Accounting – Revision For Mid Term ExamDr. Clive Vlieland-Boddy

Academic Year2009-2010

IFRS Vs GAAP

• Started as a EU standard.• Now world wide except USA• USA will eventually concede and accept.• Strength gained after failures of WorldCom

and Enron.• Makes international comparison simpler. • Accounts are founded on the same basis

worldwide.

Self Regulatory Vs Statutory

• Precise rules Vs shared principles• A book of rules Vs laid out principles.

Stakeholders• Any party interested in the financial

statements.• Include:

– Shareholders– Governments– Public– Employees– Customers– Suppliers– Lenders

Stakeholders

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Shareholders & Investors

Suppliers Employees Lenders

Customers Government Public

Double Entry Bookkeeping

Name of Account

Debit Credit

Debits

• Assets• Bank Receipts• Expenditures• Losses

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Credits

• Liabilities• Bank Payments

• Shareholders Funds• Incomes (Sales)

• Profits

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Accounting Concepts

• Going Concern• Matching or Accruals• Consistency• Prudence

Revision of Understanding Financial Statements

Professor Clive Vlieland-Boddy FCA FCCA MBA PhD

EU 2009

The Balance Sheet

Assets

• Have to have a value• Either Current or Non Current ( either < or >

12 months.• Should be shown at actual cost but can be

revalued

Current Assets

• Short term business assets < 12 months to covert to cash.

• Examples: Accounts Receivable, Inventories, WIP and Sundry Prepaiments

Inventories

Marketable Securities

Current assets include cash and those assets that are expected to be converted to cash or used up within one

year, or an operating cycle, whichever is longer.

What are Current Assets?

Cash Current Assetsinclude

Other Short Term

Assets

Accounts Receivable

Prepaid Expenses

Uncollectible Accounts – Bad Debts

If a company makes credit sales to customers, some

accounts inevitably will turn out to be uncollectible.

If a company makes credit sales to customers, some

accounts inevitably will turn out to be uncollectible.

PAST DUE

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Examples:

Insurance

Rent

Prepaid Expenses require adjusting

entries

Assets are decreased

Expenses are increased

Expenses that have been paid in the

current fiscal period but will not be

subtracted from revenue until a

subsequent fiscal period.

Prepaid Expenses and Other Current Assets

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Non Current Assets (Fixed Assets)

• Tangible• Intangible• Investments

Tangible

• Assets that can be seen and touched• Purchased to enable the business to function

Examples: Cars, Vans, Planes, Boats & Plant & Equipment

Intangible

• Invisible Non Current Assets

Examples: Patents, Trade Marks, Know How, Brand Names and Goodwill

Investments

• Investments in companies for long term benefit. Normally to control supply chain or extend monopoly.

Liabilities

• Represent a responsibility which will have to be settled.

• Either Current or Non Current ( either < or > 12 months

Current Liabilities

• Short term liabilities < 12 months

• Examples: Accounts Payable, Tax, Dividends Payable & Accrued Expenses

Non Current Liabilities

• Long term liabilities > 12 months

• Examples: Loans, Mortgages & Deferred Tax

Shareholders Funds

• Represents the monies that the owners have invested in the business.

• Is a liability of the business to those investors.• Shares and retained profits

Does it Balance?

Assets = Liabilities + Shareholders funds

The Income Statement

Sales ( Revenues )

What represents a sale?

• We have looked at revenue recognition• When is a transaction treated as a sale?• Vital we must match income with

expenditure.• Vital we are consistent.

Cost of Sales

What makes up Cost of Goods Sold?

• We need to match what has been sold to the real costs of those sales.

• What has been sold has been consumed.• We normally look at:

– Opening Inventories– Add Purchases made in the period– Then subtract closing inventories

Specific Identification

When a unit

is sold, the specific

cost of the unit sold is added to

cost of goods sold.

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Costs of Goods Sold

Costs of Goods Sold

Oldest Costs

Oldest Costs

Ending InventoryEnding

InventoryRecent Costs

Recent Costs

First-In, First-Out (FIFO)L O 8

Recent Costs

Recent Costs

Ending InventoryEnding

InventoryOldest Costs

Oldest Costs

Last-In, First-Out Method (LIFO)L O 8

Costs of Goods Sold

Costs of Goods Sold

Recent Costs

Recent Costs

The Impact of Changing Costs

In periods of rising costs, LIFO results in lower

ending inventory and higher cost of goods sold than

FIFO.

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Inventory Accounting System Alternatives

Periodic Inventory System

Cost of goods sold is determined

at the end of the fiscal period.

Cost of goods sold is determined

each time inventory is sold.

