Intro to Accounts-9

Question 1

Explain why the holder of a loan stock issued by a company might wish to have a restrictive
covenant, based on some accounting ratios.

Answer 1

The value of the loan to the holder depends on the company’s ability to pay the interest on the
loan and to repay the capital at maturity. If there were no restrictions, the company could
borrow more money after the loan issue, thereby increasing the amount of debt interest to
service and the amount of capital to be repaid. This increases the risk of non-payment.
By restricting the company with a covenant to a certain amount of debt, or a certain minimum
interest cover on the loan, the lender is ensuring the future security of the investment.

Question 2

Explain the purpose of requiring that the accounts of a company to be inspected and signed off by
a professional accountancy firm.

Answer 2

Published accounts are only useful if their content can be relied upon to be a true and fair view of
the company’s trading position and prospects. As such it is important to have the numbers signed
off by an ‘independent’ professional.
The auditors are appointed by the shareholders and report to them, so the auditors are
completely independent of the directors.CB1-09: Introduction to accounts Page 7
The Actuarial Education Company © IFE: 2019 Examinations
Should the auditor have doubts about the quality of the information, or about the manner in
which it has been presented, then a comment must be given on any deficiencies. This helps
motivate the directors of the company to behave in a manner that will be favourably viewed by
shareholders.

Question 3

The sole director of a company is considering how to state the holding of a $1 million loan to his
brother’s company. If his brother’s company continues to service the loan, his own company is
solvent, however if his brother defaults, his own company is bankrupt.
Discuss whether a ‘true and fair view’ would value the loan at book cost, at market value, or at
zero in the accounts.

Answer 3

The concept of a ‘true and fair view’ is not simple to apply. Running a business involves a large
human element, which cannot be mathematically or scientifically prescribed. The director must
make his own assessment of the likelihood of default and take all possible steps to ensure that his
decision is based on all the available information. For example, it is possible to:
 value the loan in a manner consistent with the rest of the accounts and make a disclosure
about the likelihood of default and the consequences in the notes
 value as above, but make a provision to reflect his opinion on the likelihood of default
 write the loan off as a prudent measure – this would occur in the situation that his
brother’s company is on the verge of bankruptcy. However in these circumstances his
own company would no longer be a going concern and the concept of true and fair would
have to be reinterpreted.

Question 4

The accounting framework consists of four main types of accounting statements that a company will publish each year. These are:

Answer 4

1. Statement of profit or loss:
2. Statement of financial position:
3. Cashflow statement: been spent.
4. Statement of changes in equity:

These four statements provide a comprehensive overview of a company’s financial performance and position over a given period.

PBCC

Question 5

.Statement of profit or loss: This is

Answer 5

part of a statement of comprehensive income and shows the income, expenses, and hence shareholders’ profits for the year.

Question 6

2. Statement of financial position: Also known as a balance sheet, this statement shows

Answer 6

the assets, liabilities, and shareholders’ funds at the end of the year.

Question 7

2. Statement of financial position: Also known as a balance sheet, this statement shows

Answer 7

the assets, liabilities, and shareholders’ funds at the end of the year.

Question 8

3. Cashflow statement: This statement shows where

Answer 8

cash has come from and how it has been spent.

Question 9

4. Statement of changes in equity: This statement shows how the

Answer 9

composition of equity has changed over the year.

Question 10

The statements go by a variety of different names. As
mentioned above, the term balance sheet is used as

Answer 10

an alternative name for the statement of
financial position. Also, the statement of profit or loss may sometimes be referred to as the income
statement or profit and loss account (P&L).

Question 11

Users of Financial Statements:

Answer 11

Equity investors (actual and potential shareholders): Require information about profits, dividends, and cash flows for investment decisions.
Loan creditors (long-term and short-term): Need information about a company’s ability to generate sufficient cash for loan repayment.
Employees: Interested in the company’s ability to pay salaries and job security.
Business contacts (customers and suppliers): Concerned with continuity of sales and trading policies.

Question 12

Other Uses of Financial Statements:

Answer 12

Stock exchange: Ensures compliance with requirements.
Management: Uses financial statements as a source of information.
Tax authorities: Use financial statements as a starting point for calculating tax liability.
Stock analysts: Use financial statements as a source of financial information.
Credit rating agencies: Assess the creditworthiness of the company.

Question 13

Purpose of Restrictive Covenants in Loan Stock:

Answer 13

Financial statements are regulated by various sources, including national company laws, international accounting standards, stock exchange requirements, and other legislation.
Regulations dictate specific accounting treatments, disclosures, and calculation methods.
Compliance with regulations ensures the credibility and reliability of financial statements.

