Flashcards in Section B Questions Deck (25):
What is the Payback method and its drawbacks?
Payback measures how long it takes to recover the initial investment of a project. It has the following drawbacks:
- It ignores the size and direction of cash flows after the payback period.
- It ignores the time value of money.
What is Accounting Rate of Return (ARR) and its drawbacks?
ARR measures the average percentage return on an investment. It has the following drawbacks:
- Uses accounting figures that can be subjective.
- It has many different definitions.
- It is a relative measure so it ignores the size of cash flows.
- It ignores the time value of money.
When should the Payback method or ARR be used?
Payback method should be used when there needs to be capital rationing (funds are not easily available).
ARR can be useful when the project owner is assessed on accounting profits. Companies are often assessed on ROCE, so the share price can be related to the ARR.
What is depreciation?
It is a measure of the wearing out, consumption or other reduction in the useful economic life of an asset, whether due to consumption, effluxion of time or due to technology and market changes.
There is often a conflict between the accruals method (value based on an assets ability to generate profit) and the prudence concept (value based on market value).
When are the types of depreciation best suited?
Straight line method is best suited for assets that are used equally over their life.
Reducing balance is best used when an asset is used more in its early years.
Another method of depreciation would be to depreciate an asset proportionally to the amount that it has been used in a given year.
What is a Trial Balance?
It is a summary of nominal ledger balances that can be drawn up at any time. It acts as a valuable control in that all of the credits should equal the debits. This only occurs when the nominal ledger has been maintained correctly so it does not guard against the misposting of entries.
What is the Trial balance used for?
It is used to prepare financial accounts. It is the preliminary step in moving from the ledger to full statements as it contains all of the SoFP and IS accounts.
List the reasons that investors may be more willing to invest in a limited company.
- Shareholders would have limited liability, that is relative to the capital they have invested.
- The company becomes a legal entity that exists on its own (if the owner passes, the company remains).
- It can be easier to raise finances and there can be tax advantages.
- The drawbacks are that there are costs incurred to incorporation; preparing accounts that follow extensive rules, filing accounts to company house and auditing costs.
What is Sensitivity Analysis?
Measuring the % by which a figure must change before the decision to abandon or pursue a project changes.
What does Sensitivity Analysis involve?
It involves examining the sensitivity of the output from an analysis (such as NPV) to changes in individual assumptions.
(NPV of Project) / (PV of Cash Flow) x 100%
The lower the %, the more sensitive, this is useful for identifying the critical assumptions.
Give the framework of a good Trade Receivables management policy.
- A company needs to ensure the agreed terms are being followed.
- The policy should stipulate the content of the initial sales invoice.
- It should advise on the frequency to issue reminder statements for outstanding amounts.
- Ideally payments are settle as they fall due for payment.
- Any payments not received electronically should be banked quickly to avoid costs and maximise payments.
- If accounts become overdue then notices should be issued and visits should be made.
- Legal action should only be taken when absolutely necessary.
What is accounting?
It is the process of keeping financial accounts. It provides information that aids decision making and provides a stewardship function.
What is financial accounting?
It is concerned with the summary, analysis and reporting of financial transactions pertaining to a business. It involves the preparation of financial statements that are available for public consumption. They are also used by shareholders.
What is management accounting?
It is where managers use the provisions of accounting information to better inform themselves before making decisions. This can improves business growth and development.
What is profitability?
- How much profit a company if making.
- How much income exceeds expenses.
- Prepared by the accruals concept.
Profitability generates cash, so a company cannot make money without being profitable.
What is liquidity?
- The ability to pay debts.
- Measured by money tied up in working capital and cash.
It is possible to be highly profitable, but to be illiquid due to poor cash planning.
What are the advantages of a manager setting their own targets?
- Managers are based in the department and are therefore most familiar with the information.
- Can increase morale and motivation.
- Can be more realistic.
- Knowledge from several levels of management is pulled together.
What are the disadvantages of a manager setting their own targets?
- Can set targets too low that are easily achievable.
- Can set targets too high in an attempt to impress.
Discuss the importance of good Working Capital Management.
- Importance of managing cash resources to ensure the running of day to day operations and for omitting negative shareholder perceptions of short term liquidity.
- Allows planning/avoidance of cash flow issues.
- Generally considered that the lower the WC, the more is available to pay creditors, fund growth and pay debts.
- Enforcing a credit control system is a way of managing WC. This can make a company be considered efficient.
- Good WC management can mean suppliers are paid early/on time which can improve relations.
List the IASB's conceptual framework on qualitative characteristics.
Relevance - when it influences decisions.
Faithful Representation - information should faithfully represent relevant phenomena. It should be complete, neutral and free from error.
Comparability - more useful when it can be compared.
Verability - different and knowledgeable people should be able to reach the same views.
Understandability - classifying and representing information clearly aids understanding.
What are the issues relating to the valuation of non-current assets?
- NCAs have a useful economic life of > 12 months.
- Accruals concept matches benefit with cost.
- Two methods; reducing balance and straight line method.
- Depreciation is subjective, especially useful economic life and residual value.
- There is the option to revalue assets. Revaluation gains are recorded as 'other comprehensive income'.
List the benefits to adopting a budgeting system.
- Communicating (goals)
- Controlling (variance analysis)
- Coordinating (between departments)
- Motivating (targets)
- Cost analysis (leading to cost savings)
Why is profit not the same as cash?
- Accruals concept (revenues and expenses are accounted for in the period that they occur, regardless of whether the cash has moved or not).
- Purchase/Sale of NCAs doesn't affect profit, but depreciation does (it doesn't affect cash).
- Movements in working capital (increase in inventories reduces cash, but doesn't affect profits).
- Financing activities such as receipts of loans, issuing of shares and dividends affect cash but not profit.
What are the different forms of business and how do they differ?
Sole trader - One owner. Full liability.
Partnership - More than one owner. Full liability
Limited Liability Partnership (LLP) - More than one owner. Cross between partnership and company.
Company - More than one owner (shareholders). Limited liability (usually the capital invested). Company exists as its own legal entity.