All Notes Flashcards
Explain the Differences in the following categories for Finance & Management accounting:
Level of Detail, nature of reports, regulation, time orientation, range and quality of information
Finance vs Management
Distilled & Highly Simplified vs Very Precise
Formal, standardised and regulated vs vague
Yes vs No
Annual vs frequent
Vague, rounded and generalised vs Extremely precise
Users of Finance & Management accounting
Finance
Owners (Primary)
Government
Investors
Management
Management (Primary)
Matching Convention states that..
Expenses should be matched with the revenues they help to generate within a given accounting period
-Will lead to the creation of accruals and prepayments
The accruals method involves…
Recognising revenue/debt when the sale is made, the are included Trade Receivables & Trade Payables
Name the two types of Claims
Owners Capital (Equity) Liabilities (current and non-current)
Historic Cost Convention states…
Transactions should be recorded at their original value
What is Prudence?
Caution should be exercised when creating accounts, profit should never be anticipated but losses should be if they are reasonably foreseeable
Dealing with Bad debts
Write debt off - appears as a “administration expense” in Statement of Profit & Loss
Adjusts value of trade Receivables
Methods of Depreciation
Straight line Method - Same amount every year
Reducing Balance - Fixed percentage every year
The monetary measurement convention states…
If it does not have a monetary value, it cannot be listed on the balance sheet
The Going Concern convention states…
You must assume the business isn’t going to close
Analysing Financial Accounts
Compare profit, revenue & Costs
Calculate %changes
Vertical Analysis
Ratios
A published cash flow splits activities into 3 categories. These are…
Operating: Buying Boxes
Investing: Buying Equipment
Financial Activities: Taking out loans
What is working capital?
Current assets - Current liabilities
What is the difference between ordinary and preference shareholders?
Ordinary: Owners of the company, full voting rights, no entitlement to dividends
Preference: Classified as debt, no voting rights, entitled to dividends, either fixed or culimative
Define the following terms: Issued Share Capital,
Authorised Share Capital, Nominal Value,
Share Premium Market Value:
Issued Share Capital: The nominal value of shares actually issued
Authorised Share Capital: The total amount the company is allowed to issue
Nominal Value: The minimum a share can be sold for
Share Premium: The value a share is sold above its nominal value
Market Value: Determined through trading on the open market
List the profitability ratios.
Gross Profit Margin Operating Profit Margin Return on Capital Employed (ROCE) Return on Total Capital Employed Return on Shareholder Funds (ROSF)
List the efficiency ratios.
Trade Receivables collection period Trade Payables Collection Period Inventory Holding Period Operating Cycle Revenue per Employee Sales Revenue to Capital employed
List the Liquidity ratios.
Current Ratio
Acid Test
List the Gearing ratios.
Gearing
Interest Cover
List the Investment Ratios
Dividend Payout Ratio
Dividend Yeild Ratio
Earnings per Share (EPS)
Price/Earnings Ratio P/E
Name and explain the two types of reserves?
Revenue:
A cumulative reserve of profits generated in previous years, Distributable
Capital:
Capital redemption: reserves for share buybacks
Revaluation reserves: When a company revalue assets, their added value is represented here.
Non-Distributable
What is the difference between basic and diluted EPS?
Diluted is a hypothetical value that considers how many shares would be in issue if all people excersided their entitlement
How would you gross up a dividend per share?
Divide by 0.9
What is a non recuring item and why must it be listed seperatley.
Items in the accounts that do not happen every year
Investors are more concerned in maintainable income
What is contained in an annual report?
Overview Strategic Report Governance Financial Statements (including notes to the account) Shareholder information (5year record)
What checks are there that promote integrity within the accounts?
Company law Stock exchange rules Independent audit UK corporate governance code Accounting Standards and regulatory framework Professional ethics
What is an asset?
An asset is a resource controlled by the firm as a result of past events for which benefits are expected to flow
What are the three types of inventory?
Raw materials
Finished goods
Work in progress
Name some methods for accounting for inventory?
