Chapter 3 - Test your knowledge

Question 1

What is the key objective of financial statements?

Answer 1

According to the IASB Conceptual Framework for the preparation and presentation of financial statements, the objective of general purpose financial statements is to provide useful information about the financial position, financial performance and cash flows of an entity to a wide range of users who are making economic decisions.

The objective of IAS 1 is to ensure comparability of financial statements with the entity’s financial statements of previous periods and with the financial statements of other entities.

Under IAS 1 an entity must present a complete set of financial statements (including prior period comparative information) on at least an annual basis.

Question 2

What are the components of a complete set of financial
statements as required by IAS 1?

Answer 2

A complete set of financial statements comprises:

1) a statement of financial position (also called a balance sheet)

2) a statement of profit or loss and other comprehensive income

3) a statement of changes in equity

4) a statement of cash flows

5) notes to the financial statements (comprising a summary of significant accounting policies and other explanatory notes)

Question 3

What is meant by a current asset, a non-current asset, a current
liability and a non-current liability?

Answer 3

Current assets are assets (such as inventories and trade receivables) that are sold, consumed or realised as part of the normal operating cycle even when they are not expected to be realised within 12 months after the reporting period.

They also include assets held primarily for the purpose of trading and the current portion of non-current financial assets.

All other assets should be classified as non-current assets.

Non-current assets include tangible, intangible and financial assets of a long-term nature.

A liability is classified as current by IAS 1 when it is:

1) expected to be settled in the entity’s normal operating cycle;

2) held primarily for the purpose of trading;

3) due to be settled within 12 months after the reporting period; or

4) it does not have an unconditional right to defer settlement of the liability.

Liabilities not falling within the definitions of ‘current’ are classified as
non-current.

Question 4

How does having an agreement to refinance and an unconditional right to defer settlement of the liability impact on an entity’s current/non-current classification?

Answer 4

Debt under an existing loan facility which is due to expire within 12 months of the year end is treated as current.

However, the debt becomes non-current if there is an agreement to refinance and if the lender has agreed, on or before the balance sheet date, to provide a period of grace lasting 12 months or more from the end of the reporting period, during which the lender is unable to enforce repayment of the loan.

Question 5

What is the key difference between the statement of profit or loss and other comprehensive income?

Answer 5

The statement of profit or loss includes all items of income or expense (including reclassification adjustments) except those items of income or expense that are recognised in OCI as required by IFRS. IAS 1 lists the following as the minimum items to be presented in the profit or loss section.

1. revenue
2. finance costs
3. share of profits and losses of associates and joint ventures accounted for using the equity method
4. a single amount for the total of discontinued operations
5. tax expense
6. a total for profit and loss
7. gains and losses from the de-recognition of financial assets measured at amortised cost.

Other comprehensive income includes all of the items that cannot be included in the statement of profit and loss. These include the change in a company’s net assets from non-owner sources, including all income and expenses that bypass the income statement because they have not yet been realised. Examples of the types of changes captured by other comprehensive income include:

A. changes in the revaluation surplus on long-term assets

B. actuarial gains and losses on re-measurement of defined benefit plans

C. exchange differences (gains and losses) arising from the translation of the financial statements of a foreign operation

D. certain gains and losses relating to financial instruments, including on certain instruments used for hedging

Question 6

What items are listed in the statement of profit or loss?

Answer 6

The statement of profit or loss includes all items of income or expense (including reclassification adjustments) except those items of income or expense that are recognised in OCI as required by IFRS.

IAS 1 lists the following as the minimum items to be presented in the profit or loss section:

1. revenue
2. finance costs
3. share of profits and losses of associates and joint ventures accounted for using the equity method
4. a single amount for the total of discontinued operations
5. tax expense
6. a total for profit and loss
7. gains and losses from the de-recognition of financial assets measured at amortised cos

Question 7

What items are listed in the statement of profit or loss and OCI?

Answer 7

Other comprehensive income includes all of the items that cannot be included in the statement of profit and loss.

These include the change in a company’s net assets from non-owner sources, including all income and expenses that bypass
the income statement because they have not yet been realised.

Examples of the types of changes captured by other
comprehensive income include:

1. changes in the revaluation surplus on long-term assets
2. actuarial gains and losses on re-measurement of defined benefit plans
3. exchange differences (gains and losses) arising from the translation of the financial statements of a foreign operation
4. certain gains and losses relating to financial instruments, including on certain instruments used for hedging
5. correction of prior period errors and the effect of changes in accounting policies

Question 8

Changes in equity include?

Answer 8

Changes in equity include?

1. Share Capital
2. revaluation surplus
3. Retained earnings
   4.Total equity

Question 9

What Financial Statements are in a set of accounts?

Answer 9

Financial statements is also known as the annual report, and seen as a voluntary disclosures. The Financial statement /annual report includes:

• the strategic report or business review
• the directors’ report
• the directors’ remuneration report
• the corporate governance statement
• the auditor’s report
• audited financial statements
• notes to the financial statements

The above is governed by law, IFRS, the relevant stock market ules for listed companies and AIM (alternative investment market).

The auditors report will also include:

– statement of financial position
– statement of profit or loss and OCI
– statement of changes in equity
– statement of cash flows
– notes to the financial statements

Question 10

What is a strategic report? who is responsible for producing this report ?

Answer 10

What is a strategic report? who is responsible for producing this report ?and what is the objective of the strategic report?

The strategic report or business review is a detailed report written in non-financial language. It provides clear and coherent information about the company’s activities (such as what it does and why), performance, position, the strategic position of the business and probable risks attached with the business. It ensures information is accessible to a broad range of users, not just analysts and accountants who have sophisticated knowledge. It is prepared separately from the directors’ report.

