Purpose of financial
accounting
UNIT 1
Unit 1 → Syllabus
Definition of financial accounting (P – 31) –
purposes of financial statements for the users
(P – 32) – conceptual framework (P – 38) –
main elements of financial reports (P – 42) –
definitions of asset, liability, equity, income &
expenses (P – 42)
.
Financial accounting
→ Production of financial statements for external users
→ Directors’ stewardship
→ Investors can choose which companies to invest & compare their
investments
To facilitate comparison, financial accounts are prepared using accepted
accounting conventions and standards.
International Accounting Standards (IAS® Standards) and International
Financial Reporting Standards (IFRS® Standards) help to reduce the
differences in the way that companies draw up their financial statements
in different countries.
The financial statements are public documents, and therefore they will not
reveal details about, for example, individual products’ profitability.
The main users (stakeholders) of Financial Statements are
1. Investors & Potential Investors
→ future profit estimated from target entity’s past
performance (SOPL)
→ the security of their investment → strength & solvency
(SOFP)
→ the largest and most sophisticated groups of investors →
Institutional investors (pension funds & Unit Trusts
2. Employees & Trade union reps
→ secure employment & possible pay rise
→ interest in salaries & benefits of senior management
→ divisional profitability → if a part of the business is threatened
with closure
3. Lenders
→ assurance of repayment
→ solvency (SOFP)
→ the value of the secured assets (in SOFP)
4. Government
→ to know the performance of economy (plan financial &
industrial policies)
→ Tax authorities
5. Suppliers
→ to get assurance of payment
→ new suppliers → know the financial health before supply of
goods
6. Customers
→ continuity of supply
→ specialised supplies
7. Public
→ wish to assess the effect of entity on
● Economy
● Local environment → employment generation
● Local community → patronising local suppliers
CSR activities (ex: supporting recycling schemes)
8. Management and competitors
→ use FS for economic decisions
→ Management uses MA a/c info. for decision making
→ competitors access publicly available info.
OVERALL
Users of FS need info, which is relevant and reliable to
● Assess management’s stewardship of resources →
control & manage
Conceptual Framework
The Framework presents the main ideas, concepts and principles upon which
all International Financial Reporting Standards, and therefore financial
statements, are based. It includes discussion of:
• the purpose of the Framework
• the objectives of financial reporting
• the qualitative characteristics of useful financial information
• the definition, recognition and measurement of the elements from which the
financial statements are constructed
• the accruals and going concern concepts, and
• the concepts of capital and capital maintenance (not on the syllabus).
The purpose of the Framework
→ To assist the IASB in the development of financial reporting
standards
→ To assist preparers of financial statements to develop
accounting policies when reporting standards do not provide sufficient guidance, or where
there is a choice of accounting policy. It is also a useful
→ Useful reference document to assist in understanding and
interpreting reporting standards.
The objective of financial reporting
→ To provide financial information about the reporting entity to
users of the financial statements.
Qualitative characteristics of useful information
Attributes that make information provided in financial statements
useful to others Qualitative
Characteristics
Fundamental Enhancing
Faithful Understandabi
Relevance Representation
lity
Verifiability
Comparability Timeliness
Elements of Financial Statements / Reports
1. Asset → A present economic resource controlled by the
entity as a result of past events (para 4.3).
Economic resource – A right that has the potential to
produce economic benefits (para 4.4)
2. Liability → A present obligation of the entity to transfer an
economic resource as a result of past events. (para 4.26).
3. Equity → 'Residual interest' in the assets of the entity after
deducting all liabilities.
→ Repayable to the shareholders/owners when the business ceases to
trade.
4. Income
Assets Liabilities → equity
Ex: Earning sales revenue through increase in value of an asset.
5. Expense
Assets Liabilities → equity
Categorisation of assets, liabilities and equity
in the financial statements
There are some additional rules with regard to the classification
of assets and liabilities
Relate to the length of time they will be employed in the
business.
