Interest rates

interest rates

Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds.

An interest rate is the rate at which interest is paid by a borrower (debtor) for the use of money that they borrow from a lender (creditor). Specifically, the interest rate (I/m) is a percent of principal (P) paid a certain amount of times (m) per period (usually quoted per annum). For example, a small company borrows capital from a bank to buy new assets for its business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower. Interest rates are normally expressed as a percentage of the principal for a period of one year

REASONS WHY INTEREST RATES CHANGES

• Political short-term gain: Lowering interest rates can give the economy a short-run boost. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation. The quick boost can influence elections. Most economists advocate independent central banks to limit the influence of politics on interest rates.
• Deferred consumption: When money is loaned the lender delays spending the money on consumption goods. Since according to time preference theory people prefer goods now to goods later, in a free market there will be a positive interest rate.
• Inflationary expectations: Most economies generally exhibit inflation, meaning a given amount of money buys fewer goods in the future than it will now. The borrower needs to compensate the lender for this.
• Alternative investments: The lender has a choice between using his money in different investments. If he chooses one, he forgoes the returns from all the others. Different investments effectively compete for funds.
• Risks of investment: There is always a risk that the borrower will go bankrupt, abscond, die, or otherwise default on the loan. This means that a lender generally charges a risk premium to ensure that, across his investments, he is compensated for those that fail.
• Liquidity preference: People prefer to have their resources available in a form that can immediately be exchanged, rather than a form that takes time to realize.
• Taxes: Because some of the gains from interest may be subject to taxes, the lender may insist on a higher rate to make up for this loss.

Types of Interest Available for Business Loans

 

Few businesses are able to make major purchases without taking out loans. Businesses must pay interest, a percentage of the amount loaned, to whoever loans them the money, whether loans are for vehicles, buildings, or other business needs.

Some businesses loan their own money and receive interest payments as income. In fact, a savings account can be considered a type of loan because by placing your money in the account, you’re giving the bank the opportunity to loan that money to others. So the bank pays you for the use of your money by paying interest, which is a type of income for your company.

The financial institution that has your money will likely combine your money with that of other depositors and loan it out to other people to make more interest than it’s paying you. That’s why when the interest rates you have to pay on loans are low, the interest rates you can earn on savings are even lower.

Banks actually use two types of interest calculations:

·         Simple interest is calculated only on the principal amount of the loan.

·         Compound interest is calculated on the principal and on interest earned.

Simple interest

Simple interest is simple to calculate. Here’s the formula for calculating simple interest:

Principal × interest rate × n = interest

To show you how interest is calculated, assume that someone deposited $10,000 in the bank in a money market account earning 3 percent (0.03) interest for 3 years. So, the interest earned over 3 years is $10,000 × .03 × 3 = $900.

Compound interest

Compound interest is computed on both the principal and any interest earned. You must calculate the interest each year and add it to the balance before you can calculate the next year’s interest payment, which will be based on both the principal and interest earned.

Here’s how you would calculate compound interest:

Principal × interest rate = interest for Year One

(Principal + interest earned) × interest rate = interest for Year Two

(Principal + interest earned) × interest rate = interest for Year Three

You repeat this calculation for all years of the deposit or loan. The one exception could be with a loan. If you pay the total interest due each month or year (depending on when your payments are due), there would be no interest to compound.

When working with large sums or high interest rates for long periods of time, compound interest can make a big difference in how much you earn or how much you pay on a loan.

Ideally, you want to find a savings account, certificate deposit, or other savings instrument that earns compound interest. But, if you want to borrow money, look for a simple interest loan.

Not all accounts that earn compound interest are created equally. Watch carefully to see how frequently the interest is compounded. If you can find an account where interest is compounded monthly, the interest you earn will be even higher.

Monthly compounding means that interest earned will be calculated each month and added to the principle each month before calculating the next month’s interest, which results in a lot more interest than a bank that compounds interest just once a year.

Market interest rates

There is a market for investments which ultimately includes the money market, bond market, stock market, and currency market as well as retail financial institutions like banks.

Exactly how these markets function are sometimes complicated. However, economists generally agree that the interest rates yielded by any investment take into account:

• The risk-free cost of capital
• Inflationary expectations
• The level of risk in the investment
• The costs of the transaction

This rate incorporates the deferred consumption and alternative investments elements of interest

Real vs nominal interest rates

Further information: Fisher equation

The nominal interest rate is the amount, in percentage terms, of interest payable.

