2. Users Of Financial Statements Flashcards
Main users of FSs are:
Owners Lenders (eg banks) Suppliers Employees Customers Government agencies The public
Owners interest in FSs
To see how much profit has been made
To see how much can be paid out in drawings / dividends
To see the net asset value and any increase/decrease
To assess if biz will continue in foreseeable future
Lenders interest in FSs
To see how profitable biz is.
To check if biz can pay interest/ make loan payments
To assess how much biz is being funded by lender
To see what security is available to cover loans
Suppliers interest in FSs
To decide whether to supply goods & services
To assess if biz is able to pay its suppliers
Employees interest in FSs
To assess if the biz is able to pay wages
To consider if the biz will continue to offer employment in the future
Customers interest in FSs
To see if the biz will be able to continue supplying its goods and services
To assess the ability of the biz to provide services in the future eg. Spare parts and to meet warranty liabilities.
Government agencies eg. HMRC and Charity Commission interest in FSs
To ensure biz is registered for VAT if appropriate
To calculate tax due (income tax for sole traders, partners. Corp tax for ltd companies)
To ensure the charity is being run correctly
The public’s interest in FSs
To assess the contribution to the economy
To assess employment prospects.
The framework of accounting…
..sets out the conventions that underlie the financial recording and reporting of biz accounts.
Accounting staff work within this framework in the preparation of financial statements.
What are the 3 main areas of the Framework of accounting?
- Accounting principles
- Accounting policies and characteristics
- Ethical principles of accounting.
What are the Accounting principles (1/3 part of accounting framework)
Business entity
Materiality
Going concern basis
Accruals basis
What are the accounting policies and characteristics (1/3 part of the framework of accounting)
- Application of accounting policies
- Fundamental qualitative characteristics
- Supporting qualitative characteristics
What are the ethical principles (1/3 part of Framework of accounting)
Integrity. Professional competence and due care. Objectivity. Professional behaviour. Confidentiality.
Accounting principles (or concepts) underlie the financial recording & reporting requirements of different types of organisations.
Accounting principles help to ensure that the records and statements prepared are RELEVANT and RELIABLE to users and that they are COMPARABLE and UNDERSTANDABLE.
In particular Accounting Principles help ensure that Financial records and Statements are fit to be used for?
Obtaining finance (provide lenders with current financial position)
Statutory requirements (providing info for tax and other purposes when required to do so by law)
Measuring performance (both internally & externally - so FSs Reps can be compared.)
Internal Control (ensure records are accurate & FSs show true position)
Explain the accounting principle (concept) of BUSINESS ENTITY
This refers to the fact that FSs record and report on the activities of one particular business or organisation.
They do not include the assets or liabilities of those who own or run the biz.
Thus the personal assets/liabilities of the owners are kept separate from the biz. The main links between the business and the personal funds of the owners are Capital and Drawings.
Explain the accounting principle or concept of MATERIALITY
This refers to the fact that some items in accounts are of such low value that it is not worth recording them separately, ie they are not ‘material’.
Depends on size of biz.
Low cost non-current items.
Sundry expenses grouped together.
Explain the accounting principle (concept) of GOING CONCERN
Going concern presumes that the biz the financial statements relate to will continue to trade in the foreseeable future.
The SPL & SFP are prepared on the basis that there is no intention to significantly reduce the size of or liquidate the business.
Note that if a biz is no longer a going concern assets will have very different values and the SFP will be considerably affected.
Values based on liquidation amounts are the opposite of going concern and require extra depreciation to be charged as an expense to the SPL to allow for the reduced value of non-current and current assets.
Explain the accounting principle (concept) of ACCRUALS
This means that income and expenses are matched so that they relate to the same goods and services and the same accounting period.
This means that the SPL shows the amount of expense incurred and the amount of income earned rather than reflecting payments and receipts when they happened.