Question 14

Statutory Requirements for Financial Statements:

Answer 14

National legislation may require companies to publish specific information in their financial statements.
For example, in the UK, the Companies Act requires companies to produce a statement of financial position, statement of profit or loss, detailed disclosures, directors’ report, and auditors’ report. (check zambia)

Question 15

Directors’ Report and True and Fair View:

Answer 15

Directors’ report provides information about the company’s activities, financial decisions, and director details.
Financial statements must give a “true and fair view” of the company’s financial position and performance.
“True and fair view” is a term of art and implies compliance with rules and regulations, but also requires independent judgment and assessment by directors and auditors.
Directors and auditors must consider the overall appropriateness of the financial statements beyond formal disclosure requirements.

Question 16

What is The International Accounting Standards Board (IASB); explain its roles and uses

Answer 16

The International Accounting Standards Board (IASB) develops, issues, and withdraws accounting standards known as International Financial Reporting Standards (IFRSs).

The IASB plays a crucial role in establishing accounting standards that provide a true and fair view of financial statements.

IFRSs are used by companies and entities worldwide to ensure consistent and comparable financial reporting.

Question 17

The IASB does not have the authority to enforce compliance with its accounting standards.
However, many countries require

Answer 17

publicly traded enterprises to prepare financial statements in accordance with IFRSs.
If there are any material departures from IFRSs, companies must disclose them along with the reasons.

Question 18

IFRSs are widely used in various countries, including Singapore, Hong Kong, Russia, most European countries under the jurisdiction of the European Union, and Australia.
The adoption of IFRSs facilitates

Answer 18

international comparability and enhances transparency in financial reporting.

Question 19

National accounting standard committees may be influenced by international committees due to several reasons:

Answer 19

Multinational companies prefer a global accounting standard that applies in all countries where they operate.
Compliance with global standards allows companies to access multiple markets and ensures comparability with similar companies.
National standard-setters are driven to align their standards with global standards to avoid companies opting for reporting under global standards instead.

Question 20

The power and influence of IASB and IFRSs have increased over the years due to the preference of multinational companies for global standards.
Departing from global standards would limit

Answer 20

access to international markets, making national standards less appealing to companies.

Question 21

The adoption of IFRSs has led to improved and harmonized financial reporting practices globally,

Answer 21

facilitating better understanding and analysis of financial information.

Question 22

The case for international standards

Answer 22

Arguments FOR:
- International accounting standards eliminate, or at least reduce, variations between companies in the way they prepare accounts.
- The use of international accounting standards can improve transparency and comparability of financial statements across different countries.
- International accounting standards can help reduce the cost of preparing financial statements for multinational companies.

Question 23

The against international standards

Answer 23

Arguments AGAINST:
- The sets of rules contained in the international accounting standards may not be appropriate to all companies in all circumstances.
- The adoption of international accounting standards may lead to a loss of national sovereignty over financial reporting requirements.
- The process for producing and updating international accounting standards is complex and expensive to operate.

Question 24

Contents of an annual report can vary widely from company to company and industry to industry.

Answer 24

Annual reports of companies listed on stock exchanges can be lengthy, often running 60-70 pages.
Much of the content in annual reports is promotional material voluntarily provided by the company.
The core of the report is subject to stringent rules imposed by the Companies Act 2006 and regulations imposed by the accountancy profession.
Financial industries often include content on financial ratios, capitalization, margin, risk, and risk management.

Question 25

Obtaining understanding of financial statements:

Answer 25

Obtaining one or two sets of financial statements from large companies is the best way to understand their contents.
Financial statements are often available on company websites.

Question 26

Typical contents of an annual report of a UK-based multinational:

Answer 26

Typical contents of an annual report of a UK-based multinational:

Directors’ biographical details
Highlights of financial statements, including profit, dividend figures, and key trends
Analysis of turnover and profit by product and geographical area
Chairman’s statement, including a review of the past year and the company’s future
Map showing worldwide operations
Thirty-year financial record statistics
Review of operations, describing each main business segment
Disclosure of corporate governance issues, such as directors’ remuneration
Directors’ report, including miscellaneous disclosures required by the Companies Act 2006
Statement of accounting policies used in compiling financial statements
Accounting statements: statement of comprehensive income, statement of financial position, cash flow statement, statement of changes in equity, etc.
Statement of directors’ responsibilities and auditors’ report
Notes to the accounts, providing further detail on certain items and a long-term summary of results
List of principal UK and overseas subsidiaries

