Finance part 1

Question 1

Principles based approach to regulatory frameworks (2)

Answer 1

Provide underlying set of principles within which standards are developed
Avoid need for rule covering every eventuality

Question 2

Rules based approach to regulatory frameworks (2 considerations)

Answer 2

Rules have to be designed to cover every eventuality
Minimise exercise of judgement - more appropriate in controversial areas

Question 3

What is agency theory? (2)

Answer 3

Modern corporation is based on principal-agent relationship
Agent (manager) acts as custodian over the business to maximise wealth of owner (principal)

Question 4

What is agency problem?

Answer 4

Principle cornerstone of agency theory
The agent may pursue there own interests at the expense of the principal
The principal therefore incurs agency costs arising from disagreement or inefficiency (such as excessive executive pay)

Question 5

Arguments against accounting regulation (5)

Answer 5

Rigid regulation can have detrimental effect in long term if political and economic changes are ignored
One reporting regulation may not fit all countries
Choices on certain items such as valuation of inventories can be somewhat arbitrary and may not be suitable for all
Standards tend to remove need for accountants to exercise their judgement
Gives illusion of precision and comparibility

Question 6

Advantages of adopting IFRS (5)

Answer 6

Global comparisons are easier
Cross-border listing is facilitated
Multinational companies with subsidiaries have a common accounting language
Foreign companies can more easily be appraised for mergers and acquisitions
Easier prep of group financial statements and lower audit costs

Question 7

Disadvantages of adopting IFRS (4)

Answer 7

Cost of implementation
Lower level of detail in IFRS
Many do not favour a principles based approach (particularly in US)
Emerging economies may struggle with legal incompatibilities or the education of auditors

Question 8

On what basis are IASB and FASB trying to achieve harmonisation

Answer 8

By creating new standards rather than converging old standards that are in need of replacement anyway

Question 9

Barriers to global harmonisation of accounting standards (5)

Answer 9

Legal system - whether that is common law or code law, as new developments may be restricted
Accounting practices - many countries do not have strong independent bodies which would press for higher standards
Tax system - in most countries, tax authorities may influence accounting rules re. revenues and expenses
Level of inflation - this will influence valuation methods for varios types of assets
Econ-political relationships - cultural differences represent boundaries, unwillingness to harmonise for ‘nationalist’ reasons

Question 10

Two differences between UK GAAP and IFRS

Answer 10

Goodwill - amortised in UK GAAP, but not in IFRS, where it is tested annually for impairment
Business combinations - transactions costs are included in acquisition cost in UK GAAP, expenses in IFRS

Question 11

Define environmental reporting

Answer 11

The process of communicating the environmental effects of an organisation’s economic actions through the corporate annual report or a separate environmental report

Question 12

Define social accounting

Answer 12

A commitment by business to behave ethically and contribute to economic development while remaining sensitive to the needs of all of the stakeholders. Companies should make decisions based not only on financial factors, but also on the social and environmental consequences of their actions. Over the last decade has moved from volnutary effore to subject to mandatory schemes.

Question 13

What is the order of responisbilites and Carroll’s CSR pyramid

Answer 13

1. Economic - Profitable business must be developed to create income, provide jobs and tax revenue for society
2. Legal - Observance of laws and regulations
3. Ethical - Acting morally and ethically in issues such as treatment of employees
4. Philanthropic - Discretionary behaviour to improve the lives of others such as through charitable donations

Question 14

What is the IASB conceptial framework

Answer 14

Established by the IASB to assist in developing and revising IFRS, helping parties understand and interpret IFRS

Question 15

Limitations of a conceptual framework (3)

Answer 15

Financial statement devised based on a cingle conceptual framework may not suit all users given the diversity of user requirements
It is not clear that it makes the standard setting easier
There may be a need for a variety of standards with different concepts as a basis, produced for different purposes

Question 16

Objective of general purpose financial reporting

Answer 16

To provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other users in making decisions about providing resources to the entity

Question 17

Two fundamental qualitative characteristics

Answer 17

Relevance and faithful representation

Question 18

Four enhancing qualitative characteristics

Answer 18

Comparability
Verifiability
Timeliness
Understandability

Question 19

5 elements of financial statements

Answer 19

Assets
Liabilities
Equities
Income
Expenses

Question 20

Two categories of measurement bases according to conceptual framework

Answer 20

Historical cost
Current value basis

Question 21

What is historical cost basis?

Answer 21

The price paid or cost incurred to acquire or create an asset

Question 22

What is the current value basis?

Answer 22

Based on current monetary value, to reflect conditions at the measurement date

Question 23

Three bases within current value

Answer 23

Fair value - price expected to be received if sold
Current cost - amount required to acquire equivalent asset
Value in use - Represents expectations in terms of cash flow, cannot be used if larger than recoverable amount

Question 24

Two statements withing statements of financial performance

Answer 24

Statement of profit and loss
Statement of other comprehensive income

Question 25

What is the point of statement of OCI? (2)

Answer 25

Sometimes info is more relevant or faithfully represented in the statement of OCI
These items will then be ‘recycled’ into the statement of P/L

Question 26

What is the concept of capital maintenance?

Answer 26

Profit may be recognised only if the total value of all assets (net of all liabilities) at the end of the accounting period exceeds the value at the beginning of the accounting period

Question 27

Two concepts of capital maintenance

Answer 27

Financial capital maintenance
Physical capital maintenance

Question 28

Equation for financial concept of financial maintenance

Answer 28

Opening equity (net assets) + profit – distributions = closing equity (net assets)

Question 29

When does physical concept of capital maintenance work better?

Answer 29

For entities where the capital is regarded as production capacity

Question 30

When is profit earned under concept of physical capital maintenance?

Answer 30

When the production capacity at the end of the year exceeds the production capacity of an entity at the beginning, excluding distributions/contributions of owners. ie. Value to replace used inventory has increased