Fa Chap 1

10/5/2023
Chapter 1
Financial Reporting and The Financial Statements
© ACCA
© ACCA
Chapter 1 Financial Reporting and The Financial Statements
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Types of Business Entities
Businesses exist to make a profit by producing and selling goods

and services. Profit is the difference between the income and
expense of a business.
While businesses share a similar purpose, they can still differ

significantly. Businesses vary in terms of size, financing, and legal
position. These different factors influence what is reported in
their financial statements.
A business can operate as a sole trader, a partnership, or a

limited liability company.
© ACCA 4
Exam Guidance
Exam advice
Questions on these business arrangements are popular

in the exam. Students may be tested on the ability to
recognise the key features of each type of business.
© ACCA 5
Sole Traders
A sole trader is an individual who owns, controls, and

manages a business alone.
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Sole Traders
Legal Differences of Sole Traders
• Change in Business Ownership

To change the owner of a sole trader business, the existing sole
trader would sell their business to the new owner. The sole trader is
the only person in charge, so this decision is made without involving
others.
• Business Continuation
If a sole trader exits the business, it cannot continue unless sold to
another individual.
© ACCA 7
Sole Traders
• Taxation
Sole traders are taxed on the profit the business makes. The tax
authorities do not tax the individual owner separately.
• Ownership of Business Property

There is no separation of ownership between a sole trader business
and its owner.
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Sole Traders
• Legal Action
The sole trader is legally liable for any penalties and fines incurred if a
legal dispute occurs and a court judgement is made against the
business
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Sole Traders
Advantages of Sole Traders
✓ Control – A sole trader has complete control over their business. The
owner owns the business assets and is fully entitled to all the profits
generated by the business.
✓ Business Formalities – It is easy for a sole trader to set up and

operate a business. There is no need to comply with companies’
legislation and no requirement to publish financial statements.
However, the sole trader may still need to produce financial

statements to provide information for the tax authorities.
✓ Flexibility – A sole trader can choose how to operate and is not

bound by any workload requirements.
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Sole Traders
Disadvantages of Sole Traders
 Liability – A sole trader is fully liable for all the business’s debts. Any
personal possessions may have to be sold to pay off the business's
debts.
 Raising Finance – A sole trader may not be able to raise the money
needed to develop the business in the longer term. The only available
finance sources may be the owner’s capital or short-term finance from
the bank (overdraft).
 Business Continuity – The business will cease if the sole trader dies
or retires unless arrangements have been made for it to be sold or
transferred to someone else.
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Activity 1
1. Which one of the following is MOST likely to be interested in a
sole trader's financial statements?
a) Shareholders
b) The financial press
c) Loan note holders
d) The tax authorities
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Activity 1
2. Which of the following statements about sole traders are true?
i) A sole trader may be able to obtain a bank overdraft.
ii) If a sole trader owes money, the person who is owed the money will only
be able to claim against the assets of the sole trader's business.
iii)A sole trader's business may suffer if the owner becomes ill.
a) i) and ii)
b) i) and iii)
c) ii) and iii)
d) i) only
e) All of them
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Partnerships
A partnership is where two or more people own and

run a business together to make profits.
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Partnerships
Legal Differences of Partnerships

All the partners must agree to a new partner being admitted to the
partnership. A partner will typically buy into the partnership by
investing.
If a partner leaves a partnership, the partnership automatically ends
unless the partnership agreement allows the remaining partners to
continue the partnership.
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Partnerships
Legal Differences of Partnerships
• Taxation
Like a sole trader business, the partnership is taxed on its profits. The
tax authorities do not tax the individual partners separately.

There is no separation of ownership between a partnership business
and its owner (partners).
• Legal Action
The partners are legally liable for any penalties and fines incurred if a
legal dispute occurs and a court judgement is made against the
partnership.
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Partnerships
Advantages of Partnerships
✓ Defined Roles – A partnership will have a partnership agreement

that sets out how the business will be managed concerning each
partner’s work scope and the profit-sharing arrangements.
✓ Raising Finance – If the existing partners bring another partner into

the business, the new partner will be required to contribute
financially.
✓ Paperwork – A partnership does not have to publish its financial

statements. However, financial information may be kept for proper
accounting records and to avoid disputes concerning tax expenses.
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Partnerships
Advantages of Partnerships
✓ Skills and Knowledge – Different partners have different business

