Semester 1 Flashcards
International Financial Reporting Standards
(IFRS)
- International Accounting Standards Board (IASB)
- Detailed rules
- Valuation, presentation and disclosure
- Narrow the areas of difference & variety of accounting practice
- Consistency & comparability of financial reporting
who is interest in financial statement
- investors /shareholders/analysts
-government - HMRC
-banks
-competitors
-Employees (unions)
-suppliers
-customers
-General public
Require info in respect of 3 key areas
Profitability
-is the company making sufficient levels of profit
-statement of profit or loss
Solvency
-ability for a company to pay there debts
-how much risk and debt is there
-Statement of financial position (balance sheet)
Are be able to generate the cash needed ?
-Statement of cash flows
Statement of financial position
Assets (x)
Equity
Liabilities
Statement of profit or loss
revenue (X)
Less expenses
Profit
statement of cash flows
Cash flows from operate g activities
Cash flows from investing activities
Cash flows from financing activities
Net Increase / (decrease in cash)
Asset
Resource we control with the potential to bring in profits
Non current assets
Kept and used on a permanent basis
> 1 year from accounting date
-Land / buildings
-Plant / machinery
-Fixtures / fittings
-motor vehicles
(in order of liquidity )
current assets
< 1 year
change day to day
-Inventories
-trade receivables (customers owe business money)
-cash
Liquidity
quickly can be converted to cash
liabilities
Obligations a business owes money to someone
non current liabilities
> 1 year
Bank loan
current liabilities
< 1 year
Qualities of Useful Information
These are theoretical principles that underpin the preparation of financial statements. They are stated in the International Accounting Standards Board (IASB) Conceptual Framework for Financial Reporting.
RELEVANCE
Accounting information should make a difference, i.e., it should be capable of influencing the decisions of users. To do this, it must help to predict future events, (such as next year’s profit), or help to confirm past events (such as establishing last year’s profit) or do both.
To be relevant, accounting information must cross a threshold of materiality.
MATERIALITY
An item of information is considered material, or significant, if its omission or misstatement would alter the decision that users make. If the information is not material, it should not be included in the financial statements. It will merely clutter them up and perhaps interfere with the users’ ability to interpret them.
It may be possible to disregard the proper accounting treatment of items where they are deemed to be immaterial. For example, low-cost non-current assets may be charged as expenses to the statement of profit or loss rather than to the statement of financial position and depreciated
FAITHFUL REPRESENTATION
Accounting information should represent what it is supposed to represent. It should therefore be complete, by providing all the information needed to understand what is being portrayed. It should also be neutral, which means that the information should be presented and selected without bias. It should also be free from error. This is not the same thing as saying that it must always be perfectly accurate; this is not really possible. For example, estimates may have to be made which eventually turn out to be inaccurate. It does mean, however, that there should be no errors in the way in which these estimates have been prepared and described.
Relevance and faithful representation are known as the two FUNDAMENTAL characteristics/qualities of accounting information.
COMPARABILITY
Users of accounting information often want to make comparisons. They may want to compare the performance of business over time (for example, they may want to compare profit this year with that of last year). They may also want to compare certain aspects of business performance (such as levels of sales) to those of similar businesses. Better comparisons can be made where the accounting system treats items that are basically the same in the same way and where policies for measuring and presenting accounting information are made clear.
A business should use the same accounting methods from one year to the next, and changes to policies are only permitted where valid reasons can be provided.
For example, you must use the same methods of depreciation (see next lecture) from one year to the next. Consistency of treatment will enable comparisons to be made between the financial statements of different years.
VERIFIABILITY
This quality provides assurance to users that the accounting information provided faithfully represents what it is supposed to represent. Accounting information is verifiable where different, independent experts would be able to agree that it provides a faithful portrayal. Verifiable information tends to be supported by evidence.
TIMELINESS
Accounting information should be produced in time for users to make their decisions. A lack of timeliness will undermine the usefulness of the information. Normally, the later accounting information is produced. The less useful it becomes.
UNDERSTANDABILITY
Accounting information should be set out as clearly and concisely as possible. It should be understood by those at whom the information is aimed.
ACCOUNTING CONVENTIONS
Accounting has a number of rules or conventions that have evolved over time. They have evolved as attempts to deal with practical problems experienced by preparers and users of financial statements, rather than to reflect some theoretical ideal.
BUSINESS ENTITY
An owner and the business are separate entities, the owner’s personal affairs should not be included in the business accounts.
