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Unit 2 Financial Systems & Auditing

Assignment Evaluating the Financial System

By Kinza Anjum

BTEC HND Business Studies

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Introduction

Accounting is considered as the major helping hand to form a successive management


which needs to report and analyze the business transactions. Accounting is a pathway
of measuring success through the designing projects as measuring the outcomes of the
projects in line with the target goal of the organizations (Elliot, Barry & Elliot, Jamie,
2004). Organizations maintain their financial reports with the help of accounting theories
and policies. The international financial reporting standards also help to keep the
accounting practice effectively, efficiently, and correctly. The efficient management will
be built if the organization follows the international reporting standards accurately. I
have demonstrated my understanding on the purpose, use, importance of accounting
records, accounting systems, computerized accounting system, manual accounting
systems, business risk, audit risk, internal and external control systems, importance of
auditing, and planning audit assignment as well as preparing audit report in the body
part of my report.

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Task 1

1.1 Explain the purpose and use of the different accounting records

The purpose of accounting

The purpose of accounting is to collect and report financial information about the
performance, financial position, and cash flows of a particular business. This information
is then used to reach decisions about how to manage the business, or invest in it, or
lend money to it. This information is accumulated in accounting records with accounting
transactions, which are recorded either through such standardized business
transactions as customer invoicing or supplier invoices, OR through more specialized
transactions, known as journal entries.

Once this financial information has been stored in the accounting records, it is usually
compiled into financial statements, which include the following documents:

• Income statement

• Balance sheet

• Statement of cash flows

• Statement of retained earnings

• Disclosures that accompany the financial statements

Financial statements are assembled under certain sets of rules, known as accounting
frameworks, of which the best known are Generally Accepted Accounting Principles
(GAAP) and International Financial Reporting Standards (IFRS). The results shown in
financial statements can vary somewhat, depending on the framework used. The
framework that a business uses depends upon which one the recipient of the financial
statements wants. Thus, a European investor might want to see financial statements
based on IFRS, while an American investor would prefer to see statements that comply
with GAAP.

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The accountant may generate additional reports for special purposes, such as
determining the profit on sale of a product, or the revenues generated from a particular
sales region. These are usually considered to be managerial reports, rather than the
financial reports issued to outsiders.

Accounting plays a very important and useful role by developing the information for
providing answers to many questions faced by the users of accounting information. It
gives us information about how good or bad the financial condition of the business and
which activities or products has been profitable. Accounting is important for a business
entity for the following reasons: -

 Accounting record, set on the base of even practices, will assist a business to
compare results of one period with another period.

 Insulating records, backed up by proper and genuine vouchers are good


evidence in a court of law.

 Increased volume of business results in large number of transactions and no


businessman can remember everything. Accounting records avoid the necessity
of remembering various transactions

Accounting records are defined as all documentations that are involved in the
preparation of financial statements and records which are relevant to financial review
and audits and include recording of assets and liabilities, ledgers, journals, and any
other supporting documents like invoices.

Ledger: - Maintaining a ledger is a must in all accounting systems. Ledgers are used for
preparing a trial balance which checks the arithmetical accuracy of the accounting
books. Ledger is the store-house of all kinds of information being used for preparing
final accounts and financial statements.

Prime entry books: - A book or record in which certain types of transaction is recorded
before becoming part of the double-entry book-keeping system. The main books of

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prime entry consists of sales day book, purchase day book, sales return day book,
purchase return day book, general journal and cash book (Ducha, et.al, 2008).

Why do we need books of prime entry?

The ledger accounts of a business are the main source of information used to prepare
the financial statements. However, if a business were to update their ledgers each time
a transaction occurred, the ledger accounts would quickly become cluttered and errors
might be made. This would also be a very time consuming process.

To avoid this complication, all transactions are initially recorded in a book of prime entry.
This is a simple note of the transaction, the relevant customer/supplier and the amount
of the transaction. It is, in essence, a long list of daily transactions.

Different types of book

Several books of prime entry exist, each recording a different type of transaction:

Book of prime entry Transaction type

Sales day book Credit sales

Purchases day book Credit purchases

Sales returns day book Returns of goods sold on credit

Purchases returns day book Returns of goods bought on credit

Cash book All bank transactions

Petty cash book All small cash transactions

The journal All transactions not recorded elsewhere

The sum total of the day's transactions is recorded in the accounting ledgers of the
company. This is done in a 'double entry' format.

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1. The sales day book

The sales book summarizes the daily sales made on credit terms (i.e. The goods are
sold and payment is collected at a later date). It is manually-maintained in which the key
detailed information for each individual credit sale to a customer is recorded at the end
of each business day, including:

 Customer name

 Invoice number

 Invoice date

 Invoice amount

The total sales for the day of AED20,200 will be entered into the
accounting ledgers in double entry format.

2. Purchases day book

The purchase day book summarizes the daily purchases made on credit terms (i.e. The
goods are purchased and payment is made at a later date). The purchases day book is
used to keep purchasing transactions from overwhelming the general ledger, which can
be a major problem in a manual record keeping environment. The basic information
recorded in a purchases day book is as follows:

 Transaction date

 Name of the supplier

 Supplier invoice number

 Supplier invoice amount

The total purchases for the day of AED8,615 will be entered into the accounting ledgers
in double entry format.

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3. The sales returns day book

A sales return is merchandise sent back by a buyer to the seller, usually for one of
the following reasons:

 Excess quantity shipped

 Excess quantity ordered

 Defective goods

 Goods shipped too late

 Product specifications are incorrect

 Wrong items shipped

The seller records this return as a debit to a Sales Returns account and a credit to
the Accounts Receivable account; the total amount of sales returns in this account
is a deduction from the reported amount of gross sales in a period, which yields
a net sales figure. The credit to the Accounts Receivable account reduces the
amount of accounts receivable outstanding.

4. The purchases returns day book

Purchases returns book is a book in which the goods returned to suppliers are
recorded. It is also called returns outward book. Goods may be returned because they
are of the wrong kind or not up to sample or because they are damaged etc. The ruling
of this book is absolutely the same as of purchases day book. The book and entries are
made therein just the same as those made in the purchases day book.

