Accounting Flashcards
In which act are the legal requirements relating to annual financial reporting by set out, and what is its most basic requirement?
The Companies Act 2006
- Companies should keep adequate accounting records that allow the presentation of a ‘true and fair view’.
What is the role of the Financial Reporting Council (FRC)?
Issues UK accounting standards (called Financial Reporting Standards (FRS) which are used by companies that are not using IFRS)
What is the role of the International Accounting Standards Board (IASB)?
Issues international accounting standards (IFRS).
Which two things do small-cap companies have to provide their shareholders with in their annual statements?
- Statement of Comprehensive Income (profit/loss)
- Balance Sheet (Statement of ‘financial position’)
Which five things do medium-cap companies have to provide their shareholders with in their annual statements?
- Statement of Comprehensive Income (profit/loss)
- Balance Sheet (Statement of ‘financial position’)
- Cash Flow Statement
- Director’s report
- Auditor’s report
Which seven things do all listed companies have to provide their shareholders with in their annual statements?
- Statement of Comprehensive Income (profit/loss)
- Balance Sheet (Statement of ‘financial position’)
- Cash Flow Statement
- Director’s report
- Auditor’s report
- Statement of Changes in Equity (SOCIE)
- Operating and Financial Review
According to the Companies Act 2006, what sized companies are exempt from filing a full set of accounts?
Small and Medium sized companies
When is a company considered a small-cap?
2/3 of following:
- Turnover: < £10.2 million
- Balance Sheet (total assets): < £5.1 million
- Average number of employees: 50
When is a company considered a medium-cap?
2/3 of following:
- Turnover: < £36 million
- Balance Sheet (total assets): < £18 million
- Average number of employees: 250
What is the function of an Auditor’s report?
To assess whether the company’s financial statements give a true and fair view and apply with accounting standards.
If they are satisfied, they give an unmodified opinion. If they are dissatisfied, they will give a modified opinion.
What are the assets of a company equal to?
Assets = Equity + Liabilities
Assets - Liabilities = Shareholder’s interest (equity)
What are current assets?
Assets that are continuously circulating within the business.
e. g.
- Assets intended for sale/consumption (e.g. raw materials)
- Assets held for trade (e.g. shares bought for resale)
- Cash/cash equivalents (e.g. short-term investments)
What are non-current assets?
Assets expected to give rise to an inflow of economic benefits on a continuing basis (i.e. for more than one accounting period).
What is the operating cycle?
The time between the acquisition of assets for processing and their realisation in cash (usually less than a year).
What is depreciation?
The cost of an asset’s value falling over time.
What is the “matching-concept’”?
Spreading the cost of an asset over its lifetime, as it depreciates.
What is the residual value of an asset?
The estimated value of an asset at the end of its useful value.
How do you calculate the annual depreciation of an asset using the straight line method?
(Initial cost - Residual Value) / Useful life
(Carrying amount - Residual Value) / Remaining Useful
What does the carrying amount of an asset refer to?
Its current value (i.e. the book value)
Carrying amount = (Annual charge x Remaining Useful Life) + Residual Value
How do you calculate the annual depreciation of an asset using the reducing balance method?
Apply a fixed % to the carrying amount of the asset at the start of the year.
How do you calculate the value of an asset at the point of disposal?
Gain/Loss = Disposal - Carrying Amount
What does goodwill refer to?
The additional value of a company that is not recognised on a balance sheet. e.g. reputation, technical expertise etc.
What three things does an inventory (or stock) consist of?
- Raw materials
- Work in progress
- Finished goods held for resale
What does IAS 2 require regarding inventories?
That they are carried at the lower of cost and net realisable value (NRV)
What is the net realisable value of an asset?
NRV = Selling price - Cost of Selling
What are the three methods of determining the cost of an inventory?
First in, First Out (FIFO)
- Assumes components are used in the order that they are received. Oldest inventory issued first and closing items comprises of newest items.
Weighted Average Cost (AVCO)
- Each component in the inventory is assumed to have been purchased at the average price of all components in the inventory at that time. This is matched with the selling price of the of the first inventory item sold or used.
Last in, First Out (LIFO)
- Assumes that the nearest components are issued first, leaving the oldest items in the inventory.
What do liabilities refer to?
A present obligation of the entity arising from past events, results in an outflow of resources from the entity embodying economic benefits.
What are current liabilities?
Liabilities due within a year.
What are non-current liabilities?
Liabilities due after 12mths from the reporting period.
What is a provision?
A liability of uncertain timing or amount.
