Acca f3 Financial Accounting (int) Study Text

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1: Introduction to accounting   Part A  The context and purpose of financial reporting 

amounts owed by their businesses, the shareholders of a limited liability company are only responsible for 

the

amount to be paid for their shares. Limited liability companies are dealt with in more detail in 

Chapter 20

. 

In law sole traders and partnerships are not separate entities from their owners. However, a limited 

liability company is legally a separate entity from its owners and it can issue contracts in the company’s 

name.

For

accounting purposes, all three entities are treated as separate from their owners. This is called the 

business entity concept. We will see the practical consequence in 

Chapter 5

. 

2.3 Advantages of trading as a limited liability company

(a)

Limited liability makes investment less risky than investing in a sole trader or partnership. 

However, lenders to a small company may ask for a shareholder's personal guarantee to secure 

any loans. 

(b) It 

is 

easier to raise finance because of limited liability and there is no limit on the number of 

shareholders.

(c) 

A limited liability company has a 

separate legal identity from its shareholders. So a company 

continues to exist regardless of the identity of its owners. In contrast, a partnership ceases, and a 

new one starts, whenever a partner joins or leaves the partnership. 

(d) There 

are 

tax advantages to being a limited liability company. The company is taxed as a separate 

entity from its owners and the tax rate on companies may be lower than the tax rate for individuals. 

(e) 

It is relatively easy to 

transfer shares from one owner to another. In contrast, it may be difficult to 

find someone to buy a sole trader's business or to buy a share in a partnership. 

2.4 Disadvantages of trading as a limited liability company

(a) 

Limited liability companies have to 

publish annual financial statements. This means that anyone 

(including competitors) can see how well (or badly) they are doing. In contrast, sole traders and 

partnerships do not have to publish their financial statements. 

(b) 

Limited liability company financial statements have to comply with 

legal and accounting 

requirements. In particular the financial statements have to comply with accounting standards. 

Sole traders and partnerships may comply with accounting standards, but are not compelled to do 

so.

(c) 

The financial statements of larger limited liability companies have to be 

audited. This means that 

the statements are subject to an independent review to ensure that they comply with legal 

requirements and accounting standards. This can be inconvenient, time consuming and expensive. 

(d)

Share issues are regulated by law. For example, it is difficult to reduce share capital. Sole traders 

and partnership can increase or decrease capital as and when the owners wish. 

3 Nature, principles and scope of financial reporting

You should be able to distinguish the following: 

 Financial 

accounting 

 Management 

accounting 

You may have a wide understanding of what accounting and financial reporting is about. Your job may be in one 

area or type of accounting, but you must understand the breadth of work which an accountant undertakes. 

3.1 Financial accounting

So far in this chapter we have dealt with 

financial accounts. Financial accounting is mainly a method of 

reporting the results and financial position of a business. It is not primarily concerned with providing 

information towards the more efficient running of the business. Although financial accounts are of interest 

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Part A  The context and purpose of financial reporting 

  1:  Introduction to accounting

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to management, their principal function is to satisfy the information needs of persons not involved in 

running the business. They provide 

historical information.

3.2 Management accounting

The information needs of management go far beyond those of other account users. Managers have the 

responsibility of planning and controlling the resources of the business. Therefore they need much more 

detailed information. They also need to 

plan for the future (eg budgets, which predict future revenue and 

expenditure).

Management (or cost) accounting is a management information system which analyses data to provide 

information as a basis for managerial action. The concern of a management accountant is to present 

accounting information in the form most helpful to management. 

You need to understand this distinction between management accounting and financial accounting. 

Question 

Accountants 

They say that America is run by lawyers and Britain is run by accountants, but what do accountants do in 

your organisation or country? Before moving on to the next section, think of any accountants you know 

and the kind of jobs they do. 

4 Users' and stakeholders' needs

4.1 The need for financial statements 

There are various groups of people who need information about the activities of a business. 

Why do businesses need to produce financial statements? If a business is being run efficiently, why 

should it have to go through all the bother of accounting procedures in order to produce financial 

information?

The International Accounting Standards Board states in its document Framework for the preparation and 

presentation of financial statements (which we will examine in detail later in this Study Text): 

'The objective of financial statements is to provide information about the 

financial position, performance

and

changes in financial position of an entity that is useful to a wide range of users in making economic 

decisions.'

In other words, a business should produce information about its activities because there are various 

groups of people who want or need to know that information. This sounds rather vague: to make it clearer, 

we will study the classes of people who need information about a business. We need also to think about 

what information in particular is of interest to the members of each class.

Large businesses are of interest to a greater variety of people and so we will consider the case of a large 

public company, whose shares can be purchased and sold on a stock exchange. 

4.2 Users of financial statements and accounting information

The following people are likely to be interested in financial information about a large company with listed 

shares.

(a)

Managers of the company appointed by the company's owners to supervise the day-to-day 

activities of the company. They need information about the company's financial situation as it is 

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Key term 

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