A study of different financial accounting concepts

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The business or the accounting entity, the unit with respect to which accounting information is gathered, is considered to be an independent entity which is distinct from its owners and any other businesses or individual which interacts with it and is known as the business entity concept. The business is said to have an existence on its own. Ie all stakeholders of the business such as the owners, government, debtors, creditors, employees are all considered outside parties to the business. Hence it is necessary to record all business transactions separately for this particular entity and these transactions are also recorded as transaction relevant to the business.

For example, in a sole traders business when an owner draws money from business it is recorded as drawing and hence the transaction between the business and the owner is recorded separately. Despite the business being his, there is still a two components to the transaction where the business is giving money and the owner is receiving money. Even though in legal terms the sole trader is liable for all transactions of the business in accounting terms the owner is considered a different entity. Thus, when recording transactions the business unit must see them through the "eyes" of this business entity which is assumed to be a natural and living entity.

Monetary Measurement

In a business organization it is assumed that every activity in the business will have a monitory values. ie every activity in the business can be measured in terms of money. Hence accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like employee moral, workforce skill, hostility towards management, brand recognition, quality of management, pending trade union action, etc. Thus, it is clearly evident that this concept has its own limitations. An external party is unable to understand certain internal conditions within the company just by referring to its financial statements. Of course these immeasurable entities will have an impact on company profitability, value of assets and its stability. But these conditions will not have an instant impact on the business as its impacts would be felt by the business over a longer period of time and not necessary within a specific accounting period.

This concept has the following significance:

A uniform recording of business transactions

It is an guideline for accountants what to record and what not to record.

As all transactions are expressed in monitory terms, the accounts prepared by the entity can be easily comprehended.

Going Concerns Concept

In accounting is it assumed that the organization or the business entity for which financial accounting information is gathered and financial statement are prepared will be in operation in the foreseeable future(Fonseka, 2004). The preparation of final accounts for an accounting period is based on the assumption that there is no requirement to wind up or significantly slowdown the business activities of the business entity for which these accounts are prepared. It is this principal that makes no attempt in the final accounts to express the realizable value of the assets or value of liabilities and its settlement requirements. In the event an organization is unable to continue its operations due to it being bankrupt, ie the organization is not a going concern, the final accounts do not make any reference to the order in which the liabilities must be settled. The liquation of the assets and settlement of liabilities is a legal provision and not a consideration for any financial statement due to the Going Concerns principle. Going concerns can also be described as the organiztion's ability to make sufficient amount of money to stay afloat without being bankrupt. This concept has the following significance for accounting.

It facilitates the preparation of financial statements

The depreciation of fixed assets is calculated based on this concept

Cost of fixed assets will be treated as an expense in the year of purchase in the absence of this concept.

Accounting Period Concept

Accounting period concept, also known as periodicity assumption, is evaluation of financial transactions of a business entity, by sub dividing the lifespan of the business in to equal time intervals and it is to these predefined time spans the accounting information is gathered and financial statements are prepared. As these time periods are of constant in length one time period can be compared with a previous time period which allows the measurement of the financial performance of the organization.

Almost every organization today prepares its accounting information on an annual basis. In most organizations interim accounting information are also produced on shorter time periods such as quarterly, every six months or on some predefined regular basis. Although selecting the periodicity for accounting is an organizational responsibility, it needs to be in par with the general norms of accounting practices of the country and it is a legal obligation to maintain consistency of this periodicity. The periodicity used by the company for its financial statement is clearly stated on its relevant heading. This concept has the following significance to the business:

It helps in predicting the future prospects of the business.

The tax on income can be calculated for this particular period.

It helps all stakeholders of the business to analyse its performance for a particular period of time.

It aid the management of business to plan its future projects and decide on the dividend payouts

Historical Cost Concept

In accounting, under the historical cost concept, assets and liabilities are recorded at their values when first acquired. Ie it is normally valued at its cost price. They are not then generally restated for changes in values. Costs recorded in the Income Statement are based on the historical cost of items sold or used, rather than their replacement costs.

