Week 1 New

Question 1

Define accounting

Answer 1

Often called the ‘language of business’

The process of identifying (select relevant economic transactions), analysing, recording (bookkeeping & summarising info) and communicating (preparing financial statements) economic transactions (reliable and relevant financial information)
Reliable and relevant information put together so users (e.g. shareholders and managers) can make an informed decision (accountants may also help users interpret the

Question 2

What obligations do accountants have?

Answer 2

1) They need to ensure that financial statements comply with statutory (act of parliament- law made by UK parliament), professional and listing requirements (requires accountant to possess technical expertise)

2) They also need to ensure that financial statements present the substance of the commercial transactions of the company- requires commercial awareness from the accountant and important that the accountant does not operate in isolation

Question 3

Define financial reporting

Answer 3

Financial reporting is a way of recording, analysing and summarising financial data
- transactions are summarised in the financial reports/statements

Question 4

What is the purpose of financial reporting?

Answer 4

Financial reporting enables businesses to record,
analyse and summarise financial data.

This data can then be used to satisfy one of the many, but most prominent, functions of a business which is to make a profit (excess income over expenditure) for the owners (shareholders if applicable)

Question 5

Are income and revenue the same?

Answer 5

Yes pretty much and they are interchangeable

Question 6

What is a business?

Answer 6

A business is a commercial or industrial concern (manufacturing business) which exists to deal in the manufacture, resale or supply of goods and services

A business is an organisation which uses economic resources to create goods or services which customers will buy

A business is an organisation providing jobs for people

A business invests money in resources (for example buildings, machinery, employees) in order to make even more money for its owners

A business exists to make a profit

Question 7

Define profit

Answer 7

Profit is the excess of income (revenue) over expenditure

When expenditure exceeds income (revenue), the business is running at a loss

Question 8

How many types of business entity are there?

Answer 8

3 types

Question 9

What are the 3 types of business entity?

Answer 9

1) Sole traders
2) Partnerships
3) Limited liability company

Question 10

What is a proprietorship/sole trader?

Answer 10

generally owned by 1 person but can have employees
- usually small service type business e.g. newsagent
- unlimited liability (owner is personally liable for all debts of business)- no separation between owner and entity (legally owner and business treated as one- same legal identity)

Question 11

What are partnerships?

Answer 11

• owned by 2 or more people- partnership agreement
• usually retail and service type business
• unlimited personal liability- owners personally share responsibility for debts of business for example in the case that a business fails or to settle any legal proceedings (e.g. a lawsuit due to employee injury on the job)
• profits of the business will be shared between partners BUT not necessarily in equal measure

Question 12

What is a limited liability company?

Answer 12

• ownership divided into shares
• owners have liability limited to the amount they pay for their shares
• limited liability company has a separate legal identity from its owners- owner separate to entity- owner protected under state corporation law

Limited liability company can be shortened to LLC
It is an American business structure (treat as different/separate from plc and ltd)

Question 13

What is financial accounting?

Answer 13

Mainly a method of reporting the financial performance and financial position of a business

It is NOT primarily concerned with providing information towards the more efficient running of the business

They still are an interest to management BUT their principal function is to satisfy the information needs of persons not
involved in running the business

They provide historical (past) information

Question 14

What is management accounting?

Answer 14

Management accounting information is required by management (internal users of the firm) and there needs go far beyond those of other (external) account users

This is because managers have the responsibility of planning and controlling the resources of the business which is why they need much more detailed information

They also need to plan for the future (e.g. budgets, which predict future revenue
and expenditure)

Management (or cost) accounting analyses data to provide information as a basis for managerial action. The concern of a management accountant is to present accounting information in the form most helpful to management

Question 15

What is the objective of financial statements?

Answer 15

According to the International Accounting Standard (IAS):

‘The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic
decisions’

Question 16

Who requires/are the users of financial statements?

Answer 16

1) Shareholders

2) National taxation authorities e.g. HMRC

3) Creditors

4) Managers of company- to know future growth prospects as well as financial performance of company over the last accounting period (remember financial accounting looks at the past)

5) Employees of the company

Question 17

What are employee reports?

Answer 17

Some companies voluntarily provide specially prepared financial information for issue to their employees. These statements are known as ‘employee reports’

Question 18

What is the IASB?

Answer 18

International Accounting Standards Board

Question 19

What is the IASB responsible for and what must accountants make sure of a result?