Reconciling stock (floor & book)
Assessment of the condition & likely selling price of unsold items which
Decisions about the order in which the goods have been sold and thus the appropriate costs of sales to be applied (inventory pricing)
What are the three forms of inventory pricing?
First in first out (FIFO) - Earliest stock held is the first to be sold
Last in first out(LIFO) - Last stock to be acquired is the first to be sold
Average cost (AVCO) -average cost to all stock sold
If prices are rising, which method of inventory pricing will give a lower cost of sales?
FIFO
What is a problem with the historic cost method?
If the asset is held for long periods, the information may become less useful
What are the causes of creative accounting?
Directors may need to cover up poor performance
Smooth profits to appeal to stock market
Salary is linked to performance
Desire to manage gearing and improve statement of financial position
What are some method of creative accounting?
Anticipation of revenue / deferring income
Provisions - move funds around from year to year
Optimistic inventory valuation
Depreciation
Recognition of intangibles
Omission of substantial liabilities from the SFP
What are the different way a cost could be classified?
By element (Material, labour & expense) By function (Production, selling & distribution, admin function) Direct v Indirect (Overheads)
What is a direct expense?
Something that is incurred every time a unit is produced but is not labour/materials
Name some absorbtion bases.
Rate per unit Rate per labour hour or per machine hour % of direct labour cost % of direct material cost % of prime cost
Why would you employ marginal costing?
For volume based decisions as it does not vary based on output
How would you calculate marginal costing using the scatter graph method?
Gradient = Variable cost per unit
Y intercept = Fixed cost
How would you calculate marginal costing using the high low method?
Identify periods of highest / lowest activity Work out difference Cost/hours = Variable cost per unt VCPU*Hours gives total variable cost TC - TVC =Fixed Cost
How would you calculate contribution in marginal costing?
Selling price p/u - Variable cost p/u = Contribution p/u
Sales revenue - Total variable cost = Total Contribution
Total Contribution - Fixed cost = Profit
How would you calculate a break even point?
BEP = FC/Contribution P/U
How would you work out how to achieve a given profit?
P = FC+Target Profit/Contribution P/U
Why dont businesses sit on cash?
Wasteful
What is a special order?
Where you accept a selling price lower than normal
What are the other considerations of accepting a special order?
Does price cover MC?
Are there any extra costs such as delivery costs?
Is there space capacity?
What effect would differential pricing have on consumers?
Could it be a loss leader?
How do you tackle discount questions?
Calculate total fixed costs and contribution per unit
How would you allocate scarce resources?
Allocate to products that have the max contribution per unit
What are the three phases of budgeting system?
Planning
Implementation
Review and Control
What is a Variance Analysis?
Difference between budget allowance & Actual expenditure
Can be Adverse (A) or Favourable (F)
What are some reasons for variance?
Actual quantities used differ from expected, given level of output achieved
The price for inputs differed from standard
Errors
Interdependent Variances
How would you calculate a materials variance?
Usage: (Predicted MU - Actual MU) * Original CPKG
Price: (Predicted P - Actual P) * Actual MU
How would you calculate a labour variance?
Efficency: (Predicted Hrs - Actual Hrs)* Predicate WR
Rate: (Predicated W-Actual W) * Actual Hrs
What is a reconciliation statement?
Provides all the variations to guide you from predicted to actual costs
What are some limitations of variances?
Costs of investigation
Significance levels or tolerance limits may be determined.
Significance must be assessed at the sub variance level
A small but persistent repeated variance may warrant investigation.
What is the long range Planning Process?
- What is our aim or mission?
- What are our corporate objectives?
- Which are the strategies most likely to lead to fulfilment of our objectives?
- Devise a long range financial plan to implement our chosen strategies.
Translate the long range plan into an annual operating plan i.e. BUDGET.
Why produce a budget?
- To plan annual operations
- To co-ordinate activities / harmonizes
- To communicate plans with managers
- Motivate to achieve organisational goals
- To control activities
To evaluate performance
How do you construct a budget?
