Compare the differences between a Sole Trader, a Partnership and a Limited Company Essay

Introduction In the following essay, I will compare the differences between a Sole Trader, a Partnership and a Limited Company when preparing final accounts also included in the essay will be the concepts and conventions used when preparing final accounts. I shall also outline the regulatory standards within the Accounting Profession. I shall start by giving an explanation of how the accounting system functions. How does the accounting system work? Business keep financial records for a number of practical reasons, which are: > To quantify such items as sales, expenses and profits > To present these figures in a meaningful way so the business can judge its success over the past year Below is a diagram of the Accounting System: (all things below will be explained later in the assignment) Diagram taken from Business Accounting Second Edition by David Cox. Prime Documents Business transactions generate documents, these documents go into the primary accounting records and from these records are placed throughout the accounting system. The following are prime documents: > Invoice – when a business purchases goods the company or individual the goods where purchased from sends the business an invoice which outlines the amount that is owing, when this amount is to be paid by and details of the goods or services that have been provided. This is also the same case when the business receives an order for a good or service. > Credit Note – if a buyer returns a good that has been bought on credit, a credit note will be generated and sent to the buyer, the value of the credit not will be deducted from the buyers amount owing. On the credit note it outlines the money amount and the goods or services that have been given. > Banking Transactions – businesses use their bank accounts to pay in and withdraw money at regular intervals, from these bank transactions paying-in slips, cheques and BACS are frequently used. These are then entered into the primary accounting records. Primary Accounting Records The primary accounting records are used to log the prime documents from day to day. The following are primary accounting records: > Sales day book – this is a list of sales made and is recorded from the invoices issued > Purchases day book – this is a list of purchases made and is recorded from the invoices that have been received > Sales returns day book – this is a list of the goods that have be returned and is recorded from the credit notes that have been issued > Purchases returns day book – this is a list of the goods that have been returned and is recorded from the credit notes that have been received > Cash book – this is a record of the business bank account and the amount of cash that is held, this is recorded from receipts, paying-in slips, cheques and BACS documents > Petty cash book – this is a record of the small cash purchases that have been made by the business and is completed from the petty cash voucher. Small cash purchases being ones that are made with motes and coins > Journal – this is a record of non-regular transactions, which are not recorded in any other primary accounting record Double-Entry Accounts: The Ledger The foundation of the double-entry book-keeping system is the recording of the ledgers which are broken down into separate accounts. Double-entry book-keeping The double-entry book-keeping system involves the entry of a transaction twice. If operating a manual accounting system the book-keeper will be required to input the transaction twice whereas if the book-keeper is using a computer software package the package will automatically enter the transaction twice. Accounts The sources that are entered into the ledgers are taken from the primary accounting records. Each primary accounting record will be entered into its corresponding ledger. Division of the ledger The following list shows the different types of ledgers: > Sales ledger – this is where the personal accounts of the debtors are placed > Purchases ledger – this is where the personal accounts of the creditors are placed > Cash books – the cash book is the record of the bank account and the cash account, the petty cash book is for small cash purchases. Both these books are primary accounting records. > General (nominal) ledger – this is a record of all transactions and completes the double-entry system Trial Balance The trial balance is a method used within the Double-Entry book-keeping system to check for any error that may have occurred. The trial balance takes all the final balances from the ledgers and lists them down. If the credit and debt sides don’t match at the end, there has been an error within the entering of the transactions. The trial balance is also used as a source of information when the final accounts are being prepared. Final Accounts The final accounts of a business are made up of the profit statement and the balance sheet. Profit Statement The profit statement includes the trading and profit and loss account, if the business manufacturers goods it too will be included. What this statement does is calculates the profit that was made and is now due to the owners of the business after certain deductions have been made from the income: > The manufacturing account which shows the cost of producing a quantity of a finished good > The trading and profit and loss account which shows the profit/loss after the deduction of the cost of goods this gives you the gross profit then the expenses are deducted which gives the net profit The figures that are used for these calculations are taken form the double-entry system. Balance Sheet The double-entry system also contains the figures for the following: > Assets – these are items that the business owns, they fall into two categories Fixed assets – these are items that were bought for the business use such as buildings, vehicles etc Current assets – these are items used in the everyday running of the business such as stock, debtors etc > Liabilities – these are things that the business owes and there are two types of liabilities Current liabilities – things like creditors etc Long-term liabilities – things like