5. The cash book

All transactions involving cash at bank are recorded in the cash book. Many businesses
have two distinct cash books: a cash payments book and a cash receipts book.

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A note of cash discounts given and received is also recorded in the cash book. This is
to facilitate the recording of discounts in both the general and accounts
payable/receivable ledgers.

It is common for businesses to use a columnar format cash book in order to analyze
types of cash payment and receipt.

6. Petty Cash book

The petty cash book is a formal summarization of petty cash expenditures, sorted
by date. In most cases, the petty cash book is an actual ledger book, rather than a
computer record. Thus, the book is part of a manual record-keeping system. There
are two primary types of entries in the petty cash book, which are a debit to record
cash received by the petty cash clerk (usually in a single block of cash at infrequent
intervals), and a large number of credits to reflect cash withdrawals from the petty
cash fund. These credits can be for such transactions as payments for meals,
flowers, office supplies, stamps, and so forth.

A somewhat more useful format is to record all debits and credits in a single
column, with a running cash balance in the column furthest to the right, as shown in
the following example. This format is an excellent way to monitor the current amount
of petty cash remaining on hand.

Sample Petty Cash Book (Running Balance)

Date Purchase/Receipt Amount Balance

4/01/xx Opening balance AED250.00 AED250.00

4/05/xx Kitchen supplies -52.80 197.20

4/08/xx Birthday cake -24.15 173.05

4/11/xx Pizza lunch -81.62 91.43

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4/14/xx Taxi fare -25.00 66.43

4/23/xx Kitchen supplies -42.00 24.43

7. The journal

The journal is a book of prime entry which records transactions which are not routine
(and not recorded in any other book of prime entry), for example:

 Year-end adjustments

o Depreciation charge for the year

o Irrecoverable debt write-off

o Record the movement in the allowance for receivables

o Accruals and prepayments

o Closing inventory

o Acquisitions and disposals of non-current assets

 Opening balances for statement of financial position items

 Correction of errors.

The journal is a clear and comprehensible way of setting out a bookkeeping double
entry that is to be made.

Presentation of a journal

A journal should be laid out in the following way:

Dr Non-current asset aedxxx

Cr Payables aedxxx

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A brief narrative should be given to explain the entry.

Task 2

1.2 Assess the importance and meaning of the fundamental accounting concepts

Accounting is the language of business and it is used to communicate financial


information. In order for that information to make sense, accounting is based on 12
fundamental concepts. These fundamental concepts then form the basis for all of the
Generally Accepted Accounting Principles (GAAP). By using these concepts as the
foundation, readers of financial statements and other accounting information do not
need to make assumptions about what the numbers mean.

Key Accounting Concepts

1. Entity
Accounts are kept for entities and not the people who own or run the
company. Even in proprietorships and partnerships, the accounts for the
business must be kept separate from those of the owner(s). Accounting
records reflect the financial activities of a specific business or
organization, not of its owners or employees
2. Money-Measurement
The accounting process records only activities that can be expressed in
monetary terms (with some exceptions). For this reason, financial
statements show only a limited picture of the business.
3. Going Concern
The business entity for which accounts are being prepared is in good
condition and will continue to be in business in the foreseeable future. This
concept implies that financial statements do not represent a company’s
worth if its assets were to be liquidated, but rather that the assets will be
used in future operations. This concept also allows businesses to spread
the cost of an asset over its expected useful life.

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4. Cost
Asset value recorded in the account books should be the actual cost paid,
and not the asset's current market value. Because the “worth” of an asset
changes over time it would be impossible to accurately record the market
value for the assets of a company. The cost concept does recognize that
assets generally depreciate in value and so accounting practice removes
the depreciation amount from the original cost, shows the value as a net
amount, and records the difference as a cost of operations.
5. Dual Aspect
This concept is the basis of the fundamental accounting equation:
Assets = Liabilities + Equity

1. Assets are what the company owns.

2. Liabilities are what the company owes to creditors against those


assets

3. Equity is the difference between the two and represents what the
company owes to its investors/owners.

All accounting transactions must keep this equation balanced so when


there is an increase on one side there must be an equal increase on the
other side or an equal decrease on the same side.

6. Objectivity
The objectivity concept states that financial statements should be based
only on verifiable evidence (invoices, receipts, bank statement, etc…),
including an audit trail. This means that accounting records will initiate
from a source document and that the information recorded is based on
fact and not personal opinion.
7. Time Period
This concept defines a specific interval of time for which an entity’s reports

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are prepared. This can be a fiscal year (Mar 1 – Feb 28), natural year (Jan
1 – Dec 31), or any other meaningful period such as a quarter or a month.
8. Conservatism
This requires understating rather than overstating revenue (income) and
expense amounts that have a degree of uncertainty. The rule is to
recognize revenue when it is reasonably certain and recognize expenses
as soon as they are reasonably possible. The reasons for accounting in
this manner are so that financial statements do not overstate the
company’s financial position. Accounting chooses to err on the side of
caution and protect investors from inflated or overly positive results.
9. Realization
Revenues are recognized when they are earned or realized. Realization is
assumed to occur when the seller receives cash or a claim to cash
(receivable) in exchange for goods or services. Any change in the market
value of an asset or liability is not recognized as a profit or loss until the
asset is sold or the liability is paid off. This concept is related to
conservatism in that revenue (income) is only recorded when it actually
occurs and not at the point in time when a contract is awarded.
10. Matching
Transactions affecting both revenues and expenses should be recognized
in the same accounting period. To avoid overstatement of income in any
one period, the matching principle requires that revenues and related
expenses be recorded in the same accounting period. .
11. Consistency
Once an entity decides on one method of reporting (i.e. Method of
accounting for inventory) it must use that same method for all subsequent
events. This ensures that differences in financial position between
reporting periods are a result of changed in the operations and not to
changes in the way items are accounted for.
12. Materiality
Accounting practice only records events that are significant enough to

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justify the usefulness of the information. Minor events may be ignored, but
the major ones should be fully disclosed. Technically, each time a sheet of
paper is used, the asset “Office supplies” is decreased by an infinitesimal
amount but that transaction is not worth accounting for.