Identify objectives Establish Admin Structure Obtain a forecast Identify the limiting factor Construct Subsidiary Budgets Negotiate Budgets Co-Ordinate Budgets Release & Implement Review
What is a cash budget?
A forecasting document showing cash flows arising from operating and capital investment
What are the psychological elements of the budget process?
People may not comply with budget
People may lie to meet goals
People may pad the budget
What are some technical approaches to resource allocation
Incremental: Base on previous years
Zero Base Budgeting: Compete for budget
What are control Reports
Compaison of budgeted and actual flexed figures
What are the features of an effective budget control system?
Established data collection, analysis & reporting routines
Short reporting periods & timely reports
Achievable targets are set
Clear lines of management responsibility
Reports targeted to individual managers
Action taken in response to reports, but non-disciplinary
What is the boston matrix?
A matrix of different products(diagram)
What are 3 important considerations for finance sources?
Matching the type of borrowing to the nature of assets
Fexibility
Refund risk
What are teh advantages of using retained earnings?
Easier
No dilution of control
Certain amount raised
No delay
What are the disadvantages of retained earnings?
Not free
Timing
Level available
What are the 5 C’s of risk when offering credit?
Capital Capacity Collateral Conditions Character
How could you asses if a customer should be offered credit?
Trade & Bank references Published financial statements Credit agencies Registry of County Court Judgements Other suppliers
What are the costs of holding inventory?
Holding Costs: Storage & Handling Pilferage Theft Reorder Costs: Admin
What are the 3 tools for inventory management?
Economic Order Quantity (EOQ)
Materials requirement planning (MRP) systems
Just-in-time inventory management (JIT)
What is economic order Quantity
Gives the number of each item that should be ordered
Formula
What are the assumptions of EOQ
Demand can be accurately predicted
Demand is constant over the period i.e. no fluctuations
No buffer inventory is required
There are no discount for bulk purchasing
A constant rate of usage and inventories are reduced to zero just as new ones arrive
What is Materials Requirement Planning>
Objective: Minimise holding costs
What is JIT
Goods arrive just as they are needed therefore no holding costs
What are the techniques for investment appraisal
Accounting RoR
Payback Method
Net Present Value (NPV)
Internal rate of return
What is payback period?
The fastest project to return the cash invested is best
What are the advantages of the payback method?
Simple, Easily understood
Priorities cashflow and avoids illiquidity
Considers risks associated with long term projects
What are the disadvantages of the payback period?
Ignores profitability
Cashflows after payback are ignored
Does not account for the time value of money
What is accounting ROR?
Judges profitability: Average profit per year as a % of inital investment
What are the two methods of ARR?
Initial Investment: Average Profit per year/Initial investment x 100
Average Investment: Average Profit per Year / Average Investment x 100
Average Investment = Initial + Residual / 2
What are the advantages and disadvantages of ARR
Advantages: Considers full project life Similarity to accounting ratios i.e. ROCE Disadvantages: Definitions may vary Does not consider time value of money
What is the formula for compound interest?
Formula
How would you calculate the future value when discounting?
A=P(1+R)^NT / N
How would you calculate the current value of a future amount
FV(1/(1+r)^n
What are the advantages of NPV?
It takes into account the time value of money
Uses cash flows rather than accounting profit
It is directly related to the objective of maximising shareholder wealth
Takes account of all relevant cashflows over the life of project
What are the disadvantages of NPV?
Difficult to estimate the values of cash inflows and outflows over the life of the project.
Cost of capital is difficult to estimate, and is likely to change over the life of the project.
What is internal rate of return?
% return at which NPV is zero
How do you calculate IRR
+ Rate + [ + Value /(Range of Values) * Difference in Rate)
Evaluate IRR
Advantages:
Takes into account all cash flows and the time value of money
Disadvantages:
Interpolation
How do you calculate ENPV?
NPV * Probablility
What is the veil of incorporation?
The difference between a unincorporated and incorporated company
What is the difference between a public and a listed company?
A listed company sells shares on the stock exchange
What are the four criterion for a public company?
