Learning objective 5 - Chapter 6 (6 marks) Flashcards
Understand accounting principles and practices and their application (265 cards)
1
Q
what is book keeping?
A
The process of accounting.
2
Q
What 4 things are included in the accounts of quoted companies?
A
1-Narrative reports; giving an overview of governance, activities and performance of the company.
2-Strategic report - setting out business models, strategies, a fair review of the business, future developments
3-The financial statements for the period including the balance sheet, income statement and cash flow statement.
4- Other legal requirements, such as details of the directors remuneration
3
Q
what is another term for ‘balance sheet’?
A
‘statement of financial position’
4
Q
What is another term for ‘income statement’?
A
‘profit and loss account’
5
Q
where do the terms ‘statement of financial position’ and ‘income statement’ come from?
A
The UK Financial Reporting Standards (FRS) and International Financial Reporting Standards (IFRS)
6
Q
Where do the terms ‘balance sheet’ and ‘profit and loss account’ come from?
A
The Companies Act 2006
7
Q
What is the primary legislation in the UK?
A
The companies act 2006
8
Q
What does the companies act include?
A
Includes regulations on accounting
9
Q
what are four regulations on accounting included in the companies act 2006?
A
- Requirement to keep adequate accounting records
-Directors duty to prepare accounts for a company
-Directors duty to prepare accounts for a group of companies and the consistency of financial reporting within a group
-Requirement to prepare accounts that show a true and fair view
10
Q
what does company legislation also require in terms of auditing?
A
companies, other than certain small companies are required to have their financial year-end accounts audited by an independent auditor.
11
Q
how to the accounts have to be published?
A
Accounts have to be published in a format that complies with regulations and accounting standards requirements
12
Q
What three things are included in a companies financial statements?
A
- The income statement
- The balance sheet
- Cash flow statement
13
Q
What is the income statement?
A
Shows the results of the company as a consequence of transactions during the accounting period. It sets out the income, expenses, tax and profit or loss.
14
Q
What is the balance sheet?
A
A statement of the financial position of the business at a point in time (‘as at’ a particular date) i.e the end of the accounting period or year end date, It is a ‘snap shot’ of the company’s position at a particular point in time, listing all the companies assets and liabilities - what is owned and what is owed. What is owed by the company includes the shareholders equity, which is the total of the assets less the total of the liabilities.
15
Q
What is a cash flow statement?
A
These are presented an integral part of a company’s financial statements to recognise that accounting profit, or loss is not the only indicator of a company’s performance. Cash flow statements show the sources and uses of cash and are a useful indicator of a companies liquidity.
16
Q
what is a ‘true and fair view’ in connection with financial statements?
A
Financial statements are intended to show a ‘true and fair’ view of the economic activities of the organisation and are available not just to the stakeholders, but to anyone who wishes to review them.
17
Q
What is another purpose for financial statements?
A
They are produced within a highly regulated framework to enable fair comparisons to be made on the financial position of different organisations, whether they are the same or not.
18
Q
What do UK companies listed on the stock exchange have to do?
A
They have to follow the UK-adopted International Financial Reporting Standards (IFRS)
19
Q
What do companies not listed on the UK stock exchange have to do in terms of financial statements?
A
They can also adopt the these international standards. They can also use the Financial Reporting Standards (FRS) (referred to as UK GAAP, which stands for Generally Accepted Accounting Principals)
20
Q
What does UK GAAP stand for?
A
UK Generally Accepted Accounting Principals
21
Q
What is the ‘true and fair’ view similar too?
A
The ‘substance over form’ concept.
22
Q
What is the ‘substance over form’ concept?
A
It is that the financial statement should show the economic substance of transactions rather than the legal form.
23
Q
What are the two main aspects of accounting which serve separate but inter related purposes in the operation and control of a business?
A
Financial accounting and management accounting.
24
Q
what is financial accounting mainly concerned with?
A
-providing historic information to external stakeholders and interested parties.
-involves day to day recording of the companies transactions and presenting this information in financial statements for external consumption.
25
what is management accounting mainly concerned with?
-The internal planning and control of an organisation to enable its managers to make sound decisions; its aim is to show managers how the organisation is performing in comparison with anticipated outcomes and if there is any deviation; what corrective action must be taken.
26
What are the main characteristics around the structure and sources of financial accounting?
- highly structured around the accounting equation
- has to comply with legal and regulatory framework
- used for stakeholders to compare companies performance from one year to another and against other companies in the sector.
27
What are the main characteristics around the structure and sources of Management accounting?
- Can be formulated in a variety of ways to suit many purposes.
- Management accounting will incorporate a variety of other different information sources to enable managers to fulfill their responsibilities, in addition to day-to-day transactional data captured for financial accounting purposes.
28
What are the main characteristics around the format of financial accounting?
- information in the financial position is mainly provided in a balance sheet, performance of it is found in the income statement
- financial accounting looks at and records the financial impact of events on the organisation as a whole
29
What is the main characteristics around the format of management accounting?
- Management accounting systems are not just concerned swith the money, they include non-monetary quantitative information such as labour hours, raw material usage and electricity usage etc.
- Management accounting is naturally segmented and concentrates on processes, individual departments and other areas of responsibility.
30
What are the main characteristics around the time periods of financial accounting?