Answer 19

The IASB is responsible for issuing International Financial Reporting Standards (IRSs)

These require companies to publish certain additional information. Accountants, as members of professional bodies, are placed under a strong obligation to ensure that company financial
statements conform to the requirements of IFRSs

Question 20

What is the trend seen with the size of the firm and the users of its financial statements?

Answer 20

The larger the entity, the greater the interest from various groups
of people

Question 21

What financial information would investors/shareholders/owners want?

Answer 21

• information about profits (as dividends taken from this) … ability to pay dividends
• further growth prospects
• chance of capital growth (increase in the value of an asset)

Question 22

What financial information would employees want?

Answer 22

• profitability of the firm they work at
• future/long-term growth outlook/prospects
• job security
• likelihood of receiving bonuses (link to profitability as typically earned when firm doing well financially)
• number of employees
• ability of firm to pay retirement benefits

Question 23

What financial information would lenders/creditors want?

Answer 23

• banks for example might demand a forecast of a company’s expected future cash flows as a precondition of
  granting an overdraft/loan (creditors will be less inclined to lend to companies which are struggling to pay there debt or on the verge of bankruptcy)
• need to know whether return on finance will continue to be met (… require up to date information regarding profitability and cash flows)
• other debt the firm has
• the likelihood of the firm repaying the capital (total) amount

Question 24

What financial information would suppliers want?

Answer 24

• ability to pay and to do so on time (… is firm earning enough profit to allow for this- does it have a positive working capital … lots of liquid cash available which can be used to pay suppliers)
• as a result of the info above the supplier can then decide whether they should continue to supply the firm

Question 25

What financial information would customers want?

Answer 25

• ability of the firm/entity to continue supplying the good/service … future growth prospects important here
• profitability of the firm to determine the value of the goods/services they bought compared to the amount of profit the firm/entity earned

Question 26

What financial information would the government and its agencies (e.g. HMRC etc) want?

Answer 26

• profits made (so that corporation/corporate income tax liability can be calculated)
• sales tax liability (America)
• size of company
• firm/entity growth rates
• foreign trade (to calculate national growth figures e.g. GDP etc)

Question 27

What financial information would the public want?

Answer 27

• contribution of the firm/entity to the local economy/society the firm/entity operates in
• ranges if activities/goods/services provided by the firm/entity

Question 28

What can equity also be known as?

Answer 28

Other names for equity include:
- net wealth
- capital

Question 29

What is the statement of financial position?

Answer 29

A list of all the assets owned by the entity and all the liabilities owed by the entity at a particular date allowing the equity/net wealth/capital to be calculated

Question 30

What is the accounting equation?

Answer 30

Assets = Liabilities + Equity/Net Wealth/Capital
OR
Total Assets = Total Liabilities + Total Equity/Total Capital/Total Net Wealth
OR
Assets = Liabilities + Equity + or - any profit/loss made on asset as a result of a change in the amount you owe and … the net wealth (equity)- basically change in amount owed and amount which yours broken down

Question 31

What is an asset?

Answer 31

An economic resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity

Question 32

What is revenue/income?

Answer 32

Increases in economic benefits during the accounting period in the form of inflows of assets (e.g. cash, inventory, accounts receivables etc) or decreases of liabilities which … result in increases in equity (remember equity is equal to assets minus liabilities) BUT excluding the contribution from equity participants (equity participants owners of shares in a entity/firm and … contribution includes money earned from the purchase of these shares)- so basically money earned from investors buying shares does not count as income- CHECK but for the time being could just ignore the last clause

Question 33

What is the statement of profit and loss?

Answer 33

A record of income generated and expenditure incurred over a given period

Question 34

What is a liability?

Answer 34

Present obligation of the entity arising from past events. It is expected to be settled through an outflow from the entity of economic benefits

Question 35

What is an expense?

Answer 35

Decreases in economic benefits during the accounting period in the form of outflows of assets (e.g. cash, inventory, accounts receivables etc) or increases in liabilities which … result in decreases in equity (remember equity is equal to assets minus liabilities) BUT excluding the distributions to equity participants (equity participants are owners of shares in a entity/firm and … distribution includes money paid as dividends- so basically money paid to investors as dividends does not count as expense- maybe because given own section in SOFP under dividends because retained earnings broken into revenues minus expenses minus dividends- CHECK but for the time being could just ignore the last clause

Question 36

What is Equity/Capital/Net Wealth?

Answer 36

Residual value of the asset of the entity after deducting all of the liabilities (obligations against it)

Question 37

What is relationship between the income statement/statement of profit and loss and the statement of financial position (SoFP)?

