100034 Adv Fin Acc 15 - Manual - Accounting Technicians ... · PDF...

Advanced FinancialAccounting

Course Text

Professional, Practical, Proven

www.AccountingTechniciansIreland.ie

100034 Adv_ Fin_Acc_15 - Manual.indb 1 04/08/2015 15:19


iii

Table of Contents

FOREWORD ...........................................................................................................................xi

SYLLABUS: ADVANCED FINANCIAL ACCOUNTING ......................................................xvii

CHAPTER 1: INTRODUCTION ...............................................................................................1

1.1 INTRODUCTION TO ADVANCED FINANCIAL ACCOUNTING..................................................1

1.2 CHAPTER OUTLINES ................................................................................................................3

CHAPTER 2: REGULATION IN FINANCIAL ACCOUNTING .................................................7

2.1 THE FUNCTION OF FINANCIALACCOUNTING AND REPORTING ........................................8

2.2 THE NEED FOR ACCOUNTING REGULATION ........................................................................92.2.1 Sole Trader ...................................................................................................................92.2.2 Partnerships................................................................................................................102.2.3 Unlimited Companies..................................................................................................102.2.4 Limited Companies ..................................................................................................... 112.2.5 The Regulatory Framework under which Financial Statements are prepared............12

2.3 INTERNATIONAL FRAMEWORK .............................................................................................13

2.4 NATIONAL FRAMEWORK........................................................................................................132.4.1 History ........................................................................................................................132.4.2 Current professional regulatory framework ................................................................142.4.3 The FRC Board...........................................................................................................142.4.4 The Executive Committee...........................................................................................152.4.5 The Conduct Committee .............................................................................................152.4.6 The Codes and Standards Committee........................................................................162.4.7 The Accounting and Reporting Policy Team ...............................................................16


Table of Contents

iv

Advanced Financial Accounting

2.5 THE STANDARD SETTING PROCESS ...................................................................................18

2.6 COMPANY LAW........................................................................................................................18

2.7 EU DIRECTIVES.......................................................................................................................20

2.8 STOCK EXCHANGE REGULATIONS ......................................................................................21

CHAPTER 3: ACCOUNTING CONCEPTS, CONVENTIONS AND FUNDAMENTALS........23

3.1 INTRODUCTION.......................................................................................................................24

3.2 THE OBJECTIVE OF FINANCIAL STATEMENTS (SECTION 2: 2.2) ......................................24

3.3 QUALITATIVE CHARACTERISTICS OF INFORMATION IN FINANCIAL STATEMENTS .......243.3.1 Understandability ........................................................................................................243.3.2 Relevance ...................................................................................................................243.3.3 Materiality....................................................................................................................253.3.4 Reliability.....................................................................................................................253.3.5 Substance over form...................................................................................................263.3.6 Prudence.....................................................................................................................263.3.7 Completeness .............................................................................................................273.3.8 Comparability ..............................................................................................................273.3.9 Timeliness...................................................................................................................273.3.10 Balance between benefit and cost ..............................................................................28

3.4 FINANCIAL POSITION .............................................................................................................28

3.5 FINANCIAL PERFORMANCE...................................................................................................29

3.6 RECOGNITION.........................................................................................................................30

3.7 MEASUREMENT ......................................................................................................................303.7.1 Historical Cost.............................................................................................................303.7.2 Fair Value....................................................................................................................30

3.8 PERVASIVE RECOGNITION AND MEASUREMENT PRINCIPLES ........................................31

3.9 FINANCIAL STATEMENT PRESENTATION ............................................................................313.9.1 Fair Presentation ........................................................................................................313.9.2 Going Concern............................................................................................................323.9.3 Frequency of Reporting ..............................................................................................333.9.4 Consistency of Presentation .......................................................................................333.9.5 Comparative Information.............................................................................................333.9.6 Materiality and Aggregation ........................................................................................333.9.7 Complete set of financial statements ..........................................................................34

3.10 THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING UNDER FRS 102 .........343.10.1 Importance of a Conceptual Framework.....................................................................343.10.2 Scope of the Conceptual Framework..........................................................................35

3.11 SECTION 10 ACCOUNTING POLICIES, ESTIMATES AND ERRORS....................................36

3.12 ACCOUNTING POLICIES ........................................................................................................373.12.1 Selection of Accounting Policies .................................................................................373.12.2 Consistent Application of Accounting Policies.............................................................37


Table of Contents

v


3.12.3 Change in Accounting Policies....................................................................................373.12.4 Disclosures of a Change in Accounting Policies .........................................................38

3.13 ACCOUNTING ESTIMATES.....................................................................................................383.13.1 Changes in accounting estimates ..............................................................................38

3.14 PRIOR PERIOD ERRORS........................................................................................................393.14.1 Correction of a Prior Period Error ...............................................................................393.14.2 Disclosures .................................................................................................................39

CHAPTER 4: INCOMPLETE RECORDS ..............................................................................45

4.1 INTRODUCTION.......................................................................................................................46

4.2 REVISION OF INCOMPLETE RECORD CONCEPTS .............................................................46

4.3 REVISION OF INCOMPLETE RECORD TECHNIQUES..........................................................46

4.4 RATIOS AS AMEANS OF CALCULATING MISSING FIGURES..............................................50

CHAPTER 5: PARTNERSHIPS.............................................................................................55

5.1 INTRODUCTION TO PARTNERSHIPS ...................................................................................56

5.2 PARTNERSHIP AGREEMENT..................................................................................................56

5.3 CAPITALAND THE CURRENT ACCOUNT..............................................................................57

5.4 THE APPROPRIATION ACCOUNT ..........................................................................................585.4.1 Interest on Capital.......................................................................................................585.4.2 Salaries .......................................................................................................................595.4.3 Drawings .....................................................................................................................595.4.4 Interest on Drawings ...................................................................................................605.4.5 Profit Sharing Ratio (PSR) ..........................................................................................605.4.6 Guaranteed Minimum Profit ........................................................................................615.4.7 Loans Extended from Partners to the Partnership Business ......................................61

5.5 PRO FORMA CURRENT ACCOUNT AND APPROPRIATION ACCOUNT...............................62

5.6 THE STATEMENT OF FINANCIAL POSITION OF A PARTNERSHIP......................................64

CHAPTER 6: SECTION 17: PROPERTY, PLANT AND EQUIPMENT .................................75

6.1 INTRODUCTION.......................................................................................................................76

6.2 PROPERTY, PLANT & EQUIPMENT – BOOKKEEPING ENTRIES.........................................76

6.3 SECTION 17: PROPERTY, PLANT AND EQUIPMENT............................................................79

6.4 INITIAL RECOGNITION............................................................................................................79

6.5 CAPITALISATION .....................................................................................................................80

6.6 MEASUREMENT OF ASSETS SUBSEQUENT TO INITIAL RECOGNITION ..........................83

6.7 DEPRECIATION........................................................................................................................90

6.8 DERECOGNITION....................................................................................................................93


Table of Contents

vi


6.9 DISCLOSURE...........................................................................................................................93

6.10 IMPAIRMENT............................................................................................................................94

CHAPTER 7: ACCOUNTING FOR INVENTORIES...............................................................99

7.1 INTRODUCTION.....................................................................................................................100

7.2 SCOPE OF FRS 102, SECTION 13 INVENTORIES .............................................................101

7.3 KEY DEFINITIONS UNDER SECTION 13..............................................................................102

7.4 FUNDAMENTAL PRINCIPLE OF SECTION 13......................................................................102

7.5 DETERMINATION OF COST AND NRV.................................................................................103

7.6 TECHNIQUES FOR THE MEASUREMENT OF COST..........................................................105

7.7 WRITE DOWN OF INVENTORY TO NRV ..............................................................................108

7.8 DISCLOSURE REQUIREMENTS UNDER FRS 102: SECTION 13.......................................109

CHAPTER 8: ACCOUNTING FOR LEASES....................................................................... 113

8.1 FRS 102: SECTION 20 LEASES ............................................................................................ 114

8.2 OBJECTIVES AND SCOPE OF SECTION 20 LEASES......................................................... 114

8.3 CLASSIFICATION OF LEASES.............................................................................................. 115

8.4 ACCOUNTING FOR FINANCE LEASES IN THE BOOKS OF THE LESSEE........................ 116

8.5 CALCULATION OF THE INTEREST CHARGE ...................................................................... 117

8.6 DISCLOSURE REQUIREMENTS FOR FINANCE LEASES ..................................................120

8.7 ACCOUNTING FOR AN OPERATING LEASE IN THE BOOKS OF THE LESSEE ...............120

8.8 DISCLOSURE IN RELATION TO OPERATING LEASES.......................................................121

CHAPTER 9: ACCOUNTING FOR GOVERNMENT GRANTS ...........................................125

9.1 INTRODUCTION.....................................................................................................................126

9.2 SECTION 24 GOVERNMENT GRANTS.................................................................................1269.2.1 Measurement under section 24 ................................................................................127

9.3 RECOGNITION.......................................................................................................................1279.3.1 Performance Model...................................................................................................1279.3.2 Accrual model ...........................................................................................................127

9.4 TREATMENT OF MONETARY GRANTS................................................................................1279.4.1 Monetary Grants Relating to Items of Revenue Expenditure....................................1289.4.2 Grants Relating to Items of Capital Expenditure.......................................................129

