Accounting Fundamentals

Types of Business entities

1. Sole Traders

2. Partnerships (General or LLPs) - 2 or more people

3. Limited Liability Companies (Ltd or Plc)

• Owned by shareholders

• Managed by directors

• Shareholders have limited liability i.e. the extent of their liability is limited to the amounts outstanding on their shares

Objective of Financial Statements (IFRS CFFR)

To provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity.

Users of financial statements and their information needs

1. Investors (current/potential): Assess performance of management, profitability/sustainability of entity, likely dividend payments, whether to buy/sell shares

2. Employees: Assess job security/career opportunities

3. Lenders: Assess ability to keep up loan repayments, assets that may be used as security, levels of debt already held by entity

4. Suppliers/other creditors: Assess whether to supply to entity and what credit terms should be offered

5. Customers: Assess whether to buy from company, future warranties will be upheld, supply will be continuous

6. Government: Obtain economic data, tax revenues, produce national statistics

7. Public: Review entity’s ethical and social disclosures

8. Managers: Prepare/present financial statements. Also need the financial information to held manage business efficiently and make decisions

UK GAAP

GAAP signifies all the rules which govern UK accounting

• LLC required by Companies Act 2006 to prepare+publish financial statements annually

• Financial statements need to give true and fair view of financial results of the entity

• Compliance with IFRS (international reporting standards)

IESBA code of ethics Fundamental Principles for Professional accountants

1. Integrity: Be straightforward and honest in all professional/business relationships

2. Objectivity: Not allow bias, conflict of interest, or undue influence of others to override professional/business judgements

3. Professional Competence and due care: Maintain professional knowledge/skills to provide competent service. Act diligently and in accordance with technical/professional standards

4. Confidentiality: Respect confidentiality of information from professional/business relationships, not disclosing to third parties without permission

5. Professional Behaviour: Comply with relevant laws/regulations, avoiding actions that discredit profession

ICAEW code of ethics expectation

Chartered Accountants expected to demonstrate the highest standards of professional conduct, taking consideration of public interest and maintain reputation of accounting profession

Professional competence and due care

ICAEW code of ethics Principles

1. Responsibility: Exercise professional judgement to comply with guidelines, taking ownership over actions/decisions

2. Encourages Compliance: Prevents box ticking approach to decision making, avoiding compliance loopholes

3. Adaptability: Flexibility in applying guidance in a rapidly changing modern business environment

4. Incorporates prohibitions: Rules of ethics support underlying principles of ethics

ISSB (International Sustainability Standards Board)

Develops and issues IFRS Sustainability Disclosure Standards

• These standards provide high quality, transparent and comparable information relating to information, focused on needs of investors and the financial markets

• Two ISSB Standards: IFRS S1 and IFRS S2

IFRS S1: General Requirements for Disclosures of Sustainability-related Financial information

IFRS 1:

• Requires company to disclose information about its sustainability-related risks and opportunities, useful for primary users when making decisions relating to providing resources to the company

• Requires disclosures about opportunities of governance, strategy, risk management, metrics and targets

• Sustainability-related risks and opportunities arise through a company's dependencies on its stakeholders/society/economy/natural environment, and its impacts on those relationships/resources

Impact (How company makes impact):

• Waste generated

• GHG emissions

• Health and Safety

• Worker rights

Dependency (What company is dependent on)

• Availability of natural resources

• Workforce health

• Climate risks

• Regulatory risks

Information about company’s dependencies particularly important for investors

• Helps evaluate how effectively company is managing long-term sustainability-related risks to derive value and make informed investment decisions

IFRS S2: Climate related Disclosures

IFRS S2 requires disclosure of company’s:

• Climate related opportunities: from positive effects of climate change eg. increased revenue from selling energy efficient appliances

• Climate related Risks: from negative effects of climate change; either transition risks or physical risks

Physical Risks: Risks from more frequent/severe adverse natural events e.g. droughts/heatwaves/wildfires/flood

Transition Risks: Changes made in response to climate change issues e.g. new technologies/consumer preferences/climate policy shifts

Qualitative Characteristics of financial information (aims of ISSB)

1. Fundamental Qualitative characteristics

• Relevance

• Faithful Representation

2. Relevance: Information is relevant if it makes a difference to a user’s decisions i.e. if it has

• Predictive value

• Confirmatory value

Relevance is affected by nature and materiality (What number do investors care about)

3. Faithful Represenation

• Information represents transactions and other events

• Will be complete/Neutral/Unbiased Supported by prudence)/free from error

4. Enhancing qualitative characteristics:

• Comparability - Between periods and between firms of same business line

• Verifiability - Can be proven

• Timeliness - relevant to the reporting year

• Understandability - Basic knowledge

Elements of Financial Statements (Conceptual Framework for Financial Reporting)