By understanding and applying these principles we should be able to read, prepare, and
compare financial statements with clarity and accuracy. The bottom-line is that the
ethical practice of accounting mandates reporting income as accurately as possible.

Task 3

1.3 Evaluate the factors which influence the nature and structure of accounting
systems

The accounting system of each country is affected by different influential factors. As


there is a very small possibility that influential factors of two countries will be equal, they
can also be considered as generators of national specificities. The level of differences of
each influential factor between countries implicates the intensity of accounting
differences at the international level. The actuality of international accounting
harmonization issues imposes the need of consideration and detailed examination of
factors that influence the development and accounting system in one country.

As a social science, accounting is affected by the environment in which it operates, but


at the same time, it is one of the factors impacting on this same environment. This is a
fact that points to the interdependency of accounting and its environment. A country’s
accounting system is affected by a variety of historical, economic, socio – cultural,
institutional, and other non – accounting factors, so it is highly unlikely for the influential
factors of any two countries to be exactly the same. Therefore, it can be logically
assumed that the factors affecting the development of a country’s accounting system
are also the generators of special national traits and, thus, the generators of differences
between accounting systems at the international level. After all, just as countries have
different histories and political and legal order or even value systems, so will their
accounting systems have more or less differing development and operating model.

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Management accounting uses financial information to implement effective change.
Accounting numbers provide objective feedback about profitability and efficiency, and
help to identify opportunities and problem areas. To be useful, management accounting
systems must accurately reflect company activities, tracking useful information in
sufficient detail without taking more time than they're worth. Their usefulness is also
affected by managerial willingness or reluctance to try new ideas, sacrifice unsuccessful
endeavors and devote sufficient resources to ideas and trends highlighted by
managerial accounting information.

Based on classification of influential factors, several influential factors have been


explained in detail in the following section.

 Capital Market

Capital market is a market where buyers and sellers engage in trade of financial
securities like bonds, stocks, etc. The buying/selling is undertaken by participants such
as individuals and institutions.

Capital markets help channelize surplus funds from savers to institutions which then
invest them into productive use. Generally, this market trades mostly in long-term
securities.

Capital market consists of primary markets and secondary markets. Primary markets
deal with trade of new issues of stocks and other securities, whereas secondary market
deals with the exchange of existing or previously-issued securities. Another important
division in the capital market is made on the basis of the nature of security traded, i.e.
Stock market and bond market.

Business entities within different accounting systems basically rely on earned capital;
their external sources of funding, however, may differ. Therefore, depending on whether
funds are raised by issuing securities or through credit loans from financial institutions,
accounting systems can be characterized as those whose main source of funding is
either the stock market (equity-oriented) or a bank (debt-oriented) (Saudagaran, 2004,
3). In such a context, a capital market, through its attributes, impacts on a country’s

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financial reporting system. This impact primarily depends on who are the investors or
creditors (individuals, banks, a state), who are the information users and what are their
information needs, as well as how many of them there are and what is their association
to business entities. Namely, financial reports and the accounting information they hold
are an indispensable and vital source of data on the performance of business entities
regardless of the financing system and its attributes.

For example, in countries whose businesses raise funds by issuing securities, investors
see financial reports as a very important source of information about the performance of
these businesses because investors have limited access to alternative sources of
information. Hence reporting is directed towards and focused at their information need,
regardless of whether they are investors in stocks or bonds, as countries with this type
of system also have developed proprietary securities markets as well as debt securities
markets. Because of the large number of stockholders and the impossibility of
contacting each one individually, financial reports should be transparent and contain a
sufficient amount of information to indicate how a business is performing.

 Financial Reporting System

Considering a financial reporting system in the context of individual influential factor


primarily implies the existence of singular or dual, that is, separate or joint reporting for
business and taxation needs. In accounting systems in which rules are set based on
individual decisions of precedence (Koletnik, 2001, 6) (Anglo-Saxon countries), tax
reports are independent of financial reports that are external – user oriented, and are
drawn up autonomously and independently of tax regulations. It is different in countries
whose accounting systems are based on Roman law (Austria, Germany), that is, where
accounting rules are stipulated and fixed by a country’s regulations, thus leaving them
with little elasticity (Koletnik, 2001, 6). In this case, there is a single reporting system,
with minor differences existing between reporting for tax purposes and reporting for
business purposes. In other words, the association or non – association of accounting
reporting with tax and business purposes will impact on and determine the attributes of
the financial reporting system itself.

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 Legal System

The previously described influential factor implies an understanding of the legal system
as a factor in how an accounting system is created and how it operates. The legal
systems of most countries can be classified as systems marked by strict adherence to
laws and regulations (Code law; legalistic; Roman law) or as systems in which common
law (Common law; non – legalistic) is predominant.

Characteristic of an accounting system influenced by Roman law is the legalization of


accounting standards and procedures. Prescribed by a country’s regulations,
accounting rules are very detailed and comprehensive, leaving a very small margin for
interpretation and no possibility for improvising. In this type of conservative and
inadaptable system, the role of the accountant consists in literary applying prescribed
and detailed legal requirements, with special emphasis on protecting creditors.

Conversely, in accounting systems, which are under the influence of Anglo – Saxon
rules and in which rules are set based on individual decisions, accounting rules and
policies are set by professional organizations operating in the private sector. This type
of legal system is more adaptable, more innovative and more topical than the system
described above, and it focuses on transparent and timely financial reports, as well as
on the information needs and protection of investors.

 Political system, political and economic relations among countries

The political system is considered a major influential factor of accounting systems and
reporting systems alike. The impact of this factor is also evident through history, with
invading countries imposing their political, as well as their accounting system on the
countries they have conquered and colonized. It is also a fact that many countries, upon
gaining independence, have continued to use the same political and accounting system
even though it no longer suits their current needs and economic situation, whereas
others have opted for a different political and accounting system. The influence of a
political system is reflected in the strong effect of other cultures on certain countries

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because of their size (small), low level of their development or their previous colonial
status.