It is the duty of the directors to prepare this report

Question 11

What is the purpose of the strategic report? and what must it provide?

Answer 11

The purpose of the strategic report is to provide information to the members of the company and help them assess how the directors have performed their duties and functions.

The strategic report must provide the following information:

• Fair view
• Going Concern
• References to the financial statement
• Signing and approving the report

for quoted companies, additional information is required:

• a description of the company’s strategy
• a description of the company’s business model
• information on environmental, employee and social issues, including human rights and gender diversity information
  when material

Question 12

What do we mean by Fair review as in the strategic report?

Answer 12

Fair review

A fair review is a balanced and comprehensive analysis of the company’s business for an understanding of the following:

1. The performance and development of the company’s business during the financial year, including analysis using
   financial key performance indicators (KPIs).

Large companies should also include non-financial KPIs such as those relating to environmental and employee matters in their analysis, where appropriate.

2. The position of the company’s business at the end of that year.
   Description of the principal risks and uncertainties the company faces. These may include any risks and uncertainties that have affected the company’s business.

Question 13

The directors report. What is this?

Answer 13

The directors’ report is a financial document prepared by the directors. Its purpose is to inform members of the company
of the financial state of the company, as well as its compliance with financial reporting, accounting and CSR standards.

Its purpose is that it helps shareholders make informed decisions when casting their votes at the annual general meeting or other members’ meetings.

the report is required by law under s.415 of CA2006

It provides information on:

1. whether the company has good finances
2. whether the business has the structural capacity to expand and grow
3. how well it is performing within its market and market in general
4. whether the company is complying with financial regulations, financial reporting and accounting standards (IFRS) and social responsibility requirement.

Question 14

List 5 items that a directors report should cover?

Answer 14

List 5 items that a directors report should cover?

1. the names of all directors during the financial year;
2. a summary of the company’s trading activities;
3. a summary of future prospects;
4. the principal activities of the company and, if relevant, the principal activities of its subsidiaries;
5. the amount of dividend, if any, recommended by the directors for the reporting year

Question 15

List 5 items that ‘The directors statement of responsibility’ should include.

Answer 15

List 5 items that ‘The directors statement of responsibility’ should include.

1. that the directors have a responsibility to promote the success of the company, as per CA2006 s. 172
2. directors are responsible for preparing the annual report, remuneration report and the financial statements in accordance with applicable law and regulations and with the specific requirements of IFRS
3. that the directors are required to properly select and apply accounting policies to provide relevant, reliable,
   comparable and understandable information
4. that the directors are required to properly select and apply accounting policies to provide relevant, reliable, comparable and understandable information
5. that the directors are responsible for keeping proper accounting records, safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities

Question 16

What do the notes of a financial statement provide?

Answer 16

The notes to the financial statements provide information not presented elsewhere in the financial statements.

These include:

• more detailed analysis of figures in the statements
• narrative information explaining figures in the statements
• additional information, for example contingent liabilities and capital expenditure and lease commitments

International Accounting Standard 1 requires the notes to the financial statements to disclose the following key information:

1. the basis for the preparation of financial statements, including the specific accounting policies chosen and applied to significant transactions/events
2. information which is required by IFRS but not presented elsewhere in the financial statements
3. any additional information that is relevant to understanding which is not shown elsewhere in the financial statements

Question 17

What is Segment reporting?

Answer 17

Segment reporting provides information regarding the financial performance and position of the identifiable operating segments of a company to users of its financial statements.

It can be particularly useful when dealing with large entities
that produce a diversified range of products and services and/or have a number of business lines and operations – often in different geographical areas or countries.

Segment reporting supplementing the statement of profit or loss and OCI, based on product or geographical areas, helps users to better understand and assess the following elements of an entity:

• past performance
• profit characteristics
• risks and returns
• potential for future growth
• more information about the entity as a whole

Question 18

What are Operating segments?

Answer 18

What are Operating segments?

IFR Standard 8 defines an operating segment of an entity as a business component:

1. from which it may earn revenue and incur expenses;
2. whose operating results are regularly reviewed by the entity’s chief operating decision maker (CODM) to make decisions about resources to be allocated to the segment and assess its performance; and
3. for which discrete financial information is available.

The chief operating decision maker is a function (not necessarily a person) that makes strategic decisions about the entity’s segments and is likely to vary from entity to entity. For example, the CODM may be the CEO, the chief operating officer, the senior management team or the board of directors.

Question 19

Disclosures of Operating segments?

Answer 19

Disclosures of Operating segments must include:

1. how the entity has identified operating segments and their general nature;
2. the information on operating segment assets and liabilities and profits and losses, if presented regularly to the CODM and measured in a different way to the primary or main statements;

*3. reconciliations of amounts disclosed by segments to the totals within the financial statements; and

4. any change in the internal structure of the entity with the new and old segment information.

Question 20

What are 5 Limitations of published financial statement?

Answer 20

What are 5 Limitations of published financial statement?

1. Historical cost

Fails to account for the change in price levels of assets over a period of time.

2. Creative accounting or earnings management

Is the presentation of an entity’s financial statements in the best possible or most flattering way. It is a deliberate manipulation of financial statements which is geared towards achieving predetermined results

3. Not forward looking

It becomes very difficult for an investor to arrive at any decision by looking at the financial statements prepared on the basis of historical information. The strategic report can, however, provide some insights into the future prospects of the business.

4. Seasonality of trading

Many entities whose trade is seasonal in nature tend to report their results when the company is at its most solvent (for example, retailers often report after Christmas). This may distort reported results and particularly statement of financial position items as atypical compared to the rest of the year.

5. Only covers a specific time period

A statement of financial position is prepared on a specified date and reflects the financial position on that date. The position may be different the day before or the day after.