Chapter 1: Introduction to accounting and finance
What are Accounting and Finance?
Accounting is concerned with collecting, analysing and communicating financial information
to help various groups make better decisions and judgements. Conflicts of interest between
users may arise over the ways in which business wealth is generated or distributed.
o Two main strands:
Financial accounting: provides information that is designed to satisfy the
needs of external users.
Management accounting: provides information that is useful in running a
company by internal users.
Finance is concerned with the ways in which funds for a business are raised and invested.
Management accounting Financial accounting
Nature of the
Tend to be specific purpose Tend to be general purpose
reports produced
Level of detail Often very detailed Usually broad overview
Regulations Unregulated Usually subject to accounting regulation
Reporting interval As short as required by managers Annual or bi-annual
Based on projected future
Time orientation information as well as past Almost historical
information
Tend to contain financial + non- Focus on financial information, great
Range and quality
financial, often use information emphasis on objective, verifiable
of information
that cannot be verified evidence
What kinds of business ownership exist?
1. Sole proprietorship: an individual is the sole owner of a business, type of business is usually
quite small in terms of size e.g. sales revenue, easy to set up, unlimited liability (= no
distinction between the proprietor’s personal wealth and that of the business if there are
business debts to be paid).
2. Partnership: two or more individuals carry on a business together with the intention of
making a profit, usually quite small in size, easy to set up, partners can agree whatever
arrangements suit them, usually have unlimited liability
3. Limited company: can range in size from quite small to very large, unlimited number of
individuals who can subscribe capital + become owners, limited liability for owners (=
individuals subscribing capital to the company are liable only for the debts incurred by the
company up to the amount that they have invested or agreed to invest)
1
,Main advantages and disadvantages that should be considered when deciding between a sole
proprietorship and a partnership
Advantages of partnership over a sole-proprietor business:
Sharing the burden of ownership
Opportunity to specialise rather than cover the whole range of services (e.g. in partnership
each partner may specialise in a different aspect)
Ability to raise capital where this is beyond the capacity of a single individual
Disadvantages of a partnership compared with a sole proprietorship:
Risks of sharing ownership of a business with unsuitable individuals
Limits placed on individual decision making that a partnership will impose
Main advantages of forming a partnership business rather than a limited liability company
Advantages of partnership over limited company
Ease of setting up the business
Degree of flexibility concerning the way in which the business is conducted
Degree of flexibility concerning restructuring and dissolution of the business
Freedom from administrative burdens imposed by law e.g. annual general meeting and
need for an independent audit
Disadvantages of partnership
Not normally possible to limit the liability of all the partners
How are businesses organised?
Nearly all businesses that involve more than a few owners and/or employees are set up as
limited companies
Finance:
o Owners invest in form of direct cash investment to buy shares and through the
shareholders allowing past profits, which belong to them, to be reinvested in the business
o Also comes from lenders (e.g. banks) who earn interest on their loans
o Provided through suppliers of goods and services being prepared to supply on credit
In large limited companies, owners tend not to be involved in the daily running of the
business, instead appoint a board of directors to manage business on their behalf
o Board has a chairman, elected by the directors, who is responsible for running the board in
an efficient manner
o Each board has a chief executive officer (CEO) who is responsible for running the
business on a day-to-day basis both in order to avoid excessive power
o Board is charged with three major tasks:
1. Setting overall direction + strategy for the business
2. Monitoring + controlling the activities of the business
2
, 3. Communicating with shareholder + others connected with the business
Organisations might be divided into a departmental structure (marketing, finance, HR etc.) or
divisional structure (North Division incl. finance, marketing, HR; South Division incl. same
things)
How are businesses managed?
Environmental changes has made the role of managers more complex and demanding
introduction of strategic management: setting long-term direction of the business incl. goals
3
,Chapter 2: Measuring and reporting financial position
Financial accounting statements
1. Statement of cash flows: shows cash movements over a particular period
2. Income Statements (also known as the profit and loss account): shows profitability, wealth
generated over a particular period
3. Statement of financial position (Balance sheet): shows the accumulated wealth at a particular
point in time
Balance Sheet
Assets = Liabilities + Equity
o Assets: resources of the business that have certain characteristics, such as the ability to
provide future economic benefits.
Current Assets: held for the short term. Meet the following conditions:
o They are held for sale or consumption during the business’s normal operating cycle
o They are expected to be sold within a year after the date of the relevant statement of
financial position
o They are held principally for trading
o They are cash, or near cash such as easily marketable, short-term investments
Examples:
o Inventories (stock)
o Trade receivables (trade debtors)
o Cash
Non-Current Assets (also called fixed assets): assets that do not meet the definition of current
assets, held for long-term operations, may either be tangible or intangible
o Tangible non-current assets: property, plant and equipment
o Intangible non-current assets: patents, leases taken out on assets such as a property
and licences such as a taxi licence
Claims: obligations on part of the business to provide cash or some other benefit to outside
parties claims are of two types: equity + liabilities
Equity: represents the claim(s) of the owner(s) and liabilities represent the claims of others
Current Liabilities: basically amounts due for settlement in the short term e.g. trade payables.
Meet the following conditions:
o They are expected to be settled within the business’s normal operating cycle
o They exist principally as a result of trading
o They are due to be settled within a year after the date of the relevant statement of
financial position
o There is no right to defer settlement beyond a year after the date of the relevant
statement of financial position
Non-Current Liabilities: amounts due that do not meet the definition of current liabilities and
so represent longer-term liabilities e.g. long-term borrowings
4
, Capturing a moment in time
o Business entity convention: distinguish legal position between business and owners in sole
proprietorships and partnerships law does not make any distinction, but for limited companies
there is a legal distinction between business and its owners
o Historic cost convention: value of assets should be based on historic costs (current value may
lack credibility) that is acquisition costs
o Prudence convention: caution should be exercised when making accounting judgements,
involves recording all losses at once and in full (both expected and actual loss); profits on the
other hand are only recognised when they actually arise
o Going concern convention: financial statements should be prepared on the assumption that a
business will continue
o Dual aspect convention: Each transaction has two aspects, both of which will affect the
statement of financial position e.g. purchase of a computer increase in assets, decrease in
cash
Money measurement
Goodwill and brands
o Some intangible non-current assets have clear and separate identity + cost of acquiring assets
can be reliably measured e.g. patents, trademarks, copyrights and licenses
o Others lack a clear and separate identity e.g. goodwill (=quality of products, skill of
employees + relationship with customers) or product brand (=various attributes such as brand
image, the quality of the product, the trademark and so on) when generated internally by
the business, often difficult to determine their costs or measure their current market value
excluded from statement of financial position
Human Resources
o Attempts have been made to place a monetary measurement on the human resources of a
business, but without any real success, however some exclusions such as football players
Monetary stability
o When using money as the unit of measurement, we normally fail to recognise the fact that it
will change in value over time (inflation) + currency exchange rate changes
Valuing assets
o Non-current assets: have either finite or indefinite lives recorded at their historic cost
which includes any amounts spent on getting them ready for use
o Finite life provide benefits to a business for a limited period of time
o Indefinite life provide benefits without a foreseeable time limit
o Non-current assets with finite lives will be used up over time as a result of market changes,
wear and tear etc. amount used up is referred to as depreciation (or amortisation in case of
intangible non-current assets) must be reflected in the statement of financial position; total
depreciation that has accumulated over the period since the asset was acquired must be
deducted from its costs carrying amount/net book value/written-down value
o Not really a contravention of the historic cost convention
5