- Based on historical information. i.e transactions that happened in the previous accounting period and are not intended to be a guide for the future.
31
What is the main characteristics around the time periods of management accounting?
- does not report on historical information and is largely focused on the future. it is concerned with forecasts and projections. inevitably these can sometimes be imprecise but managers are usually willing to sacrifice precision for guidance on possible future outcomes.
32
What are the main characteristics around regulationss of financial accounting?
- When peparing and presenting financial statements for external parties, all companies have to use a conceptual frame work as laid down in accounting standards. This ensures that the info on the companies financial performance and financial position is comparable with previous years and other companies.
Using the conceptual framework also helps to portray the results of 'stewardship management', which enables external users to assess the quality of the managers who take responsibility for safeguarding the assets of the company on behlf of its owners; the shareholders.
- financial statements may also include valuations and provisions and the calculation and presentation of these are subject to accounting standards.
33
What are the main characteristics around regulations of management accounting?
- no external regulatory constraints. Management accountants may presentin different ways for different purposes.
34
Is there any legal requirements to publish financial accounts?
Companies are legally required under the Companies Act Legislation to produce financial accounts which have to be filed at Companies House and hence are available to the public.
35
Is there any legal requirements to publish management accounts?
Companies have no legal obligations to produce or publish management accounts.
36
What are the audit requirements for financial statements?
- Companies of a certain size have to have their financial statements audited
37
Why do financial statements have to be audited?
- To confirm that they show a 'true and fair' view.
38
What are the audit requirements for management statements?
-Mangement accounts do not have to be audited by external auditors however auditors may wish to examine some management accounting reports to helpo in their assessment of audit risk.
-If an organisation has an internal audit department, it will have delegated authority from the audit committee or senior management to report on the adequacy of the systems of control. This will include ensuring that the management accounting system and their reports are relevant, reliable, accurate and complete for management purposes.
39
give 11 examples of potential stakeholders of insurance companies?
1 - Owners
2 - Directors & Managers
3 - Employees
4 - Regulators
5 - Tax authorities
6 - Creditors and lenders
7 - Competitors
8 - Financial analysts
9 - Brokers
10 - General Public
11 - Customers
40
What will an Owner generally want to know about the organisations financial affairs?
- They will need to know how the business is performing financially in order to make decisions abount continuing or increasing their capital incvestment. This applies especially to shareholders in Public Limited companies.Investment decisions here are often taken as purely financial.
41
What will Directors and Managers generally want to know about the organisations financial affairs?
D&M's have an overall responsibility for managing the business. They will need to know whether or not the organisation has met its strategic objectives and has been making the best use of its resources.
- they will need to know;
1.if the company has enough capital and liquidity to enable it to carry out its plans
2.whether some parts of the business are more successful than others
3.whether the company has behaved as a responsible part of the community.
42
What will an employee generally want to know about the organisations financial affairs?
- how secure their jobs are. They can use finanical information to gauge how well the organisation is performing, this if their wages are going to be paid.
- An employee may also be a stakeholder so may have conflicting stakeholder objectives.
43
What will the public generally want to know about the organisations financial affairs?
- includes people who may be potential investors or shareholders.
- Pressure groups that may want to monitor aspects of the organisations activities and people who may be considering applying to work for them.
44
What will tax authorities generally want to know about the organisations financial affairs?
- they will want to know that the organisation is paying the appropriate level of tax
45
What will financial analysts generally want to know about the organisations financial affairs?
- includes potential advisors so will want to know what they should share with shareholders and potential shareholders to buy or sell shares in the organisation.
they use financial info to track the organisations performance.
- includes journalists and financial commentators who provide general advice to the pubic.
- Rating agencies have analysts that assess insurance companies financial strength, which is a measure of the companies ability to meet their obligations to policy holders.
46
What will creditors generally want to know about the organisations financial affairs?
- they will want to keep an eye on the performance of the company to ensure debts can be paid. Includes banks, suppliers and landlords.
They will need to mak judgement on whether they should extend credit & if so, what limit.
47
What will competitors generally want to know about the organisations financial affairs?
Competitors use financial information to understand a companies strengths and weaknesses.
48
What will Brokers generally want to know about the organisations financial affairs?
From an inurance point of view, brokers will want to know whether companies they deal with are financially strong and able to pay for their clients claims.
49
What will the customers of an organisation generally want to know about the organisations financial affairs?
potential and existing customers will want to know that they are insured with a reputable organisation which is able to pay its claims
50
What will the PRA (prudential regulation authority) and FCA (financial conduct authority) want to know about the organisations financial affairs?
The PRA and FCA are the regulatory bodies for the UK financial services industry. Insurance companies are regulated for prudential issues by the PRA and for conduct of business by the FCA.
51
What do stakeholders in a business need to form a judgement or make decisions about their relationship with an organisation?
They need both Qualitative and Quantitative data.
52
How is data usually made available to stakeholders?
It can either be readily available online as public information or it will have to be interpreted and analysed from the accounts.
53
what are the three types of information that is usually required by stakeholders? (categories)
1- General
2-fundamental
3-specific
54
what do financial statements tell about an organisations activities?
