Professional, Practical, Proven

Academy 2019/2020

Subject : Financial AccountingLecture 14

Topic: Theory

Lecturer: Frank Quinn

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(1) Types of Business Entity (Sole Trader, Partnership, Limited Company)

(2) Users of Accounting Information (Managers, Investors, Lenders)

(3) Types of Accounting – Financial Accounting- Management Accounting

(4) Accountants Role and Function(5) Auditing - External Auditor

- Internal Auditor(6) Accounting ethics and scandals

Theory – Chapter 1

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(1) Types of business entity

(a) Sole Trader (b) Partnership(c) Limited company• (a) Sole trader – a business owned and operated by one person

• Advantages: – total control of the business by owner- keep all profits- easy to set up

• Disadvantages: - Unlimited liability*** • – A sole trader is liable for any debts that the business incur• - Harder to raise finance

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(1) Types of business entity

Partnership– a business owned and operated by 2 or more people

• Advantages: – Spreads the risk across more people• Partners may bring in expertise and resources

• Disadvantages: - Unlimited liability*** • – The partners are liable for any debts that the business incur• - Profits must be shared

(1)Types of Business Entity

- Limited Company – A business that is owned by its shareholders, run by directors and has limited liability.

• Advantages: – Limited Liability (Shareholders only lose what they have invested)

• Easier to raise finances

• Disadvantages: -• – Initial costs of setting a company are high• - Publishing of Accounts and Reporting requirements.

(2) Users of Accounting Information

Users Information required

(1) Investors - Interest in risk and return -Net profit, Dividends, Loans(2) Lenders - Will they get repaid ? - Net profit, Liabilities, Assets

(Security)(3) Managers - All aspects of business (Bank Balance, Profit, Sales,

Expenses)

(4) Suppliers (Payables) – Will they get paid ?,Bank Balance, Liabilities(5) Customers (Receivables) – Will company continue as a Supplier(6) Employees – Stability of the company - Profits, Company future

prospects(7) Government – Profits on Taxes, Vat payments.

(3) Types of Accounting – Financial and Management

Financial Accounting  (external users)This is the process of summarising financial information in order to prepare the company’s financial statements. The financial statements of an organisation are the Income Statement and the Statement of Financial Position.These statements are primarily of interest to external users of accounting information.

Management Accounting  (internal users) This is the process of providing detailed information to management on current and planned events. This information assists managers in their roles of planning, controlling and making decisions. Usually management accounts are only available to internal users of accounting information.

(4) – Auditing – process of examining financial information with a view to forming an opinion

•External Audit

An external audit is where an independent accountant, an auditor, examines the books and records of the company with the objective of forming an opinion and prepares an audit report that must be included in the financial statements.

If the auditors are satisfied that the books and financial statements of the company have been prepared in line with the relevant statutory requirements and professional standards, the audit report will state that the financial statements of the company gives a true and fair view of the state of affairs of the company at the end of the accounting year.

Internal Audit 

Large companies in addition to external auditors tend to have an internal audit department.

This is because in order to run a company effectively and meet their legal responsibilities, directors need assurance in a number of areas in addition to the accuracy of their published financial statements (external audit).

Internal audits help directors confirm that the internal controls and procedures of entities are adequate and working appropriately. It is becoming more expected for large companies to have internal auditors.

(5)Accounting Ethics

Ethics in accounting is of utmost importance to accounting professionals and those who rely on their services. Accounting professionals know that people who use their services, especially decision makers using financial statements, expect them to be highly competent, reliable and objective.

Whistle-blowing

A whistle blower is a person who alleges misconduct in the workplace and it covers all methods of reporting by employees of any criminal practices within their organisation.

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(6) Role of Accountant

The accountant’s role in the organisation can be analysed as follows:

1. Preparation and presentation of timely accurate financial/management accounts to management to help management interpret the financial information.

2. Identification of areas of inefficiency and wastages of resources in the business.

3. Treasury functions: The accountant also plays the role of treasury functions in such a way that they raise finance, cash management, etc.

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4. Setting up an effective system of internal and accounting controls.

5. Preparation of feasibility reports: These reports assist management in assessing the viability/profitability or otherwise of proposed capital expenditure such as the opening of a new factory or branch.

6. Investigation of the performance/operations of competing business organisations to assist management in policy formulation.

7. Investigation of fraud within the organisation, this is a key role of the accountant in preparation of an audit at year-end

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(1) Conceptual Framework(2) Accounting Concepts (Accruals, Prudence, Going Concern,

Consistency, Dual Aspect, Offsetting)(3) True and Fair View(4) Accounting Conventions (Historical Cost, Monetary

Measurement, Business Entity, Materiality)(5) Characteristics of Accounting Information (Relevance,

Reliability, Comparability, Understandability, Objectivity, Timeliness)

(6) Accounting Policies (Estimations, Measurement Bases, Selecting Accounting policies)

Theory – Chapter 2

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- A Framework that prescribes the nature, function and limits of financial accounting and financial statements.