Eg. Accruals and prepayments (expense and income) Provision for depreciation charges. Allowance for Doubtful debts. Cost of inventory (goods receipts)
Accounting Policies and Characteristics (1/3 part of Accounting framework)
Accounting policies are the methods used by a biz to show the effect of financial transactions, and to record assets and liabilities in the SFP
Eg. A biz may choose as its accounting policy to depreciate its office equipment using the straight line method at 25% p/a.
A biz selects its accounting policies to fit in with the 2 fundamental qualitative accounting characteristics. These are?
Relevance - financial info is useful to the users of the FSs (NB. For info to be relevant it must also be material)
Faithful Representation
Financial info must correspond to the effect of transactions or events.
And must be as far as possible Complete, Neutral, and Free from Error.
What are the accounting characteristics that support the fundamental qualitative accounting characteristics of Relevance & Faithful representation.
Comparability
FSs can be compared to similar businesses and to previous years.
It should be possible to compare an entity over time and with similar information about other entities.
Verifiability
Users of FSs are assured that the info given is faithfully represented.
If information can be verified (e.g. through an audit) this provides assurance to the users that it is both credible and reliable.
Timeliness
Users receive info in time to enable decisions to be made.
Understandability
Financial info is presented clearly and concisely so that users can understand the info given.
Information should be understandable to those that might want to review and use it. This can be facilitated through appropriate classification, characterisation and presentation of information.
The fundamental qualitative and supporting qualitative characteristics are taken from where?
The International Financial Reporting Standards ‘Framework for Financial Reporting’ document
..which sets out the principles that underlie the preparation and presentation of financial statements.
Material misstatement definition
When information contained in the Financial statements is Untrue - whether accidentally or intentionally - and could influence the economic decisions of users.
Examples of Material Misstatement and economic consequences
Profit overstated
May encourage investors to buy a stake of the biz
Assets overvalued
Lender may find security for loan is less than expected.
Profit understated.
Too little tax paid
Sales turnover overstated.
Too much VAT paid.
What must accounting staff ensure when preparing financial statements.
How do they ensure this
Prepared accurately
Without material misstatement
And in the public interest
Without bias to any one user (eg owner)
Achieve by applying the ethical principles set out in the AATs Code of Professional Ethics
Fundamental ethical principles (1/3 part of the accounting framework) - INTEGRITY describe and example of application.
Integrity
Being straightforward and honest in all professional & business relationships
Financial statements should not contain false or misleading figures or statements, or omit or obscure information so as to be misleading.
Fundamental ethical principles (1/3 part of the accounting framework) - OBJECTIVITY describe and example of application
Being aware of conflicts of interest and not allowing the influence of others to bias or override professional judgements.
Eg
The accountant is not influenced by the owner(s) who may want to manipulate the profit figure to suit their needs
Fundamental ethical principles (1/3 part of the accounting framework) - PROFESSIONAL COMPETENCE & DUE CARE describe and example of application
Maintaining professional knowledge and skill at the level required to ensure the employer or client receives a competent service.
The accountant is up-to-date with current accounting standards and legal developments and carries out his work carefully, thoroughly and on a timely basis.
Fundamental ethical principles (1/3 part of the accounting framework) - CONFIDENTIALITY describe and example of application
Information should not be disclosed to third parties (unless authorised or there is a legal right or duty) and should be maintained securely.
The profit and other info from the financial statements is not discussed with family and friends but only with the client and those work colleagues entitled to know.
Fundamental ethical principles (1/3 part of the accounting framework) - PROFESSIONAL BEHAVIOUR describe and example of application
Ensuring that behaviour complies with relevant laws and regulations and avoids bringing the accountancy profession into disrepute.
The accountant records all aspects of the preparation of financial statements in an honest and truthful way, in compliance with relevant laws and regulations.
Which characteristics enable financial info to FAITHFULLY REPRESENT the phenomenon it purports to represent. (Fundamental qualitative characteristics)
Complete Neutral and Free from error
Fundamental qualitative characteristic RELEVANCE
financial information is regarded as relevant if it is capable of influencing the decisions of users