What are the two examples of contingent liabilities?
A Possible Obligation:
- Arising from past events, whose existence will only be confirmed by the occurrence of one or more uncertain future events, not wholly in the entity’s control.
A Present Obligation:
- Arising from past events, but it is not recognised as a regular liability because it is not probable that a transfer of economic benefits is needed to settle to the obligation e.g. an ongoing lawsuit.
How are contingent assets and liabilities recognised in an entity’s financial statement?
Disclosed by way of note.
What is an adjusting event?
An event that occurs between the end of the reporting period and the date on which the financial statement is authorised for issue.
An adjusting event creates additional information that requires financial statements to be adjusted to reflect this information.
What is a non-adjusting event?
An event that occurs between the end of the reporting period and the date on which the financial statement is authorised for issue.
Non-adjusting events do not relate to conditions existing at the end of the reporting period end but are considered important information for the shareholders. The financial statements don’t therefore need adjusting, but the info needs to be disclosed by way of note.
e.g. the major acquisition/disposal of fixed assets.
What does owner’s equity refer to?
The residual interest in the assets of an enterprise after deducting all its liabilities.
What must be kept separate, according to the Companies Act 2006?
Each reserve in the equity section.
e.g. dividends can only be paid from the retained earnings reserve
What does share capital refer to?
Net value of share issued.
What does share premium refer to?
Consideration received from share issues in excess of the net value of shares.
What does the re-valuation reserve refer to?
Changes in non-current asset values.
What do the retained earnings refer to?
Accumulated profits not yet paid out.
In group accounting, what does a minority (non-controlling) interest refer to?
The portion of a subsidiary that does not belong to the group.
What does authorised share capital refer to?
The maximum amount of shares a company is permitted to issue (authorize).
What does called-up share capital refer to?
The amount of capital the shareholders have been asked to contribute (how much they owe) to the company to date (for equity).
What does paid-up capital refer to?
The amount of capital the shareholders have paid to the company to date (for equity).
When would a company issue a bonus share?
When it feels the share price has become too high. It is made to existing shareholders in proportion to how many shares they already own.
What are the impacts on shareholder’s funds of the issuance of bonus shares?
Share capital ↑
Share premium reserve ↓
(No impact on total assets)
Where would a change in value of a derivative be accounted for?
Profit/loss account
What does the Statement of Profit/Loss and Other Comprehensive Income (SPLOCI) show?
How much wealth has been generated, or lost, by the business for the reporting period.
How are revenues and expenses recognised on the SPLOCI?
On an accruals basis (when the transaction occurred), rather than when cash is paid or received.
How do you calculate the cost of goods sold (COS)?
= Cost of goods available for sale - Closing inventory
= (Opening inventory - Purchases) - Closing inventory
What is the purpose of the Statement of Changes in Equity?
To identify changes in share capital and reserves that took place during the reporting period. It balances the components of shareholders’ equity at the beginning and the end of the reporting period.
What are the three cash flows analysed under IAS?
- Cash flows from operating activities.
- Cash flows from investing activities.
- Cash flows from financing activities.
What are trade receivables?
Payments due from customers for goods/services sold.
What are trade payables?
Liabilities for which invoices have been received and liabilities for goods and services received.
What are group accounts?
Where a group structure occurs between a ‘parent’ and a ‘subsidiary’.
It may be the case that a parent owns 100% of the account, or that it is less than that and there exists a non-controlling interest.
What is purchased goodwill?
Arises when one business buys another. It is the difference between the cost of acquisition and the fair value of the net assets acquired.
Purchased Goodwill = Cost of Acquisition - Value of Company
What is an associate in a group account?
An entity which the investor has significant influence.
What is a significant influence in a group account?
The power to participate in the financial and operating policy decision of the investee, but not a controlling interest (usually refers to 20-50% voting power).
What do profitability ratios measure?
The performance of the business over the accounting period (e.g. return on capital employed, asset turnover, return on equity).
What do liquidity ratios measure?
The ability of the business to pay its debts when they are due (e.g. current ratio, acid test).
What do debt and gearing ratios provide?
Insight into the weight of debt that a company is carrying (e.g. capital gearing ratio, debt/equity ratio).
What are some limitations of using ratio analysis?
Lack of standard definitions
- Accounting ratios can be defined differently, causing problems with comparison.
Unrepresentative balance sheet figures
- If the business is seasonal, balance sheets will not reflect true profitability of business.
Differing accounting policies
- regarding depreciation and revaluation of fixed assets, causing comparisons problematic.