The influence of economic relations among countries on developing and designing an


accounting system is the result of developed international exchange. Accordingly, a
country’s accounting system can be affected by the accounting system of another
country because its geographical position makes it a neighbor, and also because the
former represents a large export market for the latter, with many of its businesses going
over to the other’s securities market (Canada and the U.S., for example).

 Quality of accounting education and the status of the accounting


profession

The quality of education in the field of accounting is often referred to as a factor in the
development and design of an accounting system. Various authors agree that this
factor, if lacking, can represent a constraining factor in accounting system development.

While the quality of accounting education is directly influenced by a society’s general


level of knowledge, it is also affected by other factors such as the status of the
accounting profession in a country, the level of economic development, economic
relations with other countries, and so on. Accordingly, accounting will not be more than
average in countries in which the general level of knowledge is low. Bringing in
accountants from advanced countries or sending accounting professionals to advanced
countries for education is not a perfect solution because advanced countries may not
have or do not have the same accounting system as less developed countries. Also,
advanced countries have a developed accounting system that is characteristic of large
and complex businesses with complex accounting problems that can only be solved by
highly qualified and skilled accounting professionals. Conversely, because smaller and
simpler forms of business entities prevail in less developed and developing countries,
the required level of accounting education and qualification is lower, and accounting is
“primitive” (Mueller, Gernon, Meek, 1987, 15).

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In addition to accounting education, the status of the accounting profession in a country
can also be observed as a factor affecting the country’s accounting system, even
though it is, at the same time, conditioned by some of the other influential factors. In
countries whose legal systems are based on code law, the accounting profession is less
important and is state-regulated, whereas in common-law countries, it is highly
appreciated, self-regulating, and plays a major role in setting accounting and auditing
standards, as well as in developing and promoting the profession itself.

 Size and complexity of business enterprises, forms of business ownership

The influences of these factors are explained mostly together and in a very similar
manner, based on the assumption that larger business enterprises also constitute
systems that are more complex. According to one opinion, it is highly likely that the level
of economic development a country has achieved will affect the number and size of
business enterprises operating in that country (Saudagaran, 2004, 6). As this means
that large business enterprises prevail in more developed countries, and small
enterprises, in developing countries, the accounting system of developed countries with
complex forms of business enterprises will differ from the accounting system of
developing countries. The head offices of large and complex businesses producing and
selling beyond the borders of their home country and generating profits greater than the
gross domestic product of less developed countries, are generally located in developed
countries. Accordingly, accounting and financial reporting will be more complex and
demanding than in less developed and developing countries, whose economies are
characterized by many smaller business enterprises with less complex operations and,
in turn, with simpler accounting coverage and monitoring, as well as financial reporting.
In other words, different accounting systems are generated.

The size and complexity of business enterprises is an argument that has multiple
implications in explaining accounting system differences. Namely, the accounting needs
of large businesses that have several different production lines and a wide variety of
products differ from the accounting needs of smaller enterprises producing, for example,
only a single product. The information needs of multinational companies are different

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from the needs of large businesses that manufacture only for the home market, and
they differ even more from the needs of small enterprises (Černe, 2007, 19).

Although business entities' ownership, as an influential factor, is affected by other


influential factors such as a country’s political system or its economic orientation, it
should also be viewed separately in order to underline the impact of various business
ownership forms resulting in different information needs, which in turn generate
differences in accounting systems prevalent in the various forms of ownership. For
example, the information needs and accounting requirements of stockholders differ from
those of small, family-run business or enterprises in the majority ownership of states or
banks.

 Level of inflation

An economy’s level of inflation can also be considered in the context of its influence on
a country’s accounting system, in particular because it affects the asset valuation
method and because, in conditions of high inflation, it is essential to have an accounting
system suited to inflationary conditions. For example, countries such as the U.S. or
Great Britain (Saudagaran, 2004, 8) in which inflation levels are mostly under control
apply the historical cost method for the needs of financial reporting. This method,
however, cannot be fully applied in countries such as Bolivia or Mexico (Saudagaran,
2004, 8), which have had or do have a high rate of inflation; instead, these countries
use different models that seek to reduce the impact of inflation on financial reporting to
obtain relevant information. In other words, accounting for inflation is required, and is
therefore more developed and pronounced in economies with high inflation levels,
consequently leading to differences in accounting systems as a result of different
inflation levels. Regardless of this, there are opinions that the level of inflation is not a
crucial influential factor in elucidating the differences between accounting systems,
although it could possibly be the cause for differences in accounting practices of those
accounting system belonging to the same category (Nobes, 1998, 175).

According to this perspective, a certain level of inflation will trigger a reaction in every
accounting system, and procedures for accounting inflation will be applied. In this, it is

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crucial to know who will react and how: will it be the professional accountants or the
state within the framework of the tax system (Černe, 2007, 20).

 Applying and enforcing legislative regulations in accounting

The accounting systems of countries differ not only by accounting regulations but also
by the degree to which current accounting regulations are applied in practice. This
factor can be viewed as being a continuation of the influence of the political and legal
systems, as well as the way in which a country has set up its accounting regulations.
Accordingly, deviations between accounting regulations and accounting practice in a
country will depend upon its degree of application assistance and degree of application
control, that is, upon its power of enforcement. For example, accounting practice will be
strongly consistent with regulations in countries in which accounting regulations are
widely controlled and rigorously enforced, but will be less consistent in countries in
which there is no supervision over how accounting regulations are enforced in practice.

