Chapter 11: Financial Accounting Flashcards
What should an annual report contain according to the law?
- Income Statement: Reports the company’s annual results.
- Balance Sheet: Shows the company’s financial position at year-end.
- Administration Report: Provides management insights and company performance.
- Auditor’s Report: Reviews the annual report and evaluates the board’s and CEO’s management.
Additional Requirements for Larger Companies:
- Cash Flow Analysis
- Sustainability Report
Why are external, independent auditors appointed to examine a companies accounting and financial statements?
- Ensure Accuracy: To verify that the financial statements fairly represent the company’s financial result and position according to accepted accounting principles.
- Prevent Irregularities: To ensure that resources are not removed irregularly or unnoticed.
- Provide Assurance to Stakeholders: To give external stakeholders confidence in the financial information.
What laws regulate financial accounting in sweden?
- Annual Accounts Act
- Bookkeeping Act
- Municipal Tax Law
- Companies Act
- Economic Associations Act
What organizations uphold good accounting practice in Sweden?
- Swedish Institute of Authorized Public Accountants (FAR)
- Swedish Accounting Standards Board (BFN)
- Swedish Financial Reporting Board
Compare civil laws and tax laws regarding valuation of a companies assets.
Civil Laws:
- Aim to protect stakeholders (e.g., owners, lenders, suppliers, customers) by preventing companies from overstating their earnings or financial position.
- Relevant laws include the Annual Accounts Act, Companies Act, and Economic Associations Act.
Tax Laws:
- Aim to protect society by preventing companies from understating their earnings to avoid paying sufficient taxes.
- Governed primarily by the Municipality Tax Law.
Key Difference: Civil laws prioritize stakeholder protection against inflated valuations, while tax laws focus on accurate earnings to ensure fair taxation.
Which are the two main reports of an annual report?
-Balance Sheet: Shows the company’s financial position (water level in the basin) at year-end, representing the value of equity.
Income Statement: Shows the inflow (revenues) and outflow (costs) of financial activity during the year.
Profit Calculation:
Difference between inflows (revenues) and outflows (costs) during the year.
Or, difference in the water level (equity value) from the beginning to the end of the year.
Describe the asset side of the balance sheet.
Fixed Assets: Long-term assets that wear out over time, with their cost allocated over several years through depreciation.
Examples: Vehicles, machinery, equipment, buildings, patents.
Current Assets: Short-term assets consumed or replaced within one year.
Examples: Cash on hand, bank balances, accounts receivable, raw material inventory, products in progress, finished goods inventory.
Describe the equity and liability side of the balance sheet
- Equity:
Represents the shareholders’ or owners’ capital in the company. - Untaxed Reserves:
Profits not yet taxed. - Non-Current Liabilities:
Long-term debts with maturity dates longer than one year.
Example: Loans from banks.
- Current Liabilities:
Short-term debts with maturity dates of one year or less.
Examples:
Accounts payable (to suppliers).
Advance payments from customers.
Tax liabilities.
Which are the most important parts of a companies equity?
- Share Capital: Initial investment by shareholders.
- Annual Profit: Current year’s earnings.
- Profit Brought Forward: Undistributed profits from previous years.
What is:
- non restricted equity?
- restricted equity?
Restricted Equity:
- Includes share capital and associated funds.
- Cannot be distributed to shareholders.
Non-Restricted Equity (Disposable Equity):
Includes:
- Profit or loss brought forward (accumulated from previous years).
- Annual profit or loss.
- Associated funds.
Dividends to shareholders can only be paid from this equity.
Describe the following funds and reserves that can be part of a companies equity: revaluation reserve
A part of a company’s restricted equity.
It represents the increase in book value when fixed assets are revalued (written up) under specific circumstances.
This adjustment does not impact the company’s profit and is instead added to the revaluation reserve.
Describe the following funds and reserves that can be part of a companies equity: statutory reserve
A part of a company’s restricted equity intended to protect external stakeholders, such as lenders.
Funded by allocating part of the company’s profit.
Cannot be distributed as dividends to shareholders.
May only be used for specific purposes, such as covering losses.
Mandatory for certain companies, like economic associations, under Swedish law.
Describe the following funds and reserves that can be part of a companies equity: reserve for development costs
A part of a company’s restricted equity.
Created when a limited liability company chooses to depreciate investments in areas such as new product development over several years.
The corresponding amount must, in some cases, be transferred to this reserve to reflect the deferred expense in restricted equity.
Describe the following funds and reserves that can be part of a companies equity: share premium reserve
A part of a company’s non-restricted equity used for new capital issues.
- When new shares are issued, they are sometimes sold at a price higher than their quota value (face value).
- The amount exceeding the quota value is added to the share premium reserve.
