CIMA - C2 Fundamentals of Financial Accounting
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xx Introduction
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1
Part A
Conceptual and
regulatory framework
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2
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3
The nature and
objectives of
accounting
Introduction
The syllabus for the Fundamentals of Financial Accounting paper begins with the section
'conceptual and regulatory framework'. Before you learn how to prepare financial statements,
it is important that you understand why accounting information is necessary and the
assumptions on which it is based.
In Sections 1 to 2 of this chapter, you will discover the purposes and uses of accounting
information.
As you have chosen to train for the CIMA qualification, you may be aware that there is a
difference between a management accountant and a financial accountant. This topic is
covered in Section 3.
Section 4 introduces you to the main financial statements - the income statement and the
statement of financial position.
Topic list Syllabus references
1 What is accounting? A (1)
2 Users of accounting information A (1)
3 Management accounting and financial accounting A (1)
4 The main financial statements A (1)
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4 1: The nature and objectives of accounting ⏐ Part A Conceptual and regulatory framework
1 What is accounting?
Accounting is the process of collecting, recording, summarising and communicating financial information.
Question
Accounting
(a) You will often meet with the terms 'an accounting statement' or 'a set of accounts'. Do you know what is meant
by these terms?
(b) Who do you think has the task of preparing accounting statements? In an organisation of a reasonable size,
would it be one person? One department? Several different departments?
(c) Who are the users of accounting information?
(d) What is the purpose of accounting?
Answer
(a) An accounting statement is, for example, an income statement or a statement of financial position. A set of
accounts is a number of accounting statements presented together with the intention of showing an overall view
of an organisation's income, expenditure, assets and liabilities.
(b) Most organisations of reasonable size will have at least one accounts department, staffed by people with detailed
knowledge of accounting systems and theory. In large organisations there may be several departments, or
groups, responsible for preparing accounting information to meet the different needs of accounts users.
(c) The users of accounts include a variety of people and organisations, both internal and external, as explained in
Section 2 of this chapter, such as current and potential workers, investors, customers and suppliers. Government
bodies and the general public may also be interested. The extent of their information needs varies widely.
(d) There are many purposes of accounting. You may have considered the following.
• Control over the use of resources
• Knowledge of what the business owes and owns
• Calculation of profits and losses
• Cash budgeting
• Effective financial planning
1.1 Why keep accounts?
Accounting information is essential to the efficient running of a business. It helps managers to control the use of
resources, keep track of the assets and liabilities of the business and plan effectively for the future.
Accounts show where money came from and how it has been spent, this
• aids the efficient running of a business
• indicates how successfully managers are performing
• provides information about the resources and activities of a business
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Part A Conceptual and regulatory framework ⏐ 1: The nature and objectives of accounting 5
Accounting information aids the efficient running of a business in many ways.
(a) A business needs to pay bills for the goods and services it purchases, and collect money from its
customers. It must, therefore, keep a record of such bills and invoices so that the correct amounts can be
paid or collected at the correct times.
(b) Keeping records of a business
'
s assets (eg its motor vehicles or computers) helps to keep them secure.
Accounts indicate how successfully the managers are performing.
Modern businesses are often complicated, they seldom have a single owner (some very large enterprises, such as J
Sainsbury, may be owned by millions of shareholders). Frequently the owners are not involved in the day-to-day running
of the business but appoint managers to act on their behalf. In addition, there are too many activities and assets for the
managers to keep track of simply from personal knowledge and an occasional glance at the bank statement, so accounts
which summarise transactions are very useful.
A business should provide information about its resources and activities because there are many groups of people who
want or need that information. We will look more closely at the classes of people who might need information about a
business in Section 2.
Question
Why keep accounts?
Why should a business keep accounts?
A To discover how well the business is doing
B To record assets and liabilities
C To help run the business efficiently
D All of the above
Answer
D All of the above statements are true.
2 Users of accounting information
Accounting information is required for a wide range of users both within and outside the business.
The following people might be interested in financial information about a large public company.
User group
Comment
Managers of the company
People appointed by the company
'
s owners to supervise the daily activities of the
company need information about the company
'
s current and expected future
financial situation, to make planning decisions.
Shareholders of the company,
ie the company
'
s owners
Want to assess how effectively management is performing and how much profit they
can withdraw from the business for their own use.
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6 1: The nature and objectives of accounting ⏐ Part A Conceptual and regulatory framework
User group
Comment
Trade contacts, ie suppliers of
goods to the company on credit
and customers
Suppliers want to know about the company
'
s ability to pay its debts; customers
need to know that the company is a secure source of supply and is in no danger of
closing down.
Providers of finance to the
company, ie lenders both short
and long term
Lenders will want to ensure that the company is able to meet interest payments, and
eventually to repay the amounts advanced.
The tax authorities Want to know about business profits in order to assess the tax payable by the
company.
Employees
Need to know about the company
'
s financial situation because their future careers
and the level of their wages and salaries depend on it.
Financial analysts and
advisers
Need information for their clients. For example, stockbrokers need information to
advise investors, credit agencies want information to advise potential suppliers of
goods to the company, journalists need information for their reading public.
Government and their
agencies
Interested in the allocation of resources and in the activities of enterprises. Also
require information in order to provide a basis for national statistics.
The public
Want information because enterprises affect them in many ways, eg by providing
jobs and using local suppliers, or by affecting the environment (eg pollution).
Question
Accounting information
It is easy to see how 'internal' people get hold of accounting information. A manager, for example, can ask the accounts
department to prepare whatever accounting statements he needs. But external users of accounts cannot do this. How, in
practice, can a business contact or a financial analyst access accounting information about a company?
