Chapter 1: Introduction to Accounting - The purpose of accounting information Flashcards
What is accounting?
Accounting is a way of recording, analysing and summarising the transactions of an entity.
What are the three main types of profit-focused business entity?
1) Sole traders
2) Partnerships
3) Limited liability companies
What are sole traders?
Sole traders are people who work for themselves. Examples include a local shopkeeper, plumber of hairdresser. The term sole trader refers to the ownership of the business; sole traders can have employees.
What are partnerships? What are the two forms of partnership?
Partnerships occur when two or more people decide to share the risks and rewards of a business together. Examples include accountancy, medical or legal practice. A partnership can take one of two forms: a general partnership like two or more sole traders) or a Limited Liability Partnership LLP (more like a company).
What are limited liability companies?
Limited Liability companies are incorporated to take advantage of ‘limited liability’ for their owners (shareholders). This means that, while sole traders (always) and partners (usually) are personally responsible for the amounts owed by their businesses, the owners (shareholders) of a limited liability company are only responsible for the amount to be paid for their shares.
What is the objective of financial reporting?
According to the IRFS Foundation’s Conceptual Framework for Financial Reporting, the objective of financial reporting is to ‘provide information about the reporting entity that is useful to existing and potential investors, lendors and other creditors in making decisions relating to providing resources to the entity’.
Wo are the primary users of financial statements?
When making decisions, what do the primary users need to assess? (2)
Existing and potential investors, lenders and other creditors are known as the primary users of the financial statements.
When making decisions, the primary users need to assess:
1) The economic resources of an entity (e.g. its cash and other assets), claims against the entity (e.g., its liabilities) and changes in those resources and claims.
2) How effectively and efficiently the entity’s management have discharged their responsibilities relating to the management of the entity’s resources.
Why is cash important to businesses? (4)
Cash is important to businesses. An entity needs to be able to use its resources to generate cash and use that cash to settle its claims. The timing and certainty of cash flows determines where 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?
Managers/directors appointed by the company’s owners to supervise the day-to-day activities of the company.
They need information about the company’s present and future financial situation. This enables them to manage the business efficiently (exercising the stewardship function) and to make effective decisions about matters such as pricing, output, employment and financing.
Why is financial information important to owners of the company (shareholders)?
Owners of the company (shareholders) want to assess management performance.
They are the providers of capital for the company, so they are interested in the risk of their capital, and the return they will get for taking that risk.
They need information to help determine whether they should buy, hold or sell shares.
They want to know how profitable and sustainable the company’s operations are and how much profit is available for distribution to the shareholders through a dividend.
In addition, the value of their investment in the company is affected by the company’s profitability.
Why is financial information important to lenders?
Lenders include banks which allow the company to operate an overdraft or, provide longer term finance secured on the company’s assets. A bank wants to assure that the company is able to keep up loan payments.
Why is financial information important to other creditors?
Other creditors such as suppliers who provide goods and services on credit and customers who purchase goods or services. Suppliers want to know about the company’s ability to pay it’s debts.
Trade creditors are likely to be interested in an entity over a shorter period then lenders, unless they are dependent upon the continuation of the entity as a major customer. Suppliers are also interested in the company’s corporate values such as it’s fair trade policies, how it treat’s it’s employees and its environmental practices.
Why is financial information important to trade contacts?
Trade contacts, which includes suppliers as above, and customers need to know 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)?
HMRC want to know about business profits in order to assess the company’s tax liabilities.
Why is financial information important to employees?
Employees and their representative groups need information about the stability and profitability of their employers, so they can assess the entity’s ability to provide remuneration, retirement benefits and employment opportunities.
Employees are also interested in how the company does business so that they can assess whether they want to be part of the organisation. Issues such as the the ethical stance of the company and pay equality between genders.
