1. Chapter 1: Nature and purpose of accounting
 After studying this topic you should be able to
 Explain the purpose of accounting in a business context
 Distinguish between financial and management
accounting
 Compare different types of business entity
 Explain the importance of financial information to
management
 Identify the main users of published financial statements
 Independent study
 Study Chapter 1
 Progress test and practice question(s) as set
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2. Exercise 1
Let’s talk about accounting
 Business is about money - and managers, owners
and other interested parties need to keep track of
 Where the money came from
 Where it is now
 Where it will be in the future
 Butthat doesn’t tell us what accounting is
 Required
a) What is accounting?
b) Why do you need to learn about the world of accounting?
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3. Solution 1
Let’s talk about accounting
 Accounting is ‘the process of identifying, measuring,
recording and communicating economic
transactions’ (Collis and Hussey, 2007, p. 5)
 Identifying economic transactions of the business and not
the personal affairs of the owners or managers
 Measuring the economic transactions in monetary terms
 Recording them in the accounting system
 Communicating them to users by producing financial
statements that summarise the information
 Accountants can be generalists or specialists …
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4. Two main branches of accounting
 Financial accounting is ‘a branch of accounting
concerned with ‘classifying, measuring, and
recording the economic transactions of an entity in
accordance with established principles, legal
requirements and accounting standards. It is
primarily concerned with communicating a true and
fair view of the financial performance and financial
position of an entity to external parties’ (Collis and
Hussey, 2007, p. 7)
 True and fair view implies that the financial statements are
a faithful representation of the entity’s economic activities
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5. Two main branches of accounting (continued)
 Management accounting is ‘a branch of accounting
concerned with collecting, analysing and interpreting
quantitative and financial information. It is primarily
concerned with communicating information to
management for planning, controlling and decision
making’ (Collis and Hussey, 2007, p. 8)
 So, whilst the focus of financial accounting is on meeting
the needs of external users of financial information, the
focus of management accounting is on meeting the needs
of internal users of financial information
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6. Financial objectives
 Accounting information helps both large and small
entities achieve their financial objectives
 All organisations strive to ensure that the revenue
earned and the costs incurred are at acceptable
levels but what is an ‘acceptable level’ will vary
according to the financial objectives of the
organisation
 In the public sector and the not-for-profit sector, the
objective is to break even
 In the business sector, the objective is to make a profit
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7. Classifying enterprises by size
 There are 4.3m enterprises in the UK (SBS, 2005)
 Only 0.1% are large firms (with ≥ 250 employees) whilst
99.9% are small or medium-sized enterprises (SMEs)
(with 0 – 249 employees)
 Similar proportions in many other countries
 Aswell as providing a living for their owners, SMEs
make a significant contribution to the economy
 In the UK they provide 59% of non-government
employment and 51% of turnover
 Businesses can also be classified by legal status…
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8. Legal status of business enterprises in the UK
Total number of business enterprises = 4.3m
Partnerships
13%
Companies &
corporations Sole
24% proprietorships
63%
(SBS, 2005, Table 2)
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9. Overview of main types of business entity
Entity
Unincorporated Incorporated
(unlimited liability) (limited liability)
Sole Limited liability Limited liability
Partnership
proprietorship partnership (LLP) company
Unlimited liability – owners have
personal responsibility for the debts Private limited Public limited
incurred by the business company company (Plc)
Limited liability – owners’ responsibility is
limited to the capital they agreed to invest
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10. Sole proprietorship (unincorporated)
 An unincorporated business owned by one person
(the proprietor), such as
 A sole trader (eg a newsagent, grocer or florist)
 Someone providing services (eg a consultant, hairdresser
or plumber)
 Someone making goods (eg a tailor or cabinetmaker)
 No legal formalities to set up
 Capital is restricted to what owner can invest
 Owner has sole liability
 Must keep accounting records but no requirement to
disclosure financial information
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11. Partnership (unincorporated)
 Minimum 2 partners to set up
 Business Names Act 1985 requires the names of partners
are shown on stationery, but no need to use them in the
name of the business
