FA Week 6-10

Question 1

Is land depreciated?

Answer 1

No. Land has an infinite life.

Question 2

Acquisition cost

Answer 2

PURCHASE PRICE, less any discounts, + all EXPENSES needed to PREPARE ASSET for intended use
*don’t include “interest” unless for self-constructed assets

Question 3

3 types of depreciation method

Answer 3

1. Straight line
   = (cost - residual value)/useful life in years
2. Units-of-production
   - calculate dep. rate (similar to above) then multiply by no. of units produced for the year
3. Reducing balance
   = NBV * (2/useful life in years)
   ^2 if double-declining balance rate

Question 4

How to determine if a long-lived tangible asset {fixed asset} is impaired?

Note:
If there is a loss on impairment (Dr expense), we credit Accumulated depreciation.

Answer 4

If recoverable amount < carrying value (NBV)

Recoverable amount = max(fair value - costs to sell, value-in-use)

*Impaired when a co. can’t recover the asset’s carrying value by either using it or selling it

Question 5

What is the “accounting treatment” for INTANGIBLE non-current assets?

Answer 5

We only record these in SOFP when they are purchased!

Question 6

Company has revalued its land. Is it possible for revaluation profit to be paid as a dividend?

Answer 6

No. Revaluation profit is unrealised.
Increase in land price does not go into I/S, so retained earnings don’t increase.
We can only pay dividends from R/E, therefore cannot pay dividends.

Question 7

Depreciation vs Amortisation

*Goodwill is not amortised b/c it has an indefinite life.

Answer 7

Depreciation: fixed assets (long-lived tangible)
Amortisation: intangible assets

Question 8

Goodwill

Answer 8

When purchase price > fair market value of net assets acquired

• when one co. buys another
• intangible asset only when purchased

Question 9

Types of shares

3 shareholders’ rights

Answer 9

1. Authorised shares - max no. of shares that can be sold to public
2. Issued vs Unissued shares (sold?)
3. Outstanding shares (owned by public/shareholders) vs Treasury shares (company bought back outstanding shares)
4. Voting rights
5. Dividends
6. Proportionate distribution of assets in a liquidation

Question 10

2 reasons why a company would buy treasury stock

Answer 10

1. Co. thinks market price of stock is too low
2. Co. wants to raise price per share = value of company / no. of outstanding shares, by reducing no. of outstanding shares

Question 11

3 types of activities in the cash flow statement + what kinds of accounts belong in each?

Answer 11

1. Operating - generally, current assets & current liabilities
   - adjustments for depreciation, interest expense/revenue, gain/loss on disposal
   - changes in CA & CL
   - Interest paid / received
   - Tax paid
2. Investing - non-current assets (eg. equipment), investments
3. Financing - long-term liabilities, equity
   eg. proceeds from issue of share capital,
   proceeds of long-term borrowings,
   repayment of long-term borrowings
   DIVIDENDS paid

Question 12

Corporation tax formula

• taxable profit is NOT the same as accounting pre-tax profit
• over-provision of tax last year = this year’s tax expense decreases (vice versa)

Answer 12

Income tax for the year =
Profit before tax
\+ Non-deductible expenses
- Non-taxable income
- Capital allowances
> TAXABLE PROFIT * corp. tax rate (%)

Question 13

5 non-deductible expenses

Answer 13

1. Depreciation
2. General provisions
3. Entertainment expenses (eg. dinner w/ client)
4. Expenses of a capital nature (eg. exp. for acquiring NCA)
5. LOSSES on sale of NCA

Question 14

2 non-taxable income

Answer 14

1. PROFITS on sale of NCA

2. Dividends received from UK companies

Question 15

2 capital allowances

Answer 15

1. Annual investment allowance
   - of 100% for expenditure on plant & machinery, up to £1m
2. Writing-down allowances (WDA)
   - applies on residual balances of expenditure you have carried forward from precious acct. period

Question 16

Provision (estimated liability)

Answer 16

If it is PROBABLE that an outflow of resources will be required to settle the obligation

• uncertain in timing or amount recognised in financial statements
  eg. lawsuit, environmental damage, warranties

*all provisions are generally CONTINGENT but IFRS uses ‘contingent’ for A+L that are NOT recognised in fin. stt.s

Question 17

Free cash flow

Answer 17

CFO - dividends - capital expenditure (eg. buying equipment)

Measures a firm’s ability to pursue long-term investment opportunities

Question 18

4 uses of positive cash flows

Answer 18

1. Pay dividends to owners
2. Expand operations
3. Replace assets
4. Take advantage of market opportunities

Question 19

6 reasons for acquisition of other companies

Answer 19

1. Growth by acquisition
2. Synergies
   - eliminate/reduce competition by buying out peers (horizontal integration)
   - control suppliers’ operations by buying them out (vertical integration)
3. Diversification
4. Overseas operation
5. Take advantage of limited liability
   - if subsidiary is sued, parent co. is not affected & vice versa
6. Tax benefits

Question 20

Non-controlling interest

Answer 20

NCI arises when the parent co. owns only a percentage of shares in the subsidiary instead of the full subsidiary

When less than 100% ownership of subsidiary. Represents the extent to which P does not own S

Question 21

Goodwill arising on consolidation + what could it represent?

Answer 21

Future economic benefits arising from the subsidiary’s assets that are not capable of being individually identified and separately recognised in its single company accounts

Could represent:

1. Cost synergies
2. Managerial competencies
3. Competence of team

Question 22

2 pros & 2 cons of fair value accounting

What is the main issue triggering the current fair value debate?

Answer 22

Pros

1. Reflect current market conditions, thus provide timely info about assets & liabilities
2. Increase transparency and COMPARABILITY of values across time

Cons

1. Not relevant and potentially misleading for assets that are held for a long period of time; prices could be distorted by market inefficiencies, eg. financial crisis
2. Fair values are based on models that are NOT RELIABLE, as they rely on MANAGERIAL ESTIMATES {incentivised to report higher profits}

In 2008 financial crisis, many banks were issuing loans, more supply than demand, so price of loans became very cheap.
- some say FVA significantly contributed to crisis; some say merely played the role of the messenger

Question 23

3 reasons why financial statements that comply with company law are USEFUL to shareholders who are not the directors

2 reasons why less useful for shareholders who are also the directors

Answer 23

1. Determine profits available for payment of dividends to shareholders & give info about co.’s profitabilities & the directors’ plan for future investment
2. Determine co.’s tax liability
3. More likely that co. will be properly managed and lower likelihood that co. will be used as a vehicle for fraud
4. Shareholders who are directors are already well informed on co.’s future prospects & there are less issues of stewardship and accountability
5. For proprietary companies (ie. private), determination of profits available for dividends is less crucial b/c they take most of their income out of co. by way of DIRECTORS’ SALARIES rather than dividends