skills and knowledge. This can enhance the business because they
can concentrate on what they do best.
✓ Risks – Having more partners in a partnership will spread the

business risk to more people. The impact of poor performance and
losses will be reduced for each partner.
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Partnerships
Disadvantages of Partnerships
 Costs - Drawing up a legally binding partnership agreement will cost

money.
 Decision Making – The time taken to make decisions may be slow in

a partnership if the partners disagree. This can slow down the
progression and development of business.
 Profit Sharing – Since profits and losses are shared among the
partners, there may be no incentive for the partners to work harder
than the other partner.
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Partnerships
Disadvantages of Partnerships
 Business Continuity – A partnership may need to be dissolved if

one of the partners cannot continue working. For the partnership to
continue, the remaining partners may need to admit a new partner
and establish a new partnership.
 Liability – Each partner’s personal assets are at risk if the business

fails. Personal bankruptcy can occur.
 Disagreements and Disputes – Severe disagreements or disputes

not resolved promptly between partners can result in hung decisions
or, in the worst-case scenario, the partnership breaking up.
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Limited Liability Companies
A limited liability company is where investors invest in the company

by buying shares and becoming shareholders. Shareholders require
profits on their investments in the form of dividend payments or
share value appreciation. Directors are hired to run the company on
behalf of the shareholders. Shareholders are only liable for their
investment.
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A limited liability company may be a private or public limited company.

Public limited companies tend to be larger, and their shares are listed
on stock exchanges, which means the public can buy the business’s
shares.
A private limited company will have a smaller number of shareholders

and may require the approval of existing shareholders before issuing
new shares.
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Legal Differences of Limited Liability Companies

Shareholders can buy and sell shares in a limited company without
needing other shareholders to agree. However, smaller companies can
restrict the sale to make the shares available to existing shareholders
before being placed on the open market.
If a company's shareholders change, this does not affect the
company’s existence.
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• Taxation
The limited liability company is taxed based on the profits it
generates. The individual owners (shareholders) are taxed separately.

A limited liability company can own a property itself. The ownership
does not need to be in anyone else's name. Individual shareholders
do not have control over the property.
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• Legal Action
The legal repercussions of a limited liability company are limited to
the business only. The owner’s (shareholders) legal liability is limited
to the value of the shares they own. It is the company that is legally
liable, not its shareholders.
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Advantages of Limited Liability Companies
✓ Liability – Limited liability can protect directors and shareholders

(owners) from legal actions brought against them. The shareholders’
liability is limited to the value of their invested shares. Personal
possessions of the shareholders cannot be used to repay any of the
business’s debts.
✓ Raising Finance – Limited liability companies may have easier

access to finance and may attract a wider pool of industry experts. It
can issue shares to existing shareholders or the public to raise money
for the business.
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Advantages of Limited Liability Companies
✓ Business Continuation – A limited liability company can be

transferred from one owner to another. If the current shareholders
decide to sell their shares, another shareholder can purchase them,
and the business will continue to operate as usual.
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Disadvantages of Limited Liability Companies
 Costs – Setting up a limited liability company requires a substantive

initial investment. There is also considerably more administration
involved in running a limited liability company than a partnership or
sole trader.
 Taxation – The profits of a limited liability company are taxed. The

owners (shareholders) and directors (employees of the company) are
also individually taxed.
 Public Eye – A company cannot keep its business affairs private as it

relies on the public to invest money into the business (by purchasing
shares). A limited liability company must hold general meetings and
file annual reports with the company registrar.
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Activity 2
In the following activity, match each statement to the appropriate
business arrangement:
• sole traders
• partnerships
• limited liability companies.
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Activity 2
Some statements will be scenarios where the owner considers what
business arrangement to operate.
Statement Business arrangement
Isabella wishes to open a small shop three days

a week and wants to spend as little time as
possible on business paperwork and formalities.
The business will continue even though one of its

shareholders dies.
There is a distinction between the business and

its owners.
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Activity 2
Oliver wishes to own his own business in a

country where limited liability companies must
have a minimum of two shareholders.
Riley wishes to operate by himself as a builder
but is concerned that he will be personally liable
for legal claims by his customers.
Lee has been running an accountancy practice by

herself but is concerned that she does not have
the expertise to meet all her client’s needs.
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Activity 2
The business is taxed as a distinct entity from

