November 2019 Flashcards
IAS 1 “Presentation of Financial Statements” requires the notes to the financial statements to disclose:
The basis for the preparation of financial statements, including the specific accounting policies chosen and applied.
Explain differences in accounting treatment between IFRS and UK GAAP (FRS 102).
- (1) goodwill and intangibles: amortised in UK GAAP, but not in IFRS, where tested annually for impairment. (1) Alternatively, could say have a finite life in UK GAAP (max 10 years) (1) but can have indefinite life in IFRS.
- (1) impairment - in UK GAAP, all non-financial assets are reviewed for indicators of impairment where there is an indication of impairment. In IFRS, all non-financial assets with finite lives are reviewed annually for indicators for impairment (1)
- (1) business combinations - in UK GAAP, transaction costs are included as part of the acquisition cost. In IFRS, transaction costs are expensed (1)
- (1) assets held for sale - in UK GAAP, the decision to sell an asset is assessed as an indicator of impairment, although this is not covered by FRS 102 [note for marking purposes] IFRS requires classification of items as held for sale if their carrying amount is recovered through sale rather than use (1)
- (1) development costs - in UK GAAP, choice to either expense as they are incurred or capitalise and amortise them over the useful life of the asset. In IFRS, capitalisation is mandatory where the criteria for capitalisation are met (IAS 38 (intangible assets)).
Explain propositions I and II of Modigliani and Miller’s theory of capital structure
- MM proposition I: With the assumption of no taxes, capital structure or
leveraging does not influence the market value of the company. (1) It
assumes that debt holders and equity shareholders have the same
priority in the earnings of a company and that the earnings are split
equally. (1) - MM Proposition II: The cost of equity is a linear function of the firm’s
debt/equity ratio. (1) With an increase in gearing, the equity investors
perceive a higher risk and expect a higher return, increasing the cost of
equity. (1) - The rate of return required by shareholders (Ke) increases in direct
proportion to the debt/equity ratio. (1) - As the gearing increases, the cost of equity rises just enough to offset
any benefits conferred by the use of apparently cheap debt (Kd). (1) - This means that WACC (Ko) remains constant at all levels of gearing.
(1)
Profit for a company is earned only if the financial or monetary value of the net assets at the end
of the accounting period exceeds the monetary value of net assets at the beginning of the
accounting period.
True
Explain the accounting concept of ‘materiality’ and how it is applied in producing financial
statements.
IAS1 states that each material class of similar items should be presented
separately and items that are dissimilar in terms of nature or function should
be presented separately unless they are immaterial. (1) [Answers may
alternatively state that materiality is a key part of the fundamental qualitative
characteristic of relevance.]
Award up to 2 marks for any two of the following:
- The concept of materiality is a key feature of financial reporting and its
considerations apply to all parts of the financial statements and
disclosures. (1) - Materiality depends on the nature or size of the item, or a combination
of both, and whether the non-disclosure thereof could influence the
economic decisions of the users of financial statements. (1) - The decision about whether an item is material or not requires the
application of judgement and its relative significance to the user of
financial statements. (1) - The most common examples are directors’ remuneration and related
parties’ disclosures. They may be small in size compared to the
company’s overall net assets or profit but may be material due to its
significance to the users of financial reports. (1)
Describe the advantages and disadvantages of using the accounting rate of return (ARR), for
the purposes of investment appraisal.
Advantages:
- It is widely accepted and very simple to calculate. (1)
- It uses profits which are readily recognised by most managers. (1)
- Managers’ performance may be evaluated using ROCE. (1)
- As profit figures are audited, it can be relied upon to some degree.
(1)
- It focuses profitability for the entire project period. (1)
- It is easy to compare with other projects as it links with other
accounting measures. (1)
Disadvantages:
- It ignores factors such as project life (the longer the project, the
greater the risk), working capital and other economic factors which
may affect the profitability of the project. (1)
- It is based on accounting profits that vary depending on accounting
policies (such as depreciation policy). (1)
- It does not consider the time value of money. (1)
- It can be calculated using different formulas. For example, ARR can
be calculated using profit after tax and interest, or profit before tax
thus leading to different outcomes. It is important to ensure that ARR
are calculated on a consistent basis when comparing investments.
(1)
- It is not useful for evaluating projects where investment is made in
parts at different times. (1)
- It does not consider any profits that are reinvested during the project
period. (1)
Outline three barriers which make it difficult for global harmonisation of UK GAAP and IFRS.
- Legal system (1): this affects the accounting standardisation process –
such as whether the legal system is based on common law or code law.
The differences in the legal system can restrict the development of
certain accounting practices. (1) - Business financing and accounting practices (1): decision making
processes regarding arrangement of funds may include accounting
practices. Many countries do not have strong independent accountancy
or business bodies which would press for higher standards and greater
harmonisation. (1) - Tax system (1): a country’s tax system is very influential, particularly in
terms of its connection with accounting. In most countries, tax
authorities may influence the accounting rules around recording of
revenues and expenses. (1) - Level of inflation (1): this is likely to influence valuation methods for
various types of assets. (1) - Political and economic relationships (1): while Commonwealth
countries may share similarities in their accounting and tax systems,
cultural differences may still result in accounting systems differing from
country to country. In addition, developing countries may have less
developed standards and principles, although this is not always the
case. Some countries may be experiencing unusual circumstances (civil war, currency restrictions) which affect all aspects of everyday life.
Others yet may resist the adoption of ‘another country’s standard’ for
nationalism reasons. (1)
