Week 4

Question 1

What is a financial instrument according to IAS 32 ?

Answer 1

IAS 32 defines a financial instrument to be any contract that gives rise to a financial asset of one entity and a financial liability of another entity.

It is a piece of paper that results in one equity providing finance to another.

e.g. share certificate, loan agreement.

Question 2

What are examples of financial assets?

Answer 2

Cash
A contractual right to receive cash or another financial asset from another entity
A contractual right to exchange financial assets/ liabilities with another entity under favourable conditions
An equity instrument of another entity
Trade receivables
Options
Investment in equity shares

Question 3

What are examples of financial liabilities?

Answer 3

To deliver cash or another financial asset to another entity.
A contractual right to exchange financial assets/ liabilities with another entity under unfavourable conditions.
Trade payables
Debenture loans
Redeemable preference shares

Question 4

How do you distinguish between debt and equity?

Answer 4

When raising finance the instrument must be correctly classified as either a financial liability (debt) or an equity instrument (shares).

When raising finance the instrument issued will be a financial liability, opposed to being an equity instrument where is contains an obligation to repay.

Question 5

What are capital markets?

Answer 5

Capital markets are markets for trading in long-term finance, trade instruments such as equities and debentures.
E.g. stock exchange and the AIM.

*Long-term capital = capital invested for a long period of 5 years or more.

Question 6

What is the purpose of capital markets?

Answer 6

They enable organisations to raise new finance (by issuing shares)

They enable existing investors to sell their investments.

Question 7

What are the main capital markets in the UK?

Answer 7

The stock exchange
Alternative Investment Market
Banks

Question 8

What is the London Stock Exchange?

Answer 8

The London Stock Exchange is a system which allows people who want to sell shares and people who want to buy them to connect.

Question 9

What is the stock exchange?

Answer 9

It is a primary capital market in which companies and other institutions can raise funds by issuing shares or loan stock.

Question 10

What are secondary markets?

Answer 10

They allow existing equity shares and debt to be traded.

Main capital market = London Stock Exchange

Question 11

What is the London Stock Exchanges official list - main market?

Answer 11

They are normally large companies. At least 25%- of shares owned by the public.
There are special rules for innovative, high growth companies.

Question 12

What is the FTSE 100?

Answer 12

Financial Times Stock Exchange.

This is the 100 companies that have the largest value on the stock market, most people buy and sell shares within these.

Question 13

What are some other FTSE examples?

Answer 13

FTSE 250 = 101st to the 350th largest companies within the UK.

FTSE SmallCap = companies outside of the FTSE 350 index.

FTSE All-Share = the aggregation of the FTSE 100, FTSE 250 and FTSE Small Cap indices.

Question 14

What are the characteristics of AIM?

Answer 14

Lower level of regulation
Fewer requirements
Suitable for young, fast growing businesses, family owned companies

Question 15

What examples are there of equity in FNST?

Answer 15

Share capital
Share premium
Reserves
Retained earnings

Question 16

What is share capital ?

Answer 16

Capital invested in a company by its owners.
When a company is formed, it issues shares which are purchased by investors.

Shares have a nominal value and a market value.
Nominal value = decided when shares are issued, this value is in the financial statements.

Market value = value at which traded on stock exchange, irrelevant to financial statements.

Question 17

What are the 2 types of reserves?

Answer 17

Revenue reserves =
Arise from operating activities
Realised profit
Available for distribution to shareholders
Not usually kept for long term

Capital reserves =
Arise from non operating activities
Can be unrealised profits
Not available for distribution to shareholders
Usually kept for long term investments

Question 18

What reserves are distributable and non distributable?

Answer 18

Revenue distributable = retained earnings

Capital non-distributable = share premium and revaluation reserve

Question 19

What are the two types of shares issued?

Answer 19

Ordinary shares =
commonly issued
often referred to as equity shares
take share of profits (dividend)
carry main risks
usually carry voting rights

Preference shares =
shares that carry a fixed rate of dividend
paid in preference to ordinary share holders
usually no voting rights

Question 20

What are the types of preference shares?

Answer 20

Cumulative = if the company fails to pay a dividend on the preference share, it is carried forward for payment to the following year.

