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Notes ACCA Paper F3 (FIA Paper FFA) Financial Accounting For exams in 2012

 

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ExPress Notes ACCA F3 Financial Accounting

   

Contents

Page | 2

About ExPress Notes

3

1.

Financial statements

7

2.

Objectives of financial reporting

16

3.

Sources of financial information

21

4.

Double entry bookkeeping: the debits and credits

28

5.

Tangible non-current assets

31

6.

Intangible non-current assets

36

7.

Inventory and purchases

39

8.

Receivables and payables

42

9.

Bank reconciliations

47

10.

Long term finance

50

11.

Accruals and prepayments

52

12.

Provisions and contingencies

55

13.

Sales tax

57

14.

Trial balances and correction of errors

60

15.

Suspense accounts

64

16.

Incomplete records

66

17.

Limited companies

68

18.

Statements of cash flow

72

19.

Consolidated financial statements

78

20.

Events after reporting date, errors and estimates

88

21.

Interpretation of financial statements

91

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

   

START About ExPress Notes We are very pleased that you have downloaded a copy of our ExPress notes for this paper. We expect that you are keen to get on with the job in hand, so we will keep the introduction brief. First, we would like to draw your attention to the terms and conditions of usage. It’s a condition of printing these notes that you agree to the terms and conditions of usage. These are available to view at www.theexpgroup.com. Essentially, we want to help people get through their exams. If you are a student for the ACCA exams and you are using these notes for yourself only, you will have no problems complying with our fair use policy. You will however need to get our written permission in advance if you want to use these notes as part of a training programme that you are delivering. WARNING! These notes are not designed to cover everything in the syllabus! They are designed to help you assimilate and understand the most important areas for the exam as quickly as possible. If you study from these notes only, you will not have covered everything that is in the ACCA syllabus and study guide for this paper. Components of an effective study system On ExP classroom courses, we provide people with the following learning materials:    

The ExPress notes for that paper The ExP recommended course notes / essential text or the ExPedite classroom course notes where we have published our own course notes for that paper The ExP recommended exam kit for that paper. In addition, we will recommend a study text / complete text from one of the ACCA official publishers, but we do not necessarily give this as part of a classroom course, as we think that it can sometimes slow people down and reduce the time that they are able to spend practising past questions.

ExP classroom course students will also have access to various online support materials, including:  

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The unique ExP & Me e-portal, which amongst other things allows “view again” of the classroom course that was actually attended. ExPand, our online learning tool and questions and answers database

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

 

  Everybody in the World has free access to ACCA’s own database of past exam questions, answers, syllabus, study guide and examiner’s commentaries on past sittings. This can be an invaluable resource. You can find links to the most useful pages of the ACCA database that are relevant to your study on ExPand at www.theexpgroup.com.

How to get the most from these ExPress notes For people on a classroom course, this is how we recommend that you use the suite of learning materials that we provide. This depends where you are in terms of your exam preparation for each paper. Your stage in study for each paper

These ExPress notes

ExP recommended course notes, or ExPedite notes

ExP recommended exam kit

ACCA online past exams

Prior to study, e.g. deciding which optional papers to take

Skim through the ExPress notes to get a feel for what’s in the syllabus, the “size” of the paper and how much it appeals to you.

Don’t use yet

Don’t use yet

Have a quick look at the two most recent real ACCA exam papers to get a feel for examiner’s style.

At the start of the learning phase

Work through each chapter of the ExPress notes in detail before you then work through your course notes.

Work through in detail. Review each chapter after class at least once.

Nobody passes an exam by what they have studied – we pass exams by being efficient in being able to prove what we know. In other words, you need to have effectively input the knowledge and be effective in the output of what you know. Exam practice is key to this.

Don’t use at this stage.

Don’t try to feel that you have to understand everything – just get an idea for what you are about to study. Don’t make any annotations on the ExPress notes at this stage.

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Make sure that you understand each area reasonably well, but also make sure that you can recall key definitions, concepts, approaches to exam questions, mnemonics, etc.

Try to do at least one past exam question on the learning phase for each major chapter.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

   

Page | 5

Your stage in study for each paper

These ExPress notes

ExP recommended course notes, or ExPedite notes

ExP recommended exam kit

ACCA online past exams

Practice phase

Work through the ExPress notes again, this time annotating to explain bits that you think are easy and be brave enough to cross out the bits that you are confident you’ll remember without reviewing them.

Avoid reading through your notes again. Try to focus on doing past exam questions first and then go back to your course notes/ ExPress notes if there’s something in an answer that you don’t understand.

This is your most important tool at this stage. You should aim to have worked through and understood at least two or three questions on each major area of the syllabus. You pass real exams by passing mock exams. Don’t be tempted to fall into “passive” revision at this stage (e.g. reading notes or listening to CDs). Passive revision tends to be a waste of time.

Download the two most recent real exam questions and answers.

The night before the real exam

Read through the ExPress notes in full. Highlight the bits that you think are important but you think you are most likely to forget.

Unless there are specific bits that you feel you must revise, avoid looking at your course notes. Give up on any areas that you still don’t understand. It’s too late now.

Don’t touch it!

Do a final review of the two most recent examiner’s reports for the paper you will be taking tomorrow.

At the door of the exam room before you go in.

Read quickly through the full set of ExPress notes, focusing on areas you’ve highlighted, key workings, approaches to exam questions, etc.

Avoid looking at them in detail, especially if the notes are very big. It will scare you.

Leave at home.

Leave at home.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

Read through the technical articles written by the examiner. Read through the two most recent examiner’s reports in detail. Read through some other older ones. Try to see if there are any recurring criticism he/ she makes. You must avoid these!

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ExPress Notes ACCA F3 Financial Accounting

    Our ExPress notes fit into our portfolio of materials as follows:

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To maximise your chances of success in the exam we recommend you visit www.theexpgroup.com where you will be able to access additional free resources to help you in your studies.

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© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 1

Financial Statements

START The Big Picture Financial statements (more colloquially called accounts) are a crucial part of managing a business and reporting to shareholders. A set of financial statements will need to be produced at least annually for presentation to external stakeholders, but generally much more frequently for management control within the business. Frequent and accurate financial statements can add a great deal to the efficient running of a business. A set of financial statements is produced periodically (often once a year for smaller businesses but as frequently as the users want them). A full set of financial statements for a limited company comprises a number of statements: 

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A statement of financial position, generally called a balance sheet. This lists all the assets and liabilities of the business plus the equity of the business (which explains where the assets and liabilities came from). The statement of financial position is a snapshot of the assets and liabilities of a business at a moment in time. A statement of comprehensive income, often referred to as profit and loss account. This shows all the gains and losses that the business has experienced in the period. The statement of comprehensive income is a record of what happened over a period to the net assets of a business.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    

A statement of cash flows, which shows where the cash and short-term assets very similar to cash came from and went do during the period. Income isn’t always the same as cash, as we’ll see later. Notes to the financial statements, which give further detail to readers who want to know more than the summary story.

Statement of financial position of Sole Trader X at 30 June 20x1

ASSETS

$

$

Non-current assets Licence to operate

10,000

Land and buildings

35,000

Office equipment

20,000

Motor vehicles

30,000

Fixtures and fittings

10,000 105,000

Current assets Inventory

20,000

Trade receivables

13,000

Less: allowance for doubtful receivables

(1,000) 12,000

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Prepayments

4,000

Cash at bank

3,000

Cash in hand

2,000

Total assets

146,000

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    EQUITY AND LIABILITIES Capital Initial capital introduced

30,000

Total cumulative comprehensive income at 1 July 20x0 Less: Cumulative withdrawals at 1 July 20x0

85,700 (24,000)

Total equity at 1 July 20x0

91,700

Total comprehensive income in the current period

16,000

Withdrawals in the current year

(8,000)

Total equity at 30 July 20x1

99,700

Non-current liabilities Bank loans

32,000

Current liabilities Bank overdraft

3,300

Trade payables

8,000

Accruals

3,000

Total liabilities

Total equity and liabilities

46,300

146,000

Principal features of the statement of financial position:

  

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It balances, with the total assets equaling equity (i.e. owner’s interest) plus liabilities Each section is conventionally written in terms of increasing liquidity Non-current assets and liabilities are ones that are expected to remain on the SOFP next year. Current assets and liabilities are expected to be used up or paid within the coming year.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

 

  A SOFP may be rearranged into a number of ways. IAS 1 shows a SOFP as given above: Total assets = Equity + total liabilities.

Equally validly therefore: Total assets – total liabilities = Equity Given that equity = capital + cumulative profit – cumulative withdrawals, then the equation could be written in any number of ways such as: Total assets – total liabilities = Capital + cumulative profit – cumulative withdrawals Or Cumulative profit = Total assets – total liabilities – capital + cumulative withdrawals. This is sometimes called the “accounting equation” and often comes up in the F3 exam. The task is to drop in the figures that you know and find the missing figure, whatever it might be.

Statement of comprehensive income for the year ended 30 June 20x1

$

Sales revenue

$

152,000

Cost of sales Opening inventory

30,000

Purchases of inventory

80,000

Delivery costs inwards

10,000

Closing inventory

(20,000) (100,000)

Gross profit

Page | 10

52,000

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    Sundry income

3,000

Discounts received

2,000 57,000

Less: Expenses

Delivery costs outwards

3,000

Depreciation

6,000

Discounts allowed to customers

1,000

Electricity

4,000

Irrecoverable and doubtful debts

2,500

Mobile phones

500

Motor expenses

2,500

Rent

9,000

Telephone and internet

1,500

Wages and salaries

12,000 (42,000)

Profit for the period before tax

14,000

Other comprehensive income:

Revaluation gain on property Total comprehensive income in the period

2,000 16,000

You may be required in the exam to calculate revenue, cost of sales, gross profit and total comprehensive income from given data.

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ExPress Notes ACCA F3 Financial Accounting

    Unusual items

Sometimes, it is necessary for one-off items to be disclosed separately in the financial statements if they are very large or arise from an unusual, often non-recurring, source. Typical examples might be write-off of an unusually large debt as irrecoverable, or business relocation costs. Disclosing it separately allows readers of the accounts a more in-depth understanding of what the business is doing.

KEY KNOWLEDGE Elements of financial statements There are five elements of financial statements, from which all financial statements are produced. These definitions are very useful throughout your ACCA studies and could easily be part of a question in paper F3.

