The maintenance of accurate records supplies the company with the financial data that assists them to function more effectively, it also helps to make it possible for the company to maximise profit. The key statements are the profit and loss account, bal

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Contents page

Task A                                                                                page 3

Task B                                                                                page 21

Task C                                                                                page 25

Task D        page 27

Task E                                                                                page 29

Task F         page 38

Task G         page 46

Appendix                                                                                                        page 51

Task A Why accurate financial records need to be maintained

The maintenance of accurate records supplies the company with the financial data that assists them to function more effectively, it also helps to make it possible for the company to maximise profit.  The key statements are the profit and loss account, balance sheet and cash flow statement. Having this information helps to understand if company performance is meeting expectations and is in line with strategy. If the company knows where its money is going, it enables the company to make better and more considered decisions concerning its spending and savings in the future basically a method tracking the money flow. You need to bear in mind that accurate records don’t need to be maintained for legislation purposes only.  At the same time it pictures the business at a moment in time which will help management monitor and control the business and help them make decisions.

Monitoring performance:

In order for a business to be successful it requires the management to monitor financial performance strictly in turn to produce accurate financial accounts, which enables the business to judge the success of the business or to suggest short-term and long-term strategic plans and decisions. Improvement can only be achieved when the management is accurately informed about current performance. This enables the business to identify trends occurring. For example when a firm discovers flat profit performance over recent years, depending upon the size of the business (owner managed to large plc) it could hold board meetings to discuss different options it can undertake to raise profit. Some of the options would be cutting variable costs through finding new suppliers or exiting from certain loss making activities. The cut in variable cost will result in a lower total cost figure. Furthermore the business will break even at an earlier point therefore the business will generate larger profits, the progress can only be identified if clear and accurate accounts is being produced and kept after a trading period.

Legal requirements:

The Companies House plays a big role in UK’s government as it is an Executive Agency, which falls under the Department of Trade and Industry.  A business operating as a limited company as defined by law has to register and publish its financial statements with the Company House to comply with the Companies Act 1985-1989 (a new Companies Act 2006 is starting to become law and will replace these earlier Acts of parliament). When a company generates a large sum of profit; over 1 million pounds, its financial accounts needs to be audited by an independent registered auditor, to check the companies’ figures are not materially miss-stated. Auditors will give an opinion over the truth and fairness of the financial statements based on procedures defined by auditing standards. Arthur Anderson is an example of an auditing firm where it is argued that it provided incorrect audit opinions about the financial statements of WorldCom, Enron, Waste Management Inc. and many others. For this reason the company reputation was damaged leading to an exodus of clients and eventual dissolution. () It should be noted that for most companies’ clean audit opinions are given over the reported financial statements.

Companies in the UK can prepare their accounts using accounting principles and concepts under International Financial Reporting Standards (IFRS) or UK Generally Accepted Accounting Principles (UK GAAP).

As a sole trader and partnership are an easier form of business to set up compared to a limited ownership it doesn’t require completing any paper work, however it does need to maintain a good set of financial records, and it also needs to register with the tax office for VAT and Corporation tax as the Partnership Act 1980 states. Inland Revenue may periodically visit businesses operating in a limited ownership and sole traders, it will investigate dealings over the last six years and if the businesses do not succeed to keep financial records they cannot prove their expenses and income to Inland Revenue; this increases the business costs, furthermore this will have an effect on profit rapidly as they may need to pay higher Corporation tax than required.  Custom and Excise makes use of the financial statements to calculate the VAT amount that is due.

Profit and loss, assets and liabilities:

The key reason for any form of business in the private sector after survival is to generate profit at a point. In order for a business to determine its profit figure it needs to keep up-to-date records of its sales, expenditure and purchases figures to set up a correct trading, profit and loss statement which will reflect the profitability of the business at the end of a trading period; a cash flow to track the cash generated from the business and balance sheet; a statement of assets and liabilities (the business net worth). The accurate accounts enable the company to keep track of the depreciated amount of its fixed assets. This is important as it represents a realistic view of the business to measure the amount of the fall in value. In view of the fact that the company will have a clear view of its debtors it can collect its debts quicker, this can be done through an age debtor analysis with the purpose of showing which accounts are overdue. For a business to be able to formulate a business strategy it needs to calculate its ratios, which will enable the business to make comparison between competitors and to be able to monitor last year’s performance. Ratios can be used to calculate: profitability, solvency and performance. It is important that all businesses have proper, effective processes and controls to track and monitor performance.

By keeping accurate figures, the business should be able to track any changes in its liabilities to produce a balance sheet which is a financial statement that reflects the business state at a moment in time.  In addition this will inform management if it needs to obtain additional finance (short and long term) to cover its liabilities. It also facilitates the company to foresee future problems its ability to pay interest on a long term loan which is out of place. This would be a significant aspect in a business ownership that has unlimited liabilities e.g. a sole trader or a partnership, where third parties may seek recovery of debts due from individuals not protected by limited liability companies.