HISTORICAL COST
Resources acquired by the business are recorded at their original purchase price.
prudence
Cautious never overstate good things assets, never understate bad things liabilities. Don’t want to inflate accounts
When assembling accounts, the preparer should always err on the side of caution when making judgements in relation to any estimates that are required when faced with uncertainty, such that assets or income are not overstated, and liabilities and expenses are not understated. Profits should not be anticipated and should only be recognised when they can be measured reliably.
GOING CONCERN
Financial statements are normally prepared on a going concern basis.
The financial statements should be prepared on the assumption that the business will continue operations for the foreseeable future (at least a year from the accounting date), unless there is evidence to the contrary. If the business is to be discontinued, non-current assets and non-current liabilities would need to be reclassified as current, and the values at which assets are shown in the statement of financial position would also need to be assessed.
MONEY MEASUREMENT
Financial statements only include assets which can be measured reliably in monetary terms; items such as good customer reputation and well-trained staff are excluded on the grounds that they are difficult to value, and their inclusion would only serve to reduce the reliability of the statements.
ACCRUALS/MATCHING
Expenses should be included in the statement of profit or loss in the period to which they relate and matched with the revenue they help to generate.
Applying this convention means that an expense reported in the statement of profit or loss for a period may not be the same as the cash paid for that item during the period.
VALUATION OF INVENTORIES
The unsold inventories held at the end of the year may have fallen in value, so they are worth less than their cost.
Goods may have deteriorated, been damaged or become obsolete.
The market price may have fallen, e.g. in the fashion industry, or the product may be a loss leader.
Inventories should be valued at the lower of cost and net realisable value.
Net realisable value
= expected selling price – expected selling costs
RECOGNISING REVENUE
The point at which revenue (a sale) is recognised could have a significant impact on reported revenues, and ultimately profit, for the accounting period.
DEPRECIATION
Most non-current assets fall value over time. This could be from wear and tear, use, the passage of time or obsolescence.
RECOGNISING REVENUE at what point ?
Indicators
- Legal title passes
- Physical possession passes to customer
- If customer accepts goods
- Business can demand payment for the goods
- Risks and rewards are transferred
THE DIFFERENCE BETWEEN PROFIT AND CASH
Profit does not always give a useful or meaningful picture of a business’s operations. In fact, it could even mislead the users of financial statements.
Functions of the statement of cash flows:
- It shows all the cash coming in and all the cash going out under 3 standard headings, so users can easily identify any major movements of cash.
- It helps users to predict what cash flows will be like in the future.
E.g. investment in plant & machinery v the payment of a dividend - It allows users to assess the quality of the profit showing in the statement of profit or loss.
Return on capital employed (X%) =
Return on capital employed (X%) = operating profit / (total equity + non-current liabilities) x 100
Operating profit percentage (X%) =
Operating profit percentage (X%) = operating profit / revenue x 100
Gross profit percentage (X%) =
Gross profit percentage (X%) = gross profit / revenue x 100
Current ratio (X:1) =
Current ratio (X:1) = current assets / current liabilities
Acid test ratio (X:1) =
Acid test ratio (X:1) = (current assets – inventories) / current liabilities
Inventory holding period (X days) =
Inventory holding period (X days) = inventories / cost of sales x 365
Trade receivables collection period (X days) =
Trade receivables collection period (X days) = trade receivables / revenue x 365
Trade payables payment period (X days) =
Trade payables payment period (X days) = trade payables / cost of sales x 365
Asset turnover (£X) =
Asset turnover (£X) = revenue / total assets
Interest cover (X times) =
Interest cover (X times) = operating profit / finance costs
Gearing (X%) =
Gearing (X%) = non-current liabilities / (total equity + non-current liabilities) x 100
Accounting rate of return (initial method)
= average annual accounting profit / initial cost of the investment to earn that profit x 100
Money/Nominal rate
1 + Money rate = (1 + real rate) x (1 + inflation rate)
Profitability index (PI) =
Profitability index (PI) = NPV / cost
Internal rate of return
IRR = ra + NPVa /(NPVa – NPVb) X (rb -ra)
ra = lower discount rate chosen
rb = higher discount rate chosen
NPVa = NPV at lower discount rate
NPVb = NPV at higher discount rate
Working capital cycle (X days)
= inventory holding period + trade receivables collection period – trade payables payment period.
Economic Order Quantity (EOQ) =
Economic Order Quantity (EOQ) = √ 2CoD / Ch
C0 = the costs of ordering a consignment of inventory
Ch = the cost of holding one unit of inventory for one year
D = the annual demand
