Chapter 10 Flashcards
Why are organisations transactions reported
Summarise transactions to help run business
Report to company owners and stakeholders
Enable other parties to analyse the company
What promotes standardisation of accounts
Various company acts
FRC issues and reviews accounting standards
Listed companies must abide by rules for that exchange
International accounting standards board issues the international financial reporting standards which uk firms must comply with
What must large companies provide shareholders with annually
Income statement
Balance sheet
Directors report
Auditors report
Cash flow statement
Changes in equity statement
Examples of extra rules for listed companies about reporting
Directors reasons for any significant departure from accounting practice
Particulars on company in which they hold 20% or more of equity capital
Is company close or not
What must listed companies on LSE also do
Produce half yearly or interim reports
What defines a small company
Turnover less than 6.5 m
Balance sheet total less than 3.26 m
Less than 50 employees average
What defines medium sized company
Less than 25.9 mil turnover
Less than 12.9 m on balance sheet
Less than 250 employees average
What are two legal categories of organisation
Bodies sole: consists of sole traders and partnerships, no legal requirement to produce accounts
Bodies corporate: covers all form of orgnanistation, are recognised by law as seperate from their owners
Two classes of company limited by shares
Public company - minimum issued share capital of 50 k and is registered as public
Private - everything else
Close company
One which is under control of five or fewer persons or is under control by its directors
Who is responsible for accounting standard in uk
FRC - financial reporting council
Who is international accounting standards board responsible for
International financial reporting standarprds
Problem with IASB
It is independent and has no authority to require compliance with it
What do AIM companies also require
They are required to use IFRS in drawing up their group accounts
What must companies not using IFRS use
Npmust cimoly with UK standards issues by financial reporting council FRC
What did the FRC produce
Produced FRS to create uk generally accepted accounting principles (GAAP)
What rule is altered under GAAP for small companies
FRS 102
What do micro entities operate under
FRS 105
How do FRS 105 AND 102 DIFFERENT
105 has simplifications in areas such as deferred tax and pensions
What defines micro entity
Turnover less than 632k, balance sheet of less than 316 k and less than 10 average employees
What are qualifying entities
Entities that are members of a group that prepares consolidated financial statements that are…
Publicly available
Show true and fair value
In which that member is consolidated
Reporting options for micro
Frs 105, FRS 102, FRSE 102, UK adopted IFRS
Reporting options for small companies
FRSE 102, FRS 102, uk adopted IFRS
Reporting options for medium or large companies
FRS 102
FRS101
UK adopted IFRS
What is the uk GAAP for most companies
FRS 102
When should auditors be appointed and what do they have access to
For the yeah ahead of the AGM
All the firms financial records
What is aiming to improve transparency of auditors report
International standard on auditing want an adopted extended audit rather than pass or fail
What should audits explain on their report
The scope of the audit
Risks and plans of audit
How they performed audit
Uk audit regulations and guidance implementation year and rules
2021
Audit firms rotate after 10 years
Audit committee must have someone who has competence in accounting/audit, other members competent in sectors of business operation
Balance sheet purpose I
Statement of companies financial position at a particular point in time
Shows assets and liabilities
Assets definition
Resource controlled by enterprise as a result of past events and which future economic benefits are expected to flow to the enterprise
Where can finance for a business come from
Owners or shareholders
Retained earnings
Loan
Bank overdraft or trade payabalez
Two forms of claims on assets
Claims due to shareholders and claims due to other lenders
What do shareholders claim of assets comprise of
Subscribed capital and retained earnings
Non current liabilities
Loan stocks
Debentures
Bank loans
Current liabilities
Trade payables and bank overdraft
Accounting identity formula
Shareholders fund + NCL + CL = NCA + CA
Capital expenditure
Money used to create future benefits
Revenue expenditure or expense
Money spent on items such as office supplies, services, repairs
When are goods expensed shown in income statement
In line wi5 when goods or services are received
What is the cost model for NCA
Cost less accumulated dep and accumulated impairment losses
What is revaluation model
Fair value as at the date of latest revaluation less accumulated dep and accumulated impairment losses
How are NCA s for sale valued
NCA held for sale are not depreciatedmbut measured at lower of carrying amount and fair value less costs to sell and presented separately on balance sheet
How is cost method applied to income statement
Cost of PPE is charged over multiple accounting periods normally equal to number of years asset is used to generate revenue
Net book value or net carrying value
Orginal cost of asset - accumulated deprication to date
Recoverable cost of asset
Fair value less selling cost or its value in use
What is goodwill
Amount by which value of business exceeds assets less liabilities
What is IAS 36
Goodwill is not amortised but instead is subject to an impairment test each year
Two deprication methods
Straight line method and reducing balance method
Reducing balance method formula
1 - nth root of expected residual value over orginal cost
Two current assets
Trade receivables and inventory
Manufacturing has three categories of inventory
Raw materials
Work in progress
Finished goods
Three assumptions from business flow of inventory
First in first out - oldest stock item is sold first
Last in first out - cannot be used under FRS 102 or IFRS
WEIGHTED AVERAGE SCALE
Total value of inventory equation
Cost of goods sold plus balance sheet value
Advantage to borrowing
Interest in debt must be allowable for corporation tax and not income tax
Why are debentures sometimes good for lenders
Can call their security before unsecured loan stock holders, higher priority in case of liquidation
What is a split date for loan
Can be redeemed at the date most favourable to company.
