Introduction to financial reporting

Question 1

What is Financial accounting?

Answer 1

• production of financial statements for external users
• report of the directors’ supervision of funds entrusted to them
• help investors compare which company to invest in and compare their investments
• IASs and IFRSs help reduce differences in ways companies draw up financial statements in different countries
• are public documents and dont reveal details

Question 2

What is Management accounting?

Answer 2

• management need more detailed and up to date information to control the business
• management accounts present information in a way that is useful to management
• Management accounting is essential part of management activity concerned with identifying, presenting and interpretating information used for:
  
  • formulating strategy
  • planning and controlling activities
  • decision making
  • optimising the use of resources

Question 3

What is a Sole trader?

Answer 3

• owned and operated by one person
• no legal distinction between owner and business
• owner gets all profits but fully liable for debts and losses
• capital account represents financial interest of the owner
• owner can add more funds to capital account or profits made
• capital account can be reduced by making ‘drawings’ or through losses

Question 4

What is a Partnership?

Answer 4

• owner/s receive all profit but have full liability of losses and debts
• can have between 2 to 20 partners
• joint owners/partners are jointly liable for losses
• each partner has financial interest in the business, which is divided between capital account and current account
• capital account is normally fixed and only changes when partners join or leave
• current account includes share of profit or losses each partner is entitled to minus any personal drawings made by a partner

Question 5

What is a Limited Liability company?

Answer 5

• seperate legal entity to the owners through the process of incorportation
• owners (shareholders) invest capital into the business in return for shareholdings that entitles them to a share of the residual assets
• shareholders not personally liable for debts but may loose investments
• company is not affected by insolvancy (or death) of individual shareholders
• capital structure is more formalised
• shareholders cant make drawings from the business
• shareholders receive return on their investment through dividends paid in the form of accumulated profits

Question 6

How do Sole traders operate?

Answer 6

• Accounting conventions recognise business as seperate entity to owner however legally they are the same
• business debts that cant be paid have to be done so through sale of personal assets
• are usually small as they rely on financial resources of the owner
• advantages are flexibility and autonomy (independence)
• can manage the business however they want and can introduce or withdraw capital whenever they want

Question 7

How do Partnerships operate?

Answer 7

• personal assets of partners may have to be used to pay debts
• main advantage is there is more than one owner meaning:
  
  • more resources available; capital, specialist knowledge, skills and ideas
  • administrative expenses less due to economies of scale
  • partners can substitute for each other
• can introduce or withdraw capital whenever as long as partners agree

Question 8

What are the Property holdings of companies?

Answer 8

• property of limited company belongs to company
• change of ownership of shares doesnt effect ownership of company property (in partnerships property belongs to partners so they can take their share if they leave)

Question 9

What are the Transferable shares of companies?

Answer 9

• Shares can usually be transfered without consent of other shareholders
• in partnerships, partners cant be introduced without consent of existing partners

Question 10

What is the difference in Suing and being sued?

Answer 10

• As seperate legal entities Limited companies can sue and be sued in its own name
• Judgements relating to companies dont effect the members personally

Question 11

What is Security of Loans in companies?

Answer 11

• Companies are more likely to get loans and secure them with floating charges
• Floating charge = mortgage over constantly varying assets of a company providing security for lender of money
• Floating charge used when company doesnt have any non-current assets but large valuable inventories
• Law doesnt allow partnerships or individuals to secure loans with floating charge

Question 12

What is Taxation of companies?

Answer 12

• Companies are taxed seperately to shareholders as they are seperate legal entities
• Partners and sole traders personally liable for income tax on profits

Question 13

What are the disadvantages of incorporation

Answer 13

• when company is formed, have to register and file formal constitution documents with registrar, registration and legal costs have to be paid
• required to produce annual financial statements and have to be audited
• registered company accounts and certain other documents are open to public
• limited companies have strict rules on introduction and withdrawal of capital and profits
• members cant take part in management unless they are directors
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Question 14

Which document has the foundation of the preperation of financial statements?

Answer 14

Conceptual Framework for Financial Reporting

Question 15

Who prepares the Conceptual Framework for Financial Reporting

Answer 15

International Accounting Standards Board

IASB

Question 16

What does the Conceptual Framework for Financial Reporting present?

Answer 16

the main ideas, concepts and principles which all International Financial Reporting Standards and Financial statements are based on

Question 17

What decisions does the Conceptual Framework for Financial Reporting include?