9.5 TREATMENT OF NON-MONETARY GOVERNMENT ASSISTANCE ...................................132

9.6 TREATMENT OF NON-MONETARY GRANTS ......................................................................132

9.7 REPAYMENTS OF GRANTS..................................................................................................132

9.8 REQUIRED DISCLOSURES ..................................................................................................133


Table of Contents

vii


CHAPTER 10: PROVISIONS AND CONTINGENCIES.......................................................137

10.1 FRS 102 SECTION 21 PROVISIONS AND CONTINGENCIES .............................................138

10.2 OBJECTIVES OF SECTION 21 PROVISIONS AND CONTINGENCIES ...............................138

10.3 PROVISIONS..........................................................................................................................13910.3.1 Present Obligation as a Result of a Past Event ........................................................13910.3.2 Transfer of Economic Benefit....................................................................................14010.3.3 Estimate/Measurement of the Provision ...................................................................14110.3.4 Reimbursements.......................................................................................................14110.3.5 Subsequent measurement........................................................................................141

10.4 ONEROUS CONTRACTS ......................................................................................................142

10.5 CONTINGENT LIABILITIES....................................................................................................143

10.6 CONTINGENT ASSETS..........................................................................................................143

10.7 CONTINGENT LIABILITIES, CONTINGENT ASSETS AND PROBABILITY ..........................144

10.8 DISCLOSURES ......................................................................................................................144

CHAPTER 11: EVENTS AFTER THE END OF THE REPORTING PERIOD......................149

11.1 INTRODUCTION.....................................................................................................................150

11.2 SECTION 32 EVENTS AFTER THE END OF THE REPORTING PERIOD ...........................150

11.3 AN ADJUSTING EVENT .........................................................................................................150

11.4 NON-ADJUSTING EVENTS ...................................................................................................152

11.5 GOING CONCERN .................................................................................................................153

11.6 DISCLOSURE REQUIREMENTS...........................................................................................153

CHAPTER 12: PREPARATION OF THE FINANCIAL STATEMENTS OF A LIMITED

COMPANY ...........................................................................................................................157

12.1 INTRODUCTION.....................................................................................................................158

12.2 RECAP ON THE FUNDAMENTALS OF FINANCIAL STATEMENT PREPARATION .............15812.2.1 Depreciation..............................................................................................................15812.2.2 Inventories ................................................................................................................16012.2.3 Irrecoverable receivables and Allowances for receivables .......................................16012.2.4 Accruals and Prepayments .......................................................................................163

12.3 INTRODUCTION TO THE STATEMENT OF COMPREHENSIVE INCOME FOR A LIMITEDCOMPANY ..............................................................................................................................164

12.4 MANUFACTURING ACCOUNT ..............................................................................................16512.4.1 Format of a Manufacturing Account ..........................................................................16712.4.2 The Format of the Trading account of a Manufacturing Company............................16712.4.3 Cost Classification ....................................................................................................168

12.5 FORMAT OF THE STATEMENT OF COMPREHENSIVE INCOME INLIMITED COMPANIES............................................................................................................171


Table of Contents

viii


12.6 THE FORMAT OF THE STATEMENT OF FINANCIAL POSITION FOR ALIMITED COMPANY ...............................................................................................................173

12.7 THE FINANCIAL STATEMENTS OF LIMITED COMPANIES .................................................17512.7.1 Corporation Tax.........................................................................................................17512.7.2 Other Comprehensive Income..................................................................................17812.7.3 Capital Structure of Limited Companies ...................................................................17912.7.4 Debentures ...............................................................................................................18312.7.5 Equity Reserves........................................................................................................184

12.8 STATEMENT OF CHANGES IN EQUITY ...............................................................................185

12.9 STATEMENT OF INCOME AND RETAINED EARNINGS.......................................................186

12.10 DISCLOSURE REQUIREMENTS...........................................................................................18712.10.1 Statement of Comprehensive Income Notes ............................................................18712.10.2 Statement of Financial Position Notes ......................................................................189

12.11 GOODWILL AND INTANGIBLE ASSETS ...............................................................................19012.11.1 Goodwill ....................................................................................................................19012.11.2 Intangible Assets......................................................................................................191

12.12 STATEMENT OF COMPREHENSIVE INCOME AND STATEMENT OFFINANCIAL POSITION – WORKED EXAMPLE 7 ..................................................................192

12.13 APPROACHING A QUESTION...............................................................................................199

CHAPTER 13: FRS 102: SECTION 7 STATEMENT OF CASH FLOWS............................205

13.1 INTRODUCTION.....................................................................................................................206

13.2 DEFINITIONS OF CASH AS PER FRS 102: SECTION 7 ......................................................207

13.3 DISTINCTION BETWEEN PROFIT AND CASH.....................................................................20713.3.1 Treatment of Capital Items........................................................................................20713.3.2 Non-Cash Items ........................................................................................................20813.3.3 The Application of the Accruals Concept ..................................................................209

13.4 PRO FORMA STATEMENT OF CASH FLOWS......................................................................210

13.5 CASH FLOW FROM OPERATING ACTIVITIES – DIRECT AND INDIRECT METHODS ...... 211

13.6 PREPARATION OF A STATEMENT OF CASH FLOWS......................................................... 21113.6.1 Cash flow from operations - explaining and calculating the entries .........................21213.6.2 Profit/Loss from sale of property, plant & equipment ................................................21413.6.3 Movements in Working Capital Items .......................................................................21513.6.4 Other Adjustments ....................................................................................................21613.6.5 Cash flow from investing activities - explaining and calculating the entries..............21813.6.6 Cash flows from financing activities - explaining and calculating the entries............22413.6.7 Dividends Paid ..........................................................................................................225

13.7 CASH AND CASH EQUIVALENTS NOTE..............................................................................225

13.8 INTERPRETATION OF A STATEMENT OF CASH FLOWS ...................................................225

13.9 APPROACHING A CASH FLOW QUESTION ........................................................................227


Table of Contents

ix


CHAPTER 14: RATIO ANALYSIS .......................................................................................233

14.1 INTRODUCTION.....................................................................................................................234

14.2 TYPES OF RATIO ANALYSIS AND USES THEREOF ...........................................................234

14.3 INFORMATION FOR RATIO CALCULATIONS.......................................................................236

14.4 PROFITABILITY RATIOS........................................................................................................238

14.5 LIQUIDITY RATIOS.................................................................................................................241

14.6 EFFICIENCY RATIOS AND WORKING CAPITAL CYCLE .....................................................243

14.7 GEARING RATIOS..................................................................................................................248

14.8 INVESTMENT RATIOS...........................................................................................................249

14.9 OVERTRADING......................................................................................................................252

14.10 SOLVENCY.............................................................................................................................253

14.11 RATIO ANALYSIS AS A DECISION MAKING TOOL...............................................................254

14.12 SUGGESTED REPORT FORMAT..........................................................................................255

14.13 LIMITATIONS OF RATIO ANALYSIS ......................................................................................262

CHAPTER 15: INTERNAL AND EXTERNAL AUDIT AND ETHICAL ISSUES...................271

15.1 INTRODUCTION.....................................................................................................................272

15.2 THE IMPORTANCE AND NATURE OF THE EXTERNALAUDIT...........................................27215.2.1 Agency Theory as Applied to Public Limited Companies..........................................27315.2.2 Reducing Agency Problems through the External Audit Process .............................274

15.3 THE COMMON MISPERCEPTIONS OF THE EXTERNALAUDIT.........................................27515.3.1 Opinion Not Fact .......................................................................................................27515.3.2 Fraud.........................................................................................................................275

15.4 FACTS CAN CHANGE............................................................................................................276

15.5 INTERNAL CONTROL SYSTEMS AND CORPORATE GOVERNANCE ...............................27615.5.1 Internal Control Systems...........................................................................................27615.5.2 The Turnbull Report and Internal Control Systems...................................................27715.5.3 Financial Internal Controls - An Example..................................................................277

15.6 INTERNALAUDIT ...................................................................................................................279

15.7 DIFFERENCES BETWEEN EXTERNALAND INTERNALAUDIT..........................................27915.7.1 Scope of the Work ....................................................................................................27915.7.2 Independence ...........................................................................................................27915.7.3 Reporting ..................................................................................................................28015.7.4 Legal Requirement of Both .......................................................................................280

15.8 ETHICAL ISSUES (CORPORATE SOCIAL RESPONSIBILITY) ............................................28215.8.1 Future Developments................................................................................................282


Table of Contents

x


15.9 ETHICS AND COMPANIES ....................................................................................................28315.9.1 The Rules Based Approach .....................................................................................28315.9.2 The Principles Based Approach................................................................................283

15.10 ETHICS AND THE ACCOUNTING PROFESSION.................................................................284

INDEX...................................................................................................................................289


xi

FOREWORD

Foreword

This text has been developed byAccounting Technicians Ireland for use by students participating inour programme of study and preparing for our examinations based on the new syllabus publishedfor the Academic Year 2015-2016.

While every effort is made to ensure that the information outlined in this text is accurate, AccountingTechnicians Ireland cannot accept the responsibility for lack of, or perceived lack of, informationcontained herein.

The text is intended to be a sufficiently detailed synopsis of the 2015-2016 syllabus material (andknowledge level required thereof) in relation to this module.