For example:

If a building is acquired by a company for Rs. 100Mn and if this is still held at the end of the first year, when the market value is Rs. 130Mn and the company sells this asset for Rs 115Mn in the second year, At the end of the first year this asset is recorded in the balance sheet at a cost of Rs 100Mn. There is no attempt to increase the value from Rs 100Mn to Rs 130Mn. In the second year, the company records a sale of Rs 115Mn. The cost of sale is Rs 100Mn, being the historical and not the current market value. This gives a profit of Rs 15Mn which is wholly recognized at the end of the second year. There is no attempt to match the costs with the current market value. This example illustrates the historical costs concept.

Accruals Concept

The accruals concepts states that effect of a transaction and other events are recognized and recorded when they occur and not when cash or equivalent is received or paid. When this transaction takes place they are recorded on accounting books and reported on financial statement in the period of which these transactions. This further means that revenues are recognized when they become receivable regardless of when the actual cash is received and an expenses are recognized when the they become payable regardless of whether the cash is paid or not.

For example, if a firm sells goods for Rs 10000 on the 15th of March and does not receive cash until 25th of April, as this is an amount receivable it must be included on the financial statements on the 31st of March. The amount receivable will be shown as a debtors in this financial statement. Similarly, If the same firm receives goods of Rs 5000 on the 25th of March and does not pay till the 20th of April, the accrual principle states that this transaction must be included in the financial statement created on the 31st of March although the payment has not yet been made. The firm to which the payment is due will be shown as a creditor.

This concept helps in knowing the actual income and actual expenses of the business during a particular time period and helps in calculating the net profit of the firm.

Realization of Income

This concept states that the revenue from any business transaction should be included in accounting records only when that legal right to receive money is established. This regal right to receive money is known as realization. Selling an item is a realized transaction but getting an order is not a realized transaction. Income and profits has to be incorporated in the business only after realization.

For example, if ABC limited, a motor spare parts dealer, received an order to supply spare parts worth Rs 1,000,000 on the 02 of March and they supplied Rs 200,000 worth of goods on the 15th of March and the rest was only supplied on the 15th of April, the revenue earned for the year ending 31st March for ABC limited is Rs 200,000 as it is the realized amount. It is this figure that will be recorded in accounting booking and reflected in financial statements. Similarly if ABC company placed an order of Rs 800,000 from its supplies on 4th of March and only received Rs 150,000 worth of goods by the 13th of March and the rest was only received on the 8th of April, for the accounting booking the realized transaction was only worth Rs 150,000 which will be recorded and reflected in the financial statements.

It helps in making the accounting information more objective and establishes that the transactions should be recorded only when the goods are received from the supplies and when goods have been sold to the buyers.

Conservatism

This is alternatively known as accounting prudence which states that a degree of caution must be exercised in judgment in making the estimates required under condition of uncertainty such as decisions relating to bad debtors, provisions for doubtful debt etc. This means being conservative in judgment. This concept ensures that the assets and income are not overstated and liabilities and expenses are not understated in accounting records. It is the accountant's judgment that decide which records are to be taken in to the accounting records.

For example if a debt has owed for quite a long time and if its status is unknown the accountant will need to exercise the concept of conservatism and consider that as either a bad debt or create a provision for doubtful debt. As it is the accountants responsibility to get the proper facts about the business they should exercise conservatism when dealing with uncertainty while ensuring that the financial statements are neutral, ie the gains or losses are neither overstated nor understated this principle of prudence.

Materiality

All items that appear on a financial statement should be material, which mean that is should be of interest to the stakeholders of the business. Although it may not be relevant to all stake holders the omission or misstatement of these could influence the decision of the relevant stakeholders. However, if the effort of recording a transaction is not considered worthwhile then it does not serve the purpose. For example if a box of pins are purchased by a firm which is used for more than one accounting period, it is possible to record the use of each pin every time one pin is being used. However, this is too trivial and no stakeholder will be interested in this. Hence, it will only be required to record when the box of pins were purchased and how it is being used after that is not necessary to be records as that is not a material transaction.

