The Role of Accounting Information in a Business Context - Example

Report: The role of accounting information in a business context of the client Firm ‘Turpin, Barker and Armstrong’ Introduction This report provides a reader with a brief overview of the different forms of business units available and highlights the major benefits and limitations of each form. Also, there is a section devoted to the theme of accounting whereas are defined two different forms of accounting (financial and management accounting) and highlighted the differences between these two stands. Furthermore, there are discussed various sources of finance available to a business owner varying from short-term sources medium-term sources, and long-term sources of finance. Finally, there are given some brief recommendations of choosing the best form of business entity. Section 1: Forms of Business Units Before making a decision to set up a business, it is important to know what forms of business entities are available, and to understand major benefits and limitations of each. While these are many different option for starting a business, there are identified three major forms in which most new businesses start: (1) sole proprietorship; (2) partnership; and (3) limited company (Marinel, 2005). 1.1. Sole proprietorship Sole proprietorship is the easiest and least expensive way to start a business as it requires the minimum formalities and does not require substantial capital (Prescott, Madden, & Foster, 2010). This form of business implies that entrepreneur has full control over his business and therefore, is fully responsible for management decisions. Another benefit is that any profit generated belongs to an entrepreneur as he is not accountable to anybody and does not have a boss (Marinel, 2005). Also, it is easy to dissolve this form of business unit (Prescott, Madden, & Foster, 2010). However, sole proprietor is responsible for all the liabilities and debts, as he has unlimited personal liability. Thus, in case of failure or business bankruptcy an entrepreneur’s personal assets can be sold or seized for repaying the debts (Marinel, 2005). An entrepreneur is responsible to maintain proper accounting records, however, these records will not be available for public inspection (Marinel, 2005). 1.2. Partnerships Partnership is another type of business form, appropriate in case if the business involves more than one person. In effect, this form of ownership is similar to sole proprietorship, however, it implies shared profits and responsibilities among the partners (Marinel, 2005). General partnership is easy to form, and there is increased access to resources shared with other individuals (Prescott, Madden, & Foster, 2010). While every partner is personally liable for debts incurred, he/she has a right for his share of profit. Lack of transferability of a partnership interest without agreement of all other partners is one of the main limitations of this form of business entity (Prescott, Madden, & Foster, 2010). As this form of business involves two or more people, there can be disputes and conflicts in management approach. Therefore, before deciding to start a business as a partnership it is important to ensure that the potential partners will be able to work together (Marinel, 2005). 1.3. Limited Company The limited liability company is a type of business ownership where business owners have the limited liability protection due to corporate form of business entity (Prescott, Madden, & Foster, 2010). While the formation and filling process for this type of business is generally more complex and requires significant amount of formalities and capital investment, it also offers greater opportunities for raising investment capital and allows avoiding the double taxation (Prescott, Madden, & Foster, 2010). A limited company has to follow strict accounting reporting standards, which require to disclose significant amount of information (Marinel, 2005). Documentation process can be quite burdensome. Business entity of a limited company can have four main types: (1) Private company limited by shares: member’s liability is limited to shares they hold or to the amount unpaid (Marinel, 2005). (2) Private company limited by guarantee: member’s liability is ‘limited to the amount they have agreed to contribute to the company’s assets if it is wound up’ (Marinel, 2005: 11). (3) Public limited company: the company offers publicly traded shares for sale to the general public. In this case, member’s liability is limited to the amount of shares they hold or to the amount unpaid (Marinel, 2005). (4) Private unlimited company: no limit to the member’s liability (Marinel, 2005). Note: More detailed overview of different forms of limited company may be provided upon client’s request. Section 2: Financial and Management Accounting Accounting reporting is differentiated by two strands: management accounting and financial accounting. Management accounting deals with the accounting needs of managers, while financial accounting deals with the needs of all other users of financial information. As the major difference of these two strands of accounting is associated with different target groups and their interests, there are several areas of difference (McLaney and Atrill, 2010). Some of these differences are briefly outlined below: Nature of the reports produced Financial accounting reports are designed for a broad range of users and therefore, they contain financial information that can be useful for investors, customers, employees, partners, suppliers, media and other stakeholders (McLaney and Atrill, 2010). Management accounting, on the contrary, is specifically designed to meet the needs of a specific group of decision makers or a set of decisions (McLaney and Atrill, 2010). Level of detail Financial accounting implies a production of reports that inform a broad category of users on a broad overview of a firm’s performance for a specific period of time (McLaney and Atrill, 2010). Quite often details of a firm’s performance are lost or omitted. Management accounting reports usually provide more detailed and specific information, so that management could use this information in operational decision-making process (McLaney and Atrill, 2010). Regulations Another important difference between financial and