 In the absence of a partnership deed, the Partnership Act
1890 applies to profit sharing, interest on capital, interest
on loans and partners’ salaries
 Capital is restricted to what partners can invest
 Partners have ‘joint and several’ liability
 Must keep accounting records, but no requirement to
disclose financial information
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12. Limited liability entities (incorporated)
 Many legal formalities under the Companies Act
1985 (CA85)
 On formation, must register at Companies House
(part of the DTI) and file
 A memorandum of association (details about the
constitution of the business and its objects)
 And articles of association (details about internal
regulation of the business eg voting rights of
shareholders, conduct of shareholders’ meetings, powers
of management, etc)
 Two types of limited liability entity in the UK…
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13. Limited liability partnership (LLP)
 Introduced by Limited Liability Partnership Act 2000
 7,396 LLPs on the register (DTI, 2004)
 Has a legal identity separate from its owners (known as
members), who have limited liability
 Organised internally as a traditional partnership
 Capital is raised by increasing the number of members
 Must keep accounting records
 Many requirements under CA85, including disclosure of
financial information
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14. Limited company
 1.6m limited companies on the register (DTI, 2003)
 A company has a separate legal identity from its
owners (members)
 Capital is raised by issuing shares to members
 Shareholders have limited liability
 Many requirements under CA85, including disclosure
of financial information
 Jargon alert!
 A company is a particular type of entity
 If you want a generic term, use business or firm
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15. Private limited company
A company that is not a public company (99.3% of
companies on the register)
 Name must end with ‘Limited’ or ‘Ltd’ (or the Welsh
equivalent)
 Shares can only be offered for sale privately
 No minimum amount of share capital
 Minimum 1 director
 Company secretary need not have formal qualification
 Extent of financial disclosure depends on size and public
interest (concessions for qualifying small and medium-
sized companies)
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16. Public limited company (plc)
 Only 0.7% of companies on the register
 Most are converted from private companies under re-
registration procedure in CA85
 Name must end with ‘public limited company’ or ‘plc’
 Minimum 2 directors
 Must have a qualified company secretary
 Minimum amount of authorised share capital is £50,000, of
which at least £12,500 must be paid up share capital
 Can offer shares to the public (via stock exchange listing)
 Extensive financial disclosure due to public interest
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17. CA85 main requirements – all limited liability entities
 Must keep accounting records
 Must prepare an annual report and accounts
 Annual financial statements with supporting notes
(concessions for most small and medium-sized entities)
 Directors’ report
 Auditors’ report on the truth and fairness of the view given
by financial statements (exemption for most small entities)
 The annual report and accounts must be
 Filed at Companies House (on the public record)
 Given to every shareholder
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18. Users of financial statements
 No public disclosure of financial information by
unincorporated entities, so the main users are
internal
 Management (ie owner-managers and other senior
managers) who use it for running the business, which may
include passing it on to others at their discretion)
 Limited liability entities are legally obliged to disclose
financial information to the public, so the main users
are external
 Seven main user groups who use the information for
economic decision making…
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19. Users of the financial statements of limited liability
entities
1. Present and potential investors – risk/return, stewardship
2. Employees – security, bargaining, opportunities, benefits
3. Lenders – assess/monitor lending risk (liquidity, collateral)
4. Suppliers and other trade creditors – credit risk
5. Customers - continuity, after sales service, warranties
6. Governments and their agencies – allocate resources,
assess economic and fiscal policies, regulation, taxation,
national statistics, etc
7. The public – impact on local economy,
the community, the environment, etc.
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20. Conclusions
 Accounting is used in all types of business and can
be divided into two main branches
 Financial accounting is primarily concerned with
communicating a true and fair view to the 7 groups of
external users for making economic decisions
 Management accounting is primarily concerned with
communicating information to internal users to ensure the
business meets its financial objectives
 The legal status of the business affects the number
of owners, their financial liability, legal formalities,
how capital can be raised and financial disclosure
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