those who own it. The business may be subject
to different tax rates from its owners.
The owner’s savings are likely to be an essential

business finance source.
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Financial Reporting
The finance department in a business exists to produce reliable
information, which becomes the basis for preparing financial statements.
Users of these statements want to know that the information it contains
can be understood and is reliable. Therefore, a business needs to
prepare financial statements logically and consistently.
Financial reporting is the recording, analysing, and summarising

of financial data to present the financial performance of a business.
The financial statements produced from this data are analysed by users
interested in the business’s financial standing.
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Financial Reporting
• Recording
A bookkeeper records all business transactions promptly so that the
information is updated. The records should show enough information
about its transactions to help managers prepare financial statements
and meet legal requirements.
For example, a business records information such as customer sales

and purchase of goods.
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Financial Reporting
• Analysing
A bookkeeper analyses individual transaction records and sorts the
information into different categories so the business can analyse
information concisely.
For example, transactions are categorised according to their

accounting type so that managers can identify the business’s main
expenses or how much cash it has received from each customer.
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Financial Reporting
• Summarising
Complete accounting records usually contain too many details for the
needs of most interested parties in the business's financials.
Therefore, businesses summarise their financial transactions and
position in annual financial statements. This enables users to obtain
an overview of the business without looking through detailed
accounting records.
Financial data is summarised in the financial statements at the end of

each accounting period.
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Financial Reporting
• Analysis of Financial Statements
Readers compare different items in the statements to see how things
have changed over time and compare how the business has
performed against others. Analysing the reports helps readers make
informed financial decisions. Therefore, financial statements need to
be accurate.
For example, readers compare the value of assets in the statement of

financial position against previous years to identify if new investments
have been made. The financial statement is also analysed using
financial ratios to be compared with historical or competitor financials.
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Nature, Principles and Scope of Financial Statements

Financial statements are a set of documents a business prepares
that contain information about its financial results and what it owns
and owes.
Interested parties of the business can read and analyse the financial
statements to determine its financial viability. The readers can better
assess the figures contained in the financial statements by comparing
them with those issued in other years or by similar businesses in the
industry.
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The main financial statements of a business are:
• Statement of Financial Position

The statement of financial position shows the business’s financial
standing at the end of the accounting period. This includes assets and
liabilities such as:
—land and buildings the business owns

—equipment and motor vehicles needed for operation
—goods not yet sold to customers
—cash-in-hand and in the bank
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—money owed by customers
—money owed to its suppliers
—income taxes owed to authorities
The statement also shows the sources of finance that support the
business. Finance borrowed by banks or other lenders is a form of
liability. Finance supplied by investors who have purchased shares
and owner’s investments make up part of the business’s capital
(equity) portion.
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The statement of financial position shows the financial strength of the
business. It helps the reader of the statements assess whether it will
be able to keep operating, expand in the future, or possibly face
financial difficulties.
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• Statement of Profit or Loss and Other Comprehensive Income
the statement of profit or loss and other comprehensive income
shows whether the business has made a profit for the year. It informs
the reader whether the business’ sales have exceeded its costs.
The statement gives details about different types of costs:
—Costs of trading (producing and selling goods or services)

—Other costs of running the business
—Cost of finance (interest paid to banks for borrowings)
—Income taxes on business profits
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• Statement of Profit or Loss and Other Comprehensive Income
The Statement of Profit or Loss and Other Comprehensive Income
shows how successfully the business has traded over the year.
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• Statement of Cash Flows
The statement of cash flows gives details about the movement of
cash in the business. Cash movements are caused by:
—receipts from customers

—payments to suppliers
—payment for the purchase of non-current assets such as land,
buildings, equipment, and motor vehicles
—payment to tax authorities

—cash borrowings and investments
© ACCA 44

• Statement of Cash Flows
The statement of cash flows indicates how well the business is at
generating cash and the primary sources of money on which it
depends. It may also show if it is running out of cash.
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• Statement of Changes of Equity
The statement of changes in equity provides details of the change in
the equity of a business during the financial year.
Transactions that affect the equity balance include:
—Net profit or loss

—Proceeds from the sale of shares
—Dividend payments
—Equity gains and losses
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• Statement of Changes of Equity
The statement provides a breakdown of the reason for the difference
between the opening and closing equity of a business which is not
provided by the Statement of Financial Position.
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• Non-Financial Reports
Non-financial statements may be included in a company's annual
report alongside the financial statements:
—Financial Review (by management)

