1 Introduction to the Accounting World PDF PDF

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1 Introduction to the Accounting World Textbook Definition: Summarises numerical data relating to past events and represents this data as information to managers and other interested parties as a basis for both decision making and control purposes. Definition: The process of identifying, measuring and communicating financial information about an entity to permit informed judgements and decisions by users of the information. How does Accounting help with Accountability? • Presenting accounts describes how company directors have looked after the money and other resources that have been entrusted to them and how they have used that money to invest and generate income for shareholders. • If shareholders are happy with their directors’ performance, they will not reappoint them as directors of their company or elect others to replace them with the expectation the new directors will manage their investment more carefully and profitably. Role of Accounting in Decision Making • Since businesses run to make a profit, they need to make decisions on a daily basis that lead towards achieving this profit aim. • Since accounting communicates financial information to the different departments, this makes accounting at the heart of each decision to make sure decisions are made profitably. • Accountants have to ensure they provide accurate and up to date information to make the most effective decisions that are profitable. - Eg. Accounting department tells the marketing staff what product costs to make and the selling price set in order to generate a profit on each sale. Qualities Accounting Information should Possess 1. Comparability • Should be able to compare information over time. • The same items should be presented in the same way in financial statements over different financial periods. • Presentation of items should be consistent across periods. 2. Understandability • Financial information should be presented in a way that those making use of it can understand what it represents. • Users of the reports should have sufficient knowledge of business and economic events in order to make sense of what they are presented with. 3. Relevance • Information must be able to influence economic decisions otherwise there is no point in producing the information. • Information may be used to predict and assist users in making predictions about the future or it may confirm the accuracy of past predictions. • The more accurate past predictions have been, the more likely it is for users to rely on current predictions of future profits. • Information must be timely to be relevant because it has to be presented quickly enough for users to use it in making economic decisions. 4. Reliability • Free of significant error or bias. • Information is reliable if it can be dependent upon to represent faithfully the transactions or events it claims to represent.

5. Materiality • Should not be overloaded with unnecessary detail. • Information should not misrepresent the truth as it could influence the economic decisions of users taken on the basis of financial statements. 6. Cost v Benefit • Information should only be presented if the benefits of providing this information outweigh the costs of obtaining it. Types of Accounting 1. Financial Accounting Definition: Provides information about the financial position (balance sheet), financial performance (income statement) and cash flows (cash flow statement) of an entity that is useful to a wide range of users in making economic decisions. Functions • Putting together financial statements. • Recording transactions such as paying expenses, revenue, assets, liabilities and equity. • Processing the way the recorded data is turned into financial information. • Presenting financial statements such as Statement of Profit or Less (Income statement), Statement of Financial Position (balance sheet), Statement of Cash Flow. • Financial statements provide a basis upon which questions are asked. - Eg. Investors ask about the ethical and environmental record to see whether the entity is an organisation they would want to invest in. External Users of Financial Statements Investors & Advisors

• Financial gains and profit made from the company. • Whether its worth investing more money into the share of the company based on their performance. • Whether its worth selling shares if the company has done well or the prospect of the company doing even better if you keep your shares.

Employees & Representative Groups (Trade Unions)

• • • • • •

The stability and so job security of the company. Whether the company is making a profit. If making losses, is it likely I will remain in the company in the near future? To look for employment elsewhere. Pay rise or bonuses if the company is making a profit. Retirement benefit scheme company offers to employees.

Lenders (Banks)

• • • •

Is it realistic the company can repay what it has been lent? Will the company be able to pay loan instalments and interest when it’s due? Is the company at risk of bankruptcy (insolvency)? What cash resources does the company have.

Suppliers & Other Trade Payables

• Whether they are being paid for the goods they have supplied so the same trade credit deal can continue. • Whether they are paid on time so they can pay their suppliers. • Will the customer company expand so there is prospect of expanding too.

Customers

• Will the entity survive long term so it can continue to provide goods and services to meet my needs?

Government

• The taxation the entity has to pay. • The contribution the entity makes to the economy. • Whether the entity exports goods to other countries.

Public

• Contribution the entity makes to society. • Whether the entity will survive to contribute to the local economy. • What the entity provides to the local community - employment, environmental issues?

Competitors

• To spot and make improvements on what the competitors can do that the current entity is not. • Where the weak spots of competitors are to use them to their advantage in terms of increasing market share.

Why Statement of Cash Flow is Important • Accrual Concept: Recognise transactions when they occur not when cash is received or paid. • Statement of financial performance will not tell us how much cash is coming in so we need cash flow statement so users know the availability of cash. • Availability of cash tells us whether we can pay dividends, salaries, loan interests, credit, taxes so is relevant to all external users. 2. Management Accounting Definition: The application of accounting and financial management principles to create, protect, preserve and increase value to deliver that value to stakeholders. - Requires identification, generation, presentation, interpretation and use of information relevant to business strategy, decision making and performance improvement. - How much time to make this, how much will it cost to make, how long will it take? Functions • Concerned with planning, control and decision making (internal processes of a company). • Reporting accounting and cost information to users within an organisation. • Looking at internal processes and how you can improve them to help managers manage the business and its activities. • Concerned with the costs that go into producing products and services to determine a selling price for those products and services that will generate a profit. • Looks at past information to make short term decisions and long term planning. Comparing Financial & Management Accounting Financial Accounting Main Users

Management Accounting

External - Reports past information to users outside the organisation.

Internal - Used to analyse and improve finances in company.

Reporting on past performance to where the company is at present.

Forecasting for the future from our current performance.

Financial - quantitative.

Financial and non-financial, quantitative and qualitative.

Reporting Frequency

Annual report that all companies are obliged to produce by law.

Monthly or more regular.

Regulation

Have to publish the reports on their website and lodge with the Registrar of Companies at Companies House. IFRS comprising of GAAP.

Little regulation, management discretion.

Set format required.

Presented in a format most appropriate for managers to aid their decision making.

Relevant and faithful representation of the facts.

Relevant to management decisions and control of operations.

Primary Information Principle Measurement

Presentation of Information

Criteria

Benefits of Accounting • Helps you communicate fully with other members of the organisation. • Understand accounting reports put in front of you. • Draw up financial plans for the future. • Prepare simple reports to evaluate performance and outcomes. • Check and evaluate the accuracy of what you are being told. • Understand how the figures you are presented with have been put together - what they are telling you and the limitations of information given.

• Provide potential employers with a full range of skills needed for a successful career in business. Limitations of Accounting Information • Does not provide the measures of quality of an organisation’s performance. - Measured by customers and level of satisfaction with goods and services delivered, willingness to recommend the products and the number of repeat purchases. • If a business doesn’t make a profit, accounting doesn’t tell you the time, effort and thought that went into delivery the products and services and generating the profit. • Pollution and environmental or social damage an entity has caused. - Businesses may ignore the wider external effects of their actions to natural resources and the costs to the community they operate in such as destruction of landscape, burdens on families, social services, NHS and the state. • Valuation or measure of the skills base and knowledge of organisations. - Value of employees to a business is not in their financial statements due to valuing staff being subjective....