【Learning outcomes】

When you have completed this chapter, you should be able to:

• An overview of three major financial statements

• Prepare a Trading and income statement from information given for a sole trader and a limited company

• Prepare a Statement of financial position 

• Prepare a Statement of changes in equity

• Basic understanding of Cash Flow Statement

The nature and purpose of the three major financial statements

The business’s accounting system will normally produce three particular statements. These three are concerned with answering the following questions:

 What cash movements (that is, cash in and cash out) took place over a particularperiod?

 How much wealth (that is, profit) was generated, or lost, by the business over thatperiod?

 What is the accumulated wealth of the business at the end of that period?

These questions are addressed by the following three financial accounting statements, with each one addressing a particular question. The financial statements are:

 The Statement of Cash Flows 

 The Income Statement 

 The statement of Financial Position

When preparing these financial statements all companies are required to comply with accounting standards (or rules) enforced by the Accounting Standards Board.

The intention of the Accounting Standards Board is to standardise the way in which financialinformation is reported, promote confidence and increase reliability. By following the standards, the financial statements are objective and give a true and fair view of a company’s financial position. Without these standards,accountants would be able to use their own methods leading to inconsistenciesand perhaps misleading profit figures.

As these accounting standards will not be assessed, they are only briefly mentioned here.

REQUIREMENTS OF FINANCIAL INFORMATION

Relevant

The informaton that is contained in financial statemnts is relevant and can be used to make business and economic decisions by helping users to evaluate past, present and future events.

Reliable

Information contained in financial statements is free from material errors and can be depended upon to be a true reprentation of the busines and its financial position.

Comparable

Information can be compared over time to identify trends in financial performance and position, or to compare one business with another. in order for this to be possible businesses must prepare accounting information using consistent accounting policies and layouts. normally when presenting financial information a business will include figures from last year to allow a user to compare the results.

Undersandable

Information provided should be easily understandable by users.

Material

Materiality depends on the size of the item. Information is material if its oission or misstatement could indluence the economic decisions of users of the statements.

FUNDAMENTAL ACCOUNTING CONCEPTS

The Matching Concept

The profit figure must be based on costs that were actually incurred in that period.  A misleading  impression would begiven if the accounts simply compared cash received with cash paid out in aparticular period.  Accruals are added tothe amount paid this period whereas prepayments are deducted.  Adjusting for accruals and prepayments allows the incomes of one period to bematched more fairly against the costs of the same period. The comparisons aretherefore not distorted by the accidental timing of cash receipts  and cashpayments.

The Prudence Concept

The accountant should adopta conservative (or prudent) view when preparing the accounts and always takethe figure that will understate rather than overstate profits.  In addition, profit must not be recogniseduntil   it is actually certain whereaslosses must be taken into account as soon as they areforeseen.

The Consistency Concept

When recording financialinformation an accountant should choose the methods that give the most reliableand accurate view in terms of profitability and worth. Constantly changingmethods would lead to misleading figures and make comparisons less meaningful.This concept therefore states that once the method of recording or dealing withan item of financial information is fixed then this method will be applied toall similar items thatfollow.

The Going-Concern Concept

 Preparing accounts underthis concept implies that the business will continue trading from oneaccounting period to the next. This means that the final accounts are preparedon the assumption that the business will not be closing down and assets will bevalued accordingly.

True and Fair View

When preparing financial information you must always bear in mind that the financial statements must be a true representation of the real picture of the business and its finances. if presenting information might be misleadeing then the accountant has a dilemma. if including the information may distort the picture then the information might be included but additional information may be provided to put it into context. similarly by omitting information the user of the financial information might have a distorted picture of the business then it's essnetial to make sure that it is included in some form in the ANNUAL REPORT.