Answer
Limited liability companies (though not other forms of business such as partnerships) are required to make certain
accounting information public. They send copies of the required information to the Registrar of Companies at Companies
House. The information filed at Companies House is available, at a fee, to any member of the public who asks for it.
Other sources include financial comment in the press and company brochures.
Question
Company accounts
Mark the following statements as true or false.
(a) Shareholders receive annual accounts, prepared in accordance with legal and professional requirements.
(b) The accounts of limited liability companies are sometimes filed with the Registrar of Companies.
(c) Employees always receive the company's accounts and an employee report.
(d) The tax authorities will receive the published accounts and as much supplementary detail as they need to assess
the tax payable on profits.
(e) Banks frequently require more information than is supplied in the published accounts when considering
applications for loans and overdraft facilities.
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Part A Conceptual and regulatory framework ⏐ 1: The nature and objectives of accounting 7
Answer
True
(a) Yes, and, in addition, companies listed on the Stock Exchange have to comply with the regulations in the Stock
Exchange's Listing Rules (Yellow Book).
(d) Yes.
(e) Yes, banks may require cash flow and profit forecasts and budgets prepared to show management's estimates of
future activity in the business.
False
(b) The accounts of limited liability companies must always be filed with the Registrar of Companies and be available
for public inspection. In addition, the company itself will often distribute these accounts on request to potential
shareholders, the bank and financial analysts. These accounts are all that is usually available to suppliers and
customers.
(c) Employees will not necessarily receive company accounts (unless they are shareholders for example), but many
companies do distribute the accounts to employees as a matter of policy. Some companies produce employee
reports which summarise and expand on matters which are covered in the annual accounts and are of particular
interest to them.
Many different people use financial statements to acquire information about a business.
3 Management accounting and financial accounting
Management accounts are produced for internal purposes – they provide information to assist managers in running the
business. Financial accounts are produced to satisfy the information requirements of external users.
Financial accounting is the preparation of accounting reports for external use.
Management accounting is the preparation of accounting reports for internal use.
3.1 Management accounting
Management accounting systems produce detailed information often split between different departments within an
organisation (sales, production, finance etc). Although much of the information deals with past events and decisions,
management accountants produce information which is forward-looking, and used to prepare budgets and make
decisions about the future activities of a business. They also compare actual performance with budget and try to take
corrective action where necessary.
3.2 Financial accounting
Financial accountants, however, are usually solely concerned with summarising historical data, often from the same
basic records as management accountants but in a different way. This difference arises partly because external users
have different interests from management and do not need very detailed information. In addition, financial statements
are prepared under constraints (such as International Financial Reporting Standards and company law) which do not
apply to management accounts.
Key terms
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Assessment
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8 1: The nature and objectives of accounting ⏐ Part A Conceptual and regulatory framework
Question
The financial accountant
Which of the following is a function of the financial accountant in a business which employs several accounting staff?
A Preparing budgets
B Costing products
C Setting selling prices
D Summarising historical accounting data
Answer
D Correct; this is a function of financial accounting.
A This is usually a job for the management accountant.
B This is usually a job for the management accountant.
C This is usually a job for the management accountant.
Management accounts are for internal use and the financial accounts for external use. Management accounts provide
information for decisions affecting the future; financial accounts provide information about what has happened in the
past.
4 The main financial statements
The two most important financial statements are the statement of financial position and the income statement.
4.1 The statement of financial position
The statement of financial position is a list of all the assets owned by a business and all the liabilities owed by a
business at a particular date.
Assets are the business
'
s resources eg buildings to operate from, plant and machinery, inventory to sell and cars for its
employees. These are all resources which it uses in its operations. Also, it may have bank balances, cash and amounts of
money owed to it. These provide the funds it needs to carry out its operations and are also assets. It may owe money to
the bank or to suppliers: these are liabilities.
4.2 The income statement
The income statement is a record of income generated and expenditure incurred over a given period.
The income statement which forms part of the financial accounts of a limited liability company will be made up for the
period of a year, commencing from the date of the previous year
'
s accounts.
Management accountants might need quarterly or monthly income statement. The incomes statement shows whether
the business has more income than expenditure (a profit) or vice versa (a loss) during a period.
Organisations which are not run for profit (charities etc) produce a similar statement called an income and expenditure
account which shows the surplus of income over expenditure (or a deficit where expenditure exceeds income).
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Part A Conceptual and regulatory framework ⏐ 1: The nature and objectives of accounting 9
4.3 Accruals concept
The accruals concept means that income and expenses are included in the income statement of the period in which they
are earned or incurred, not received or paid.
The accruals concept is very important as it underlies the preparation of the income statement.
It is very important to grasp that, in nearly all businesses, accounts are not prepared on a cash basis but on an accruals
basis. This is because cash accounting does not present a true picture of the business
'
s activities in any given period.
4.4 Example: accruals concept
Emma has a business printing and selling T-shirts. In May 20X7 she makes the following purchases and sales.
Invoice date Numbers bought/sold Amount Date paid
Purchases $
7.5.X7 20 100 1.6.X7
Sales
8.5.X7 4 40 1.6.X7
12.5.X7 6 60 1.6.X7
23.5.X7 10 100 1.7.X7
What is Emma
'
s profit for May?
Solution
$
Cash basis
Sales 0
Purchases
0
Profit/loss
0
Accruals basis
Sales ($40 + $60 + $100) 200
Purchases
(100
)
Profit
100
The accruals basis gives a truer picture than the cash basis. Emma has no cash to show for her efforts until June, but
her customers are legally bound to pay her and she is legally bound to pay for her purchases.
Her statement of financial position as at 31 May 20X7 would therefore show her assets and liabilities as follows.
$
Assets
Receivables ($40 + $60 + $100)
200
Proprietor's capital
100
Liabilities
Payables
100
200
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