Week 5 Notes
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This 6 page Class Notes was uploaded by Natasha Harvey on Friday February 13, 2015. The Class Notes belongs to BUS-A100 at Indiana University taught by Vivian Winston in Spring2015. Since its upload, it has received 38 views. For similar materials see Basic Accounting Skills in Business at Indiana University.
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Date Created: 02/13/15
21015 02122015 Internal Controls amp Auditing 0 Financial Audit To carry out a thorough examination of an entity s books and records nancial accounts and policies and procedures 0 Performed by external auditors who are certi ed public accountants CPA s o Auditors must rely on the company s internal controls 0 Internal Controls Procedures or systems which are designed to 1 Control environment The quotTone at the topquot Management must set an ethical tone for its employees 2 Risk assessment The company must realize the risks it faces and take steps to control the risks 3 Control activities The company must establish procedures amp policies to protect its assets 4 Information amp communication The policies amp procedures must be communicated to employees 5 Monitoring There must be continual follow up to see how the procedures are working and to make any necessary modi cations Promote ef ciency Safeguard assets Avoid fraud and errors Keep accounting data accurate 0 SEC Securities and Exchange Commission 0 Created in 1933 during Great Depression 0 Companies publicly offering securities for investment dollars must tell the public the truth about their businesses the securities they are selling and the risks involved in investing o Auditing Terms 0 Sampling Using a random subset of the population in order to form an opinion on the population as a whole 0 Audit evidence Information gathered by the auditors for their analysis and evaluation o Materiality Refers to the size of an error in the nancial statements An error or omission in the nancial statements is considered material if it is signi cant enough as to make it probable that the decision of a reasonable person would be impacted by the error or omission SarbanesOxley Sarbox Established quotPublic Company Accounting Oversight Boardquot PCAOB 0 Under SEC 0 To oversee the auditing of publiclyheld companies 0 Implications for auditors 7year workpaper retention Second partner review quotQuality reviewquot by PCAOB every year of the auditors Can t provide consulting services to audit clients Report to the audit committee Lead auditor must rotate every 5 years Oneyear wait before auditor can go to work for client 0 Implications for companies Audit committee a Oversight of internal audit n Independent amp one must have nancial expertise In Hires amp receives report from independent auditors Limits on loans made to executives Section 404 internal control audit required Section 302 holds management responsible Public accounting rms provide o Assurance services Independent professional services that improve information quality Ex Audits of nancial statements audits of internal controls 0 NonAssurance services Independent professional services that improve information quality Ex Tax preparation amp planning Fraud investigations Information technology consulting Auditors 0 Compilation review or audit 0 With an audit an opinion is given Unmodi ed opinion Quali ed opinion Adverse opinion Disclaimer of opinion Business Taxes Taxable Entities o Corporations A business which is incorporated It is a separate entity from its owners The corporation les a tax return and is required to pay corporate tax The income of regular corporations is subject to double taxation 1 Tax is paid on taxable income at the corporate level 2 When the corporation pays dividends these are not deductible to the corporation but are taxable income to the stockholders Advantage Potential loss to the stockholders is usually limited to the amount invested Disadvantage The income earned by these corporations is subject to double taxation Flowthrough Entities 0 Limited liability company LLC s A business which has elected to be treated as an association having some of the characteristics of a corporation and some of either a proprietorship or partnership Primary characteristic LLC s share with corporations is a limited liability Primary characteristic LLC s share with proprietorships or partnerships is owthrough taxation Advantage Potential loss to the investors is usually limited to the amount invested Disadvantage Not as standardized as corporations requirements differ in various states 0 S Corporations A business which has incorporated and has chosen to be taxed as a partnership It is a separate entity from the owners The S Corporation les a tax return but does not pay tax All net income ows through to the owners to pay taxes on their individual returns Owners pay tax on the taxable income of the business NOT the amount of cash withdrawn Advantage Potential loss to the stockholders is usually limited to the amount invested Disadvantage Only some closelyheld corporations meet quali cations to elect quotSquot status 0 Partnerships Owned by two or more parties and the business is not incorporated Considered a separate entity from the owners The partnership les a tax return but does not pay tax Income ows through to the owners to pay taxes on their individual returns Owners pay tax on the taxable income of the business NOT the amount of cash withdrawn Advantage easy to establish Disadvantage all liabilities of the business are considered liabilities of the owner 0 Proprietorships Owned by one individual and the business is not incorporated Not considered a separate entity from the owner All net income ows through to the owner to pay taxes on hisher individual return Owner pays tax on the taxable income of the business NOT the amount of cash withdrawn Advantage easy to establish Disadvantage all liabilities of the business are considered liabilities of the owner 0 Tax Terminology 0 Tax avoidance Legally structuring transactions to reduce tax you owe Ex Structuring your business in a legal manner that limits your liability 0 Tax evasion Using illegal means to avoid tax liability Ex Claiming illegal deductions o The Tax Formula Gross income realized Exclusions Gross income recognized for tax purposes Deductions Taxable income Go to IRS Tax Schedules to determine Regular income tax expense before credits Tax credits Total tax expense 0 Gross Income Realized The revenue realized from transactions This includes revenue from amounts such as sales fees charged and interest income Exclusions Revenue that is included in accounting income but is not taxable An example of an exclusion is interest received on municipal bonds 0 Gross Income Recognized for Tax Purposes Revenue after exclusions have been subtracted out This is the revenue that is required to be reported for tax purposes Deductions Amounts that are allowed by tax law to be subtracted from gross income to determine taxable income Most expenses of operating a business are deductible The following are not 0 Federal income tax 0 Penalties 0 Entertainment expenses 50 deductible o Taxable Income The amount on which the tax will be computed Regular income ta expense before credits The amount determined when the IRS Tax Schedules are applied to the company s taxable income 0 Tax Credits Credits reduce tax expense dollar for dollar 0 They are a direct reduction of tax owed and because of this credits are more valuable than deductions Total tax expense The amount of tax owed for a year 0 Cash Flow Estimates How much cash will the company get to KEEP o This is often used when analyzing investments 0 Can be determined before tax or after tax 0 BeforeTax Cash Flow Approx how much cash will an investment generate before paying tax on the income Net income before taxes Depreciation Cash ow before taxes 0 AfterTax Cash Flow Approx how much cash will an investment generate after paying tax on the income Net income before taxes x 1 tax rate Net income after taxes Depreciation Cash ows after taxes 0 Marginal Tax Rate The tax rate at which your next dollar of income would be taxed o This is useful information in deciding whether or not the invest in a project and is helpful in determining the investment s aftertax cash ow