Chapter 1 - Purpose of Financial Statements Flashcards
What type of organisations are considered private sector?
Sole traders (unincorporated)
Partnerships (unincorporated)
Private limited company (incorporated)
Public limited company (incorporated)
What types of organisations are considered public sector?
Local authorities
Central government
National health service
Not-for-profit (charities/societies)
Who owns a sole trader company?
The sole trader
Who owns a partnership company?
The partners
Who owns the limited company?
The shareholders
What is the legal status of the sole trader?
The sole trader is the business
What is the legal status of the partnerships?
The partners are the business
What is the legal status of the limited company?
It is a separate legal entity from its owners
How many members does a sole trader have?
One
How many members does a partnership have?
Between 2 - 20 (normal maximum)
How many members does a limited company have?
minimum of one shareholder; no maximum
What liability does a sole trader have?
Unlimited liability for debts of the business
What liability does a partnership have?
partners normally liable for entire partnership debt
What liability does a limited company have?
shareholders can only lose their investment
Which legislation is a sole trader bound to?
None
Which legislation is a partnership bound to?
Partnership Act 1890
Which legislation is a limited company bound to?
The Companies Acts (1985, 1989, 2006)
What regulation does a sole trader follow?
None
What regulation does a partnership follow?
Written or oral partnership agreement
What regulation does a limited company follow?
Articles of Association
Who manages a sole trader?
Owner makes all decisions
Who manages a partnership?
All partners usually take an active part
Who manages a partnership?
Directors and authorised employees
Are sole trader’s financial statements private or public?
Private
Are partnerships financial statements private or public?
Private
Are limited companies financial statements private or public?
Public - must be filed at Companies House and made available to the public
What is the most common motive for a company?
Profit. After this is satisfied, usually other motives are focused on such as environmental issues, reducing waste, being a good employer, better facilities, better training, energy efficiency etc
Name the three financial statements used by limited companies?
Statement of Financial Position
Statement of Profit and Loss and other comprehensive income
Statement of Cash Flows
What is the purpose of a Statement of Financial Position?
To list the assets, liabilities, and equity at the end of the accounting period
What is the purpose of the Statement of Profit and Loss and other comprehensive income?
To measure the financial performance of the company for a particular time period (the accounting period)
What is the purpose of the Statement of Cash Flows?
To link profit with changes in assets and liabilities and the effect on the cash of the company?
What is the objective of financial reporting?
‘The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful for existing and potential investors, lenders and other creditors in making decisions about providing any resources to the entity’.
Which parties are interested in a company’s financial statements?
Existing and potential investors Lenders Suppliers Employees and trade unions Customers Competitors Government and government agencies The public Managers
The five main elements of financial statements are?
Assets (current and noncurrent) Liabilities (current and noncurrent) Equity Income Expenses
The Accounting Equation
Assets minus Liabilities equals Equity
Income (definition)
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets of decreases of liabilities that result in increases in equity (other than those relating to contributions from equity participants).
Expenses (definition)
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity (other than those relating to contributions from equity participants).
Asset (definition)
An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
Liabilities (definition)
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
Equity (definition)
Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Equity is represented in the financial statements as…
Capital from shareholders
Retained earnings from the statement of profit and loss
other reserves
What is Regulatory Framework of Accounting and what is it made up of?
It forms the rules of accounting and is made up of the accounting standards, company law and the conceptual framework for financial reporting.
Purpose of Accounting Standards
Standardisation
Provides rules on how to prepare and present financial statements
Enable compliance with the Companies Acts and audit requirements.
Going Concern
means that financial statements are prepared on the assumption that the entity will continue in business for the foreseeable future.
Accrual Accounting
The effects of transactions are recognised when they occur (and not when cash is received and paid) and they are recorded in the accounting records in the financial statements of the periods to which they relate.
What are the fundamental and enhancing qualitative characteristics of financial statements according to the Conceptual Framework for Financial Reporting?
Fundamental = relevance and faithful representation Enhancing = comparability, verifiability, timeliness, understandability.
Materiality
The conceptual framework says ‘information is material if omitting it or misstating it could influence the decisions that users make on the basis of financial information about a specific reporting entity’.
What is ‘Recognition’ in terms of financial statements?
Recognition is the process of including an element (i.e. assets, liabilities, equity, income, expenses) in the financial statements. An item should be recognised if 1) if it is probable that future economic benefits will flow to or from the entity and 2) it has a cost or value that can be reliably measured.
What does ‘Measurement’ mean and what are the four types?
measurement is the process of determining the money amounts at which the elements are recognized and carried in the financial statements.
The four types are historical cost, current cost, realisable (settlement) value and present value.
Historical cost
Assets are recorded at the amount paid, or the fair value at the time of acquisition; liabilities are recorded at the amount expected to be paid.
Current cost
What it would cost to replace assets and liabilities at today’s prices.
Realisable (settlement) value
What the assets could be sold for, and the amount required to settle the liabilities, today.
Present value
Assets and liabilities are valued at the present discounted values of their future cash inflows and outflows.
Business entity
This term refers to the fact that financial statements record and report on the activities of one particular entity.
IAS
International Accounting Standard
IFRS
International Financial Reporting Standard
Name the two fundamental and four enhancing qualitative characteristics of the Conceptual Framework for Financial Reporting…
Relevance
Faithful Representation
Comparability
Verifiability
Timeliness
Understandability
Relevance
for information to be relevant it must
- be capable of making a difference to the decisions made by users.
- Have predictive value, which helps users to predict future outcomes
- Have confirmatory value, which helps users to confirm previous evaluations.
Faithful Representation
For the faithful representation of information it must;
- Correspond to the effect of transactions or events.
- As far as possible be complete (to include all necessary information for a user), neutral (without bias), and free from error (no errors in the description or process).
Comparibility
Enables users to identify and understand similarities in, and differences among, items - a comparison relates to at least two items
Verifiability
Helps assure users that information is faithfully represented - can be direct (e.g. counting cash) or indirect (e.g. calculating inventory valuations using a method such as first in, first out).
Timeliness
means having information available to decision makers in time to be capable of influencing their decisions - generally the older the information is the less useful it is.
Understandability
means that information is classified, characterised and presented clearly and concisely - financial reports are prepared on the basis that users and their advisers have a reasonable knowledge of business and economic activities.
What is the Purpose of the Statement of Cash Flows?
it is to link profit with changes in assets and liabilities, and the effect on the cash of the company
