Week 1 - Introduction, the accounting entity and the financial statements Flashcards
What is the main purpose of accounting?
Communication of information for decision-making
What are the two categories of accounting
- Management decisions within organisations (internal)
- External stakeholders’ decisions about organisations (external)
What is the accounting category of management decisions within organisations (internal)
Management accounting and control
What is the accounting category of external stakeholders’ decisions about organisations (external)
Corporate reporting/ financial accounting
What does the nature of information and decisions assess?
Economic/ financial performance and position
What does the nature of information and decisions assess after economic/ financial performance and position?
Social impacts and dependencies
Few examples of financial questions accounting can answer
- Has the business made a profit/ loss?
- Is there enough cash to pay salaries
- Is the business growing?
- Which product is the most successful
- How much does the business owe?
- What is the value of the business
- Possible financial impacts from risks and opportunities
What does the nature of information and decisions assess after economic/ financial performance and position, and social impacts and dependencies
Broader impact, environmental impact and dependencies
What are the 3 types of business/ entity
- Sole trader
- Partnership
- Company
What is a sole trader?
- one individual owns and operates a business
- business is unincorporated
- individual responsible for the debts of the business
- creditors have a claim over the individuals’ personal assets if the business cannot pay
- the owner/ individual bear unlimited liabilities to the creditors
What is an unincorporated business?
a business that isnt seen as legally separate from the individual
What type of liability does a sole trader have
the owner/ individual bear unlimited liabilities to the creditors
What is unlimited liability
the business owner/owners are personally responsible for all of the debts of the business
What is a partnership?
- the business is run and owned by two or more individuals
- can be unincorporated or incorporated
What happens when a partnership is unincorporated?
the partners are jointly responsible for the debts of the business and creditors have claim over their personal assets if the business cannot pay (unlimited liabilities)
What happens when a partnership is incorporated?
the partnership is considered to be a separate legal entity and its called a company. The partners have limited liabilities and creditors can only get access to the funds that the partner has invested in the business, not their personal assets.
What is a company?
- own their own assets and can take action on their own behalf
- incorporated by law as separate legal entities
- either public limited companies or private limited companies
What is an owner of a company called?
- shareholders or equity holders, have limited liabilities for the companys debt
- shareholders will only lose the value of their shares if the company goes bankrupt
- shareholders liability is limited to the amount invested in the company when buying the shares
Who are the two users we are communicating with in financial accounting?
primary users and other users
What are the three types of primary users?
- investors (both current and future)
- lenders
- other creditors (eg owe money to supplier)
What are the 6 other users included in financial accounting?
- customers
- competitors
- employees
- government
- investment analysis
- community representatives
What is the broad purpose of financial accounting?
is decisions about commencing, continuing or ceasing a relationship with an organisation
What financial information is most useful for investors?
profitability and prospects
What financial information is most useful for governments?
firms ability to pay tax
What financial information is most useful for banks and lenders?
how the business will repay debts
What financial information is most useful for customers and employees
whether the business will carry on trading
What is the main objectives of
(external) financial reports according to the international accounting standards board (2018)
“the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity”
What are the 3 stages in financial accounting to satisfy investors, lenders and other creditors informative demands?
- identifying - business/ economic activities
- measuring - measure these activities
- communicating - put these measurements/ numbers into some statements that the users can communicate with each other
What happens in the 1.identifying stage in financial accounting to satisfy investors, lenders and other creditors informative demands?
collect data on business transactions
What happens in the 2.measuring stage in financial accounting to satisfy investors, lenders and other creditors informative demands?
asses the monetary value of business items and then recording them using double-entry bookkeeping
What happens in the 3.communicating stage in financial accounting to satisfy investors, lenders and other creditors informative demands?
summarise the information in financial statements, then interpret the information so it can be understood by users
What are the 5 broad elements in financial accounting?
(accounting entity, then ->)
1. income
2. expenses
3. assets
4. liabilities
5. equity capital
What is the accounting entity?
focus of the decision making
(could be company, business, or any entity, all the company/ business transactions are related to this entity)
What is income
the value received when goods and/or services delivered to customers
What are expenses?
costs consumed in delivering goods/ services to customers
Wha are assets?
resources controlled by the entity that are of future value
What is a liability?
obligations to transfer resources to third parties
What is equity capital
owners investment in the equity
Assets equations
Assets = Liabilities + Equity Capital
What can we sometimes call Assets - Liabilities
Net assets
What is the profit equation
Profit = income - expenses
Where does profit go to?
Equity capital
What is the equity capital equation?
Equity capital = Amounts paid in by owners + Profit - Amounts withdrawn by owners
What are the three core financial statements?
- Statement of profit or loss/ Income Statement
- Statement of Financial Position/ Balance Sheet
- Statement of Cash Flows
What does the Statement of Profit or Loss/ Income Statement cover?
All income and expenses DURING an accounting period
ie all components of the period’s profit figure (over a period)
What does the Statement of Financial Position/ Balance Sheet include?
all assets, liabilities and equity capital
AS AT THE END of the accounting period (specific point in time)
What does the Statement of Cash Flows/ Cash Flow Statement include?
Sources of cash generation and cash use DURING an accounting period
Reconciles cash balances at the beginning and end of the accounting period
What is another word for financial accounting
Financial Reporting
What is another word for Management Accounting?
Managerial Accounting
Link between financial statements
- First start with a Balance Sheet at the beginning of Y1 (assets, liabilities, equity a company has at the beginning of the period)
- Over the period the business/ company may make some profits.
So shown in the Statement of Profit or loss - End of first year, will have a new Balance Sheet that will include the profit the company earned over the year into this one
- End of year 1 position is the beginning of Y2, over year 2 make some profits
- End of year 2 we need to include the profits earned over the year 2 to the Balance Sheet
Link between financial statements with Cash flow statement
- Since cash is an asset, we need to record cash in the Balance Sheet
So we will have a cash position at the start of Y1 - Over the year spend and receive some cash which will be shown in the statement of cash flows
- End of Y1 will have a new cash position that is shown in the new balance sheet
- Over the second year we have another cash flow statement that tells us how much cash generated and how much cash spent and this cash position is going to include the cash number in the 3rd Balance sheet at the end of Y2
Net profit equation
Net profit = Total Income - Total expenses
What are the three limitations of financial statements?
- Accounting information in the financial statements is mainly backward looking and provides largely historical information
- Accounting and financial statements dont capture non-financial aspects of the business, such as the value of human inputs
- Financial statements involve a substantial degree of classification, aggregation and allocation (results in costs and revenues which may differ to each sometimes being aggregated)