long-term loans > Capital – this is money or assets that have been introduced by the owner(s) of the business and is a liability to the business because it owes it to the owner Note: all examples of final accounts for each type of business are shown at the end of the essay also shown is a trial balance The Final Accounts for a Sole Trader The sole trader accounts are the basis of all accounts Legal requirements of a Sole Trader By law a sole trader is not required to keep accounts and thus is not legally required to publish their accounts for viewing by the General Public, however they must keep all VAT receipts so that the Inland Revenue can take their tax from the business and the situation regarding VAT can be sorted. Final Accounts and the Trial Balance The final accounts of a company are produced annually, but can also be produced at anytime in order to inform shareholders and stakeholders of how the business is performing. When starting to prepare any final accounts the trial balance must be prepared by the book-keeper. All the figures that have been entered onto the trial balance will be used in the final accounts. The trading, profit and loss accounts are a part of the double-entry system, meaning that the records that are within these accounts have to be recorded somewhere else for the double-entry system to work. However the balance sheet is not an account it is simply a statement, which outlines the account balances reaming after the trading, profit and loss accounts have been completed. Trading Account The purpose of a trading business is to by a good at one price and sell it on for a profit. The profit that is gained is known as the gross profit. Instead of the gross profit being calculated on each item, the sales and purchases that have been recorded in the primary accounting records will be calculated together. This also includes things like purchase returns and sales returns. When the end of the financial year comes around, the trading account is drawn up this includes: > The total sales > Minus purchases > Plus purchase returns > Minus sales returns > Also included is the opening stock and the closing stock Notes on trading account > Sales and purchases – these are only the items that the business trades > Adjustments – these are the adjustments that have happened in relation to the stock, the opening stock, which is calculated at the start of the year, this is added to the purchases because it has been sold during the year. The closing stock on the other hand will be deducted form the purchases because it has still yet to be sold. The closing stock will then become the opening stock for the next financial year > Cost of sales – this is the cost to the business of the goods that have been sold. To calculate the cost of sales you do the following: * Opening stock * + Purchases * + Carriage in * – Purchases returns * – Closing stock * = Cost of sales > Gross profit – to calculate gross profit you do as follows: * Sales * – Sales returns * = Net sales * – Cost of goods sold * = Gross profit If the cost of sales is more than the net sales then the business has made a Gross Loss > Carriage in – is the expense that the business incurs due to having the purchases delivered. The carriage in is added to the purchases > Net sales – the net sales is the turnover and is calculated by doing the following: * Sales * – Sales returns * = Net sales > Net purchases – to calculate the net purchases you do the following: * Purchases * + Carriage in * – Purchases returns * = Net purchases Profit and Loss Account In the profit and loss account the running expenses of the company are listed these are then taken away from the gross profit to give the net profit. The net profit then shows how profitable the business has been that particular year. Balance Sheet A balance sheet is used to show the financial state of the business at any one time. It lists the assets and liabilities of the business at a particular time. The balance sheet however is not a part of the double-entry system. Notes on balance sheet > Assets – an asset is an item or an amount that is owned by the business. There two types of assets fixed and current. Fixed assets are material assets such as premises or vehicles. Current assets are short-term assets, which change in value every day. > Liabilities – a liability is an item or amount owned by the business. There are tow types of liabilities current and long-term. Current liabilities are ones that are due to be repaid within 12 months or less. A long-term liability is a something like a loan that can be paid later than 12 months. > Capital and working capital – capital is money that is owed to the owner by the business. Working capital is the capital left after the current liabilities have been subtracted from the current assets. If the business does not have any working capital the business will not be able to continue to operate. Significance of the balance sheet The balance sheet shows how the business has been financed. For he sole trader the balance sheet can be shown as a formula, which is: > Fixed assets > + Working capital > – Long-term liabilities > = NET assets The final Accounts for a Partnership Accounts Definition of a Partnership The Partnership Act of 1890 defines a partnership as: The relation which subsists between persons carrying on a business in common with a view of profit Accounting requirements of a partnership The accounting requirements of a partnership are as follows: > To follow the rules that have been set out in the Partnership Act of 1890 > Or they could agree upon a partnership agreement, to follow different accounting rules. This will be explained in further detail later on in the essay If the partners cannot agree upon terms then the Partnership Act 1890 will apply it stats the following accounting rules: > Any profits or losses are to be shared between the partners equally > No partner is eligible to a salary > Partners are not entitled to receive any interest on their capital > Interest is not to be charged on drawings made by the partners > If any partner contributes more capital than has been agreed, they are entitled to receive interest at 5% per annum on the extra amount This only