Framework of Accounting

Aims of the Session Users of financial statements. Framework of accounting – Comprises accounting principles Accounting policies Ethical principles Application of ethical principles when preparing financial statements.

Users of Financial Statements Owners or potential owners. Potential investors. Suppliers. Employees. Customers. Government agencies. The public. Owners or potential owners. Potential investors. Suppliers. Employees. Customers. Government agencies. The public.

Why Would the Users Use Them? Profitability. How much money can be taken out or paid out. Value of the business. Can finance charges be covered. Asses how much of the business is funded by debt. Should the supplier supply? Is the business realistically a going concern? Can we be paid more? Will the business continue to supply goods/services. Tax calculations. Is the charity being run correctly? Contribution to the economy as a whole.

Framework of Accounting Consists of 3 main areas: Accounting Principles Accounting Policies and Characteristics Ethical Principles Accounting Principles Business entity Materiality Going concern Accrual basis Accounting policies and characteristics Application of accounting policies Fundamental qualitative characteristics Supporting qualitative characteristics Ethical Principles ICPOP

Underlying Assumptions of Accounting Principles Accounting principles ensure that records and statements that are prepared are relevant and reliable, are comparable and understandable. Financial statements and records can be used for: Internal control. Measuring business performance (comparability). Obtaining credit and financing. Statutory requirements.

Accounting Principles – Business Entity What does this mean? Only report on the activities of one particular organisation. Personal assets/liabilities of the owners are kept separate. Main links are drawings and capital.

Accounting Principles – Materiality Does the amount make a difference to the decision making? Will a £1000 error make a difference to a company with a turnover of £1 million? But if the turnover was £50,000 then it may. Materiality needs to be relevant to the business. Material misstatement the consequences: Profit is overstated Assets are overvalued Profit is understated Sales turnover is overstated Encourage investors to buy a stake when they shouldn’t Lender may find that the security of the loan is less than expected Lower amount of tax if paid to HMRC – also think of Starbucks and Apple – public perception More tax paid to HMRC.

Accounting Principles – Going Concern Is the business viable for the next 12 months? Assets will be valued differently if not. Limited use of assets such as purpose built factory, extra depreciation charged think of BHS

Accounting Principles – Accrual Accounting Income and expenditure relate to the correct accounting period. Accruals and prepayments from accounts prep. Examples are: Accruals Prepayments Provisions for doubtful debts Cost of inventory

Accounting Policies & Characteristics These are the policies that a business uses to show the effect of financial transactions: Depreciation They need to be relevant and need to aid the faithful representation. Supporting qualitative accounting characteristics: Comparability Verifiability Timeliness Understandability

Ethical Principles in Preparing Financial Statements Integrity Confidentiality Professional behaviour Objectivity Professional competence and due care Financial statements should not contain false or misleading information figures or statements, or omit or obscure information to be misleading. Confidentiality – nothing is disclosed without the client’s permission Professional behaviour – prepares financial statements in an honest and truthful way and in accordance with relevant laws & regs. Objectivity the accountant is not unduly influenced by owners who may want to manipulate the profit figures. Professional competence and due care – ensuring CPD is up to date.

Lesson Recap Users of financial statements are: owners, lenders, employees. Accounting principles: business entity, going concern, accruals and materiality. Policies and characteristics: verifiable, comparable, timely and understandable Ethical principles: integrity, confidentiality, professional competence & due care, objectivity, professional behaviour.

Exercises