- Financial statements often contain narrative about the organisations activities, outlining areas of particular success or failure and covering new or discontinued projects, as well as directors assessment of risk and objectives for current and future management of the company.
55
what has the FRC said about Covid-19 disclosures with regards to the understanding of financial positions?
The FRC has said that C-19 disclosures should be sufficient for users to understand the impact on a company's performance, cash flows and financial position.
56
is there any other information that larger companies are required to provide?
Yes - how they undertake their social responsibilities to the wider community, e.g how they are addressing environmental issues or helping to reduce the impacts of climate change.
57
what is the definition of profitability?
the company's ability to make profit. i.e if there is a positive amount of money left over when all costs and expenses are subtracted from all of the organisations income, then the organisation has made a profit.
58
What does it mean when a company 'breaks-even'?
a company 'breaks-even', when, if after all costs and expenses are subtracted from the organisations income, they are left with net zero. (when expenditure matches income exactly)
59
what does it mean when a company is at a loss?
if there is a negative amount when all costs and expenses are subtracted from the organisations income.
60
why might managers be interested in a companys profitability?
To know how well they have managed the business.
61
why might employees be interested in a companies profitability?
They need to be reassured that the organisation will continue to trade and that thier jobs are safe. There may also be a profit sharing arrangement that direcly affects the salaries of employees.
62
why might existing and potential shareholders be interested in a companies profitability?
they will want to know how likely they are to receive from the shares they have in the organisation; this knowledge will enable them to decide whether or not to get a better return on their investment. Note that while rising profits may be reflected in rising dividens, the management may instead decide to retain profits to fund future expansion.
63
what is the definition of cash position (liquidity)?
- the amount of cash a business has, or has access to is known as liquidity.
64
why is it so important for a company to have good liquidity?
Because if a company does not have cash it will not be able to pay for its costs and expenses which will lead quickly to difficulty trading and failure of the business.This can happen even if an organisation is profitable and even if it has an excess of assets compared to its liabilities. A company has to be able to meet its liabilities when they fall due in order to continue to trade.
65
what is the definition of income and expenditure?
-knowing how much income has come into a business and the expenses that have gone out. This information is comparable year to year.
income: i.e premium income is one measure of an insurers relative size. similarly, a brokers size can be gauged by the amount of premium income it manages, its fee income or a combination of both.
Costs: wages, raw materials, rent, company cars. but insurance companys expenditure may also include net claims, reinsurance premiums, acquisition costs and operating costs.
66
Why might stakeholders want to know about a companys income and expenditure.
when this information is compared year to year it is possible to build up a picture of the volume of sales and to see whether it has gone up or down over time (income) and also whether costs have increased or decreased over time (expenditure)
67
what will stakeholders want to know about an organisations wealth?
-- How much wealth is held and in what form. I.e non-curent assets (property, equipment and investments) and current assets (debtors, cash that can be turned into liquid funds easily)
68
what is working capital?
Working capital is the difference between current assets and current liabilities.
Where a company has a decreasing working capital this could be due to poor management or due to a short term problem that needs to be finances.
An analysis of the accounts may show that it is just the result of a successfully growing business. If this is te case working capital management is critical to maintain liquidity.
69
what is the definition of solvency?
Solvency is a measure of the excess of an organisations assets compared to its liabilities. If a company's liabilities exceed its assets it is said to be technically insolvent and will usually be required to cease trading.
70
why does solvency have a particular significance in the UK Insurance space?
As all UK insurers are required by the PRA to meet a solvency margin
71
what is a solvency margin?
This is the amount by which the value of an insurers assets should exceed the amount of its liabilities.
72
What happens if an insurers net assets falls below its solvency margin?
It may be said that the company is insolvent. This is different to a usual company as they would be declared insolvent when their liabilities exceed their assets.
73
What is another indicator of an insurance companys financial strength and its ability to pay claims to its customers?
The amount of regulatory capital a company holds in excess of its solvency margin.
74
What are the main differences between liquidity and solvency?
Liquidity refers to an enterprise's ability to pay short term obligations, and ability to sell assets quickly to raise cash.
Solvency refers to an enterprise's capacity to meet its long-term financial commitments
75
What is the definition of income as per the IFRS?
The amounts of money earned by the company from any source, including sales, rentals, interest payments and investments.
76
What is income generated from sales sometimes called?
Revenue or turnover (alternatives names from 'income')
77
What is the definition of expenditure as per the IFRS?
The amounts of money incurred to pay for goods and services
78
What is the definition of profit as per the IFRS?
In accountancy terms, profit is any excess of income over expenditure incurred in running the business that earns that income
79
What is the definition of shareholders equity as per the IFRS?
The stake that shareholders have in the company. This is calculated as the total value of all of the assets in the business less the total value of all the liabilities.
80
What is the definition of capital and regulatory capital as per the IFRS?
The capital ofa trading company is the sum of the equity and long-term debt used to finance the business.
81
what is the importance of regulatory capital for insurance companies?
This is the sum of the equity and long term debt that is classified as regulatory capital. Long-term debt can only be classified as regulatory capital if it meets stringent rules set out by the PRA.
It is an advantage to have regulatory debt capital in addition to equity as the cost of regulatory debt capital is normally lower than the cost of equity.
I.e for a given level of regulatory capital and profitability shareholders shoud expect higher earnings per share if the company has tier 1 or 2 debt compared to just equity.