applies if the partners fail to agree on an agreement of their own. Year end accounts of a Partnership A partnership prepares that same end of year accounts as the sole trader, this being: > A trading and profit and loss account > And a balance sheet The difference between the end of year accounts for a sole trader and a partnership is that after the profit and loss account the partnership must prepare an appropriation account. This serves to show how the net profit that the profit and loss account shows is divided amongst the partners. Partnership Agreement A partnership agreement is drawn up by the partners and is a deviation form the accounting rules set out by the Partnership Act 1890. All partners must agree to the agreement before being allowed to go ahead. The partnership agreement will normally follow the following areas: > The division of profits and losses between the partners > Any partners salaries/commission > If interest is allowed on capital and at what rate > If interest is to be charged on partners drawings and at what rate The division of profits and losses between the partners The partnership act 1890 states that no matter how much someone has contributed to the business in the form of capital, they will only receive the same share of the profits as a person who has contributed less. This is why many partnership agreements state that if someone contributes more capital they get more of the profit. Partners salaries/commission The partnership act 1890 states that no partner is to receive a salary. This however is not normally the case within partnership agreements, many partnership agreements set out that those partners who work more within the business deserve a salary due to the time they are committing to the business. Similarly a partnership agreement may have within it a commission payment with sales that a partner may make once again this is due to the contribution this partner is making. Interest allowed on capital The partnership act 1890 states that no interest on capital is to be paid unless a partner contributes more than agreed then they are allowed 5% on the extra capital. Within many partnership agreements there is a clause that allows interest to be given on capital this is a form of compensation to the partner because they can use this interest money to invest in other things. The interest on capital may also be used as a form of compensating the differences that may appear between the capitals that are contributed. Interest charged on partners drawings In the partnership act 1890 it states that no interest is to be charged on the drawings made by a partner this leads to problems because the partner may withdraw valuable funds when they are most required, so many partnership agreements outline that a charge is to be set on the withdrawal of capital, this then deters the partner from withdrawing due to the penalty they will incur. Other points > Interest on loans – if a partner makes a loan to the partnership then as set down in the partnership act 1890 they will receive interest of 5%, this is why many partnership agreements agree on a different rate of interest > Interest on current accounts – a partnership agreement may outline the interest that is to be allowed on the balance of a partner’s current account this will be paid to the partner if they are still credited and taken away if they are debited. Capital accounts and Current accounts An important difference between the final accounts of a sole trader and that of a partnership is that each partner of a partnership has a capital account and a current account. The capital account is usually fixed and only changes if an alteration in the amount of capital is exhibited. The current account is constantly changing and is the account that the following are placed: > Share of any profit is credited > Share of any loss is debited > Salary/commissions if there are any are credited > Any interest on partners capital is credited > Any drawings are debited > Any interest on charged on partners drawings is debited The current account is treated as a working account. Appropriation of Profits The appropriation account shows how the net profit has been divided amongst the partners, before the net profit can be divided the following things must be taken or added to the net profit before the final share of profits can be disturbed: > Any interest added on partners drawings > Salaries/Commissions to be taken away > Any interest on partners capital to be subtracted After these have been taken or added the final share of profits will remain, this then can be distributed between the partners at the correct percentage for each. Balance Sheet When a partnership is completing its balance sheet at the end of the year the end balances on each partner’s capital and current accounts must be shown. It is usual that the transactions that have taken place on each account be shown in a summary form, just as in a sole traders balance sheet they will take the drawings away from the net profit for that year. The other features of a balance sheet are the same as a sole traders balance sheet. The Final Accounts for a Limited Company Accounts Advantages of forming a Limited Company A limited company is owned by the shareholders and run by the directors, it is a separate legal entity. A limited company is often chosen as the legal status of a business because of the following reasons: > Limited liability > Separate legal entity > Ability to raise finance > Membership > Any other factors Limited liability If a company where to go into solvency with limited liability the shareholders would only lose the capital they have invested. This means the shareholder is covered for any losses of the company and will not be liable to repay the creditors. Separate legal entity The company is a separate legal entity form the shareholders, if someone where to take action against the company they do so against the company and not against the individual shareholders. Ability to raise finance A limited company can raise funds from the follow outside sources: > For a PLC – this capital is generate from the general public buyer shares which are traded on the Stock Market > For a LTD – this capital