management accounting is the type of regulation of reporting. Financial accounting reports should comply with the standards of accounting reporting (depends on the country legislation) and follow a standard format or layout for information presentation. Management accounting reports are prepared for internal use, and therefore, the company/management can present the report in flexible way/format (McLaney and Atrill, 2010). Reporting interval As financial accounting reports are prepared for external users and are subject to standard accounting regulations, there is also established an interval of reporting. Usually companies should produce financial reports on an annual basis. For management accounting reports there is no legally established frequency for reporting. These reports can be produced when it is necessary for managers. The frequency of reporting may vary from daily, to weekly and monthly basis (McLaney and Atrill, 2010). Time orientation Financial accounting reports present information of the company’s position and performance for the past period (usually for the past financial year). Management accounting reports present information which covers both current and future performance of the company, as well as its past performance. Range and quality of information Finally, the rand and quality of information in financial and management accounting reports vary significantly. While financial accounting reports are mainly based on the financial performance of the company, management accounting reports might cover much broader and detailed information of a non-financial nature (McLaney and Atrill, 2010). Section 3: Source of finance for business start-up There exist many sources which entrepreneurs can use for business start-up. These sources are differentiated by a time factor, and include the following: short-term sources, medium-term sources, and long-term sources (Dyson, 2010). More detailed overview of each category of sources is given below. 3.1. Short-term finance There are five key external sources of short-term finance, including: trade credit; bank overdraft, factoring, and commercial paper (Dyson, 2010). Trade credit is a form of financing which is suitable for companies of all forms of business entity. In this case, a company purchases goods or services from suppliers but pays for it later after these goods or services have been delivered (Dyson, 2010). Bank overdraft is a loan where the customer of a bank can draw out larger sum of money that he/she has left for deposit (Dyson, 2010). This type of loan implies that the bank can claim on the entity’s assets in case if the customer fails to repay this overdraft (Dyson, 2010). Factoring is one of the convenient ways to get ready cash, however, often at a high interest rate on loan (Dyson, 2010). Factoring can be of two types: resource and non-resource factoring. Resource factoring implies that a customer or an entity receives a loan in accordance with its debtor balances (Dyson, 2010). In non-resource factoring the debtor balances are resold to a factor. Commercial paper is a short-term borrowing, whereas is developed a bearer document. This type of short-term financing can be used by large publicly listed organisations (Dyson, 2010). 3.2. Medium-term finance There are several types of external medium-term finance, including the following: bank loan, credit sale, hire purchase and leasing. Bank loan is one of the most common forms of finance. Banks provide a customer with a loan for a fixed period of time. This lending is usually accompanied with the interest rate charge, and secured on the firm’s assets. Sum, interest rate, period may be variable (Dyson, 2010). Credit sale is another form of borrowing, whereas the buyer agrees to sign legal agreement for paying for goods on an instalment basis over a certain period of time (Dyson, 2010). Sometimes there can be offered very loyal conditions, stimulating business start-up. Hire purchase is a form of borrowing similar to a credit sale. However, in this case, the ownership passes to the purchaser when the goods have been paid for (Dyson, 2010). Leasing is a form of renting, whereas a fixed asset such as expensive manufacturing equipment is legally owned by a leasing firm (lessor) but is used actually by a lessee (the firm using this equipment and paying for the use during a certain period of time) (Dysone, 2010). 3.3. Long-term finance There are several types of external long-term finance, including the following: debentures, loan capital, unsecured loan stock Debentures are the formal long-term loans given to a company on the open-ended conditions or for a certain period of time (Dyson, 2010). Usually, this form of loan is secured on the company’s assets. This type of borrowing can be more economic for a firm than other types of loans, as it is allowable against corporation tax (Dyson, 2010). Loan capital is a type of borrowing, whereas investors loan money for a firm and the firm pay back this loan on a regular basis, paying out the amount of loan and interest (Dyson, 2010). Thus, instead of banks, investors provide credit to the entity. Unsecured loan stock has common features with debenture stock except there is charged a higher interest rate as the loan is not secured by entity’s assets (Dyson, 2010). Recommendations While deciding on what form of business entity is better for you it is helpful to get a professional advice of solicitor or an accountant. However, your personal circumstances also should be taken into account while making a final decision. The decision will greatly depend not only on the financial aspects and required investment of the firm, but also on personal traits of entrepreneurs, their resources, managerial capabilities, type of business and other factors. It is highly recommended to apply to the accounting specialists for further enquiry and discussion. References: Dyson, J. (2010) Accounting for non-accounting students. Harlow, UK: Financial Times Prentice Hall. Marinel, A. (2005) Start and run your own business. How to Books. McLaney, E. and Atrill, P. (2010). Accounting: An Introduction. New York: Financial Times/Prentice Hall. Prescott, G.L., Madden, E.K. & Foster, R.M. (2010), "Forms of Business Ownership: A Primer for Commercial Lenders", Commercial Lending Review, vol. 25, no. 6, pp. 27. Read More