Financial reporting Flashcards
What does a steward do (stewardship)?
Has control over finance, purchasing & hiring decisions. Needs to show records of in and outcomes.
What defines a private company, sole trader & partnerships?
- No public shareholders
- Need for record keeping and statements: for tax, decisions, bank loans, equity.
What defines a public company?
- Shareholders, traded on stock exchange.
- May have controlling shareholder or no overall control.
- Need to account for investor needs, less freedom
Need to account for:
Managers - scope for fraud -> need to report regularly.
Owners - no access to company records.
Investor needs
What are the 2 accounting standards?
US GAAP: Generally Accepted Accounting Principles.
IFRS: International financial reporting standards.
What are the 3 primary financial reports?
Statement of financial position: at a moment in time (assets, liabilities, equity)
Statement of profit & loss: commercial substance instead of cashflow. For a period of time (revenue + expenses + profit)
Statement of cashflows:
Cashflows. For an accounting period (operating, investing and financing activities)
What is an audit?
A formal examination of an organization’s or individual’s accounts or financial situation
What is an internal audit?
- Controls and procedures to protect assets.
- Avoid fraud
- Give reasonable assurance
What is an external audit?
- Provide external reasonable assurance
- Follows standards
- Review work of international audit
- Identify and report problems
What is the difference between financial accounting and management accounting?
Financial:
- Backward looking
- Key user outside firm
- Reports highly standardised
- Regular schedule
Management:
- Forward looking
- Inside firm
- Free form and unregulated
Define assets
A present economic resource controlled by the entity a result of past events e.g. cash, property.
Current: <12 months
Non-current: >12 months
Define liabilities
A present obligation of the entity to transfer on economic resource as a result of past events e.g. taxes, loans, employee pay.
Current and non-current
Define equity
Residual interest in the assets of the entity after deducting all its liabilities.
Assets - Liabilities = equity
What assets are excluded from the the statement of financial position?
- Human resources
- Intangible assets e.g. trademarks, logos
Define owners equity
- Share capital and premium
- Retained earnings (profit after tax)
What is the going concern principle?
Financial statements are prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future.
Define credit sale
- Firms transact most business with one another on credit terms.
- Typically 30-60 days.
Define trade receviable
- Amounts owed from credit sales.
- Used to record invoices issued for goods sold on credit.
Define trade payables
- Amounts owed for good bought on credit.
- Records invoices from suppliers bought on credit
How do you calculate trade receivables at the end of a period?
Trade receivables at end period = Trade receivables at start + revenue from credit sales - payments received from customers
What does the statement of profit and loss record?
Revenue & expenses
- Where profit comes from and where it goes.
What are the 3 different means of payment for goods and services?
Cash on delivery: paid at time received.
Paid in arrears: paid at a later date.
Paid in advance: paid for in advance.
Why can’t cashflow be used for profit?
- Timing mismatch makes it impossible to produce a value profit for accounting period.
What is the accrual principle?
Revenue should be recognised when earned regardless of when paid for. So should expenses.
What are the IFRS revenue recognition requirements?
- Based on satisfying contractual obligations.
- Returns can be reliably estimated.
- Revenue and costs can be measured reliably.
What is the flow diagram of profits?
Gross profit -> core operating profits -> operating profit -> tax/owners/shareholders
What is a non current asset?
Long term investments not easily converted to cash
What are the 3 main types of non current assets?
PPE: property, plant & equipment
Investment property: property kept to rent out
Right of use assets: don’t own, just have right to use
(Others: intangible, associates, goodwill)
What is capital expenditure?
Investments made in the expectation needed to run the firm or that will generate future revenues -> return on investment
What do depreciation costs take into account?
Capital cost of ownership:
- Initial cost
- Residual value (value when disposed)
Length of use
Benefits earned from asset
(Running costs and maintenance taken as expenses at the time)
What are the 2 methods calculating depreciation?
Straight line
Reducing balance
How do you use straight line depreciation formula?
Used when lasts longer than expected
1) calc depreciable amount (purchase cost-residual value) - capital cost
2) calc annual depreciable change by:
depreciable amount/no. of years of useful life
3) calc netbook value (value start - annual depreciation value)
How do you use reducing balance depreciation?
Used when benefits from asset are front loaded.
Estimate residual value and depreciation rate
1) Take net book value @ start of year
2) x by depreciation rate = annual depreciation charge
3) Netbook end of year = net book start - annual depreciation charge
How do you calc annual depreciation charge?
(Net book value - residual value) x depreciation rate
How do you calc net book value after n years?
(initial book value year - residual value) x (1-depreciation rate) + residual value
What are some causes of impairment on PPE?
Physical damage: fire, flooding
Valuation: market condition, periodic reviews/
What are some causes of impairment on PPE?
Physical damage: fire, flooding
Valuation: market condition, periodic reviews/D
Define amortisation
Same as depreciation but for intangible assets
What are the 3 accounting methods?
