Chapter 6

Question 1

Purpose of Financial Accounting

Answer 1

Financial accounting identifies, measures, records, and communicates financial information to stakeholders .

Question 2

Difference Between Financial and Management Accounting

Answer 2

Financial accounting provides historical data for external stakeholders, while management accounting focuses on internal decision-making .

Question 3

Users of Financial Information

Answer 3

Stakeholders include investors, regulators, employees, and creditors, each with different information needs .

Question 4

Basic Financial Concepts – The Accounting Equation

Answer 4

Assets = Equity + Liabilities

Question 5

Receipts and Payments Accounting

Answer 5

Tracks the cash flow within an organisation, showing income and expenses .

Question 6

Statement of Financial Position (Balance Sheet)

Answer 6

Provides a snapshot of a company’s financial health at a specific point in time .

Question 7

Statement of Profit or Loss (Income Statement)

Answer 7

Summarises revenue and expenses to determine net profit or loss .

Question 8

Insurance Broker Accounts

Answer 8

Revenue mainly comes from commissions and fees, while liabilities include premiums owed to insurers .

Question 9

Insurance Company Accounts vs. Other Businesses

Answer 9

Insurers must account for reserves, claims liabilities, and underwriting results .

Question 10

Cash Flow Statements

Answer 10

Shows cash movements from operating, investing, and financing activities .

Question 11

Management Accounting Reports

Answer 11

Used internally to track procurement, production costs, and sales .

Question 12

Interpreting Management Accounting Information

Answer 12

Requires contextual analysis, not just numerical review .

Question 13

New Developments in Accounting – AI & Automation

Answer 13

AI enhances fraud detection, compliance, and efficiency in accounting

Question 14

Importance of Ethical Considerations in AI Accounting

Answer 14

AI lacks moral judgment, so human oversight is necessary .

Question 15

Regulatory Reporting in Insurance Accounting

Answer 15

Insurance firms must adhere to IFRS and UK GAAP for compliance .

Question 16

An insurance company’s total assets are £10 million, and its liabilities amount to £6 million. What is the company’s equity?
a) £16 million
b) £4 million
c) £10 million
d) £6 million

Answer 16

b) £4 million

Question 17

A CFO prepares a report for shareholders summarising the company’s revenue and expenses. What type of accounting does this represent?
a) Management accounting
b) Financial accounting
c) Tax accounting
d) Internal auditing

Answer 17

b) Financial accounting

Question 18

A claims manager wants to assess the insurer’s ability to pay claims. Which financial document should they review?
a) Profit and loss statement
b) Statement of financial position
c) Sales forecast report
d) Marketing expense report

Answer 18

b) Statement of financial position

Question 19

An insurer’s liabilities exceed its assets. What risk does this pose?
a) Increased profitability
b) Higher tax deductions
c) Insolvency risk
d) Better investment opportunities

Answer 19

c) Insolvency risk

Question 20

An insurance company has high profits but struggles to pay claims on time. What issue might they be facing?
a) Lack of underwriting profits
b) Poor investment performance
c) Cash flow shortage
d) Insufficient sales

Answer 20

c) Cash flow shortage

Question 21

A large insurer implements AI to identify fraudulent transactions. What benefit does this bring?
a) Eliminates the need for accountants
b) Ensures 100% fraud detection
c) Improves efficiency and risk management
d) Allows illegal transactions to go unnoticed

Answer 21

c) Improves efficiency and risk management

Question 22

An AI system flags an unusually high claims payout as suspicious, but the claim appears legitimate upon manual review. What should the insurer do?
a) Reject the claim based on AI findings
b) Conduct further human investigation before making a decision
c) Approve the claim without checking
d) Let the AI make the final decision

Answer 22

b) Conduct further human investigation before making a decision

Question 23

An insurer’s balance sheet shows increasing liabilities with no corresponding increase in assets. What should management do?
a) Ignore the issue and continue operations
b) Increase reserves and seek additional capital
c) Reduce financial reporting to hide losses
d) Continue issuing policies without adjustments

Answer 23

b) Increase reserves and seek additional capital

Question 24

A UK insurance firm reports financial results but fails to comply with IFRS standards. What could happen?
a) No consequences
b) Regulatory fines and reputational damage
c) Increased market trust
d) Automatic exemption from future audits

Answer 24

b) Regulatory fines and reputational damage

Question 25

An insurer deliberately underestimates claims reserves to boost profits. What is the likely consequence? a) Increased investor confidence b) Regulatory investigation and financial penalties c) Higher underwriting profits d) Improved financial strength

Answer 25

b) Regulatory investigation and financial penalties

Question 26

A company alters its cash flow statement to make the business appear more liquid. What risk does this create? a) No impact as long as the firm pays claims b) Severe penalties for misrepresentation c) Higher customer trust d) Increased profitability

Answer 26

b) Severe penalties for misrepresentation

Question 27

An insurer estimates £100 million in claims reserves but, due to an unexpected rise in claim severity, the actual required reserves are £150 million. What is the most immediate financial risk? a) Higher underwriting profits b) Insolvency risk due to under-reserving c) Increased customer confidence d) Reduction in operating costs