Answer 37

The accounting equation used in the statement of financial position (SoFP):
Assets = Liabilities + Equity
OR
Assets = Liabilities + Equity +/- profit/loss
Profit/loss can also be written as sales revenue minus expenses which are components of the income statement …
Assets = Liabilities + Equity + (Sales Revenue - Expenses)

Question 38

What are the responsibilities of governing authorities, specifically directors, in accounting?

Answer 38

Directors:
- main aim is to create wealth for shareholders
- must act honestly in best interest of company
- they must have a Fiduciary position (director must act on behalf of the owners/shareholders and putting their clients’ interests ahead of their own, with a duty to preserve good faith and trust)
- responsible for preparation of financial statements (doesn’t necessarily mean they prepare them themselves)
- must show reasonable competence

Question 39

What is corporate governance?

Answer 39

The system by which companies/entities/firms are directed and controlled

Question 40

Why is corporate governance important?

Answer 40

Remember corporate governance is the way by which commoners are directed and controlled-it is the structure of rules, practices, and processes used to direct and manage a company

… it is important because of the conflict that arises between owners (equity shareholders- principals) and management (agents employed by company’s owners to manage company on their behalf)- conflict known as ‘agency theory’

Management without corporate governance have difficulty making decisions that are both in the best interests of the shareholders and their own … corporate governance is needed so that directors can make these decisions for management

Question 41

What is agency theory?

Answer 41

The conflict that arises between owners and management

Question 42

What is an audit?

Answer 42

Work performed by auditors (independent experts) to provide an informed professional independent opinion on whether financial statements portray a true and fair view

Question 43

Why must audits be carried out?

Answer 43

The financial statements of limited companies share required by the Companies Act of 2006 to give a true and fair view of the company’s financial position at the reporting period date and of its profit or loss for the reporting period (basically saying that entity/firms statement of financial position and statement of profit and loss/income statement should give a true and fair view)- REMEMBER that statement of financial provides snapshot of business performance at a reporting period date whereas the statement of profit and loss/income statement shows the business performance over a reporting period

Question 44

How do financial statements provide a true and fair view (have a clean audit report)?

Answer 44

If they contain sufficient information (in both quantity and quality) to satisfy the reasonable expectations of the users of the financial statements

Question 45

What is the objective/purpose of an audit?

Answer 45

Purpose of audit is to enhance the degree of confidence of the intended users of the financial statements

This is achieved by the auditor expressing an opinion on whether the financial statements are well prepared in all material respects and in accordance with an applicable financial reporting framework

Question 46

What is a general overview of the process of an audit?

Answer 46

1) Figures reported in the statement of profit and loss/income statement have occurred/exist, are complete, are accurate, are properly prepared under the accruals concept and are classified correctly

2) The items reported in the statement of financial position have occurred/exist, are complete, items properly reflect the rights and obligations of an asset or liability, items are included at the correct valuation and disclosed in accordance with accounting standards and company law

3) That the presentation and disclosure of the information in both statements is complete, appropriately classified, understandable and accurate

Question 47

Who appoints the auditors and when do they do so?

Answer 47

The auditors are appointed by the equity shareholders at the annual General Meeting (AGM)

Question 48

What must auditors do during and following their appointment and audit process?

Answer 48

Auditors must act on the behalf of the owners/equity shareholders and report to them in the annual published financial statements with an audit report

Question 49

What is the function of an auditor?

Answer 49

To report their opinion on whether the financial statements give a true and fair view of state of affairs that have taken place over the last accounting period and that the profit of the company has been properly prepared in accordance with the Companies Act of 2006

Question 50

What is an audit report with a positive opinion on a company’s financial statements called?

Answer 50

Called unmodified (opinion), unqualified (opinion) or a clean audit report

Question 51

What is an audit report with a negative opinion on a company’s financial statements called?

Answer 51

Audit report with negative opinion called a modified audit report, adverse opinions or qualified audit reports

Question 52

How many types of modified audit reports are there (those that generate a negative opinion)?

Answer 52

2 types of modified audit reports

Question 53

What are the 2 types of modified audit reports (those that generate a negative opinion)?

Answer 53

1) Those modified audit reports where matters arise that do not affect the auditors opinion

2) Those modified audit reports where matters arise that do affect the auditors opinion

Question 54

How many types of a modified audit report (generating negative opinion) are there that can also be regarded as clean (generating positive opinion)?

Answer 54

1 type

Question 55

When can a modified audit report (generating negative opinion) also be regarded as clean (generating positive opinion)?

