Textbook stuff Flashcards
What are the main advantages of a partnership over a sole proprietor business
sharing the burden of ownership
opportunity to specialise rather than cover the whole range of services
ability to raise capital where this is beyond the capacity of a single individual
what are the main disadvantages of a partnership over a sole proprietor business
the risk of sharing ownership of a business with unsuitable individuals
limits placed on individual decision making that a partnership will impose
What are the main advantages of forming a partnership business rather than a limited liability company
easier to set up the business
degree of flexibility concerning the way the business is conducted
degree of flexibility concerning restructuring and dissolution of the business
freedom from administrative burdens imposed by law
What sort of poor decisions may be made as a result of overstating the financial strength of a business?
excessive amounts being paid out of profit to the owners and thus depleting equity
excessive bonuses based on overstated profits
lenders providing funds to a business based off wrongly perceived financial strength
what is the historic cost convention + problems and benefits
the value of assets shown of the statement of financial position should be based on their historic cost (at purchase)
means problems of measurement reliability are minimised as the amount paid is a demonstratable fact whereas depreciation isnt 100% accurate
however, information provided may not be relevant as historic costs can become outdated compared to current markets
what is the prudence convention and why is it useful
means that caution should be exercised when preparing financial statements ie be conservative as you dont want to overstate the strength of your financial position
who are the users of financial statements
owners, managers, lenders, investors, competitors
what is the going concern convention
financial statements should be prepared on the assumption that a business will continue operations for the forseeable future unless there is evidence to the contrary
what is the dual aspect convention
asserts that each transaction has two aspects, both of which affects the statements
Benefits of accounting rules
users of financial statements are better placed to compare the financial health of companies based in different countries
transparent and comparable information
this draws investors into the market which thus increases supply of capital and lowering cost of capital for firms
problems of uniform accounting standards
standards may inhibit change - development of new and better procedures may be inhibited
risk that unique aspects of each business will be obscured
standards can be costly - cost of complying with these rules is high which can reduce profits
standards can be complex
what sort of information might managers have an incentive to conceal
anything that would cast a doubt on their ability or might prevent the business from obtaining funds e.g.
excessive management rewards
poor business performance
weak financial health
what characteristics of financial statements are there
relevance and faithful representation, comparability, verifiability, understandability
role of the auditor
report whether the financial statements do what they are supposed to do mainly to show true and fair view of the financial performance, position and cash flows
carefully scrutinise financial statements and the underlying evidence
assess the risks of misstatements arising from either fraud or error
what are the main features of a limited company
artificial person created by law that has a life separate to its owners and is granted a perpetual existence
must take responsibility for its own debts but owners granted limited liability
governed by a board of directors elected by shareholders
difference between ordinary and preference shares
ordinary shares are riskier but give higher returns and are given voting rights
preference shares are lower risk lower reward and are given right to a fixed dividend before ordinary shareholders are given a dividend
three other reports in annual report
directors report - financing decisions, business activities, future prospects
strategic report - provide context for the financial statements so help shareholders assess how well directors performed in promoting the success of a company - objectives, risks, analysis of past performance
management commentary - review of the results and disclosure of any further relevant information to understanding the financial health
creative accounting meaning and examples
structure financial statements to portray the financial health of a company in line with what investors want to see
misstating revenue - early recognition of sales or revenue or reporting transactions that have no real substance or artificial trading which is when businesses in same industry sell same items between themselves to boost sales revenue
manipulating expenses - changing estimates about the future for depreciation or switching from FIFO to AVCO to reduce costs
misstating assets - using values that are higher than the fair value or recording assets that are not owned
conceal information / bad news
signs of creative accounting
reported profits significantly higher than operating cash flow
tax charge is low in relation to reported profits
valuation of assets held are based on historic cost or fair values
changes in accounting policies particularly in revenue recognition and inventory valuation and depreciation
what is the audit process
external audit - role is to form an opinion concerning the integrity of the statements
expectations gap - difference between what external auditors believe their responsibilities are and what shareholders believe them to be
problems of inflation
overstate profits due to time gap between buying a resource and its subsequent use e.g. buying inventory and then inflation will make your gross profit higher
assets tend to be understated
gains or losses from holding monetary items will not be recognised
eroding equity base