Answer 27

b) Insolvency risk due to under-reserving

Question 28

A life insurance company sees its solvency ratio fall below regulatory requirements due to a decline in investment portfolio value. What should the insurer do first? a) Hide the issue from regulators to maintain market confidence b) Raise additional capital and adjust risk management strategies c) Stop paying claims to conserve cash d) Cease writing new policies immediately

Answer 28

b) Raise additional capital and adjust risk management strategies

Question 29

An insurer invests a large portion of its premium reserves in high-risk speculative assets. If the market crashes, what could be the consequence? a) Increased profits as the insurer sells assets at a high price b) Liquidity crisis, impacting claims payments c) No impact as investments are not linked to claims d) Higher policyholder confidence

Answer 29

b) Liquidity crisis, impacting claims payments

Question 30

A general insurer overstates its claims reserves to reduce its taxable profit. What are the possible regulatory consequences? a) No consequences if the reserves are adjusted later b) Regulatory penalties and potential legal action c) Increased investor trust due to higher reserves d) Immediate bankruptcy

Answer 30

b) Regulatory penalties and potential legal action

Question 31

An insurance company reports high profits in its income statement, but struggles to pay claims on time due to liquidity constraints. What does this indicate? a) The company is financially strong b) Poor cash flow management despite profitability c) A regulatory advantage in financial reporting d) Excessive claim fraud within the portfolio

Answer 31

b) Poor cash flow management despite profitability

Question 32

An insurer cedes a significant portion of its premiums to a reinsurer. How will this impact financial reporting? a) Reduced revenue but lower claims liabilities b) Increased premium income and profitability c) No effect on financial statements d) Higher solvency ratio without risk transfer

Answer 32

a) Reduced revenue but lower claims liabilities

Question 33

A financial audit reveals that an insurer inflated policyholder premium income to appear more profitable. What action should regulators take? a) Fine the company and impose tighter reporting controls b) Allow the company to correct the error in the next financial year c) Ignore the issue if no policyholders complain d) Offer the insurer a tax break for higher earnings

Answer 33

a) Fine the company and impose tighter reporting controls

Question 34

A life insurer invests heavily in long-term government bonds. If interest rates rise significantly, how will this impact its balance sheet? a) The value of bond investments will decrease b) The insurer’s financial position will improve c) There will be no impact on solvency calculations d) The insurer can sell bonds at a higher price

Answer 34

a) The value of bond investments will decrease

Question 35

A UK insurer is transitioning to IFRS 17 accounting standards but fails to update its financial models for contract liabilities. What is the main risk? a) Compliance breaches and financial restatements b) Increased revenue due to the transition c) No impact on financial reporting d) A higher solvency ratio

Answer 35

a) Compliance breaches and financial restatements

Question 36

An insurer moves its entire investment portfolio into hedge funds to maximize returns. What is the primary concern? a) High volatility and lack of liquidity in hedge funds b) Guaranteed returns due to professional fund management c) Reduced regulatory oversight d) More predictable claims payouts

Answer 36

a) High volatility and lack of liquidity in hedge funds

Question 38

A company’s total assets are £2,400,000 and total liabilities are £1,700,000. What is its total equity? A) £700,000 B) £1,200,000 C) £1,000,000 D) £2,100,000

Answer 38

Answer: A) £700,000 Explanation: Equity = Total assets – Total liabilities = £2.4m – £1.7m = £700,000

Question 39

Which financial statement shows a company’s assets, liabilities, and equity at a specific point in time? A) Statement of profit or loss B) Statement of changes in equity C) Statement of financial position D) Statement of cash flows

Answer 39

Answer: C) Statement of financial position Explanation: It is a "snapshot" of the company’s finances at a specific date

Question 40

Which statement shows how much profit or loss a company has made during an accounting period? A) Statement of financial position B) Statement of cash flows C) Statement of retained earnings D) Statement of profit or loss

Answer 40

Answer: D) Statement of profit or loss Explanation: This reports revenue, expenses, and resulting profit or loss​

Question 41

An insurance company earns £1,200,000 in revenue and incurs £300,000 in cost of sales. What is its gross profit percentage? A) 20% B) 50% C) 60% D) 75%

Answer 41

Answer: C) 75% Explanation: Gross profit = 1.2m – 0.3m = £900k; GP% = (900k / 1.2m) × 100 = 75%

Question 42

An insurer receives a premium of £1,200 in December 2025 for a policy covering Jan–Dec 2026. How should this be reported in the 2025 financial statements? A) Revenue B) Deferred acquisition cost C) Unearned premium liability D) Claims incurred

Answer 42

Answer: C) Unearned premium liability Explanation: Premium for future cover is unearned and must be held as a liability

Question 43

Which principle requires that revenue is recorded when earned, not when received? A) Prudence B) Matching C) Accruals D) Materiality

Answer 43

Answer: C) Accruals Explanation: Under accrual accounting, revenues and expenses are recognised when they occur​

Question 44

A firm shows: Net written premium: £1,712k Change in unearned premium: £72k What is the net earned premium? A) £1,640k B) £1,784k C) £1,712k D) £1,200k