Students should take particular note of the weighting attaching to this module, as clearly outlined in thesyllabus. It is on the basis of this weighting that students should prepare their own timetable for study.

This text also includes questions related to the topics for this module. These questions are part of alarger database of questions that students (and also Lecturers) can access online for this subject. Thesequestions (and suggested solutions) are available through your “TouchPoint” portal in the MyRevisionarea.

We recommend that students refer to MyRevision having completed each chapter or a section of thismodule. This resource allows students to study and revise online through ‘self-test’ questions. Examstandard questions are also available here.

We also recommend students refer to the past exam papers for this module. These papers are publishedon our website (www.AccountingTechniciansIreland.ie) along with suggested solutions and commentsfrom the Examiner. Attempting these “under exam conditions” will help students to prepare for theexamination and plan their study time appropriately.


xii

Referencing

For the purposes of consistency, all references to “he” or “she” will be referred to as “he” in thispublication. No other implication whatsoever is implied from this policy.

For the purposes of presentation, all references to “euro” or “sterling” will be referred to as “euro” inthis publication. No other implication whatsoever is implied from this policy.

Acknowledgement

This text was reviewed and edited by Anne Marie Ward. Anne Marie is Professor of Accounting atUlster University, Jordanstown.

Copyright

This text is issued by Accounting Technicians Ireland to students taking its examinations. It may notbe used in whole, or in part, for any course of study and/or examination of any other body whatsoeverwithout prior permission in writing from Accounting Technicians Ireland. This publication, or any partthereof, may not be made available in any library, and it may not be reproduced, in whole or in part,stored in a retrieval system or transmitted in any form or by any means – photocopying, electronic,electrostatic, magnetic, pdf, mechanical, recording or otherwise, without prior permission in writingfrom Accounting Technicians Ireland, 47-49 Pearse Street, Dublin 2.


xiii


xiv


xv


xvi


xvii

SYLLABUS: ADVANCED FINANCIAL ACCOUNTING

Module:Advanced Financial Accounting

Mandatory Module

SYLLABUS 2015-2016


Syllabus 2015-2016

xviii



Subject Status Mandatory

Terminal Exam 100%

Module Pass Mark 50%

Learning Modes Direct Lectures, Workshops, Online Tutorials, Self-Directed Learning

Pre-requisite: Financial Accounting, Taxation and either Business Management or Law& Ethics

Key Learning Outcome

The key objectives of this module is to ensure that learners build on the competencies gained inFinancial Accounting and develop a knowledge and understanding of more advanced accountingissues.

Key Syllabus Elements and Weightings

1. Conceptual and Regulatory Framework............................................................................... 30%

2. Financial Statements............................................................................................................ 50%

3. Interpretation of Financial Statements.................................................................................. 20%


Syllabus 2015-2016

xix


Learning Outcomes linked to Syllabus Elements

Conceptual and Regulatory Framework

On completion of this aspect of the module, learners will have acquired the following knowledge,competencies and know-how: -

(a) An understanding of the influence of legislation and accounting; standards on the production ofpublished accounting information for organizations;

(b) An understanding of the accounting standard setting process;

(c) A knowledge of and ability to critically analyse specified accounting standards;

(d) Be able to recognise and comment on professional ethical issues relevant to business owners,managers and accountants.

Financial Statements

On completion of this aspect of the module, learners will have acquired the following knowledge,competencies and know-how:-

(a) The ability to prepare accounts from incomplete records;

(b) The ability to prepare financial statements for partnerships and demonstrate an understandingof capital and current accounts for individual partners;

(c) The ability to prepare accounts for limited companies for internal and external purposes anddemonstrate an understanding of the impact of legislation and accounting standards on thepublication of financial statements;

(d) An appreciation of the importance of cash to business and the ability to prepare cash flowstatements for limited companies.

Interpretation of Financial Statements

On completion of this aspect of the module, learners will have acquired the following knowledge,competencies and know-how:-

(a) An ability to understand, explain and use ratio analysis as a technique in decision making andperformance evaluation

(b) The ability to critically analyse and interpret financial statements and communicate in aprofessional manner to relevant interested parties.


Syllabus 2015-2016

xx


MODULE: ADVANCED FINANCIAL ACCOUNTING

Specific Functional Knowledgeand Competencies

Understanding Application Analysis

Conceptual and Regulatory Framework (30%)

Influence of legislation and accounting standards on the production ofpublished accounting information for organisations

Impact of legislation on the preparation andreporting of financial statements

l

Roles of the Financial Reporting Council, theAccounting Standards board, the ExecutiveCommittee, the Conduct Committee, theCodes and Standards Committee and theAccounting and Reporting Policy Team.

l

Application of FRS 102 to the preparationand presentation of financial statements

l

Framework for the Preparation and Presentation of Financial Statements

FRS 102 – Section 1 (Scope) l l

FRS 102 – Section 2 (Concepts & PervasivePrinciples)

l l

The objective of financial statements l l

Underlying assumptions l l

Qualitative characteristics of financialstatements

l l

Elements of financial statements l l

Standard setting process

Standard setting process l

Accounting standards and the law l

Published accounts l l l

The role of the stock exchange l

Internal and external auditors and ethical issues for the AccountingTechnician

Role and duties of internal and externalauditors

l

Internal control systems l l l

Ethical issues and responsibilities accruing l l


Syllabus 2015-2016

xxi




Content and application of specified sections of FRS 102 (excluding GroupAccounts throughout)

Section 3: Financial Statement Presentation l l l

Section 4: Statement of Financial Position l l l

Section 5: Statement of ComprehensiveIncome and Income Statement

l l l

Section 6: Statement of Changes in Equityand Statement of Income and RetainedEarnings

l l l

Section 13: Inventories l l l

Section 7: Statement of Cash Flows(excluding Foreign Exchange cash flows)

l l l

Section 10: Accounting Policies, Estimatesand Errors

l l l

Section 29: Income Tax (excluding DeferredTax)

l l l

Section 32: Events after the End of theReporting Period

l l l

Section 17: Property, Plant and Equipment l l l

Section 20: Leases l l l

Section 24: Government Grants l l l

Section 21: Provisions and Contingencies l l l

Professional ethical issues for business owners, managers and accountants

Understanding and application of ethicalissues

l l

Financial Statements (50%)

Financial statements for limited companies for internal and externalpurposes

Preparation of financial statements forlimited companies

l l

Differences between a sole trader and alimited company

l l l

Accounting records of a limited company l l l


Syllabus 2015-2016

xxii




Capital structure of a limited company l l l

Share premium account l l l

Dividends l l l

Reserves l l l

Practical application of FRS 102 sectionsalready listed

l l l

Disclosure and filing requirements for limited companies

Format and filing requirements l l l

Wording and layout of an Income Statement,Statement of Comprehensive Income andStatement of Financial Position

l l l

Size criteria for companies l l l

Disclosure Requirements l l l

Split of turnover l l l

Details regarding staff numbers andremuneration

l l l

Movement in non-current assets l l l

Details of taxes owing l l l

Cash flow statements for limited companies and an understanding of theimportance of cash to the business entity

Preparation of cash flow statements inaccordance with FRS 102 Section 7:Statement of Cash Flows

l l l

Importance of cash to a business entity l l l

Preparation of reports on the interpretationof a cash flow statement

l l l

Preparation of financial statements for partnerships

Preparation of financial statements of apartnership

l l

Preparation of, and distinction between, thecapital and current accounts of individualpartners

l l


Syllabus 2015-2016

xxiii




The accounts of manufacturing businesses

Classification of costs l l

Work in progress l l

Preparation of the manufacturing account l l

Preparation of accounts from incompleterecords

Incomplete records l l

Preparation of accounts from incompleterecords

l l

Interpretation of Financial Statements (20%)

Ratio analysis of accounting information

Broad categories of ratios l l l

Profitability and return on capital employed l l l

Long term solvency and stability l l l

Short term solvency and liquidity l l l

Efficiency l l l

Shareholders’ investment ratios l l l

Interpretation of Financial statements and explanation of ratios used

Interpretation of Financial Statements l l l

Explanation of information provided by ratios l l l

Limitations of ratio analysis l l l

Preparation of reports for the users of accounting information as a tool inthe decision making process

Preparation of reports in a professionalmanner

l l l

Ratio analysis in the decision makingprocess

l l l


Syllabus 2015-2016

xxiv


Assessment Criteria

AssessmentTechniques

100% Assessment based on the final examination.

Format ofExamination Paper

The Paper Consists of SIX Questions which will examine all keysyllabus elements to ensure that learning outcomes are achieved

SECTION ATHREE Compulsory Questions

SECTION BTHREE Questions - Answer TWO(All questions in Section B carry equal marks)

Sample Papers Each of the 3 sample papers will examine appropriate parts of thissyllabus.