—Chairman's Statement
—Directors' Report
—Employee Reports
—Five-year Financial Record
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—Analysis of Commercial Properties
—Environmental Reports
—Value-added Statements
The term "annual report" generally means the glossy, colourful
brochure companies publish to meet their statutory obligations to
report to shareholders. This usually includes far more information
(both financial and non-financial) than the financial statements on
which an independent auditor will report.
© ACCA 49

Financial statements also contain a written report by the business's
directors. Larger companies produce an annual report containing
information other than financial such as the details of risks that the
business faces, the impact the business has on the environment and
any significant issues the business faces.
All three business arrangement types – sole traders, partnerships,

and limited liability companies – will prepare these statements. It is
an accountant's responsibility to make sure these statements are
prepared correctly and according to applicable accounting standards.
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Statement of Financial Position
Definition
The Statement of Financial Position (SFP) is a primary

statement that shows the financial position of a business at a
point in time. This includes the assets owned, liabilities owed
and the capital/equity balance.
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The "financial position" can be defined as a company’s net worth

(assets minus liabilities). The statement of financial position a shows
the book value or carrying amount of the entity at a particular date
for:
• Assets (resources controlled)

• Liabilities (obligations owed)
• owners' Capital or Equity (how to business is financed)
© ACCA 52
Example 1
Abu is a sole trader who operates Glara, a business that manufactures
goods and sells them to tourists. Glara has a workshop and a small
shop.
Glara’s statement of financial position is shown below:
© ACCA 53
Example 1
Glara’s Statement of Financial Position
as at 31 December 2014
$ $
Non-Current Assets
Property X
Equipment X
Motor Vehicle X
X
Current Assets
Inventory X
Trade Receivables X
Prepayments X
Cash at Bank and in hand X
X
TOTAL ASSETS: X
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Example 1
$ $
Capital
Capital brought forward X
Profit for the year X
Capital introduced X
Less: (Drawings) (X)
Total Capital: X
Non-Current Liabilities
Bank Loan X
© ACCA 55
Example 1
$ $
Current Liabilities
Trade Payables X
Accruals X
Overdraft X
X
TOTAL CAPITAL AND X
LIABILITIES:
© ACCA 56
Example 1
• Title – The statement of financial position shows the closing position
of Glara’s assets, capital and liabilities balance at their financial year-
end of 31 December 2014.
• Non-Current Assets – Assets come first on Glara's statement of

financial position. Non-current assets are assets that glara intends to
use to generate profits over more than 12 months. They include the
workshop and shop that Glara occupies, equipment items, and motor
vehicles.
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Example 1
• Current Assets – These assets can be converted into cash or
consumed by the business within the next 12 months.
—Inventory is goods that Glara will sell in the future.

—Trade receivables are customer debts expected to be received
after the period end.
—Prepayments are expenses paid in advance.

—Lastly, it includes cash Glara holds on its premises or in its bank
account.
© ACCA 58
Example 1
Note: Current Assets are usually presented in the order in which they
can be turned into cash most easily (increasing liquidity order). For
conversion into cash:
1. inventory takes the longest time
2. receivables and prepayments are relatively liquid and take less

time
3. cash is the most liquid form.
© ACCA 59
Example 1
• Capital – Capital is the owner's interest in the business. It comprises
the cash invested into the business by the owner, any profits (or
losses) generated minus any owner’s withdrawals.
For Glara, capital brought forward is the earnings it has made in

previous years that have been kept in the business; this is also called
retained earnings. In a limited company's financial statements, capital
is called equity.
• Non-Current Liabilities – These are liabilities of Glara that will be

settled (paid) in more than 12 months. It includes long-term loans
from the business's bank.
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Example 1
• Current Liabilities – These liabilities will be settled (paid) within 12
months.
—Trade payables are money owed by Glara to its suppliers, which it

will pay after the period end.
—Accruals are other expenses incurred that have not yet been paid.
—A bank overdraft is a negative balance on a bank account. Glara
may hold an overdraft for some time, but it is treated as a current
liability because the bank could demand it be cleared at any time.
• The Total Asset amount should equal the Total Capital and Liabilities
amount.
© ACCA 61
The statement of financial position in the above example is for a sole

trader business.
The statement of a limited liability company would include different

information relating to capital: shareholders own the company, and its
capital is expressed as shares.
© ACCA 62
Activity 3
State whether the following statements are true or false.
1. Prepayments are a current liability.
2. The company’s bank account balance is always a current asset.
3. A current liability is due to be settled within six months of the

reporting date.
4. Drawings are added to capital in a sole trader’s statement of financial

position.
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Statement of Profit or Loss and Other Comprehensive Income
The statement of profit or loss and other comprehensive income

