Introduction to Accounting

The purpose of financial reporting

Financial reporting is a way of recording, analyzing and summarizing financial data.

Financial data is the name given to the actual transactions carried out by a business e.g. sales of goods, purchases of goods, payment of expenses.

These transactions are recorded in books of prime entry

The transactions are analyzed in the books of prime entry and the totals are posted to the ledger accounts

The transactions are then summarized in a trial balance and presented in financial statement

types of businesses

definitions

Sole Trader

A sole trader is an individual who undertake their business on their own. And all the risks and rewards of business belong to one person (owner).

Partnership

A partnership is where two or more persons undertake a business and all the risks and rewards of business are shared by partners.

Corporation

A corporation is a separate distinct legal “entity”, commonly known as a company. It is set up in accordance with the relevant laws (e.g. Companies Act in the UK). The most important thing about a company is that the individuals do not own the assets and liabilities of the company. The individuals are known as shareholders and are members of the company. They do not necessarily run the business: the Directors do this.

A company can either be:

Private – which means the shares are not traded publicly – “Ltd”

Public – which means the shares can be traded publicly – “plc”

Legal differences

In accounting perspective business and owners are separate and distinctive, whether it is sole trader, partnership or corporate business.

Law doesn’t recognize any difference between owners of sole traders and partnerships. Both sole traders and partners are responsible for all business liabilities and agreements. The important thing here is that the individual’s personal possessions are not protected if their business falls on hard times and they end with large debts. Their personal possession (e.g. house or car) can be used to pay off these debts. Just like sole traders, partnership’s personal and business affairs are the same and therefore have the same risk of personal possession’s being used if the business falls on hard times.

Law recognizes corporate business as a separate legal entity i.e. it can enter into legal contract in its own name. This means if the company falls on bad times, it’s the company who is liable and not the individuals, (this is also known as limited Liability for the shareholders).

advantages and disadvantages

Sole trader	Partnership	Companies
Easy to form and start business	Easy to form and start business	One has to fulfill legal requirements before starting business
All rewards(profits) of business belong to one person	Rewards(profits) of business are shared between to or more persons	Rewards(profits) are distributed among all members (shareholders)
All risk of business are born by the owner	All risks of business are shared by partners	Limited liability makes investment in business less risky
Limited finance available to expand business	Relatively more finance available for expansion and business needs.	Easier to raise finance because of limited liability and there is no limit on number of shareholders
Limited skills and knowledge available as business is owned and run by one person	Two or more people combine their skills to run business	Due to large scale operations company can afford to hire skilled people.

nature principal and scope of financial reporting

Before we look at how financial information is produced, we need to identify who are the “users”.

Financial information can be split into two elements

FINANCIAL ACCOUNTING

MANAGEMENT ACCOUNTING

Financial accounts are produced mainly for external users, and are published

It shows all transactions recorded according to all the laws and regulation, showing how much profit or loss has been made. What the assets and liabilities are, and how much cash has been generated.

These include the income statement, balance sheet and cash flow statement.

Management accounts are produced mainly for internal users.

Management information is analyzed accordingly (i.e. profitability of products or departments)

Management accounts are used mainly for decision-making purposes.

Management information aids in planning and control of the business.

Users and their information needs

There are many types of users and they need different type of information

INVESTORS AND THEIR ADVISORS

Providers of capital are concerned with the risk and return of their investment, they need information:
For decision making (i.e. buy, selling, taking up right issue and voting)
Level of dividend past, present and future and any changes in share prices
Whether the management has been running the company efficiently.
To assess the liquidity, the future prospects and how the shares compare with those of its competitors.

EMPLOYEES AND THEIR REPRESENTATIVES

Security of employment and future prospects for jobs in the company
To assess the ability to provide remuneration retirement benefits and employment opportunities

LENDERS (E.G. BANKS)

Whether loans and interest repayments are secured and will be paid when due
Suppliers and other trade creditors customers
Whether amounts owing will be paid when due, continuance of entity is important for long term involvement with, or dependence, on the enterprise

GOVERNMENT AND THEIR AGENCIES (E.G. TAX AUTHORITIES)

Allocation of resources and information to regulate activities, determine taxation policies and general contribution to the economy.

PUBLIC

Contribution to local economy including number of employees and patronage of local suppliers.
Trend and recent developments in prosperity and range of activities

MANAGEMENT

To plan, make decision and control operational activities.

suppliers and other trade customers

Whether amount will be paid when due

customers

Continuous – important for long term involvement with, or dependence on, the enterprise