82
What is equity?
This counts as tier one capital; the best sort of capital as it gives the greatest protection to policyholders.
Depending on the structure of the debt, particularly the repayment terms, long-term classified debt may be categorised as either Tier 1 or Tier 2 capital.
83
what is the definition of an asset according to IFRS?
An asset is a resource controlled by the enterprise as a result of past events an from which future economic benefits are expected to flow to the enterprise.
84
what are the two types of assets?
Tangible and Intanglible
85
What is a tangible asset?
A physical one. I.e cash, land, buildings, machinery or investments. some tangible assets - especially machinery and equipment lose their value over time. (in accountancy terms this loss in value is called depreciation)
86
What is an intangible asset?
One that is not physical, such as a trademark, copyright or goodwill. Purchased goodwill is the difference between the amount paid for acquiting a business and the value of its net assets of that business when acquired.
87
what is the definiton of liability by the IFRS (accountancy terms)
An obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits. (shortly; an amount owed by an organisation)
88
What is the definiton of liability in insurance terms?
An insurers acknowledged commitment to pay an amount of money arising out of a claim under a policy, or to a class of business or sub-section of a policy.
89
what is the definition of cash as per the IFRS?
Money that is available to the business. This incluudes money deposited at the bank or cash retained on the premises i.e petty cash.
90
What is the definition of a creditor as per the IFRS?
Any individual or organisation to whom a debt is owed.
This will remain on the borrowing companies balance sheet as a liability and the lending companies balance sheet as an asset until it is paid off.
91
what is the definition of a debtor as per the IFRS?
any organisation or person who owes a debt to a company.
This debt is considered as part of the lending company’s current assets and is shown as such in the balance sheet. It will be shown as a liability in the borrowing companies balance sheet
92
money owed to you is an...?
Asset
93
money you owe is a....?
Liability
94
What is depreciation?
- Depreciation is a representation of how much of an assers value has been used up and involves allocating the cost of a tangible, physical asset over its useful life or expected life.
95
how do we think of depreciation in accounting terms?
The cost of an asset apportioned over the financial period during which the business will benefit from the use of that asset.
96
why is it advantageous for insurance companies to have regulatory debt capital in addition to equity?
It is an advantage to have regulatory debt capital in addition to equity as the cost of regulatory debt capital is normally lower than the cost of equity.
97
what is accounting based off of?
The accounting equation
98
what does a company need in order to operate effectively?
resources; cash, office, furniture, equipment, stock etc
99
What is the whole basis of accounting?
That everything owned by a business has to be funded from somewhere
100
what does the accounting equation show and what does it mean?
The accounting equation shows the relationship between the things owned by a business (its assets) and the funds that were used to buy them.
The equation means that the amount of assets must equal the combined amount of equity plus liabilities
The accounting equation forms the basis of more formal financial statements that are compiled by companies to meet statutory reporting standards. i. the income statement and the balance sheet.
101
What is the accounting equation for assets
Equity + Liabilities = Assets
102
What must the equation always do?
Balance
103
Can the accouting equation be altered?
Yes - it can be rearranged so that the equity is the amount left over after liabilities are deducted from the assets.
i.e
Assets - Liabilities = Equity.
104
Assets are..
Anything the company owns / in their name (even items on credit) or any cash
105
liabilities are...
Anything the company owes to creditors
106
Equity is
Assets MINUS liabilities
i.e Assets at 2,000. Liabilities at 750. = Equity at 1,250
107
what is 'book-keeping'?
the system of recording a businesses financial transactions.
108
what is used to record amounts that are owed to a business by other parties?
Invoices/debit notes/fee notes
109
what 7 types of information is usually available on an invoice?
- The amount of debt incurred
- The individual or organisation who owes the money
- The individual or organisation to whom the debt is owed
- the date when the debt was incurred
- the date when payment was due
- the way the debt amount was calculated and what service or goods were supplied
-Ancillary financial information such as any VAT associated with the charge and the organisations VAT number
-
110
what is used to keep track of amounts of expenditure by the organisation?
Receipts or invoices from suppliers will be retained.
111
where will money receieved be recorded?
In a cash/balance book. the balance will be calculated frequently to monitor liquidity
112
how are all financial transactions recorded in the books of account?
The double entry principle
113
What is the double entry principle?
- This shows the two fold effect on the accounting equation by reflecting that the business both receives and gives value in each transaction.
i.e recording any earnings and also provide information for financial statements.
114
what is the balance sheet?
-Statement of financial position - of net wealth of a business at a particular time.
115
What are items of wealth controlled by a business?
Assets
116
what are items of wealth owed by a business?
Liabilities
117
what is the difference between a businesses total assets and its total liabilities?
Shareholders equity - This belongs to the owners of the business.
118
who does the shareholders equity belong to ?
The owners of the business.
119
What is shareholders equity?
The difference between a companies total assets and total liabilities.
120
what two categories are assets usually classified into?
Current assets and non-current assets
121
What are non-current assets?
Items of wealth, controlled by the business that the company intends to keep for more than one year.
122
Give three examples of non-current assets:
- Goodwill & other intangible assets
- property
- investments
123
what is goodwill?