Elements of the statement of financial position:

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An asset is a resource that is controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Equity is the residual interest in the assets of the entity after deducting all its liabilities. Depending on the type of business, this may be called just capital (sole trader), partners’ current account (partnership) or share capital and reserves (for a limited company). For a limited company, reserves show the net cumulative gains above cumulative losses, less all dividends paid. This therefore explains the difference between what the net assets were when the share capital was originally paid in and what the net assets are at the reporting date.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    Elements of the statement of comprehensive income: 

Income is an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

An expense is a decrease in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Note that income and expenditure are defined effectively as the reason that a change in net assets happened.

KEY KNOWLEDGE Relationship between the statements: the business equation An increase in net assets of a business will come from a mixture of these sources:

  

Total comprehensive income made in the period (a profit will increase net assets) New capital introduced by the owner (will always increase net assets) Withdrawals made in the period (will always reduce net assets).

This is sometimes called the accounting equation or the business equation. It is a frequent exam question and can be summarized:

Closing net assets =

Opening net assets + total comprehensive income in the period + new capital introduced in the period – withdrawals in the period.

This is also a frequent exam question, with some figures given and the others having to be deduced.

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ExPress Notes ACCA F3 Financial Accounting

 

  Remember that net assets = equity + liabilities, by definition. So net assets may be given in a question separately as equity and liabilities.

Separate accounting entity Even with a sole trader (a person who runs a business on their own, but the business has never been set up formally to be a separate legal identity), there is a distinction between personal income/ expenses and business income/ expenses. The accounts will largely be maintained so that the sole trader can report business profits to the tax authority. Personal expenditure such as personal holidays is not deductible against tax! The accountant will therefore only record transactions that are considered to be legitimate business transactions; personal transactions will be ignored. In smaller businesses, one of the first steps when producing accounting records for clients is to separate the business transactions from the personal, as the latter will not be recorded anywhere.

Sole traders and limited companies - We’ll look at these in more detail in each chapter, but here’s a summary: Sole trader

Limited company

Number of investors

1 (the sole trader!)

Can be between 1 and an unlimited large number

Must produce accounts for the tax authority

Yes

Yes

Must produce accounts to file with the commercial register

No

Yes

Business name

Normally just the name of the owner “trading as” the name of the business

Can offer shares to the public?

No

Must end Ltd (if private limited company) or plc (if public limited company) Yes, if a plc. No if Ltd.

Equity part of the

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Initial capital

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

Share capital

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ExPress Notes ACCA F3 Financial Accounting

    SOFP

 

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© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

Cumulative profit Cumulative withdrawals

 

Reserves: (revaluation reserve, retained earnings, etc).

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 2

Objectives of financial reporting

START The Big Picture Financial reporting is the business of collecting financial information, analysing, summarising it and presenting it in a useful form to a wide range of different users. Different users will have different objectives and therefore slightly different needs. Financial statements are aimed at giving useful information to a wide range of different users, though the investor is the most significant user.

For financial information to be useful, it must exhibit a number of characteristics. It’s important to understand what these are because you may be asked for a definition of them in the exam.

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© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

   

Page | 17

Qualitative characteristic

Our definition

Fair presentation

Items are described in accordance with their true nature. For example, loans repayable within six months are classified as current rather than non-current.

Going concern

The business is expected to trade into the foreseeable future. This means that assets will not have to be sold in a hurry, which would be likely to result in significant impairments in value.

Accruals

A key concept covered in chapter [x]. It means recording transactions in the period when they happened; not necessarily when the cash was settled. It also means matching costs and associated revenues.

Consistency

Items should be reported the same way between periods, so that it’s possible to make meaningful comparisons between years. Similar transactions must be reported the same way within the same accounting period.

Materiality

Materiality means large enough to influence the user’s opinion on the financial statements. Immaterial information should not be disclosed, as it’s a distraction. Material information must be presented accurately and fairly.

Relevance

Irrelevant information is a distraction and should not be presented.

Reliability

Information is useless if it’s not considered to be reliable. E.g. an external valuation of property is more reliable than a biased director’s valuation.

Faithful representation

Items should be described in accordance with their true nature. E.g. an expense for repairs should not be classified as research costs, even though research costs are more favourably viewed by investors.

Substance over form

Items should be reported in accordance with their commercial substance, rather than their legal form. E.g. if a sale is made on credit but legal title remains with the seller until the goods are paid for, it should still be recorded as a sale/ purchase at the time of the transaction, since this is when the obligation arises.

Neutrality

Unbiased – neither excessively optimistic nor excessively prudent.

Prudence

Conservatism. This is no longer a core concept in IFRS accounting, but broadly losses should be recognised more readily

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    than gains. Completeness

All information that needs to be presented in order to give a full picture has been presented.

Comparability

Financial statements this period should be presented using similar principles to previous years, so that valid comparisons may be made. Company accounts should be comparable with each other. This means that if a company changes its accounting policy, it must restate its previous years’ accounts using the new accounting policy, in order to facilitate comparison between years.

Understandability

Information should be presented in a way that users can understand. Excessive complication reduces usefulness.

Business entity concept

See chapter 1. Even if there is no separate legal entity, as with a sole trader, the business is still considered to be separate to its owners for accounting purposes.

Sometimes, it’s not possible to deliver all of these desirable characteristics. For example, an investor is principally interested in future profits, so this is what is relevant to them. However, estimates of future profit are unreliable, so historical information is given, even though it is less relevant.

KEY KNOWLEDGE Historical accounting Accounting is derived from recording information about transactions that have happened. This means that assets are recorded at their historical cost; i.e. what the business paid for them. This has the advantage of being objective and relatively easy, but has a number of disadvantages, including:

  

Page | 18

It can give out of date asset valuations for long-lived assets This can result in an unrealistically low depreciation charge Profit trends can be misleading (e.g. a profit growth of 10% per year isn’t so impressive as it first seems if inflation is 12% per year!)

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

    

Where there’s significant inflation and inventory is held for a long time, profit can be reported simply by matching today’s revenues with yesterday’s costs.

There are some large advantages of historical cost accounting, however; principally the fact that people understand it and it is objective. During periods of modest inflation, the weaknesses of historical cost accounting are generally outweighed by its advantages. There are alternative systems of accounting, such as replacement cost accounting. Replacement cost accounting records inventories in the SOFP and at the point of sale at the cost that would be incurred to replace them today. This has many advantages but is complicated to apply so is not common in practice. You will only have to apply historical cost accounting in the paper F3 exam.

KEY KNOWLEDGE Regulation of financial reporting

Some entities have to report under regulated accounting standards. Different countries may have their own systems of GAAP (generally accepted accounting practice) or may follow International Financial Reporting Standards (IFRS) or IFRS for SMEs (SME means smaller and medium sized enterprises).

It is a matter of national regulation which financial reporting standards an entity must use when producing their financial reports. Large plc’s will have to report under a much more extensive financial reporting framework than sole traders.

There are a number of bodies that you need to be aware of for the Paper F3 exam. Their roles are given below.

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ExPress Notes ACCA F3 Financial Accounting

   

Page | 20

IASCF: the International Accounting Standards

This has recently been renamed the IFRS Foundation. The Foundation is made up of trustees, who appoint the members of the bodies below.

IASB: International Accounting Standards Board

The IASB issues International Financial Reporting Standards and the IFRS for SMEs. It employs a permanent staff to draft new accounting standards and amendments considered necessary to extant accounting standards.

SAC: Standards Advisory Council

This has recently been renamed the IFRS Advisory Council. It is made up of a cross section of advisors from different user groups. It advises the IASB on the IASB’s work programme.

IFRIC: International Financial Reporting Interpretations Committee

This has recently been renamed the IFRS Interpretations Committee. This body is designed to respond quickly where there are significant differences in interpretation of an extant IFRS. For example, it issued guidance on how to account for loyalty programmes, where users were uncertain to follow the extant accounting standard on revenue recognition, or provisions.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 3

Sources of financial information

START The Big Picture The accounting system must naturally be fed with raw source data. This data is then analysed, categorised and recorded in the accounting system itself, which may be a fully manual (paper based) system or may be maintained using software. Both use the same system of double entry bookkeeping that we will see later on. For an accounting system to work well, it must be simple to operate and be capable of being fed by non-specialist staff. A key step is therefore ensuring that the right stationery and documentation is in place. The F3 syllabus requires you to be able to define the following:

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ExPress Notes ACCA F3 Financial Accounting

    Document Quotation

Sales order

Purchase order Goods received note

Goods despatched note Invoice Statement

Credit note

Debit note

Remittance advice

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Purpose To give a potential customer an indication of what a product or service would be likely to cost. It may be a binding quote or just an indicative quote. To record an order from a customer. Signing a booking form for an ExP classroom course is a sales order that ExP will then process. To record an order placed with a supplier. It may require preauthorisation to be valid. To record that an order for inventory for resale has been received. It will normally only be produced once the goods have been inspected at the point of delivery to ensure that they are correct in description and quality. To record that an order from a customer has been sent out. A request for payment from a supplier. Sent by the supplier to the customer. A summary of transactions recorded by a supplier with a customer, including amounts received from the customer. Sent by the supplier to the customer.

Acknowledgement from a supplier that the customer has overpaid and is entitled either to a refund or free goods/ services in the future. To cancel a credit note that previously existed, e.g. if goods were ordered, paid for and then returned there would initially be a credit note. The refund made would be accompanied with a debit note. Normally included with an invoice. A document that is included with the

Often feeds the accounting information on.... Nowhere. At this stage, there has been no transaction to record; it’s still at the state of being a prospective transaction. Sales (revenue).

Purchases, normally of inventory for resale. Purchases of inventory for resale and payables.

Sales (revenue) and possibly also inventory management, depending on how the accounting system is set up. Payables. Does not generally instigate any recording of a transaction, since all transactions on the statement will have been recorded when goods were ordered. But useful for cross-checking our records with the supplier’s records. Payables.

Receivables.

Receivables.

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ExPress Notes ACCA F3 Financial Accounting

   

Receipt

payment (e.g. if paid by cheque) with details that will allow the recipient of the funds to match the payment to the customer’s account. Issued by the supplier for goods, to acknowledge payment of a debt.

Receivables, payables and purchases.

KEY KNOWLEDGE Data sources / data capture

When a business transaction happens, it is essential that the source data is captured immediately. This does not necessarily mean immediately writing up the books, but it does involve some record being made of the transaction happening.

