Lecture 1 - Purposes, Users and Content of Financial Reports

8/8/2019 Lecture 1 - Purposes, Users and Content of Financial Reports

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NBS8227 Analysis of

Company Accounts

Lecture 1 Purposes, Users and

Content of Financial Reports

By

Laurence Ferry


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Learning objectives

Explain the nature and role of accounting

Identify the main users of financial information andtheir needs

Identify the different types of business entity List the influences on preparation of financial

information

Explain the accounting equation

Explain the components making up the accountingequation

Understand the limitations of financial reports


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What is accounting?

Accounting is the process ofidentifying,

measuring and communicating financialinformation about an entity to permit

informed judgements and decisions by users

of the information


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Analysis of Company Accounts

Various types of profit making organisations

Sole trader

PartnershipPrivate Limited Company

Public Listed company


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Publicly listed companies are more heavily

regulated than private companies


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Company

law

International

accounting

standards

External

accounting

rules

Stock Exchange

Sources of accounting regulations for a UK limited

company listed on the London Stock Exchange


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Regulation is necessary due to :-

Gap between owners and preparers of accounts/ those

managing the organisation

Reliance by stakeholders as no other source of

information

Stakeholders include, shareholders, employees,

bankers, creditors, debtors, trade unions, publicinterest, government agencies, pressure groups.


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What qualities should accounting information have -

usefulness

Characteristicsthat make

financial

information

useful

Understandabilit

y

Comparability

ReliabilityRelevance

Limitation to the

application of

the qualitative

characteristics

Cost/Benefit

Necessary for

including

information in the

financial statements

Materiality


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Preparation of Company Accounts

Conceptual Framework (IASB)

Sets out general guidance about what should be reported infinancial statements

Considers the following:-

1. Users and their needs

2. Objective of financial statements (GPFR)

3. Underlying assumptions

4. Qualitative characteristics of financial statements

(understandable, relevant, reliable and comparable)

5. Elements of financial statements

6. Recognition and measurement of the elements


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Preparation of accounts

Influenced by:-

Accounting concepts

Conceptual frameworkAccounting standards

legislation


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Preparation of Accounts

The regulatory framework for accounting in the form ofAccounting standards lays out the measurement anddisclosure rules to be followed.

There are also general assumptions used in thepreparation process and these are called accountingconcepts (refer Pendlebury and Groves)

Some of the concepts are questionable and may evolve

to reflect current developments


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Accounting concepts

Accruals

matching

prudence

Money

measurement

Going concern periodicity

realisation

consistency

materiality

Cost

Entity

Preparation of accounts


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Financial Reports

Consist of:

Income statement (Profit and loss account)

which shows revenue and expenses Balance Sheet shows assets, liabilities and

shareholders equity

Cash Flow statement


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IAS 1 Presentation of Financial

Statements

According to IAS 1, the financial statements consist of:

Income Statement (Profit & Loss account)

Statement of Financial Position (Balance Sheet)

Statement of Changes in Equity Cash Flow Statement

Notes on accounting policies and other explanatory notes

The concept of fair representation

Why do you think IAS 1 says fair representation ratherthan correct or accurate presentation of the financialposition? (Hint: think of depreciation of non-currentassets)


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IAS 1 Income Statement


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IAS 1 Balance Sheet

Assets = Capital + Liabilities


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IAS 1 Statement of changes in equity


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IAS 7 Cash flow statement


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Accounting Equation

Accounts are prepared on the basis of the

accounting equation, i.e.