Goodwill is the difference between the amount paid for acquiring a business and the value ofthe net assets of that business when acquired.
othert intangible assets include patents, brands and licenses.
124
what is property defined as when referring to a businesses assets?
Freehold or leasehold propertyand land (used by a business for trading)
125
what is investments defined as when looking at a businesses assets?
Investments includes property if help for investment rather than use by the business for trading, government bonds and corporate bonds
126
what are current assets?
items of wealth that the business controls and intends to use in the next 12 months.
127
Give three examples of current assets:
Cash, Cash equivilents, stock and debtors
128
what is meant by cash and cash equivilents when looking at current assets?
- Cash in hand and cash held in the businesses bank accounts including deposits held for up to three months from the balance sheet date.
129
what is meant by stock when looking at current assets?
- in most cases there are three types of stock owned by a company.
raw materials
works in progress
finished goods
The business would expect to convert its stocks into cash by selling finished products to its customers within a year.
130
what is meant by debtors when looking at current assets?
debtors are customers who owe the business money. this is often the case when goods are sold on credit.
debt is considered an item of wealth on a balance sheet, since a customer oes the money to the business and is expected to pay.
131
What is a current liability?
If the business has to pay the money out in less than 12 months, it is a current liability. If over 12 months then it is a non-current liability.
132
What is a bank overdraft in terms of current liabilities?
This may have to be paid within 12 months which makes it a current liability. Banks usually hold the right to call in an overdraft with 24 hour notice.
133
How are Trade Creditors a current liability?
Most businesses have trade creditors as a current liability on their balance sheet. These arise when a business has bought goods or services from a supplier but has yet to pay the suppliers invoice.
134
What is a non-current liability?
Anything that must be paid back but not within 12 months.
135
Give three examples of non-current liabilities
Bank loans, Mortgages, Bond Issues (long-term financing)
136
Give two main examples of how businesses may raise long term finance
Share capital
Reserves
137
How can a business raise long term finance through share capital?
Limited liability businesses can sell shares in order to raise long term finance. The amount raised is always owed to the businesses shareholders (the owners). In this way share capital can also be seen as an item of wealth that the business effectively owed to the shareholders
138
How can companies raise long term finance through reserves?
Businesses can often raise the necessary finance required to expand their operations by using profits from previous years.
Reserves are accumulated profits that have been reinvested into the business.
Profits of Limited companies are owned by its shareholders, and not by the business, therefore when the business takes back the profits, it is indebted to its shareholders - therefore reserves are seen as money that is owed by the business to the shareholders
139
How do share capital and reserves differ from a liability?
Because, in the course of trading, there is no requirement to repay these amounts.
140
What is working capital?
The money used to finance day-to-day trading activities. WC is used to pay for wages, raw materials or overheads such as utility bills.
141
On a balance sheet, how is the value of working capital calculated?
By subtracting the current liabilities from current assets
142
What is another way of referring to working capital?
net current assets (i.e current assets minus current liabilities)
143
What are assets employed and how are they calculated?
Assets employed are assets used in a business that contribute to a companies ability to earn revenue.
Assets employed are calculated by adding non-current assets to working capital (net current assets)
144
when are assets employed useful?
when a firm wants to calculate their return on asset/capital employed ratio (R.O.C.E)
145
What can assets employed also be referred to ?
Capital employed
146
what does the return on assets/capital employed ratio show us?
- operational efficiency
- managerial efficiency in using the businesses capital to make a profit
147
What is minority interest?
Minority interest is a figure that is shown on a balance sheet where a company owns the majority of a second company (say, 80%), so the balance sheet will show a minority interest of (20%) to show that there are external shareholders. This 20% in £ will be subtracted from the total 100% net asset figure which will show the owning companies net assets for both their company and their 80% share in the second company.
148
What does the IFRS require regarding the lay out of assets and liabilities on the balance sheet?
That current assets and non current assets are shown separately as are current liabilities and non current liabilities.
149
Is there ever an exception to the IFRS's rules to the lay out of assets and liabilities on a balance sheet?
Yes - with Insurance companies balance sheets. They also have a prescribed list of items which must be shown separately if they are significant, however unline GAAP there are no prescribed lay outs.
150
what is a balance sheet?
A statement of the assets and liabilities of a business on one day of the year (a 'snapshot')
The most major financial statement
151
What is the income statement?
the second most major financial statement
The income statement shows the amount of profit or loss made by the business in the last year.
152
What is an income statement?
The second most major financial statement.
Shows a companies profit, or loss, in the last financial year
153
what is profit?
the difference between total income and total expenses
154
What should we be aware of when interpreting an income statement?
That the profit calculation is subject to estimations.
155
why do we have to be particularly careful when interpreting an income statement for insurance companies?
As the profit figure will be sensitive to the estimate of the amount that needs to be set aside for claims.
156
is showing operating profits on income statements a requirement of the IFRS
No, but some companies choose to show this anyway
157
Why do some companies show their operating profit on their income statement?
This is a measure of profit typically used to assess the financial performance of the business units.
158
How is gross profit calculated?
By subtracting cost of sales from turnover.
Note: costs should be matched against the revenues generated within the same accounting period and so, as a consequence, the value of unsold stock is not included as a cost on the income statement
159
what is the definition of revenue?