In very simple accounting systems for sole traders (e.g. a self-employed builder) it may involve the proprietor keeping pocket books to record things like quotes given and a shoe box used to collect receipts for business expenses. From this source data, the accounting records can then be produced each period. The accountant is often not physically present at the time that transactions happen, so it is essential that there are simple and fool proof systems to ensure a complete and accurate record of business transactions.

KEY KNOWLEDGE Books of original entry

Alternatively called books of prime entry, these will be the bridge between the raw data (e.g. receipt for cash purchase of some building materials and the accounting system. They may be written up by the accountant, or by a semi-trained member of staff within the client’s business.

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ExPress Notes ACCA F3 Financial Accounting

    The most commonly used books of original entry are:

Book of original entry:

Used to record data on:

Data typically used to feed:

Cash in book

Cash received into the business bank account.

All sorts of things! Anything that may generate cash for the business.

Cash payments book

Cash paid from the business bank account.

All sorts of things! Anything that results in cash being paid out of the business.

Petty cash book

Cash in and out of the balance of cash held in notes and coins by the business (normally small). This is often controlled using the imprest system (see later).

Typically, small expenses (e.g. Friday cakes for staff!) and sundry income.

Sales day book

Sales on credit. Note that sales immediately settled in cash will be recorded in either the cash book (if paid directly into the bank account) or petty cash book (if received in notes and coins).

Sales revenue.

Purchases day book

Purchases of inventory for resale on credit. Note that purchases settled immediately in cash will be recorded immediately in the cash payments book or petty cash book.

Purchases of inventory for resale.

Journal book

Anything not covered by any of the other books of original entry.

Often, this is the book maintained by the accountant, in which “period 13” adjustments like depreciation and bad debts are recorded.

Books of original entry may be recorded in paper form, or using a spreadsheet.

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Computerised systems Computerised systems are common and can be cheap. They still require rigorous systems for data capture at the point when transactions happen, as the maxim “garbage in, garbage out” very much applies! Input to a computerised system will not look like a book of original entry, but will require the same data. Software may be more user friendly, for example asking “how much cash was spent?” and “what was this for?”, whilst then offering a drop down menu of choices. The software will still prepare records using the same methodology as the manual recording systems above.

Advantages of using a computerised system include:     

Back ups can be made easily Makes producing periodic frequent accounts much less laborious than a manual system Can be user-friendly Analyses sales taxes more easily than manual systems (see later) Can be used to quickly produce lots of reports such as VAT returns and interim management accounts.

Disadvantages of a computerised system include:   

Cost May not be tailored very well to the business own needs Still requires effective data capture and maintenance of the underlying records.

KEY KNOWLEDGE Journal book The journal book is the book of original entry that captures transactions not covered by other books of original entry. Often, it includes adjustments and correction of errors and omissions in the other books of original entry. In a computerised system, there are often restrictions on who can access the journal book.

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ExPress Notes ACCA F3 Financial Accounting

 

  The journal book records double entry records (see later), with an explanation of the reason. We’ll see an example of it after tackling double entry bookkeeping.

KEY KNOWLEDGE Credit control and memorandum accounts

In parallel with (and thus duplication of) the main accounting system, it is likely that an accounting system will maintain separate records of individual records of customer and supplier balances. This duplicates effort and increases costs, but provides useful information for credit control and a check on the accuracy of data input.

Each supplier or customer will have a supplier or customer code and individual record of transactions with them. This is outside the general ledger (i.e. double entry system) and in a simple accounting system may be kept using a simple card index box.

KEY KNOWLEDGE Controlling petty cash – the imprest system

Cash balances are prone to error, theft and poor record keeping. A way to ensure that any cash payments out of the petty cash box are recorded is to use the imprest system. The imprest system has these features:

The cash box has a pre-set limit of maximum cash that it ever contains, e.g. $1,000 

 

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Before any cash is taken out of the cash box (which should be guarded by a very diligent and ideally slightly frightening person), the person claiming the cash must provide a receipt and complete an expense voucher. As an expense record is submitted, the same amount of cash is taken out of the box. Under no circumstances is anybody ever allowed to take money out of the tin without completing a petty cash voucher.

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ExPress Notes ACCA F3 Financial Accounting

 

  The result of this is that at any point in time, the sum of cash plus the expense vouchers will always equal the pre-set limit of $1,000. When cash reaches a low level, more cash is withdrawn from the bank to replenish the sum up to the $1,000 limit. The expense vouchers are then exchanged for the replenishment cash. These movements in petty cash can then be summarised in a petty cash book each period, which will look like this:

PETTY CASH BOOK Reason for cash movement

Date

Cash in/ out

Voucher #

From bank

01/03/2010

1,000.00

03/03/2010

(21.12)

332; Supermarket

12/03/2010

(20.00)

333; Taxi for MD

23/03/2010

(430.00)

334; Stationery shop

25/03/2010

(32.00)

335; Flowers for new baby

27/03/2010

(43.12)

336; Supermarket

31/03/2010

453.76

Subtotal

31/03/2010

546.24

Replenish

546.24

1,000.00

Subtotals

546.24

Staff food & drink

Travel

Stationery

Other

Opening balance (21.12) (20.00) (430.00) (32.00) (43.12)

(64.24)

(20.00)

(430.00)

(32.00)

Note that any time the cash is replenished, the expense vouchers are taken out of the petty cash box and stored somewhere safe, probably with the accounts department. The accounts department will then use the totals to record the totals in the accounting system each period.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 4

Double entry bookkeeping: the debits and credits

START The Big Picture The starting point for double entry bookkeeping is to think about assets and liabilities, i.e. net assets. If there is a change in an asset, there must be an explanation for why it changed.

  

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If you win the lottery, you have more cash because you have lottery income. If you buy lunch, you have less cash because you spent money on lunch (i.e. more expenditure). If you decide that the home you own is worth more, you have more assets because you’ve recognised a revaluation gain.

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ExPress Notes ACCA F3 Financial Accounting

 

  Many textbooks explain double entry bookkeeping in the framework of double entry meaning that for each transaction, there is an equal and opposite transaction. We think that this is needlessly confusing. The key word in double entry is because.

KEY KNOWLEDGE So why debits and credits? Imagine that we call assets “debits”, only so that people who speak different languages can communicate more effectively with each other. If we now say that we have an asset, or more of an asset because you’ve been paid your salary. This would be recorded as “recognise new or increased asset of cash”. It’s shorter just to say “debit cash”.

There must be a reason for this increase in cash. The reason is that there’s been some income. This can’t be a debit, as what we’re trying to do is explain where the debit came from. The explanation is arbitrarily called a credit.

You may have encountered the words debit and credit in the context of your bank statement. This brings danger, since the bank statement is a record from their own records. This means that it’s upside down. This can cause confusion, so it’s best for the moment if you try to unlearn everything you’ve ever come to think of debits and credits as being. The truth is the opposite way round to the way that lay people use the terms.

KEY KNOWLEDGE Building up the rules Here are the core concepts that you need to be happy with:

  

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An asset, or an increase in an asset, is a debit. The opposite of an asset is a liability. The opposite of a debit is a credit. So a liability is a credit. If you have more assets (debit assets), the explanation will be to credit income.

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ExPress Notes ACCA F3 Financial Accounting

 

  So you may have started to think “debits good, credits bad” or even the other way round. That’s not the way to look at it. Neither is good or bad. A debit can be an asset, but it can also be an expense. So it’s not correct to think of one being good and the other bad. It’s simpler than that. Here’s a table to summarise the rules. Review this and then try to produce is yourself, using the logic of explaining movements in net assets and things being opposites (e.g. a liability is a credit because an asset is a debit). It will take a while to become familiar with this system, just the way that it takes a while to become familiar with riding a bicycle. Don’t panic – it comes and don’t feel pressured to rush it. There’s not much intrinsically to actually understand here – it’s just a task and a system that becomes really easy with repetition.

Debits mean

Credits mean

What happens to net assets: An increase in assets

A decrease in assets

An increase in liabilities

An increase in liabilities

And the reason for that increase in net assets: An item of expenditure

An item of income

If you’re asked to record a transaction, the first step is to identify what assets and/ or liabilities are in question. Decide one of these first (it’s often easiest at first to start with cash if it’s a cash transaction) and decide if this is a debit or a credit. Then work out the explanation why. If you think that there’s a new liability, that must be a credit to liabilities. That means that the explanation must be a debit, which could be either an asset (e.g. if you’ve just got some cash in your hand because you borrowed it), or an expense (e.g. if you just bought dinner on your credit card).

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 5

Tangible non-current assets

START The Big Picture An asset is a resource controlled by an entity that is expected to give inflow of benefits. Many assets will have a period of expected benefit over more than one period. These are non-current assets.

KEY KNOWLEDGE Capital and revenue expenditure

In slang terms, capital expenditure means any cash paid to acquire assets that will result in the acquisition of a new asset, or an increase in the earning capacity of an existing asset. Revenue expenditure means money paid to maintain the existing earning capacity of an existing asset.

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ExPress Notes ACCA F3 Financial Accounting

 

  The terminology is very confusing here, since it has nothing to do with share capital/ equity or sales revenue! They are commonly used terms, however inaccurately.

KEY KNOWLEDGE Acquisition of a non-current asset The cost of a non-current asset that will initially be recognised will be all the costs necessarily incurred in bringing the asset into its initial working condition, as long as those costs are expected to last more than a year. Any recoverable taxes will be excluded.

KEY KNOWLEDGE Depreciation All assets, with the sole exception of freehold land, wear out over time. This means that the total cost of ownership of the asset must be matched to the revenue stream that the asset generates, or supports. This is done by making an allowance for depreciation and charging depreciation. The aim of depreciation is to match the cost of using the asset to the income stream that it generates. It is not aimed at anything else such as showing the asset at its current market value in the SOFP. The depreciation method chosen for an asset should be the method that most closely matches the cost of the asset to the pattern of revenue that it generates. The SOFP will show the asset at its net book value (NBV). NBV is original cost less cumulative allowance for depreciation.

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Method

Annual depreciation calculated as

Straight line

(Cost – estimated residual value)/ expected useful life.

Example where suitable estimate of revenue generated Office furniture, or anything that does not produce materially greater income when it’s new. This is the most commonly used method of depreciation.