Essential Reading Advanced Financial Accounting(Second Year)

Author: Accounting Technicians Ireland

Web Resources www.AccountingTechniciansIreland.iewww.charteredaccountants.iewww.ft.comwww.frc.org.uk

Other Resources Business and FinanceAccountancy IrelandIrish Times Business SectionIrish Independent Business SectionSunday Business PostFinancial Times


1

CHAPTER 1: INTRODUCTION

CHAPTER 1

Introduction

1.1 INTRODUCTION TO ADVANCED FINANCIAL ACCOUNTING

Over the past decade financial accounting in the UK and Ireland has experienced much change. Tofacilitate the harmonisation of accounting practices, the European Union (EU) decided that publiclylisted companies with shares quoted on securities exchanges within the EU should have their financialstatements prepared using International Financial Reporting Standards (IFRS) from 1 January 2005.Convinced that harmonisation was the ‘way forward’ the accounting setting body for the UK and Irelandat the time, the Accounting Standards Board (ASB), decided to make changes to its national standardswhich were typically used when preparing the financial statements of non-public companies. The nationalstandards were called Financial Reporting Standards (FRSs) and Statements of Standard AccountingPractice (SSAPs). The accounting bodies, including Accounting Technicians Ireland, started to teachfinancial accounting using IFRS on the assumption that harmonisation would continue until completeadoption occurred.

However, in 2006, the ASB started a consultation on complete harmonisation, wherein the alreadyavailable standard, the IFRS for SMEs (Small and Medium-sized Entities) was suggested as a substitutefor the numerous national standards that were in existence (except for the Financial Reporting Standardfor Small-Sized Entities which was widely supported by users and preparers). However, respondentsto the consultation process were not supportive of extending the use of EU-adopted IFRS. Therefore,the ASB amended the IFRS for SMEs to make it relevant to a broader range of preparers and usersand to eliminate parts that were not supported in the UK and Ireland. The resulting national frameworkis currently six standards. These standards were issued by the Financial Reporting Council (FRC) - thecurrent body responsible for issuing accounting standards in the UK and Ireland. One of the standards,Financial Reporting Standard (FRS) 102 is applicable to the majority of reporting entities in the UKand Ireland from 1st January 2015 and hence, Accounting Technicians Ireland have decided to teachfinancial accounting using this framework from 2015/16.

The result of this is that accounting for entities in the UK and Ireland is not simple. Companies with sharespublicly traded must adopt IFRS, however most other companies have a choice; they can adopt IFRSor UK and ROI Generally Accepted Accounting Practice. This means that there are two frameworks thatstudents need to be aware of and though the terminology used by UK and ROI standard setters and the


Chapter 1 : Introduction

2


international accounting standard setters is the same, legislation in the UK and the ROI uses differentterminology. The differences arise because, the content of FRS 102 is based on IFRS and, therefore,uses IFRS language and terminology, whereas the statutory formats were set out in legislation thatoriginally pre-dated the introduction of IFRS to ROI and UK.

For example under UK/Irish law the term given to credit customers who owe money to a company isdebtors, under accounting regulation the term used is trade receivables. In both cases the underlyingitem is the exact same – credit customers who owe monies to the company. The most commondifferences are:

FRS 102 vocabulary Equivalent statutory vocabulary

Income Statement Profit and Loss Account

Statement of Comprehensive Income Not referred to

Statement of Financial Position Balance Sheet

Statement of Changes in Equity Not referred to

Statement of Cash Flows Not referred to

Property, plant and equipment Tangible assets

Investment property Tangible assets

Financial assets Investments/Financial assets

Inventories Stocks

Receivables Debtors

Cash equivalents Short-term investments

Bank Cash at bank and in hand

Current liabilities Creditors: Amount falling due within one year

Trade payables Trade creditors

Non-current liabilities Creditors: Amount falling due after one year

Retained earnings Profit and loss account

Allowance for receivables Allowance for doubtful debts

Irrecoverable receivables Bad debts

Revenue Turnover

The Advanced Financial Accounting syllabus (and this text) have been written using the FRS 102vocabulary shown in the above table. This approach has been followed as FRS 102 is closely based onthe IFRS terminology. Students should note, however, that companies may use the statutory vocabularywhen preparing financial statements.

Nonetheless, for consistency and simplicity, the FRS 102 vocabulary will be used throughout this textand in your examination.



3


1.2 CHAPTER OUTLINES

The manual is split into 15 chapters and a brief outline of each chapter is now provided.

Chapter 1: Introduction

Chapter 1 provides the contextual background for Advanced Financial Accounting, highlighting theregulatory framework being followed (UK and ROI Generally Accepted Accounting Practice), thedifferences in the terminology between Financial Reporting Standard (FRS) 102, the Financial ReportingStandard applicable in the UK and Republic of Ireland, and the terminology required under companylegislation (which is used in practice in Ireland and in the UK). Most small and medium sized entities inIreland and in the UK have elected to follow the FRS issued by the Financial Reporting Council (FRC)and prepare them in compliance with company law. The FRC assumed responsibility for accountingstandards on 2 July 2012.

The rest of this chapter provides a brief summary of the contents of each chapter in the manual.

Chapter 2: Regulation in Financial Reporting

The introductory part of chapter two describes the financial accounting function and explains the linkbetween the Financial Accounting course and the Advanced Financial Accounting Course. However,the regulatory framework for financial reporting is the main focus of this chapter. Regulation typicallycomes from three sources, company law, stock exchange rules and the accounting profession. In thismanual the focus is on the UK and ROI accounting framework, though also provides a brief account ofthe international framework. To this end, the chapter describes the structure of the bodies that supportthe professional accounting standard setting body in the UK and Ireland, the FRC. The chapter not onlydescribes the UK and ROI regulatory structures but it also outlines the processes that are followed bythe FRC when formulating a new, or updating an existing standard. The role of the EU and legislation onfinancial reporting are also briefly considered as are stock exchange requirements.

Chapter 3: Accounting Concepts, Conventions and Fundamentals

This chapter considers the fundamental principles that underpin financial accounting. This version ofthe manual has been written using the current UK and ROI framework, in particular, FRS 102. Thenew approach by the UK and ROI accounting standard setters is not to refer to a separate documentthat deals with a generic framework; instead a number of sections at the start of FRS 102 sets out thefundamentals. Section 2 Concepts and Pervasive Principles, details the objective of financial statements,the qualitative characteristics of information in financial statements, the items to be included whendetermining an entity’s financial position and performance including definitions, recognition criteria andmeasurement basis. Section 3 Financial Statement Presentation explains fair presentation and how thiscan be achieved. The latter part of the chapter deals with Section 10 ‘Accounting Policies, Estimates andErrors’, detailing differences between the treatment of each type of change that is required to alreadyprepared financial statements.

Chapter 4: Incomplete Records

The technical side of accounting that was focused on in Financial Accounting is revisited in this chapter.This provides a strong foundation for the rest of the text as students are encouraged to revisit all the



4


adjustments and control accounts that were examined in depth in Financial Accounting. Proforma controlaccounts are provided and a range of questions are included at the end of the chapter for revision.

Chapter 5: Partnerships

This chapter starts by recapping (from Financial Accounting) on what partnerships are and outlines thetypical contents of a partnership agreement. Partnership financial statements are similar to sole traders’financial statements but their capital (equity) account is more complicated. Instead of having a singlecapital account, partnerships typically have two accounts for each partner, called the capital accountand the current account. The capital account records the long-term investment made by the partnersand the current accounts records the profit allocation and the drawings from those profits. In addition,another statement called the profit and loss appropriation account is required. This account shows theadjustments to and from distributable profit before it is split between the partners in their profit sharingratio.

Chapter 6: Property, Plant and Equipment

This chapter examines FRS 102: section 17 Property, Plant and Equipment. It discusses the valuationof assets, their subsequent revaluation and devaluation, depreciation, the sale of an asset and thedisclosure requirements for property, plant & equipment. Several worked examples are used to explainthe treatment under section 17.

Chapter 7: Accounting for Inventory (Stock)

This chapter examines FRS 102: section 13 Inventories. It defines inventory, highlights the impact thatinventory valuation has on the financial statements, highlights the fundamental principle underpinningthe valuation of inventory, works through an example on the valuation of inventory and on the inventoryflow assumptions (FIFO and weighted method).

Chapter 8: Accounting for Leases

This chapter examines FRS 102: section 20 Leases. This is a controversial standard that is currentlybeing updated by the IASB and therefore is subject to change as the FRC try to keep their standardsconsistent with international practice. However, for the purpose of the syllabus it has been decided toexamine what is covered in the manual. This chapter outlines the differences between an operatinglease and a finance lease and the accounting for each type.

Chapter 9: Accounting for Government Grants

The accounting treatment for government grants is provided in FRS 102: section 24 Government Grants.It highlights that grants need to be classified as either revenue (period) or capital (related to an asset).The accounting treatment for each type will differ and examples of both are included in this chapter.Indeed, two treatments are allowed for capital grants under international financial reporting standardsthough only one is included in FRS 102 section 24. This chapter highlights this and explains why.



5


Chapter 10: Provisions, Contingent Liabilities and Contingent Assets

Accounting for provisions, contingent liabilities and contingent assets is covered by section 21 Provisionsand Contingencies of FRS 102. Using this standard, Chapter 10 defines, explains and provides examplesof provisions, contingent liabilities and contingent assets. It can sometimes be difficult to determine ifan event is a liability that requires a provision or a contingent liability. By explaining the conditions forrecognition of a provision or a contingent liability and by providing a number of worked examples, thischapter aims to provide students with the skills that enable them to recognise the conditions that arerequired for either and to then advise on the appropriate accounting treatment, including disclosures.