Answer 17

• objectives of financial reporting
• Qualitative characteristics of useful financial information
• definition, recognition and measurement of elements from which the financial statements are constructed
• the arruals (growth) and going concern concepts
• the concepts of capital and capital maintenance

Question 18

What is the objective of financial reporting?

Answer 18

is to provide financial information about the organisation to users of the financial statements, that is useful in making decisions about providing resources to the organisation and other financial decisions

Question 19

What are the concepts of fair presentation?

Answer 19

• compliant with relevant laws and regulations
• compliant with relevant financial reporting framework
• apply the qualitative characteristics of framework as far as possible

Question 20

Who are the main users of financial statements?

Answer 20

• Customers
• Suppliers
• Lenders
• Government
• The public
• Employees
• Investors

Question 21

What are the investors interested in?

Answer 21

• potential profits and security of their investment
• future profits estimated from past performance shown in Statement of Profit or Loss
• security of investment shown by financial strength and solvency of company in Statement of Financial position
• Largest and most sophisticated group of investors are institutional investors

Question 22

What are Employees and trade unions interested in?

Answer 22

• if employer can offer secure employment and offer pay rises
• have an interest in saleries and benefits of senior management
• info on divisional profitability useful if business is threatened with closure

Question 23

What are Lenders interested in?

Answer 23

• need to know if they will be repayed
• depends on solvancy of company shown in Statement of financial position
• Long-term loans backed up by security of assets, value of assets shown in Statement of financial position

Question 24

What are Government agencies interested in?

Answer 24

• need to know how economy is performing to plan financial and industrial policies
• Tax authorities use financial statements to calculate tax payable

Question 25

What are Suppliers interested in?

Answer 25

• need to know if they will be paid
• new suppliers require info on financial health before agreeing to supply goods

Question 26

What are Customers interested in?

Answer 26

• need to know if company can continue to supply goods in the future especially if they count on the company for specialised goods

Question 27

What is The public interested in?

Answer 27

• may want to assess the effects of the company on the economy, local environment and community
• may contribute to providing jobs
• companies may run corporate responsibility programmes that public may be interested in

Question 28

What do Management and competitors use financial statements for?

Answer 28

to make economic decisions

Question 29

What do managers use as their main source of financial information?

Answer 29

management accounts

Question 30

What are the five key elements that must be summarised in financial statements?

Answer 30

• Assets
• Liabilities
• Equity
• Income
• Expenses

Question 31

What is a non-current asset?

Answer 31

• any tangible or intangible asset acquired on a long-term basis to be used in providing a service to the business
• usually over 12 months
• not held for resale in the normal course of trading

Question 32

What is a current asset?

Answer 32

• Assets expected to be used in the business normal course of trading
• disclosed in the statement of financial position with the least liquid item first (usually inventory)

Question 33

What is a non-current liability?

Answer 33

• long-term liability payable more than 12 months after the reporting date

Question 34

What is a current liability?

Answer 34

• liabilities payable within 12 months of the reporting date

Question 35

What are the components of the Statement of financial position?

Answer 35

• summarises assets, liabilities and equity balance of the business at end of reporting period
• used to be called ‘balance sheet’
• standard format
• assets and liabilties classified into current and non-current

Question 36

What are the components of the Statement of Profit or Loss?

Answer 36

• summarises revenues earned and expenses incurred throughout the reporting period
• used to be called ‘profit and loss account’
• groups expenses together based on their function
• items accounting for in arriving at profit are recorded as having been realised (completed)
• for limited companies there may be another section for other comprehensive income
  
  • includes unrealised gains and losses and are seperately disclosed to get total comprehensive income for the year
  • revaluation surplus = when company accounts for increase in value of land/buildings
• profit for the year and items ofother comprehensive income are reflected in statement of financial position and statement of changes in equity

Question 37

What are the components of the Statement in changes in equity?

Answer 37

• summarises the movement of equity balances (share capital, share premium, revaluation surplus and retained earnings) from beginning to end of period
• only applies to limitied companies
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Question 38

What are the components of the Statement of Cash flows?

Answer 38

• summarises cash paid and received throughout the reporting period
• Only for limited companies

Question 39

What are the notes to Financial statement?

Answer 39

• include a statement of accounting policies and other disclosures required to allow shareholders and other users to make informed judgements about the business
• usually more detailed and longer for limited liability companies than sole traders or partnerships

Question 40

What are Qualitative Characteristics?

Answer 40

teh atributes that make information provided in financial statements useful to others

Question 41

What are the two categories of qualitative characteristics?

Answer 41

1. Fundamental qualitative characteristics
2. Enhancing qualitative characteristics