(SPL&OCI) can be prepared either as a single statement or as two
separate statements:
• Single statement of comprehensive income

• Two statements
—A Statement of Profit or Loss
—A Statement of Other Comprehensive Income (which begins with
profit or loss for the period)
© ACCA 64
Statement of Profit or Loss
Definition
The Statement of Profit or Loss is a primary

financial statement summarising an entity's
financial performance in terms of profit or loss in a
year.
© ACCA 65
Statement of Profit or Loss
This statement comprises:
• trading account summarising trading transactions (Sales – Cost of

sales = Gross Profit) li nhun gp (kt qu t trading transaction)
• profit and loss account (also called income and expenditure
account) for all other items of income and expenditure legitimately
earned because of business activities. kt qu cui cùng
It shows the profit or loss for the period after taking account of all
items of expenditure (including interest and taxation), excluding
components of other comprehensive income.
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Other Comprehensive Income
Other comprehensive income consists of items of income and

expense which are not recognised in profit or loss. For example,
a surplus arising on revaluation of a property which is not
recognised in profit or loss (because it is not realised as cash).
© ACCA 67
Example 2
Glara’s Statement of Profit or Loss and Other Comprehensive Income

details the business’s financial performance in terms of Income and
Expenses.
© ACCA 68
Example 2
Glara’s Statement of Profit or Loss
for the year ended 31 December 20X2
$ $
Sales X
Less: Sales Returns (X)
X
Cost of Goods Sold
Opening Inventory X
Purchases X
Less: Purchase Returns (X)
X
Less: Closing Inventory (X)
X
Gross Profit: X
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Example 2
$ $
Other Income X
Expenses X
Electricity X
Rental X
Repairs X
Sundry Expenses X
Discounts Allowed X
Loan Interest X
(X)
© ACCA 70
Example 2
$ $
li nhun thun Net Profit:
Other Comprehensive Income

Gains on Property Revaluation X
Total Comprehensive Income

X
for the year:
© ACCA 71
Example 2
• Title – The Statement of Profit or Loss and Other Comprehensive
Income reports the income and expenses for Glara‘s accounting
period of 1 January 20X2 to 31 December 20X2.
• Sales – Sales are the income generated by Glara‘s normal trading

activities.
• Cost of Goods Sold – This is the cost of the goods Glara sells during
the year. It includes purchases made during the period and opening
and closing inventory adjustments.
• Gross Profit – the surplus that Glara has made from its trading
activities. It would be a gross loss if the cost of goods sold exceeded
sales revenue.
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Example 2
• Other Income – This is income generated by a business from
anything other than its normal trading activities. This can include any
interest earned from Glara’s bank deposits.
• Expenses – These are costs incurred in the day-to-day running of the

business.
• Net Profit – is the excess of income after all business expenses have
been paid. The Net Profit amount is transferred to the 'Profit for the
Year' section of the Statement of Financial Position, thus increasing
capital.
(If a net loss is made, a negative amount is transferred to the SFP,
thus reducing the business’s capital).
© ACCA 73
Example 2
• Other Comprehensive Income – highlights any profit or losses not
reflected in the Statement of Profit or Loss.
An example is a revaluation of a non-current asset, which may give

rise to a revaluation gain. For instance, a building valued at $750,000
is now worth $850,000. This is a revaluation gain of $100,000, which
is classified as other comprehensive income.
© ACCA 74
Activity 4
In the following activity, arrange the items in the order they must appear
in the statement of profit or loss, reading from top to bottom.
Line Item Order