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ExPress Notes ACCA F3 Financial Accounting

    Reducing balance (also known as diminishing balance)

Machine hour method

NBV at start of the period x annual depreciation %

(Cost – estimated residual value) x (Machine hours this period/ estimated total useable hours)

Motor vehicles used by a taxi company. Older cars generate less net revenue as they break down more than new cars and require more maintenance. Where an item of machinery has an estimated maximum useful life.

Ledger accounting Depreciation is charged each year by creating an expense and an allowance for depreciation account. The allowance for depreciation is maintained as a separate account rather than crediting the asset account itself. This is because the original historical cost of assets often needs to be extracted quickly to allow for preparation of non-current asset disclosure notes (see below).

Dr Depreciation expense (SOCI)

$x

Cr Allowance for depreciation (SOFP)

$x

KEY KNOWLEDGE Disposal

When an asset is eventually disposed, it will generally be sold for some cash. This means that a new asset will be recognised in the SOFP (the cash) and another will be derecognised (the NBV of the asset). A gain or loss will arise on this simultaneous recognition and derecognition. If sales proceeds > NBV then a profit on disposal will be recognised If sales proceeds < NBV then a loss on disposal will be recognised.

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ExPress Notes ACCA F3 Financial Accounting

 

  In effect, a profit or loss on disposal is a correction to the estimated figures each year for depreciation. This means that this is reported in profit or loss, just as depreciation is.

KEY KNOWLEDGE Revaluation

Sometimes, revaluations are made to assets that have increased in value. This is not required, but is possible. Once an asset has been revalued, all similar assets must be revalued and the valuations must be kept up to date. Depreciation must also be based on the new, revalued amount.

KEY KNOWLEDGE Depreciation of revalued asset

A revalued asset will still need to be depreciated. The depreciation charged must be on the higher, revalued amount (a revaluation downwards is an impairment, which is unlikely to feature in the F3 exam). Depreciation expense and allowance for depreciation will therefore increase.

KEY KNOWLEDGE Disposal of revalued asset

On disposal of a revalued asset, a gain or loss will arise as normal. The gain or loss will be the difference between the new revalued amount and the net book value immediately prior to the revaluation.

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ExPress Notes ACCA F3 Financial Accounting

 

  If there is any remaining revaluation surplus in revaluation relating to the disposed asset, it is normal to transfer this from revaluation reserve to retained earnings, as above.

KEY KNOWLEDGE Disclosure of non-current assets Non-current assets are generally disclosed on the face of the SOFP at their net book value, but with a breakdown in the notes to the financial statements that provide details of cost and allowance for depreciation.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 6

Intangible non-current assets

START The Big Picture An intangible asset is an asset with no physical substance. Often this is intellectual property rights or a licence to undertake some activity. As with tangible assets, it is necessary to prove that there is sufficient certainty of a future inflow of benefits to categorise this as an asset rather than an expense. Costs that result in something that the entity cannot be reasonably sure of controlling into the future must be written off as an expense.

KEY KNOWLEDGE Research and development costs An asset is a resource controlled by an entity that is expected to generate an inflow of benefit to the entity. The key issues in recognition of an intangible non-current asset therefore tend to be whether the asset is truly controlled by the entity and whether it is likely to generate an inflow of benefit.

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ExPress Notes ACCA F3 Financial Accounting

 

  Most research and development fails to produce a commercially viable product. It is also difficult to patent (i.e. restrict commercial use of) knowledge until it has reached a relatively advanced stage. Research costs are costs incurred in the early stages of a development project. It is defined in IAS 38 as is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. The key issue here is that it is not reasonably certain that expenditure will generate a viable income stream in the future. The accounting treatment required for research costs is to write them off immediately in profit or loss.

KEY KNOWLEDGE Development costs Development is defined in IAS 38 as “the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use”. The accounting treatment of development costs is to recognise them as an intangible noncurrent asset if they meet the criteria that suggest that they will be likely to generate a profitable income stream in the future and can be reliably separately identified using the mnemonic RAT PIE:      

Resources are adequate to complete the project Ability to complete Technically feasible Probable economic benefit (i.e. expected to be profitable) Intend to complete the project Expenditure on the project can be separately recorded.

A development cost asset can include the depreciation on machinery used in the development project. Instead of depreciation being written off against profit, it is asset to the cost of the qualifying development cost asset.

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Write-off period Intangible assets are written off over the period during which they generate benefits. As with tangible non-current assets, the aim is to match the pattern of cost to the pattern of benefit that the intangible asset generates. Development projects such as drugs patents tend to generate their greatest revenues in the early years of their commercial life. For this reason, amortisation is often chosen to be by the reducing balance method of amortisation rather than straight line.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 7

Inventory and purchases

START The Big Picture For most businesses, inventory will be a very short lived asset, which is expected to be sold (or possibly thrown away or stolen!) by the end of the accounting period. When inventory is purchased, it creates an asset, since the inventory is expected to give an inflow of benefit to the entity and the entity controls it. Strictly speaking therefore the correct accounting treatment for inventory would be, using illustrative numbers:

Step 1: Inventory is purchased: Dr Inventory asset (SOFP)

$10,000

Cr Cash/ payables

$10,000

Step 2: Inventory is sold:

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Dr Cost of sales (SOCI)

$12

Cr Inventory asset (SOFP)

$12

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ExPress Notes ACCA F3 Financial Accounting

 

  For a retailer, this could create practical problems, since each time an item of inventory is sold it would be necessary to identify the historical cost of that specific item of inventory and charge it to cost of sales (step 2 above). If the retailer deals with fast moving consumer goods, or perishable goods, then only a very small proportion of inventory purchased during the year would remain in inventory at the year end. In practical terms, journal step 2 above could be repeated many thousands of times as each individual sale happened. To simplify matters, most accounting systems (and all accounting systems that you can expect to encounter in the F3 exam) take the shortcut of writing inventory purchases off immediately to cost of sales in the SOCI, thus:

Single step: Inventory is purchased and treated as an expense: Dr Cost of sales (purchases expense) $10,000 Cr Cash/ payables

$10,000

At the end of the period, any inventory that remains in stock is then valued in accordance with IAS 2 (see below) and this is lifted out of cost of sales and treated as an asset that will probably be used up in the next period: Dr Inventory asset (SOFP)

$800

Cr Cost of sales (closing inventory) (SOCI)$800

At the start of the next period, this inventory asset is then treated as an expense, since it’s expected that it will be used up (e.g. by being sold or scrapped) by the end of that period and so becoming an expense of that period: Dr Cost of sales (opening inventory) (SOCI)$800 Cr Inventory asset (SOFP)

$800

The effect of these journals is to create the hopefully familiar working for calculating cost of sales: Opening inventory Add: Purchases in the period Less: Closing inventory Cost of sales made

Page | 40

0

Expense in SOCI

10,000

Expense in SOCI

(800)

Reduction in expense in SOCI

9,200

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Valuing inventory The purchase price of inventory is normally fairly simple. It will include costs necessary in order to bring the inventory into saleable condition, so including:

  

Cost paid to the supplier Irrecoverable taxes (e.g. import duties) Costs of delivery inwards (sometimes called carriage inwards).

Where inventory is work-in-progress in a manufacturing process it will also include fair costs of conversion (e.g. labour costs, production overhead costs). Recoverable sales taxes, non-production administrative costs and one-off costs that do not add anything to the inventory’s value (e.g. costs of delivery to the wrong location and cost of bringing to the right location) would be excluded from cost of sales, since they are unnecessary to bringing the inventory to saleable condition. By writing inventory off immediately to cost of sales, it is possible to keep inventory outside the accounting system. This simplifies matters considerably. However, it does mean that at the end of each period, inventory must be physically counted and valued, in order to make the necessary adjustments to lift unsold inventory out of cost of sales. Maximum value: lower of cost and NRV

An asset is only an asset if it is expected to generate an inflow of benefits. This means that if inventory is expected to sell for net proceeds below cost, the maximum valuation of that item of inventory in the SOFP will be the net amount that its sale is expected to generate (called its net realisable value or NRV).  

Any costs incurred up to the date of the accounts might be included within the determination of cost. Any revenues and future costs to be incurred to enable sale will be included within the determination of NRV.

The final valuation for each item of inventory will be the lower of cost and NRV. This has to be estimated on a stock line by stock line basis, so that realised losses on some stock do not mask unrealised expected gains on others.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 8

Receivables and payables

START The Big Picture We have already looked at how credit sales are often made to encourage sales. The problem with extending credit is that not all receivables will pay. This means that some will become irrecoverable. Before being written off as irrecoverable, some will also look like they may not pay (perhaps by being a month overdue for payment). These are doubtful debts. Remember that an asset is a resource that is expected to give an inflow of benefits. Logically therefore if a receivable is not expected to pay, it cannot be shown as an asset. The SOFP of the receivables cannot exceed the neutral estimate of how much cash is actually expected to be received.

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Irrecoverable debts If a debt is not going to pay, for example if a person has died bankrupt, then it must be written out of the accounting records as the receivable is no longer an asset. Removing an asset reduces net assets and so generates an expense, which is normally called irrecoverable debts expense, hence:

Dr Irrecoverable debts expense

$x

Cr Receivables

$x

KEY KNOWLEDGE Recovery of debts written off If a debt is unexpectedly paid having previously been written off, it is likely that the cash received will initially be recorded in the cash received book as a receipt from a debtor. This means that the journal to record the cash will be automatically generated thus:

Dr Bank

$800

Cr Receivables

$800

However, the balance is no longer in receivables, as it was written off. In order for the journal to work, it is then necessary to reinstate the balance that was previously written off. This is a change in accounting estimates, since the estimate last period was there was no realistic chance of the debt being recovered:

Dr Receivables

$800

Cr Irrecoverable debt expense

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$800.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

 

  There is no attempt to change the previous year’s figures, which include an expense for the write off of the debt, since this was a fair estimate at the time. There will be an expense recorded for the write off in the year when it was written off and a credit to profit or loss when the cash was received. Depending on how the initial cash receipt has been recorded, it may be possible to simplify the above two journals, because there is a debit and credit of the same amount to receivables, thus:

Dr Bank

$800

Cr Irrecoverable debt expense

$800.