 Achieved level of economic development

The development of an accounting system is conditioned by a country’s economic


development, that is, by the level of economic development it has reached. Considering
that most of the world can be divided into the rich and the poor, countries can also be
divided as “accounting “have” and “have nots” nations” (Mueller, Gernon, Meek, 1987,
15). In addition to a powerful economy, developed countries are also marked by
diversity of economic – and, in turn, financial – activities. Stockholders prevail in the
ownership structure of capital; securities markets are present and operating. Earlier it
was mentioned, when explaining the influence of the size and complexity of business
enterprises, that a country’s level of economic development also affects these
attributes. Hence, it follows that large and complex business enterprises whose
operations exceed national boundaries are the prevailing form in developed countries,
and that management is highly developed in terms of the application of complex
techniques, tools and decision-making procedures. Also, the currencies of developed
countries are more stable, and their inflation rate is lower in comparison to developing
countries On the other hand, the influence of the state is evident in developing and less

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developed countries, in particular, regarding the contents and form of financial reporting,
accounting periods, and the way profit is determined and costs are accounted. Their
financing systems are not developed relative to the systems of developed countries,
and are marked by a large number of constantly growing bank loans and a failure to
develop other financial instruments. Securities markets either do not exist or are poorly
developed. Also, accounting education in some developing countries is influenced by
the educational system of the advanced countries whose colonies they once were, and
whose accounting knowledge they have accepted and whose practice they follow. Such
countries are also marked by rather strong nationalism, with political leadership ranging
from pragmatic and fairly stable in some countries to unstable in others (Benson, 1981,
88). Finally, it could be said that the achieved level of economic development is a factor
from which several influential factors can be derived and that an accounting system
then develops and is improved in dependence of circumstances, that it, as it is adjusted
to circumstances in the environment. Hence, it is logical to assume that the accounting
system of a less developed or developing country will reflect the (less developed)
environment in which it operates.

Nevertheless, besides opinions that a country’s accounting system will begin to develop
when the factors that influence this system are developed, some authors contend that it
is the lack of expertise and legislation within the accounting system of developing
countries that is holding back their potential economic growth and development
(Mueller, Gernon, Meek, 1987, 15). Regardless of this, our opinion is that concurrent
efforts should be made to develop both the accounting system as well as the factors
that influence it, and that such interdependent action will help towards improving an
accounting system and its environment.

 Culture

In addition to knowing a country’s legal, political or financing system, it is also necessary


to know something about its culture in order to better understand the country’s
differences and its accounting practice. Even when financial reports are comprehensible
to users with regard to language, monetary unit or the accounting principles applied,

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culture should be considered as a factor that affects the development of an accounting
system. Especially interesting is the theory that links some of the structural elements or
dimensions of culture (Gray, 1998) to accounting values and systems (Gray, 1998), and
the testing of hypotheses formulated by this theory (Salter, Niswander, 1995). Among
other things, the justification of considering culture as a criterion in classifying national
accounting systems is analysed (D'Arcy, 2001).

Contrary to the model mentioned, there is the opinion that culture is not primarily an
influential factor because the use of cultural variables opens up new questions and
because the way in which culture may possibly influence an accounting system is not
completely obvious (Nobes, 1998). Nevertheless, we are of the opinion that culture can
be seen as a factor that indirectly affects those factors whose influences are more
direct, such as capital markets or financing systems. The influence of culture may also
help in studying the differences in the behavior of accountants in decision-making or the
behavior of auditors. Also, the influence of culture could be linked to the earlier
mentioned political system or colonial heritage as influential factors in countries that
were once colonies (Černe, 2007, 29). Schultz and Lopez (2001, 276) consider that
cultural differences have a crucial role in developing accounting systems, in particular,
in how accountants make personal judgements regarding evaluation and disclosure.

The results of their study that takes into account cultural elements have shown that
given similar principles, the judgement of accountants in different countries will vary).

Task 4

2.1 Identify the different components of business risk

Running a business can be a dangerous occupation with many different types of risk.
Some of these potential hazards can destroy a business, while others can cause
serious damage that can be costly and time consuming to repair. Despite the risks
implicit in doing business, ceos and/or risk management officers – no matter the size of
the business, from small to corporate giant – can prepare for them if they know what
they are.

22
If and when risk becomes reality, a well-prepared business can moderate the risk's
impact. Dollar losses, lost time and productivity and the negative impact on customers
can all be minimized.

For startup businesses and established organizations, the ability to identify which risks
pose a threat to successful operations is a key component of strategic business
planning. Business risks are identified using a myriad of methods, but each identifying
strategy relies on a comprehensive analysis of specific business activities that could
present challenges to the company. Under most business models, organizations face
preventable, strategic and external threats that can be managed through acceptance,
transfer, reduction or elimination.

Risk is inherent in any business enterprise, and good risk management is an essential
aspect of running a successful business. A company's management has varying levels
of control in regard to risk. Some risks can be directly managed; other risks are largely
beyond the control of company management. Sometimes, the best a company can do is
try to anticipate possible risks, assess the potential impact on the company's business
and be prepared with a plan to react to adverse events.

There are many ways to categorize a company's financial risks. One approach for this is
provided by separating financial risk into four broad categories: market risk, credit risk,
liquidity risk and operational risk.

1. Market Risk

Market risk involves the risk of changing conditions in the specific marketplace in which
a company competes for business. One example of market risk is the increasing
tendency of consumers to shop online. This aspect of market risk has presented
significant challenges to traditional retail businesses. Companies that have been able to
make the necessary adaptations to serve an online shopping public have thrived and
seen substantial revenue growth, while companies that have been slow to adapt or
made bad choices in their reaction to the changing marketplace have fallen by the
wayside.

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This example also relates to another element of market risk – the risk of being
outmaneuvered by competitors. In an increasingly competitive global marketplace, often
with narrowing profit margins, the most financially successful companies are most
successful in offering a unique value proposition that makes them stand out from the
crowd and gives them a solid marketplace identity.

2. Credit Risk

Credit risk is the risk businesses incur by extending credit to customers. It can also refer
to the company's own credit risk with suppliers. A business takes a financial risk when it
provides financing of purchases to its customers, due to the possibility that a customer
may default on payment.

