Learning objective 5 - Chapter 6 (6 marks) Flashcards
Understand accounting principles and practices and their application
what is book keeping?
The process of accounting.
What 4 things are included in the accounts of quoted companies?
1-Narrative reports; giving an overview of governance, activities and performance of the company.
2-Strategic report - setting out business models, strategies, a fair review of the business, future developments
3-The financial statements for the period including the balance sheet, income statement and cash flow statement.
4- Other legal requirements, such as details of the directors remuneration
what is another term for ‘balance sheet’?
‘statement of financial position’
What is another term for ‘income statement’?
‘profit and loss account’
where do the terms ‘statement of financial position’ and ‘income statement’ come from?
The UK Financial Reporting Standards (FRS) and International Financial Reporting Standards (IFRS)
Where do the terms ‘balance sheet’ and ‘profit and loss account’ come from?
The Companies Act 2006
What is the primary legislation in the UK?
The companies act 2006
What does the companies act include?
Includes regulations on accounting
what are four regulations on accounting included in the companies act 2006?
- Requirement to keep adequate accounting records
-Directors duty to prepare accounts for a company
-Directors duty to prepare accounts for a group of companies and the consistency of financial reporting within a group
-Requirement to prepare accounts that show a true and fair view
what does company legislation also require in terms of auditing?
companies, other than certain small companies are required to have their financial year-end accounts audited by an independent auditor.
how to the accounts have to be published?
Accounts have to be published in a format that complies with regulations and accounting standards requirements
What three things are included in a companies financial statements?
- The income statement
- The balance sheet
- Cash flow statement
What is the income statement?
Shows the results of the company as a consequence of transactions during the accounting period. It sets out the income, expenses, tax and profit or loss.
What is the balance sheet?
A statement of the financial position of the business at a point in time (‘as at’ a particular date) i.e the end of the accounting period or year end date, It is a ‘snap shot’ of the company’s position at a particular point in time, listing all the companies assets and liabilities - what is owned and what is owed. What is owed by the company includes the shareholders equity, which is the total of the assets less the total of the liabilities.
What is a cash flow statement?
These are presented an integral part of a company’s financial statements to recognise that accounting profit, or loss is not the only indicator of a company’s performance. Cash flow statements show the sources and uses of cash and are a useful indicator of a companies liquidity.
what is a ‘true and fair view’ in connection with financial statements?
Financial statements are intended to show a ‘true and fair’ view of the economic activities of the organisation and are available not just to the stakeholders, but to anyone who wishes to review them.
What is another purpose for financial statements?
They are produced within a highly regulated framework to enable fair comparisons to be made on the financial position of different organisations, whether they are the same or not.
What do UK companies listed on the stock exchange have to do?
They have to follow the UK-adopted International Financial Reporting Standards (IFRS)
What do companies not listed on the UK stock exchange have to do in terms of financial statements?
They can also adopt the these international standards. They can also use the Financial Reporting Standards (FRS) (referred to as UK GAAP, which stands for Generally Accepted Accounting Principals)
What does UK GAAP stand for?
UK Generally Accepted Accounting Principals
What is the ‘true and fair’ view similar too?
The ‘substance over form’ concept.
What is the ‘substance over form’ concept?
It is that the financial statement should show the economic substance of transactions rather than the legal form.
What are the two main aspects of accounting which serve separate but inter related purposes in the operation and control of a business?
Financial accounting and management accounting.
what is financial accounting mainly concerned with?
-providing historic information to external stakeholders and interested parties.
-involves day to day recording of the companies transactions and presenting this information in financial statements for external consumption.
what is management accounting mainly concerned with?
-The internal planning and control of an organisation to enable its managers to make sound decisions; its aim is to show managers how the organisation is performing in comparison with anticipated outcomes and if there is any deviation; what corrective action must be taken.
What are the main characteristics around the structure and sources of financial accounting?
- highly structured around the accounting equation
- has to comply with legal and regulatory framework
- used for stakeholders to compare companies performance from one year to another and against other companies in the sector.
What are the main characteristics around the structure and sources of Management accounting?
- Can be formulated in a variety of ways to suit many purposes.
- Management accounting will incorporate a variety of other different information sources to enable managers to fulfill their responsibilities, in addition to day-to-day transactional data captured for financial accounting purposes.
What are the main characteristics around the format of financial accounting?
- information in the financial position is mainly provided in a balance sheet, performance of it is found in the income statement
- financial accounting looks at and records the financial impact of events on the organisation as a whole
What is the main characteristics around the format of management accounting?
- Management accounting systems are not just concerned swith the money, they include non-monetary quantitative information such as labour hours, raw material usage and electricity usage etc.
