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UoM Shiz Yaheardme > Financial Reporting and Accountability > Flashcards

Financial Reporting and Accountability Flashcards

1
Q

What are normative theories of accounting?

A
  • Based on judgements about types of information people need
  • Provide prescriptions about how financial reporting should be undertaken
  • They are prescriptive theories of accounting
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2
Q

What is the definition of income?

A

“the max amount that can be consumed while still expecting to be as well off as the beginning period”
- “well-offness” relies on capital maintenance
- Different notions of capital maintenance provide different perspectives of incomes
- These are considered in conceptual framework

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3
Q

What are the 3 capital maintenance perspectives?

A

Financial Capital
Purchasing Power
Physical Operating Capital

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4
Q

What is financial capital maintenance?

A

Perspective is taken in historical cost accounting

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5
Q

What is purchasing power maintenance?

A

Historical cost accounts adjusted for changes in purchasing power (inflation)

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6
Q

What is physical operating capital maintenance?

A

Revaluing transactions to current costs to maintain funds for the same level of operations

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7
Q

Historical Cost assumes money holds constant purchasing power - what 3 assumptions about the economy make this less valid?

A
  1. Specific Price Level Changes (shifts in consumer preference, technological changes)
  2. Inflation
  3. Fluctuation in exchange rates
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8
Q

What are the limitations of historical cost in times of rising prices?

A

Problem of relevance (asset’s current value may be different)
Problem of additivity (they add up assets with different bases)
Can overstate profits
Including holding gains accrued from differing years can distort year’s operating results

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9
Q

What are the main points in support of historical cost accounting?

A

The predominant method used today so tended to maintain the support of the profession
Would have been abandoned if not useful

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10
Q

What are some advantages of Current Purchasing Power?

A

Relies on data available under historical cost accounting
No need to incur cost or effort to collect data about current asset values
CPI data also readily available

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11
Q

What are some disadvantages of Current Purchasing Power?

A

Movements in price of goods and services included in general price index (GPI) may not reflect specific price movements
Information generated may be confusing
Studies show share price reactions failed to find support

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12
Q

Advantages of Current Cost Accounting?

A

Better comparability
Differentiating operating profit, holding gains and losses can enhance usefulness

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13
Q

What are some criticisms of Current Cost Accounting?

A

Replacement cost of assets might not be same for all firms
Doesn’t reflect resell cost if sold
Difficult to determine replacement costs

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14
Q

What are the advantages of CoCoA?

A

Using one method for all assets (exit value) means the resulting numbers can be added together
No need for arbitrary cost allocation

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15
Q

What are some criticisms of CoCoA?

A

If implemented there is a fundamental shift in accounting
Exit prices aren’t relevant if we don’t plan to sell

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16
Q

What is a financial instrument?

A

“Any contract that gives rise to financial asset of one enterprise and a financial liability or an equity instrument of another”

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17
Q

What is a financial asset?

A

Cash or contractual right to receive cash from another enterprise
(A contractual right to exchange financial instruments with another enterprise under conditions that are potentially favourable)

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18
Q

What is a financial liability?

A

A contractual obligation to deliver cash/financial instruments to another enterprise
(exchange financial instruments with another enterprise under conditions that are potentially unfavourable)

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19
Q

What is an equity instrument?

A

A contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities

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20
Q

Which of the following are financial instruments?

A

Debentures
Preference shares (contract that results in paying cash)
Ordinary shares
(Cash is a financial asset not a contract, trade receivables is an asset not a contract, prepayment as rights to receive goods or services not cash)

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21
Q

What are derivatives as financial instruments?

A

(Financial options, futures, forwards, interest rate swaps, currency swaps)
- Values change in respond to changes in interest rate, exchange rates, index rates etc
- Require no initial net investment or little investment
- Settled at a future date

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22
Q

What is IAS 32: Compounding Instruments?

A
  • Split presentation into equity and liability
  • Measure liability by deriving fair value of a similar liability without conversion option
  • Total fair value-liability fair value = residual equity fair value
  • Fair value is amount an asset could be exchanged between willing parties
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23
Q

What is the initial IAS 39 Measurement?

A

At fair value (FV), plus transaction costs

24
Q

What are the subsequent measures for financial assets at fair value through profit or loss (FVTPL)?

A

FV, with gains/losses in the income statement

25
Q

What is the Held-to-maturity measurement?

A

Amortised cost using effective interest method

26
Q

What is the loans and receivables measurement?

A

Amortised cost using effective interest method

27
Q

What is the available for sale (AFS) measure?