This highlights the fact that not to waste time in elaborate recording of transactions of trivial items. Although there is governing rules in determining which transaction are material and which once are not, this is based on the judgment of the business and it will establish rules of its own for the purpose of determining material vs non material transactions. The rules set by different business may also change depending the size of the business and the nature of the business and its stakeholders.

Objectivity

The objectivity concept requires an accountant to draw up any accounts, and further analysis, only on the basis of objective and factual information. Thus, this concept attempts to ensure that if, for example, 100 different accountants were to draw up a set of accounts for one business, there would be 100 identical accounting statements prepared. Everyone would be obtaining and using only facts.

The problem here is that there are many aspects of accounting ensuring that objectivity cannot be universally applicable in the preparation of accounts. For example, with fixed assets: the cost of a van must be known at its purchase: say Rs 1,000,000. However, how long will this van be in service? One accounting say five years, and another could say 10 years. If the first accountant prepare the accounts using the straight line method of depreciation calculation, first accountant would provide Rs 1,000,000 ÷ 5 = Rs. 200,000 each year for depreciation; while the other accountant would charge Rs 1,000,000 ÷ 10 = 100,000 each year for depreciation; and both of could be correct. The problem is that with an issue such as depreciation it is not possible to be objective. However, most organizations have their accounting principles to prevent such ambiguities.

Accounting principle requires that an objective view is always taken.

Dual Aspect Concept

This is the very foundation of the universally applicable double entry book keeping system and it stems from the fact that every transaction has a double (or dual) effect on the position of a business as recorded in the accounts. For example, when an asset is bought, another asset cash (or bank) is also and simultaneously decreased OR a liability such as creditors is simultaneously increased. Similarly, when a sale is made the asset of stock is reduced as goods leave the business and the asset of cash is increased (or the asset of debtors is increased) as cash comes into the business (or a promise to pay is made and accepted). All transactions in a business are having this duality nature and it is the most fundamental concept which helps in booking keeping.

This concept stems from the fact that the financial world is a closed system. That is, money does not just arrive from nowhere. If money is received by one person or entity, it must have been given by another person or entity. This duality concept is the foundation for the double entry system that we use in accounting today. 

Full Disclosure Principle

This principle states that any and all information that affects the full understanding of a company's financial statements must be included with the financial statements. Some items may not affect the ledger accounts directly. These would be included in the form of accompanying notes. Examples of such items are outstanding lawsuits, tax disputes, and company takeovers. General acceptable accounting practice usually requires as much disclosure as possible. This is to enable the investors to know more on the business they have invested in or going to invest in. Investors need well informed information, events and others to make the correct investment decision, understand the risk, identify the perception of the management and clearly review financial performance of the business. It should not only contain the facts but also should relate to events, information and others which might be relevant to the users of the financial statement. Full disclosure is hence an important principle and the accounting standards also guidelines on the full disclosure needs to be followed.

Substance Over Form Concept

When an business entity practice the Substance Over Form, it means that the financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events(Form) which underlie them. Ie Substance over form is to ensure that the financial statements reflects the complete, relevant and accurate picture of the transactions and events and not its legal aspect. This is extremely important as the legal standing of a transaction or event may be different to that of the financial one and hence the actual transactions within the company may be distorted and does not reflect the correct economic picture. To be able to differentiate Substance Over Form very good inner knowledge of the company's operation is required and it should take a more investigative in-depth approach so as to seek further evidence or proof. This is because normally some types of events or transactions are often quite complex. It is this principle that that helps to prevent creative and fraudulent accounting practices which are a violation of the standard accounting practices.

