Semester 1 Week 5 Tutorial 3 Flashcards
The Nowak Partnership is a firm of joiners run by Agata and Karol Nowak, who are the only two partners. There is no significant bank debt or any other outside interest.
Is the Nowak partnership required to file accounts with any external body?
Why?
The Nowak partnership is not required to file accounts with any party because essentially no one is relying on the accounts. Nowak has no external shareholders or lenders and the partners are personally responsible for any debt. There is therefore no need for any other party to know Nowak’s financial position.
Please note Nowak will still be required to provide some financial information to HMRC for tax purposes.
Hiflux Ltd. (‘Hiflux’) is a manufacturer of electronic components and is based in the town of Newton, where it is a large employer. Hiflux supplies several large customers throughout Scotland and Northern England on long term contracts.
Hiflux is supplied by a number of local and international companies and has an overdraft and term loan with Scotland Bank.
Outline who would be interested in the accounts of Hiflux and the potential consequences if they were incorrect.
Interested parties and potential consequences of incorrect accounts.
Employees – could continue/take employment based on incorrect understanding of company’s position.
Suppliers – could have problems if key customer goes out of business, need to judge ability of company to stay in business.
Customers – could have difficulties if a key supplier goes out of business suddenly – who would fulfil their needs?
Local community/government – potential impact of large employer going out of business.
Bank – could lend to a company unable to actually pay them back.
Shareholders – could lose money if company goes out of business.
Note this is not a fully exhaustive list.
Outline the objectives of the Conceptual Framework for Financial Reporting.
The objectives of financial reporting are:
Stewardship – good financial reporting allows users to judge how well the managers of a company are doing in managing the company.
Decision making – good financial reporting allows users to make informed decisions about the company.
Outline the qualitative characteristics of financial reporting and why they are important.
The qualitative characteristics of financial reporting are relevance, materiality and faithful representation.
Relevance means that the information in the financial statements must be capable of affecting a user’s decision; this can be predicative of confirmatory. Predicative means the information is capable of allowing the user to be able to forecast future events, whereas confirmatory means that it is capable of confirming or denying the user’s expectation in a certain area.
Faithful representation means that the financial information must accurately reflect the situation. This means that the information is complete, neutral and free from error. Complete means that none of the information which would be required by users is missing, neutral means that there is not a “spin” or bias put on the information, and free from error means that (as far as possible) the information is free from any error.
Materiality means that the financial statements should include all information which could impact upon a user’s decision (but small adjustments which would have negligible impacts are not necessary to be included).
Bradford Plc. built an office building in 1990 for £65,000. It is estimated that to build the same building today would cost £100,000. Were the building to be sold on the open market a surveyor estimates that it would sell for £130,000 but that there would be selling costs of £3,000 associated with the sale. If the building were to be rented for the remainder of its useful life it would bring in an inflation adjusted amount of £125,000.
Outline the measurement bases used in the conceptual framework and identify the value of the building under each.
The historic cost or original cost of the building is £65,000.
The current cost of the building is the cost as if the building was built today this is £100,000.
The realisable value is how much the building would sell for on the open market; £130,000. The net realisable value is after taking into account any appropriate selling costs so £127,000.
The present value is the value of the cashflows the asset would bring in, adjusted for inflation in this case £125,000.
Give examples of level one, level two and level three inputs for determining fair value.
Level one inputs, an open market value of an identical asset: The quoted price of a traded share.
Level two inputs, an open market valuation of a similar asset: A surveyor’s estimate of how much a building would sell for taking into account their knowledge of the current market.
Level three inputs, an internally based calculation: A company’s own internal model of how much an asset is worth.
Download this document https://www.ifrs.org/-/media/project/disclosure-initative/better-communication-making-disclosures-more-meaningful.pdf?la=en&hash=801789DBF05F1AF50CA3E1701060E7A612A037CF and read case study 1.
Outline your thoughts on the effectiveness of financial reporting.
Currently a lot of academic research is being undertaken on financial reporting. What do you think this research adds to the debate? Is it a good use of research time?
On the case study I would expect you to discuss:
* How the adoption of these standards made the financial statements much more useful for users. It gave them more of the information they needed, less superfluous information and made the information provided easier to read and understand – it’s useful to draw students attention to page 13 note 6 where the information on the dividends is much easier to see and understand.
* It’s also important to draw to student’s attention that useful and correct application of the standards is helpful to management also. If financial reporting is done with an aim very much of “box-ticking” and following rules it is likely that management will spend a large amount of time preparing information that nobody will really read. Correct and appropriate application of financial reporting standards will mean that management spend their time concentrating on what users want to see leading to a more effective application of financial reporting.
The academic study may be more difficult to initially explain, emphasise to students that:
- Financial reporting standards are written for a reason, either because the reporting of something is inaccurate, because there’s a problem with how something is measured or reported, or there is insufficient guidance on how something is dealt with.
- Academic studies and research can help us understand WHAT a problem is and WHY it is a problem.
- Academic research can then help determine approaches to this problem, how could we measure, treat or interpret something more accurately? What are the various possible treatments and what is the benefit of each?
- This can feed into the creation of new standards.
- Academic study can then investigate how the new standards are being applied, what are the benefits of the new standard? Is it actually solving the problem? Are there any unforeseen issues which have arisen?
Outline some of the limitations of financial reporting.
Financial reporting is primarily backwards looking, it has limited use in giving the current or future position of an entity.
Some things (e.g. creativity, public perception) are very difficult to represent in a set of financial statements.
The “real” value of something and the accounting value can be quite different.
Financial reporting often ignores the non-financial impacts of certain items.
