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L.R. Dickson has defined business as a form of activity pursued primarily with the object of earning profit for the benefit of those on whose behalf the activity is conducted. "Business involves production and/or the exchange of goods and services to earn profits or in a broader sense, to earn a living".
Main types of Business Organisations
The three main types of business organisation are sole traders, partnerships and limited companies (including both public and private). The sole trader is the most common type or form of business ownership, found from plumbing to florists. It is an unincorporated business owned by one individual. There is no requirement for complicated paperwork to be set up as a sole trader, the individual just begins to trade. Decisions are able to be made quickly, close relations are able to be formed with customers and employees and all profits go directly to the sole trader. However main limitation is unlimited liability with all finance to be provided by sole trader himself. Next is the partnership, a partnership exists whenever two or more persons work together to form a non corporate business. An example of this could be accounting or solicitor partnerships. Partnerships may operate under different levels of formality, ranging from informal or oral agreements to more formal detailed contracts. However if there are only informal or oral agreement then they are still subject to the Partnership Act 1890. The major advantage of a partnership is its low cost and ease of formation. The disadvantages are similar to those associated with sole traders in its unlimited liability and its difficulty in raising large amounts of capital. The tax treatment of a partnership is similar to that for sole trader, which is often an advantage. Finally we come to limited companies, they are owned by shareholders who appoint Directors to give direction to the business. A limited company is a legal entity in its own right with its existence being completely separate from its owners and its main advantage is its limited liability. However, the formation of a limited company is more difficult than that of a sole trader or partnership. Documents of incorporation must be prepared. A typical example could be a Water Treatment company.
Refer to Figure 1 below for table indicating standing of each organisation with regard to ownership, financials, legal & taxation.
Limited liability Companies
Private - between 2 - 50
between 2 - 20 *
Public - minimum 7 but no maximum limit
Set up costs minimal
Set up costs minimal
Legal fees and stamp duty
No restriction on distribution of profit or cash withdrawal
Profits distributed in
Restricted under company law
No legal requirement to prepare accounts
No Legal requirement to prepare accounts
Accounts must be prepared and registered with the Company's Registrations Office
No audit fees
No audit fees
No limited liability
No limited liability
No real legal restrictions except tax law
Must obey Partnership Acts
Restricted under companies acts & accounting regulations
Profits taxed at income tax rates 42% & 20%
Profits taxed at the income tax rates of 42% and 20%
Profits taxed at corporation tax rates 12.5%
As you can see from the above with regard to accounts, the sole trader and the Partnership are relatively straightforward to prepare as they are not under any legal obligation to produce accounting information for anyone but the tax authorities. For the limited company the picture is very different and much more onerous. Their accounts must be prepared in accordance with the regulatory framework and on nearly all occasions be audited by an independent accounting firm.
Nature and Scope of Management Accounting
Management accounting is the process of identification, measurement, analysis, preparation, interpretation and communication of information to plan, evaluate and control within an organisation to ensure proper allocation and control of its resources. It is defined by the Chartered Institute of Management Accountants (CIMA) as "The application of professional knowledge and skill in the preparation and presentation of accounting information in such a way as to assist management in the formulation of policies and the planning and control of the operations of the undertaking". The main point of management accounts is that they must satisfy the needs of the user. This can be applied to all types of business but they must be clear, concise and contain relevant information. These types of accounts benefit planning by providing information about pricing, capital expenditure or competition. They benefit the control process by its assistance in budget formulation and achievement and also serve to motivate senior and middle managers to achieve organisational objectives. They main idea with these types of accounts is to prepare information that is of specific use to the user of such information. To do this you must look at the end user and tailor them to suit what they require subject to any statutory requirements, case law and accounting bodies. For example the Inland Revenue require these accounts to determine the liability of a company for taxation purposes, while a bank will be more interested to confirm if an outstanding or future loan would be repaid. Competitors on the other hand will use them for comparison purposes to position their own business and a board of directors will use this information to formulate short, medium and long term plans.
Definition of Profit & Loss and Balance Sheets
(Investopedia, 2012) "A financial statement summarizes the revenues, costs and expenses incurred during a specific period of time. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs. The P&L statement is also known as a statement of profit and loss, an income statement or an income and expense statement". An explanation of this can be as follows; the statement of profit and loss begins with an entry for revenue and subtracts from the revenue the costs of running the business, including the cost of goods sold, operating expenses, tax expenses and interest expenses. The bottom line both literally and figuratively is net income or profit. The balance sheet presents a company's financial position at the end of a specified date. The balance sheet can be described as a "snapshot" of the company's financial position at a specific point in time. For example, the amounts reported on a balance sheet dated December 31, 2011 reflect that instant when all the transactions through December 31 have been recorded.
There are five main elements to financial statements and to remember these then the acronym ALICE can be used equating to assets, liabilities, income, capital and expenses. So for clarity the Balance sheet contains only assets, liabilities and capital which determine what the company is worth and the Profit & Loss contains only expenses and income. I will now go on to give a brief description of each element of financial accounting:
Assset: is defined as the right to receive future economic benefit as a result of a past event. It is something a business owns or controls such as a piece of machinery;
Liability: is defined as an obligation to transfer future economic benefit as a result of a past event. It is something that is owed by the business to another person or company, an example it could be a bank loan or electricity bill;
Income: is the money generated by a business such as sales, revenue or turnover
Capital: normally cash, equity or shares in a company;
Expenses: regular expenditure of a company such as the heating, lighting.
Main differences between Management and Financial Accounting
Financial and management accounting are both important tools for a business and both prepare and analyse financial data but they serve different purposes and have different audiences. Management accounting provides information to people within an organisation to enable managers to make decisions containing the day-to-day operations of a business. It is not based on past performance but instead on current and future trends. Examples of these users would be employees, managers and executives of the company. Financial accounting is used primarily by those outside a company and reports are usually created for a specific period of time. Financial reports are factual, reporting on the profitability, liquidity, solvency and stability of the organisation and the interested parties for these types of reports would be to it's external stakeholders, board of directors and financial institutions. The users of these types of accounting could Shareholders asking whether or not they should invest, the Suppliers checking the liquidity of the company and whether they would get paid, even the employees confirming if they are employed by a company who is stable in the current market and is a going concern.
However, these are not the only major differences between the two. They also differ on the aspect of regulatory oversight as financial accounting is regulated by various boards and agencies such as the Securities and Exchange commission (SEC), the Financial Accounting Standards Board (FASB), and the Public Company Accounting Oversight Board (PCAOB) and adhere to Generally Accepted Accounting Principles (GAAP), while in contrast management accounting is not regulated by any specific agencies or standard setting bodies.. Also as I have indicated previously that even the frequency of reporting differs as between the two as managerial accounting provides reports which are future orientated while financial accounting provides reports based on historical information. Management accounting does not have a set or standard time span but in fact are reported continually but financial accounting statements are generally produced for a period over the past quarter or fiscal year.
I hope you found this report useful and it can be further discussed further after the next meeting of the Board of Directors