1. Purpose of financial statements Flashcards
Sole trader characteristics
The owner and the business are one legal entity but two different economic or business entities, maintaining separate business and personal accounts. The owner is legally responsible for any debts or other liabilities of their business.
Partnerships characteristics
The owner and the business are one legal entity and partners are jointly and severally liable for the debts of the partnership.
Partnership Act 1890.
LLPs characteristics
Legal entities separate from their owners. Limited liability.
LLP Act 2000.
Limited company characteristics
- Incorporated.
- Shareholder limited liability.
- Ability to raise finance.
- The business will pay tax on its full profits (corporation tax).
- Shareholders appoint directors to run the business on their behalf.
- The ‘articles of association’ provides the constitution of the company and sets out the rules for running it.
- Companies Act 2006 and financial reporting standards set the regulations and requirements they need to adhere to.
- Annual financial statements filed with Companies House and available for public inspection.
Public Ltd Vs Private Ltd
- Public limited companies sell shares to members of the public.
- Issued share capital of over £50,000
- At least two shareholders and two directors.
- Private limited company is any company that is not a public company.
- No minimum requirement for issued share capital
- At least one shareholder and one director (can be the same person).
Financial statements of a limited company
- Statement of profit and loss and other comprehensive income
- Statement of changes in equity
- Statement of financial position
- Statement of cash flow
Elements of Financial Statements
- Assets
- Equity
- Liabilities
- Income
- Expenses
The importance of these elements is that they define the items which can be included in financial statements.
Asset definition IASB
A present economic resource controlled by the entity as a result of past events.
An economic resource is a right that has the potential to produce future economic benefits
Equity definition IASB
Residual interest in the assets of the entity after deducting all its liabilities
Liability definition IASB
A present obligation of the entity to transfer an economic resource as a result of past events.
An obligation is a duty or responsibility that the entity has no practical ability to avoid.
Income definition IASB
Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.
Expense definition IASB
Decreases in assets or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.
Profit or loss definitions IASB
Increases in equity not resulting from contributions from holders of equity claims.
Decreases in equity not resulting from distributions to holders of equity claims.
Recognition
Process of including an element in the financial statements. If they meet the definition of an asset, liability, income or expense and provide information that is useful to users.
Measurement
Process of determining the money amounts at which the elements are to be recognised and carried in the financial statements.
- Historical Cost
- Current value (Fair Value, Value in Use, Current Cost)
Financial Reporting Framework of rules based on
- Company law (such as The Companies Acts)
- Accounting standards (such as IAS 1)
- Conceptual Framework for Financial Reporting
Purposes of Accounting Standards
- To provide a framework for preparing and presenting financial statements.
- To standardise financial statements so that the same accounting rules apply to all companies.
- To reduce the variations of accounting treatments.
- To help to ensure high quality financial accounting.
- To enable compliance with the Companies House Acts and audit requirements.
- To allow users of financial statements to make inter-firm comparisons.
Conceptual Framework for Financial Reporting
- Developed by the International Accounting Standards Board (IASB).
- Sets out the underlying concepts for the preparation and presentation of financial statements.
- It requires that users of financial information can interpret a company’s financial statements, knowing that they have been prepared in the correct way.
- It helps users to deal with topics that have not yet been covered by the standards.
- It also helps the IASB with the amendment and development of future accounting standards.
The objective of financial reporting
(Conceptual Framework for Financial Reporting definition)
“To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity”.
The statements relate solely to what has happened in the past, and they cannot provide all of the information that users need.
Underlying assumptions of financial statements
- Accounts have been prepared on the accruals basis (Transactions are recorded and reported in the financial statements of the periods to which they relate).
- The company is a going concern (the company will remain in business for the foreseeable future)
Accounting concepts:
- Business entity
- Materiality
- Going concern
- Accruals
Qualitative characteristics of financial information (IASB conceptual framework)
- Relevance
- Faithful representation
- (Materiality deciding on relevance)
- Comparability
- Verifiability
- Timeliness, and
- Understandability
Business entity definition
Financial statements record and report on the activities of one particular entity. They do not include the personal assets or liabilities of those who own or run the entity.
Materiality definition
Information is material if omitting it or misstating could influence decisions that users make on the basis of financial information about a specific reporting entity (materiality is an entity-specific aspect of relevance).