Number
Loan Interest
Cost of Goods Sold
Property revaluation loss
Other Income
Net Profit
Gross Profit
Sales Revenue
© ACCA 75
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Statement of Cash Flows
Definition
The Statement of Cash Flows is a primary

statement that shows an overall view of the inflows
and outflows of cash over the period.
© ACCA 76
The statement of cash flows is a historical statement. It shows cash

inflows and outflows that have already taken place. Users can see
where cash in the business has come from and how it has been spent.
A business's cash position is one of the most important measures of

its financial situation. If a business runs out of cash, it cannot survive
even though it is making profits.
© ACCA 77
The statement of cash flows classifies the movement of cash into three
categories:
• Operating Activities
• Investing Activities
• Financing Activities
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Example 3
Kenravi Co is a large limited company that manufactures clothing. The
Statement of Cash Flows is shown below:
Kenravi Co Statement of Cash Flows

for the year ended 30 April 20X5
$ $
Cash Flows from Operating Activities
Cash generated from operations X
Interest paid X
Income taxes paid X
Net cash from operating activities: X
© ACCA 79
Example 3
$ $
Cash Flows from Investing Activities
Purchase of property, plant and
X
equipment
Proceeds of sale of equipment X
Interest received X
Dividends received X
Net cash used in investing activities: X
© ACCA 80
Example 3
$ $
Cash Flows from Financing Activities
Proceeds of issue of shares X
Repayment of loans X
Dividends paid X
Net cash used in financing activities: X
Net increase in cash and cash equivalents X

Cash and cash equivalents at beginning of
X
period
Cash and cash equivalents at end of
X
period
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Example 3
• Title – Kenravi Co's Statement of Cash Flows shows the cash receipts
and payments of the business during the period. Some of the
amounts in the statement of cash flows and its statement of profit or
loss will be the same. However, the statement of profit or loss
includes figures that are not cash movements, such as depreciation
and is not included in the Statement of Cash Flows.
• Cash Flows from Operating Activities – Cash flows from operating

activities relate to Kenravi Co's operations. They also include the
interest and income taxes paid by Kenravi Co.
© ACCA 82
Example 3
• Cash Flows from Investing Activities – Cash flows from investing
activities show Kenravi Co’s asset investments. The cash flows from
investment can be positive or negative. Negative is the purchase of
assets, while positive is the selling of existing assets.
Kenravi Co may also invest in financial investments or other

businesses. The income and dividends received from these
investments are usually included under this heading.
© ACCA 83
Example 3
• Cash Flows from Financing Activities – Cash flows from financing
activities are monies Kenravi Co has received from finance providers.
These would be from shareholders or lenders. The heading also
includes money that it has repaid to providers of finance.
Dividends paid to Kenravi Co's shareholders are included here, but

the interest paid on loans is usually reported within cash flows from
operating activities rather than in this category. If Kenravi Co has
issued shares for cash, those receipts will be included in cash flows
from financing activities.
© ACCA 84
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Example 3
• Net increase in cash and cash equivalents – The totals for each
category are added together to arrive at a net figure, which is Kenravi
Co's movement in cash over the year. If cash receipts have exceeded
payments, there will be an increase; if payments have exceeded
receipts, there will be a decrease.
Cash and cash equivalents include the bank overdraft. Cash

equivalents are short-term investments that can easily be converted
into cash.
• Cash and cash equivalents at end of the period – This figure

links the bank and cash figure or figures in Kenravi Co's Statement of
Financial Position with the movement in cash flows. It shows the
difference in cash flows between the period’s start and end.
© ACCA 85
Activity 5
For each statement of cash flow example, state whether they belong to the
operating, investing or financing activities.
1. Purchase of buildings
2. Income taxes paid
3. Profit on sale of motor vehicle
4. Dividends paid
© ACCA 86
Statement of Changes in Equity
The purpose of the statement of changes in equity is to state the

changes in equity that have occurred in the financial year. The
statement reconciles the equity account balances at the start and end of
the year.
Equity of a business includes share capital, share premium, revaluation

surplus and retained earnings. Each element will have its column in the
Statement of Changes in Equity.
In this pro forma layout, the columns represent capital components, and
the rows represent the changes in the period. A whole year's
comparative information also would be shown.
© ACCA 87
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Statement of Changes in Equity
Share Share Revaluation Retained Total

capital premium surplus earnings
$ $ $ $ $
Balance at 31 December 20X5 x x x x x
Changes in accounting policy x/(x) x/(x)
Restated balance x x x x x
Changes in equity for 20X6