- The quota value portion is added to the share capital.
This reserve reflects the premium paid by shareholders above the nominal value of the shares.
Describe the following funds and reserves that can be part of a companies equity: equity method reserve
A reserve used in consolidated financial statements for groups of companies.
- When a company acquires another (purchasing at least 50% of shares, making it a subsidiary), the book value of the acquired company often differs from the acquisition value (purchase price).
- If the book value is higher than the acquisition value, the difference is added to the equity method reserve, which is part of the company’s restricted equity.
This reserve reflects adjustments in the valuation of subsidiaries to align group financial statements.
Describe the following funds and reserves that can be part of a companies equity: fair value reserve
A part of a company’s non-restricted equity.
- Normally, changes in an asset’s market value are reported as revenue or cost in the income statement.
- Exception: For financial assets not intended for active trading or stock exchanges, market value changes are instead added to the fair value reserve.
- These changes are recorded directly against equity, bypassing the income statement.
This reserve reflects unrealized gains or losses on certain financial assets.
What are the differences between an income statement classified by function of expense, and an income statement classified by nature of expense?
Function of expense:
Highlights costs based on business activities.
Costs are grouped by company functions, such as:
* Production
* Sales
* Administration
Provides insight into how much each business activity costs.
Nature of Expense:
Focuses on the types of expenses incurred, regardless of their function.
Costs are classified by type, such as:
* Raw Materials
* Labor
* Depreciation
Focuses on the type of resources consumed
What do the abbreviations EBITDA and EBIT in an income statement mean?
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization.
- Represents operating profit before depreciation and amortization are deducted.
EBIT: Earnings Before Interest and Taxes.
- Represents operating profit after depreciation and amortization are deducted.
What are net sales in an income statement?
Net sales (or net turnover) is the total revenue from the sale of goods and services that are part of a company’s normal business operations, excluding VAT.
The first item in the income statement.
Examples of normal operations include:
- Internet-based services
- Manufacturing
- Consulting services
- Financial services
What is deprecation according to plan?
Depreciation according to plan is the annual allocation of a fixed asset’s cost over its expected economic life.
Fixed assets are used for several years, so their cost is spread out to match the revenue they help generate.
Example: A machine with a 10-year life is depreciated by 10% annually for 10 years.
This process reflects the asset’s consumption over time.
For intangible assets like patents, the process is called amortization.
What are financial revenues and costs?
- Financial Revenues:
- Income not related to normal business operations.
- Examples: Interest earned on bank balances or financial investments.
- Financial Costs:
- Expenses incurred from borrowing money.
- Examples: Interest payments on loans or credit.
Together, these are often referred to as financial items in the income statement.
What should an administration report contain?
The administration report provides an overview of the company’s activities, results, and plans.
According to the Swedish Companies Act, it must present a fair review of:
* The Company’s Operations: Overview of activities during the fiscal year.
* Financial Position and Results: Explanation of significant factors impacting the company’s financial health.
Additional Information:
* Events not recognized in the financial statements but important for assessing the company’s financial position.
* Key events during or after the fiscal year.
* Description of research and development activities.
The report combines past performance with future insights.
What companies are required to submit a sustainability report and what should this report contain?
Required Companies:
Large Swedish companies, with either:
* 250 employees.
* Turnover > SEK 350 million.
* Total assets > SEK 175 million.
Contents of the Report:
* Contribution to long-term sustainable development.
- Key information on:
- Business Model.
- Sustainability Policies.
- Handling of Sustainability Risks.
- Performance Indicators.
Areas to Cover:
* Environment.
* Social conditions.
* Staff.
* Respect for human rights.
* Combating corruption.
What should a cash flow analysis in the annual report contain?
- Information on how the company acquired and used capital during the year.
- Details of how operations were financed.
- Capital investments made during the year.
The cash flow analysis supplements the balance sheet and income statement.
What should the auditors report in the annual report contain?
Analysis of Financial Statements:
* Examination of the company’s financial statements.
* Evaluation of the board’s and CEO’s management of the company.
Tax Compliance: Verification that income taxes, employer contributions, and VAT have been correctly reported and paid.
Opinion on Compliance: Assessment of whether the financial statements comply with generally accepted accounting principles and the law.
Discharge from Liability: A statement on whether the annual general meeting (AGM) should grant the board and CEO discharge from liability for the past year.
Identification of Issues:
* Notes any mistakes or problems in the accounting records for the AGM’s attention.
* If serious errors are found regarding taxes or other charges, the report must be sent to the tax authorities.
Authorized Public Accountant: Required for major corporations and publicly listed companies.
The auditor primarily examines the company on behalf of its owners, and the report is publicly available for limited liability companies.