ASSETS - LIABILITIES = OWNERSINTEREST


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Accounting Equation- Assets

Assets

A resource controlled bythe entity as a resultof a pasttransactionfrom which future economic benefits are expectedto flowto the entity

Controlled ability to enjoy benefits and restrict othersaccess (not necessarily owned)

May be split between current and fixed (non-current)

Assets are recognised when it is probable that the economic

benefits will flow to the entity and can be measured reliably(usually at cost)


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Assets

Examples:

Land & buildings

Plant & machinery

Raw materials

Cash at bank

Classified as:

Current assets

Non-current (fixed) assets: intangibles & tangibles

Recognised in balance sheet: future economic value & measurable


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Accounting Equation

Some problems with recognition and

measurement of assets:-

o Human resource accountingo Reputation of the business

o Quality of customer base

o Tax refunds in the future


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Liabilities

A present obligation of the entity arising from

the past events, the settlement of which is

expected in an outflow from the entity of

resources embodying economic benefits

Present obligation refers to a liability to

another entity having a legal claim on the

organisation


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Liabilities

Examples of liabilities include:-

Bank loans

Trade payables

Taxation payable

Accruals Provision for deferred taxation

Long term loans

Liabilities are also classified into current and non-current, similarto assets

Liabilities are recognised in the balance sheet if it is probablethat there will be an outflow of economic benefits and theamount can be measured reliably


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Liabilities

There may be liabilities which fail the recognition test andare therefore not shown in the balance sheet (BS). It isimportant to review the notes to the Financial Reportsthoroughly for items such as contingent liabilities

Items which may not be shown in the BS are:- A commitment to purchase fixed assets after the year end

A remote liability for a defective product

A guarantee given to support a subsidiary where the

guarantee is unlikely to be called upon


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Ownership interest

Ownership interest is also known as shareholders

funds, shareholders equity.

In accounting once owners invest money it is

recorded separately. Subsequent profits earned areadded to the investment

This is the residual interest in the net assets (i.e.

assets liabilities)

Any assets acquired will either be financed by

liabilities or owners equity.


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Ownership interest

In companies the ownership interest is in the

form of shares (ordinary and preference

shares)

Naturally if net assets increase the owners

equity will increase too


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Revenue and Expenses

Revenue is created by a transaction or event duringthe ordinary activities of the entity which causes anincrease in the ownership interest. E.g. sale of stock

by a book seller will increase revenue, decrease stock Expenses is caused by a transaction or event arisingduring the ordinary activities of the business whichcauses a decrease in the ownership interest e.g.utility costs for the bookstore will reduce cash andincrease expenses


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Worked example

Books Galore provides the following information:-

The business was incorporated with 10,000 shares of 1 each fully paid incash. During the year the business borrowed 5,000 to assist inrenovations. Sales were 20,000 (debtors 5,000)

Purchases of books 10,000 (creditors 2,500). Interest paid on

borrowings was 500. Utilities were 1,000 and salaries paid 4,000.Administration costs were 2,000 all fully paid.

Required

1.What is the ownership interest at the beginning of the year when thebusiness was incorporated?

2.What is the net profit for the year?3.What is the ownership interest at the end of the year?


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Worked example cont:

1. Ownership interest at incorporation.

Using the accounting equation of A= L +OE

BALANCE SHEET:

CURRENT ASSET

Bank 10,000

OWNERSEQUITY

Issued share capital 10,000


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Worked example cont ;

PROFIT & LOSS ACCOUNT:

2. Revenue 20,000

Less Purchases (10,000)

Gross profit 10,000

Less Operating Expenses

Administration costs (2,000)

Salaries (4,000)

Interest costs (500)Utilities (1,000)

Profit for the year 2,500


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Worked example con:

3. Owners Equity at the end of the year

BALANCE SHEET:

CURRENT ASSETS

Bank 15,000

Debtors 5,000

Less LIABILITIES

Creditors (2,500)

Bank Loan (5,000)

12,500

OWNERSEQUITY

Issued share capital 10,000Profit 2,500

12,500


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Relationship between the balance sheet & income statement

Income statement 1

Balance sheet at

the end of Period 1

Balance sheet at the

beginning of Period 1

Balance sheet at

the end of Period 2

Income statement 2

TimePeriod 2Period 1


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Limitations of financial reports:

1. Basis of preparation2. Timing of release

3. General purpose, not meant for specific

purpose reporting4. understandability

Lecture 1 - Purposes, Users and Content of Financial Reports

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Transcript of Lecture 1 - Purposes, Users and Content of Financial Reports