KEY KNOWLEDGE Doubtful debts It is likely that some receivables will not pay, even if they have not yet been written off. The business will continue to chase the receivables for full payment and may eventually even sue for the full balance. The amount cannot be written out of debtors, as credit control will need the records of the debt in full to know how much to chase for payment. However, if it’s estimated that there is a 20% chance that a debt will not pay, it would fail to give a true and fair view on the face of the SOFP to show the full amount as an asset. The solution is to create an allowance account, which reduces the value of net receivables on the face of the SOFP without corrupting the records of the actual debtor balance that will be needed to try to obtain payment. Creating, or increasing, an allowance will reduce net assets. This therefore creates an expense. The allowance account itself is a SOFP account, so just like assets and liabilities it will remain on the balance sheet until it is removed.

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Control account reconciliations It is possible that an accounting system will maintain memorandum ledgers with individual customer balances outside the main accounting system. This creates duplication of effort and record keeping, but provides a check on accuracy of the figures. The receivables account in the double entry system is often called the “control account”, since it contains only summary figures of lots of transactions, rather than lots of detail of individual transactions. It may alternatively be called the general ledger, or nominal ledger. The memorandum ledger cards are confusing sometimes referred to as the “ledgers”. The double entry system will be kept as simple as possible, with as few figures posted to the ledger accounts (T accounts) as possible, since the fewer transactions there are, the less the chance of error and the less information to seek through in order to find errors when they occur. For this reason, the ledger accounts are normally updated using the totals from the sales day book and cash receipts book, rather than details of individual sales.

KEY KNOWLEDGE Other common items with receivables Interest on overdue debts If a sale agreement with a customer provides for a right to charge penalty interest on an overdue debt, this will increase the amount receivable. Increasing a receivable increases net assets, which therefore generates a source of income. It will normally be recorded as: Dr Receivables Cr Sundry income (or perhaps finance income)

$x $x

Discounts There are two types of discount that you may encounter: trade discounts and settlement discounts. Trade discounts are those given to customers at the point of sale, perhaps because the customer buys in large volumes or is a member of staff. These discounts are

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ExPress Notes ACCA F3 Financial Accounting

 

  not subject to any uncertainty at the time of sale – it is known for sure that the customer will never pay the list price of the goods or services. The accounting is therefore very simple: they are simply ignored. The sale is recorded at the amount net of the trade discount.

Settlement discounts A settlement discount is an incentive for customers to pay you earlier than they otherwise naturally would. For example, a discount of 5% may be offered on the invoice sent to customers if payment is received within seven days of the invoice being sent. If payment is not received within that period, the offer of the discount lapses. Settlement discounts are uncertain at the point of sale. The actual amount of the debt is gross of the settlement discount, i.e. before its deduction, since this is the amount that the customer will eventually be chased for if they don’t pay early. If the settlement discount is allowed to the customer, this is similar to the treatment of irrecoverable debts. It is simply a debt that we are voluntarily choosing to write off as partially irrecoverable because of the cash flow advantage of receiving the cash quickly. Settlement discounts are sometimes also called cash discounts for this reason. The terminology can be confusing here. Discounts allowed are settlement discounts that we allow to customers. They are therefore partial write off of debts receivable by us. They are therefore an expense in our books. Discounts received are settlement discounts that our suppliers allow to us. They are therefore partial forgiveness of debts that we owe to other people. They are therefore a source of income in our books.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 9

Bank reconciliations

START The Big Picture The cash book will record payments in and out of the bank account. Banks, of course, provide bank statements that record all the transactions that they have recorded in the same bank account. This independent record keeping is a powerful check on the accuracy of a business’s accounting records. In a small company scenario, it is likely that each transaction on the bank statements will be manually compared to the transactions on the cash book, ticking off matching transactions. This will then leave only items that don’t agree. In larger businesses that use a computerised accounting system, it is likely that the bank’s transactions will be downloaded in a raw data file (such as a .csv file) and will then be run through the accounting software. The accounting software will then match transactions and run off a report of differences. It is a good accounting practice to reconcile the bank accounts frequently. In some regulated scenarios, such as accounts that are used to hold client money, it is a professional requirement to reconcile the accounting records to the bank statements at least once a month.

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ExPress Notes ACCA F3 Financial Accounting

 

  To reconcile is to satisfactorily explain a difference between two numbers or records.

Reasons for differences  between bank  account and cash book

Errors/ omissions

Timing differences

(require correction)

(no action needed)

Errors/ omissions  by  the company itself

Errors/omissions  by the bank

Errors can be almost infinitely varied and can be made by either the bank or the company. If errors are made by the bank, the company will need to notify them, so that the bank can correct their records. If errors are made by the company, the company will need to amend its own records, using the journal book. Typical errors/ omissions made by the company:      

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Misposting of amounts, e.g. recording a cash payment of $45 as $54 Omission of cash payments or receipts Omission of standing orders processed by the bank (i.e. automatic payments of nonvariable amounts) Omission of “direct debit” payments processed by the bank (i.e. automatic payments of variable amounts) Omission of bank charges Processing errors, e.g. miscasting manually maintained accounts.

© 2012 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.

 

 

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ExPress Notes ACCA F3 Financial Accounting

 

  Typical errors/ omissions made by the bank (typically much rarer than the company):  

Incorrect charges Processing payments or receipts incorrectly.

Typical timing differences:  

Payments made into the bank not yet processed (“uncleared lodgements”) Cheques drawn or online payments ordered not yet processed by the bank.

A warning about terminology! A bank statement will record positive deposits with the bank as a credit, where the cash book will record them as debit. Both are correct, as a debit is an asset. If the bank holds some of your money, that means that the bank owes you money – i.e. you are a liability of the bank. So the bank statements will list your balance as a credit. Bank statements are run off from the records of the bank, not of the client. Hence, our debit correctly equals their credit and vice versa.

Page | 49

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 10

Long term finance

START The Big Picture Long-term finance means cash used to operate the business over the long-term. It may be paid into the business by owners, or by providers of loan finance. The former is capital and the latter is debt. Capital is normally only repaid to owners if the owners choose to close down a solvent business. The business has no obligation to pay back ordinary share capital while the business is a going concern.

KEY KNOWLEDGE Long term debt

Debt is a liability, meaning it’s an obligation of the business. Long-term debt may be funds raised from banks, or from other investors who buy loan notes (also called bonds, securities or commercial paper). Debt generally incurs an interest charge and may be redeemable (meaning repayable) over a period of time, on a fixed date or exceptionally irredeemable debt. The last category simply therefore pays interest into perpetuity without ever repaying

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ExPress Notes ACCA F3 Financial Accounting

 

  the loan principle. It is only ever issued by governments, and then only rarely. Loan notes are often tradable, meaning that the original buyer can get their cash back before redemption by selling the loan note to somebody else for its market value on that day. Any loan principal due for repayment within the current year is a current liability; any debt due for repayment after more than one year is a non-current liability. On the issue of a loan, the cash received will be credited to a loan liability account. No liability is recorded for expected future interest, as the obligation to pay interest only arises as time passes.

KEY KNOWLEDGE Equity

Equity is the residual interest of all assets after deducting all liabilities. For a sole trader, equity is simply termed proprietor’s interest. In a partnership, it is the sum of each partner’s capital account and each partner’s current account. In the case of a company, IFRS and national regulation often require a greater analysis of each component of equity. Equity in total is often termed shareholders’ interest or shareholders’ funds. In a large limited liability company, equity may comprise the sum of the following:   

Ordinary share capital Preference share capital Reserves: o Share premium account o Revaluation reserves o Other reserves o Retained earnings Companies are required to present a note in their financial statements that reconcile each component of equity at the start of the year to the end of the year. This is another expression of the accounting equation and business equation from chapter 1.

Page | 51

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 11

Accruals and prepayments

START The Big Picture One of the fundamental assumptions of accounting that we saw in chapter 1 was the accruals concept. There are two aspects to the accruals concept:  

Accruals

Prepayments

Where an expense has been incurred, but it’s not yet been paid. Often, an invoice hasn’t yet been received, so an estimate of expense incurred by the year-end will need to be made. This means there is a liability at the period end.

Where an amount has been paid in advance, but that cash payment gives a right to receive benefits beyond the current period end. This means that there is an asset at the period end, since there is a right to receive future benefits.

Examples:

Examples:

 

Page | 52

Matching costs to the associated revenues. For example, depreciation and the cost of sales working both do this. Recognising transactions as they are incurred, not necessarily when the cash is paid. This also has the effect of ensuring that a profit calculation for a period will hopefully show a sustainable profit, since all expenses incurred in the period will be matched to all revenues earned, even if the expense hasn’t yet been paid.

Estimated water and electricity used Estimated telephone charges for a

Insurance paid in advance for a year’s insurance cover.

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ExPress Notes ACCA F3 Financial Accounting

    traditional landline telephone at a month end.

Prepaid balances on pay-as-you-go mobile telephones.

KEY KNOWLEDGE Accounting treatment at the year end Accruals

Prepayments

Estimate the cost of goods or services used by the year end but not invoiced. This might be done using typical levels of usage, or done after the period end using invoices that came in after the period end, but before the accounts are prepared.

Calculate the amount of the prepayment from cash paid before the year-end. Determining the amount of the prepayment will normally be easier than estimating the amount of an accrual, since there is an actual cash payment before the period end to base the calculation on.

Recognise this as a liability, since there is an obligation to pay this charge. Recognising the liability reduces net assets, so generates an associated expense:

Recognise the asset (the right to receive future benefits) at the period end. Doing this increases net assets so generates a source of income. In reality, this source of income will be a reduction in the expense recognised so far from posting cash payments from the cash book to expenses.

Dr Expense in SOCI (e.g. electricity) Cr Accruals in SOFP (liability)

$x Dr Prepayment in SOFP (asset) $x Cr Expense in SOCI (e.g. insurance)

KEY KNOWLEDGE Accounting treatment in the following period In the following period, it’s reasonable to assume at the start of the period that the prepayment asset will be used up (e.g. the benefit of insurance received) or the liability will be settled by payment of cash. It’s therefore normal at the start of the year to anticipate this by reversing the accrual liability or prepayment asset through profit. This is often done

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ExPress Notes ACCA F3 Financial Accounting

 

  at the beginning of the following period, but it could be done at the end of the period in some companies. It’s a manual adjustment through the journal book, so it can be done anytime that the company likes. It must be done, however, as otherwise redundant assets and liabilities will be shown on the SOFP forever!

Accruals

Prepayments

Recognise the discharge of the liability in the following period. This increases net assets, so creates a credit to expenses. This means that as cash is paid the following period, not all of it will be recognised as an expense in that period, since an amount equivalent to the opening accrual will already have been reported as an expense the previous year. Reversing the accrual removes any chance of accidental double recognition of the expense.

