Weak Areas Flashcards
What are the constituent elements of financial statements?
1 Assets 2 Liabilities 3 Expenses 4 Income 5 Equity
What is an asset?
A present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits
What is a liability?
A present obligation of the entity to transfer an economic resource as a result of past events. An obligation is a duty or responsibility that the entity has no practical ability to avoid.
What is an expense?
Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims
What is income?
Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.
What is equity?
The net assets of an enterprise after all other creditors have been paid off.
Why might IASs help reduce borrowing costs? (2 reasons)
- A single set of standards used by a multi-national company reduces audit costs
- Potentially easier to borrow on the international money market as lenders may have a better understanding of the accounting principles used.
IAS2 manages Inventories. What rules must be followed when valuing closing inventories?
- Valued at the Lower of cost price or net realisable value
- Costs may include:
a. Inventory Price
b. Local taxes
c. Delivery
d. Conversions costs
e. Manufacturing Overhead - LIFO is not to be used
What is the five-step model for recognition of revenue according to IFRS15?
- Identification of contracts with customers
- To identify the obligations contained within the contract
- To determine the transaction price
- Match the transaction price to the performance obligations contained within the contract
- When the performance obligation is satisfied revenue can be recognised
When may a company change its accounting policy?
a. Change in the Law
b. Change in Accounting Standards
c. The change in policy will result in a truer and fairer picture of the affairs of the business.
How are retained profits calculated within the statements of financial position?
Profit after tax for current period + profit after tax for the previous period - dividends paid.
How are fundamental qualitative characteristics introduced in the IASB Conceptual Framework?
“For information to be useful it must both be relevant and provide a faithful representation of what it
purports to represent. Relevance and faithful representation are the fundamental qualitative
characteristics of useful financial information, and the guiding concepts that apply throughout the
revised Conceptual Framework”
What items comprise a complete set of financial statements?
statement of financial position statement of profit and loss and other comprehensive income statement of changes in equity statement of cash flows notes to the financial statements
What is the typical order of items in the Statement of Financial Position?
(usually given as current and previous reporting period in two columns)
ASSETS
Non-current assets
Property Plant & Equipment
Goodwill
Other Intangible Assets
Investments
Current Assets Inventories Trade receivables Cash and cash equivalents
TOTAL ASSETS
EQUITY & LIABILITIES
Equity
Share capital
Retained earnings
Revaluation reserve
TOTAL EQUITY
Non-current liabilities Long-term borrowings Deferred tax Long-term provisions TOTAL NON-CURRENT LIABILITIES
Current liabilities Trade and other payables Short-term borrowings Current portion of long-term borrowings Current tax payable Total current liabilities Total liabilities TOTAL EQUITY AND LIABILITIES
What is the typical order of items in the Statement of Profit or Loss and Other Comprehensive Income?
(usually given as current and previous reporting period in two columns)
INCOME FROM CONTINUING OPERATIONS
Revenue
Cost of sales
GROSS PROFIT
Distribution costs
Administrative expenses
PROFIT FROM OPERATIONS
Investment income
Finance costs
Other expenses
PROFIT BEFORE TAX
Income tax
PROFIT FOR THE YEAR FROM CONTINUING OPERATIONS
DISCONTINUED OPERATIONS
Loss for the period from discontinued operations
OTHER COMPREHENSIVE INCOME
Gain/loss on revaluation
TOTAL COMPREHENSIVE INCOME
What is the typical order of items in the Statement of Changes in Equity?
Split into four columns (for just the current reporting period) with the following titles: 1 Share capital 2 Retained earnings 3 Other reserves 4 Total equity
Balance at 01/01/20X1
Changes to accounting policy/error corrections
RESTATED BALANCE:
CHANGES IN EQUITY FOR YEAR 20X1 Issue of share capital Profit for the year from continuing ops Loss for year from discontinued ops Other comprehensive income (e.g. revaluation) Dividends
BALANCE AT 31/12/20X1:
What is the typical order of items in the Statement of Cash Flows using the DIRECT METHOD?
