Week 1 Flashcards
What is the purpose of financial information
Accounting is concerned with collecting, analysing and communicating financial information. This information is useful for those who need to make decisions and plans, therefore, businesses, including those who need to control those businesses.
The ultimate purpose of financial statements is, therefore to give people better information on which to base their decisions.
Identify external parties that would be interested in a business’s financial information and explain why.
External interested parties may use financial statements to decide whether to:
•Invest or disinvest in ownership of the business.
•Lend money to the business.
•Offer credit facilities.
•Enter into contracts for the purchase of products or services.
Specific external interested parties would include:
Shareholders The main target of financial statements. They will wish to ensure the investment they have made is doing well.
Customers: Customers will want to check if the company is likely to remain in business for the foreseeable future so that there is a definite source of supply.
Suppliers: Suppliers will want to ensure the company is likely to remain in business for the foreseeable future so that there is a definite customer for their goods. They will also be interested in how long it takes the company to pay its bills and how committed they are with other loans.
Lenders: Lenders will want to see how committed the company are with regard to other loans, how strong their cash flows are and what assets the company has to use as security against the loans.
Government: Government will want to ensure the company is paying the appropriate amount of tax and is complying with legislation and codes of conduct.
Employees: Employees will want to check for continued employment and also the company’s ability to offer pay rises and their ability to meet pension commitments.
Community: The community will be concerned with the continued employment the company can offer, what the company does for the community and any plans which may have environmental impacts.
Competitors: Competitors may look at claims regarding market share and any other information which may be of use, Eg R&D projects, overseas expansion etc.
What are the benefits of understanding accounting
Accountants collect a great deal of information about an entity’s activities and then translate it into monetary terms – a language that everyone understands. The information that is collected can help non-accountants to do their job more effectively because it provides them with better information with which to make decisions. It should be noted, however, any eventual decision is still theirs.
Furthermore, all managers must be aware of the statutory accounting obligations to which their organisation has to adhere if they are to avoid taking part in unlawful acts.
Discuss the principle characteristics, together with the advantages and disadvantages, of the following types of business organisations:
i. Sole trader
ii. Partnership
iii. Limited company
Sole trader - Small business:
Advantages: Simple administration and Privacy.
Disadvantages: Tax inefficient at higher profits and Unlimited liability
Partnership - Two or more people carrying on a trade with a view to making a profit. Often professional practices.
Advantages: Simple administration and Privacy.
Disadvantages: Tax inefficient at higher profits and Unlimited liability
Limited company - An organisation owned by its shareholders whose liability is limited to their share capital.
Advantages: Tax efficient at higher profits, Shares may be bought & sold to raise finance and Limited liability.
Disadvantages: Strict rules & regulations
identify why internal management requires financial information.
The managers of businesses may need accounting information to decide whether to:
•Develop new products or services.
•Increase or decrease the price or quantity of existing products or services.
•Borrow money to help finance the business.
•Increase or decrease the operating capacity of the business.
•Change the methods of purchasing, production or distribution.
The information provided should help in identifying and assessing the financial consequences of these sorts of decisions.
Define financial accounting and Management accounting
Financial accounting: Provides information to shareholders, creditors and others outside the organisation to assist them with financial decisions
Management accounting: Provides information to internal managers in order to help them direct and control the organisation’s operations
What is faithful representation
To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent. This fundamental characteristic seeks to maximise the underlying characteristics of completeness, neutrality and freedom from error. Information must be both relevant and faithfully represented if it is to be useful.
Faithful representation means that the information included in financial statements (accounts) should be:
Complete
Unbiased (neutral)
(Reasonably) accurate (free from error)
Define Comparability
Information about a reporting entity is more useful if it can be compared with a similar information about other entities and with similar information about the same entity for another period or another date. Comparability enables users to identify and understand similarities in, and differences among, items.
Comparability allows users to understand business performance by:
Identifying similarities and differences between
- different businesses (for the same period)
- different periods (for the same business)
Define Verifiability
Verifiability: Helps to assure users that information represents faithfully the economic phenomena it purports to represent. This means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.
Assures users that (knowledgeable and independent)observers would broadly agree that faithful representation has been achieved
Define timeliness within accounting terms
Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions.
Define understandability in terms of accounting
Classifying, characterising and presenting information clearly and concisely makes it understandable. While some phenomena are inherently complex and cannot be made easy to understand, to exclude such information would make financial reports incomplete and potentially misleading. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence.
It is fair to assume that users of financial information:
have a reasonable knowledge of business and economic issues; and that they review and analyse the information carefully.
Thus, they will understand financial information.
Define Consistency
The consistency principle requires entities to treat the same item in the same way from one period to the next, or to signal and justify a change in treatment.
Accounting standards and regulations aim to enhance the consistency of accounting treatment across entities.
Define materiality
An item is material if including it or leaving it out influences a decision-maker
An item must make a difference, otherwise, it does not need to be disclosed
Materiality is subjective and will depend on several things e.g. the size of the entity.
Define money measurement
Assets and Liabilities are measured in terms of money.
Accepted as objective and reliable in reporting an entity’s performance and position
The difficulty is that not all transactions or events can be measured in terms of money and may be relevant in communicating the performance of the organisation
What is Substance over form
Substance of the transaction will take precedence over the legal form
Need to see through any superficial legal arrangement and look at the real economic effects e.g. hire purchase/leases.
