Week 6 - Preparing Income Statement

Question 1

What is inventory costing?

Answer 1

Where a firm determines the cost of goods sold during the period and the cost of goods remaining at the end of the period.

Question 2

What are the three most common methods of costing inventories?

Answer 2

First In First Out (FIFO) - goods bought first are sold first
AVCO (weighted average cost) - weighted average cost of the inventory held (after inventory acquisition takes place)
Last In Last Out (LILO) - Goods bought last are sold first (not allowed under IFRS)

Question 3

What is an intangible asset?

Answer 3

An identifiable non-monetary asset without physical substance.

Question 4

What are the characteristics of an intangible asset?

Answer 4

1. Identifiable - and it is so if it is either:
   * Separable - capable of being separated and sold, licences, transferred, exchanged or rented separately, without selling the whole business
   or
   * Arises from contractual or other legal rights
   Must also fulfill the recognition criteria for an asset
2. Control
3. Economic Benefits
4. For any item to be recognised in financial statements, its cost or value must be measurable with sufficient reliability.

Question 5

How may a firm acquire an intangible asset?

Answer 5

1. Separate acquisition
2. Acquisition as part of a business
3. Internally generated intangibles

Question 6

What is meant by separate acquisition and what may it be used for?

Answer 6

This is when the cost can be measured and so measured=price paid. It is identifiable, since it could be bought/sold. The purchase transaction suggests that there is an indication future economic benefits are probable. The purchaser now has control over the asset.

Question 7

What is meant by acquisition as part of a business and what may it be used for?

Answer 7

This is when a firm buys another firm and the intangible assets owned by the firm that is purchased are now owned by the purchasers. When a company buys another company and they produce a combined balance sheet, they have to include intangible assets (like brand names or customer lists) in the balance sheet, even if the company they bought didn’t recognise these intangibles in their separate balance sheet. Trademarks / brands are recorded as intangible assets ONLY if they are purchased.
Used to acquire an intangible asset.

Question 8

What are internally generated intangibles and what may they be used for?

Answer 8

Only recognised if their cost can be reliably measured and probable that expected future benefits will flow into the business. This can be difficult if the intangible assets are internally generated.
For research and development Research phase costs shall be expensed (since at this stage its difficult to demonstrate that further economic benefits will flow).
Development phase costs are capitalised provided that certain criteria’s are met.
Used to acquire an intangible asset.

Question 9

How are intangible assets subsequently measured (two methods) and under which conditions would you pick which one?

Answer 9

Cost: Identical to PPE: an intangible asset should be carried at its cost less any accumulated amortisation and any accumulated impairment losses.

Revaluation Model: The model can only be applied if there is an active market for that type of intangible asset

Question 10

How are intangible assets amortalised (two methods) and under which conditions would you pick the one to use?

Answer 10

If asset has a finite life: ▪ Amortise the asset over its useful economic life
▪ Residual value is presumed zero
unless someone has agreed to buy it or there is an active second-hand
market

If asset has an indefinite UEL: ▪ Do not amortise, instead perform an
annual impairment review

Question 11

How would owners equity in a sole trader be calculated?

Answer 11

Capital introduced + Profit - Drawings

Question 12

How would owners equity be shared in partnerships?

Answer 12

They will have a partnership agreement which will include how partners will share profits and losses. The law will assume that net income is to be divided among the partners proportionately to the capital contributed.
The partners receive:
A) a stated salary, or a stated percentage of interest on the capital contributed, or a combination of both
B) a stated share of residual profit after salaries

Question 13

Owners equity in limited corporations?

Answer 13

In this order
Share capital
Share premium
Retained earnings

Question 14

What is the nominal (par) value of shares?

Answer 14

Value of shares determined at IPO

Question 15

What are ordinary shares?

Answer 15

The basic unit of ownership.

Question 16

How is share premium calculated and what is it?

Answer 16

▪ The price of a share differs from
its nominal value afterwards
▪ At subsequent offerings shares
are sold at market value
▪ Difference between market value
and nominal value at the time of
issue =share premium

Question 17

What are the characteristics of ordinary shares?

Answer 17

• Basic form of finance
• If the business closes down, the ordinary shareholders receive proceeds
  after lenders, creditors and preference shareholders
• Ordinary shareholders have voting rights
• Ordinary shareholders benefit from dividends and appreciation of
  share market price

HIGH RISK HIGH RETURN

Question 18

What are preference shares and their characteristics?

Answer 18

▪ Fixed rate of dividend each year
▪ Preference dividends are paid before ordinary dividends
▪ Where a business is closed down, preference shareholders have priority
over the claims of ordinary shareholders
▪ Preference shares do not have voting rights
SUMMARY: LOW RISK, LOW RETURN

Question 19

What are revenue (distributable) reserves?

Answer 19

Retained earnings: increase through profits and decrease when earnings are distributed to shareholders or when the entity makes losses. Retained for
reinvestment.

Question 20

What are dividends?

Answer 20

Dividends represent drawings by the shareholders of the company

Question 21

What are the two types of dividends?

Answer 21

Interim dividend and final dividends

Question 22

What is an interim dividend?

Answer 22

An interim dividend is paid halfway through the accounting year, when the profit for the first six months is known. The amount is decided by the directors.

Question 23

What is a final dividend?

Answer 23

An interim dividend is paid halfway through the accounting year, when the profit for the first six months is known. The amount is decided by the directors.

Question 24

How would you record a dividend in a double entry?

Answer 24

Interim dividend declared
Dr Dividends payable (current liability, SOFP)
Cr Bank

Interim dividend paid
Dr Dividends*
Cr Dividends payable (current liability, SOFP)

Question 25

How are retained earnings calculated?

Answer 25

RE end = RE beg +net profit (IS) - dividends

Question 26

How is corporation tax payable calculated?

Answer 26

Profit before tax + non deductible expenses - non taxable income - capital allowances = taxable profit
Taxable profit x Corporation tax rate (%) = Income tax for the year

Question 27

How is corporation tax accounted for in double entry?

Answer 27

Dr Tax expense (IS)
Cr Tax liability (SOFP)

Question 28

What/why is a corporation tax over/under provision used?

Answer 28

▪ Last period’s actual tax paid is likely to have been different from the estimated charge that went through the income statement
▪ The difference needs to be included in this period’s tax charge, either as an extra charge (if the tax paid was higher than the charge to the last period’s income statement) or as a reduction (if the tax paid was lower)
▪ This ensures that the whole tax bill hits retained profits at some
point.

Question 29

What formula is used to account for over/under provision?

Answer 29

Current years tax estimate +/- prior years under/(over) provision = current years tax expense