Question 27

The auditors’ report:

Answer 27

Every UK company above a certain size is required to appoint auditors by the Companies Act 2006.
Auditors report to the shareholders on the published accounts.
The auditors’ report includes:
Title, addressee, and introductory paragraph identifying the audited financial statements
Sections on respective responsibilities of directors and auditors, basis of the auditors’ opinion, and the auditors’ opinion on the financial statements
Auditors’ signature, address, and date of the report

Question 28

Caveats and variations on the standard audit report:

Answer 28

The wording of the standard audit report can be modified based on auditor’s judgment and circumstances.
Emphasis of matter paragraphs can highlight significant uncertainties disclosed in the accounts.
A qualified opinion may be issued when there are restrictions on evidence or disagreements with the treatment of a matter.
A disclaimer of opinion is issued when extreme uncertainty prevents forming an opinion.
An adverse opinion is issued when the financial statements are misleading and do not provide a true and fair view.

Question 29

Importance of receiving an unqualified opinion on accounts:

Answer 29

Companies aim to receive an unqualified opinion to maintain their credibility and reputation.
A negative opinion or qualification can affect a company’s credit rating, increase borrowing costs, and impact share prices.
Management may face consequences, such as being replaced or a takeover, if accounts reflect poorly on their performance.

Question 30

Regulation of auditors:

Answer 30

Auditors must belong to recognized supervisory bodies registered with the Department of Business, Innovation and Skills.
Supervisory bodies are responsible for supervising and disciplining registered auditors.
The accountancy profession regulates audit practice through the publication of auditing standards, such as International Standards on Auditing (ISAs) issued by the Auditing Practices Board (APB).
Conflicts of interest and familiarity are

Question 31

Explain why a company would want to avoid receiving anything other than an unqualified opinion
on its accounts

Answer 31

Anything that reflects badly on the company can reduce its credit rating, increase its cost of
borrowing and reduce its share price. Anything that reflects badly on the management team
controlling the company can lead to them being replaced or taken over.
Management will therefore, for personal and corporate reasons, wish to avoid receiving anything
other than an unqualified set of accounts

Question 32

11 accounting concepts explained in points: give first 5

Answer 32

1. Cost concept (historical cost): This concept states that assets should be recorded at their original cost and not their current market value.
2. Money measurement concept: This concept states that only transactions that can be expressed in monetary terms should be recorded in the financial statements.
3. Business entity concept: This concept states that a business is a separate entity from its owners and should be treated as such for accounting purposes.
4. Realisation concept: This concept states that revenue should only be recognized when it is earned, regardless of when payment is received.
5. Accruals concept: This concept states that expenses should be recognized when they are incurred, regardless of when payment is made.

CM BRA

Question 33

11 accounting concepts explained in points: give last 6

Answer 33

6. Matching concept: This concept states that expenses should be matched with the revenue they helped generate in the same accounting period.
7. Dual aspect concept: This concept states that every transaction has two aspects - a debit and a credit - which must balance each other out in the accounting equation (assets = liabilities + equity).
8. Materiality concept: This concept states that only significant items need to be disclosed in the financial statements.
9. Prudence (conservatism): This concept states that when there is uncertainty about an item’s value or future outcome, it is better to err on the side of caution and record it at a lower value or higher expense.
10. Going concern concept: This concept assumes that a business will continue to operate indefinitely unless there is evidence to the contrary.
11. Consistency: This principle requires companies to use consistent accounting methods from one period to another so that financial statements can be compared over time.

MD MP GC

Question 34

Question
Last year, the XYZ company sold £100,000 worth of goods. It received payment for £70,000 of
these during the last year, and expects to get paid £25,000 in the future in respect of the
remainder. XYZ does not expect to receive the remaining £5,000 because the person who owes
this money has been declared bankrupt.
Determine how much should XYZ show in its accounts as sales in the last year.
Soluti

Answer 34

Prudence means that the amount of £5,000 should not be included in the total figure for ‘sales’.
The accruals concept means that the £25,000 that will be paid in the future can be included.
Therefore one answer is £95,000. An alternative solution, more in line with best accounting
standards, would be to show sales of £100,000 with a deduction of £5,000 as a provision for bad
debts

Question 35

Question
Explain whether it would be appropriate to spread the costs of a failed drug development over a
5-year period.