is generated from Venture Capital companies and friends and family who can purchase shares Membership To be a member of a limited company you are required to own at least one share of that company, there is a minimum number of members which is two and no upper limit. If you are a member of a company you are the same as a shareholder. Other factors As a limited company is normally larger than that of a sole trader or partnership it benefits from economies of scale and makes it of sufficient size to employ such specialists as production, marketing, finance which work in their respective functions. The Companies Act The Limited Companies Act 1985, which was amended in 1989 states that there are two types of limited companies. The large Public companies or PLC’s and the smaller Private companies or LTD’s there is also another type of limited company which is called the limited by guarantee. Public limited company (PLC) A company can become a public limited company if it has the following: > The issued share capital is over à ¯Ã‚ ¿Ã‚ ½50,000 > There are at least two members and at least two directors A public company does not have to sell stocks and shares on the Stock Exchange but this is normally where most of the capital is raised. Private limited company (LTD) The most common limited company is the private limited company or LTD, the term private company was not set out in the Companies Act 1985, but is the most traditional way of describing a LTD. A private limited company has the following: > There are no minimum requirements for issued share capital > There needs to be at least two members and at least one director The shares are not traded on the stock market, but can be traded between individuals although with the shares not being traded on the stock exchange the price at which these shares will be traded may fluctuate. Company limited by guarantee The limited by guarantee company does not rely on the purchase of shares, but relies on members agreeing to pay a stated amount if the company goes bankrupt. Governing Documents of Companies When a limited company is being set up the Companies Act requires the two following documents: > Memorandum of Association > Articles of Association The Memorandum of Association is the constitution of a company, it outlines how the business is to relate to the outside world. It will contain the following five clauses: 1) The name of the company along with the public or private limited part 2) The authorised share capital 3) The objects of the company which is the activities that the company can engage in 4) The registered company of the company 5) A statement that the liability of the members is limited The Articles of Association this regulates the internal administration of the company, it also includes powers of directors and the holding of company meetings. Accounting requirements of the Companies Act The Companies Act 1985 which was amended in 1989, requires the production of accounts for a limited company it also sets out the detailed information that must be disclosed. For a large company the accounts are audited by an external auditor, this is not often the case with a small or medium sized company due to them being exempt. After the end of the financial year the accounts must be completed within nine-months and sent to the Companies House where they are available for the viewing of the public. A copy of the accounts must be available to all shareholders this is paired with a report on the companies activities during the year. Types of shares by Limited Companies In the Memorandum of Association the authorised share capital is stated. The issued shared capital may not be the same as the authorised share capital, the issued share capital under law is not allowed to exceed the authorised share capital. If a company wishes to extend the amount of share capital that it is allowed to issue it must pass an appropriate resolution at a general meeting of the shareholders. The authorised and shared issue capital is divided into different types of shares which are: > Ordinary shares > Preference shares With these shares come voting rights to the holder which can give the right to the holder to have their say at the annual general meeting. Ordinary shares An ordinary share is the most commonly issued share and carry’s with it the main ‘risks and rewards’ that come with the success of the business. If the business makes a profit the holder of the share will receive a dividend, these share are paid after preference shares dividends. Also of the company records a loss the share holders will loss part or all of their investment. Many companies when they have made a profit don’t pay out all the profit, many keep a percentage as a reserve. This reserve money can be used the next year as a dividend if the company does not make a sufficient profit, this serves to keep the investor interested and thinking they are getting a return on their shares. When a business goes into solvency the ordinary share holders receive any payments last. Preference shares A preference share normally carry’s a fixed rate of dividends. The dividends of the preference shares are paid out before the dividends of an ordinary share, although the dividends are only paid if the company makes a profit. If the company goes into solvency the preference share will receive a part of their payment before the ordinary shares. Nominal and market values of shares The nominal value of a share is the face value of the share, shares can be issued for any amount. This nominal value is not normally the same as the market value of the share due to it being traded at different prices constantly. Issue price This is the price the shares are issued to the shareholders by the company. The issue price is either at a par with the nominal value or above the nominal value. When the issue of the issue price is above the nominal value it is known as a share premium. Loans and Debentures As well as selling shares to raise capital the business may also be required to take a loan or debenture which can be obtained from the shareholders. With these two methods of raising capital usually comes a fixed rate of interest on the amount. This interest is considered