(usually given as only current reporting period in two columns - one for items, one for totals)
CASH FLOWS FROM OPERATING ACTIVITIES Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash generated from operations Interest paid Income taxes paid NET CASH FROM OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES Acquisitions (subsidiaries) Purchase of PP&E Proceeds from sale of equipment Interest recieved Dividends received NET CASH USED IN INVESTING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issue of share capital Proceeds from long-term loans Payment of finance lease obligations Dividends paid NET CASH USED IN FINANCE ACTIVITIES
NET INCREASE IN CASH AND EQUIVALENTS
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
CASH AND EQUIVALENTS AT END OF PERIOD
What is the typical order of items in the Statement of Cash Flows using the INDIRECT METHOD?
CASH FLOW FROM OPERATING ACTIVITIES (INDIRECT)
C2: Profit for the period
C2: Add depreciation charges
C2: Less gain on disposal of fixed assets
WORKING CAPITAL CHANGES MOVEMENT IN CURRENT ASSETS C1: Opening inventory C1: Closing inventory C2: Change in inventory C1: Opening trade receivables C1: Closing trade receivables C2: Change in receivables
MOVEMENT IN CURRENT LIABILITIES
C1: Closing payables
C1: Opening payables
C2: Change in payables
C2: CASH GENERATED FRFOM OPS
C2: Tax expense
C2: Tax paid (opening + expense - closing)
C2: NET CASH FROM OPS
CASH FLOWS FROM INVESTING:
C2: Cash from purchase of fixed assets:
C2: Proceeds from disposal of fixed assets
C2: NET CASH FROM INVESTING
CASH FLOWS FROM FINANCING
C2: Issued share capital
C2: Dividends paid
C2: Repayment of loan
C2: NET CASH FROM FINANCING
C2: NET INCREASE IN CASH
C2: CASH AT START OF YEAR
C2: CASH AT END OF YEAR
How is equity accounting (for associated and joint ventures) achieved in the statement of financial position?
1) Account for investment in the associate in non-current assets
2) Add % post-acquisition profit gained in NCA
3) Add proportion of reserves gained to reserves (under equity)
How is goodwill calculated in the statement of financial position (for a subsidiary)?
Investment in sub - (total shares and pre-acq reserves x % interest)
How are reserves calculated in the consolidated SOFP?
Reserves A + Reserves B - pre-acquisition reserves - %NCI
How is NCI calculated in the consolidated SOFP?
Total subsidiary shares + total reserves (including pre-acq) x % NCI
What are the steps in calculating consolidated SOFP?
1) Calculate goodwill and add to NC assets
2) Add all assets and liabilities line by line
3) Calculate reserves, taking into account pre-acquisition and NCI share.
4) Calculate NCI (total shares+reserves x NCI %)
How is ROCE calculated?
operating profit/(average of share capital + reserves + non-current liabilities) x 100
How is return on shareholder’s equity calculated?
profit after tax / average shareholder equity
How are inventory days calculated?
(Average inventory / cost of goods) x 365
How are receivables days calculated?
(average receivables / credit sales) x 365
How is total asset turnover calculated?
sales / average total assets
How is gearing ratio calculated?
(Debt)/(Debt + Equity) x 100
How is interest cover calculated?
profit from ops / finance cost
How is Baumol’s EOQ model calculated?
Q = Sq.root(2UP/S)
Q = optimum cash balance U = annual demand P = fixed costs per transaction S = annual cost for one unit
In the Miller Orr Cash Management Model, how is return point calculated?
return point = lower limit + (spread/3)
In the Miller Orr Cash Management Model, how is spread calculated?
S = 3[(3(transaction cost))variance)/(4(interest rate))]^1/3
In the Miller Orr Cash Management Model, how is upper limit calculated?
upper limit = lower limit + spread
What is a bill of exchange?
A negotiable instrument drawn up by one party to another, whereby the accepting party acknowledges the debt owed either immediately or at a future date, The hold of the bull can use the accepted debt to pay a third party or can discount it (to a bank to pay a debt).
What are the two types of debt factoring?
With recourse / without recourse.
When dealing with convertible debentures, how is conversion ratio calculated?
number of shares / value of debenture. e.g. £100 debenture converted to 50 shares would be 50/100 = £0.5 per share.
What is the step-by-step process for appraisal of projects using NPV with a capital allowance?