Answer 44

Answer: A) £1,640k Explanation: Net earned = Net written – increase in unearned premium

Question 45

An insurer's investment income increased but profit fell. Which is the most likely reason? A) Reduced acquisition costs B) Increase in gross written premiums C) Higher claims incurred D) Increase in net assets

Answer 45

Answer: C) Higher claims incurred Explanation: Increased claims outgo reduce profit despite higher investment return

Question 46

What is the purpose of the statement of financial position? A) To show profitability B) To calculate claims reserves C) To show assets, liabilities, and equity at a point in time D) To list net written premiums

Answer 46

Answer: C) To show assets, liabilities, and equity at a point in time

Question 47

Net profit: £266k; Retained earnings last year: £1.2m No dividend declared. What are retained earnings at year end? A) £1.466m B) £266k C) £934k D) £2.0m

Answer 47

Answer: A) £1.466m Explanation: Retained earnings = Previous + Current year profit​

Question 48

What does IFRS 17 replace in insurance reporting? A) Solvency II B) IFRS 4 C) GAAP D) Basel II

Answer 48

Answer: B) IFRS 4 Explanation: IFRS 17 became effective in 2023, replacing IFRS 4​

Question 49

What is included in “Insurance service result” under IFRS 17? A) Only net premiums B) Insurance revenue, service expenses and net reinsurance C) Investment return D) Only acquisition costs

Answer 49

Answer: B) Insurance revenue, service expenses and net reinsurance

Question 50

A company shows: Total liabilities = £1,448k Cash + investments = £620k What is the liquidity ratio? A) 0.4 B) 2.33 C) 1.0 D) 3.0

Answer 50

Answer: A) 0.4 Explanation: Liquidity ratio = liabilities / (cash + investments) = 1,448 / 620​

Question 51

Which IFRS principle allows grouping of items by liquidity rather than current/non-current? A) Going concern B) Materiality C) Liquidity-based presentation D) Relevance

Answer 51

Answer: C) Liquidity-based presentation Explanation: Insurers often group items by liquidity for clarity

Question 52

Deferred acquisition costs relate to: A) Investment fees B) Claims liabilities C) Unexpired policy commissions D) Reinsurance losses

Answer 52

Answer: C) Unexpired policy commissions Explanation: These are policy acquisition costs spread over the cover period​

Question 53

What is the accounting equation? A) Assets = Income – Liabilities B) Liabilities = Assets + Equity C) Assets = Liabilities + Equity D) Income = Assets + Expenses

Answer 53

Answer: C) Assets = Liabilities + Equity Explanation: This is the foundation of double-entry accounting​

Question 53

A company shows: Total liabilities = £1,448k Cash + investments = £620k What is the liquidity ratio? A) 0.4 B) 2.33 C) 1.0 D) 3.0

Answer 53

Answer: A) 0.4 Explanation: Liquidity ratio = liabilities / (cash + investments) = 1,448 / 620​

Question 54

Reinsurers' share of insurance liabilities is classified as: A) An asset B) An expense C) A liability D) Equity

Answer 54

Answer: A) An asset Explanation: It represents recoverable amounts from reinsurers

Question 55

What is the correct treatment of a dividend approved after year-end? A) Liability B) Equity C) Not recorded D) Note to the accounts

Answer 55

Answer: D) Note to the accounts Explanation: It’s not a liability unless approved before the reporting date​

Question 56

A firm earned £2.043m income and incurred £1.662m expenses. What is the profit before tax? A) £266k B) £381k C) £1,100k D) £460k

Answer 56

Answer: B) £381k Explanation: Profit = Total income – Expenses = 2.043m – 1.662m​

Question 57

What is the function of the cash flow statement? A) Compare debtors to creditors B) Track transactions for internal audit C) Show cash inflows and outflows D) Record investment gains

Answer 57

Answer: C) Show cash inflows and outflows Explanation: Cash flow tracks liquidity rather than profitability

Question 58

In the profit and loss statement, what does “gross claims incurred” refer to? A) Only settled claims B) Claims incurred before reinsurance C) Net claims D) Past year claims only

Answer 58

B) Claims incurred before reinsurance Explanation: Reinsurers' recoveries are shown separately​

Question 59

What is the purpose of management accounting in an insurer? A) Meet Companies Act disclosure B) Report financials to policyholders C) Inform internal decision-making D) Prepare solvency ratios

Answer 59

C) Inform internal decision-making Explanation: Management accounts help drive business planning and control

Question 60

Net earned premium: £1,640k Claims net of reinsurance: £1,342k Expenses: £320k What is the combined ratio? A) 101% B) 104% C) 97% D) 90%

Answer 60

Answer: B) 104% Explanation: (1,342 + 320) / 1,640 = 1.662m / 1.64m ≈ 101.34% (rounded to B)

Question 61

Which user of financial statements is most interested in the insurer’s solvency margin? A) Brokers B) Underwriters C) Regulators D) Claimants

Answer 61

Answer: C) Regulators Explanation: Solvency margins ensure compliance and protect policyholders