The total value of all sales (excluding VAT) invoiced during the year. Revenue, or turnover, is not always the same as the business's annual cash inflow from sales as it includes both cash and credit sales.
160
what is the definition of cost of sales?
This is the cost of stock bought during the year that has been subsequently sold - not including money spent on stock that has yet to be sold.
161
what items need to be subtracted in order to achieve profit for the year?
Financial costs
Overheads
taxation
162
What items need to be added in order to achieve profit for the year?
Finance income
163
what is finance income
The income earned on any investment held during the year
164
why do 'financial costs' have to be subtracted in order to reach your profit figure
The cost of loans made to the company. such as, bank loans, mortgages and corporate bonds
165
why do 'overheads' have to be subtracted in order to get to your profit figure?
The other expenses incurred by a company such as the cost of management, administration staff and office accomodation
166
Define why ' taxation' has to be subtracted in order to achieve the profit figure
all business have to pay corporation tax on their profits
167
what is movement in equity?
This is also known as changes in reserves. I.e when the profit increases the reserves will increases and reserves will decrease when dividens are paid to shareholders.
168
where are changes in reserves (movement in equity) required to be shown according to the IFRS?
The IFRS requires changes in reserves / movement in equity to be shown in either a statement of changes in equity (SOCE) or a statement of recognised income and expense (SORIE).
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Are there any other items that the IFRS requires to be reflected as movement in equity apart from changes in reserves?
Yes - foreign currency movements and actuarial adjustments to defined benefit pension schemes
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What does SOCE stand for?
Statement of changes in equity
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What does SORIE stand for?
Statement of recognised income and expense
172
What is the main revenue for insurance brokers?
The commission they receive from the insurance companies with which they place business and the fees they receive from their clients.
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What are the main costs for an insurance broker?
the cost of staff and running the office
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What is the main non-current asset for an insurance broker?
Office equipment and property
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what is the main current asset for an insurance broker?
liquid assets such as money in the bank
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what kind of liquid assets (examples) are usually available to an insurance broker?
Premiums held on behalf of insurance companies and money (commissions due from insurance companies)
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What is usually the biggest liability for an insurance broker?
The biggest liability for an insurance broker is usually the premiums owed to insurance companies. or loans that have be raised to finance the business and provision for liabilities and charges that may have to be met.
The rest of an insurance brokers liabilities is shareholders equity .
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What percentage does a company have to own of another for it to have 'controlling interest'?
more than 50%
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are insurance brokers accounts or insurance companies accounts more similar to non-insurance business accounts?
Insurance brokers accounts are more similar to non-insurance companies accounts.
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when preparing accounts, what is the minimum number of years that an insurance company will show?
two years.
181
Define what is meant by gross written premium and why this is included in an insurance companies income statement?
GWP is the gross amount payable by the insured to which the insurer is contractually bound within the accounting period
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Does GWP include commissions and IPT?
GWP is gross of commissions but net of IPT
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what four other categories fit into the definition of premiums in finance terms?
R-enewal Premiums
-Premiums payable by instalments
-An estimate of pipeline premiums receivable from binding authorities
- adjustment premiums receivable
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What is outward reinsurance?
Reinsurance purchased to protect the account
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when should outward reinsurance premium be accounted for?
in the same period as the premiums for reinsurance business.
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Why should outward reinsurance premium be accounted for in the same period as the premiums for reinsurance business?
Because this gives an indication as to the amount of reinsurance purchased to protect the underwriting book of business.
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What is net earned premium?
The difference between premiums written and premiums earned
in a growing book, earned premium will be less than written premium, and in a declining book of business, earned premium will be greater than written premium.
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How can you tell that a book is declining by their written vs earned premium?
the earned premium will be greater than written premium
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How can you tell a book of business is growing by their written vs earned premium?
Their earned premium will be less than written premium
190
What does investment return include?
Realised gains & losses
Investment income
i.e dividends, interest and rents receivable/
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What does unrealised gains and losses impact on the balance sheet?
The values shown in the balance sheet
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Can unrealised gains and losses impact the values shown in the income statement?
No, if the investment is classified as available for sale, which is a common category used.
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if an investment is classified as 'held to maturity' what does this mean?
It is valued on an amortised cost basis which essentially means that the return recognised each year in the income statement is the effective return calculated when he asset was purchased up to the date it matures.
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Are investments that are classified as 'held to maturity' fair valued at the end of each year?
No
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What does fair value mean?
Valued at the market value.
196
what does 'gross claims incurred' mean on an income statement?
This is the cost of claims gross of reinsurance.
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What is the 'reinsurers share' shown on an income statement?
The recovery due from reinsurers following a claim - leaving claims incurred NET of reinsurance.
198
What is meant by 'claims incurred' on an income statement
This is the sum of the claims paid in the last year plus the value of claims outstanding at the end of the year, less the value of claims outstanding bought forward from the prior year.
claims paid in last 12 months + value of claims outstanding at the end of the 12 months, less the value of the claims bought forward from the year before
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what are acquisition costs?
The amounts paid to brokers and other intermediaries who have placed business with the company and other direct costs of acquiring the business such as policy issue costs
200
What might ' other operating expenses' mean?
These will include all the other outgoings needed to run the business including admin costs
201
what is a tax charge comprised of?
