Financial Accounting
1. Financial accounting is concerned with the production of financial
statement for external users.
2. These are a report on the directors statements of the funds
entrusted to them by the shareholders.
3. Investors need to be able to choose which companies to invest in
and compare their investments.
4. The Financial statements are Prepared using accepted accounting
conventions and standards.
➔ Investors and potential investors are interested in their potential profits and the
security of their investment.
➔ Employees and trade union representatives need to know if an employer can
offer secure employment and possible pay rises.
➔ Lenders need to know if they will be repaid. This will depend on the solvency of
the entity, which should be revealed by the statement of financial position.
➔ Government agencies need to know how the economy is performing in order to
plan financial and industrial policies. The tax authorities also use financial
statements as a basis for assessing the amount of tax payable by a business.
➔ Suppliers need to know if they will be paid. New suppliers may also require
reassurance about the financial health of the business
➔ Customers need to know that an entity can continue to supply them into the
future.
➔ The public may wish to assess the effect of the entity on the economy, local
environment and local community.
Types of Business Entity
• Sole trader • Partnerships
• This is the simplest form of business • The key distinction with
where a business is owned and sole trader is that, there
operated by one individual. are at least two owners.
• Although it might employ any number
• Similar to a sole trader
of people.
the owners of a
• No legal distinction between the owner partnership receive all
and the business. the profits and have
• That is, owner receives all of the unlimited liability for the
profits of the business but has losses and debts of the
unlimited liability for all the losses and business.
debts of the business.
LIMITED LIABILITY COMPANY
• Limited liability companies are established as separate legal entities to
their owners (incorporation).
• The shareholders are not personally liable for the debts of the company.
• Limited liability companies are managed by a board of directors who are
elected by the shareholders.
ELEMENTS OF FINANCIAL STATEMENTS
• Asset • Liability
• A present obligation of the entity
• A present economic resource
• To transfer an economic resource
• Controlled by the entity
• As a result of past events
• As a result of past events
• Income • Expense
• This consists of the increases in • This consists of the decreases in
assets or assets or
• decreases in liabilities • increases in liabilities
• that result in increases in equity • that result in decreases in equity
• Equity
• This is the residual interest in the assets of the entity after
deducting all liabilities.
• Asset – Liability = Equity
ASSETS
• Non Current Assets • Current Assets
• Not expected to be realised • Expected to be realized within
within twelve months after the twelve months after the
reporting date. reporting date.
• Examples are Land and buildings, • Examples are Inventory,
Motor vehicles, Plant and Receivables, and Cash
Machinery.
LIABILITIES
• Non current liability • Current liability
• Payments can be deferred • Payment is due to be settled
unconditionally for more within twelve months after
than twelve months after the the reporting date.
reporting date
• Trade payables, bank
• Loans overdraft, short term loans
TYPES OF FINANCIAL STATEMENTS
• Statement of financial Position (SOFP)
• Statement of profit or loss (SOPL)
• Statement of changes in equity (SOCIE)
• Statement of Cash flows
• Notes to the financial statements
QUALITATIVE CHARACTERISTICS
• Fundamental Qualitative characteristics
• Relevance (Timeliness, Materiality)
• Faithful Representation (Completeness, Free from bias, free from Error)
• Enhancing Qualitative characteristics
• Comparability
• Verifiability
• Timeliness
• Understandability
IMPORTANT ACCOUNTING CONCEPT
• Materiality
An item is regarded as material if its omission or misstatement is likely to change the
perception or understanding of the users of that information
• Substance over form
If information i
s to be presented faithfully, the economic reality must be accounted for and not just the
strict legal form.
• The going concern concept
Financial statements are prepared on the assumption that the entity is a going concern,
and will continue to operate for the foreseeable future. (More than twelve months)
• The business Entity Concept
From an accounting perspective the business is treated as being separate from its
owners.
• The accrual basis of accounting
This means that transactions are recorded when revenues are earned and when
expenses are incurred. This pays no regard to the timing of the cash payment or
receipt.
• Prudence
Preparers of financial statements should exercise prudence when preparing financial
statements. Assets and income should not be overstated whilst liabilities and expenses
should not be understated.
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