Chapter 11: Events after the end of the Reporting Period

This topic is covered in section 32 of FRS 102 and the chapter is written using the guidance on accountingfor events after the reporting period that are outlined in this section. Specifically the chapter identifiestwo types of event, those that are ‘adjusting events’ and those that are ‘non-adjusting’. Lists of examplesand problem questions and solutions are used to assist students in their comprehension of this topic.

Chapter 12: Preparation of Financial Statements of a Limited Company

One of the larger chapters in the manual, this chapter deals with the published financial statements (theincome statement or the statement of comprehensive income – where there is other comprehensiveincome), the statement of financial position and a new statement called the statement of changes inequity). The chapter starts off by examining some new transactions that are unique to companies suchas taxation, debentures and issuing shares. It uses double entry and worked examples to guide thestudent through the new adjustments. Then manufacturing accounts are introduced. This statement isunique to manufacturing entities and provides a detailed breakdown of all the factory costs that makeup the cost of goods sold in the company’s income statement. As this statement focuses on identifyingand analysing costs, a section is included which considers all the different revenue costs that a companyincurs and details how these are classified as either factory direct or indirect, (in which case they willbe included in the manufacturing account) or administration, selling and distribution or finance costs (inwhich case they will be included in the income statement).

Finally, a section discusses each of the main statements, proformas for each type of statement areprovided and worked examples outline how to prepare each type of statement from source information.

Chapter 13: Statement of Cash Flows

This chapter starts by explaining the importance of cash for a business and more importantly howuseful it is for stakeholders to know the sources and uses of cash in a period. A brief explanation ofthe difference between profit and cash is provided with examples of non-cash items and accountingadjustments that are required under the accruals and matching concept but which are not cash. Nextthe format, as recommended by FRS 102: Section 7 Statement of Cash Flows, of the statement of cashflows is explored with a proforma and a discussion of the typical entries that can be found under thethree main headings: Cash flows from operating activities, cash flows from investing activities and cashflows from financing activities. Perhaps you, the reader, could list five types of cash flow that you mightexpect to find under each heading? The chapter provides detail on a number of calculations that youtypically have to do when preparing the statement of cash flows from the income statement such astaxation, interest, grants, property, plant & equipment and issuing shares.



6


Finally the last part of the chapter discusses the interpretation of the statement of cash flows andoutlines the best way to approach preparing a statement of cash flows in an exam type question.

Chapter 14: Ratios

This chapter introduces ratio analysis and how it can be used to compare the financial statements of anentity across time, across companies and relative to the industry average. It discusses a variety of ratiosthat are analysed according to their ability to provide information on the profitability, liquidity, efficiency,gearing and investment potential of an entity.

In the latter part of the chapter overtrading is explained and the symptoms discussed. Then guidanceon preparing a report is provided. Examination questions on ratio analysis typically require a report tobe prepared so a proforma is presented and a worked example puts the theory into practice. Finally, thelimitations of ratio analysis are outlined.

Chapter 15: Internal and External Audit and Ethics Issues

By this stage of the manual, students should have a reasonable understanding of accounting andthe systems underpinning accounting transactions. The concluding chapter in the manual deals withauditing. This topic is left to last on purpose as it is easier to understand its role and the types oftesting used after a good knowledge of accounting is achieved. This chapter considers the importanceof external audits and why they are carried out, explains the limits of an audit, describes and discussesthe internal control function and the internal audit function, explains the difference between external andinternal auditing and discusses the importance of ethics in financial accounting and the processes theaccounting profession have put in place to promote ethical behaviour within their membership.


7

CHAPTER 2: REGULATION IN FINANCIAL ACCOUNTING

CHAPTER 2

Regulation in FinancialAccounting

LEARNING OUTCOMES

Upon completion of this chapter you should be able to understand:

• Why accounting regulations are important and required.

• The need for and the structure of professional regulation, company law, stock exchangelegislation and EU Directives.

• How the different aspects of regulation work together and complement each other.

• The process through which an accounting standard comes into being.

REVISION RESOURCES

EXAM QUESTIONS: Sample and Past papers are available from the website of AccountingTechnicians Ireland and are essential aids when studying Advanced Financial Accounting topics.


Chapter 2 : Regulation in Financial Accounting

8


2.1 THE FUNCTION OF FINANCIAL ACCOUNTING AND REPORTING

The Financial Reporting Council (FRC) in Section 2 Concepts and Pervasive Principles of FRS102state that ‘the objective of financial statements is to provide information about the financial position,performance and cash flows of an entity that is useful for economic decision-making by a broad rangeof users who are not in a position to demand reports tailored to meet their particular information needs’(FRS102:2.2). Therefore themotivation for all accounting is to provide information, financial or otherwise,that can assist the users of financial statements in their economic decision-making. In addition financialstatements aim to provide information on the stewardship of management (FRS102:2.3). The financialstatements act as vehicles for management to show how they have managed the resources (assets)entrusted to them by the owners. This includes proving information on how the assets were used togenerate profits and cash flows. The conceptual and pervasive principles underpinning accountingunder UK and ROI GAAP are discussed in detail within chapter 3.

While there are many definitions of accounting worldwide, provided by various accounting bodies, alltend to have the following elements in common. That is that financial accounting is a process which isundertaken with the ultimate aim of:

• Identifying

• Measuring

• Communicating

information to the users of accounting information, in order to allow them to make informed judgementsand decisions. The information which is identified, measured and communicated is largely financial innature.

The identification of information is undertaken in the bookkeeping process - covered in FinancialAccounting. Here transactions are identified and recorded in the books and records of the businessentity via the double entry system of bookkeeping.

At year-end or month-end, information is extracted from the double entry bookkeeping system and ismeasured, presented (disclosed) and communicated in a manner that is more understandable to theusers of accounting information through the financial statements. The Statement of ComprehensiveIncome provides information on the income, expenditure and resultant profitability of the entity. Whilein the Statement of Financial Position, information relating to the assets and liabilities and the ultimatefinancial position of the business entity is measured and communicated.

Financial Accounting focused on the following areas:

• Identification and recording of financial information – this is achieved via the double entry bookkeepingsystem which records transactions. Accounting procedures such as the preparation of controlaccounts and bank reconciliation statements ensure that the information contained in the doubleentry system is accurate. Items in the control accounts or bank reconciliation for which there isinadequate information are initially recorded and subsequently corrected via a suspense account.This suspense account is a working account that must be cleared before the financial statements arepublished. (A suspense account should never appear in either an Income Statement or Statement ofFinancial Position).

• Measuring the financial performance of a sole trader via the Income Statement and the Statement ofFinancial Position.

• Communicating by preparing the financial statements of a sole trader or a not-for profit organisation.



9


In Advanced Financial Accounting, the knowledge gained in Financial Accounting is built and expandedupon. The preparation of an Income Statement (Statement of Comprehensive Income) and Statementof Financial Position for a partnership and limited company are examined. A new financial statementthat measures the cash position of a business entity is also examined. Therefore while FinancialAccounting primarily focused on identifying and measuring financial information, Advanced FinancialAccounting focuses on the communication of this information to users of accounting information. Howthis information is communicated is extremely important as the ultimate aim of the financial accountingprocess is to produce financial information about an entity that is understandable, relevant, reliable andcomparable to aid the users of financial information make decisions about the business entity.

Take for example the financial information of a limited company – this is potentially of interest to a widevariety of users (e.g. suppliers, investors, credit institutions, etc.) of accounting information. All of theseusers have different needs and requirements. Therefore the manner in which financial information iscommunicated is important.Asignificant body of professional regulation andCompany Law requirementsseek to ensure that appropriate detail is provided in a readily understandable format to meet varioususers’ needs. These rules and regulations are discussed in detail in Advanced Financial Accounting.

It should be clear that the information presented in Financial Accounting and Advanced FinancialAccounting combined describe in detail the financial accounting process. Students should be awarethat the information presented in Financial Accounting is assumed knowledge and is built upon over thecourse of Advanced Financial Accounting. It is quite possible that the Advanced Financial Accountingexamination will incorporate areas covered in Financial Accounting.

2.2 THE NEED FOR ACCOUNTING REGULATION

When an individual chooses to set up a business, that business can be carried on through the mediumof either: a sole trader business, a partnership, a limited company or a European Company. AEuropeancompany (Societas Europaea (SE)) operates on a Europe-wide basis and is governed by EC law directlyapplicable in the Member States, rather than by national law.

The decision, as to which medium to carry on a business through, depends upon several factors.Conducting business through each type of business entity has both advantages and disadvantages.These, other than a European Company, were examined in Financial Accounting and are assumedknowledge. A European Company can be a public or private company. It can operate on a Europewide basis and is governed by Community law directly applicable to all European member states. Theadvantages of a European Company is that is allows businesses to merge and operate through theEU using a single set of rules and unified management and reporting systems. In addition, EuropeanCompanies can restructure quickly and easily to take advantage of internal trading markets.

Theneed forand importanceofaccounting regulationonlybecomesapparentwhen thekeycharacteristicsof the various mediums through which a business venture can be carried on is examined.

2.2.1 Sole Trader

A sole trader business, as the name suggests, is a business where one person owns the business.A sole trader business tends to be small and operates on an informal basis. Further and critical tounderstanding the need for professional regulation, the following two traits of a sole trader businessmust be understood:



10


• A sole trader will usually undertake an active role in the management and running of the business.Therefore on a daily basis a sole trader will know how the business is performing in financial terms.The Income Statement and Statement of Financial Position produced at the end of each month/yearwill just formalise in financial terms what the sole trader is already aware of.