Describe allocation of the following income and expenditures:
- interim liabilities. i.e, deferred income and accrued expenditures.
Deferred Income:
- Income received but not yet earned (e.g., advance payments for goods/services to be delivered in the future).
- Recorded as a liability on the balance sheet until the income is earned.
- Allocated to the income statement in the correct period when the goods/services are provided.
Accrued Expenses:
- Costs incurred during the period but not yet paid or invoiced (e.g., a utility bill covering two fiscal years).
- Recorded as a liability on the balance sheet.
- Allocated as a cost in the income statement for the correct accounting period.
Interim Liabilities: These ensure that income and expenses are correctly matched to the fiscal period in which they occur, adhering to the accrual accounting principle..
Describe allocation of the following income and expenditures:
- interim claims, i.e, accrued income and prepaid expenditures.
Prepaid Expenses:
* Payments made in advance for goods or services not yet consumed.
* Examples: Rent paid in advance or insurance fees covering the current and next year.
* Recorded as assets on the balance sheet until the goods or services are used.
* Allocated as costs in the income statement when the goods or services are consumed.
Accrued Income:
* Revenues earned but not yet invoiced or received.
* Example: Services performed by year-end but billed in the next year.
* Recorded as assets on the balance sheet.
* Allocated as revenues in the income statement for the correct period.
Interim Claims: Ensure that revenues and expenses are allocated to the appropriate accounting period, reflecting actual income earned and costs incurred.
Describe the following items under fixed assets in the balance sheet:
- machinery and equipment
Machinery and Equipment (Fixed Assets in the Balance Sheet):
Depreciation According to Plan:
* Valuation is based on the cost of acquisition, which is the upper limit for depreciation.
* Depreciation is spread over the asset’s economic life, e.g., 10% annually for 10 years or 20% annually for 5 years.
Accelerated Depreciation (Tax Code):
* Allows faster depreciation than planned rates, lowering asset values and reported profits to reduce taxable income.
* In some cases, assets can be fully depreciated (100%) in the first year, treating the purchase as a cost.
* Common for consumables, providing flexibility in managing taxes.
Describe the following items under fixed assets in the balance sheet:
- goodwill
Goodwill represents the difference between the purchase price a company pays for another company and the book value of the acquired company. This difference is recorded as an asset on the purchasing company’s balance sheet.
Goodwill is depreciated over time, reflecting the decline in its real value. Depreciation may occur as a one-time event or spread over several years, depending on accounting policies and the asset’s useful life.
Describe the following items under fixed assets in the balance sheet:
- real estate
Real estate is depreciated using rates set by tax authorities, typically ranging from 2% to 5% annually, depending on the type of building. Only the buildings are depreciated, while the land is not subject to depreciation.
Describe the following items under fixed assets in the balance sheet:
- land improvements
Land improvements, such as parking lots and landscaping, are depreciated at a rate of 5% annually. However, undeveloped land is not subject to depreciation.
Describe how a companies inventories should be valued.
Lower of Cost or Market: Inventories are valued at the lower of their acquisition cost (usually purchase price) or current market value (selling price or replacement cost).
Depreciation for Obsolescence: Inventories are typically depreciated by 3% annually to account for unsellable or unusable items.
What is obsolescence?
Obsolescence occurs when inventory becomes unsellable or unusable due to being too old, out of date, or damaged.
What do we mean by physical count of an inventory?
- A physical count involves listing and counting all raw materials, components, and products in inventory.
- Items are categorized by type and their value determined using the lower of cost or market rule.
- Typically performed annually during financial statement preparation or more frequently for interim reporting.
What is an appropriation in the income statement?
Appropriations are costs recognized in the income statement under Swedish tax law that allow businesses to reduce their reported profit.
These adjustments create untaxed reserves on the balance sheet.
Describe the following appropriations:
- additional deprecation
The difference between tax-related depreciation and depreciation according to plan.
Applies to fixed assets like machinery, equipment, vehicles, ships, patents, rented apartments, and goodwill.
Two rules determine the depreciation:
30% Rule: 30% of remaining book value.
20% Rule: 20% of original acquisition cost annually.
The lower value is chosen each year, and the same rule is applied to all assets that year.
Recorded as a cost in the income statement and as a liability (accumulated additional depreciation) in the balance sheet.
Describe the following appropriations:
- allocation to tax allocation reserve
A company sets aside a percentage of profit before tax to spread profits over several years.
25% for legal entities, 30% for sole proprietorships.
Recorded as a cost in the income statement and subtracted before calculating tax.
The allocated amount can remain in the reserve for up to six years, after which it is added back to the annual profit and taxed.
The amount can also be added earlier, such as in a loss year, to cover the loss with untaxed reserves instead of taxed capital.