- Management accounting is naturally segmented and concentrates on processes, individual departments and other areas of responsibility.
What are the main characteristics around the time periods of financial accounting?
- Based on historical information. i.e transactions that happened in the previous accounting period and are not intended to be a guide for the future.
What is the main characteristics around the time periods of management accounting?
- does not report on historical information and is largely focused on the future. it is concerned with forecasts and projections. inevitably these can sometimes be imprecise but managers are usually willing to sacrifice precision for guidance on possible future outcomes.
What are the main characteristics around regulationss of financial accounting?
- When peparing and presenting financial statements for external parties, all companies have to use a conceptual frame work as laid down in accounting standards. This ensures that the info on the companies financial performance and financial position is comparable with previous years and other companies.
Using the conceptual framework also helps to portray the results of ‘stewardship management’, which enables external users to assess the quality of the managers who take responsibility for safeguarding the assets of the company on behlf of its owners; the shareholders. - financial statements may also include valuations and provisions and the calculation and presentation of these are subject to accounting standards.
What are the main characteristics around regulations of management accounting?
- no external regulatory constraints. Management accountants may presentin different ways for different purposes.
Is there any legal requirements to publish financial accounts?
Companies are legally required under the Companies Act Legislation to produce financial accounts which have to be filed at Companies House and hence are available to the public.
Is there any legal requirements to publish management accounts?
Companies have no legal obligations to produce or publish management accounts.
What are the audit requirements for financial statements?
- Companies of a certain size have to have their financial statements audited
Why do financial statements have to be audited?
- To confirm that they show a ‘true and fair’ view.
What are the audit requirements for management statements?
-Mangement accounts do not have to be audited by external auditors however auditors may wish to examine some management accounting reports to helpo in their assessment of audit risk.
-If an organisation has an internal audit department, it will have delegated authority from the audit committee or senior management to report on the adequacy of the systems of control. This will include ensuring that the management accounting system and their reports are relevant, reliable, accurate and complete for management purposes.
give 11 examples of potential stakeholders of insurance companies?
1 - Owners
2 - Directors & Managers
3 - Employees
4 - Regulators
5 - Tax authorities
6 - Creditors and lenders
7 - Competitors
8 - Financial analysts
9 - Brokers
10 - General Public
11 - Customers
What will an Owner generally want to know about the organisations financial affairs?
- They will need to know how the business is performing financially in order to make decisions abount continuing or increasing their capital incvestment. This applies especially to shareholders in Public Limited companies.Investment decisions here are often taken as purely financial.
What will Directors and Managers generally want to know about the organisations financial affairs?
D&M’s have an overall responsibility for managing the business. They will need to know whether or not the organisation has met its strategic objectives and has been making the best use of its resources.
- they will need to know;
1.if the company has enough capital and liquidity to enable it to carry out its plans
2.whether some parts of the business are more successful than others
3.whether the company has behaved as a responsible part of the community.
What will an employee generally want to know about the organisations financial affairs?
- how secure their jobs are. They can use finanical information to gauge how well the organisation is performing, this if their wages are going to be paid.
- An employee may also be a stakeholder so may have conflicting stakeholder objectives.
What will the public generally want to know about the organisations financial affairs?
- includes people who may be potential investors or shareholders.
- Pressure groups that may want to monitor aspects of the organisations activities and people who may be considering applying to work for them.
What will tax authorities generally want to know about the organisations financial affairs?
- they will want to know that the organisation is paying the appropriate level of tax
What will financial analysts generally want to know about the organisations financial affairs?
- includes potential advisors so will want to know what they should share with shareholders and potential shareholders to buy or sell shares in the organisation.
they use financial info to track the organisations performance. - includes journalists and financial commentators who provide general advice to the pubic.
- Rating agencies have analysts that assess insurance companies financial strength, which is a measure of the companies ability to meet their obligations to policy holders.
What will creditors generally want to know about the organisations financial affairs?
- they will want to keep an eye on the performance of the company to ensure debts can be paid. Includes banks, suppliers and landlords.
They will need to mak judgement on whether they should extend credit & if so, what limit.
What will competitors generally want to know about the organisations financial affairs?
Competitors use financial information to understand a companies strengths and weaknesses.
What will Brokers generally want to know about the organisations financial affairs?
From an inurance point of view, brokers will want to know whether companies they deal with are financially strong and able to pay for their clients claims.
What will the customers of an organisation generally want to know about the organisations financial affairs?
potential and existing customers will want to know that they are insured with a reputable organisation which is able to pay its claims
What will the PRA (prudential regulation authority) and FCA (financial conduct authority) want to know about the organisations financial affairs?