Sole traders are only required to produce financial information for the tax authorities or where a loanis being sought they may be required to produce this information for the lending institution.

• The sole trader and the business are not recognised as separate legal entities, and because of thissole traders have unlimited liability. Unlimited liability means that there is no distinction between thesole trader’s personal wealth and that of the business. If the business runs into financial difficulty andcannot meet its debt repayments, the business’s payables (people to whom money is owed) haverecourse to the personal assets of the sole trader. The sole trader bears all the risks and receives allthe return from the business operations. This feature reduces the risk of interacting on a businesslevel with sole traders as not only do payables have recourse to the wealth of the business but to thepersonal wealth of the sole trader, should the business fail.

• The sole trader is responsible for the tax on all the profits of the business and hence it is regarded asa drawing, not a business expense.

2.2.2 Partnerships

Partnerships are business entities where ownership is divided between at least two people. Usuallypartnerships have no more than twenty individual partners. Partnerships are discussed in detail inChapter 5. However for the moment the most important feature of a partnership business is that, likea sole trader business, partners in a partnership tend to be involved in the day to day operations ofthe business. Partnerships are not required to produce financial information for any other users ofaccounting information except the partners of the partnership, the tax authorities or a lending institution,where applicable. Like sole traders, partners in a partnership typically do not enjoy limited liability;however, some partnerships can incorporate as Limited Liability Partnerships (LLPs). For example,PricewaterhouseCoopers LLP or KPMG Europe LLP. A LLP is a partnership that is set up as a corporatebody (an independent legal entity that is separate from the partners). The members (partners) havejoint responsibility for the business; however, are not responsible for the other partner’s actions. Likeshareholders in a limited company, partners in a LLP cannot lose more than they invest, unless theyhave committed fraud or wrongful trading. If one partner commits a fraud and the other partners areunaware of this and have good business practices which are designed to circumvent or uncover fraud,then they, as individuals, are not liable for the claims made because of actions by that partner.

There are similarities between a LLP and a partnership when it comes to taxation, with the partnersbeing legally responsible for their share of the tax on business profits, not the LLP (The taxation expensedoes not form part of the financial statements of a LLP).

2.2.3 Unlimited Companies

It is possible to have an unlimited company which is much the same as a limited company; except thatthe liability of the members is unlimited (This fact will be stated in the company’s Memorandum andArticles of Association). An unlimited company has the advantage of not requiring a Court Order inorder to return its capital to its members and has recently become more common for certain groups ofcompanies to have an unlimited company in their group structure for this reason.



11


2.2.4 Limited Companies

The term limited company is derived from the fact that, in most cases, the liability of the owners(shareholders) of a limited company is limited to the funds which they have invested in the company. Insome cases involving fraud/reckless trading the Directors may become personally liable for the debtsof the company; however, this would be a matter decided by the courts. Thus, in most cases a keyadvantage of a limited company is that the personal wealth of the owners is protected to a greater extentthan either a sole trader or partnership business.

However from the point of view of those that interact with limited companies this increases the risk thatthey face. If a limited company goes into liquidation, payables do not have recourse to the personalwealth of the company owners, recourse is limited to the wealth and assets of the company.

A limited company can either be a Private Limited Company (Ltd) that does not sell its shares to thegeneral public or a Public Limited Company (PLC) that sells its shares to the public. As discussed indetail in Chapter 12 the possession of an ordinary share in a limited company gives the holder the rightof partial ownership of the company. EU regulations allow the formation of private limited companieswith only one member as against previous requirements for a minimum of two members.

Some limited companies are limited by guarantee – the guarantee being the amount the members agreeto pay in the event of the company going into liquidation. This form of company is more suitable for clubsand associations than for trading businesses.

Limited companies are subject to muchmore regulation than other forms of business entity as the ownersare typically external to the management and the owners’ liability is limited. Therefore, the ownersneed regulation to provide them with information that enables them to obtain some assurance thatmanagement are looking after their interests and loan providers (payables of all types) need informationto enable them to determine if managers are putting their funds at risk or not. These two points are nowdiscussed more fully:

• Limited liability – this implies that those who interact with the company on a daily basis, for examplesuppliers who supply goods and services on credit, are exposed to the risk that the company willgo out of business. In such a situation suppliers only have recourse to the assets of the businessin order to secure payment for debts and not to personal assets of the owners of the business (theshareholders). This implies that those who interact with limited companies take on a high level ofrisk. The risk can be mitigated by examining the financial statements of a limited company prior tocommencing transacting with that company.

• Ownership of limited companies tends to be much broader and more dispersed than that of eithera sole trader or partnership business. In most cases, in PLCs, the shareholders (owners) will notbe involved in the day to day running of the business at all. Thus shareholders require informationas to the financial performance and position of the PLC. This is achieved by making the financialstatements of a PLC widely available.

The preceding discussion highlights that the financial statements of limited companies (both private andpublic) are available to a much wider population of users than those of either a sole trader or partnershipbusiness. Many of these users have no involvement in the day to day running of the company, yet they stillneed to be able to rely upon and understand the information contained in the financial statements. Overtime, to this end, a wide body of professional regulation and statutory legislation has been developed.The remainder of the chapter is devoted to examining the various sources of regulation in financialreporting in Ireland and the UK.



12


Note to ROI students re: Companies Act 2014

Students in the Republic of Ireland may be aware that the Companies Act 2014 has created newclassifications of company (e.g. ‘Designated Activity Company, etc.). The essential concept of limitedliability remains and students are not expected to distinguish between types of company for the purposesof this examination.

2.2.5 The Regulatory Framework under which Financial Statements are prepared

The users of financial information are a broad and diverse group as discussed in Financial Accounting.The users of financial information require information for a wide variety of reasons. Nonetheless, everyuser of financial information has a common requirement, i.e. that the information is relevant, fairlypresented, understandable and comparable. To this end a broad range of regulation has developedaround the preparation and presentation of a set of financial statements. Combined these are referredto as the Regulatory Framework or Generally Accepted Accounting Practices (GAAP).

The term GAAP is used widely in relation to accounting regulation although the term is seldom referredto in the Companies Acts and is not defined therein. Generally Accepted Accounting Practices are madeup of all the accounting rules and regulation in a particular jurisdiction.

In Ireland and the UK the various pieces of regulations, which combined, constitute GAAP/RegulatoryFramework are as follows:

GAAP in other countries may be different but the source of regulation is typically the same, for example,US GAAP, is different to Irish and UK GAAP but is still comprised of US Professional Regulation, USCorporations Law and Stock Exchange Regulations.



13


2.3 INTERNATIONAL FRAMEWORK

The International Accounting Standards Committee (IASC) was set up in 1973. The IASC issuedaccounting standards called International Accounting Standards (IAS). Its members were drawn fromthe professional bodies of accountants worldwide (including the ASC and later the ASB in Ireland andthe UK). Members were encouraged to use their best efforts to encourage domestic standard setters,auditors, governments and stock exchanges to comply with international financial reporting standards.The aim of the IASC was to promote international comparability and consistency between the financialstatements prepared by companies worldwide. International financial reporting standards are onlyeffective if adopted by national regulatory bodies in various countries.

In January 2001 the International Accounting Standards Board (IASB) on the recommendation of theIASC’s Strategy Working Party replaced the IASC as the standard setting body. The IASB adopted theIASs that had been published by the IASC. They update these standards and issue new standardscalled International Financial Reporting Standards (IFRS). The difference between the IASC and theIASB is that the IASB adopts a more open, participatory and transparent approach to standard settingthat involves collaborating with investors, regulators, business leaders as well as the global accountancyprofession at all stages of the standard setting process. By the 1st January 2015 the IASB has issued16 IFRSs (including the IFRS for SMEs) and support 28 IASs. Further information on internationalregulation can be obtained on: http://www.ifrs.org/. However, this module will focus on the nationalregulatory framework.

2.4 NATIONAL FRAMEWORK

2.4.1 History

Professional regulation was largely absent in Ireland and the UK prior to the 1970s. The Institute ofChartered Accountants in England and Wales issued guidance on accounting principles to its members.The guidance issued was not legally enforceable. In the late 1960s the accounting profession suffereda wave of adverse publicity in relation to the accounting principles widely used by companies. One suchexample was the GEC-AEI takeover. AEI, prior to the takeover, issued a forecasted profit figure for1967 of £10m (Sterling). GEC re-prepared the profit statement for the same period using the accountingmethods used by GEC and reported a forecast loss of £4.5m.About £5m of the difference was explainedby the fact that AEI’s profit forecast contained predicted information for a number of months whereasGEC’s profit statement was based on actual data and the predictions had not been correct. However,an outcry resulted from the fact that £9.5m of the difference occurred because GEC used a differentmethod of inventory valuation for the same underlying inventory items. The fundamental issue behindthe controversy was that the methods of valuing inventory used by the two companies were allowableat the time. The concern which this raised was that if entities were free to choose different accountingmethods and these methods resulted in very different profit figures being reported, then how could theusers of accounting information rely on the information contained in the annual report of companies.