- Set out the time horizon of the project, adding an extra year for tax paid in arrears
- Calculate the capital allowance for the investment, on a reducing basis, and apply it to the next year (arrears)
- Calculate the tax payable on the remainder (i.e. investment minus allowance multiplied by tax).
- Carry the remaining cost to be taxed over to the next year (i.e. cost - CA) and repeat for all years.
- Write out the cash flows, and deduct tax payable each year, adding an additional year for tax in arrears.
- Don’t tax the sale of equipment as this will happen in the final year, and tax should only be paid once.
- Apply a discount factor to the final net cash flows to calculate NPV.
What are the conditions for an efficient market?
a. Share prices react quickly to new information
b. Low transaction costs
c. Few restriction on investments
d. No single investor or group of investors can influence the market
e. The value of a security is a true reflection of the value of a company
f. Information about the economy, the company and the market is widely available
Which characteristic was reintroduced by IASB 2018 Conceptual Framework?
Prudence
What assumptions are made by Sharpe and Lintner’s Capital Asset Pricing Model? (CAPM)
- investors are rational and posses full market knowledge
- investors expect greater return for greater risk
- investor portfolios remove unsystematic risk
- borrowing and lending rates are equal
- there are no transaction costs
- markets are perfect and imperfections correct themselves eventually
- RFR = government bond rate
- no taxation or inflation.
What is meant by “substance” of transactions?
The economic benefits or losses or any implications relating to a transaction - i.e transactions must reflect their economic substance rather than their legal form
Give four examples where the substance of transactions is significant.
1 Sale and leaseback arrangements - sale might not be genuine if legal ownership does not change
2 Consignment stock - consignor ships goods to the seller, but the consignor still owns the stock
3 Invoice factoring - a business sells trade receivables but the risk may not be transferred
4 Sale and repurchase agreements - the sale of an asset is made with the intention to buy back later at a higher cost.
How is Return on Capital Employed calculated?
ROCE = (PBT/EQUITY + LIABILITIES) X 100
How is net profit percentage calculated?
(net profit / revenue) x 100
How is interest cover calculated?
profit before finance costs / finance costs
What level of financial gearing is considered “high”?
50%
What are the two man subcategories of equity finance?
Internally generated (retained earnings) Externally generated (share capital)
How is cost of equity calculated?
P = [D(1+g)] / [Ke-g]
Where P = market price of a share D = dividend g = dividend growth rate Ke = cost of equity
How is cost of debt calculated?
Kd = [I(1-t)/Sd
Where Kd = cost of debt I = annual interest t = tax rate Sd = market price of debt
What is the Fisher equation and what does it calculate?
Shows relationship between nominal and real interest rates:
Real discount rate = [(1+nominal rate)/(1+inflation rate)-1]x100
How is price to earnings ratio calculated?
P/E Ratio = market price share / EPS
How is EPS calculated?
EPS = net profit / outstanding shares
How is Gordon’s dividend growth mode calculated?
Growth rate = annual rate of return from investing x proportion of annual earnings retained
How are finance leases accounted for n the SOFP?
Finance Lease agreement which is shown on the Statement of Financial Position.
- Appears as an asset and is subject to depreciation
- Future payments are shown as a liability
- The finance cost and depreciation is shown as an expense
How are operating leases accounted for in the statements?
Operating Leases are treated in the same way as a rental. The agreement is shown as an expense in
the Statement of Profit and Loss but is not reported in the Statement of Financial Position.
What are the main drivers affecting shareholder value?
- tax rate
- profit margin
- growth in sales
- investment in non-current assets
- cost of borrowing
What are some strategies for increasing shareholder value?
- minimise tax payments
- increase profit margin
- reduce borrowing costs
What is economic value added (EVA)?
Alternative to shareholder value analysis Based on the premise that profit should be included deduction of operating profit and finance costs.
How is EVA calculated?
EVA = operation profit - [Opening capital x WACC]
What are the advantages of EVA?
- based on reported accounting profit and will therefore be acceptable to managers and shareholders
- easily calculable
- accounts for cost of capital
What are the disadvantages of EVA?
- ignores time value of money
- does not account for goodwill and other intangibles
- profit can be calculated subjectively