In recent times, several cases were observed where substance over form concept was not exercised which has led to fraud. Two such cases very popular are the one at the US computer giant Computer Associates and the American energy giant Enron.

Matching Concept

Income determination or measurement of Income is a considered as matching the revenues earned during the accounting period with the expenses that were incurred in the process of earning these revenues. This attempt to match the revenues against its related expenses is known as the matching concept. When the revenues are recognized, the next step is to allocate it among the different accounting periods if as necessary and this is achieved with the help of the accrual concept with related the expenses to the revenues for a given accounting period. This can be further elaborated as an attempt to calculate the net income earned in a particular accounting period of the business entity by means of deducting the expenses from revenues earned. The term matching, therefore, refers to a close relationship that exists between certain expired costs or expenses and revenues realized as a result of incurring these costs.

Double Entry bookkeeping

The double-entry bookkeeping system is a set of rules to record financial information in a financial accounting system of the business entity where every transaction or event impacts at least two different accounts. The double entry accounting system records financial transactions in relation to asset, liability, income or expense related to it through accounting entries. Any of these accounting entry in double entry accounting system has two effects one of increasing one account and decreasing another account by equal amount. Ie  If an accounting entry debits a particular account, the opposite account will be credited and vice versa. These entries recorded in the "Books of Accounts". It is this aspect of affecting two different accounts which leads to this principle to be known as double entry book keeping.

It can also be an error detecting mechanism as at any point in time if the sum of debits does not equal the corresponding sum of credits, then an error has occurred. However it is unable to detect the following errors:

Error of Omission: A transaction may not have been entered at all.

Error of principle: Any entry in the cash book may have been posted on the correct side of the wrong account

Error of compensation: A series of errors have neutralized each other resulting a zero effect.

Luca Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the double-entry system in the 15th century, thus enabling others to study and use it.

Single Entry Bookkeeping

Most businesses maintain a record of all transactions based on the double-entry bookkeeping system as specified in the previous concept. However, many small, simple businesses maintain only a single-entry system that records the "bare-essentials". In most cases it only keeps records of the cash, debtors, creditors and taxes to the government. Records of assets, inventory, expenses, revenues and other elements usually considered essential in an accounting system may not be kept in this form of accounting system. In most cases these exemption are recorded as memorandum form. Single-entry systems are usually inadequate except where operations are especially simple and the volume of activity is low. It has several disadvantages over it double entry counterpart.

Data may not be available to management for effectively planning and controlling the business which is an essential aspect of accounting.

Inefficient administration and reduced control over the affairs of the business.

Does not provide checks against clerical error.

Does not record all transactions.

Losses are less likely to be detected and auditing becomes difficult.

Cash Basis Accounting

It is an accounting system that doesn't record accruals but instead recognizes income (or revenue) only when payments are received and expenses only when payment is made. Ie when the actual money is received or paid and not when it becomes receivable or payable. There's no match of revenue against expenses in a fixed accounting period, so comparisons of previous periods aren't possible. Cash basis accounting does not deal with accounts receivable or accounts payable and only recognizes transactions actually paid for. This accounting system is easiest and perhaps best for organizations with few or no credit sales.

The obvious advantage to cash accounting is that it is simple to understand and the easiest concept to apply. If you received or paid cash, it counts as revenue or an expense in the current fiscal year; there are no accruals. A disadvantage of cash basis accounting is that it can be difficult to get an overall view of the business's exact financial position. The records do not show all the revenue or expenses the business has incurred at the close of the financial year.

Working Capital

A working capital is as the capital available for conducting the regular(day to day) activities of a company which is calculated as :

Working Capital = Current Assets - Current Liabilities

A positive working capital means that the company is able to meet its short term liabilities when they fall due while a negative working capital is an indication that the company may be facing financial trouble where it is unable to meet its short term liabilities. ie, the company's current assets do not exceed its current liabilities, and it may run into problems paying back creditors in the short term. This is also known as working capital deficiency which could lead to bankruptcy. A declining working capital ratio over a longer time period is also a red alert for a company which must be subjected to further analysis. Thus, the working capital is an indication of the company's financial health.

