Finance and Investment

Cycle
Lecture 1
 Test 1 information
Date: 8 March 2013
Time: 08:00
Venue: D 1 Lab 208
What to study:Risk management, finance
and investment cycle, bank and cash
cycle, purchases and payments cycle.
(Leave out Payroll for test 1)
 m e nt
a n a g e
Ri s k M es t 2
t i ve T
Ob j ec
Questions
1. Who are the two parties in a business who are
responsible for managing risk?
2. Risk must be disclosed:
a. To whom?
b. Using what medium?
Solution
1.Shareholders and management
2. disclosure:
a. All stakeholders
b. An integrated report to be included in the financial
statements.
 INVESTMENT & FINANCE
CYCLE
• Study material:
• Pre-Reading
• Module
• Class notes/slides
• Question bank
• Objective Tests
• Study outcomes:
• Understand the risks inherent within the cycle.
• Be able to understand and recommend controls to be
implemented in order to mitigate risks.
• Be able to apply your knowledge to any given scenario
 Cycles and how they integrate

Cycles in a
business
 Pre-reading
3 Ways to get investors interested in your business:
1. Write a business plan;
• What to include in the business plan:
• Mission statement
• Management team
• Market summary
• Opportunities
• Business concept
• Competition
• Goals and objectives
• Financial plan
• Resource requirements
• Risks and rewards
• Key issues
2. Prepare your talk;
• Be able to give information on your own personal credit history, how will potential customers learn about your business
• Show the investors that you have put a lot of thought into your new business and you have considered everything.
3. Create relationships, not transactions;
• Take advise from your investors and make them feel like they are important to you and their opinions matter. Make them
part of your business decisions.
INVESTMENT & FINANCE
CYCLE
INVESTMENT & FINANCE CYCLE
CHARACTERISTICS OF THE CYCLE:
 Journals for different types of transactions
Transaction Account debited Account credited

Purchase of assets Land & Buildings, Accounts payable

Capitalization of assets Plant & equipment Long-term loans
Bank
Lease accounts

Disposal of assets Accounts receivable Land & Buildings, Plant &

Accumulated Depreciation, Loss Equipment
on disposal

Purchase/ Goodwill Accounts payable

development of intangible assets Patents, trademarks, Bank
Research & development

Revaluation Land & Buildings Revaluation reserve (NDR)

Plant and Equipment

Depreciation Depreciation expense Accumulated depreciation

 INVESTMENT & FINANCE CYCLE

IMPORTANT FACTORS IN THIS CYCLE:

• Nature and significance of tangible and intangible assets;

• Nature and incidence of additions and disposals of assets;
• How the assets acquired have been funded;
• Management’s expected returns on assets acquired;
• Management’s strategic plans for growing the assets of the
business and how management proposes to fund future
acquisitions.
INVESTMENT & FINANCE CYCLE
• There are numerous accounts that can be manipulated
in this cycle, including:
• Omitting long term loans;
• Understating the value of long term liabilities;
• Overstating assets by including fictitious assets or
assets which the company does not own;
• Overstating assets by understating depreciation
allowances or impairment.
INVESTMENT & FINANCE CYCLE
• Two components:
1. Investment
Activities
 Investment Activities
TYPE OF TRANSCATIONS:
• Purchase of assets
• Capitalisation of assets
• Disposal of assets
• Purchase/development of assets
• Depreciation on assets
• Revaluation of assets
• Maintenance of assets
Investment Activities:
Authorisation
• The following specific authorisation requirements have to
be adhered to for investment activities:
• Top management and BOD should authorise any
acquisitions/disposals
• Statutory approval from the shareholders
• Existence of Capex committee that will prepare and
present all requests and proposals to the BOD
• Different levels of authorisation in the organisation
Inherent Risks: Investment
activities
• Management bias and incentive to misstate capital
expenditure to achieve budget and obtain performance
bonuses
• Nature and complexity of the assets acquired leading to
errors in accounting, such as property – stage of
completion
• Valuation of intangible assets for example goodwill &
brands
• Determining useful lives of assets or fair market values
Inherent Risks: Investment
activities (continue)
• Risk of management override of controls through
unauthorized acquisitions
• Risk of fraud and theft of assets
• Errors in the recording of assets
 Investment Activities
(Documents & Records)
• Capital budget
• Fixed asset requisition with quote/negotiated prices
• Minutes of BOD (authorization for purchases and sales)
• Invoices (purchases, sales)
• Fixed assets register
• General ledger accounts
 Investing Activities
MAIN ACTIVITIES:
 Investment Activities
1. Fixed asset ADDITIONS: AUTHORISATION

• Formal written proposal by capex committee

• Supported by quotes and source of finance
• Presented to BOD
• Decision minuted
• Large organization –different levels of authorization
• Directors’ interest in contracts disclosed
• Usual issue of purchase order/ DN from supplier/ invoice
• Formal signed contract (Financing from bank)
 Investment Activities
2. DISPOSAL of fixed assets:

• Proceeds (amount we receive for selling the asset)

• There are less formal controls over disposal – thus
accurate accounting is sometimes overlooked.
• Risk – disposed assets still reflected as assets in
SOFP. Thus they are overstating their assets
 Investment Activities
3. REPAIR & MAINTENANCE and IMPROVEMENTS

• Risk – items capitalized in stead of expensed

• Or items expensed in stead of capitalized
Internal Controls and Test of Controls

• It is not sufficient for management to just implement controls. They

will need to also test the controls to determine if the controls
implemented meet the objectives as set out by management.
• The internal controls can be divided into 3 “categories", namely:

1. The Objective to be achieved by the control that you implement.

Eg: Occurrence, Completeness, Authorisation etc.
2. How the objective will be achieved. (Internal Control that you will
implement)
3. How to test implementation of the control.