A company must handle its own credit obligations by ensuring that it always has
sufficient cash flow to pay its accounts payable bills in a timely fashion. Otherwise,
suppliers may either stop extending credit to the company, or even stop doing business
with the company altogether.

3. Liquidity Risk

Liquidity risk includes asset liquidity and operational funding liquidity risk. Asset liquidity
refers to the relative ease with which a company can convert its assets into cash should
there be a sudden, substantial need for additional cash flow. Operational funding
liquidity is a reference to daily cash flow.

General or seasonal downturns in revenue can present a substantial risk if the company
suddenly finds itself without enough cash on hand to pay the basic expenses necessary
to continue functioning as a business. This is why cash flow management is critical to
business success – and why analysts and investors look at metrics such as free cash
flow when evaluating companies as an equity investment.

4. Operational Risk

Operational risks refer to the various risks that can arise from a company's ordinary
business activities. The operational risk category includes lawsuits, fraud risk, personnel
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problems and business model risk, which is the risk that a company's models of
marketing and growth plans, may prove to be inaccurate or inadequate.

These risks are often interdependent on each other which makes the company more
vulnerable. For instance, exchange rates and interest rates are strongly linked to each
other. The co-dependency of these risks should be taken under account while
structuring the framework of Investment and Financial Risk Management. Financial risk
management aims to protect the firm from these risks by using several financial
instruments. It can be quantitative and qualitative both. Investment and Financial Risk
Management subject involves managing the relationship between internal aspects of
financial institutions and the external factors that influences the investment. Also, it
deals in modern financial markets. Investment and Financial Risk Management proffers
foundational understanding about underpin modern investment and risk management
techniques. Financial Risk Management Methods and Techniques: A firm needs to
understand the intensity and types of potential risks it is prone to. Finance managers
are supposed to thoroughly analyze the situation and they’ve to choose the most apt
approach or process or method to check that financial risk.

1. Regression Analysis – This approach is used to study the effect on one variable
when the other one changes. Let’s say for instance what changes will cash inflow
encounter when rate of interest increases or decreases.

2. Value at Risk (var) – Another popular approach in measuring and checking the
financial risk is var analysis. Var is measured with respect to the amount of potential
loss, the probability of that amount of loss, and the time frame. For example, a financial
firm is exposed to 5 per cent one month value at risk of INR 50,000. This implies that
there is a 5 per cent chance that the firm has to bear a loss of INR 50,000 in any given
month. Let’s understand this concept with another example. Suppose another firm owns
an investment portfolio on which they determine the var to be INR 100,000, at a 50 per
cent confidence level over a 40 day holding period. Now, if no investments are infused
or sold over within 40 days then there is a 50 per cent chance that the firm might lose

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out INR 100,000. Var is estimate of the possible maximum loss. Actual losses may be
above or below the estimated value.

3. Security Analysis – Analysis of tradable financial instruments like debts (money


borrowed from market), equities (owner’s fund), mixture of these two and warrants of
company is known as security analysis. Sometimes futures contracts and tradable credit
derivatives are also included. Security analysis is further sub-categorized into
fundamental analysis, which works in accordance to different fundamental business
factors such as financial statements, and technical analysis, which focuses upon price
trends and momentum.

4. Scenario Analysis – Scenario analysis is another useful approach in quantifying risks.


It is also known by stress tests, sensitivity tests, or ‘what if?’ analyses. Financial
managers create more than one scenario and ask ‘what if’ this situation was to occur?
For example: What if the stock market crashed by 38 per cent? What if interest rates
were to rise by 100 basis points? What if the exchange rate were to rise by 40 per cent?
What if an important client were to leave the firm? Now, the results of these hypothetical
scenario analyses are converted into a risk measure by assuming the risk exposure
based on the calculations and maximum loss predicted is assumed to be the worst case
scenario.

2.2 Analyze the control systems in place in a business

Any financial performance process becomes meaningless if a strategy to control it is not


defined and implemented based on objectives consistent with the current state of the
company and its upcoming projects.

Financial control has now become an essential part of any company's finances. Hence,
it is very important to understand the meaning of financial control, its objectives and
benefits, and the steps that must be taken if it is to be implementing correctly.

Financial control may be construed as the analysis of a company's actual results,


approached from different perspectives at different times, compared to its short,
medium and long-term objectives and business plans.

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These analyses require control and adjustment processes to ensure that business plans
are being followed and that they can be amended in the event of anomalies,
irregularities or unforeseen changes.

Objectives and benefits

1. Checking that everything is running on the right lines

Sometimes, financial control just checks that everything is running well and that the
levels set and objectives proposed at the financial level regarding sales, earnings,
surpluses, etc., are being met without any significant alterations. The company thus
becomes more secure and confident; it’s operating standards and decision-making
processes being stronger.

2. Detecting errors or areas for improvement

An irregularity in the company finances may jeopardize the achievement of an


organization's general goals, causing it to lose ground to its competitors and in some
cases compromising its very survival. Therefore, it is important to detect irregularities
quickly.

Various areas and circuits may also be identified which while not afflicted by serious
flaws or anomalies could be improved for the general good of the company.

Implementation strategies

Financial control must be designed on the basis of very well defined strategies if the
directors of the companies are to be able to:

 Detect anomalies in budgets, balance sheets and other financial aspects.


 Establish different operational scenarios putting profitability, sales volume and
other parameters to the test.

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Although there are many different types and methodologies, a very common set of
steps can be distinguished in the vast majority of financial control implementation
strategies.

STEP 1. Analysis of the initial situation

The first step is to conduct an exhaustive, reliable and detailed analysis of the
company’s situation across various areas: cash, profitability, sales, etc.

STEP 2. Preparation of forecasts and simulations

On the basis of the initial situation analyzed above and the establishment of a set of
parameters or indicators, a set of forecasts and simulations of different contexts and
scenarios can be prepared.

