1. Accounting standards

• What is accounting? Accounting is the process of identifying, measuring, and communicating financial information to allow users of the information to make informed decisions about a company
• Why is financial reporting highly regulated? -Financial reporting is highly regulated to allow investors to easily compare the performance of different companies to decide on investments -Financial reporting is also highly regulated to make financial reporting more cost-effective and efficient for companies to carry out
• What are the two main sets of accounting standards? Where are they used in the world? The two main sets of accounting standards are: -The International Financial Reporting Standards (the IFRS)- which are used internationally in regions such as the EU -The USA’s Generally Accepted Accounting Principles (GAAP)- which are used for companies within the USA
• Explain how the US GAAP works -The US GAAP are the accounting standards used by companies within the USA -The US GAAP set out strict rules for companies to follow when creating financial reports, and the rulebook is around 25,000 pages long
• Explain how the IFRS works -The IFRS are the accounting standards used by international companies, particularly within the EU -Unlike the US GAAP, the IFRS are principles-based and give general guidance for companies to follow when producing financial statements rather than prescribing strict rules for companies to follow
• What does the IFRS conceptual framework set out? The IFRS conceptual framework sets out: 1. The key objectives of financial reporting 2. The key user groups of financial reporting 3. The key financial statements which companies should produce 4. The fundamental concepts, principles, and conventions that financial reports should follow
• What are some of the main user groups of financial reports? Some of the main user groups of financial reports include: -Current and potential investors in companies -Commercial banks and other creditors to companies -Suppliers -Past and present managers & employees -Trade unions Etc.
• What are the three primary financial reports companies create/use? The three primary financial reports that companies create are: 1. The statement of financial position/the balance sheet 2. The statement of profit and loss 3. The statement of cash flows
• Explain the statement of financial position -The statement of financial position (or balance sheet) is prepared on a regular basis, and is a snapshot of a business’ current financial position -The balance sheet shows a company’s assets, liabilities, and the owner’s equity- and is thus based on the accounting equation: assets = liabilities + equity
• What are assets? Where are they shown? -Assets are items that a firm owns that generates them economic benefit -Assets are shown on the balance sheet of a company
• What are liabilities? Where are they shown? -Liabilities are items or amounts that a firm owes to other companies or individuals -Liabilities are also shown on the balance sheet of a company
• What is equity? Where is it shown? -Equity consists of money invested into the company by its owners (known as share capital) and retained profits -Equity is shown alongside liabilities on the balance sheet of a company
• What does the statement of profit and loss show? What is it based on? -A statement of profit and loss shows how much a company earned or lost within a given accounting period -Statements of profit or loss are based on commercial substance- i.e., the raw revenue and costs of the company- rather than cash flows
• Explain what the statement of cash flows shows -The statement of cash flows shows cash flow going in and out of the business for a given accounting period -Cash inflows consist of monies coming into the business- and include sales revenue & bank loans etc. -Cash outflows consist of monies going out of the business- and include wages & payment to suppliers etc.
• Explain the entity concept -The entity concept means that the financial statements of a company cover the financial activities of that company only -This means that the finances of the owners and their companies are kept separate
• Explain the going concern assumption -The going concern assumption means that managers prepare financial statements with an assumption that the company will continue to operate for the foreseeable future -This means that the company will not cease operations or be liquidated in the foreseeable future
• Explain the historical cost convention The historical cost convention means that only items capable of being measured in monetary value are included in a company’s financial statements
• Explain the accrual principle -The accrual principle applies to a company’s revenue and costs -For the company’s revenue, the accrual principle means that revenue should be recognised the moment it is earned, not when it is received -For the company’s costs, the accrual principle means that costs should be recognised the moment they are incurred, not when they are paid for
• What is the main aim of financial accounting? The main aim of financial accounting is to allow creditors and investors to make informed decisions regarding a company’s finances
• What are the characteristics of financial accounting? -Financial accounting is inherently backward-looking and only looks at historical financial data of a company -The key users of financial accounting are investors and creditors (among others) hence the key users are outside of the firm -Financial reports are highly standardised and regulated, and are published according to a regular schedule decided by the company
• What is the main aim of management accounting? Management accounting aims to apply the financial data of a company to inform managerial decision-making
• What are the main characteristics of management accounting? -Management accounting is inherently forward-looking and aims to help managers make decisions for the future -The key users of management accounting are managers of companies, hence the key users are inside of the firm -Reports in management accounting are free form and unregulated, and are created when needed (they are not published on a strict schedule)
• What is internal auditing used for? -Internal audits are used to control a company’s recordkeeping, and are used to safeguard company assets -Internal audits are also carried out to deter, prevent, and detect fraud within companies
• What do external auditors do? When are external auditors required? -External auditors provide a true, fair, and unbiased opinion regarding the financial statements of a company -External auditors ensure that financial statements follow accounting standards and regulatory requirements by reviewing the work of internal auditors -It is mandatory for publicly traded companies to be externally audited
• What are sole traders? Explain the key principles of sole traders -Sole traders are individuals who work for and/or by themselves -The personal and business accounts of a sole trader are kept separate for accounting and tax purposes -However, a sole trader does not have a separate legal identity from the business they run; therefore, they are solely responsible for the debts, taxes, and liabilities of a company- which is known as unlimited liability
• What are partnerships? Explain the key principles of partnerships -Partnerships are very similar to sole traders, except they consist of between 2 and 20 people -Each partner owns a set percentage of the business, but all partners are jointly responsible for the debts, taxes, and liabilities of a company- thus unlimited liability still applies
• What are limited companies? -Limited companies are companies that have a separate legal identity from their owners -Shareholders appoint boards of directors to run limited companies, and the shareholders are not responsible for the debts, liabilities, and taxes of the company- hence they have limited liability
• What is the difference between private and public limited companies? -Private limited companies have their shares held privately, and shares are sold privately -Public limited companies have their shares traded on public stock exchanges
• Why do businesses keep financial records? -Financial records are kept to inform managerial decision-making using data regarding cash flows, assets, and liabilities -Financial records are also kept to file for tax returns -Financial records are also kept to support a company’s application for bank loans and other sources of credit