Ch 9 - Introduction to accounts

Question 1

Why do companies publish accounts annually?

Answer 1

To report back to their SH’s. These accounts show how shareholders’ funds have been used to generate profits.

Question 2

Who are the main users of accounting info? (legitimate)

Answer 2

BLEE
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-Business contacts (i.e customers & suppliers)
-Loan creditors (both ST & LT)
-Equity investors (both actual & potential SH’s)
-Employees

Question 3

What other uses do accounts have?

Answer 3

i) S.E to ensure certain requirements are met
ii) MGNT themselves as a source of info
iii) TAX AUTHORITIES as a starting pt in calculating the tax liability
iv) STOCK ANALYST as a source of fin info
v) CREDIT RATING AGENCIES in order to asses the creditworthiness of a company.

Question 4

Equity investors

Answer 4

-investment decisions require info about profits (including dividend policy) CF’s
-analysts are constantly preparing & updating forecasts of performance. Annual report provides an opportunity to ‘fine tune’ these forecasts.
-existing SH’s require info about transactions authorised by directors for stewardship purposes (accounts designed so that directors & SH’s can hold managers to account)

Question 5

Loan credits

Answer 5

-lending decisions involve the measurement of risk of default. A lender wants to know whether a business can generate sufficient cash to repay any loan
-The lender also wishes to ensure that the business has an adequate asset base to meet its obligations in the event of failure. (loan agreements often contain restrictive covenants which are based on figures from the accounts)E

Question 6

Employees

Answer 6

-are interested in the co’s ability to pay salaries & offer job security. (the accounting info is of limited value for such decisions)

Question 7

Business contacts

Answer 7

Interested in continuity of sales (to customers) & of materials & services (from suppliers). Their interest is, therefore, similar to that of SH’s. (they may also use accounting info to try gain some insight into the company’s pricing & trading policies)

Question 8

Financial statements are also ready by who else?

Answer 8

-government agencies (including tax authorities)
-competitors
-potential predators

Question 9

Regulations governing the preparation of accounts are of 2 types

Answer 9

-those concerning specific disclosures (mainly covered by the national laws & stock exchange rules)
-those concerning the manner in which items should be valued (mainly covered by professional standards & conventions)

Question 10

What statements/reports must companies produce?

Answer 10

i) statement of financial position (balance sheet)
ii) statement of P/L (IFRS- statement of comprehensive income)
iii) detailed disclosures (or notes to the accounts)
iv) directors’ report
v) auditors’ report

Question 11

Director’s report

Answer 11

must give a ‘true & fair view’ -> overriding requirement (& auditor’s report)
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meaning whether the statements comply with the rules & regulations outlined
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Directors must consider whether financial statements they approve are appropriate. Auditors are required to exercise professional judgement before expressing an audit opinion.
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Some companies will be subject to other legislation specific to their type of industry (insurers, banks, PF & charities)

Question 12

Role of IASB (International Accounting Standards Board)

Answer 12

def: body that develops, issues & withdraws international accounting standards. Standards issued are called IFRS.
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International standards relate to co’s & other kind of entities which prepare accounts intended to provide a true & fair view.
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require financial statements of publicly traded enterprises to be prepared in accordance with IFRS & to give any material departure from those standards & with reasons for it.
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IASB collaborates with national accounting standard setters in order to ensure that its standards are developed with due regard to international & national developments. (Improve & harmonise financial reporting around the world)

Question 13

Arguments FOR international standards

Answer 13

-ELIMINATE / REDUCE VARIATIONS between co’s in the way they prepare accounts
- discussion process leads to focussing their ATTENTION on particular areas for debate about accounting practice
-oblige co’s to DISCLOSE more info than that required by national laws
- allow SOME DEGREE OF FLEXIBILITY in a way that legislation doesn’t

Question 14

Arguments AGAINST international standards

Answer 14

-set of rules contained in the stds may not be APPROPRIATE to all companies in all circumstances
-std-setting may NOT be entirely OBJECTIVE
-stds often alllow more than one ALTERNATIVE treatment, which negates the attempt to ensure conformity between companies
-some stds are so GENERAL as to be meaningless, while others are far too DETAILED

Question 15

Auditors’ report

Answer 15

auditors must comment on whether, in their opinion, the SFP & SPL have been properly prepared & give a true & fair view of the state of the company’s affairs
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every co. above a certain size is required by the Companies Act 2006 to appoint auditors to hold office from one annual general meeting to the next. The auditors must report to the SH’s on the published accounts.
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sole purpose = to add credibility to the financial statements

Question 16

Variations of the standard report

Answer 16

i) emphasis of matter paragraphs
ii) qualified opinion
iii) disclaimer of opinion
iv) adverse opinion
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wording of the standard report can be modified if the auditor wishes to highlight areas of uncertainty or is unable to express an unqualified opinion that the financials give a true & fair view