Answer 35

Solution
No. It would not be consistent with either the prudence principle or the accruals principle. If the
drug has failed, then the next five years do not have anything to do with the expenditure – it
should be recognised immediately.

Question 36

Which of the following is responsible for developing, issuing and withdrawing accounting
standards?
A International Accounting Standards Board
B Auditing Practices Board
C International Financial Reporting Standards
D Department of Trade and Industry

Answer 36

Answer = A

Question 37

Inventories (ie stock or raw materials used by a company) are valued at the lower of cost or net
realisable value. This is an application of which accounting concept?
A cost concept
B accruals concept
C prudence concept
D realisation concep

Answer 37

Answer = C
According to the prudence concept, assets should not be overestimated. If there is some
uncertainty about the value of the inventories (eg Easter eggs after Easter!) and it is felt that the
sale value is lower than the cost value then the lower (net realisable) value should be used in the
statement of financial position

Question 38

Which of the following statements most accurately describes the main purpose of the external audit
of a limited company?
A To review the company’s accounting systems and related internal controls.
B To assist the directors to prepare the company’s annual financial statements.
C To express an opinion on the truth and fairness of the company’s annual financial
statements.
D To prevent and detect fraud within the company.

Answer 38

Answer = C
The wording of a typical auditors’ report is:
‘In our opinion, the financial statements give a true and fair view, in accordance with IFRSs as
adopted by the European Union, of the state of the group’s and the parent company’s affairs as at
…….. and of the group’s and the parent company’s profit [loss] for the year then ended; the
financial statements and the part of the Directors’ Remuneration Report to be audited have been
properly prepared in accordance with the Companies Act 2006 and Article 4 of the IAS Regulation;
and the information given in the Directors’ Report is consistent with the financial statements.’

Question 39

‘Expenses are recognised when they are incurred. It is not necessary to wait until the bills are paid.’
This statement refers to the:
A realisation concept
B accruals concept
C going concern concept
D money measurement concept

Answer 39

Answer = B

Question 40

(i) List the elements of a set of financial statements that are required under the Companies Act
and state the Act’s overriding requirement for the financial statements. [3]
(ii) A company’s accounts should comply with various accounting concepts. Outline the cost
concept and the going concern concept. [2]
[Total 5

Answer 40

(i) Requirements of the Companies Act
Companies must produce:
 a statement of financial position [½]
 a statement of profit or loss [½]
 detailed disclosures which are normally presented as notes to the accounts [½]
 a directors’ report [½]
 an auditors’ report. [½]
The overriding requirement is that the financial statements must give a true and fair view. [1]
[Maximum 3]
(ii) Accounting concepts
According to the cost concept, non-current assets should be valued at cost less depreciation. [1]
According to the going concern concept, accounts should be prepared on the assumption that the
business will continue indefinitely in its present form. [1]
[Total 2

Question 41

Explain why the going concern concept may simplify the preparation of financial statements.

Answer 41

The going concern concept, where it is assumed that a business will continue indefinitely in its
present form, acts as a justification for the limitations imposed by the cost concept because there
is little harm in reporting historical figures for value if the assets concerned are unlikely to be sold
in the immediate future. [1]
This simplifies the preparation of financial statements because:
 there is no need to make difficult (and spurious) estimates of the market value of all the
company’s assets and liabilities, because we assume that they are not about to be sold
imminently [1]
 not claiming to estimate market values also leaves the preparers and auditors of the
accounts less open to challenge in the event that their estimates prove to be incorrect [1]
 non-current assets that are purchased can be depreciated on a straight-line basis over the
useful life of the asset, because we assume that the asset will continue to be used for its
useful life [1]
 potential errors in short-term estimates can be tolerated because the figures will resolve
themselves over time [1]
 inventory, which often has zero value on wind up, can be included in the financial
statements at original cost until it is used and generates revenue. [1]
If directors are in doubt that the company is a going concern they should indicate this fact and the
accounts should not be drawn up using this principle. [1]
[Maxim

Question 42

Describe the different opinions that a company’s auditors may give on the company’s financial
statements. [5