For example, suppose a household deposits $100 with a bank for 1 year and they receive interest of $10. At the end of the year their balance is $110. In this case, the nominal interest rate is 10% per annum.

The real interest rate, which measures the purchasing power of interest receipts, is calculated by adjusting the nominal rate charged to take inflation into account.

If inflation in the economy has been 10% in the year, then the $110 in the account at the end of the year buys the same amount as the $100 did a year ago. The real interest rate, in this case, is zero.

After the fact, the 'realized' real interest rate, which has actually occurred, is given by the Fisher equation,

outsourcing

The role of the internal auditor

Your internal auditor must take a systematic and risk-based approach to evaluation to:

• meet your strategic business goals
• ensure the integrity of financial and operational information
• protect your assets
• comply with local laws and regulations
• assess any risk of fraud.

The case for outsourcing

While there is a clear need for internal audit, you need to decide whether to create your own internal audit function or use the services of an external consultancy.

For the typical small and medium-sized enterprise there are clear benefits to outsourcing.

• You can focus your attention on your core business activities – the activities that make you money.
• You will find it easier to buy in the services of an expert than it is to recruit and employ an expert.
• Specialist consultancy firms can give you the range of skills that you won’t find in one person. For example, you may not only need an accountant but also an information technology or human resources expert.
• When you employ a specialist you create a reliance on that person. When that person leaves, you suffer disruption to your business while you try to replace that expertise. This is not an issue when you outsource as each consultant works to a common process.
• Employing someone with the experience and qualifications to perform an internal audit role is expensive. If you try to recruit cheaply you will get someone who is poorly qualified; this may cost you in the future. There is a clear cost-benefit argument for outsourcing.
• When you outsource you ensure independence and objectivity.
• You can monitor easily your relationship with your consultant through confidentiality and service-level agreements.

Development of standards

Standard-setting has developed at a pace in recent years and will no doubt continue to do so in the future.

The Institute of Internal Auditors (IIA) – the international professional body – laid down the first standards in 1978. These were reviewed and updated in 1998. In doing so, the IIA redefined the role of an internal auditor, introduced a code of ethics, created international standards and incorporated earlier guidelines.

You can expect the internal audit arena to continue to develop and evolve in the future. This strengthens further the case for outsourcing as you can be confident you are using up-to-date expertise.

Regulation

Financial scandals such as Enron increased the need for robust regulation. One of the most important developments was the Sarbanes-Oxley Act, the requirements of which all companies listed on the US stock exchange have to meet.

This US law was designed to protect stakeholders in listed companies by improving the accuracy of corporate disclosures and deterring corporate and accounting fraud.

Among other things, the Act introduced the idea of the audit committee to oversee corporate financial reporting, established mandatory registration of auditors of listed companies, defined conflicts of interest, prohibited external auditors from providing certain services, and introduced a system of periodic rotation of auditors.

The Act also imposed on management the legal responsibility for the content of the financial report and for maintaining a system of controls to discourage fraud.

Although Sarbanes-Oxley only applies to companies listed on the US stock exchange, many companies are adopting its requirements in the spirit of good governance. Several countries around the world have developed legislation that has its roots in Sarbanes-Oxley.

Information technology (IT) risk

In recent decades, business reliance on IT has increased out of all proportion. It is essential that your corporate governance addresses and manages your IT risk, and there are steps you can take to do this.

• Review your IT service level agreement and check that it meets the needs of your business.
• Ensure your IT operates in a secure area, is reliable, and confidentiality and integrity are not compromised.
• Make sure you provide adequate training and support to users.
• React to issues and solve them as they arise.
• Review your business continuity and other contingency plans to ensure they are robust and up to date.

The IIA’s international standards contain specific guidance on evaluating IT risk and provide a methodical approach to doing so.

In summary, outsourcing your internal audit provides you with a highly specialised, systematic approach to a task that carries the utmost importance to the success of your business. For the small and medium-sized enterprise there is also a clear cost-benefit advantage to outsourcing.