Question 17

Emphasis of matter paragraphs

Answer 17

SIGNIFICANT UNCERTAINTY, auditor should point this out for the sake of emphasis. (unnecessary to issue a qualified audit report because the financial statements give a true & fair view. Management has disclosed the problem & the auditor has taken care to ensure that the SH’s have read the disclosure)

Question 18

Qualified opinion

Answer 18

circumstances where a RESTRICTION has been placed on the evidence that the auditor can access or where the auditor disagrees with the treatment of a matter.
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give a true & fair view EXCEPT for

Question 19

Disclaimer of opinion

Answer 19

auditor faced with such EXTREME UNCERTAINTY about the financials that is impossible to express an opinion
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extreme form of qualified audit report that it should only be used very sparingly & in cases where its unavoidable

Question 20

Adverse opinion

Answer 20

EXTREME CASES OF DISAGREEMENT where the financials have been rendered so misleading that it must be stated that they don’t give a true & fair view.
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form of qualified report should be used sparingly & only when necessary

Question 21

Explain the regulation of auditors

Answer 21

Auditor must belong to one of the recognised supervisory bodies who have registered with the Department of Business, Innovation & Skills.
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Supervisory bodies are responsible for the supervision & discipline of all the registered auditors whom they accredit.
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2 major fears about auditors are the:
1) Conflict of interests
2) Familiarity

Question 22

List the 11 accounting concepts

Answer 22

BAD MMM CCPGR
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1) Business entity
2) Accruals
3) Dual aspect
4) Money measurement
5) Materiality
6) Matching
7) Cost / historical cost
8) Consistency
9) Prudence
10) Going concern
11) Realisation

Question 23

Cost concept

Answer 23

def: non-current assets generally appear in the SFP at their original cost less depreciation to date, subject to possible impairment write-down
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_
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movement from cost to FV indicates that the accountancy profession is constantly reviewing the adv & disadv of competing approaches

Question 24

Money measurement concept

Answer 24

def: accounting statements restrict themselves to matters which can be measured objectively in money terms
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_
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SFP rarely give a rough approximation of the value of the business because it will exclude such items as the values of the co’s customer base, its workforce & its brand names

Question 25

Business entity concept

Answer 25

def: affairs of the business are kept separate from those of the owners (applies to limited co’s, sole traders & partnerships)

Question 26

Realisation concept

Answer 26

def: income is recognised when it’s ‘earned’ (it’s not necessary to wait until the customer settles his or her bill)
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avoids fluctuations in reported income which might arise if everything was accounted for on a cash basis [it can also create the impression that the business is performing well when it is in fact in danger of running out of cash]

Question 27

Accruals concept

Answer 27

def: expenses are recognised as & when they are incurred, regardless of whether the amount has been paid.
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avoids random allocation of costs to periods depending on whether the bill happens to have been paid of not (concept runs alongside realisation)

Question 28

Matching concept

Answer 28

def: incomes & expenses which relate to each other must be matched together & dealt with in the same SPL - this should be for the period in which the amounts were earned/incurred.

Question 29

Dual aspect concept

Answer 29

def: recognises that every transaction or adjustment will affect 2 figures (double entry system)

Question 30

Materiality

Answer 30

def: there’s little point in providing info which is so detailed as to be unintelligible
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can be clearer by showing totals such as ‘admin expenses’ instead of listing every item which makes this heading up
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accountants might report rough approximations for certain costs rather than wasting time calculating more precise figures
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whether something is material/not depends on the extent on emphasis which the company will put on relevant figures

Question 31

Prudence

Answer 31

def: preparers of financials should avoid presenting an unduly optimistic set of results
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lowest reasonable figure should be state for profit or for any assets & highest reasonable figure for liabilities or expenses. (there is very little danger of the figures lulling everybody into a false sense of security by overstating the company’s strengths)
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Prudence should only be applied in situations where there is uncertainty

Question 32

Going concern concept

Answer 32

def: business will continue indefinitely in its present form (i.e will continue in operational existence for the foreseeable future)

Question 33

Consistency

Answer 33

def: figures published by the co. should be comparable from one year to the next. (any changes should be highlighted and their impact explained, which may involve restating prior year figures in the accounts)

Question 34

In the absence of a specific rule to specify an appropriate accounting policy, the company should select policies on what basis?

Answer 34

That they are RELEVANT & RELIABLE:
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Info is RELEVANT if it informs decisions taken by users of financials
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Info is RELIABLE if:
> provides a faithful representation of the entity’s financial position, financial performance & CF’s
> reflects the economic substance of transactions, other events & conditions, and not merely the legal form
> is neutral & free from bias
> expresses prudence
> complete in all material aspects
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can have conflicts between relevance & reliability -> valuations