Recognise the consumption of the asset in the following period. This derecognises the asset that no longer exists. Derecognising the asset reduces net assets, so generates an expense. This will be an expense in period 2 of the cash payment not recognised as an expense in period 1.

Dr Accruals in SOFP (liability)

Dr Expense in SOCI (e.g. insurance) Cr Prepayment in SOFP (asset) $x

$x

Cr Expense in SOCI (e.g. electricity)

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 12

Provisions and contingencies

START The Big Picture A liability is defined in IFRS as being:   

An obligation at the period end (i.e. something that is impossible to avoid – not just an intention to do something), and Where an outflow of benefit is expected to arise from that obligation, and A reliable (which in practice means meaningful) estimate of the outflow can be made.

A provision is simply a liability of uncertain timing or amount. Accruals may be a form of provision, if there is no firm data on which to base the estimate of the amount expected to be paid. A provision is valued at the neutral best estimate of what the business expects to pay to settle the obligation. For a one-off liability (e.g. lawsuit) this will be the single most probable outcome. For a recurring series of similar liabilities (e.g. lots of goods sold under warranty) it will be the weighted average of outcomes.

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ExPress Notes ACCA F3 Financial Accounting

    Contingent liabilities A contingent liability exists in one of two situations, which are either:

It is believed that there is probably no obligating event (<50% probability) but the chances of there being an obligating event are more than remote (>5% probability), or An obligation probably exists, but it is so difficult to obtain an estimate of what the outflow is likely to be that any estimate would be no more reliable than zero. This second situation is very rare. Contingent liabilities are disclosed in the notes to the financial statements but are not shown with any value on the SOFP.

Contingent assets A contingent asset is one where it is uncertain if the asset (i.e. right to something) even exists. Examples are insurance claims where it’s uncertain if the item being claimed for is covered by the policy at all or a lottery ticket before the lottery draw. Contingent assets are not shown as assets in the SOFP, nor disclosed in the notes to the financial statements.

Movement in provisions A provision is a liability. As with any item on the SOFP, it will remain on the SOFP until it is removed. If a provision is increased during the period, the effect will be to reduce profit and net assets: Dr Expense (e.g. for legal costs)

$ Increase in provision

Cr Provision

$ Increase in provision

The provision is categorised on the SOFP within current liabilities or non-current liabilities, depending upon whether it is expected to be settled within 12 months of the reporting date or longer. If a provision is no longer needed, it will be reversed. This will reduce the profit effect of the cash payment in the period.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 13

Sales taxes

START The Big Picture Sales taxes, such as Value Added Tax (“VAT”) are a common feature of business. The rules vary considerably between countries, but typically businesses are required to register for sales tax if their expected turnover exceeds a certain limit. Businesses that are not registered for sales tax simply record purchases and sales at whatever cash they pay or receive. Businesses that must register for sales tax have an additional complication in their accounting system. In order to comply with the law, they must very accurately maintain records of sales taxes that they have been required to charge on their sales (their “output tax”) and the tax that they have paid on their purchases of goods and services (their “input tax”). As people who are not registered for sales tax, we may often be unaware of what sales taxes we are suffering, though receipts will normally provide a breakdown of the amount inclusive of the sales tax (“gross”), the amount of the sales tax itself and thus the amount excluding the sales tax (“net”).

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ExPress Notes ACCA F3 Financial Accounting

 

  Local laws vary on how prices must be quoted. In most countries, the convention appears to be that prices must include sales tax unless they specify otherwise. In the USA, it is normal for prices to be quoted net of sales tax and then the sales tax is added at the point of purchase. In an exam question, it’s first important to know which way the prices have been quoted.

If a business is not registered for sales tax, it does not need to charge sales tax on its outputs, but it cannot recover sales tax on its inputs. If a business is registered for sales tax, it must charge sales tax on its outputs which it must then pay over to the government periodically. It recovers sales tax on its inputs by netting it off the sales tax payable.

Ledger accounting Purchases and payables would be recorded as:

Dr Purchases (SOCI, so net)

$135,000

Cr Cash/ payables (SOFP, so gross)

$162,000

= > Dr Sales tax control account (SOFP)

$27,000

The sales tax control at any point will show the amount due to or from the tax authority for sales taxes. Sales and receivables would be recorded as:

Cr Sales revenue (SOCI, so net)

$178,000

Dr Cash/ receivables (SOFP, so gross)

$213,600

= > Cr Sales tax control account (SOFP)

$35,600

This leaves a net balance on sales tax control of $8,600.

Page | 58

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ExPress Notes ACCA F3 Financial Accounting

    Recoverable or irrecoverable?

Some items will include sales taxes that under local law are not recoverable, as a matter of public policy. These might include business entertaining expenses or sales tax on cars. In the UK for example, sales tax on vans is recoverable for a registered business, but sales tax on purchase of a company car is not. If an item includes irrecoverable sales tax, it is included within the recognised value of the asset or expense.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 14

Trial balances and correction of errors

START The Big Picture In chapter 4, we prepared simple records of a sole trader and listed all the balances on their accounts at the end of the period. This was a preliminary trial balance. Dr Cash

16,140

Capital Purchases

15,000 3,000

Payables

2,040

Sales income

4,140

Staff costs

Page | 60

Cr

50

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ExPress Notes ACCA F3 Financial Accounting

    Non-current assets Telephone

540 60

Receivables

1,240

Withdrawals

150

Totals

21,180

21,180

The fact that the total debits equal the total of the credits gives us a considerable amount of comfort that the bookkeeping has been done accurately. If the total debits does not equal total credits, it implies that errors have been made in the recording of transactions, the adding up of the T accounts or the extraction of balances from the T accounts into the trial balance itself. It does not mean that no errors have taken place. These types of errors will not be picked up in a trial balance:

Page | 61

Errors of omission – having totally ignored a transaction or necessary adjustment

Compensating errors – two errors happening to cancel each other out

Errors of principle – treating an expense as an asset, income as liability, or vice versa

Errors of commission – recording the correct journal, but at the wrong amount.

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ExPress Notes ACCA F3 Financial Accounting

    Overview of stages in preparation of financial statements

Record transactions using  books of original entry

Periodically total books of  original entry and post  totals to ledger accounts

Total ledgers and produce  preliminary trial balance

Use journal book for  corrections and  "period 13" adjustments

Final trial balance

Produce financial  statements

 

Reset income and  expenditure accounts to  zero by transferring  balacnes to profit and loss  account

Transfer profit and loss T  account to equity

Opening trial balance for  next period

Page | 62

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Correction of errors As professional accountants, much time is spent dealing with correcting errors from draft records prepared by less experienced people. Knowing how to correct errors is therefore a critical skill for a chartered certified accountant. The easiest approach to take is to take three steps and resist the temptation to try to simplify them, as rushing into a simplification normally results in further complication and a poor trail for another person to review the work that you’ve done. So the approach to take is: 1. Work out what has been done to record a transaction and write down the journal that has been recorded, no matter how crazy it might be. 2. Work out what the journal entry should have been. 3. Compare the results from steps 1 and 2 to work out a correcting journal.

Page | 63

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 15

Suspense accounts

START The Big Picture We saw in previous chapters that if all is working well with an accounting system, the total of the debits will equal the total of the credits when a trial balance is presented. Errors may occur that will result in total debits not being equal to total credits. This may arise in many situations, including:   

One sided journal (e.g. Dr Cash $100 only) Posting both sides of a journal on the debit or credit side (e.g. Dr Receivables $80, Dr Sales $80) Recording different amounts on the debit and credit sides (e.g. Dr Payables $230, Cr Cash $320).

If a trial balance is produced frequently, it will be possible to spot these errors while they are recent enough to have a good chance of finding them.

Page | 64

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ExPress Notes ACCA F3 Financial Accounting

 

  In order to highlight the problem, a suspense account is created which will fill the hole in the trial balance. A suspense account is an equity account, which should be eliminated in full before the financial statements are produced. Because a suspense account may arise due to multiple errors, some of which will be a debit to suspense and some a credit to suspense, it really ought to be eliminated in full and this is what you should expect to have to do in the exam. In practice, it’s normal to find that suspense accounts can become very small, when the effort in clearing them becomes disproportionate to the benefit. They are then often written off to profit or loss to clear them once the residual figures become trivially small, as the chance of a difference of $0.10 being the net of two large compensating errors is very small.

Deliberate creation of suspense accounts A suspense account may be used deliberately where a transaction has happened but the bookkeeper is uncertain what it relates to. By recording the transaction in suspense, it can ensure that the records are at least partially correct, but can then be corrected fully when the information necessary is known.

Page | 65

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 16

Incomplete records

START The Big Picture It’s common for smaller businesses not to maintain perfect systems for capturing data that can then be used to produce the financial statements. In some situations as well, it’s common to have to construct financial information to find missing information about transactions that don’t get recorded in the system because of their nature, such as losses due to theft of inventory.

The key techniques to answer exam questions on this are:   

Page | 66

Cost structures of mark-up and margin Use of T accounts to find missing figures Use of the accounting equation/ business equation to find missing figures such as profit (this was covered in chapter 1).

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Margin and mark-up There is a terminology distinction here that is important: Mark-up means that you start with the cost of a sale, then add the mark-up % to determine sales price. Margin means that you start with the sales price, of which a specified % will be gross profit.

Mark-up

Margin

Sales revenue

120%

Sales revenue

100%

Cost of sales

100%

Cost of sales

80%

Gross profit

20%

Gross profit

20%

Withdrawal of inventory for own use In a smaller business, a proprietor is likely to withdraw inventory for his/ her own use. This is a withdrawal from the business. The purchase of inventory will have been written off to purchases, within cost of sales. However, if the inventory is taken by the proprietor, it has not been sold. A common accounting treatment and the one to use in any exam question is therefore to remove it from cost of sales (at cost) and debit to withdrawals.

Page | 67

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 17

Limited companies

START The Big Picture Separate legal identity A sole trader is a different entity to his/ her business as far as accountants are concerned, but not as far as the law is concerned. The business debts of a sole trader are indistinguishable from that person’s general debts in the event that the business goes insolvent. A sole trader, or traditional unlimited partnership, is a risky form of enterprise as if it goes bankrupt, the trustee in bankruptcy can seek to recover personal assets to make up the shortfall. This can be a different story with a company, since a company has a legal identity of its own, being an artificial legal person.