A significant amount of criticism was levied against the accounting profession in this respect. Thereforein the 1970s the Accounting Standards Committee (ASC) was set up by the UK accounting professionin an attempt to self-regulate and address the criticisms that had been levied. The committee issuedaccounting standards known as Statements of Standard Accounting Practice (SSAPs). Later in the1990s the Accounting Standards Board (ASB) replaced the ASC. The ASB issued accounting standardsknown as Financial Reporting Standards (FRSs). In 2012 responsibility for the issuance of accounting



14


standards transferred to the ‘Accounting Council of the Financial Reporting Council (FRC)’ and since 1January 2015 all the standards issued by theASC and theASB have been withdrawn, with the exceptionof the Financial Reporting Standard for Smaller Entities (FRSSE) which is widely supported by bothusers and preparers and new standards issued.

The Companies Act 1985 (GB) gives the FRC the authority to issue accounting standards.

2.4.2 Current professional regulatory framework

The structure of the FRC Board and Councils that make up the current professional regulation in the UKand Ireland is as follows:

Each of the main bodies are now discussed in turn.

2.4.3 The FRC Board

The FRC Board is made up of 14 members and has 3 senior members of staff. It is the UK’s independentregulator responsible for ‘promoting high quality corporate governance and reporting, to foster investment’(FRC website, 2015).

It sets the framework of codes and standards for the accounting, auditing, actuarial and investorcommunities and oversees the conduct of the professionals involved. It is accountable to parliamentand its wide range of stakeholders. However, it is independent of parliament and is funded through non-statutory arrangements. Publicly traded companies, large private entities, insurance providers, pensionproviders and public sector organisations provide a voluntary levy to cover the operating costs of theFRC and its committees.

Its core principles involve improving regulation with the use of especially wide public consultation. TheFRC’s culture is one of openness and collaboration. Its goal is to ensure that the capital markets benefit



15


from timely and relevant information about company performance and board behaviour. The FRC’sactivities aim to achieve better corporate governance and reporting. To this end it:

• Issues Corporate Governance and Stewardship codes that aim to foster trust in in board behaviour.

• Issues standards for financial reporting that promote reports that are fair, balancedandunderstandableas well as being clear and concise.

• Issues standards, FRC abstracts and codes of recommended behaviours that enhance confidencein the value and quality of audits.

• Oversees the standards that underpin high quality actuarial practice, and the integrity, competenceand transparency of the actuarial profession

• Operate effective, proportionate and independent investigative, monitoring and disciplinaryprocedures which safeguard the integrity of auditors, accountants and actuaries

• Influences key developments in issues that affect stakeholders in the UK and internationally

• Engages continuously with stakeholders at every stage of the process to ensure it us responsive totheir needs

• Operates a Financial Reporting Lab that brings together companies and investors to collaborate onimprovements and innovations to reporting (FRC website, 2015).

The FRC Board is supported by the Executive Committee, the Codes and Standards Committee andthe Conduct Committee. These are now described in brief.

2.4.4 The Executive Committee

The Executive Committee supports the Board by advising on strategic issues and providing day-to-dayoversight of the work of the FRC.

2.4.5 The Conduct Committee

The Conduct Committee advises the FRC Board in matters relating to conduct activities that promotehigh-quality corporate reporting, including monitoring, oversight, investigative and disciplinary functions,through its Monitoring Committee and Case Management Committee. Both committees use four teams.

1. The ‘Corporate Reporting Review Team’ reviews the reports and financial statements of large privatecompanies and public companies for compliance with relevant law.

2. The ‘Professional Discipline Team’ runs the disciplinary schemes for UK accountants, auditorsand actuaries and investigates cases that affect the public interest in the UK bringing disciplinaryprocedures in instances where misconduct is proven.

3. The ‘Professional Oversight Team’ oversees the regulation of auditors by the professional bodies(ICEAW, CAI, ATI, etc) and regulates the auditors of companies outside the EEA that trade in the UK.

4. Finally, the ‘Audit Quality Review Team’ monitors the quality of the audits of listed companies andpublic interest entities and monitors the procedures supporting quality audits in the larger UK auditfirms.



16


2.4.6 The Codes and Standards Committee

The Codes and Standards Committee advises the FRC Board on matters relating to issued codes,such as the Corporate Governance code, standard-setting and policy questions, through its Accounting,Actuarial and Audit & Assurance Councils. The three councils operate with a number of teams

The Accounting Council has three teams:

1. The Accounting and Reporting Policy Team (outlined below).

2. The Corporate Governance Team which sets and monitors the UK Corporate Governance andStewardship Codes

3. The Financial Reporting Lab Team which runs thematic projects bringing together investors andcompanies to develop solutions to their reporting needs.

The Actuarial Council has one team, the ‘Actuarial Policy Team’ which sets technical actuarial standardsand oversees the actuarial profession and the Audit and Assurance Council has one team, the ‘Auditand Assurance Team’, which consults on and implements International Standards for Auditors.

2.4.7 The Accounting and Reporting Policy Team

The Accounting and Reporting Policy Team implements EU adopted IFRS, sets UK GAAP andimplements elements of Companies legislation.

At the time of writing UK GAAP consisted of six Financial Reporting Standards (FRSs). The standardsare:

FRS 100 Application of Financial Reporting Requirements

FRS 101 Reduced Disclosure Framework

FRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland.

FRS 103 Insurance Contracts

FRS 104 Interim Financial Reporting

In addition, the Financial Reporting Standard for Smaller Entities (FRSSE) as issued by the formerstandard setter, the ASB, continues to be available for small entities. However, in 2016 it is expectedthat this will be withdrawn and replaced by FRS 105 The Financial Reporting Standard applicable to theMicro-entities Regime.

Any entity that wishes to prepare financial statements that provide a true and fair view must preparethem in accordance with accounting standards. Some companies have a choice. For example:

• Small companies can apply the FRSSE, or can opt to apply FRS 102 or EU-adopted IFRS.

• Qualifying companies under FRS 101 (companies that are subsidiaries or ultimate parents thatotherwise apply the recognition, measurement and disclosure requirements of EU-adopted IFRS)may apply FRS 101 which has reduced financial reporting requirements and disclosure exemptionswhen compared with FRS 102.

• Insurance companies apply FRS 103.



17


• The remaining companies not eligible to apply the FRSSE, not qualifying under FRS 101 and notapplying EU-adopted IFRSmust apply FRS 102, including public benefit entities, pension providersand financial institutions (though these types of entity are beyond the scope of the syllabus).

Therefore, FRS 102 will apply to the majority of reporting entities, and as a result, this textbook hasbeen prepared in accordance with that standard. The standard is about 350 pages long and has 35sections that deal with each topic area that typically had its own standard under the old framework.All the sections have equal authority. Section 1 sets out the scope of the FRS, section 2 provides theunderpinning concepts and pervasive principles. When the specific requirement of any other sectionwithin the FRS conflict with the concepts and principles set out in section 2, then the other section takesprecedence (FRS 102, 2.1A). Finally, cherry picking is not allowed, entities must comply will all therequirements of FRS 102 and should make an explicit and unreserved statement of such compliance inthe notes (FRS 102, 3.3).

The following table summarises the UK and ROI financial reporting framework to apply from 1 January2015.

As required by legislation/regulationinclude here (for example, plcs)

IFRS

Qualifying group entities FRS 101

Non-small FRS 102

Small FRSSE 2015

Micro* FRSSE 2015

*size details provided later in the chapter. (Note: Smaller sized entities can use the framework requiredfor larger entities, but large entities cannot use the framework required for smaller entities)

However, from 1 January 2016 the Framework will change again as the FRSSE is being withdrawn.Thereafter small and non-small companies will have the option of preparing their financial statementsin conjunction with FRS 102 (as amended by FRED 59) and micro entities can apply FRS 105 (asamended by FRED 58). Simplifications in FRS 105 include, no use of fair value or alternative accountingrules (no revaluation of assets) and simplified accounting for financial instruments.

The FRC’s objective when setting accounting standards is to enable users of accounts to receive high-quality understandable financial reports that are proportionate to the size and complexity of the entityand the users’ information needs. To this end, the FRC aim to produce succinct financial reportingstandards that:

a) have consistency with IFRS, however, will use an alternative treatment if it better meets the over-riding objective.

b) reflect up-to-date thinking and developments in the way entities operate and the transactions theyundertake.

c) balance consistent principles for accounting by all UK and ROI entities with practical solutions, basedon size, complexity, public interest and users’ information needs.

d) promote efficiency with groups; and

e) are cost-effective to apply (FRS 102, Summary (iv)).



18


In general the sections of FRS 102 describe and provide guidance to accounting practitioners andusers of financial information on how to account for contentious and difficult areas. Thus FRS 102outlines the recommended treatment and disclosure requirement of items to be included in thefinancial statements. Several of the sections are covered in this textbook.

2.5 THE STANDARD SETTING PROCESS

The FRC undertake an extensive consultation process and encourage a high degree of input fromstakeholders when addressing the needs of investors and other users of information. To encourageinput to the standard setting process they use outreach events and Financial Reporting Lab activities.Their standard setting process involves eight steps:

1. Research (initial scoping of the issue being considered)

2. Discussion paper (providing a detailed overview of the issue, why a standard is necessary, differentpotential approaches for dealing with the issue, preliminary views of the FRC and an invitation tocomment on the issue.