Issuance of share capital x x x
Dividends (paid and declared) (x) (x)
Total comprehensive income for the year x/(x) x/(x) x/(x)
Transfer to retained earnings (x) x
Balance at 31 December 20X6 x x x x x
© ACCA 88
Users of Financial Statements

Stakeholders
A stakeholder is anyone who can affect the business or is affected by

the business. They are users of the prepared financial statements.
Since the financial statements are an important record of the

performance of the business in the year, stakeholders are naturally
interested in them. As there are different types of stakeholders, they will
be interested in various areas in the financial statements. This means
that the financial statements need to include enough detail to satisfy the
information requirements of different stakeholders.
© ACCA 89
Stakeholders
Internal Stakeholders
• Business Owners
Owners may manage the business or appoint managers to do it for
them. They need detailed financial data to run the business effectively
and efficiently and make business decisions.
Much of the information that interests a business owner is the

management accounts used daily and not available to the public.
© ACCA 90
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Stakeholders
Internal Stakeholders
• Employees of the company

Employees such as accountants and salespeople may be interested in
the company’s information as part of their work scope within the
business. Employees may also be interested in the company’s
financial standing to assess their job stability.
© ACCA 91
Stakeholders
External Stakeholders
• Customers
Some customers will rely on the company to provide them with
regular supplies. They will be interested in whether the company is
financially strong enough to continue to trade. They will also be
interested in the profits that the company is making, considering
them from the viewpoint of the prices they have to pay the company.
© ACCA 92
Stakeholders
• Suppliers
Suppliers sell goods and services to the company. Their main concern
will be that the company will be financially secure enough to pay the
suppliers and continue to use their goods and services.
© ACCA 93
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Stakeholders
• Government and Local Authorities

The government will be interested to know if the company is
complying with the law and how it uses its resources. This will help
the government understand what is happening in the economy and
influence government policy.
The taxation authorities report to the government. They will be

interested in the company’s profits to calculate the tax to pay.
© ACCA 94
Stakeholders
• Shareholders
Shareholders are interested in the company’s results to determine
how much money can be paid to shareholders each year in the form
of dividends. Shareholders will also be interested in how much money
they could make if they sell their shares in the company.
© ACCA 95
Stakeholders
• External Lenders
Loan finance providers lend the company money for repayment in the
future. Naturally, they want to be sure that the company will pay the
principal and the interest on the loan every year. Loan finance
providers will therefore be interested in how much money and
resources the company has and whether it looks like the company
may find it difficult to repay what it owes.
© ACCA 96
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Stakeholders
• Auditors
Many companies are required to have an audit each year. Auditors
examine whether the financial statements present the results and
financial position accurately. Auditors will review whether the annual
financial statements agree with the detailed accounting records the
company keeps. They will also work to check how reliable the
company's accounting records are.
© ACCA 97
Stakeholders
• The Public
The public will be interested in various aspects of the company, such
as its contribution to the economy by providing jobs. Some
companies – for example, water and electricity suppliers – deliver
essential public services. The public will also be interested in anything
the financial statements say about the company’s impact on the
natural environment.
© ACCA 98
Stakeholders
The below table is a summary of the information needs of internal users
of financial information:
Users/ Stakeholders Information Needs

Investors (owners) and their • Providers of capital are concerned with the risk
advisers and return of their investment. They need the
following information:
– for decision-making (to buy, hold or sell)
– to assess the entity's ability to pay interest
or dividends.
Management (interested in • To plan, make decisions and control

management accounts rather operational activities.
than published financial
• Financial analysis of the financial statements
information)
may form part of a "management review".
Employees • Stability and profitability of employers.
– Ability to provide remuneration,
retirement benefits and employment
opportunities.
© ACCA 99
33
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Stakeholders
The below table is a summary of the information needs of external users
of financial information:
Users Information Needs