- Coherent system of interrelated objectives and fundamental principles.

- It sets out the concepts that underlie the preparation and presentation of financial statements for external users.

(1) Conceptual Framework

Accruals Concept – Expenses and revenue are recognized whenever it is earned, regardless of when the money comes in.The rule is that you include the item if it belongs to that financial year (whether paid or not)

Prudence Concept – A cautious approach should be taken so that Gains and Assets are not overstated and Liabilities are not understated.- Gains should not be recognized until they occur or reasonably

certain they will occur (Credit Sales ?, Inventory Value ?)- In contrast, Losses should be recognized as soon as they are

foreseen and reasonably certain.

(2) Accounting Concepts – Six important concepts underpin the preparation of accounts.

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** Conflict between Accruals and Prudence concepts

- There are times when the Accruals concept and prudence concept conflict. e.g A prudence concept says that a sale should only be recognized when the cash is received or its receipt is reasonable certain.

- Accruals concept states that a sale is recognized as earned, when the transaction takes place (which is before the cash is received)

- The argument is resolved by the words “Reasonably Certain”

- Every debit has a corresponding credit.

Going Concern Concept - the financial transactions are usually prepared on the basis that the company will continue for the foreseeable future (usually 12 months).- The financial statements are prepared on the assumption that

there is no intention or necessity to close down the business.

Offsetting Concept – Assets and Liabilities are not permitted to be offset nor Income and Expenses, unless permitted by FRS 102.Consistency Concept – A business should be consistent in its accounting treatment of similar items between one accounting period and the next.

Dual Concept (duality) - every transaction should have a two sided effect to the extent of the same amount.

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In drawing up financial statements, a clear objective is that the accounts fairly reflect the true substance of the business and the results of its operation.

The concept of a “True and Fair View” is applied to the financial statements to assess whether accounts do indeed portray accurately the business activities.

(3) True and Fair View

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(4) – Accounting ConventionsMateriality Materiality is a threshold quality that is demanded of all information given in the financial statements. When immaterial information is given in the financial statements, the resulting clutter can impair the understand ability of the other information provided.

Historical CostAssets are recorded at historical cost i.e. what they were bought for. Liabilities are valued at the amount initially received in exchange for the obligation. Thus the figure shown in the financial statements for an item is the value of the item when the transaction occurred, not its current market value.

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(4) – Accounting Conventions

Monetary MeasurementAccountants do not account for items unless they can be quantified in monetary items, every recorded event or transaction is measured in terms of money.  Items like workforce skill, morale and quality of management are not accounted for.

Business EntityFinancial Accounting information relates only to the activities of the business entity and not to the personal activities of its owners.  The business accounts are prepared as though the business is an entity that is separate from its owners.

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(5) Characteristics of Information

Relevance Information should only be included in financial statements if it is relevant. Relevance is taken to mean that the information has the ability to influence the economic decisions of users.

ReliabilityThe Framework states that information is reliable if It can be depended upon by users of accounting information to faithfully represent what it either purports to represent or could reasonably be expected to represent – that is that the information is not misrepresented or misleading. That is it gives a true and fair view.

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ComparabilityIn order for financial information to be useful it must be comparable with the financial information of the business in previous accounting periods and with other businesses in the same industry.

UnderstandabilityIn order for financial information to be of any real value it must be presented to the users of accounting information in a manner that is understandable.

TimelinessThe information must be provided in a timely manner i.e. in time to influence those decisions.

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(6) Accounting policies

Accounting policies are a set of standards that govern how a company prepares its financial statements. ... These policiesmay differ from company to company, but all accounting policies are required to conform to Generally Accepted Accounting Principles (GAAP) and/or International Financial Reporting Standards (IFRS).

Accounting policies are those principles, bases, conventions, rules and practices applied by an entity that specify how the effects of transactions and other events are to be reflected in its financial statements .

Estimation techniques (allowance for receivables, depreciation)The methods adopted by an entity to arrive at estimated monetary amounts for assets, liabilities, gains, losses and changes to capital. An accounting policy specifies the basis on which an item is to be measured and where there is uncertainty, an estimation technique is used to arrive at that money value.

DisclaimerCare has been taken to ensure that all data and information in Academy lectures is factual and that numerical values are accurate. To the best of our knowledge, all information in the Academy lectures is accurate at the time of publication. Accounting Technicians Ireland and its lecturers assume no responsibility for errors or misinterpretation of the information contained in these lectures or in its use.