Working capital can also be used by investors to give them an insight on the company's underlying operational efficiency. If Money that is tied up in the stock or debtors are not paying the company on time which has resulted in the company unable to meets its financial obligations when they fall due will illustrate that the company is not progressing in the most efficient manner. This lack of efficiency will be seen when financial performance of number of years are compared is a clear indication of a problem in its operations. The company will need to monitor its operations closely and should increase its efficiency in order to sustain operations and is a wakeup call for the company's management. A company who does not monitor its working capital closely and who turns a blind eye to a negative working capital may not be able to sustain its business operations.

Working capital is also referred to as "working capital ratio" or "net working capital".

Revenues concept

In general revenue is income received by an organization in the form of cash or cash equivalents. In business activities revenue can be referred to as the income a particular company will received as a result of its normal business operations. These can usually be sale of goods or services to the customers. For example in businesses such as manufacturing or retail shops the revenue is generated from the sale of goods while in companies which offer services such as software outsourcing, audit firms earn their revenues through the sale of its services.

The sales revenue is considered as the revenue generated through its primary sales activities. For example if a retail shop's sales revenue will be from the sales activities and yet if it is also sharing its own business premises with another business which is generating earning to the business as rent, it is not a part of the sales revenue of the retail shop but considered as other revenues for the business. In accounting, revenues are calculated based on the standard accounting or government standards. Revenues can be calculated based on the two accounting practices described above, accrual accounting or cash accounting, both will not yield the same result for obvious reasons as the practices of calculating revenue is different in each method(as highlighted in previous sections).

Revenue is an important figure as all subsequent calculations on the financial statements such as profit and net income are stemming from it. Several financial ratios are based on the revenue and are also an important indicator when evaluating the company's financial performance.

Profit

This is defined as the financial gain of a particular business when the total revenue gained by the business exceeds its expenses, costs and taxes. It can be further elaborated as the money a business makes after accounting for all its expenses. Any profit that is gained belongs to the owners of the business and they may or may not decide to spend it on the business. In a company it is the directors that decide which portion of the profits needs to be retained as reserves, which portion of the profits are to be distributed among its share holders and which portion must be reinvested in the business. The term profit evolved from the Latin term "to make progress" and the main objectives of all business organizations are to earn a profit from its activities and to "make progress".

In accounting there are several important profit measurements:

Gross profit: Sales revenue less cost of sales

Operating profit: This is Gross profit less all operating expenses. This is also known as

Earnings Before Interest and Taxes - EBIT

Operating Profit Before Interest and Taxes - OPBIT

Profit Before Interest and Taxes PBIT.

Net Profit Before Tax: Operating profit less interest expense (but before taxes).

Net Profit / Profit After Tax: This is the profit earned after all the taxes are paid and also known as the net income.

Limited Liability

This is a concept whereby a person's or an investor's financial liability is limited to a particular fixed amount, which in most cases is amount that he or she invested in a particular company. This company is also then said to be a limited liability company. It can be further elaborated as the type of investment in which a partner or investor cannot lose more than the amount invested and they are not personally responsible for any debts or obligations of the company in the event that these are not fulfilled.

If a limited liability company is taken to court for not fulfilling its financial obligations then the company will be sued and not the individual investors or its owners as a shareholder of a limited liability company is not personally responsible for the company's finances. In the event this company lose its court cases and declared bankrupt, the investors may stand to lose its investments and any subsequent dividend payments from this particular company while their personal assets or investment in other companies remains intact. This is in contrast to a sole trader or partners in a partnership business where the sole trader or partner is personally liable for all debt of the company and must pay back all the debt in the event of bankruptcy with their own assets which may or may not be part of the business. This is also known an unlimited liability.

