3 Flashcards
Why do numbers in financial statements matter for directors and managers
Pay and bonuses usually depend on reported profits. Lenders often try to restrict what managers can do through debt covenants based on accounting numbers. Tax and dividends. Resulting in managers having an incentive to choose particular accounting methods
What are the effects of off-balance-sheet finance
Liabilities are not shown in balance sheet so companies financial structure looks less risky and may avoid breaching debt covenants. Assets are not shown in balance sheet so users are not told about potentially risky situations
What are examples of off-balance-sheet finance
Leasing unless leases on balance sheet. Company obtains use of item and promises to pay future rentals to items legal owner
Special-purpose entities/vehicles. 
What is form and substance
Key characteristic of good financial statements is faithful representation meaning financial statements should give a fair presentation of economic reality of entity including entities resources (assets) and claims on those resources (liabilities and equity). Substance of transaction is based on economic resources and claims arising from transaction not its legal form
What is the IASB and Substance over form
In IASB Conceptual framework concept of substance over form is part of process of giving faithful representation
“ providing information only about legal form that differs from economic substance of underlying economic phenomenon would not result in faithful representation. Framework gives guidance on applying substance over form including taking into account all terms in contract whether explicit or implied unless a term has no commercial substance. if a term has no commercial substance disregard it. if several separate contracts are part of a single agreement then analyse separate contracts as if they are one contract. Lessee’s obligations and its control of leased asset depends on contract. Reason SPE Shouldn’t be consolidated is because it’s controlled and that will depend on exact legal arrangements.
What is the definition of accounting for leases in IAS 17
Contract that conveys rights to use an asset for a period of time in exchange for consideration
Under IAS 17 what were leases classified into
Finance leases and operating leases 
What is a finance lease
Transfers substantially all risks and rewards associated with ownership
When is a lease normally a finance lease
Legal ownership transfer to lessee at end of lease
Bargain purchase option
Lease term for major part of Items economic life
Present value of minimum lease payments equal to most of fair value of asset at start
Leased items of specialised nature
Under IAS 17 or FRS 102 what is a lease if it’s not classified as a finance lease
Operating lease. In many cases operating leases are for short periods. In some cases leases are structured as operating leases but are in substance finance leases. With operating leases, no asset or liability is recognised on balance sheet and lease rentals are recognised in income statement as they become payable
What is an asset
Present economic resource controlled by entity as a result of past events
What is a liability
Present obligation of entity to transfer an economic resource as a result of past events
What is a resource
A right that has potential to produce future economic benefit
How are leases treated under IFRS 16
Right of use assets. Exemption for leases up to 1 year. Asset initially measured at cost.
How do you calculate assets initially measured at cost
Payments made before lease or at start + liability for expected payments (at discounted cash flows) including options and residual payments that are probable + purchase costs + expected final costs
