1.1 - The Purpose of Accounting Information Flashcards
What is accounting?
A way of recording and summarising transactions of an entity.
What are the three main types of profit-focused business entity?
- Sole Traders
- Partnerships
- Limited Liability Companies
What are sole traders?
Business that is owned and managed by one person. Unlimited liability as the owner and business are one entity.
What are partnerships? Name the two forms of partnerships?
Business that is owned by 2 or more partners. Unlimited liability. Each partner is jointly and severally liable for any losses.
1. General partnership
2. Limited Liability Partnership (LLP)
What are limited liability companies?
Incorporated businesses that have limited liability. owners are not personally responsible for amounts owed. Shareholders are only responsible for the amount to be paid for their shares.
What is the objective of financial reporting?
The objective is to provide information about the entity that is useful to existing and potential investors, lenders & other creditors in helping them make decisions on providing resources to the entity.
(IFRS Foundation’s Conceptual Framework for Financial Reporting)
Who are the primary users of financial statements?
Existing and potential:
1. Investors
2. Lenders
3. Other Creditors
When making decisions, what do the primary users need to assess? (2)
- Economic resources (cash & assets) claims (liabilities) and changes in both of these features.
- Whether managements have effectively discharged their responsibilities in the management of the entity’s resources.
Why is cash important to businesses?
An entity needs to be able to use its resources to generate cash and use that cash to settle its claims.
What does the timing and certainty of cash flow determine? (4)
The timing and certainty of cash flows determines whether the business can:
1. Pay its employees and suppliers
2. Meet interest payments
3. Repay loans
4. Pay something to its owners
Why is financial information important to managers/directors? (2)
- Enables them to manage the business effectively (exercising the stewardship function)
e.g. pricing, output, employment and financing decisions) - Allows them to measure how they are performing against ESG targets
Why is financial information important to owners of the company (shareholders)? (4)
- They are interested in the return they will get for risking their capital. (helps determine whether they should buy, hold or sell shares)
- Want to know how profitable and sustainable the business is and if profits are available to pay dividends.
- Whether the entity’s dependency on ESG issues affect its ability to create and maintain value.
- If policies and practices in relation to ESG are in line with investor’s expectations
Why is financial information important to lenders? (3)
- Banks want to know if an entity is able to keep up loan payments
- If financial conditions are not met, whether the loan needs to be withdrawn or whether the terms need to be changed.
- If ESG related conditions may affect the loan
Why is financial information important to other creditors? (2)
- Suppliers want to know about an entity’s ability to pay debt
- Interested in the company’s corporate values (e.g. fair trade ESG)
Why is financial information important to trade contacts? (1)
- Need to know that the company is a secure source of supply, so that repeat purchases and after-sales care will be available.
Why is financial information important to HM Revenue and Customs (HMRC)? (1)
- HMRC want to know about business profits in order to assess the company’s tax liabilities.
Why is financial information important to employees? (2)
- Need information about the stability and profitability so they can assess the entity’s ability to provide remuneration, retirement benefits and employment opportunities.
- Interested in how the company does business so that they can assess whether they want to be a part of the organisation. (ESG issues may not align with personal values)
Why is financial information important to financial analysts/advisers? (1)
- Need information for their audience.
Why is financial information important to government agencies? (3)
- Interested in the efficient allocation of resources and activities of enterprises.
- Required for providing a basis for national statistics.
- May want to assess how entities are implementing mandatory reporting requirements to disclose information
Why is financial information important to the public? (2)
- Assess the impact on the local community
- Assess the impact of the entity on the natural environment
Why is financial information important to regulatory bodies? (1)
- Require information to ensure compliance with regulations and the law.
Why are ethical considerations important to the work of accountants? (2)
- Must be perceived as trustworthy. If reliability becomes compromised, users will no longer depend on the information. Value of the profession will be damaged.
- Maintains value and public confidence. Achieved by adhering to a code of conduct and ethical behaviour.
What is the ‘information gap’ in financial statements?
Information needs that is not satisfied by financial statements due to conflicting stakeholder needs.
Likely to be greater in large companies
Give two examples where some stakeholders may receive additional accounting information to satisfy their specific information needs?
1) HMRC will receive information to make tax assessments.
2) A bank might demand a cash flow forecast as a pre-condition of granting an overdraft.
How should management be thought of in relation to the financial statements? Why?
- Responsible for preparation and presentation
- Because they need financial information to help them make planning and control decisions.
- However, they do not rely on the financial statements as they have access to internal business information. Can be obtained through cost and management accounting system.
What other types of organisation prepare financial statements? (2)
Not-for-profit entities:
1. Charities and clubs
2. Government (public sector) organisations