Although it is stated that a shareholder's liability for the company's actions is limited, if he or she is a part of the day to day running of the business then the shareholder may still be liable for its own acts. They are also liable for any personal guarantees that they provided to any lending company or are responsible for any fraudulent acts that they may take place while they operate in the business. Limited liability is not a blank cheque for investors or owners to run operations in the company as they wish but a legal framework within which provides is a clear boundary for the business entity and the investors and owners of the business.

Depreciation

Depreciation can be described as a method of allocating the historical or purchase cost of an asset across its useful life of with an approximate correspondence to normal wear and tear when used in the business operations. The prudence concept described is exercised here when evaluating the useful life of the asset and wear and tear of it. Depreciation is a noncash expense and is a figure that is attributed to most assets which lose their value over time (in other words, they depreciate), and must be replaced once the end of their useful life is reached.

Depreciation is mainly calculated based on two methods.

The straight line method

The reducing balance method

It is a company's policy to select the appropriate depreciation method for its assets and is basically dependent upon its accounting principles. The company could choose to use one method of depreciation calculation for one particular type asset and the other method of another asset. For example, the company could use the straight line method to calculate the depreciation of land and buildings while the reducing balance method is can be used for the depreciation of its machinery. However, it is unlikely to change the method of depreciation calculation for the same asset unless the there is a change of accounting principle within the company which needs to be channeled through the appropriate protocols before it is implemented.

A company must report depreciation accurately in its financial statements to:

Match the expenses of depreciation with the income generated.

Prevent overstatement of asset values in the balance sheet.

Assets are stated in the balance sheet at its historical value and depreciation is calculated as in expense and reduced from the asset value to get the net book value. The net book value of an asset will decrease over the years as depreciation is accumulating each year and eventually seize to exists after its useful life that is stated in accounting principles.

Solvency concept

Solvency can be defined as the ability of a company to meet its long-term fixed expenses and also to accomplish long-term expansion and growth. It can also be defined as the ability of a company to pay its debt when they fall due. When the solvency of a company is better, it is in a better financial footing. If the company is unable to operate then it is said to be bankrupt and is insolvent.

Capital Expenditure

A capital expenditure is incurred when a business spends money for buying fixed assets or to add to the value of an existing fixed asset by extending the useful life of it beyond the taxable year. It is used by a company to acquire or upgrade physical assets sucha as buildings, property and machinery. Capital expenditure helps an organization to increase its earning capacity and help generate profits over longer term which is more than 12 months of operation. The amount of capital expenditure that a company would have to incur is depends on the type of industry that it operates in. Some industries such as the telecom and oil exploration are highly capital intensive.

The following items illustrate some examples of capital expenditure (http://en.wikipedia.org/wiki/Capital_expenditure):

Starting a new business venture

Acquiring fixed assets

Fixing problems with an existing asset

Preparing an asset to be used in business

Legal costs of incurred for establishing or maintaining one's right of ownership in a piece of property

Restoring property or adapting it to a new or different use.

If a capital expenditure is incurred, it needs to be capitalized. Ie, the cost must be spread over the useful life of the asset. As described under depreciation, the values of the assets acquired through capital expenditure are deprecated over the life of the asset as determined by the company under the prudence concept.

Revenue expenditure

Revenue expenses are costs incurred in the day to day activities of the business where the costs are attributed to the current year of operation and not beyond it. These costs are matched against the revenues generated in the current accounting period. . Some examples of revenue expenditure are

Servicing of machines

Purchase of spare parts

Rent payments

Electricity payments

Office expenses

Repairs of building

Accounting standards clearly outlines which items must be classified as capital expenditure and which items are classified as revenue expenditure as fraudulent practices can be exercised in accounting specifying by revenue expenditure as capital expenditure and there by excluding them from the income statements and showing in the balance sheet. This will show lower costs in the income statements and hence show higher profits.

However, the categorization of the expense type may vary from industry to industry. For example in a property sales company who buys and sells land, the expenses incurred in buying new property cannot be categorized as capital expenditure as it is their core business activity and it is said to be a revenue expenditure.