A

FV, with gains/losses in other comprehensive income

28
Q

What is amortised cost? (rolling up transaction cost)

A

Rolling up transaction cost and differences between issue redemption value in an effective interest rate (so need to start with inital proceeds after transaction costs deducted)

29
Q

What is the effective interest rate?

A

YTM
Internal rate of return of the instrument
- need to ‘roll up’ the amount that is repayable at the date of maturity

30
Q

What is the definition of a liability?

A
  1. Present obligation
  2. Past event
  3. Outflow of economic benefits
31
Q

What is the recognition of a liability?

A
  1. Probable outflow
  2. Amount can be measured
32
Q

What is a provision (IAS 37)?

A

A liability of uncertain timing or amount
- IAS 37 views provisions as a sub-class of liabilities
- Provisions can be distinguished from other liabilities such as trade payables and accruals, because of the degree of uncertainty

33
Q

What is the provision criteria?

A
  • Present obligation from past event
  • Probable outflow of economic benefits
  • Method to evaluate timing and amount (so it can be measured reliably)
    If all 3 are met, recognise the provision
34
Q

Why was IAS 37 created?

A

To address big bath accounting (company’s management purposefully manipulating income statement to make poor results look even worse to make future look better)

Creation of provisions where no obligation to a liability exists

The use of provisions to smooth profits

35
Q

What is a legal obligation?

A

Contractual
Legislation or operation of law e.g. environmental legislation

36
Q

What is a constructive obligation?

A

Past practice or statements have created a “valid expectation” that the company will act in a certain way

37
Q

What is expected values? (obligation)

A

When there is a large population of items obligation is estimated by weighting all possible outcomes by their associated probabilities, to arrive at the expected value

38
Q

What is a reliable estimate?

A

Where an entity can determine a range of possible outcomes - a reliable estimate can be made
(if no estimate can be made and the liability can’t be recognised, it’s a “contingent liability”

39
Q

What is discounting?

A

When possible - amount of provision should be discounted: recorded at present value of expenditure required to settle the obligation (likely to be before settlement)
Discount rate used should be pre-tax rate that reflects current market assessments

40
Q

What is an onerous contract?

A

Contract which unavoidable costs of meeting obligations under contract exceed economic benefit to be received under it
Unavoidable costs: The lowest net cost of exiting from the contract

41
Q

What is restructuring?

A

Changes the scope of a business undertaken by an entity
or
Changes the manner in which business is conducted

42
Q

What is the criteria for making a provision? (restructuring)

A
  1. Detailed formal plan
  2. Valid expectations in those affected that it start by announcing main features - board decision at the end to see if it had started or made public announcement)
43
Q

What are some examples of events that may be restructuring?

A

Sale or termination of business
Changes in management strucutre
Closure of business locations

44
Q

What do you do with gains from expected disposal of assets? (regarding provisions)

A

Not included - include under PPE or Non-Current assets

45
Q

What do you do with future operating losses?

A

Provision not recognised - don’t meet definitions of a liability

46
Q

What is a contingent liability?

A

Possible obligation arising from past events whose existence is confirmed by one or more future uncertain events
or
Present obligation that arises from past events but not recognised because not probable or the amount can’t be measured

47
Q

How do you treat contingent liabilities?

A

Shouldn’t be recognised in financial statements, but may require disclosure
Need to be assessed continually

48
Q

What is a pension plan?

A

Arrangement where an employer provides payments to employees after they retire for services they provided while working

49
Q

What is a defined contribution plan?

A

Employer contribution fixed by plan
Risk borne by employees
Benefits based on plan value

50
Q

What is a defined benefit plan?

A

Benefit determined by plan
Employer contribution varies
Risk borne by employer

51
Q

What are different types of defined payment plans?

A

Final pay plan - % of final salary before retirement
Final average pay plan - benefits calculated as a % of average of last 3-5 years before retirement
Career average pay plan - benefits related to average salary someone earned during his career

52
Q

Why is accounting for defined benefit plans so complicated?

A

Subjective
Uncertain costs (how long will they live etc)
(extras - inflation, rpi vs cpi, salary increase expectations, life expectancy)

53
Q

Why is accounting for defined benefit plans so complicated?

A

Subjective
Uncertain costs (how long will they live etc)
(extras - inflation, rpi vs cpi, salary increase expectations, life expectancy)

54
Q

What does IAS 19 say about pensions?

A

Prioritises SoFP not Income Statement
Assets measured at market value
Liabilities measured using project unit credit method (spreads cost out over life on a systematic basis)

55
Q

What is the projected unit credit method?

A

Valuation method used to calculate an enterprise’s defined benefit obligations
Each period gives rise to an additional unit of benefit entitlement and measures each unit separtely

UoM Shiz Yaheardme (3 decks)

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