1. Chapter 1 – Purpose of financial statements Introduction to limited companies Limited companies Financial statements and their purposes Limited company financial statements: interested parties Elements of financial statements The accounting equation The regulatory framework of accounting Conceptual framework for financial reporting Accounting concepts

2. Background knowledge: Units in accounting preparation 1 and sole trader & partnership accounts took you from ledger accounts to a trial balance, then through to the extended trial balance On the extended trial balance you put through a number of adjustments for inventories, accruals, prepayments, depreciation and irrecoverable / doubtful debts Each account on the extended trial balance was then balanced and extended into either the income statement columns or the statement of financial position columns depending upon whether the balance was income, expenditure, an asset or a liability For this unit your accounting knowledge must be taken further

3. Limited companies are incorporated businesses that trade as entities, rather than individuals, like sole traders or a group of individuals like partnerships do This unit involves the drafting of the relevant financial statements for limited companies You must be able to prepare a; statement of profit or loss and other comprehensive income (measures the performance of the company for a specified time period) statement of financial position (reports the financial position of the company at a point in time) statement of cash flows (links profit with changes in assets and liabilities, and shows the effect on the cash of the company)

4. ‘The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity’ The above definition is taken from the ‘Conceptual Framework for Financial Reporting’ (IASB), note the following from the definition; general purpose financial reporting (provides financial information about the reporting entity) financial information (is given about the financial position, performance and changes in financial position of the reporting entity) entity (an organisation (such as a limited company, whose activities and resources are kept separate from those of the owners) existing and potential investors, lenders and other creditors (financial statement are used by a number of interested parties) making decisions (information from the financial statements is used to help in making decisions about investment or potential investment in the entity )

5. Interpretation of financial statements: The unit also involves interpretation of limited company financial statements The unit requires the analysis and understanding of the structure and purpose of financial statements of limited companies It requires a sound understanding of the knowledge and skills required to prepare financial statements and an ability to interpret the relationships between these elements of financial statements by using ratio analysis In order to understand and interpret limited company financial statements you must be able to understand how they have been prepared Therefore your knowledge of accounts preparation 1 and sole trader & partnerships will assist in the understanding of how the financial statements of limited companies are prepared

6. Stewardship Financial statements also show the results of the stewardship of an organisation Stewardship is the accountability of management for the resources entrusted to it by the owners or the government This applies to the financial statements of limited companies as well as to central and local government and the National Health Service

7. Needs of users, All users of financial statements need information on financial position, performance and financial adaptability, however many different groups of people may use financial statements and each group will need particular information Users of financial statements may include investors, management, employees, customers, suppliers, lenders, the government and the public investors need to be able to assess the ability of a business to pay dividends and manage resources management need information with which to assess performance, take decisions, plan and control the business lenders, such as banks, are interested in the ability of the business to pay interest and repay loans HMRC uses financial statements as the basis for tax assessments

8. The five main elements of financial statements are; _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

9. The five main elements of financial statements are used here; _ _ _ _ _ _ MINUS _ _ _ _ _ _ _ _ EQUALS _ _ _ _ _ _ OR _ _ _ _ _ _ _ _ _ _ MINUS _ _ _ _ _ _ _ _ _ _ _ EQUALS _ _ _ _ _ _ _ _

10. UK domestic accounting standards Financial Reporting Standards (FRSs) Statement of Standard Accounting Practice (SSAPs) Financial Reporting Council (FRC)

11. International financial reporting standards International Financial Reporting Standards (IFRSs) International Accounting Standards (IASs) International Accounting Standards Board (IASB)

12. The purpose of using accounting standards are; to provide a framework for preparing and presenting financial statements (the ‘rules’ of accounting) to standardise financial statements to reduce the variations of accounting treatments (window dressing) to help to ensure high quality financial accounting for users through the application of the qualitative characteristics of useful financial information to enable compliance with the Companies Act and audit requirements to allow users of financial statements to make inter-firm comparisons in the knowledge that all the financial statements have been prepared using the same standard

13. The law requires limited companies to prepare financial statements annually These financial statements must be filed with the Registrar of Companies and are then available to all interested parties Most businesses, whether incorporated or not, are required to produce financial statements for submission to HMRC In the UK, the form and content of limited company accounts is laid down within the Companies Acts(1985, 1989 & 2006) The preparation of limited company accounts is also subject to regulations issued by the Accounting Standards Board (if the company is still following UK standards) or International Accounting Standards Board (if the company has adopted international standards)

14. The financial statements of limited companies must usually be prepared within the legal framework relevant to that company In the case of UK companies, the Companies Act 2006 contains guidance and rules on, formats for the financial statements fundamental accounting principles valuation rules The Companies Act 2006 allows companies to use the format of accounts set out in IAS 1 (revised) Presentation of Financial Statements if they have adopted IFRS or continue to use the format in the Act if they have not

15. The ‘Conceptual Framework for Financial Reporting’ has been developed by the IASB Although not an accounting standard, it sets out the concepts that underlie the preparation and presentation of financial statements for external users, Its purpose is to; assist in the development and review of international financial reporting standards assist in promoting harmonisation of standards by reducing the number of permissible alternative accounting standards help preparers of accounts to deal with issues not yet covered by the standards help users of accounts to interpret the information in financial statements which have been prepared in accordance with the standards

16. The qualitative characteristics identify the types of information that are likely to be most useful to users of financial statements for making decisions The ‘Conceptual Framework for Financial Reporting’ identifies; fundamental qualitative characteristic  relevance  faithful representation enhancing qualitative characteristics  comparability  verifiability  timeliness  understandability Now review the diagram on page 16

17. There are a number of accounting concepts which form the ’bedrock’ of the ‘preparation of financial statements’ Some are included in the ‘Conceptual Framework for Financial Reporting’, while others are discussed further in IAS 1 (Presentation of Financial Statements) business entity materiality going concern accruals

18. In previous years going concern, consistency, prudence and accruals were known as the ‘four fundamental concepts’ and were to be considered in preparing accounts In recent times, only going concern and accruals are seen as being key accounting concepts Prudence is less important now as excessive prudence in accounting can cause financial statements to misrepresent the true picture (consider a company that makes large non specific provisions, this would misrepresent the true results for the period as the profit should have been higher had the provisions not been made) Consistency in terms of accounting means to use the same method and policies year on year, this would not necessarily be relevant if a business changed its key operations and needed to change its method of accounting to reflect this