2.3 Evaluate the risk of fraud within a business suggesting methods for detection

Employee fraud is a significant problem faced by organizations of all types, sizes,


locations and industries. While we would all like to believe our employees are loyal and
working for the benefit of the organization (and most of them probably are), there are
still many reasons why your employees may commit fraud and several ways in which
they might do it. According to the 2014 Report to the Nation on Occupational Fraud and
Abuse (copyright 2014 by the Association of Certified Fraud Examiners, Inc.), research
shows that the typical organization loses 5% of its annual revenue each year due to
employee fraud. Prevention and detection are crucial to reducing this loss. Every
organization should have a plan in place as preventing fraud is much easier than
recovering your losses after a fraud has been committed.

Types of Fraud

Fraud comes in many forms but can be broken down into three categories: asset
misappropriation, corruption and financial statement fraud. Asset misappropriation,
although least costly, made up 90% of all fraud cases studied. These are schemes in
which an employee steals or exploits its organization’s resources. Examples of asset

28
misappropriation are stealing cash before or after it’s been recorded, making a fictitious
expense reimbursement claim and/or stealing non-cash assets of the organization.

Financial statement fraud comprised less than five percent of cases but caused the
most median loss. These are schemes that involve omitting or intentionally misstating
information in the company’s financial reports. This can be in the form of fictitious
revenues, hidden liabilities or inflated assets.

Corruption fell in the middle and made up less than one-third of cases. Corruption
schemes happen when employees use their influence in business transactions for their
own benefit while violating their duty to the employer. Examples of corruption are
bribery, extortion and conflict of interest.

Control Systems

Internal control considered as a process of influencing organization structure, its work,


organization’s flows, people of the organization, and MIS (Management Information
Systems) (Oldroyd, David & Dobie, Alisdair, 2008). It is a way of reducing fraud in the
organization that makes the audit report suspicious. It is a process of detecting and
protecting the wrong doings.

Risks of Fraud

In the organization, the company may create its fraud. If a company makes any unlawful
works with its financial records then it will be considered as fraud. It is an intentional
unlawful work which is also considered as crime (Friedlob, Thomas & Plewa, James,
1996). The intentional unlawful works will be detected if the auditors are efficient to its
activities. The activities of auditors are the risks of fraud. As a manager will be higher
efficient the risks of fraud will be greater. The characteristics of efficient auditors and the
risks of fraud are as follows:

 The individual Authorization,


 Exact Book Keeping,
 Having Authority of Transaction,

29
 Retaining Records,
 Operating Supervision,
 Monitoring Auditors,
 Information Technology Security
 Top Level Security.
 Controlling over IT processing.

Fraud Prevention

It is vital to an organization, large or small, to have fraud prevention plan in place. The
fraud cases studied in the ACFE 2014 Report revealed that the fraudulent activities
studied lasted an average of 18 months before being detected. Imagine the type of loss
your company could suffer with an employee committing fraud for a year and a half.
Luckily, there are ways you can minimize fraud occurrences by implementing different
procedures and controls.

1. Know Your Employees

Fraud perpetrators often display behavioral traits that can indicate the intention to
commit fraud. Observing and listening to employees can help you identify potential
fraud risk. It is important for management to be involved with their employees and take
time to get to know them. Often, an attitude change can clue you in to a risk. This can
also reveal internal issues that need to be addressed. For example, if an employee feels
a lack of appreciation from the business owner or anger at their boss, this could lead
him or her to commit fraud as a way of revenge. Any attitude change should cause you
to pay close attention to that employee. This may not only minimize a loss from fraud,
but can make the organization a better, more efficient place with happier employees.
Listening to employees may also reveal other clues. Consider an employee who has
worked for your company for 15 years that is now working 65 hours a week instead of
40 because two co-workers were laid off. A discussion with the employee reveals that in
addition to his new, heavier workload, his brother lost his job and his family has moved
into the employee’s house. This could be a signal of a potential fraud risk. Very often

30
and unfortunately, it’s the employee you least expect that commits the crime. It is
imperative to know your employees and engage them in conversation.

2. Make Employees Aware/Set up Reporting System

Awareness affects all employees. Everyone within the organization should be aware of
the fraud risk policy including types of fraud and the consequences associated with
them. Those who are planning to commit fraud will know that management is watching
and will hopefully be deterred by this. Honest employees who are not tempted to
commit fraud will also be made aware of possible signs of fraud or theft. These
employees are assets in the fight against fraud. According to the ACFE 2014 Report,
most occupational fraud (over 40%) is detected because of a tip. While most tips come
from employees of the organization, other important sources of tips are customers,
vendors, competitors and acquaintances of the fraudster. Since many employees are
hesitant to report incidents to their employers, consider setting up an anonymous
reporting system. Employees can report fraudulent activity through a website keeping
their identity safe or by using a tip hotline.

3. Implement Internal Controls

Internal controls are the plans and/or programs implemented to safeguard your
company’s assets, ensure the integrity of its accounting records, and deter and detect
fraud and theft. Segregation of duties is an important component of internal control that
can reduce the risk of fraud from occurring. For example, a retail store has one cash
register employee, one salesperson, and one manager. The cash and check register
receipts should be tallied by one employee while another prepares the deposit slip and
the third brings the deposit to the bank. This can help reveal any discrepancies in the
collections.

Documentation is another internal control that can help reduce fraud. Consider the
example above; if sales receipts and preparation of the bank deposit are documented in
the books, the business owner can look at the documentation daily or weekly to verify
that the receipts were deposited into the bank. In addition, make sure all checks,

31
purchase orders and invoices are numbered consecutively. Use “for deposit only”
stamps on all incoming checks, require two signatures on checks above a specified
dollar amount and avoid using a signature stamp. Also, be alert to new vendors as
billing-scheme embezzler’s setup and make payments to fictitious vendors, usually
mailed to a P.O. Box.

Internal control programs should be monitored and revised on a consistent basis to


ensure they are effective and current with technological and other advances. If you do
not have an internal control process or fraud prevention program in place, then you
should hire a professional with experience in this area. An expert will analyze the
company’s policies and procedures, recommend appropriate programs and assist with
implementation.