Income

Expenses

Equity

Assets

Liabilities

Source Document that is recorded in an entity’s cloud based accounting software

Credit Note

When purchase order received from supplier, which two documents would invoice be checked to before recorded in the cloud based accounting system

Purchase Order and Goods Received Note

When sales order issued to customer, which two documents would invoice be checked to before recorded in the cloud based accounting system

Sales Order and Goods Despatched note

Credit Note

Issued by a supplier when a customer returns goods to them

Remittance Advice

Sent in by the customer to the supplier with payment

Invoice

Issued when goods are originally sold, on the basis of a delivery note

Delivery Note

Shows what exactly has been sold

Output VAT

Tax that a VAT-registered business charges on its Sales

Recorded in receivables/cash ledger

Liability - Owed to the government

Dr Cash (Gross)

Cr Sales (Net)

Cr VAT Control

Input VAT

Tax paid to supplier during purchase of goods

Recorded in Payables/cash ledger

Asset - Government has to repay you

Dr Purchases (Net)

Dr VAT Control

Cr Cash (Gross)

Capital Equation

Capital = Assets - Liabilities

Capital = Debits - Credits (excluding capital) → Trial Balance

(Capital account is the balancing figure for the trial balance)

Unrepresented Cheque

Payment made by business, already recorded in its internal books, but has not yet been processed by the bank

• Must be deducted from bank statement balance during bank reconciliation for adjusted cash book balance

Bank Reconciliation

Process explaining why balance on the Bank Statement does not match the balance in the company’s nominal ledger (Cash book)

• Identifies errors made by company or bank/timing differences/unrecorded items

Bank Reconciliation vs. Adjusted Cash Book

It depends on who needs to catch up. Use the "Whose Job?" rule:

• Adjusted Cash Book (My Job to Fix):

  • Reason: The bank has processed these, but YOU haven't recorded them yet.

  • Key Items: Bank charges, interest, Direct Debits, Standing Orders, and Dishonoured (Bounced) Cheques.

  • Action: Update your internal Ledger (the "Cash at Bank" account).

• Bank Reconciliation Statement (The Bank's Job to Catch Up):

  • Reason: YOU have recorded these, but the BANK hasn't processed them yet (Timing Differences).

  • Key Items:

    • Unpresented Cheques/Payments: (Deduct from Bank Balance)

    • Uncleared Lodgements/Receipts: (Add to Bank Balance)

    • Bank Errors: (Fix on the Statement only)

  • Action: List these to explain the gap between your Ledger and the Bank Statement.

The "Easy Way" to Remember:

Ask yourself: "Is my Cash Book already updated for this?"

YES: It goes in the Bank Reconciliation Statement.

NO: It goes in the Adjusted Cash Book first.

Contra Entry

When one entity is both a customer (owe you money) and a supplier (you owe them money), you simply "wipe out" the overlap so that only the net difference remains.

The rule is: Always eliminate the lower of the two balances from both Receivables and Payables.

1. Identify smallest balance between receivables and payables for the company

2. Deduct that amount from both sides

• Subtract from Receivables (Credit)

• Subtract from Payables (Debit)

• Remaining amount still to be settled
  

Ordinary shares vs Preference shares:

1. Ordinary Shares (Equity)

These are always at the bottom of the Balance Sheet in the Equity section. They represent the true owners who have voting rights and get what’s left of the "100% pie" after everyone else is paid.

2. Preference Shares (It depends!)

There are two places these can live, and your trial balance will tell you which one:

• In the Equity Section: This is for Irredeemable preference shares. Because the company never has to pay the money back, it’s treated like permanent "ownership" capital.

• In the Liabilities Section: This is for Redeemable preference shares (like your 6% ones due in 20x9). Because you must pay them back, they are hidden up with the bank loans and debentures.

Qualitative Characteristics of the Conceptual Framework

Information for Financial reporting must be:

1. Fundamental:

• Relevant: Influences decisions

• Faithful Representation: is complete, neutral, free from error

2. Enhancing:

• Comparable

• Verifiable

• Timely

• Understandable

Over/Under provision

E.g. Income tax

• Overprovision from last year = ASSET for current year

Too much put in the income tax payable account, HMRC owes refund

• Underprovision from last year = LIABILITY for current year

Not enough put in the income tax payable account, still owe HMRC a portion

For Income tax for current year, always start with the under/overprovision, and net it off the income tax payable for this year.

i.e. Use it towards or against your income tax payable balance for this year

e.g. Overprovision of 34000 from last year, 125000 income tax for this year:

Dr Income Tax exp 91000

Dr Income Tax Payable 34000
Cr Income Tax Payable 125000