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ExPress Notes ACCA F3 Financial Accounting

 

  Note that limited liability does not mean that the liability of the company to its creditors is limited! It means that the liability of the members to the company is limited. This is developed in greater detail in paper F4 GLO.

The members...

....enjoy limited liability to....

...the limited company....

...which has unlimited liability to...

...its creditors.

Taxation With a sole trader, taxation expense does not appear in the SOCI. This is because the sole trader’s tax liability depends on lots of other things, such as any other sources of income that they may have or tax deductible personal expenses. The business is not the complete story of the owner’s wealth, so the tax liability of that person from business earnings cannot be known. With a company, the tax position is known, since the company itself will have a liability for corporate income tax. This means that it is possible to make an estimate of what tax will be due on profit for the period. This tax: 

Page | 69

Is likely to be an estimate at the year-end as there are often adjustments to accounting profit to agree with the tax authority, clarification to be obtained on whether certain expenses are deductible, if any tax losses can be offset against current year profit, etc, and Is likely to be paid some time after the period end, so is a liability in the SOFP at the period end.

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE Equity The equity section of the SOFP of a limited company will look different to that of a sole trader. This was outlined in chapter 10. Companies are regulated in law by what dividend they can pay and which reserves dividends can be paid from. Basically, dividends can only be paid out of retained earnings. Retained earnings are the cumulative of recognised profit (not total comprehensive income) less cumulative dividends paid. Other comprehensive income (e.g. revaluation gains) are transferred to revaluation reserve. See the statement of changes in equity in chapter 10 for an example of this.

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Component of equity

What it is

Distributable?

Ordinary share capital

Records the nominal value of the shares issued to date. Ordinary shares generally have only a discretionary dividend and come with voting rights.

No

Preference share capital

Records the nominal value of preference shares issued to date. Preference shares normally carry a fixed dividend but have no voting rights.

No

Share premium account

Records the excess over nominal value of consideration received on the issue of shares.

No

Revaluation reserve

Records cumulative revaluation gains on profit above historical cost. Movements on revaluation reserve will be reported in other comprehensive income within the statement of comprehensive income

No

Retained earnings

Records cumulative recognised profit, less cumulative dividends received.

Yes

Other reserves

Some IFRS require some gains and losses to be reported in “other equity”. Sometimes companies may choose to maintain a separate component of retained earnings, or national law requires it, e.g. some national laws require that 5% of profit each year is transferred to a non-distributable other reserve.

Partially. Wise to treat as nondistributable.

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ExPress Notes ACCA F3 Financial Accounting

 

  Note that current market price of shares is not relevant to accounting. Only the valuation of consideration (normally cash) received by the company for issue of shares is relevant to the SOFP.

Page | 71

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 18

Statement of cash flows

START The Big Picture Purpose of a statement of cash flows In addition to information about profit and other comprehensive income, it is useful to provide investors with analysed information about cash flows. This gives the following benefits:

Understandability - Smaller investors in particular are likely to find cash flows easier to understand than total comprehensive income.

Business valuation – a common method of valuing businesses is to work out the net present value of cash flows. This is covered in other ACCA papers, but for F3 you need to know that cash flow information feeds into this common type of valuation.

Predicting liquidity problems – when companies run out of cash, they are often in serious trouble and may go out of business. If a business is reporting profits but not collecting cash (e.g. by making sales on excessively generous credit terms) then this needs to be made clear to readers.

Page | 72

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ExPress Notes ACCA F3 Financial Accounting

   

KEY KNOWLEDGE What is cash? IAS 7 presents a statement of cash flows using both cash and cash equivalents. A cash equivalent is a short-term, highly liquid short-term investment that is readily convertible into a known amount of cash and is subject to insignificant risk of changes in value. To some extent, this is a subjective definition. In the exam, it will be made clear. Cash and cash equivalents will include:    

Notes and coins Demand deposits at a bank Foreign currency deposits (will not be in paper F3) Government bonds very close to maturity date (will not be in paper F3).

Cash and cash equivalents will exclude:  

Shares in other companies Long-dated bonds.

If a company uses cash to buy a cash equivalent, it will not be reported in the statement of cash flows as a cash movement. If a company uses cash or cash equivalents to buy shares, it will be reported in the statement of cash flows as a cash outflow on investing activities.

Profit vs. cash flow We have seen already that there are many items within a statement of comprehensive income that do not represent a movement of cash. The method used by most companies to present a statement of cash flows reconciles operating profit (earnings before interest and taxation) to cash generated from operations (i.e. cash flow from core operations, before buying or selling non-current assets or raising new finance). If a transaction or journal adjustment affects earnings before interest and tax, but does not affect cash from operations, then it is a difference. That difference will be part of the reconciliation.

Page | 73

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ExPress Notes ACCA F3 Financial Accounting

 

  A number of multiple choice items is likely to focus on this part of preparation of a statement of cash flows under the indirect method, so it’s worth being able to do in full; even if this could not be required in the exam itself.

KEY KNOWLEDGE Direct method or indirect method The cash generated from operations may be presented under IAS 1 using two alternative presentations, both of which reach the same figure, but by different means. The direct method is shorter in presentation but often longer to calculate the figures in an exam.

$ Cash received from customers

$ 28,200

Cash paid to suppliers and employees

(24,500)

Cash generated from operations

3,700

Interest paid

(140)

Income taxes paid

(340)

Net cash from operating activities

3,220

Cash flows from investing activities Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividends received

(1,620) 120 80 190

Net cash used in investing activities

Page | 74

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(1,230)

 

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ExPress Notes ACCA F3 Financial Accounting

    Cash flows from financing activities Proceeds from issue of share capital

70

Proceeds from long-term borrowings

180

Dividends paid

(40)

Net cash used in financing activities

210

Net increase in cash and cash equivalents

2,200

Cash and cash equivalents at the start of the period

(1,450)

Cash and cash equivalents at the end of the period

750

Indirect method $ Profit before tax Finance costs Profit before interest and tax

$

3,105 150 2,995

Adjustments for: Depreciation

370

Amortisation

100

Increase in inventories

65

Increase in receivables

330

Increase in payables

Cash generated from operations

Page | 75

(120)

3,700

Interest paid

(140)

Income taxes paid

(340)

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ExPress Notes ACCA F3 Financial Accounting

   

Net cash from operating activities

3,220

Cash flows from investing activities Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividends received

(1,620) 120 80 190

Net cash used in investing activities

(1,230)

Cash flows from financing activities Proceeds from issue of share capital

70

Proceeds from long-term borrowings

180

Dividends paid

(40)

Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the start of the period

210 2,200 (1,450)

Cash and cash equivalents at the end of the period

750

Finding cash flows using double entry A multiple choice question may provide you with information about items in the SOFP at the end of this period, the end of the previous period and provide figures from the SOCI. You would then be required to find the cash flow as the balancing item, using T accounts. This is exactly the same technique as used in incomplete records.

Technique to use The technique here is nothing new to learn; it is exactly the same approach as for incomplete records:

Page | 76

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ExPress Notes ACCA F3 Financial Accounting

      

Page | 77

Identify any asset/ liability accounts in the question where you are given both an opening and closing balance. Write up a T account for this account, including all the data that you are given. Balance off this account to find the information that you are looking for, which will be the cash paid or received relating to that asset/ liability in the period.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 19

Consolidated financial statements

START The Big Picture There are three possible levels of investment that one company may have in another:

Page | 78

Type of investment

Level of influence

Accounting treatment in group financial statements

Available for sale asset (i.e. trade investment)

Little or none

Historical cost or market value

Associate

Significant influence, normally by holding between 20% and 50% of the voting shares

“Equity accounting”, which is a simplified form of consolidation.

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ExPress Notes ACCA F3 Financial Accounting

    Subsidiary

Control, normally by holding >50% of the voting shares

Line-by-line consolidation of all items under parent’s control, plus goodwill and non-controlling interests.

Subsidiary Companies often trade through a group of companies. This might be due to acquisition of other pre-existing companies or by setting up separate legal entities to ring-fence business risks. Legally, each company exists separately and must produce separate (“individual” or “entity”) financial statements. Investors in the parent company, however, will be interested to see all the assets, liabilities and profits that their company has controlled. This is achieved by the process of consolidation, which presents the financial statements of all entities under the parent company’s control as if it were one single entity.

Investors

Parent Group Subsidiary

Consolidation is the process of replacing the single figure for “investment in subsidiary” in the individual financial statements of the parent with more useful information about what assets, liabilities, income and expenditure the parent company controls via its investment, i.e.:

Page | 79

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ExPress Notes ACCA F3 Financial Accounting

   

Net assets in the subsidiary’s financial statements (i.e. equity or capital plus reserves) at the acquisition date. Consideration transferred to buy subsidiary (as shown in the parent company’s individual accounts)

Non-controlling interests’ share of the net assets of the subsidiary.

Goodwill arising on acquisition (premium paid to acquire the subsidiary). Consolidation is basically a double entry to derecognise the carrying value of the investment (Cr Investment in subsidiary) and recognise the individual assets (Dr PP&E, etc), the liabilities (Cr Payables, etc), the non-controlling interest (CR NCI) and recognise goodwill as a balancing, residual, item (normally DR Goodwill).

Key definitions  

Page | 80

What group accounting is trying to do

 

Subsidiary

Any entity that is controlled by another entity, normally by having more than 50% of the voting power, though there is no minimum shareholding.

Parent

The entity at the top of the group structure, controls the subsidiaries and has a significant interest in associates.

Associate

A company in which the parent has significant influence, but not control nor joint control (as with a joint venture).

Control

The power to control the financial and operating policies of another

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ExPress Notes ACCA F3 Financial Accounting

    entity, so as to obtain benefit from its activities. Significant influence

The power to participate in the financial and operating policies of another entity, so as to obtain benefit from its activities.

Equity

Equity is defined in the Framework document as assets less liabilities. By definition, this is the same as capital and reserves of any company at any date in time. In group accounting, we very frequently use the capital + reserves = net assets. For example, this is used to work out the net assets on the date of acquiring control of a company (as part of the goodwill working) and to work out post-acquisition growth in a subsidiary’s assets (i.e. post-acquisition profit).

Group reserves

The cumulative gains made under the control of the parent. The parent company’s reserves, plus the post-acquisition retained gains of all subsidiaries, joint ventures and associates.