Memorandum of Association States Public Company
PLC after Company Name
Authorise Share Capital >£50k (with 25% paid up)
Must have limited liability
What do you need to do to set up a company?
Registered address
Appoint Directors
And a company secretary for plc
Shares and shareholders
A memorandum association - a legal statement signed by all initial shareholders agreeing to form the company
Articles of association - written rules about running the company signed and agreed by shareholders, directors and company secretary
Also need to register for corporation tax
What are the directors responsibilities?
Make the company succeed Follow the articles of association Declare personal benefits Register for self assessment Ensure accounts are true and fair view
What are the responsibilities of Auditors?
Ensure accounts are accurate
Report to AGM
What are the two ways shareholders aim to make money?
Growth of share value
Dividends
Primary Objective: Maximise wealth
What is the link between net present value and shareholder wealth?
A companies projects add to its value which effect its share price which effect the wealth
Discuss the agency problem
Directors (agents) make decisions which are not compatible with interests of owners (principles)
Arises as: Divergence of ownership an control, goals differ, asymmetry of information
What are the rewards packages offered to a director?
Basic salary Performance related bonus Non cash benefits Executive pension scheme Share linked option/bonus scheme
What are the responsibilities of a Financial Manager?
Financing decisions: where will the money come from?
Investment decisions: What will the money be spent on?
Divined Decisions: Hybrid Decisions
What are they key points of corporate governance?
Rights of Shareholders: Protection
Equitable Treatment:All shareholders the same
Stakeholders: Recognise the rights of non financial stakeholders
Disclosure: Relevant and timely disclosures on relevant matters
Board of Directors: Should set the objective and manage performance
Evaluate the Issuing of Equity
Benefits: No interest, no payback, No variable IR
Drawbacks: Lose control, pay taxes on dividends, IPO expensive
What are the long term external sources of finance?
Ordinary Shares Preference shares Borrowings Finance leases Hire purchase Securitisation of assets
What are the short term external sources of finance?
Bank Overdrafts
Debt Factoring
Invoice Discounting
What are the common methods of share issue?
Rights Issue Bonus Issue Offer for Sale Public Issue Placing
What is a rights issue>
Offered to existing shareholders before expansion so they can maintain control.
Purchase proportion of initial shares
No obligation to take offer
Sold at less than market value
What are the key points of bonus issue & offer for sale?
Bonus issue: Does not raise Finance, only changes distribution
Offer for sale: Shares are sold to an issue house who then sells them on to the public
What are the key points of a public issue?
Issues directly to public
IPO -Initial public offering
SEO - Seasoned equity offering
Discuss private placings?
Not open to public
Placed with selected investors
Cheap as savings on advertising and legal costs
Can result in concentrated ownership
Discuss Borrowings & loan convernants
Lenders enter into a contract in which repayment and security is stated.
May require security which could be seized
Loan covenants introduce additional obligations such as providing financial reports or maximum levels of gearing
What are some forms of borrowing?
Term loans Loan notes ( loan stock) Convertible loan notes Mortgages Finance leases Sale and leaseback Hire purchase Securitisation- Borrowing against future assets
What are the key points of bank overdrafts?
Flexible current account with negative balance
Cheap and popular but with higher IR
What are the key points of Debt factoring and Invoice Discounting?
Trade Receivables turned into cash through selling them to others
Debt Factoring: Handling Admin of portfolio to a service
Invoice Discounting: Selling Individual Invoices
Evaluate Debt Factoring?
More certain cash flows, Key personnel can do other tasks
Sell value is less than invoice value, reputation?
Evaluate Invoice Discounting
Confidential, Cheap, No need to upset stakeholders
Still a delay on payment, just more certain
What is the formula for constant dividends in perpetuity?
Forever the same returns:
Price today = Dividend / ROR
What is the formula for non constant dividends?
Price today = Dividends for next period / (Shareholder ROR / Expected future growth of dividends)
What are the key points of dividend payment?
Paid in two batches: Interim (paid before earnings known) and Final
Directors can recommend the 4 states of dividend
Some shareholders require a constant source of income i.e pension funds