Current tax and deferred tax
202
What is current tax?
The tax payable as shown in the companies tax return together with adjustments made to provisions established in previous years
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what is deferred tax
Is charged or credited to the income statement to deal with timing differences between recognised income, or an expense that will be recorded in a future tax return
204
What does the IFRS require with regards to statements regarding the reconciliation of equity?
What should it show?
The IFRS require a statement to be shown which reconciles the equity from the previous year to the current year.
The statement will show the profit for the year as per the income statement, dividends due to shareholders, unrealised gains on investments classified as available for sale, and other items such as the effects of changes to the accounting policies
205
when will a dividend show as a liability on a balance sheet?
If a dividend has been approved but not yet paid.
206
if a dividend has not been approved by the shareholders on the date of the balance sheet, will it show as a liability on the balance sheet?
No
207
When might the current/non-current liability split rule for balance sheets be omitted?
if a presentation based on liquidity provides information that is reliable and more relevant, then this rule might be omitted.
208
what are the overriding requirements on a balance sheet?
There is an overriding requirement that if an asset or liability category combineds amounts that will be received/settled after 12 months with A's or L's that will be received or settled within 12 months, disclosure is required to seperate th longer term amount from the 12 month amounts.
209
what is provision for unearned premiums?
This is the portion of premiums that have already been entered into the accounts as due but relate to a period of risk subsequent to the balance sheet date.
210
Give an example where there would be provision or unearned premium:
I.e if a premium is due on 1 september for an annual policy, at the balance sheet date of 31 december, only four months premium would have been earned (1/3 of total). Therefore, only 1 3rd should appear as earned in the revenue account for the year with the remaining 2/3 being held over to the next year as a 'balance carried forward', appearing in the next balance sheet.
211
what is 'provisions for losses and loss adjustment expenses' on a balance sheet?
The provision for losses is the estimated ultimate cost for Incurred but not settled claims at the date of the balance sheet, whether reported or not, combined with administrative expenses.
IBNR claims are incredibly hard to estimate, and can only be estimated in light of the companies experience,
212
What are reinsurance liabilities on a balance sheet?
This includes amounts due to reinsurers such as reinsurance premiums
213
What is included in 'investments' on a balance sheet?
All investments are to be included on the balance sheet. These investments are often government bonds, property, corporate bonds and equities (shares in other companies)
214
What is included in 'reinsurers share of insurance contract liabilities' on a balance sheet?
These balances are the potential reinsurance recoveries available on technical provisions in the liability section of the balance sheet
215
What is included in ' deferred acquisision costs' on a balance sheet?
This is the costs of acquiring insurance policies that have been written during the financial year but will be earned in a subsequent year. Hence rthey are a portion of acquision costs attributable to the unearned premiums.
216
What are debtors, on a balance sheet?
Premium owed by an insured either directly or via a broker and possibly from other insurance or reinsurance companies , where the business has been written but the premiums not yet paid.
217
what is the purpose of a cash flow statement?
This records the movements of cash in and out of the business during the last financial year. It also shows the companies net cash flow for the year
218
How are profits and cash flow different?
Profit is not calculated by subtracting cash inflows from outflows, but instead is based on the calculation of total income and expenses.
Income is not always the same as cash flow - i.e a business with income of 2m may have recieved only a small fraction of ths in cash as this may have been via extended credit.
219
How are profits and cash flow different?
Profit is not calculated by subtracting cash inflows from outflows, but instead is based on the calculation of total income and expenses.
Income is not always the same as cash flow - i.e a business with income of 2m may have recieved only a small fraction of ths in cash as this may have been via extended credit.
220
what is revenue equal to?
The total value of all invoices issued during the year. This may be totally different to cash inflows as not all customers will pay in cash and not all invoices are paid on time,.
221
Why are cash outflows not always the same as costs?
I.e if a business buys a machine at 1m, the cost of buying the machine is spread over thr assets life: so, rather than charging all of the £1m to this years income statement, only the depreciation due this year should be allocated as a cost.
222
Why is lack of cash worse for a business than lack of profit?
A lack of cash is more likely to cause a company to cease trading than a lack of profit.
223
Is it more important to look at a business cash or profits?
Cash flow statement is more important as a lack of cash is more likely to cause a company to cease trading than a lack of profit. - so the cash flow statement is more relevant than the income statement
224
what are the three main types of financial report for a business?
- Balance sheet
- Cash flow statement
- income statement
225
what is the format of a cash flow statement / what does this statement analyse cash flow into (activities)?
- Operating activities
- investing activities
- financing activities
226
How do business generate cash flow?
From their trading activities
227
What does the operating activities section of the cash flow statement deal with?
How much cash the business managed to generate or consume as a direct consequence of its trading activities including tax paid.
228
What do financial statements show regarding operating activities?
A reconciliation of the cash generated from operations to net profit before tax
229
what does the investment activities of the cash flow statement deal with?
This shows the cash inflows and outflows created by investment activities.
230
what are inflows and outflows regarding investment activities?
Inflows include proceeds of sales of investments including associates and subsidiaries purchased and outflows will include investments made
231
What does the financing activities of the cash flow statement deal with?
- This deals with changes to loan and share capital and payment of dividends to shareholders.