Lack of information
- It is easy to misinterpret a ratio without full knowledge of the company’s circumstances.
Return on Capital Employed (ROCE):
This ratio expresses the business’ operating profits as a % of the capital invested.
ROCE = Net profit / Shareholder’s equity+debt.
Net profit = net operating profit (before interest + tax)
Shareholder’s equity + debt = capital employed (total assets - current liabilities).
ROCE = Operating profit margin x Asset turnover
Operating Profit Margin:
This ratio expresses operating profit as a % of sales revenue.
= Profit (before interest + tax) / sales revenue
Asset Turnover:
This ratio gives an indication of how efficiently a company has utilised its assets in generating sales revenue.
= Sales revenue / Capital Employed.
Return on Equity:
= Net profit (after interest, tax and preference dividends) / Shareholder’s equity
Operational Gearing:
This expresses the sensitivity of profits to changes in sales revenue. The higher the multiple the more sensitive the profits are to changes in sales.
= (Sales - Variable costs) / Operating Profit
Current Ratio:
This ratio gives an indication of the company’s ability to meet its short-term financial obligations out of its current assets.
= Current assets / Current liabilities
The Quick Assets Ratio (“Acid Test”):
This is a more severe test of liquidity. The ratio takes a slightly more pessimistic view by excluding inventory, which often cannot be converted into cash at short-term notice. It measures how quickly current assets be realised.
= (Current assets - Inventory) / Current liabilities
What does it mean if the Current Ratio and the Quick Assets Ratio (Acid Test) is less than one?
The company has less assets than liabilities, and would therefore be insolvent.
Capital Gearing Ratio:
This ratio gives an indication of the financial risks posed by the use of debt relative to the use of equity.
= Debt / (Debt + Equity)
Debt/Equity Ratio:
= Debt / Equity
What are shareholder’s funds equal to?
Net assets
On an income statement and balance sheet, what does an entry titled ‘minority interests’ refer to?
A deduction for profits owed to parties outside of the group of companies.
What do accruals represent?
The amounts owed by a company, but where no invoice has been received by year end. As such they are liabilities, not assets.
When is someone represented as an associate (significant influence) in a group account?
A stake between 20-50%
When is someone represented as a trade representative in a group account?
A stake below 20%
When is someone represented as a subsidiary (controlling interest) in a group account?
A stake above 50%
Is a loan repayment a revenue expense? (i.e. would it be shown on an income statement?)
No - it would be shown as a reduction in assets and a reduction in liabilities on the company balance sheet and therefore would have no impact on the income statement for the year.
In the accounting equation, non-current assets + working capital =….
Shareholders’ funds + long-term loans and provisions
Total Assets = Liabilities + Shareholders’ Funds
Accruals in accounting statements give rise to the inclusion of what?
Depreciation - the accruals/matching concept states that costs should be allocated to the periods where revenues are generated. Depreciation involves allocating the costs of a fixed asset over its useful economic life.
Are inventories regarded as current or non-current assets?
Current assets - it has been acquired by the company for conversion into cash. It is the least liquid of current assets.
If a company increases the value of an asset over its initial cost on the balance sheet, the surplus should be shown as part of:
The Revaluation Reserve - the value of non-current assets will increase as will therefore net assets. The revaluation reserve will be increased by the same amount, increasing shareholder’s funds.
How would prepayments be shown in a set of accounts?
As current assets, as the company is awaiting the benefit they have paid for.
Why would a company want to repurchase its own shares?
- Pay surplus cash back to shareholders as an alternative to dividends.
- To increase the share price and EPS.
How are preference share dividends classed?
As franked investment income.
How are pension scheme assets and liabilities measured?
Pension scheme assets are measured at fair value, whilst liabilities are calculated using the projected unit method which discounts back the liabilities using an AA rated corporate bond.
How should an investment in shares that has a quoted price, and that is not held for trading, be classified?
As an available-for-sale financial asset
How are derivative instruments recorded on a balance sheet?
All freestanding derivative instruments should be recorded on the balance sheet at their fair value and gains/losses should appear in profit and loss.
Where are preference shares normally reported?
In equity with the dividend reported in the Statement of Change in Equity.
Unless the preference share is redeemable, in which the nominal value to be repaid would be shown as a liability and the dividend reported as an interest expense (profit/loss account).
When would a firm report a pension fund asset on their balance sheet?
If the firm was offering a DB scheme and plan assets greater than the PV of the future pension obligation.
Firms offering DC schemes do not need to report any liability/asset.