Audit Types

An audit can usually be classified into one of the following categories:
Operational Audit

·  Examines an operating process to determine if resources are being used in the most efficient and effective way to meet the unit's mission and objectives

·  Internal control reviews are a major portion of an operational audit

·  Activities such as cash handling, procurement, equipment inventories, and human resources services are generally subject to this type of audit

Financial Audit

·  Reviews accounting and financial transactions to determine if commitments, authorization, receipt, and disbursement of funds are properly and accurately recorded and reported

·  Determines if there are sufficient controls over cash and other assets and if adequate process controls exist for the acquisition and use of resources

Compliance Audit

·  Determines if departments are complying with applicable Federal or State laws, NCAA and OSHA regulations, and University policies and procedures

·  Recommendations from these audits usually require improvements in processes and controls used to ensure compliance with regulations

Information Systems Audit

·  Reviews the internal control environment of automated information processing systems and how people use these systems

·  Evaluates system input and output processing controls, backup and recovery plans, system security, and computer facilities

Investigative Audit

·  May result from findings during a routine audit or from information received from personnel

·  Audits are specialized and tailored to the circumstances and can include investigation of alleged violations of laws, regulations, or University policy.

 

Auditing

Quality control policies and procedures in an auditing environment

To fully appreciate the need for the existence of quality control policies and procedures in an audit firm, there  should focus on the assertion that auditing is a commercial activity. As such, in order to achieve the objective of (at least) maintaining the profitability of an audit firm, the audit partners need to: make best use of the resources of the firm; maintain a good level of service and quality of advice to clients; minimise the risk of litigation against the firm arising from the poor performance of an audit; From careful analysis of the above points, it is reasonable to conclude that, as a commercial organisation an audit firm should operate clearly defined quality control policies. These policies should ensure that the firm’s day to day procedures meet the needs identified above and so help to ensure the continued profitability of the firm. Quality control policies and procedure should be considered at two levels. First, at the level of the audit firm and second at the level of individual audits. (a) Audit firm Policies and procedures instigated at this level should ensure that all audits are properly conducted in accordance with accepted best practice. They should include the following matters: professional requirements, including adherence to professional ethics; skills and competence of personnel; acceptance and retention of clients; assignment of audit work; delegation of audit work, comprising direction, supervision and review of work; consultation within and outside the audit firm; monitoring of all quality control policies and procedures. Whilst a detailed explanation of the points relevant to each of the above matters is outside the scope of this article, I would strongly advise students to enhance their knowledge of them by further reading. From my experience, students of auditing often have difficulty in identifying procedures relevant to the headings (i) to (vii) above, but given the importance of them, students should have this knowledge. (b) Individual audits It is vital that appropriate quality control procedures are applied to each audit assignment. Further, any work delegated to assistants should be directed, supervised and reviewed in a manner which provides reasonable assurance that such work is performed competently. The direction of assistants, supervision and review are important aspects of quality control and I would recommend that students should carry out further reading to ensure they have a sound understanding of them. The aspects of direction and supervision seem to be more easily understood by students who appear to be more at ease when confronted with questions about them, as compared to questions about review of audit work. For this reason I shall not expand further on the aspects of direction and supervision. The review of audit work forms an integral part of the audit process. Students should recognise that the term ‘review’ as applied to the work of assistants, normally describes the process whereby audit working papers are subject to a detailed check. The detailed check preferably carried out by an audit manager or partner, should seek to ensure that: the work has been performed in accordance with the audit programme; the work performed and the results obtained have been adequately documented; any significant audit matters have been resolved or are reflected in audit conclusions; the objectives of the audit procedures have been achieved; and the conclusions expressed are consistent with the results of the work performed and support the audit opinion. Finally, students will be aware that audit assignments are often carried out by auditors who trade as sole practitioners without any assistance. In such circumstances, arrangements should exist for their audit work to be independently reviewed by, for example, another sole practitioner. The assurances sought from such a review should be identical to those listed above.

Importance Generally Accepted Auditing Standards

The main importance of generally accepted auditing standards is that the standards are used to determine the quality of how audits are performed. They also give a set of standards that all audits should follow. The standards consist of the standards of fieldwork and standards of reporting

Definition of 'Assurance Services'

A type of professional service usually provided by CPAs. Assurance services can include review of any kind of financial document or transaction, such as a loan, contract or financial website. This review certifies the correctness and validity of the item being reviewed by the CPA.

Assurance services can come in variety of forms and are meant to provide the firm contracting the CPA with pertinant information in order to ease decision making. For example, the client could request that the CPA carefully go over all of the numbers and math that are on the client's mortgage website to ensure that all of the calculations and equations are correct.

