situation after an undesirable event with armed response, fire extinguishers, insurance, and data backups.

Directive Controls

• Put in place to encourage desirable events through procedural manuals, codes of ethics, employee training, and job descriptions.

Accounting Controls

• Designed to ensure accurate financial reporting, involving training, standardized documents, and reconciliations.

Fraud 101

• Focus on the importance of internal controls to limit theft and fraud in businesses.
• Theft is the physical removal of an object without the owner's consent.
• Fraud is wrongful or criminal deception intended for financial or personal gain.

Employee Fraud

• Bribery: An employee receives money to influence a decision.
• Paying salaries to "ghost employees": Money calculated for fictitious employees is transferred to the employee's bank account.
• Theft: Taking cash, goods, or assets for personal use.
• Kick-backs: Ordering goods from a friend at inflated prices and receiving a portion of the price in return.
• Rolling of cash: A cashier deliberately understates monthly deposits, taking a large amount of money for their use.
• Insider trading: An employee uses confidential information for self-gain by buying or selling shares.
• Forgery: An employee fabricates documents to acquire money illegally.
• Money laundering: Processing illegally acquired money through legal transactions.
• Embezzlement: Misusing funds obtained from another person for an unintended purpose

Business Fraud

• This may happen when the business has an ethical corporate culture
• Tax evasion: Avoiding taxes through illegal means
• Price-fixing: Competitors agreeing to set a high minimum price on goods
• Industrial espionage: Using cunning methods to obtain information from a competitor
• Trading in illegal goods: Buying and selling stolen or illicit goods.
• Money laundering: Processing illegally obtained money by using it in a legitimate transaction
• Misrepresentation: Misleading the truth of a fact in order to take money or property away from a person.
• Misleading advertising: Clients make false information about products, prices, warranties and abilities.
• Embezzlement: Using funds obtained from a customer for a purpose other than for what is was intended.

Testing Internal Control

• Expected to identify fraudulent behaviors and suggest internal controls to prevent, detect, and correct the situation.
• Employees should provide a copy of their ID and bank statements
• The HR manager should prepare the payroll (list of employees to be paid), and the accountant should double check the to payroll and make the payments

Financial vs Management Accounting

• There are two types of accounting, financial and management, with different purposes and users

Financial Accounting

• Involves the identification, measurement and recording of financial transactions of a business to produce financial statements

Management Accounting

• Uses financial information for the purpose of business planning, internal control and decision-making.
• This information is mainly used internally (e.g. budgets, cost projections)