Explain the Purpose of Accounting

PAST PAPER QUESTIONS - THEORY

1. Explain the purpose of accounting.

The purpose of accounting is to provide information about business transactions for   internal control purposes and for the owners of a business. Managers need to know who owes money for goods sold. Shareholders in a company need to know how much profit is being made and whether the company is able to meet its debts as they fall due.

        (4 marks)

1.         Distinguish between financial accounting and management accounting, stating the main differences between these types of accounting. 

Financial accounting provides accounting information to external users and helps these users to make better economic decisions and to judge the stewardship of management.

The information which is supplied usually takes the form of a set of annual financial statements including an income statement (statement of financial performance) and a balance sheet (statement of financial position). Further financial statements may also be provided, such as a statement of cash flows.

Financial accounting information is historical in nature and is highly summarised. It is generally provided annually and is intended for external users. To a large extent, its content is prescribed by legislation and by accounting standards.        

        Management accounting provides accounting information to the internal managers of an organisation. Managers use this information in order to make better management decisions.

Management accounting information may include forecasts and projections (as well as historical information). The information is highly detailed and is provided on a continual basis. It is intended for internal consumption and its content is not prescribed.

(8 marks)

1. List the internal and external user groups which might benefit from the information produced by a financial accountant.

The main user groups which may benefit from the information produced by a financial accountant include:

–        investors

–        employees

–        lenders

–        suppliers and other trade creditors

–        customers

–        governments and their agencies

–        the public.

        (5 marks)

1. List and explain briefly FOUR accounting concepts.        

1. Consistency

When a business has once fixed a method for the accounting treatment of an item, it will treat all similar items that follow in exactly the same way.

1. Accruals

Net profit must be the difference between revenues generated and costs incurred in generating that revenue.

1. Prudence

Caution should always be exercised when dealing with uncertainty, gains should never be overstated and losses should not be understated.

1. Going Concern

When preparing the accounts, it is assumed that a business will continue to operate for the foreseeable future – implications for valuation of assets.

                (8 marks)

1. Identify the THREE principal financial statements of a company and explain the purpose of each.

Income statement

A summary of a management's performance as reflected in the profitability (or lack of it) of an organization over a certain period. It itemizes the revenues and expenses of past that led to the current profit or loss, and indicates what may be done to improve the results.

An income statement depicts what happened over a month, quarter, or year. It is based on a fundamental accounting equation (Income = Revenue - Expenses) and shows the rate at which the owners equity is changing for better or worse. It shows both gross profit (trading profit) and net profit (operating profit). Also called earnings report, operating statement, or profit and loss account.                                                        

Statement of Financial Position

A condensed statement that shows the financial position of an entity on a specified date (usually the last day of an accounting period).

Among other items of information, a balance sheet states (1) what assets the entity owns, (2) how it paid for them, (3) what it owes (its liabilities), and (4) what is the amount left after satisfying the liabilities. Balance sheet data is based on a fundamental accounting equation (assets = liabilities + owners' equity), and is classified under subheadings such as current assets, fixed assets, current liabilities, Long-term Liabilities. To be considered valid, a balance sheet must give a true and fair view of an organization's state of affairs, and must follow the provisions of GAAP in its preparation. Also called statement of condition, statement of financial condition, or statement of financial position.