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Accounting > Chapter 2 > Flashcards

Chapter 2 Flashcards

1
Q

Discuss the Nature of Sole Traders and key characteristics

A

An individual in business on his or her own account.

Characteristics:
- No separate legal entity between owner and business

  • Limited life - restricted to the period in which the owner continues in that position
  • Unlimited liability - Owner is fully responsible for the obligations and debts of the business
  • Minimum reporting regulations - Regs for financial recording and reporting are minimal compared with other entity structures
  • Limited access to funds - Ownership funding is restricted to the personal resources of single owner
  • The costs to establish a sole trader structure are normally much lower than for other entity structures
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2
Q

Discuss the nature of partnerships and key characteristics

A

The relationship that exists between two or more persons carrying on a business with a view to making a profit.
Characteristics:
- No separate legal entity
- Limited Life
- Unlimited Liability
- Mutual agency (responsible for each others actions)
- Co-ownership of assets
- Co-ownership of profits (equally or otherwise)
- Limited membership

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3
Q

Discuss the nature of companies and key characteristics

A

An artificial legal person which has an identity separate from that of those who own an manage it.
Characteristics:
- Separate legal entity
- Unlimited life (not related to the individuals who own it)
- Limited liability
- Company ownership of assets
- Company profits belong to the shareholders
- Extensive membership
- Separation of ownership & management
- Extensive regulation

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4
Q

What are the three guiding principles to help monitor & control Directors within corporate governance?

A
  1. Disclosure (of reliable information)
  2. Accountability (defining role of directors and adequate monitoring process. Act in the best interest of the company).
  3. Fairness (restrict ability of directors to be able to buy or sell shares. I.e. shouldn’t be able to benefit from ‘inside’ information).
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5
Q

What is the difference between ordinary shares and preference shares

A

Ordinary shares carry more risk, they are only entitled to the benefits (eg. dividends) after all other stakeholders have been satisfied.

Preference shares have fixed rate of dividend that must be paid before any ordinary dividend can be paid. They usually have higher priority.

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6
Q

What is a Rights Issue?

A

An issue of shares for cash to existing shareholders on the basis of the number of shares already held.

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7
Q

What is the role of the Regulatory Bodies?

A

Financial Reporting Act 1993:
Requires directors to prepare financial statements within 5 months of the balance date of entity. Financial statements must comply with GAAP.

The Companies Act 1993:
Requires directors to be accountable for their actions as stewards of company’s assets. Requires directors to maintain accounting records from which the financial position can be determined.

Also: 
The Security Markets Act
The NZX
The Financial Markets Authority
The External Reporting Boar
Auditors
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8
Q

What does the Companies Act of 1993 require the Directors to provide in the annual report?

A
  • The nature of the company and any changes believed to be important (by the board)
  • Directors remuneration & value of benefits
  • Details of directors
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9
Q

What is the role of accounting standards in financial reporting?

A

Accounting Standards play a significant role in financial reporting. The standards allow accountants to provide info in a manner that can be understood by people important to the organisation – management, board of directors, investors and stakeholders etc.

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10
Q

What is the role of the NZ Exchange (NZX) in financial reporting

A

NZX requires:

  • more frequent reporting (half-yearly and preliminary announcements)
  • continuous disclosure (any significant news affecting share price must be made public timeously)
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11
Q

`What is the role of the Auditor in financial reporting?

A

Makes a report on whether a Company’s financial reports are a true & fair view and comply with statutory regulations.

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12
Q

What could the profit/loss distribution among partners be based on?

A

Individual capital contribution, physical effort, and/or entrepreneurship

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13
Q

What is the role of the Directors in governance?

A

Individuals who are elected to act as the most senior level of management of a company.

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14
Q

Why might accounting principles lead to financial reports that do not fairly represent the financial performance or position?

A

Many are in conflict with each other & with economic reality, eg.

Historical Cost: While at time of acquisition, $ paid is a useful measure, this eventually becomes out of date due to exchange rates, inflation, tech etc

Accounting Period: dividing up business into periods of time creates issues when, for eg, there are incomplete transactions (e.g building under construction, crops not harvested, etc).

Prudence: Caution in recognizing transactions can conflict with full disclosure and leads to reversals in future accounting periods.

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15
Q

(2.16) What would be the benefits of harmonising NZ Accounting standards with International?

A
  • Improved comparability across countries
  • Enhanced international capital flows due to consistent global standards
  • Reduced accounting & reporting costs for multinationals
  • Greater understanding of financial statements.
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16
Q

(2.22) Would you expect a company to pay out all of it’s retained earnings as a dividend?
What Factors might be involved with a dividend decision?

A

Very unlikely, despite being legal this doesn’t necessarily make it a good decision. Most companies see poughed-back profits as a major source of new finance.

Factors:

  • availability of cash
  • the needs of the business for finance for investment
  • possibly a need for directors to build good relationships with investors, who might see a dividend as a positive thing.
17
Q

(2.9) Why might companies have limited liability?

A

Investors of companies aren’t directly involved in the day to day running of a business, therefore limited liability protects them. Without this, investing in company would carry too great a risk.

18
Q

(2.12) What regulations could apply to a Company Entity?

A
  • Company registration before being granted a cert of incorporation
  • Requirement to submit Annual Statements to the NZ Securities Commission
  • Requirement to have accounts audited
  • Requirement to prepare Financial Statements
19
Q

(2,2) Why would regulations for reporting etc be simplier for a sole trader vs. other entities?

A

Regulations are concerned with protecting the interests of those who fund the business. Owners of a Company tend to be removed from day-to-day mgmt, but with sole traders, mgmt is carried out by the owner, so potential for damage is limited. And creditors can sue the Sole Trader for any loss caused by his/her actions.

20
Q
  1. What is the Solvency Test?

2. Why would the Companies Act have a Solvency Test?

A
  1. The Companies Act 1993 requires directors to focus on the financial state of the company and to consider whether the company meets the solvency test before permitting distributions.
    Checks:
    a. is company able to pay debts as they become due in the normal course of business, and
    b. is the vlue of the company’s assets greater than the value of it’s liabilities (including contingent)
  2. This safeguards the company’s short term liquidity situation, and safeguards it’s longer term liquidity, especially by including contingent liabilities such as those whose occurrence depends on an uncertain future (e.g. lawsuit).
21
Q
  1. What is corporate governance
  2. What activities are included in governance
  3. Why has governance become such a big issue over past decade?
A
  1. The system by which companies are directed and controlled
  2. Activites such as setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship.
  3. Directors may be more concerned with pursuing their own interests, these may conflict with what’s best for the business. Causes an issue for society as a whole as shareholders become reluctant to invest, which in turn affects economy

Accounting (4 decks)

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