Budgets and forecasts:

Budgeting is a detailed plan that allows the management to make confident financial decisions and meet the business objectives. It can be used as a monitoring tool when realistic forecasts are made; it allows variance analysis which means the business can monitor its performance. As shown in the example below, it helps the business through making comparison between the actual figures and the plans in the budget, in other words it shows the manager where spending is greater, less or equal to the budget plan. It also enables identifying which factors have caused the variance to be adverse or favourable.

For example, the table above illustrates that raw material costs have been under forecasted by £200 than expected, this could have happened because the prices of raw materials have risen. This could be prevented through negotiating with a supplier with lower prices or through making use of economies of scale. The company could also look for alternative and cheaper suppliers. Budgeting is the most effective way to control cash flow as it shows expenditure and income patterns, it also sets target for different departments within the business which is a motivating activity at the same time. It allows the business to make comparison between its competitors and set up a strategic plan to get ahead of the competitors. For this reason it is essential that the budgets are prepared accurately this can be only guaranteed when accurate financial records are kept.

Obtaining additional finance for expansion:

If a business wants to expand and it has not got enough internal funds which will support the expansion, it will need to obtain external finance. In a business ownership such as a sole trader or partnership the external finance that can be obtained can come from investors, bank loan, friends and families. Only limited companies have access to most forms of external finance such as debentures, mortgages and issuing shares. The stakeholders providing finance externally will be interested in accurate annual accounts, which show the value of the business. This will help them to decide if the business investment is viable. The management of the business will also benefit from the accurate accounts as it will illustrate if the business can support the expansion. In order to be able to draw up accurate financial accounts the business needs to keep good records of financial records. Banks also need accounts on a regular basis to check whether their loans will be repaid and whether the companies they are dealing with are credit-worthy.

 Businesses should keep an eye on the rate of interest charged on any form of loan, in order to discover what the right time is to obtain external finance. Recently the bank of England stated that it wants to cut interest rates due to the credit crises the economy is suffering from. In my opinion if a business is seeking for external finance, it should try to arrange a long term loan at the moment as the repayment including interest rate will be lower than short term funding. Having this detailed information provides management with the tools to make effective decisions.

Consequences of failing to keep accurate financial records:

Criminal action:

As mentioned earlier if the company does not succeed to keep accurate financial records, when HMRC comes and checks the accounts it business cost will increase as it will pay higher corporation tax than required. Inaccurate financial records can lead to criminal action. If the submission of financial records of a company is found to be incorrect by purpose by the director for various reasons, such as covering up liquidation problems, to remain the reputation of the business as a result showing shareholders that investment is worthwhile. This could be classified as fraud, when the business is caught it can face up a fine or be put on trial. Waste Management, Inc. is a company in the US that offers environmental services to nearly 21 countries and it owns 22 000 vehicles. The company has the largest trucking possessions in the waste industry. When the new chief executive officer requested a review of the company's financial statements, the company revealed inappropriate increase to the depreciation time length for their property, plant, and equipment. Which makes their profit after taxation seem higher. As a result they had to pay $457M to settle the shareholders and Waste Management’s auditor, Arthur Andersen was fined with $7 million by Securities and Exchange Commission for getting involved in the fraud. (.)

On the other hand, if the company can prove it has made an innocent mistake it can get away with it through paying off a fine and interest charged on the outstanding tax liability. Furthermore the failure of keeping financial records and the absence of proper and effective financial controls and processes allows others to potentially take advantage of the situation and steal money as the businesses possessions isn’t recorded on paper, it cannot be proven that theft is taken place because there is no evidence.

Cash flow problems:

One of the important annual accounts that is necessary to be drawn up by businesses is a cash flow statement as it shows the state of liquidity of the business and whether the profits generated are properly converted into cash. Although the profit and loss statement determines a profit this does not equal to cash and high valued assets does not necessarily mean a huge bank balance. The cash flow statement links profit with changes in assets and liabilities, and the effect on cash. If a business fails to keep accurate financial records it will be unaware of the level of its expenditure and the amount of tax that is outstanding, whether it is capable to pay of its debts and taxes. As mentioned earlier failing to submit accurate and correct financial records to Inland Revenue can result in paying of a fine, this can have an effect on the cash flow of the business badly. Enron was one of the world’s leading electricity, natural gas, and pulp and paper companies. The firm faced liquidity problems due to the enormous drop in its share value. To be able to cover up its liquidation problems, Enron agreed to work on a systematic and well planned accounting fraud together with the auditing firm; Arthur Anderson. The firm did not show its debts and the losses it had made on its financial statements. When the scandal was publicised as a result the firm suffered from bankruptcy. (

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Shareholders lose confidence:

Limited companies are financed by shareholders; shareholders are awarded through receiving dividends based on the profitability of the business. If there is lack in the keeping of financial records, it is difficult to produce a correct profit and loss statement which determines the dividends that is supposed to be distributed to the shareholders. Shareholders are alert of the difficulties of failing to keep records which have been discussed earlier this can cause to lose the confidence of shareholders. Therefore they will sell their shares and invest elsewhere or vote for a new board of directors at the ...

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