Low I rate environment means early redemption
High I rate means late redemption
Deep discount bonds
Bonds issued at well below par and do not have to pay coupons, usually issued by financially unstable firm s
Convertible loan is sometime called and what is it
Deferred equity so I rate paid out is lower than that of normal loan stock,
Higher in cap structure than normal shares
Accruals
Are amounts owing for services already partly received
Sizes of trade payables in Uk
Max 500k min 100k
Maturity max 1 year , min 7 days
Provison
Amount charged against profit (treated as an expense) to record a reduction in the value of an asset
Types of provision
For…
Doubtful debt s
Depriciation
Unrealised profit on stock
Where are provisions in income statement
Expense
Contingent liability meaning and examples
Potential liability that has not come into excistnce by time balance sheet was compiled
Court action
Goods sold under warranty
Garentees given to banks
Must make note in accounts about potential liabilities
What standard is used for defined benefit pension costs
Ias 19
Defined benefit schemes and balance sheet under IAS 19
PV of expected future payments of pension benefits less the value of plan assets
Features of ias 19
Pension scheme assets measure using market value
Liabilities measured using projected unit method and discounted at an AA corporate bond rate
Post balance sheet events
Occur between balance sheet date and date accounts are approved by the board
R types of shares and ranking of distribution in event of liquidation
Preferred shares
Ordinary shares
Deferred shares
Warrants to subscribe for shares
Rights issue
Issue offering to existing shareholders at discounted rate
Eg a 1 for 7 rate, shareholder offered 1 share for every 7 shares they hold
Scrip issue
Free issue of shares to existing shareholders and share price falls proportionately to additional shares
Stock split
Increases number of shares in company, price adjust so market value remains constant and no dilution occurs
What is usually response to share buyback
Share price rises as firm believes shares are undervalued
How are share buyback an alternative to dividends
Repurchasing shares means less shares held by public so earnings per share increases
Share premium account
Shares issued over their nominal value, premium cannot be redistributed to shareholders except on liquidation
Financial instrument
Contract that gives rise to financial asset for one company and a financial liability to another entity
Basic financial instruments
Cash
Commercial paper
Bonds
Other financial assets
Asset backed securities,
Option rights
Warrants
Hedging instruments
A financial instrument is an equity instrument if…
includes no contractual obligation to deliver cash or anything else to another entity
Will or maybe settled in the issuers own equity instruments
IFRS 7
Company is required to describe financial risk management objectives and policies including hedging policies
IFRS 7 also discloses fair value hedges and Cash hedges. How does it describe them
A description of the hedge
Description of the financial instruments designated as hedging instruments and their fair value
Nature or risks being hedged
Fair value hedge
Hedge of the exposure to changes in fair value of a recognised asset or liability
Cash flow hedge
Hedge of an exposure to variability in cash flows
Derecognition of financial asset occurs if one of the following criteria is met
Contractual rights to cash flows has expired
Financial assets have been transferred (sold)
IFRS 9
Deals with classification of financial assets
How are loans classified
Amortised cost
Fair value through other comprehensive income(FVOCI)
Fair value through profit and loss (FVPL)
How are preference shares classified
FVPL
How are derivative contracts classified
FVPL
How are equity instruments classified
FVOCI
Income statement
Provides info on performance of business over a specified period of time
Retained income equals
Sales - costs - taxes - dividends
IFRS 15
Covers revenue recognition and is a 5 step model
5 step model of IFRS 15
Identify contracts with customers
Identify performance obligations in contract
Transaction price
Allocate transaction price to performance obligations
Recognise revenue when entity satisfies performance obligation
Operating profit
Operating revenue - cost of goods sold - operating expenses - dep - amortisation
What is operating profit also known as
Earnings before interest and tax
Why is EBITDA useful
Useful for comparing companies , as it eliminates the effects of financing and cap expenditure
Comprehensive income
Net income form income statement plus any changes in net assets of the company
Information obtained from statement of equity
Amount of new share capital
Dividends paid
PPE valued up or down