In the module, the above is clearly set out in table format.

CONTROLS – Investment Cycle

Occurrence/Validity: All recorded assets are valid (really exist) and are supported by proper
documentation

Internal Control Test of Control

1) All fixed asset purchases are supported by a 1) Select a few fixed asset purchases and inspect
fixed asset requisition and capital budgets. the supporting requisition and capital budget.
(Supporting documentation).
2) Enquire with the client's personnel about the
2) Recorded assets are periodically compared to procedures i.r.o. purchasing of fixed assets
physical assets by an independent senior official. and periodic comparison of fixed assets with
book assets.

3) Inspect proof of comparisons by client official

(signature).
 CONTROLS
Authorisation: All purchases and sales are authorised according to company’s policy

Internal Control Test of Control

1)Purchases and sales of fixed assets: 1) Enquire with the client personnel about the
policy i.r.o. authorisation of purchases and
- Authorised by senior management on a sales.
numerical capital requisition/sales document;
- Authorisation/decision recorded in minutes.

2) Inspect supporting documentation and

minutes as proof of authorisation.
 CONTROLS
Completeness: All valid fixed assets are recorded and nothing is omitted

Internal Control Test of Control

1) Capital requisitions are numerically accounted 1) Inspect capital requisitions for numerical
for (Sequentially pre-numbered). sequence and proof of client review (signature).

2) The list of missing numbers is regularly 2) Inspect the fixed asset register for proof of
followed up. review (signature).

3) Fixed assets are recorded in a fixed asset

register and are regularly compared with fixed
assets (see refer to the test under validity.
 CONTROLS
Accuracy: All fixed assets are recorded at the correct amount and are arithmetically correct

Internal Control Test of Control

1) Fixed assets are recorded at the amount of 1) Enquire about procedures followed.
the invoice.

2) Depreciation and other calculations are done
by computer with a program which has been
tested beforehand (if calculation is per hand,
perform an independently reviewed on
calculation).
2) Test the functioning of programmed controls
(e.g. test date). If calculation performed by
hand, inspect schedules for proof of client
review of calculation.
 CONTROLS
Recording: All transactions i.r.o. fixed assets and depreciation are correctly recorded

Internal Control Test of Control

1) All purchases and sales of fixed assets are
recorded in the fixed asset ledger accounts
(control account) and fixed asset register from the
source documents.
1) Select purchases and sales of fixed assets
from the cash book and follow it through to the
source documents, fixed asset register and
entries in the ledger. Agree details such as the
date, amount, description and category of asset.

2) The fixed asset register is reconciled with the 2) Inspect the reconciliation and agree it with the
control accounts in the ledger on a regular basis. accounting records and source documents.

3) Inspect the reconciliation for proof of review by

a senior employee at the client.
 CONTROLS
Classification: All transactions i.r.o. fixed assets are correctly classified according
to its nature

Internal Control Test of Control

1) Fixed assets are classified into the 1) Verify procedure by means of enquiries.
respective categories according to company
policy. 2) Review the fixed assets register and the
ledger accounts for maintenance costs that
2) Improvements are capitalised as fixed have been erroneously classified.
assets and clearly distinguished from
maintenance.
 CONTROLS
Cut off: All purchases and sales of fixed assets are recorded in the period to which it relates

Internal Control Test of Control

1) Fixed assets purchased are recorded at the 1) Enquire about procedures i.r.o. recording and
date of receipt (per GRN) and when sold as from cut-off.
the date that the risks and rewards of ownership
passes to the purchaser in substance 2) Select purchases and sales from source
documents and follow it through to the ledger
accounts and fixed asset register - ensure
recorded in correct period. (Test also in other
direction from records to supporting
documentation).
 CONTROLS
General Controls: Assets are properly safeguarded against theft and physical elements

Internal Control Test of Control

1) Fixed assets are, as far as possible, stored in 1) Enquire with personnel about procedures i.r.o.
permanent form (bolted). safeguarding.

2) Observe procedures i.r.o. safeguarding.

2) Safe guard assets by: 3) Investigate company policy and proof of

Limiting access to authorised persons (locked, application.
key control)
Controls protecting assets against physical 4) Confirm by way of enquiry and inspection of
elements (rain, weather) insurance contracts that the assets are insured.

3) Asset adequately insured

2. Finance
Activities
 Finance Activities
• Financing activities:
• Means by which entity obtain FUNDING for business
operations and capital investment
• Two main sources:
• Equity
• Borrowings/loans
 Finance Activities
Type of transactions in the cycle:

• Owner’s Equity:
• Share issue
• Dividends
• Share buy-backs
• Borrowings:
• Loans/repayments (eg: Bank)
• Interest on borrowings
 Finance Activities
• Knowledge of the business:
• If the issue of shares and obtaining funding can be
classified as the entity’s core business. Eg: Loan
shark
• Authorisation requirements for issuing shares and
obtaining funding
• Statutory requirements for issuing of shares/loan
transactions – Companies Act has various
requirements when it comes to loans
Financing Activities - RISKS

• Highly regulated environment, strict controls by directors

over financing activities – risk low.
• Comprehensive disclosure requirements i.t.o. IFRS for
equity and borrowings
• Global markets – laws/regulations in foreign markets
• Foreign exchange gains/losses in statement of
comprehensive income
 Financing Activities
Documents & Records
Common Documents:
• Minutes of shareholders/directors
• Debenture trust deed
• Prospectus & articles of association
• Share certificate & share register

• Mortgage bond
• Bank statements
Any Questions?