a business expense so is placed in the profit and loss account with all the other expenses. If the company goes into insolvency the loan/debenture will be paid off before any shareholders are paid. Trading and Profit and Loss Account When most limited companies are creating their financial statements they are normally the same as that of a sole trader and a partnership. However there are two expenses that are found in a limited companies profit and loss account but not in any other type of business, these are: > Directors remuneration (directors salary) – this is entered because the directors are employed by the company and thus are an expense to the company > Debenture interest – this is entered into the companies profit and loss account because it is an expense to the company The limited company completes it profit and loss account and finds out the Net profit, an appropriation account is then drawn up below this. Balance Sheet The balance sheet of limited companies are for the most part the same as all other companies balance sheet apart from the odd difference in the things that go into the current assets, fixed assets and liabilities. The difference is that the capital section of the balance sheet is rather complex due to the different shares that are issued and the various reserves. Reserves A limited company will very rarely disburse all its profits between its shareholders, it will instead keep back a certain amount as a reserve. There are two types of reserve: > Capital reserves – which are created because not all the capital that has been taken was used for trading > Revenue reserves – these are the retained profits from the profit and loss account Capital reserves Examples of capital reserves which cannot be used to fund dividends payments include: > Revaluation reserve – this takes place when a fixed asset is revalued in the balance sheet, this revaluation is then placed in a revaluation reserve, it then serves to increase the shareholders investment in the company > Share premium account – a company may wish to issue extra shares to be available to the general public at a price over that of the nominal price. The nominal value of the shares is input into the share capital account and the extra money on top of the shares laced into the share premium account. Revenue reserves This is very often left as the balance of the appropriation account of the profit and loss account, it is most commonly known as the profit and loss account balance. On the other hand they may choose to put this revenue into a separate account of its own. This transfer to and from these accounts will in recorded in the appropriation account. The regulatory framework of accounting When talking about the regulatory framework of accounting you are simply talking about the rules that are to be followed when preparing final accounts. There are two forms these rules take the form of these are: > Accounting concepts > Accounting standards Accounting concepts Below are the basic accounting concepts that are to be followed when preparing final accounts: > Business entity > Money measurement > Historical cost > Duality > Materiality > Going concern > Accruals > Consistency > Prudence Business entity concept This concept outlines that the final accounts and records of a business are that of the business and that no personal assets of the owner’s are included within these records. The main links that are disclosed between the business and the owner(s) is the capital accounts and drawings. Money measurement concept This concept means that all items that are within the final accounts are expressed as money, this means all the values can be added together to come up with the net profit, gross profit and so on. The problem with this is that things that cannot be recorded as money such as good management will not be valued and all companies will be seen to be managed the same way, only in time will the good management become apparent. Historical cost concept This is an extension of the money measurement concept, it basically means that a transaction should be recorded at the value it was historically recorded or initially recorded, so if a vehicle cost à ¯Ã‚ ¿Ã‚ ½20,000 at purchase it should be entered for that amount. This concept brings with it advantages which are as follows: > Verifiable – there is a prime document that confirms that this transaction has occurred > Objective – there are no new valuations of the vehicle which will make it easier to price when it comes to sale This concept also brings with it disadvantages which are as follows: > The change of value – all items change in value over time and this wont be recorded the value may have went up or down > The effects of inflation Duality concept This concept ensures that all transactions are entered into the double-entry system twice one on the credit side and one on the debit side. Materiality concept This concept sets out that some items within accounts are so low in monetary value there would be no point in recording them separately. Some examples of these types of items are listed below: > The likes of donations to charities, the purchasing of plants for the office and other small expenses such as these are seen not to justify their own expense account, so they are grouped together in a sundry expenses account > The end of year stocks of stationary such as paper for printers, paper clips, pens etc are not seen to be material due to the fact they don’t affect the business earnings however they are placed within the profit and loss account > The low cost fixed expenses such as bins, staplers etc are not classed as capital expenditure, they are instead classified as expenses within the profit and loss account. Technically they should be placed within the fixed assets account of the balance sheet and be depreciated every year of their life span, but it would not be worth the effort due to them being immaterial in that they wouldn’t cause any real affect to final figures. What a business will consider material depends really on the size of the particular business, the likes of a large business would find anything under à ¯Ã‚ ¿Ã‚ ½1,000 immaterial and not worth putting into their own account