Retained net income
Reserve changes
3 classes of cash flows
Operating
Investing
Financing
Activities
How is deprication treated for operating cash flow activities
Add depriciation back to operating profit
Where do we start for operating cash flow activities
Operating profit from income statement
Holding company
If a company holds the majority voting rights in that subsidiary
Partially owned subsidiary
Between 50 and 100% ownership of company is held by holding company
What defines significance of holding when preparing group accounts
Greater than 20% of voting power
, then company has influence
Less than 20%, company. Doesn’t have significance
How can it be proved that a company has significant influence on another company
Involved in policy making
Representation on the board
Transactions between companies
Management interchange
Information exchanges
When is it treated as an investment rather than subsidiary undertaking
When the holding company does not exercise their significant influence
What must also be disclosed in group accounts
Relationship between holding and subsidiary
Why the ownership
Reporting dates of different subsidiaries
Ability of subsidiary to transfer funds to holding
How is goodwill measured in accounts and what happens after initial recognition
Recognised as an asset and initially measured at cost.
Goodwill will be recorded at cost less accumulated impairment charges
Frequency and type of testing on goodwill
Impairment testing done annually
What does negative goodwill mean
Total fair value of assets - liabilities is more than purchase consideration
FRS 2 FOR goodwill
Goodwill is finite useful life
Amortised on a systematic basis over its life time
Internally generated Intangible asset ps must be recognised if certain conditions are met
Asset is identifiable
Future economic benefit is probably
Company has intent to complete the asset
Return on capital employed
Operating profit / capital employed
Capital employed is share capital + reserves + long term borrowing
Profit margins equation
Operating profit / sales
Alternative equation ROCE
(Operating profit / sales) x (sales / capital employed)
Asset turnover equation and is high or low good
Sales / total assets
High ratio means company performing well
Return on equity
Net income / shareholder equity
Operational gearing meaning
Examines the sensitivity of profits to sales revenue
Measure percentage change in operating profits that result from a 1% change in sales revenue
Operational gearing equations
(Sales revenue - variable costs): operating profit
(Operating profit + fixed costs): operating profit
When is company solvent
When assets value greater then liabilities value (excluding shareholder fund)
Gearing ratio
Debt / capital employed
Capital employed = debt +equity
What is equity equal to in ratios
Shareholders fund ( share capital plus reserves)
What does low gearing mean
Predominantly financed by equity
Current ratio
Current assets / current liabilities
Current ratio considered prudent when it is between
1.5 and 2
Why could high current ratio not necessarily be good
Too high inventory or too high cash which is diminishing profits
Quick ratio
Current assets - liabilities
/
Current liabilities
Quick ratio indicates and what if ratio less than 1
Firms ability to readily turn assets into cash
Less than 1 indicates inability to convert
What happens to share price, gearing ratio, ROE AND ROCE WITH RIGHTS ISSUE
Share price falls
Gearing falls
Roe and ROCE falls
Scrip issue effect on value of equity, ROCE, roe and gearing
No impact on any values
Stock split on market cap, roe, ROCE and gearing
Market cap remains the same so roe, ROCE and gearing unchanged
Share repurchase effect on shareholder equity, roe, ROCE and gearing
Shareholder equity falls
Roe, ROCE and gearing rise
Accounting manipulation examples
Recording sales before transaction occurs
Delaying the recording of expenses
Avoiding allocating pordiction costs to goods or services
Over valuing assets writing down the value of target assets
Why does share price fall with rights issue
Reflects the proportion of new shares issued at a discounted price
What does.a right issue aim to do
Raise capital
Is there dilution for shareholders during a rights issue
Not for investors who take up the right, yes for those who don’t
What standards deal with financial instruments
Ias 32 IFRS 9 IFRS 7 for IAS
Sections 11 and 12 under FRS 102 for UK GAAP
What is the fundamental principle of iAS 32
Classify instruments as either an equity or liability
Where is LIFO not peremiteed
Under IFRS or GAAP
Does accounting for tangible non current asset affect cash flow statements
No
How are derivatives treated in financial accounts
They are captured on the balance sheet when a contractual agreement is entered