The PRA and FCA are the regulatory bodies for the UK financial services industry. Insurance companies are regulated for prudential issues by the PRA and for conduct of business by the FCA.
What do stakeholders in a business need to form a judgement or make decisions about their relationship with an organisation?
They need both Qualitative and Quantitative data.
How is data usually made available to stakeholders?
It can either be readily available online as public information or it will have to be interpreted and analysed from the accounts.
what are the three types of information that is usually required by stakeholders? (categories)
1- General
2-fundamental
3-specific
what do financial statements tell about an organisations activities?
- Financial statements often contain narrative about the organisations activities, outlining areas of particular success or failure and covering new or discontinued projects, as well as directors assessment of risk and objectives for current and future management of the company.
what has the FRC said about Covid-19 disclosures with regards to the understanding of financial positions?
The FRC has said that C-19 disclosures should be sufficient for users to understand the impact on a company’s performance, cash flows and financial position.
is there any other information that larger companies are required to provide?
Yes - how they undertake their social responsibilities to the wider community, e.g how they are addressing environmental issues or helping to reduce the impacts of climate change.
what is the definition of profitability?
the company’s ability to make profit. i.e if there is a positive amount of money left over when all costs and expenses are subtracted from all of the organisations income, then the organisation has made a profit.
What does it mean when a company ‘breaks-even’?
a company ‘breaks-even’, when, if after all costs and expenses are subtracted from the organisations income, they are left with net zero. (when expenditure matches income exactly)
what does it mean when a company is at a loss?
if there is a negative amount when all costs and expenses are subtracted from the organisations income.
why might managers be interested in a companys profitability?
To know how well they have managed the business.
why might employees be interested in a companies profitability?
They need to be reassured that the organisation will continue to trade and that thier jobs are safe. There may also be a profit sharing arrangement that direcly affects the salaries of employees.
why might existing and potential shareholders be interested in a companies profitability?
they will want to know how likely they are to receive from the shares they have in the organisation; this knowledge will enable them to decide whether or not to get a better return on their investment. Note that while rising profits may be reflected in rising dividens, the management may instead decide to retain profits to fund future expansion.
what is the definition of cash position (liquidity)?
- the amount of cash a business has, or has access to is known as liquidity.
why is it so important for a company to have good liquidity?
Because if a company does not have cash it will not be able to pay for its costs and expenses which will lead quickly to difficulty trading and failure of the business.This can happen even if an organisation is profitable and even if it has an excess of assets compared to its liabilities. A company has to be able to meet its liabilities when they fall due in order to continue to trade.
what is the definition of income and expenditure?
-knowing how much income has come into a business and the expenses that have gone out. This information is comparable year to year.
income: i.e premium income is one measure of an insurers relative size. similarly, a brokers size can be gauged by the amount of premium income it manages, its fee income or a combination of both.
Costs: wages, raw materials, rent, company cars. but insurance companys expenditure may also include net claims, reinsurance premiums, acquisition costs and operating costs.
Why might stakeholders want to know about a companys income and expenditure.
when this information is compared year to year it is possible to build up a picture of the volume of sales and to see whether it has gone up or down over time (income) and also whether costs have increased or decreased over time (expenditure)
what will stakeholders want to know about an organisations wealth?
– How much wealth is held and in what form. I.e non-curent assets (property, equipment and investments) and current assets (debtors, cash that can be turned into liquid funds easily)
what is working capital?
Working capital is the difference between current assets and current liabilities.
Where a company has a decreasing working capital this could be due to poor management or due to a short term problem that needs to be finances.
An analysis of the accounts may show that it is just the result of a successfully growing business. If this is te case working capital management is critical to maintain liquidity.
what is the definition of solvency?
Solvency is a measure of the excess of an organisations assets compared to its liabilities. If a company’s liabilities exceed its assets it is said to be technically insolvent and will usually be required to cease trading.
why does solvency have a particular significance in the UK Insurance space?
As all UK insurers are required by the PRA to meet a solvency margin
what is a solvency margin?
This is the amount by which the value of an insurers assets should exceed the amount of its liabilities.
What happens if an insurers net assets falls below its solvency margin?
It may be said that the company is insolvent. This is different to a usual company as they would be declared insolvent when their liabilities exceed their assets.
What is another indicator of an insurance companys financial strength and its ability to pay claims to its customers?
The amount of regulatory capital a company holds in excess of its solvency margin.
What are the main differences between liquidity and solvency?
Liquidity refers to an enterprise’s ability to pay short term obligations, and ability to sell assets quickly to raise cash.