Non-cumulative = if the company does not pay the preference dividend, the preference shareholder loses the dividend payment for that year.

Participating = extra dividend above the fixed return if the company profits reach a certain prescribed level.

Redeemable = dated preference shares that the company will repay the capital on the set date

Convertible = preference shares that may convert to ordinary shares if the share price reaches a certain specified level

Question 21

What is the journal entry for share capital?

Answer 21

Debit = cash (amount of authorised share capital)

Credit = share capital

When an entity issues shares they may incur costs (prof fees) IAS 32 requires these costs to be deducted from equity and charged to share premium.

Question 22

What is the share premium account of a company?

Answer 22

The capital that a company raises upon issuing shares that is in excess of the nominal value of the shares.

Question 23

How can companies raise finance?

Answer 23

Rights issues of shares to existing shareholders (called pre-emption rights)

Public issue of shares to general public (only if public company)

Private placings of shares to specific investors

Question 24

What are rights issues of shares?

Answer 24

Shares offered to existing shareholders in proportion to their existing holding.
Offered at a discount to existing share price to encourage take up.

Question 25

How does ISA 12 define current tax?

Answer 25

IAS 12 defines current tax as the amount of income taxes payable (recoverable) in respect of the taxable profit (taxable loss) for a period.

Question 26

How is current tax recorded in the journal?

Answer 26

Debit = tax charge (income statement)

Credit = Tax liability (SOFP)

Question 27

How is current tax recorded in the FNST?

Answer 27

The amount of current tax for an accounting period should be recognised as an expense.

Any underestimates or overestimates of current tax in PREVIOUS periods should be included in the tax expense for the CURRENT period.

Current tax from other comprehensive income should be recognised in other comprehensive income.

The amount of any current tax unpaid at the end of the period should be recognised as a liability.

Question 28

How is taxation recorded in the income statement?

Answer 28

Tax charges in the IS will consist of three items:

An estimate of the corporation tax payable on the profit for the CURRENT accounting period.

An adjustment for the PREVIOUS period consisting of an estimate of tax (DR or CR depending on under or over estimate)

An adjustment to the provision for deferred tax (DR or CR depending on whether the provision needs to be increased or decreased)

Question 29

How is taxation recorded in the SOFP?

Answer 29

Current liabilities = corp. tax currently due on this and previous periods profits, less any refunds due.

Provisions = deferred corp. tax on the current and previous periods accounts profits that is not immediately payable due to the various tax allowances the business can claim.

Deferred tax asset = this arises when the accounts profit is less than the taxable profit.

Question 30

What is deferred tax?

Answer 30

When companies incur tax but don’t pay it straight away.

Question 31

What does IAS 12 require for tax bases?

Answer 31

IAS 12 requires that the tax base of each asset and liability at the end of the carrying amount should be compared with its carrying amount (the amount at which it is carried or shown in the financial statements).

Question 32

What is a tax base?

Answer 32

The tax base of an asset or liability is defined as the amount attributed/ assumed to that asset or liability for tax purposes.

Question 33

What is temporary difference?

Answer 33

When the tax base of an asset or liability is not the same as its carrying amount.

A deferred tax adjustment is required when this occurs.

Question 34

How do you calculate a tax base?

Answer 34

Purchase price - accumulative depreciation

Question 35

How do you calculate a deferred tax liability?

Answer 35

The difference between the tax base and the carrying amount.
Then multiply by the current tax rate.

Question 36

What are the journal entries for estimated tax?

Answer 36

DR = tax expenses
CR = tax liability

Question 37

What is the journal for adding underestimated tax ?

Answer 37

DR = tax expense
CR = tax liability

Question 38

What is the journal for subtracting overestimated tax?

Answer 38

DR = tax liability
CR = tax expense

Question 39

What is the journal for deferred tax increasing?

Answer 39

DR = tax expense
CR = provision for deferred tax

Question 40

What is the journal entry for deferred tax decreasing?

Answer 40

DR = provision for deferred tax
CR = tax expense

Question 41

When is deferred tax an asset?

Answer 41

When accounting profit is less than taxable profit.

Question 42

When is deferred tax a liability?

Answer 42

When accounting profit is more than taxable profit.