FIFO - first in first out
LIFO - last in first out
AVCO - average cost
What are the 3 types of cash flow?
- operating activities (goods sold)
- investing activities (non-current assets)
- financing activities (issuing bonds, borrowing from banks)
How do you calculate cash position?
= (cash + short term financial assets) - (overdrafts +short term liabilities)
How do you calculate cash position?
= (cash + short term financial assets) - (overdrafts +short term liabilities)
How do you calculate cash position?
= (cash + short term financial assets) - (overdrafts +short term liabilities)
How do you calculate indirect cash flow from operating activities?
(PBIT + non cash charged) - (increase in non cash working capital + investment income + tax expenses)
Define window dressing
Making firm look more liquid @ the end of an accounting period
Define inventory days and how to calculate it?
- How long firm takes to turn inventory over once.
= inventory/cost of sales x 365
What does an increase in inventory days mean?
Stock build up.
Could be preparing for a sale or a drop in demand
Define days-sales-outstanding and how to calculate it
How long it takes customers to pay for goods bought on credit.
= Trade receivables/revenue (from credit sales) x 365
Define days-purchase-outstanding and how to calculate it
how long it takes to pay for trade payables
=trade payables/cost of sales x 365
Define non current assets turnover and how to calculate it
How effective a firm is at creating revenue from non current assets
=revenue/non current assets x 365
How do you calculate the current ratio of a firm and what is it?
Value driven by nature of business
=current asset/current liabilities
> 1 more current assets
<1 more current liabilities
Define days-free-cash and how to calculate it
Number of days between receiving customer payment and having to pay supplier for goods sold.
=(days purchase outstanding) - (inventory days) - (days sales outstanding)
Define days to be financed and how to calculate it
Number of days between paying the supplier and receiving a payment.
=(inventory days) + (days sales outstanding) - (purchases outstanding)
Define gross margin and how to calculate it
Difference (%) between firm sales & how much it costs to produce and deliver.
=gross profit/revenue
Define cost-income ratio and how to calculate it
How much of company’s gross profit go on paying for running costs
=other operating expenses/gross profit
Define operating margin and how to calculate it
Cents from each dollar of revenue left after paying costs.
=profit before interest & tax/revenue
Define asset turnover and how to calculate it
Dollars of revenue generated from each $ invested
=revenue/operating assets
Or =revenue/non current assets + working capital
Define return on capital employed and how to calculate it
Return on firms operating assets
=operating profits/operating assets
Or =PBIT/non current assets + working capital
Define net profit margin
Operating profits post tax that go to the owners.
Define financial leverage multiplier and how to calc it
Measure of debt gearing
=capital employed/equity
Define return on equity and how to calculate it
Annual accounting return to owners of firm.
=profit after tax/equity
Define interest cover and how to calculate it
Number of times finance expense covered by PBIT
=PBIT/finance expenses
What factors impact ROE (return on equity)?
- Operating profitability (ROCE)
- Level of debt gearing (D/E)
- Cost of debt (rD)
- Marginal tax rate (tr)
What is the role of the board of directors?
- Safeguard assets
- Record keeping
- Accounting policies
- Law
- Sign off statements
- Report presentation; going concern assumption
What is the true & fair view?
True: Financial statements are factually accurate: no omissions/errors, follows standards.
Fair: No bias + “economic reality”
What is the IFRS foundation?
Standards -> describe economic reality faithfully & neutrally.
What are the limitations of financial reporting?
- Backward looking: past periods
- Subjective
- Fraud & earning’s manipulation
- Partial
Difference between objective & subjective values?
Objective: One value
Subjective: Vale determined in a number of ways (choices + estimates)
What is the principle of prudence?
Caution when making judgements under conditions of uncertainty.
Nothing over or understated
What are the 2 common reporting goals?
- Bring gains forward
- Push back impairments
What are some ways of committing accounting fraud?
- Overstating earnings
Common frauds:
- Delaying book closing
- Bring forward unearned revenue
- Selling with buy back agreement
- Fictitious sales
- Booking loans received as revenue
- Failure to recognise receivables as impairments
How do you commit fraud with your inventory?
Falsifying physical stock.
Extra fraud:
- PP&E & intangibles: estimates & toxic assets.
- Expenses: treating expenses as prepayments, recurring expenses into one-off charges.
How does employee fraud occur?
- Theft
- Fake employees & supplies
- Stealing payments
- Overbilling
How does management fraud with connect parties occur?
- Selling assets below market prices
- Buying assets at inflated prices
- Supplier frauds
- Making loans
What does the audit committee do?
Check accounts to ensure no fraud:
- Approved by shareholders, responsible to them.
- Review firm’s financial system, risk mgmt & internal controls.
What are the audit market structural issues?
- High degree of industry concentration
- Big 8 (80s) -> Big 5 (2000)
- All FTSE 100 audited by big 4
- Too big to fail, too fragile to prosecute