Solvency refers to an enterprise’s capacity to meet its long-term financial commitments
What is the definition of income as per the IFRS?
The amounts of money earned by the company from any source, including sales, rentals, interest payments and investments.
What is income generated from sales sometimes called?
Revenue or turnover (alternatives names from ‘income’)
What is the definition of expenditure as per the IFRS?
The amounts of money incurred to pay for goods and services
What is the definition of profit as per the IFRS?
In accountancy terms, profit is any excess of income over expenditure incurred in running the business that earns that income
What is the definition of shareholders equity as per the IFRS?
The stake that shareholders have in the company. This is calculated as the total value of all of the assets in the business less the total value of all the liabilities.
What is the definition of capital and regulatory capital as per the IFRS?
The capital ofa trading company is the sum of the equity and long-term debt used to finance the business.
what is the importance of regulatory capital for insurance companies?
This is the sum of the equity and long term debt that is classified as regulatory capital. Long-term debt can only be classified as regulatory capital if it meets stringent rules set out by the PRA.
It is an advantage to have regulatory debt capital in addition to equity as the cost of regulatory debt capital is normally lower than the cost of equity.
I.e for a given level of regulatory capital and profitability shareholders shoud expect higher earnings per share if the company has tier 1 or 2 debt compared to just equity.
What is equity?
This counts as tier one capital; the best sort of capital as it gives the greatest protection to policyholders.
Depending on the structure of the debt, particularly the repayment terms, long-term classified debt may be categorised as either Tier 1 or Tier 2 capital.
what is the definition of an asset according to IFRS?
An asset is a resource controlled by the enterprise as a result of past events an from which future economic benefits are expected to flow to the enterprise.
what are the two types of assets?
Tangible and Intanglible
What is a tangible asset?
A physical one. I.e cash, land, buildings, machinery or investments. some tangible assets - especially machinery and equipment lose their value over time. (in accountancy terms this loss in value is called depreciation)
What is an intangible asset?
One that is not physical, such as a trademark, copyright or goodwill. Purchased goodwill is the difference between the amount paid for acquiting a business and the value of its net assets of that business when acquired.
what is the definiton of liability by the IFRS (accountancy terms)
An obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits. (shortly; an amount owed by an organisation)
What is the definiton of liability in insurance terms?
An insurers acknowledged commitment to pay an amount of money arising out of a claim under a policy, or to a class of business or sub-section of a policy.
what is the definition of cash as per the IFRS?
Money that is available to the business. This incluudes money deposited at the bank or cash retained on the premises i.e petty cash.
What is the definition of a creditor as per the IFRS?
Any individual or organisation to whom a debt is owed.
This will remain on the borrowing companies balance sheet as a liability and the lending companies balance sheet as an asset until it is paid off.
what is the definition of a debtor as per the IFRS?
any organisation or person who owes a debt to a company.
This debt is considered as part of the lending company’s current assets and is shown as such in the balance sheet. It will be shown as a liability in the borrowing companies balance sheet
money owed to you is an…?
Asset
money you owe is a….?
Liability
What is depreciation?
- Depreciation is a representation of how much of an assers value has been used up and involves allocating the cost of a tangible, physical asset over its useful life or expected life.
how do we think of depreciation in accounting terms?
The cost of an asset apportioned over the financial period during which the business will benefit from the use of that asset.
why is it advantageous for insurance companies to have regulatory debt capital in addition to equity?
It is an advantage to have regulatory debt capital in addition to equity as the cost of regulatory debt capital is normally lower than the cost of equity.
what is accounting based off of?
The accounting equation
what does a company need in order to operate effectively?
resources; cash, office, furniture, equipment, stock etc
What is the whole basis of accounting?
That everything owned by a business has to be funded from somewhere
what does the accounting equation show and what does it mean?
The accounting equation shows the relationship between the things owned by a business (its assets) and the funds that were used to buy them.
The equation means that the amount of assets must equal the combined amount of equity plus liabilities
The accounting equation forms the basis of more formal financial statements that are compiled by companies to meet statutory reporting standards. i. the income statement and the balance sheet.
What is the accounting equation for assets
Equity + Liabilities = Assets
What must the equation always do?
Balance
Can the accouting equation be altered?
Yes - it can be rearranged so that the equity is the amount left over after liabilities are deducted from the assets.
i.e
Assets - Liabilities = Equity.
Assets are..
Anything the company owns / in their name (even items on credit) or any cash
liabilities are…
Anything the company owes to creditors
Equity is
Assets MINUS liabilities
i.e Assets at 2,000. Liabilities at 750. = Equity at 1,250