GAAS (Generally Accepted Auditing Standards)

The acronym GAAS stands for ‘Generally Accepted Auditing Standards’ and describes a set of formal and informal rules (that can be written or unwritten) acknowledged as the basis for auditors to conduct their work and have the quality of their work assessed by. These include, legislation, pronouncements from professional or standard setting bodies, legal judgements in cases involving auditors and practitioners ‘internal’ standards that are accepted practice even when no formal public pronouncements have been issued .

Audit-related services

• Business valuation and associated services (fairness opinion, purchase price allocation, impairment testing, business modelling)
• Financial due diligence
• Internal audit
• Compliance management systems audit
• Accounting-related IT audits
• Forensic accounting
• Corporate restructuring advice
• Special advice in the field of banking finance

Five Key Trends in Internal Audit

The Chief Audit Executive (CAE) and his team of internal auditors have a clear mandate - sharpen their focus on business risk and add value by being more risk-centric. Evolved from an objective assurance and consulting activity, IA will address the growing needs of global organizations and meet the new expectations of investors and board members.

Based on our engagements with several large organizations relying on MetricStream solution for managing its audit, risk and compliance processes, five key trends we observe are:

1. Evolving role of internal auditors and expanding scope of audits: Internal audit in organizations has evolved from the task of financial auditing. The traditional work of the function – operations, systems, fraud investigations, and special project audit work – has taken a back seat to the more pressing needs of regulatory compliance as well as business process optimization. A properly structured internal audit function, impacting not just regulatory compliance but also operational excellence - is being actively sought. Today, the role of an internal auditor has evolved from merely financial reporting on controls to managing risk, prioritizing goals and activities, eliminating complexity and redundancy, streamlining operations, while driving down cost and protecting and enhancing shareholder value.
2. Business performance and quality assessments: Every stakeholder, management and the audit committee, relies heavily on internal audit for providing assurance and establishing trust in the organization. The answer comes in the form of performance and quality assessments—an examination of the effectiveness and efficiency of the function. Continuous performance reviews and quality assurance activities built into the job descriptions and operating routines of the department provides a window into work performed and quality of operations. Audit staff can run a check on issues like: Does a comprehensive risk assessment serve as the basis for planning and execution? Are stakeholders’ needs met in a timely fashion?
3. Organizational structure for accountability and transparency: Today’s environment calls for greater collaboration and strong relationship between the auditor and the auditee at all levels. The trend therefore is moving towards developing a structure that facilitates healthy environment. This will encourage free flow of information regarding any issues or concern between the auditee and the auditor. The organization has to be structured in a way that facilitates accountability i.e. not limited to only the Audit Committee.
4. Shift away from SOX compliance towards risk-based auditing: Out of necessity, internal auditors have been devoting their time, energy and resources in recent years primarily to SOX compliance activities. Now, it is time for internal auditors to reevaluate its activities and sharpen its focus on stakeholder expectations and risk-based auditing. Enterprise-wide risk management and fraud are also gaining precedence. Moreover, the modern day, technology savvy companies require additional focus on risk assessment, particularly because these risks have the potential to impact organizations more rapidly. Activities relating to fraud detection and auditing IT security are also generating more responsibility for internal audit.
5. Upgrading audit infrastructure and technological advancement: Large companies, specially with complex auditing requirements that span not just financial audits but also audits, assessments and inspections related to operations, quality, safety, suppliers and IT are upgrading the technology infrastructure used to carry out auditing – from risk assessments and audit universe creating and planning to audit data collection, reporting and remediation. Companies are migrating from their legacy systems, point applications and paper-based procedures to a web-based integrated audit management system. The technological advancement allows the CAE to streamline and strengthen the internal audit function enabling it to deliver more strategic value while lowering its costs of operation. Expected benefits are better enterprise-wide visibility, a transparent and collaborative environment and data-driven decision making. Solution and tools available today provide a reliable means to monitor access controls, observe the closed-loop processes and analyze important data and KRIs.

Internal Audit 2014: Emerging Trends and the Outlook Ahead

The profession of internal auditing is changing, and the skills and abilities that served us well in the past may no longer be sufficient to meet the challenges of the future. The IIA’s President and CEO Richard Chambers will share insights gathered by The IIA during recent months on where the profession finds itself in 2014 and what he sees in store for the year ahead. During this session we’ll examine:
- Recent trends and emerging challenges in internal auditing resources and priorities
- The key imperatives that Chief Audit Executives must address immediately
- New strategies for aligning internal audit with stakeholder’s expectations
- Some long term considerations for internal auditors and their profession
- “Keys” to diagnosing and maintaining continuous alignment with stakeholder expectations