Week 1 - Introduction to Accounting Flashcards
What is the process of accounting?
Accounting is the process of identifying, measuring and
communicating financial information
What are the three major financial Statements?
Statement of financial position
Income statement
Cash flow statement
What is the statement of financial position commonly referred to as?
The balance sheet
What are the key sections that make up the statement of financial position?
Assets
Liabilities
Owners’ Equity
What are the key sections that make up the income statement?
Revenue
Expenses
Profits
What are the key sections that make up the cash flow statement?
Cash flows from operating, investing and financing activities
Outline the relationship between the three major financial statements
The income statement and statement of cash flow
measure flows of wealth and cash respectively over time
The statement of financial position measures the
amount of wealth at a particular moment in time
State the differences between financial accounting and management accounting with reference to the following factors:
- Nature of the reports produced
- Level of detail
- Regulations
- Reporting interval
- Time orientation
- Range and quality of information
Management accounting
- Tend to be for a specific purpose
- Often very detailed
- Unregulated
- As short as required by managers
- Often based on projected future information as well as past information
- Tend to contain financial and non-financial, often use information that cannot be verified
Financial accounting
- Tend to be for a general purpose
- Usually a broad overview
- Usually subject to accounting regulation
- Usually annual or bi-annual
- Almost always historical
- Focus on financial information, great emphasis on objective, verifiable evidence
What are the three types of business entity?
- Sole trader
- Partnership
- Limited liability company
What is a sole trader?
• An individual may enter into business alone
• The sole trader may borrow from a bank
• For accounting purposes, the business is regarded as a separate economic entity
• The sole trader is the owner who takes the risk of the bad times and the benefit of the good times
• The owner may not feel any great need
for accounting information, but accounting information will be needed by:
– The Government (HM Revenue and Customs)
– A bank for the purposes of lending money
– A person intending to buy the business
What is a partnership?
• The sole trader may expand to enter into a partnership with one or more people
• Permits a pooling of skills
• Allows one person with ideas to work with another who has the money
• But there are real financial risks if the business is unsuccessful
• For accounting purposes, the partnership is seen as a separate economic entity, owned by the partners
• One partner may be required to meet all the obligations of the partnership if the other partner does not have sufficient personal property, possessions and cash
• This is described in law as joint and
several liability
Need for accounting information:
• Partners wishing to be sure that they are
receiving a fair share of the partnership
profits
• HM Revenue and Customs
• Banks who provide finance
• Other persons who may be invited to join the partnership
What is a limited liability company?
• The major risk attached to either a sole trader or a partnership is that of losing their personal property and possessions, including the family home, if the business fails
• To encourage the development of larger
business entities owners need the protection of limited liability
• This meant that if the business failed, then the
owners might lose all the money they had put into the business, but their personal wealth would be safe
• For accounting purposes, the company
is an entity with an existence separate from the owners
Need for accounting information:
• Accounting information is very important for the shareholders of relatively large companies
• HM Revenue and Customs
• To attract potential investors
• Employees, customers, suppliers, etc.
What are the two forms of limited liability company?
- A private limited company has the word ‘Limited’ (abbreviated as ‘Ltd’) in its title
- A public limited company has the abbreviation ‘plc’ in its title
- A private limited company is prohibited by law from offering its shares to the public, (appropriate to a family-controlled business)
- The public limited company is permitted to offer its shares to the public. In return, it has to satisfy more onerous regulations
Outline the differences between a partnership and a limited liability company with regards to the following factors:
- Formation
- Running the business
- Accounting information
- Meeting obligations
Partnership
- By agreement but not necessarily in writing
- All partners share in the running of the business
- Not obliged to make accounting information available to the public
- Partners are jointly and severally liable for money owed by the firm.
Limited Liability Company
- Registering the company under the Companies Act Memorandum and articles of association setting out the powers allowed to the company
- Shareholders appoint directors to run the business
- Must make accounting information available to the public. Annual Financial Statements (The Accounts)
- The personal liability of the owners is limited to the amount they have agreed to pay for shares
State the users of accounting information
- Managers (internal user)
- Shareholders
- Financial analysts and advisors
- Employees (internal user)
- Lenders
- Suppliers
- Customers
- Competitors
- Government
- The public, special interest groups and students
How does management use accounting information?
• Concerned with running the business, using assets to generate profit. Need information on performance and position • Have access to specially produced internal management accounting information on a regular basis
How do owners as investors
(shareholders) use accounting information?
• If ownership is separate from the
management, owners are viewed as investors
• Is the return from the investment, at present and in the future, adequate? Make decisions about buying, holding and selling shares
• Also interested in the entity’s financial
performance and financial position
How do financial analysts and advisors use accounting information?
• Most shares of listed companies are
traded by fund managers of financial institutions on the advice of equity analysts
• Investment analysts conduct a fundamental analysis of company financial information and produce recommendations (buy, sell or hold) for potential equity investors
How do employees use accounting information?
• Ability to pay wages and continuity of employment
How do lenders use accounting information?
• Ability to pay loans and the related interest
How do suppliers or trade creditors use accounting information?
• Ability to pay for supplies delivered on credit terms
How do customers or trade debtors use accounting information?
• Continuity of supply
How do competitors use accounting information?
• Performance comparison and learn how to improve own performance
How do governments and their agencies use accounting information?
• Governmental planning, national statistics, taxation and regulation of utilities
How do public and special interest groups use accounting information?
- Impact on local economy
* Environmental concerns
What is a ‘primary user’ of financial performance and financial position information from a reporting entity?
Investors (i.e. owners and long-term lenders)
State some useful websites for financial and
accounting information
LSE website Google Finance Yahoo! Finance Reuters FT.com Bloomberg
Why is the LSE a useful website for financial and
accounting information?
LSE website: Search for stocks and share prices, company fundamentals and trading information for all securities traded on the London Stock Exchange’s markets. http://www.londonstockexchange.com/prices-and-markets/stocks/stocks-and-prices.htm
Why is Google Finance a useful website for financial and accounting information?
Google Finance (Stock Screener): Search for stocks based on various criteria (e.g. financial ratios, share price)
What is profit guidance?
An estimate of future earnings provided by the company, which will influence investors’ decision
to buy, hold or sell the stocks
What is corporate governance?
The process by which companies are directed and
controlled (Cadbury Report, 1992)
What is the comply or explain approach regarding UK Corporate Governance Code?
- UK listed companies have to comply with the UK Corporate Governance Code
- The compliance with the code is not a legal requirement, but if a company does not comply with it, they must provide an explanation
What are the board of directors of a company responsible for?
The company’s overall success
What do the boards of publicly limited companies consist of?
- The boards of plcs consist of executive directors (EDs) and non-executive directors (NEDs)
- The majority of the board should be NEDs
What is the difference between an executive and non-executive director?
An ED will be an employee of the company, an NED will not
What is the Chief Executive Officer of the board?
The senior ED
What is the Chair of the board?
The senior NED
State the legal differences between UK and US law with reference to the roles of chief executive officer and chair of the board
- It is against the UK Corporate Governance Code to combine these roles
- In US companies however, having one person carry out both roles is quite common
Describe the ideal board of directors
• The ideal board should not be too large or too small
• It should be as diverse as possible
–Socially diverse: gender, age, ethnicity
–A diversity of skills and experience
• NEDs should not remain on a board for too long: the longer they remain, the less independent they become
• There is also guidance regarding a director’s age