whereas a small company would consider these items material and have them in their own account. Going concern concept This concept is presuming that the business to which the final accounts relate will continue to trade for the foreseeable future. The final accounts are prepared on the basis that the business has no intention of significantly down sizing or liquidating its assets. If the business was going to down size and where to sell a purpose built factory this factory would be a going concern to the business but would be of limited use to other industries for this reason the building would command less value. This instead of being described as a going concern would instead be described as a gone concern. In a gone concern extra depreciation would be added to the profit and loss account to account for the reduction in fixed assets. Accruals concept This concept is concerned with the expenses and revenues being matched so that they will concern the same goods/services and the same time period. In the profit and loss account expenses should always be entered whether they have been paid for or not. This is where the principle of income and expenditure accounting came from. Below are further examples of the accruals concept: > Debtors > Creditors > Depreciation > Bad debts > Provision for bad debts > Opening and closing stock adjustments in profit and loss account Consistency concept This concept is concerned that when a company adopts a particular method for accounting they should continue to use that method in a constant fashion. When a business has adopted a particular practice for accounts they may at times wish to make some changes, this is acceptable as long as there is a good reason for it, this change is to be noted on the final accounts to explain what has happened. With the consistency of the accounts the business can make comparisons between different years. Prudence concept This concept is also known as the conservatism in accounting. This concept requires where there is any doubt as to the value of an item report a conservative figure to be entered within the final accounts. Although this does not mean that profits are to be anticipated and should only be recognised if there is a distinct possibility they will be realised, as well as this all known liabilities should be provided for. A good example of this process is the provision for bad debts this is so any debt that maybe written off may be accounted for. The theory behind this concept is that it prevents the business from being to over optimistic with its presentation of final accounts. All of the above concepts apply to the final accounts of a sole trader, a partnership and a limited company. With relation to the limited companies the Companies Act 1985 gives legal force to the following concepts: > Going concern > Accruals > Consistency > Prudence If the company does not apply these concepts will receive a qualified report from its auditors. Accounting Standards The framework for accounting is represented by the Statements of Standard Accounting Practice (SSAP) and Financial Reporting Standards (FRS). The Statements of Standard Accounting Practice are no longer issued, but they still come under the control of the Accounting Standards Board. The Accounting Standards Board requires that accountants adhere to all applicable accounting standards and are able to disclose and explain deviations from the standards that may occur. To try and reduce the number of permissible accounting treatments, a number of Statements of Standard Accounting Practice have been replaced by Financial Reporting Standards. The main accounting standards are: > SSAP 5 Accounting for Value Added Tax > SSAP 9 Stocks and long-term contracts > FRS 15 Tangible fixed assets > FRS 18 Accounting policies SSAP 5 Accounting for Value Added Tax VAT is a tax on the supply of goods and services. Business with a turnover of over a certain figure will be registered for VAT. At regular intervals the business that are registered will pay VAT Authorities such as HM Customs and Excise on the following: > The amount of output tax collected on sales made > Less the amount of input tax on goods and services purchased The business can claim a refund from the HM Customs and Excise department if the input tax is greater than the output tax. This claim will be made on the difference. A business that is VAT-registered does not normally include the VAT in the income and expenditure of the business – whether for capital or revenue reasons. There are goods and services that are exempt from VAT these are things such as the loaning of money and letting of land, VAT cannot be charged by the charge so no output tax is received, they can only clam back an agreed proportion of the input tax that has been pre agreed with the VAT authorities. Irrecoverable VAT occurs when a business that has been registered cannot reclaim VAT on input tax, this means the VAT is entered into the accounts as an expense. A business that is not registered for VAT will include VAT within its input financial statements. SSAP 9 Stocks and long-term contracts This sets out the broad rule that stock should be valued at cost or, where lower, selling price. FRS 15 Tangible fixed assets This sets out that a fixed asset has a known economic life and must be depreciated, this doesn’t apply to land unless it is either a quarry or mine. As long as the depreciation method is acceptable it can be used to spread the cost of a fixed asset consistently over that fixed assets economic life. A depreciation amount is most of the time based on the cost of the fixed asset. FRS 18 Accounting policies This standard is to ensure that all material items have the following: > The particular circumstances of the business accounting policies are fit of the given purpose and give a true and fair view > The policies that have been selected by a company are regularly reviewed to ensure they are still appropriate, also when the circumstances change the policies are changed to > The information that is disclosed within the financial statements is of sufficient information to enable users to understand the accounting policies that have been adopted and how they have been implemented