Stocks

Stocks are also known as inventory and is an import item for the day to day smooth running the business. It ranges from the inventory that a retail shop will have for its sales to the items that a manufacturing organization would have for producing its goods. Every organization need the adequate amount of stock available as otherwise the business operations might have to be suspended each time their runs out of stock which will lead to valuable time wasted and decrease in productivity. Every company has structured their processes in order to adequately maintain their stock as required by its business. It is undesirable for the business to have either a too smaller stock or too larger stock. Both could be detrimental to its business activities as too smaller stock would mean they are unable to sustain its business and too larger stock would mean that cash is held up unnecessarily in stock. Stocks are categorized as current assets as they are considered to be able to converted to cash reasonably easily. It is also the least liquid of the current assert.

Drawings

Drawings of a business are the money withdrawn from the business or the cash drawn out of the business by the owners or proprietors of a business in a sole trader or partnership. It is considered a disinvestment in the business where the owner's equity is reduced. Hence, drawings or withdrawals by a sole proprietor will affect the company's balance sheet through the reduction of the asset withdrawn. It is also reported in the financing activities section of the cash flow statement while the income statement (Profit and Loss Accounts) remain unaffected.

It is a usual accounting practices to maintain a separate drawings accounts and not reflecting the drawing in the capital account. The main reason for this is that it helps the business to separately identify the amounts taken out of the business by the owners in a particular finance period.

Shareholders

A share holder also known as a stockholder in a company is a person, another company or other organization which holds at least one share of that particular company. The collection of all shareholders are in fact are owners of the company. The shareholder will benefit when the company performs well and earns a profit which is shared by the shareholders which is proportional to its share holding. However, if the company performs badly, there will be no returns for the share holders as the company has incurred a loss.

In a public limited liability company (PLC) the shares are traded through the stock exchange while in a private limited company the shares are based on the share holders agreement in the business. Both type of organization has its own legal framework in which the shareholders are given specific legal rights in the business yet limiting them from exercising personal agenda's in management of the in the company. It is the director's responsibilities to run the company and take management decision and not the responsibility of the shareholders.

In a situation of bankruptcy of a company share holders would be the last on the list of liabilities that has to be settled by this particular company. Hence, in the event of a company being declared bankrupt the share holders will receive nothing after its creditors are paid as if the shareholders can be paid after its creditors, it will not have been declared bankrupt in the first place.

Stakeholders

Stakeholders of a company are individuals or other organizations that can affect or that can be affected by the decisions taken by this particular company. They are not only shareholder of the company but include a wide range of individuals or organizations. They usually include the employees, the employees' families, suppliers, customers, community, and others.

The stakeholders can be categorized in to two broad areas. The internal stakeholders which are the interested parties within the company or organization such as the employees or the external stakeholders which are the parties outside the business but who yet have interest in the business such as the supplier's and creditors.

It is also possible for an organization to have stakeholders without shareholder. For example in a sole trader business there are no shareholders yet there are stakeholders who are affected by the decisions taken by the sold trader such as its suppliers, creditors, debtors etc.

Reserves

Reserves are funds in a company which is taken out of the company's net profit after taxes before dividends are paid and kept in a special account or accounts for anticipated future payments. The funds are transferred to the reserve account when the company earns a net profit and the directors decide to keep aside a portion of these profits so that it can be used when the company fail to perform well or when they have large expansion plans in the pipeline. On occasions, funds are transferred from the reserves and paid as dividends when the company does not perform well and make a loss yet the shareholders needs to be rewarded.

The reserve accounts take many forms and few can be listed as:

General Reserve

Share Premium

Remuneration Reserve

Legal Reserve Fund

The amounts transferred to and/or from the reserve accounts are listed on the balance sheet of a company.

Work-in-progress

Work in progress can be defined as

Equity

Retained earnings

Liquidation

Audit

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