Transcript Personal Taxation - Abingdon and Witney College

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
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
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)
‘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)
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
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
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
The five main elements of financial statements are;
______
___________
_____
______
________
The five main elements of financial statements are used here;
______
MINUS
________
EQUALS
 _ _ _ _ _ _ OR _ _ _ _
______
MINUS
___________
EQUALS
________
UK domestic accounting standards
Financial
Reporting Council
(FRC)
Statement of Standard
Accounting Practice
(SSAPs)
Financial Reporting
Standards (FRSs)
International financial reporting standards
International
Accounting
Standards Board
(IASB)
International
Accounting Standards
(IASs)
International Financial
Reporting Standards
(IFRSs)
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
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)
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
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
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

enhancing qualitative characteristics
 relevance
 faithful representation
 comparability
 verifiability
 timeliness
 understandability
Now review the diagram on page 16
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
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