Chapter 1 Flashcards
Define Accounting
The process of recording, analysing, summarising and communicating financial
information.
What is the objective of financial reporting
To provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors
What do financial statements consist of?
1) Statement of Financial Position
2) Statement of Profit or Loss and Other Comprehensive Income
3) Statement of Cash Flows
What is the Statement of Financial Position sometimes called
The Balance Sheet
What is the Statement of Profit or Loss and Other Comprehensive Income sometimes called?
Income statement
or
Profit and Loss Account
What are the seven main user groups of financial reporting
POEBELL
Public
Owners/investors (equity investors)
Employees
Business Constacts
Analysts and Advisors
Local and central government (incl. HMRC)
Lenders
What are other user groups
Pension funds
Pressure groups
Charities
User group information need: Public
Any or all of the following
User group information need: Owners/investors
How business is doing. What their income is likely to be. How well the managers perform, whether to buy or sell shares
User group information need: Employees
Stability, profitability, likelihood of pay rise.
User group information need: Business Contacts
Stability? Credit-worthiness? Profitability (e.g. scope to negotiate price cuts)
User group information need: Analysts and Advisors
Whether current strategies are working. Future plans. Key performance indicators.
User group information need: Local and Central Government
Profit for tax purposes, employment information, carbon emissions etc
User group information need: Lenders
Company’s ability to repay debts, assess security
Types of Businesses comparison: Minimum Members
Sole Trader: One
Partnership: Two (max 20 if not a recognised profession)
Company: One
Types of Businesses comparison: Formalities
Sole Trader: None
Partnership: None (but partnership agreement is normally in writing(
Company: Must register (e.g companies house). Plc and listed companies have more formalities
Types of Businesses comparison: Advantages
Sole Trader:
–Flexible.
–Trader keeps all of the profits.
–No disputes with fellow owners.
–Privacy.
Partnership:
–Flexible.
–Share risk and management responsibilities.
–More expertise.
–Duty of utmost good faith.
–Privacy.
Company:
–Members have limited liability
–Easier to raise capital.
–Perpetual succession.
Types of Businesses comparison: Disadvantages
Sole Trader:
–Unlimited liability for business obligations.
–Harder to raise finance.
–Lack of resources.
Partnership:
–Unlimited liability for business obligations.
–Harder to raise finance
Company:
–Regulatory burden, e.g. accounts in a statutory form, audit, file accounts and annual return etc. Lack of privacy.
Types of Businesses comparison: Who manages the business
Sole Trader: Owner
Partnership: Owners
Company: Directors
How are accounts prepared?
All accounts are prepared using an accounting system, from which accounting information is produced, typically financial accounts and management accounts
Financial Accounts vs Management Accounts: Prepared for?
Financial accounts: Prepared for external users (eg. shareholders, tax authorities)
Management accounts: Prepared for internal purposes e.g. mangers
Financial Accounts vs Management Accounts: Deadlines
Financial Accounts: Normally deadlines for “publishing” accounts
Management accounts: No deadline for production (other than as set by management)
Financial Accounts vs Management Accounts: timespan
Financial Accounts: Summarise historical data (results and financial position)
Management accounts: Forward looking e.g. budgets, cash flow forecasts
Financial Accounts vs Management Accounts: Information level
FInancial Accounts: Summary Information
Management Accounts: Detailed information and analysis
What are primary users of financial statements ( and who)
Accounting regulation views some users as more important than others, these are primary users
Primary users:
–Investors (owners)
–Lenders and other creditors
Why do primary users of financial statements need financial information?
Investors and lenders provide finance to a business, they need financial information for two main reasons:
1) To make decisions about providing resources to the business (e.g. whether to buy, hold or sell shares, whether to make a loan
2) To assess the stewardship of management.
In respect to primary users, what is stewardship of management?
Stewardship is managements responsibility to act in the best interests of the owners of the business, by safeguarding its assets and using them efficiently and effectively to generate profits and/or increase their value
Why are financial statements particularly important if the primary users are external
If investors and lenders are external to the business, the published financial statements may be their only or main source of information.
Accounting regulation ensures that the financial statements give a fair presentation of the financial performance and financial position of a business and that they present the information that providers of finance need
What are the four main sources of accounting regulation
1) Companies legislation
2) International Financial Reporting Standards (IFRS)
3) National accounting standards
4) Stock Exchange regulations
Sources of regulation: Companies Legislation
This varies from country to country.
In the UK, the Companies Act 2006 applies to all companies.
It sets out prescriptive layouts for the financial statements and requires the preparers of accounts to present a true and fair view.
Sources of regulation: IFRS
International Financial Reporting Standards are standards issued by the International Accounting Standards Board (IASB).
In many countries, including the UK, all listedcompanies are required to follow these.
Sources of regulation: National accounting standards
In the UK, these are issued by the Financial Reporting Council (FRC).
Many countries have now either adopted IFRSs as their national standards, or (as in the UK) base their national standards very closely on IFRSs.
One important exception is the USA.
Sources of regulations: Stock exchange regulations
Listed companies only
do sole traders and partnerships have to use any accounting standards
only companies have to prepare financial statements using IFRSs or other accounting standards.
In theory, unincorporated businesses such as sole traders and partnerships can use whatever accounting regulations they wish.
International Financial Reporting Regulatory Framework: set up
IFRS Foundation appoints:
1) IFRS Advisory Council (advises IASB)
2) IASB (International Accounting Standards Board)
3) IFRS Interpretations Committee
IASB reports to IFRS Foundation
IFRS Advisory Council and Interpretation committee both advise IASB
International Financial Reporting Regulatory Framework: role overview
IFRS foundation - appoint, oversee, raise funds
IFRS Advisory Council - advises IASB
IASB - issues standards and exposure drafts
IFRS interpretations committee - guidance & interpretation
IFRS Foundation: Roles and Responsibilities
Main objective is to develop a single set of high quality IFRSs through its standard-setting body, the IASB
A further objective: to bring about convergence of national and international standards.
-Monitor, fund, appoint members of IASB, IFRD AC and IFRIC
-Establishes and amends operating procedures, consultative arrangements and due processes of IASB, IFRS IC and IFRS Advisory Council
IASB: Roles and Responsibilities
The IASB is an independent privately-funded body
It issues International Financial Reporting Standards (IFRS).
The Board has 16 members.
Before 2003, these were called International Accounting Standards, or IAS.
IFRIC: Roles and Responsibilities
Provides timely guidance on the application and interpretation of IFRSs
Provides guidance on new financial reporting issues not specifically addressed by IFRSs.
Interpretations are approved by the IASB prior to being issued.
IFRS AC: Roles and Responsibilities
The IFRS Advisory Council is the formal advisory body to the IASB and IFRS Foundation.
It takes recommendations from individuals, corporations and national standard setters
and then provides advice to the IASB on priority areas of accounting.
What is corporate goverance?
the system by which companies are directed and controlled
What is “charged with governance”
A company needs to be appropriately “governed” as the owners of a business do not necessarily work for or run the company and therefore need to ensure that the business is being run properly.
The Directors of a company are those “charged with governance”. Their responsibilities are laid down in law.
What are the legal responsibilities of a director
These vary according to national companies legislation
1) The preparation of the financial statements in accordance with the applicable financial reporting framework (e.g. IFRSs)
2) The internal controls needed to prepare financial statements
3)The prevention and detection of fraud
4) Ensuring that the entity complies with all relevant laws and regulations
Directors should explain their responsibility for preparing accounts within the financial statements.