3. Public consultation (inviting a variety of stakeholders to comment on the discussion paper)

4. Outreach events (Financial Reporting Lab activities, case studies on topics and reports oninvestigations)

5. Exposure Draft (a specific proposal in the form of a draft standard for dealing with the issue. This willconsider the comments made on the discussion paper, the public consultation and research by theFinancial Reporting Lab)

6. Final code/standard (will implement feedback received on the Exposure Draft)

7. Post implementation review (involves holding meetings with interested parties to considerunanticipated issues that arose relating to the practical application of the standard.

8. Regular reviews (standards require continual review, they are regularly updated when the financialreporting environment or regulatory environments change and when comments and feedback on thepractical application of the standard is received).

As can be seen from the preceding list the process through which an accounting standard isdeveloped involves a significant amount of public consultation. This is undertaken in order to improvetransparency in the standard setting process. As previously mentioned, the FRC operates with anobjective of being fully transparent in its operations.

2.6 COMPANY LAW

A detailed discussion of the provisions and requirements of the Companies Acts is beyond the scope ofthe course. The Companies Acts cover all aspects relating to a company, for example: the setting up of acompany (preparation of the Memorandum and Articles of Association), the rights and responsibilities ofthe officers of a company (for example the company directors), the manner in which financial informationmust be presented and disclosed to the users of accounting information and filing requirements forcompanies. For example, when financial statements are due to be filed with the Company RegistrationOffice and thereby made available to the public?



19


From the perspective of Advanced Financial Accounting the most relevant aspects of Company Laware the disclosure requirements – the information that under law must be presented in a set of financialstatements. Examples of disclosures include the level and nature of directors’ remuneration and thelevel of the audit fee. This is discussed in more detail in Chapter 12.

Company law also determines what a set of financial statements must include - this depends upon thesize of the company. Company law prescribes the criteria for determining the size of a company.

In the Republic of Ireland (following Companies Act 2014) the criteria are as follows:

Size Small Medium Large

Statement of Financial Position total up to €4,400,000 €10,000,000, > €10,000,000

Revenue (Turnover) up to €8,800,000 €20,000,000 > €20,000,000

Average number of employees 50 250 > 250

Note: the company must comply with two of the three criteria for two consecutive years to qualify.

In the UK the criteria are as follows:

Size Small Medium Large

Statement of Financial Position total up to £3,260,000 £12,900,000 >£12,900,000

Revenue (Turnover) up to £6,500,000 £25,900,000 >£25,900,000

Average number of employees 50 250 > 250

Normally an entity will require that two out of the three criteria be met for two consecutive years, for theentity to fall within a particular category.

The following table outlines what information must be disclosed depending upon the size of a company.

Company Type Content of Financial Statements

Small private company limitedby shares

Auditor’s report (if applicable) and an abridged/abbreviatedStatement of Financial Position. Certain restricted notes are alsorequired for small companies.

Medium private companylimited by shares

Auditor’s report, directors’ report, a Statement of ComprehensiveIncome (starting at gross profit) and a Statement of FinancialPosition

Large private companylimited by shares

Auditor’s report, directors’ report, a Statement of ComprehensiveIncome and a Statement of Financial Position

Public company limited byshares

Auditor’s report, directors’ report, a Statement of ComprehensiveIncome, a Statement of Financial Position and a CorporateGovernance Statement.



20


From 1 January 2016 company law in the UK will increase the thresholds for accounting exemptionpurposes to the following (earlier adoption from 1 January 2015 permitted):

Size Micro Small Medium Large

Statement of Financial Positiontotal up to

£316,000 £5,100,000 £18,000,000 >£18,000,000

Revenue (Turnover) up to £632,000 £10,200,000 £36,000,000 >£36,000,000

Average number of employees 10 50 250 > 250

As mentioned, entities that qualify as Micro entities will be able to prepare their financial statementsunder FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime (compulsoryfor accounting periods starting on or after 1 January 2016).

2.7 EU DIRECTIVES

Both Ireland and the UK joined the European Union (formally the European Economic Community) onJanuary 1st 1973. One of the fundamental projects that the EU has engaged in is harmonisation acrossmember States. Financial Accounting is no different in this respect and several EU Directives wereissued in the 1980s and 1990s towards this goal.

It was recognised that achieving harmonisation in this manner would prove time consuming andcostly. The European Commission decided not to issue further directives concerning accounting butinstead to support the accounting standards issued by the IASC (now the IASB) in its efforts to ensureharmonisation of accounting policies across the EU. In June 2002, the EU issued a regulation requiringcompanies listed on a regulated market (stock market) to prepare consolidated financial statements inaccordance with IFRS by 2005 (including comparative figures for 2004). With respect to unlisted privatecompanies – small and medium enterprises/entities (SMEs), the EU states that Member States eitherrequire or allow unlisted companies to prepare their financial statements in line with IFRS. However, dueto objections to the removal of various options that exist in Irish/UK GAAP, the FRC introduced a newnational framework for the UK and the ROI that currently consists of six FRSs (discussed earlier) thatare in the main consistent with IFRS but tailored for smaller entities that do not qualify for reporting underthe FRSSE. Hence IFRS for non-listed companies is not being mandated by the FRC. Hence IFRS isonly required in PLCs and that requirement is enforced through legislation.

The conversion to IFRS has in effect allowed the EU to achieve its goal of harmonising accountingstandards and treatments across the EU. This was deemed an essential ingredient in the promotion ofcross border trade and investment between member states.

From a company’s point of view, the advantages of preparing financial statements under internationalaccounting standards are significant:

• The largest capital markets (where finance to grow a business is secured) are located in the USAand London. Investors in these capital markets will be more inclined to invest in companies fromother countries, such as Ireland, if the financial statements of the companies in these countries areprepared under accounting rules and regulations with which they are familiar.



21


• Similarly, if all EU companies are preparing financial statements under the same regulations thisshould increase the level of cross border share ownership. For example an Irish investor is morelikely to purchase the shares of a French company if that French company is preparing financialstatements under regulation with which the Irish investor is familiar.

• Prior to the introduction of IFRS, a multinational with companies operating in Ireland, France andGermany, for example, would have had to produce a set of financial statements for the Irish companyunder Irish accounting standards, the French company under French accounting standards and theGerman company under German accounting standards. In addition, all of the financial statementswould have had to have been re-prepared using the GAAP of the country of the Head office of thecompany so that overall group financial statements could be prepared. Now all of these can beprepared under IFRS and used to prepare the overall group financial statements. This significantlyreduces costs for the multinational organisation and therefore helps to promote cross border trade.

2.8 STOCK EXCHANGE REGULATIONS

These regulations only apply to those companies which seek to float on a regulated market. That is, tothe public limited companies who issue (sell) shares and have their shares traded by the investing publicon the stock exchange. Companies listed on the Main Securities Market of the Irish Stock Exchange(ISE) must comply with the Listing Rules (ISE), the UK Corporate Governance Code (2014), the IrishCorporate Governance Annex; the Admissions to Trading Rules (ISE) and relevant EU legislation.Companies listed on the Main Market of the London Stock Exchange must comply with the UK ListingRules, the UK Corporate Governance Code (2014) and the requirements of the UK Listing Authority(UKLA).

Stock exchange regulation contains important regulations not addressed in other areas, arguably themost important of which relates to the disclosure of price sensitive information to all shareholders at thesame time. This ensures that no market participant has an unfair advantage over others. The situationwhere an individual has information which is not available to the public and uses that information for theirown personal benefit is referred to as insider trading and is illegal.

Although FRSs and company law deal with calculation and disclosures, FRSs tend to deal with howthe various figures in the financial statements should be calculated while company law tends to focuson how the information should be presented to users. Therefore it can be seen that both FRSs andcompany law requirements work together in order to achieve the overall goal that a set of financialstatements are fairly presented and can be relied upon by the users of accounting information as thebasis for making economic decisions regarding the company.



22


PRACTICE QUESTIONS

The following questions examine the key areas the student is expected to know for this particular subject.These questions will assist the student significantly while preparing for examinations in May/August.You should also review the questions available through MyRevision in your TouchPoint portal. SamplePapers for this subject can be downloaded from www.AccountingTechniciansIreland.ie

Question 1 (ref: 1900)

“Management accounting information and financial accounting information are prepared underdifferent regulatory environments”.

a) Outline your understanding of both management and financial accounting.

b) Do you agree with the statement as outlined above? You are required to support your answer.

Tuition note: this question draws on knowledge gained in Financial Accounting, this is assumedknowledge in Advanced Financial Accounting. The information is discussed in this question is inorder re-fresh student knowledge.


Outline the FRC standard setting process currently in place for new Financial Reporting Standards.


It is important that financial reporting be subject to rules and regulations. The rules and regulationswhich apply are commonly referred to as the ‘regulatory framework’ or Generally AcceptedAccounting Practices (‘GAAP’).

(a) Explain the need for regulation in the context of financial reporting and explainwhy it is important. 8 Marks

(b) Describe briefly the four main sources of regulation that represents Irish/UKGAAP. 12 Marks

Total 20 Marks

(May 2011, Q1)


Outline the history of the establishment of professional regulation for financial reporting in Irelandand the UK.


Date post:	20-Mar-2018
Category:	Documents
Upload:	doanhuong
View:	219 times
Download:	4 times

100034 Adv Fin Acc 15 - Manual - Accounting Technicians ... · PDF...

Documents