Non-controlling interest

Formerly called minority interest. The share of the net assets and gains of a subsidiary that is not owned by the parent.

Goodwill

The premium paid by the parent to acquire its interest in a subsidiary or associate.

The mechanics of consolidation  

 

The best approach to consolidation is to use a set of standard workings. (W1) Establish the group structure P Date of acquisition

80%

This indicates that P owns 80% of the ordinary shares of S and when they were acquired.

S (W2) Goodwill IFRS 3 Revised introduced an accounting policy choice when accounting for goodwill on acquisition. It can either be calculated on a full ("fair value") basis or a proportionate ("net") basis. Only full goodwill method is relevant for F3 examination.

Page | 81

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ExPress Notes ACCA F3 Financial Accounting

    Purchase consideration paid by parent (i.e fair value paid by parent) NCI value at acquisition Fair value of net assets at acquisition

X X (X) ___ X

Goodwill (W3) Group reserves Parent Sub (% × post-acq reserves)

Retained earnings X X –––– X ––––

Other reserves X X –––– X ––––

(W4) Non-controlling interests NCI value at acquisition NCI value of post acquisition reserves

X X

NCI value at reporting date

___ X

 

Fair Values  

To ensure that an accurate figure is calculated for goodwill: • the consideration paid for a subsidiary must be accounted for at fair value • the subsidiary’s identifiable assets and liabilities acquired must be accounted for at their fair values.

Calculation of cost of investment The cost of acquisition includes the following elements: • cash paid • fair value of any other consideration i.e. share exchange.

Page | 82

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ExPress Notes ACCA F3 Financial Accounting

    Share exchange

Often the parent company will issue shares in its own company in return for the shares acquired in the subsidiary. The share price at acquisition should be used to record the cost of the shares at fair value.

Fair value of net assets of subsidiary At acquisition, the parent recognises in the group accounts the identifiable assets acquired and liabilities assumed of the subsidiary. They are to be measured at their fair value as at the date of acquisition. Adjustments will be required to subsidiary’s accounts if the carrying values do not reflect fair value. Most common adjustment in the exam will relate to land and buildings and it will ignore depreciation.

 

Intra-group trading  

P and S may trade with each. If this is done on a credit basis one company will have a receivable and the other a payable at the year end. These amounts must be cancelled on consolidation, since only assets and liabilities outside the group will appear on consolidated statement of financial position. If inter-company trading is done at a profit it should be eliminated on consolidation for all items traded and still held in inventory at the year end.

Adjustments for unrealised profit in inventory The following steps should be considered when adjusting for unrealised profits: (1) Determine the value of intra-group purchases still held in inventory at year end.

Page | 83

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ExPress Notes ACCA F3 Financial Accounting

 

  (2) Use markup or margin to calculate the profit earned by the selling company. (3) Always make the adjustments in the books of the seller.

Mid- year acquisition  

 

If the subsidiary is acquired part way into the year, the net assets at the date of acquisition must be determined. Unless otherwise stated, the calculation is based on the assumption that subsidiary’s profits accrue evenly over the year.

Principles of consolidated statement of comprehensive income The principles used to prepare the group statement of financial position are equally applicable when preparing group income statement and summarised below:

Page | 84

Group statement of financial position

Group income statement

Comment

Cross casting

Basic rule: all assets and liabilities are fully cross cast

Basic rule: all income and expenses are fully cross cast

Subsidiary results need to be time apportioned if it was acquired part way into the year.

Intercompany items

Inter-company current account

Inter-company sales and purchases are

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ExPress Notes ACCA F3 Financial Accounting

   

Provision for unrealized profit

Page | 85

balances are excluded.

excluded.

Same principle applies for intercompany loans

Same principles apply with intercompany interest.

Group statement of financial position

Group income statement

Comment

For all unsold inventory at year end at a transfer price between group companies. The PURP will reduce both inventory and equity.

The PURP consolidation adjustment will reduce profits.

The extra expense in respect of PURP is included in COS.

If the subsidiary is the seller the NCI is charged

If the subsidiary is the seller the NCI is charged

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ExPress Notes ACCA F3 Financial Accounting

    NCI

The NCI in the subsidiary’s net assets will reflect fair value adjustments on assets and PURPs (where the subsidiary is the seller).

The NCI in the subsidiary’s profit will reflect fair value adjustments, and PURPs (where the subsidiary is the seller) and.

By showing the profit of the subsidiary that is attributable to NCI, the group SOCI can show as a balancing figure the total group profit that are attributable to equity holders.

Associate IAS 28 Investments in Associates defines an associate as an entity over which the investor has significant influence and that is neither a subsidiary nor an interest in joint venture. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies. Significant influence is assumed with a shareholding of 20% to 50%, but other factors may be taken into account, such as: 

Representation on the investee’s board of directors

Evidence that the investee company is used to accepting the investor as having significant influence

Whether the investee is part of the supply chain of the investor

Sharing key personnel

Sharing key information.

Under these circumstances the parent cannot consolidate each item of the investee’s assets, liabilities, income and gains, since the parent does not have control of them. Equity accounting is a method of accounting whereby the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the investor’s share of net assets of the associate.

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ExPress Notes ACCA F3 Financial Accounting

   

Consolidated statement of financial position will include one line within non-current assets “investment in associate” that will reflects group share of the assets and liabilities of the associate. Consolidated income statement will include one line “share of profits from associates” that reflects group share of the associate’s profit after tax. Note: in order to equity account, the parent company must already be producing consolidated financial statements (i.e. it must already have at least one subsidiary). Trading with the associate The associate is considered to be outside the group and therefore only unrealised profit in inventory and dividends are adjusted for.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 20

Events after reporting date, errors and estimates

KEY KNOWLEDGE Events after the reporting date Events after the reporting date are ones that happen between the financial year end and when the financial statements are authorised for issue. They are colloquially referred to by most people as “post balance sheet events”. All material events after the reporting date must be disclosed and explained in the notes to the financial statements. An adjusting event is one that gives further information on conditions that existed at the reporting date. The figures in the financial statements are amended to incorporate the latest available information.

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ExPress Notes ACCA F3 Financial Accounting

 

  Examples of adjusting events according to IAS 10 Events After the Reporting Period include:    

Bankruptcy of a major receivable, as the receivable would be almost certain to have been in trouble at the period end. Sale of inventory after the period end at a loss. Resolution of a matter requiring a provision at the reporting date, such as a litigation in progress at the period end. Any matter which causes the company to no longer be a going concern after the period end will be an adjusting event, even if it would normally be a non-adjusting event. Discovery or fraud or error in the preparation of the financial statements.

Examples of events that would be non-adjusting, but would be disclosed in the notes to the accounts only include:  

Issue of new shares Declaration of a dividend after the reporting date.

KEY KNOWLEDGE Errors and estimates

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors Accounting policies are the detailed applications of IFRS that a company chooses to apply. Examples:   

How similar types of transactions are grouped and reported together (e.g. classes of non-current asset) At what exact point revenue is recognised What de minimis figure to use when recognising non-current assets.

Accounting estimates are best guesses necessarily made in the preparation of the financial statements, including:   

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Expected useful lives of assets Residual value of assets How much a lawsuit is likely to cost the company to settle

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ExPress Notes ACCA F3 Financial Accounting

     

Recoverable value of assets for the purposes of calculating impairment losses Default rate by overdue receivables when determining allowance.

Accounting estimates are by their nature uncertain and unlikely to prove to be exactly what happens. Correction of accounting estimates is prospective. This means that an error in estimate in 20x1 is corrected in 20x2, with no attempt to restate the figures for 20x1. Accounting errors relate to errors in previous periods. These are errors that could reasonably have been expected to have been corrected at the time that the previous period’s financial statements were authorised for issue. Errors discovered before issue of the current year’s financial statements will be corrected, as all accounting errors are adjusting events under IAS 10 (see above). Correction of accounting errors is retrospective. This means that the previous year’s financial statements are restated to the figures that they should have been. The comparative figures will be different to what was previously reported so will need to be headed “restated”. Any cumulative differences at the start of the year between the previously reported figures and the restated figures will be taken to equity at the start of the current period. Any correction of an accounting error will only be if the error is material (i.e. large enough to influence users’ opinions). Particulars, reason and effect of the correction will also need to be given full and frank disclosure in the notes to the accounts.

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ExPress Notes ACCA F3 Financial Accounting

    Chapter 21

Interpretation of financial statements

START The Big Picture Financial statements on their own are of limited use and therefore in order to gain additional useful information from them ratio analysis is used. For F3 exam purposes calculating a series of ratios and explain their interrelationship is a must.

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ExPress Notes ACCA F3 Financial Accounting

   

Interpretation  of financial  statements

Profitability

Liquidity and  efficiency

Gearing

Investor ratios

Profitability Typical ratios to measure relative profitability include:

Gross margin

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Gross profit Revenue

Net margin

Profit before interest and tax Revenue

Return on capital employed (ROCE)

Profit before interest and tax Equity + interest bearing debt

Asset turnover

Revenue Equity + interest bearing debt

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ExPress Notes ACCA F3 Financial Accounting

    Liquidity and efficiency

If a business runs out of cash and cannot refinance in a hurry, it goes out of business. It’s possible for companies to focus excessively on profitability at the expense of liquidity management.

Current ratio

Current assets Current liabilities

Quick ratio (“Acid test”).

Current assets, except inventory Current liabilities

Inventory days

Average inventory x 365 Purchases/COS

Receivables collection period

Average receivables x 365 Credit sales

Payables payment period

Average payables x 365 Credit purchases

Gearing This is of considerable topical relevance at the moment, as many companies are criticized for having taken on excessive amounts of debt, which they felt were cheap at the time. However, this has provided a high amount of interest to pay off as revenues have fallen.

Debt/ equity

Interest cover

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Interest bearing debt Capital + reserves Profit before interest and tax Interest expense

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ExPress Notes ACCA F3 Financial Accounting

    Investor ratios

These largely give an indication of the risk to investors of putting money into the company, i.e. what is the chance that the money may not come back to them? As the greater the risk of investing in a business, the greater the return investors will want, it is important to look at profitability ratios against the backdrop of investor returns as well.

Dividend cover

Profit before ordinary dividend Ordinary dividend

Dividend yield

Dividend Market price of shares

Price/ earnings ratio

Market price of shares Earnings per share

(end of ExPress Notes)

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ACCA F3 2012 ExPress Notes