Answer 55

When the auditor wants to emphasise some matter to the reader of the financial statements

Question 56

What is the expectations gap?

Answer 56

This is the gap between the auditor’s role and opinion and the public’s perception of the auditor’s role

Question 57

Why is there an expectation gap?

Answer 57

Many members of the public believe that auditors:
- look for fraud when they undertake an audit
- just say the financial statements are accurate
- are responsible for the financial statements and … should give warnings about the future of the entity when they suspect it is going to fail

Question 58

Does the audit report say whether the financial statements are correct?

Answer 58

No, the audit report does not say that the financial statement are correct

Question 59

How do auditors check transactions in practice?

Answer 59

Auditors only check a sample of transactions not every transaction and … cannot guarantee that fraud will be detected

Question 60

Does an audit guarantee that a company/firm/business will succeed in the future?

Answer 60

No, an audit does not guarantee that a company will succeed in the future

Question 61

Who are responsible for the financial statements?

Answer 61

Management (more senior members of a business/entity/firm that are involved in the running of a business) are responsible for the financial statements they prepare or that are prepared on their behalf

Question 62

Who is responsible for the running of a company/entity/business?

Answer 62

Management are fully responsible for the running of the company/entity/business

Question 63

How should auditors abide by the law?

Answer 63

Auditors should be independent (separate from the firm/business/company), auditors should carry out their work with integrity, objectivity (be impartial and fair), they should be technically up to date, be competent and maintain competence and be able to defend their audit work

Question 64

How important is ethics in the auditing industry?

Answer 64

Auditing industry is reliant on ethics for survival as ethics underpins the whole point of an audit

Question 65

How can one be a practicing auditor?

Answer 65

To be an auditor, an accounting practice must be registered under law with a Recognised Supervisory Body (RSB) and be eligible for appointment as an auditor under the rules of that body

Question 66

When is an auditors integrity supported?

Answer 66

Supported when an auditor is sufficiently competent with an up-to-date record of continuing professional development and when an auditor is visibly independent from the client being audited

Question 67

How many threats/potential issues may an auditor face with regards to their independence from the client (firm being audited)?

Answer 67

6 potential threats/issues

Question 68

List the threats/potential issues an auditor may face with regards to their independence from the client (firm being audited)?

Answer 68

1) Business relationships
2) Financial interests
3) Employment relationships
4) Family and other personal relationships
5) Length of service
6) Fees (remuneration), gifts and hospitality

Question 69

What are business relationships as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 69

A business relationship between the auditor and client (entity being audited) is only allowed if the transactions that have taken place between the 2 parties are in the normal course of business, are at arm’s length (transactions in which two or more unrelated and unaffiliated parties agree to do business, acting independently and in their self-interest) and immaterial/insignificant/unimportant to both parties

Question 70

What are financial interests relationships as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 70

An auditor should not have any direct financial interest in an audit client

They should also not have any indirect material/important/significant financial interest in the audit client

Question 71

What are employment relationships as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 71

An audit member of staff can ONLY work on a part-time basis for a client

They MUST not hold a management role nor make management decisions

Question 72

What are family and other personal relationships as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 72

These relationships should between the auditor and the client should be reported immediately

A decision should be taken as to whether this reduces independence and to what extent and therefore if it is necessary to select an audit team that has no links with the client being audited

Question 73

What is length of service as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 73

The audit firm should rotate the engagement partner (the auditor responsible for the effective functioning of all phases in the audit) on audit engagements (arrangement that an auditor has with a client to perform an audit of the client’s accounting records and financial statements) as close relationships between the client and the individual auditor may foster/develop over time which may reduce the perceived independence

In plc’s rotations should be at least every 5 years

Question 74

What are fees (remunerations), gifts and hospitality as a threat/potential issue an auditor may face with regards to their independence from the client (firm being audited)?

Answer 74

The fee from a non-listed (company who is not permitted to sell its shares on a stock exchange) should not exceed 15% of the audits firms total fee income

The fee from a listed (company who is permitted to sell its shares on a stock exchange) should not exceed 10% of the audits firms total fee income

Auditors or their family should not accept gifts from audit clients unless the amount is insignificant

Also the provision of non-audit services by an audit firm/auditor e.g. tax advice is severely restricted

Question 75

What are some ethical issues facing management?

Answer 75

• globalisation (in itself a positive for trade as the world is more interconnected allowing for more international/global trade) but downsides that may come with it include child labour, low wages (exploitation)
• pollution
• bribery/corruption- norm in certain countries
• employee welfare- conditions of working environment- health and safety, pensions (long term welfare)