Regulatory Framework/Role of professional judgement Flashcards
What is the income statement?
Entity’s ability to earn a profit
What is the balance sheet?
About the financial position of an entity at a given time
What is the equation of the income statement to calculate profit/loss?
Income - expenses = profit/loss
What is profit also known as?
Earnings
What does the balance sheet show?(3)
Assets
Liabilities
Equity
How are the assets funded?
Using equity and liabilities
What is equity?
What is it made up of and how do these effect equity?
The owner’s stake within the company.
Made up of:
- Capital from owner/share capital (increase equity)
- Drawings/dividends (decrease equity)
- Retained earnings/reserves (increases equity)
What does equity equal in terms or assets and liabilities?
E = A - L
What is profit measured on ad what does this mean?
Measured on the accrual basis.
Income and expenses are recognised as they occur, not when the cash is received or paid.
What is net cash position?
Cash position = Cash receipts - Cash payments
What do you exclude when calculating net cash payments?
Accruals
What is cash?
Cash is a resource of the business and is seen as an asset
What are the advantages of measuring profit in an accrual basis rather than cash basis?(1)
- Recognising revenue and expenses when they are earned or incurred is more accurate
What are the disadvantages of measuring profit on an accrual basis rather than a cash basis?(2)
- The accrual process is more complex
- More judgement involved when determining the timing of things
What sort of company might prefer measuring profit through cash?
Small companies
What is a conceptual framework?
A set of ideas and principles that can be used to establish specific guidelines and/or guide specific decisions
What is the name of the conceptual framework in Financial Reporting?
IASB = International Accounting Standards Board
What are accounting standards?
What is the difference between this and the conceptual framework?
Specific principles and/or rules on particular areas.
Conceptual framework are broad principles and sets boundaries.
What are the benefits of having a conceptual framework? (2)
Provides some protection from political interference in accounting standard setup.
Guides financial statement preparers in accounting for difficult issues not yet covered by existing accounting standards.
Who is the regulator for accountants, auditors and actuaries?
The Financial Reporting Council (FRC)
What does GAAP stand for?
Summarise what it means?
Generally Accepted Accounting Principles
The frameworks of different regions and nations
Since 2005, what has been mandatory for companies listed in the EU?
To prepare their accounts using International Financial Reporting Standards (IFRS)
What standards do the US use?
What is different about this?
GAAP
Very different to IFRS, unlike the UK GAAP
What was the IFR formally known as?
International Accounting Standards (IAS)
What are the pros of international standards?
- Improve comparability across companies
- One common business language
- Opens up more investment and trade opportunities- firms raise funds across the border
What are the cons of international standards?
- Costly to convert from local GAAP to IRFS
- Reliance on IFRS expertise from developed nations at the expense of local accounting talent
- May not be well suited to country/culture specific transactions
What is IFRS based on?
The broad principles outlined in the Conceptual Framework- not based on rules, but principles
What do principles rather than rules allow for?
Professional judgement
What is the Net realisable value (NRV)?
The estimated selling price in the ordinary course of the business less the estimated costs of completion and the estimated costs necessary
What is an example in accounting when professional judgment is necessary?
Why is it important that this is done professionally?
Inventories
Effects the year-end profit and assets
What can create a distortion of economic reality of the entity?
The judgments and choices made in the accounts can serve the
interest of the preparers rather than the users
What is an example of an area of professional judgement within accounting?
Provisions- represent liabilities of uncertain timing or amount
According to IAS 37, when should a provision be recognised ?
- There’s a present obligation as a result of past events
- it is probable that a transfer of economic benefits will be required
- a reliable estimate can be made of the amount of the obligation
If a provision does not follow meet the recognition criteria, what happens?
Obligations are disclosed as contingent liabilities off the balance sheet
- Not part of the company’s financial position
How is professional judgement used when determining provisions?
- How probable an obligation is?
- Estimating the amount of the obligation
- Whether and how much to recognise as provision on balance sheet
What is the impact of provisions on the financial statements?
To create/increase a provision:
- Dr relevant expense (e.g bad and doubtful debt)
- Cr provision liability
What is another example of where professional judgement is required?
What is this an example of?
Accounting for research and development expenditure
An intangible asset
Under IAS 38, what is an intangible asset? More specifically, what is said about accounting for research and devolvement expenditure?
Non-monetary assets which are without physical substance and identifiable.
Expenditure on research which
may or may not lead to a
marketable product or service
should be expensed in the
Income Statement in the period
in which it was incurred.
Development expenditure for
which a viable profitable
market is envisaged may be…
Capitalised - recognised as an asset on the balance sheet
When an intangible asset is recognised, what happens?
The recognised intangible has to be amortised on a systematic basis over its estimated useful life
Where is professional judgment involved within accounting for research and development expenditure?
- Judgment in determining the research vs development phase of a project
- Judgment involved in determining the method of amortisation and
estimating the useful life of the intangible
How does an intangible asset effect financial statements?
The ability to capitalise on development expenditure arising from a given R&D project:
* Increases the company’s financial position in the development phase
* Protects the profits in the development phase and defers recognition of the expenditure into the future
What are 4 other examples of professional judgement?
- Bringing forward or deferring the recognition of revenue and/or expenses
- Depreciation of Property Plant and - Equipment: method, estimated useful life
- Inventory valuation: whether to write down to NRV depends on judgment on condition and saleability
- Impairment of non-current assets
Where can you see what judgements have been made?
The annual report