232
when is a cash inflow flow shown regarding financing activities?
if a business has managed to raise cash by negotiating new loans or by issuing more shares, a cash flow is shown
233
when is cash outflow shown regarding financing activities?
if the business has paid back some of its loan capital during the year, or if the business decides to redeem or buy back some of its share capital, an outflow of cash is shown.
Tax paid may also be shown as a cash outflow, but this differs from the tax expense relating to the profit for the year
234
what is the combination of cash flows from operations, investing and financing used to show on the cash flow statement?
these three aspects are totalled to show the increase or decrease in cash and cash equivalents
235
what are the three main types of financial reports?
Cash flow statement
income statement
balance sheet
236
what are the three main types of financial report?
cash flow statement
income statement
balance sheet
237
what is the main purpose of the cash flow statement?
this shows the businesses ability to generate cash
238
what is the main purpose of the cash flow statement?
this shows the businesses ability to generate cash
239
what is the main purpose for the income statement?
this shows the businesses trading conditions
240
what is the main purpose for the income statement?
This shows the businesses trading conditions
241
what is the main purpose for the balance sheet?
this demonstrates the financial strength of the business (i.e excess of assets over liabilities)
242
What is the main purpose for the balance sheet?
This demonstrates the financial strength of the business (i.e excess of assets over liabilities.
243
what is management accounting concerned with?
giving managers information they need to make sound business decisions and assisting them in taking corrective action when required.
244
What is the starting point when designing management accounting system?
Looking at the companies aims and objectives. The process will include making projections on future outcomes and performance which management will use to set plans and targets
245
what do management accounting reports show?
they give info on all key aspects of a company such as procurement, production, costs and sales.
Performance compared to anticipated outcomes as well as comparisons to industry benchmarks and competitors
246
what is the key aim of management accounting?
To help the managers to take the appropriate decisions to enable the company to achieve the business objectives
247
For a service company, what might the management accounts give information on? (4)
- Customer satisfaction
-The quality of the service provided
-the cost of the service analysed as appropriate for the business
-the financial performance of each of the various distribution channels such as direct sales force, outsoursed call centres and web.
248
what 4 non-financial & financial things might management accounts report on?
Productivity ratios
quality of goods
customer satisfaction
finanical information
249
what principal is crucial to the concept of management accounting and what is this concerned with?
Costing - this is concerned with establishing the necessary accounting information for profit and contributions to overhead costs of the various components of the business. In order to be able to do this, the company has to have a good costing system which is able to collect, store and process data and report the information in the required format.
250
what is the disadvantage of allocating cost to the profit centres?
Business managers will not be in control of the cost and so may not take ownership of the costs thats being incurred on their behalf.
251
what is a management accounting technique used to deal with business managers not being in control of their costs and thus not taking ownership of the costs that are being incurred on their behalf?
Activity based costing
252
How does activity based costing work?
First - establish the activities that drive the costs. i.e the number of invoices raised and the number of queries received by customers.
The profit centres can then be charged per number of these tasks.
253
what is the benefit of using activity based costing?
This technique makes it clear to the business the costs of each task, which will incentivise the business managers to improve accuracy of their billing, thereby reducing the number of queries and the costs charged to their profit centres.
254
How is a budget plan usually initiated?
By the board setting a strategy which is communicated throughout the business. From this, profit centres prepare a plan for two to five years in support for the companies aims.
255
what are revenue budgets usually based on
actions planned for in the period and are based on a range of assumptions i.e economic environment, expected changes in competition, customer demand for new products.
256
how do you calculate the gross profit percentage
gross profit divided by revenue
257
if management information shows that the gross profit percentage is declining what does that show?
this is a sign that something needs to change, i.e maybe corrective action or a new line of business has commenced with a lower profit margin
258
if management accounts suggest a line of business is creating a lower profit margin, should we shut this down straight away?
No - before making a decision the finance team should prepare a forecast result assuming that line did not exist, to see whether this makes an overall difference,
259
How can we make a business decision to when to stop using a piece of capital equipment?
calculating the cost of labour, electricity costs for running the machine, the cost of the space and the capital cost of the machine spread over the years per life expectancy of the machine and see if the machine is operating at a loss
260
what are sunk costs?
Costs that are incurred by the company but not necessarily relevant to future decisions.
261
give an example of sunk costs
If a machine is a bespoke bit of equipment which can only be sold at the value which equates to the cost of removing the item
if the cost of the space occupied by a machine cannot be made use of in any other way
262
what are opportunity costs?
'revenue foregone' i.e by taking away resources from one department to focus on a new line of business = opportunities foregone by not being able to do other work
263
what should you consider when interpreting which project to select using internal rate of return and net present value?
Sometimes a project with a high IRR may only produce a small profit and it may e better to select a project with lower IRR if it has a higher NPV and only one project can be selected.
264
what is NPV?
Net present value - this shows a project, which is up for debate for selection, expressed in todays money.
I.e this recognises that £100 today might be worth more than earning £100 in a years time as cashflows in the future are reduced in value to recognise the cost of holding capital
265
What is the use of using IRR when measuring if a project is worth selection?
The internal rate of return - IRR shows the effective interest rate the project will produce.
I.e if an investment is £100 and the return is £110, the IRR is 10%