Prospective investors
• Risks and returns (profitability and
future growth) of investing may be
assessed (by a financial analyst) based
on published financial information.
Financial institutions (e.g. • Information used:
banks and other lending – to decide whether to provide/extend
companies) loan facilities
– to determine whether repayments
(principal and interest) can be settled
when due.
© ACCA 100
Stakeholders
Suppliers (may have • Information used to determine:
greater interest if – whether amounts owed will be paid
dependent on an entity
when due
as a major customer)
– what prior claims the finance providers
have on the entity's assets.
Customers • Continuance of supply of goods/services is
essential for long-term involvement with, or
dependence on, the entity.
Government entities and • Allocation of resources and, therefore,
their agencies (e.g. tax activities of the entity.
authorities) • Information used to regulate activities,
determine taxation policies and as the basis
for national income and similar statistics.
© ACCA 101
Stakeholders
General public and media • Information used to measure the
following:
– contribution to the local economy (e.g.
number of employees and patronage of
local suppliers)
– trends and recent developments in
prosperity and range of activities.
Environmental groups
• How the entity works to keep the
environment "green" is increasingly
reported in annual reports.
© ACCA 102
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Activity 6
State whether the following statements are True or False.
1. Shareholders will be the most interested stakeholders in a partnership's

financial statements.
2. Auditors are particularly interested in the reliability of the figures shown

in the financial statements.
3. Employees will likely want to use the financial statements to assess how
well the business will do in the future.
4. Loan finance providers are likely to be interested in how much the

business pays out to its owners each year.
© ACCA 103
Activity 6
State whether the following statements are True or False.
1. Management's primary source of daily financial information is the

annual financial statements.
2. Tax authorities are interested in the financial statements of

partnerships, sole traders and companies.
© ACCA 104
Summary
• A sole trader is self-employed.

• A partnership is a business owned and managed for the mutual benefit of two
or more partners.
• A limited liability company is a separate legal entity that one or more directors
manage for the benefit of the shareholders.
• Financial reporting includes:
— recording transactions ("bookkeeping")
— preparation of financial statements ("accounting")
— presentation of financial statements ("reporting")
© ACCA 105
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Summary
• The main components of financial statements are the statements of:

— financial position (includes assets and liabilities)
— profit or loss (includes income and expenses)
— changes in equity (if relevant, for transactions with investors)
— cash flows (cash flows in and out of the business).
• Users of financial statements are internal (e.g. owners, managers and
employees) and external (e.g. potential investors, banks and customers).
• Financial statement users have widely differentiated information needs.
© ACCA 106
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10/5/2023

Chapter 1 Financial Reporting and The Financial Statements

Types of Business Entities

Businesses exist to make a profit by producing and selling goods

While businesses share a similar purpose, they can still differ

A business can operate as a sole trader, a partnership, or a

Questions on these business arrangements are popular

A sole trader is an individual who owns, controls, and

• Change in Business Ownership

• Ownership of Business Property

✓ Business Formalities – It is easy for a sole trader to set up and

However, the sole trader may still need to produce financial

✓ Flexibility – A sole trader can choose how to operate and is not

b) The financial press

c) Loan note holders

d) The tax authorities

i) A sole trader may be able to obtain a bank overdraft.

A partnership is where two or more people own and

• Change in Business Ownership

• Ownership of Business Property

✓ Defined Roles – A partnership will have a partnership agreement

✓ Raising Finance – If the existing partners bring another partner into

✓ Paperwork – A partnership does not have to publish its financial

✓ Skills and Knowledge – Different partners have different business

✓ Risks – Having more partners in a partnership will spread the

 Costs - Drawing up a legally binding partnership agreement will cost

 Decision Making – The time taken to make decisions may be slow in

 Business Continuity – A partnership may need to be dissolved if

 Liability – Each partner’s personal assets are at risk if the business

 Disagreements and Disputes – Severe disagreements or disputes

Limited Liability Companies

A limited liability company is where investors invest in the company

Limited Liability Companies

A limited liability company may be a private or public limited company.

A private limited company will have a smaller number of shareholders

Limited Liability Companies

• Change in Business Ownership

Limited Liability Companies

• Ownership of Business Property

Limited Liability Companies

Limited Liability Companies

✓ Liability – Limited liability can protect directors and shareholders

✓ Raising Finance – Limited liability companies may have easier

Limited Liability Companies

✓ Business Continuation – A limited liability company can be

Limited Liability Companies

 Costs – Setting up a limited liability company requires a substantive

 Taxation – The profits of a limited liability company are taxed. The

 Public Eye – A company cannot keep its business affairs private as it

Statement Business arrangement

Isabella wishes to open a small shop three days

The business will continue even though one of its

There is a distinction between the business and

Statement Business arrangement

Oliver wishes to own his own business in a

Lee has been running an accountancy practice by

Statement Business arrangement

The business is taxed as a distinct entity from