4. Monitor Vacation Balances

You might be impressed by the employees who haven’t missed a day of work in years.
While these may sound like loyal employees, it could be a sign that these employees
have something to hide and are worried that someone will detect their fraud if they were
out of the office for a period of time. It is also a good idea to rotate employees to various
jobs within a company. This may also reveal fraudulent activity as it allows a second
employee to review the activities of the first.

5. Hire Experts

Certified Fraud Examiners (CFE), Certified Public Accountants (CPA) and cpas who are
Certified in Financial Forensics (CFF) can help you in establishing antifraud policies and
procedures. These professionals can provide a wide range of services from complete
internal control audits and forensic analysis to general and basic consultations.

6. Live the Corporate Culture

A positive work environment can prevent employee fraud and theft. There should be a
clear organizational structure, written policies and procedures and fair employment
practices. An open-door policy can also provide a great fraud prevention system as it

32
gives employees open lines of communication with management. Business owners and
senior management should lead by example and hold every employee accountable for
their actions, regardless of position.

Fraud Detection

In addition to prevention strategies, you should also have detection methods in place
and make them visible to the employees. According to Managing the Business Risk of
Fraud: A Practical Guide, published by Association of Certified Fraud Examiners
(ACFE), the visibility of these controls acts as one of the best deterrents to fraudulent
behavior. It is important to continuously monitor and update your fraud detection
strategies to ensure they are effective. Detection plans usually occur during the
regularly scheduled business day. These plans take external information into
consideration to link with internal data. The results of your fraud detection plans should
enhance your prevention controls. It is important to document your fraud detection
strategies including the individuals or teams responsible for each task. Once the final
fraud detection plan has been finalized, all employees should be made aware of the
plan and how it will be implemented. Communicating this to employees is a prevention
method in itself. Knowing the company is watching and will take disciplinary action can
hinder employees’ plans to commit fraud.

Task 5,6,7,8

What Is a Financial Audit?

A financial audit is the investigation of a business’ financial statements and


accompanying documentation and processes, and is performed by someone who is
independent of the organization. These annual events probe a company’s financial
position: They look at the accounting records, internal control policies, and accounts in
accordance with industry-accepted accounting standards. This process can look and
feel as if someone is scrutinizing the sensitive files, searching for errors and
misstatements. However, financial auditors use this process to assure the stakeholders
(and any interested outsiders) of the company’s financial position. They give them

33
reasonable assurance and they give the company’s financial documentation more
value. Other reasons to conduct an audit include to verify that you are in compliance
with regulatory agencies, and to protect the company from the risk of fraudulent
financial practices.

Independent financial auditors are people who are not on the payroll of the company
and do not have a stake in the outcome. At the conclusion of an audit, they render their
opinion on the integrity of the documentation. Financial auditors can perform an external
or an internal audit for you, but they must not have a stake in your company.

While external audits assess financial risks and statements, internal audits go further
and consider the business’ growth, impact to the environment, employee culture, and
reputation. Internal auditors report to the board and senior management within the
governance structure and, instead of just providing reasonable assurance to your
stakeholders and outsiders, they offer ways to improve the company overall. Performing
regular internal audits also shows the external auditors that the company has a means
to improve the internal controls and thereby manage the organization effectively.

There are many different types of checklists available for financial audits. Whether you
are an auditor, or you own a company and want to prepare for an audit, using a
checklist is a very good way to get ready.

Financial audit preparation checklist

Auditor: Kinza Anjum

General ledger

Year-end trial balance and financial statements broken down by net asset class

Schedule of federal awards showing federal awarding agency, pass through agency,
and grant number, program name, cfda number, award amount, current year

34
expenses, and prior year expenses.

Grant agreements for those grants expired or expiring.

List of board of directors for the fiscal year.

List of members of the audit committee, if applicable, or oversight board for the audit.

Minutes of meetings of the board of directors and committees, including summary of


any board actions that affect the designated and undesignated fund balances.

Personnel manual.

Accounting policies and procedures manual.

Lease agreements.

Year-end payroll tax reports, forms w-2, w-3, and 1099’s issued during the calendar
year

Outside payroll service report for the fiscal or calendar year end

Fiscal year budget.

Detailed list of donations of goods and services, including the number of hours on
donated services.

Detail of legal fees paid, with the name and address of all attorneys used throughout
the year.

35
Detail of repairs and maintenance account

All paid bills, bank statements and grant reports for the year.

Year-end bank reconciliation and bank statements

Bank reconciliation should have a complete list of outstanding checks with check
number, date, and amount.

Detail of deposits in transit should also be listed.

Year-end investment summary showing year-to-date transactions and balance of


investments held at year-end at fair market value (fmv) and original cost (fmv at date
of donation).

Documentation of donations of marketable securities.

List of unconditional promises to give and underlying documentation.

List of grant funds received and receivable, including grant award numbers and
funding sources. Extended physical inventory of items held for resale.

Fixed asset and depreciation schedule, including copies of any documentation


relating to donated fixed assets.

Reconciliation to support any other asset accounts.

List of year-end accounts payable and accrued expenses such as payroll tax payable
and accrued compensated absences

36
Schedule of changes in notes payable and copies of the notes.

Reconciliation of deferred grant revenue and refundable advances.

Reconciliation of net assets classifications.

Audit Report Attached in PDF

CONCLUSION

The overall report has been designed to focus my understanding on the whole course
material of financial systems and auditing. The task one is designed on the basis of
understanding different accounting records, the fundamental accounting concepts, the
factors of influence in the accounting systems. The components of business risk make
me able to analyze the business of a one country. The fraud within the business risk
makes the company unprofitable or may influence to go behind. The control and audit
basically supports the accounting standards and principles. The accounting principles
and concepts are used in making financial reports and statements. Organization need to
follow the accounting principle in line with the accounting standards (IMF, 2011). The
audit report is made on the basis of the auditing standards of the organization. Finally
this report has focused on the basic principles, concepts, of accounting which finds the
way to evaluate the financial statements through the audit report in line with the audit
standards which are followed by organizations or corporations within a country.

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