Bookkeeping is handled similarly to additional depreciation.
Why is there an additional depreciation rule when a company is determining the deprecation as recorded in the books?
The additional depreciation rule exists to allow companies to reach a lower book value for depreciable assets than the main depreciation rule (30% rule) permits.
The main rule does not allow assets to reach a zero value, even with continuous investments.
The additional rule (20% rule) provides flexibility for companies to accelerate depreciation and reduce taxable profits more effectively.
What happens in the balance sheet when a company disposes of a fixed asset?
When a fixed asset is sold or scrapped, it is removed from the balance sheet, and the outcome depends on the sale price relative to the book value:
- Capital Gain: Sale price exceeds the book value.
- Capital Loss: Sale price is less than the book value.
- No Gain or Loss: Sale price equals the book value.
The book value is the cost of acquisition minus accumulated depreciation, and it differs from the asset’s market value.
The fixed asset must remain in the company’s fixed assets register, even if fully depreciated, until disposed of.
The register includes details such as name, acquisition year and value, economic life, accumulated depreciation, and book value.
Describe the most commonly used earning ratios of a company
- Return on Equity (ROE):
* Measures return on shareholders’ capital.
* Formula: Profit after financial revenues and costs ÷ Adjusted equity.
* Adjusted equity = Equity + (Untaxed reserves × (1 - tax rate)).
* Indicates the company’s ability to generate profit for its shareholders. - Return on Total Capital (ROT)
* Measures profitability on all invested capital (equity + liabilities).
* Formula: Profit after financial revenues ÷ Adjusted total capital.
* Excludes financial costs like interest, focusing on total capital returns. - Return on Capital Employed (ROCE)
* Measures profitability on capital employed, excluding non-interest-bearing liabilities (e.g., accounts payable).
* No universally accepted formula; varies depending on context. - Profit Margin
* Formula: (Operating profit after depreciation + financial revenues) ÷ Net sales.
* Shows surplus from every 100 kr in sales before considering interest costs, enabling comparison of business efficiency across companies. - Operating Margin
* Formula: Operating profit after depreciation ÷ Net sales.
* Excludes both financial revenues and costs to focus purely on operating performance.
Earnings ratios are typically expressed as percentages, with higher values indicating better performance.
Describe the most commonly used liquidity ratios of a company
- Acid Test Ratio:
* Measures the relationship between the company’s most liquid assets and its current liabilities.
* Formula: (Current assets - Inventories) ÷ Current liabilities.
* A ratio of 1.0 or higher is a common benchmark, indicating enough liquid assets to cover current liabilities. - Current Ratio
* Compares all current assets to current liabilities.
* Formula: Current assets ÷ Current liabilities.
* For manufacturing companies, a ratio of 2.0 or higher is generally recommended. - Liquid Assets as a Percentage of Turnover
* Compares cash and bank balances to net sales (turnover).
* Indicates how much cash a company has relative to its revenue-generating activities.
In general, higher liquidity ratios indicate a better ability to pay short-term obligations. Larger companies with higher turnover typically require more current assets to maintain adequate liquidity.
What does the equity ratio measure?
The equity ratio measures a company’s equity in relation to its total liabilities. It indicates financial stability by showing how well the company can handle future losses, as losses are charged against equity.
A high equity ratio means the company is more stable and can better manage risks like increased production costs or market expansion. A low equity ratio suggests limited capacity to absorb losses or take on new ventures.
What is a company group?
A company group consists of a parent company and one or more subsidiaries.
The parent company owns or controls more than 50% of the voting rights in its subsidiaries. Subsidiaries can also control other companies, creating groups within groups.
Key points:
* Common among large industrial and publicly listed companies.
* Formed due to economies of scale, synergies, and globalization.
* Governed by legal regulations regarding their creation, structure, and financial reporting.
Difference from Divisions: Subsidiaries are legally distinct entities, while divisions are internal organizational units without legal or mandatory rules governing their structure.
What are the purposes of a consolidated financial statement and what should a consolidated financial statement contain?
The purpose of a consolidated financial statement is to present the financial results and position of a group of companies as if the group were a single limited liability company.
Key objectives:
* Eliminate internal transactions (e.g., purchases and sales) between the parent company and subsidiaries or among subsidiaries.
* Ensure consistent valuation of assets and liabilities across the group, following the parent company’s principles.
* Minimize the group’s total tax liability through group contributions, when the parent owns at least 90% of the subsidiary’s voting rights.
What should a consolidated financial statement contain?
1. Consolidated balance sheet
2. Consolidated income statement
3. Administration report
4. Cash flow analysis (for larger groups)
5. Parent company’s individual financial statements
Each company in the group must also prepare its own annual report and submit tax returns on individual profits.
