1 – Introduction to Financial Reporting
2 Definition of AccountingAccountancy is the art of communicating financial information about a business entity to users such as the owners of the business and the government Definition: the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information – Accounting information is communicated using “financial statements” Report of the Financial Position - (SOFP) Show how the entity has performed over a particular period of time (SOCI)
3 Financial Accounting(External Users) v Management Accounting (Internal Users)-Financial Management: process by which accounting information is collected, reported, interpreted and actioned Key Objectives Create Wealth for the Entity Generate Cash Provide an adequate return on investment bearing in mind the risk profile
4 Main Financial Accounting StatementsStatement of Comprehensive Income (SOCI) Statement of Financial Position (SOFP) SOFP - think camera!!!! SOCI – Measures profit – Profit is the amount by which sales revenue (aka turnover or income) exceeds expenses (or costs) for the period being measured
5 TYPES OF BUSINESS ENTITYSOLE TRADER PARTNERSHIP LIMITED COMPANY (PRIVATE AND PUBLIC)
6 Types of Business Entity – Sole TraderSole Trader: a business owned and operated by one person Owner is personally liable for the debts of the business Profits taxed as a self employed person Main Adv’s of Sole Trader Total Control – Cheap and easy to start up – limited form filling – set up bank account and register with Tax Authorities No obligation to produce a set of published financial statements – business affairs are kept private 100% of profit can be retained
7 Types of Business EntityLegal Requirements of a Sole Trader Answerable to Tax Authorities For Income Tax and if applicable, VAT Consumer Protection Law (Sale of Goods Act) Main Disadv’s of Sole Trader Unlimited Liability – sole trader is liable for any debts that the business incurs – no separation Taxed on Income Tax rates which are higher than corporation tax rates Difficult to raise finance – bank unwilling to lend Can be difficult to enjoy economies of scale Problem of continuity if sole trader retires or dies
8 Types of Business Entity - PartnershipA business where there are 2 or more owners of the enterprise – accountants, doctors A partnership is normally set up using a deed of partnership Main Adv’s of a Partnership Spreads the risk across more people – burden sharing Partner may bring money and resources to the business New Partner may inject new skills and ideas to the business Increased credibility with customers and suppliers (dealing with a partnership less risky than dealing with a sole trader)
9 Types of Business EntityPartnership Main Disadv’s of a Partnership Have to share profits Less control of the business for the individual Problems if partners disagree over the direction of the business Adv’s of a Partnership v Private Limited Company Costs to set up a limited company Company a/c’s are filed so the public can view them (and competitors) May need to engage the services of an auditor – cost!!
10 Types of Business Entity – Limited CompanyOwned by shareholders (aka members), run by directors, liability is limited Limited liability: investors can only lose the money they have invested and no more – no claim on personal assets – company is a “separate legal entity” from its shareholders Must be registered with “Registrar of Companies” (CRO) Memo & Articles of Association Must prepare annual statutory(published) accounts (unlike sole trader & partnership) Public Limited Co v Private Limited Co
11 Types of Business EntityDisadv’s of Being a Public Limited Company Costly to set up as a Plc Loss of Privacy as certain financial info must be available to all parties – e.g. EPS Shareholders have an expectation of Dividends Threat of Takeover - Why shareholders buy shares?
12 Types of Business EntitySome Terminology relating to Public Limited Companies Flotation – to float on the stock market Corporate Governance – Agency relationship between directors and shareholders
13 Users of Financial StatementsN.B. :Main Users Groups – Management – Use the Financial Statements for decision making Payables/Suppliers – Assess the short term liquidity of the business Employees – info about the stability and continuing profitability of the business Analysts - for company quoted on the stock exchange, detailed financial and other info is required Receivables/Customers – customers will want to know if the business will continue trading as going concern Lenders – ability to repay loans (capital and interest) Public at large – e.g. environmental policy etc. Investors – risk and return for their investments Government – Rev Comm (Corp Tax, VAT) Environment Agency (Grant Provision) Memory Aid - “M PEARL PIG”
14 Elements of Financial StatementsAssets: A resource controlled by an entity as a result of a past event from which future economic benefits are expected to flow to the entity Liabilities: An obligation to transfer economic benefit as a result of a past event Equity: The residual interest in a business when liabilities are subtracted from assets Income: Inflow of economic benefit during the reporting period Expenses: Outflow of economic benefit during the reporting period
15 Financial Accounting v Management Accounting – Memory Aid – “PULPS”Prepared Annually Prepared Monthly Use - Summary FS – External Use Internal Use – Used by Mgt to Control & Run the business Laws - Required By Law Not Mandatory Profiles past performance & current Position - Camera!!! Included Budgets and Forecasts of Future Activities as well as past performance Structure - - Info presented in accordance with accting stds No set structure
16 Accounting TerminologyStatement of Comprehensive Income= Net Profit/Net loss Gross Profit: Sales – Cost of Sales Net Profit: Gross Profit less expenses Sales (turnover, revenue): Both cash and credit Purchases: bought to be resold (as opposed to say TNCA) Income: Sales + Other Income (i.e.. Interest received and rental income) Expenses : Purchases + Other Costs like wages, light & heat
17 Accounting TerminologySTATEMENT OF FINANCIAL POSITION SOFP (Current Position – Taking a Photo of the Business at a Given Date i.e. year end) Assets: Anything of value that the business owns (non current & current and tangible/intangible) Liabilities: Anything a company owes to people or other businesses , other than its owners) is considered a liability (current & non current liabilities) Owners Equity(aka capital) : Money that the business owes to its owners – tricky concept – not technically a liability but the same treatment essentially Drawings: Money or Goods taken out of the business for the owners own use – treated as a reduction in Owners Equity in the SOFP – NOT A BUSINESS EXPENSE IN THE SOCI
18 Accounting TerminologyStatement of Changes in Equity: Summarises the Movement in Equity Balances Statement of Cash Flows: Summarises the cash physically paid and received throughout the reporting period The Notes: Accounting policies disclosures and any other disclosures required
19 Qualitative Characteristics of Financial InformationRelevance: Information must be relevant to the decision making needs of users. Faithful Representation: Information in Financial Statements is reliable when it is free from material error and the information provides a faithful representation of what it is supposed to represent Materiality: Materiality provides a threshold or cut off point.
20 Qualitative Characteristics of Financial InformationNeutrality: to be reliable, the information in the financial statements should be neutral, that is, free from bias. Completeness: to be reliable, financial information should be complete Prudence: Used where there are elements of uncertainty surrounding transactions or events. avoid overstating the value of assets or the amount of income or avoid understating the amount of a liability or the amount of an expense
21 Qualitative Characteristics of Financial InformationComparability: The information in the financial statements for one year should be capable of comparison with previous years (trend analysis) Understandability: Information in Financial Statements must be readily understandable to users
22 Other Important Accounting ConceptsAccruals: Recognise revenue when earned and expenses when incurred (as opposed to when received/paid) Business Entity: From an accounting perspective, the business is treated as being separate to its owners Going Concern Accounts are prepared on the basis that the entity will continue to trade for the “foreseeable future” (12 months from the reporting date)
23 Chapter Highlights Definition of Accounting 3 Types of Business EntitySole Trader, Partnership, Limited Company Users of Financial Information - “PEARL PIG” Elements of Financial Statements Qualitative Characteristics of Financial Information