Answer 42

An unqualified opinion is a statement that, in the opinion of the auditors:
 the financial statements and the part of the Directors’ Remuneration Report to be audited
have been properly prepared in accordance with the Companies Act and Article 4 of the
IAS Regulation; [1]
 the financial statements give a true and fair view of the state of the group’s and the
company’s affairs; and [1]
 the information given in the Directors’ Report is consistent with the financial
statements. [1]
The wording of the standard report can be modified if the auditor wishes to highlight an
uncertainty or is not able to express an unqualified opinion that the accounts give a true and fair
view. [1]
There are various degrees of qualification:
Emphasis of matter paragraphs
If there is a significant uncertainty which has been disclosed in the accounts, the auditor should
point this out for the sake of emphasis. [1]CB1-09: Introduction to accounts Page 31
The Actuarial Education Company © IFE: 2019 Examinations
Qualified opinion
The auditor would issue a qualified opinion in circumstances where a restriction has been placed
on the evidence that the auditor can access or where the auditor disagrees with the treatment of
a matter. [1]
Disclaimer of opinion
If the auditor is faced with such extreme uncertainty about the financial statements that it is
impossible to express an opinion then the auditor would issue a disclaimer instead (‘we are
unable to form an opinion …’). [1]
Adverse opinion
The auditor issues an adverse opinion in extreme cases of disagreement where the financial
statements have been rendered so misleading that it must be stated that they do not give a true
and fair view.

Question 43

Describe the different opinions that a company’s auditors may give on the company’s financial
statements. [5

Answer 43

An unqualified opinion is a statement that, in the opinion of the auditors:
 the financial statements and the part of the Directors’ Remuneration Report to be audited
have been properly prepared in accordance with the Companies Act and Article 4 of the
IAS Regulation; [1]
 the financial statements give a true and fair view of the state of the group’s and the
company’s affairs; and [1]
 the information given in the Directors’ Report is consistent with the financial
statements. [1]
The wording of the standard report can be modified if the auditor wishes to highlight an
uncertainty or is not able to express an unqualified opinion that the accounts give a true and fair
view. [1]
There are various degrees of qualification:
Emphasis of matter paragraphs
If there is a significant uncertainty which has been disclosed in the accounts, the auditor should
point this out for the sake of emphasis. [1]CB1-09: Introduction to accounts Page 31
The Actuarial Education Company © IFE: 2019 Examinations
Qualified opinion
The auditor would issue a qualified opinion in circumstances where a restriction has been placed
on the evidence that the auditor can access or where the auditor disagrees with the treatment of
a matter. [1]
Disclaimer of opinion
If the auditor is faced with such extreme uncertainty about the financial statements that it is
impossible to express an opinion then the auditor would issue a disclaimer instead (‘we are
unable to form an opinion …’). [1]
Adverse opinion
The auditor issues an adverse opinion in extreme cases of disagreement where the financial
statements have been rendered so misleading that it must be stated that they do not give a true
and fair view.

Question 44

Describe the potential advantages and disadvantages of making it compulsory that the auditors of
a company should be changed at least once every five years

Answer 44

Advantages of compulsory changing of auditors:
 An inherent problem with the concept of auditing in that the auditor is paid for its work
by the company it is passing comment on. [1]
 In order to ensure that the auditor’s opinion is not swayed by the desire to keep the
client, it could be wise to force a change on a regular basis. [1]
 This may be worth imposing purely for public perceptions, ie avoiding any questions about
potential conflicts of interest, even if there is no particular concern about a firm’s
behaviour having been influenced. [1]
 If an auditor audits the accounts for a long period, it may be too close to the company,
and a fresh perspective may be valuable. [1]
Disadvantages of compulsory changing of auditors:
 It is arguable that an auditor builds up expertise in the financial accounts of a company
over the years. It should therefore get better at auditing the accounts as the years go by.
[1]
 In addition, there may be relatively few big auditing firms, and it may be argued that
rotation of auditing firms would not increase the independence of the opinion, only the
expense and the bureaucracy

Question 45

Discuss the advantages and disadvantages of international accounting standards. [5

Answer 45

The advantages of international standards:
 Such standards reduce or eliminate variations between how companies produce
accounts, allowing comparisons to be made across companies. [1]
 In formulating the standards attention is paid to particular areas of the accounts, the
resulting debate can help ensure an appropriate approach. [1]
 International standards may lead to companies disclosing more information that
otherwise they would do. [1]
 The standards may give flexibility in a way that legislation does not. [1]
The disadvantages of international standards:
 The standards are likely to be based on an average company, and may not be appropriate
for all companies in all situations. [1]
 The standards may not be objective, eg if lobbying of certain industry groups has led to
the standards being formulated in a particular way. [1]
 The standards may allow flexibility in approach, which makes it more difficult to compare
company’s accounts. [1]
 The detail in the standards may not be appropriate, either too high level or too
detailed. [1