Perpetual Inventory System

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Inventory Accounts

Retail Firm Merchandise Inventory

Finished Goods InventoryRaw Materials Inventory

Work in Process Inventory

Manufacturing Firm

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Product available to

be sold

Used to produce products

Partially completed products

Lower of Cost or Net Realisable Value

Inventory must be reported at realisable value when it is lower than cost.

Inventory must be reported at realisable value when it is lower than cost.

Can be applied three ways:(1) separately to each

individual item.(2) to broad categories of inventory.(3) to the whole inventory.

Can be applied three ways:(1) separately to each

individual item.(2) to broad categories of inventory.(3) to the whole inventory.

Defined as current replacement cost (not sales price).Consistent with

the conservatismprinciple.

Defined as current replacement cost (not sales price).Consistent with

the conservatismprinciple.

• This gives us the total cost of what has been sold.

Gross Profit or Margin

• By subtracting the cost of goods sold from sales we arrive at the gross profit/margin

Trading Statement

• Sales 160,000• Less Cost of Sales• Opening Inventories 21,000• Add Purchases 92,000• Less Closing Inventories -18,000 • Cost of goods Sold 90,000 • Gross Profit/Margin 80,000

Gross Profit %

• Sales – Cost of Sales = GP % (Margin)• Very important ratio

Overheads, EBIT & Beyond

Overheads

• Expenses consumed in the period• We may need to adjust what is incurred to

what is actually consumed!

Overheads

• Normally grouped under a few principal headings.

• Examples: Sales and Marketing, General Admin and Depreciation

Incurred Vs Consumed

• We may well incur expenses but we need to evaluate these.

• We should only show what has actually been consumed.

• Example: We may have received invoice for telephone or insurance but for what period do those represent?

• They can easily be for the previous or next accounting period.

• We need to adjust these

The Matching Concept

Revenue Vs Capital Expenditure

Capital Expenditure

• Companies buy items to sell on to customers but might also acquire for its own use.

• Take a computer retailer. It will buy computers to sell to customers but may also keep some for its own use.

• Again we return to what has been consumed?

Capital Expenditure

• Represents a NON CURRENT asset.• It is an expense but expected to last more

than 12 months.Example:

Microsoft develops a new version of windows over 12 months at a cost of $100m. It then expects to sell the new version over the following 2 years generating revenues of $150m per year.

MS Development Expenditure

Balance Sheet End Accounting Period 1 Income Statement Accounting Period 1

Current Assets

Non Current AssetsExpenditure Incurred on Development $100m

Current Liabilities

Non Current Liabilities

Equity

Sales

Less Cost of SalesOpening InventoriesAdd PurchasesLess: Closing InventoriesGross Profit

Deduct OverheadsExpenditure Incurred on Development $100m

EBIT

Balance Sheet End Accounting Period 2 Income Statement Accounting Period Current Assets

Non Current AssetsExpenditure Incurred on Development 100mLess: consumed part (50%) -50m

Current Liabilities

Non Current Liabilities

Equity

Sales New Ver 150m

Less Cost of SalesOpening InventoriesAdd PurchasesLess: Closing InventoriesGross Profit

Deduct OverheadsConsumed R & D 50m

EBIT

Balance Sheet End Accounting Period 3 Income Statement Accounting Period 3

Current Assets

Non Current AssetsExpenditure Incurred on Development 100mLess: consumed part (100%) 100m

Current Liabilities

Non Current Liabilities

Equity

Sales New Ver 150m

Less Cost of SalesOpening InventoriesAdd PurchasesLess: Closing InventoriesGross Profit

Deduct OverheadsLess Consumed R & D 50m

EBIT

What is Actually Consumed

Question? What is left?• Consumption means we have eaten it all. • What we have not eaten remains and is

shown on the Balance Sheet.Example:A company making Orange juice may well

purchase many tons of oranges. It will crust these to extract the juice. At the end of an accounting period it way well have sold 1000’s of gallons but may also have some still in their warehouse as well as tons of un crushed oranges.

Matching Vs Prudence

Meaningful Results

• We need to balance the aim of a meaningful result by applying the matching and prudence concepts.

• Yes be cautious but don’t destroy the real picture.

• And remember … try to be consistent!

Questions

Question 1

• What is Historic Cost?:a. The current valueb. The future valuec. The Original Costd. All of the above

Answer:c. It represents the price originally paid.

Question 2

• What do you understand by Shareholders Funds:

a. Monies invested in the company by the shareholders.

b. Accumulated retained profits. c. All of the above

Answer:c.

Question 3

• What are debtors?:a. Accounts Receivableb. Accounts Payablec. Bad Debtsd. All of the above

Answer:b. Accounts Receivable

Question 4

• What are accounting policies?a. A summary of the ways management have

prepared the financial statements.b. Require subjective judgement.c. Should normally follow industry standardsd. All of the above

Answer:d. All of the above

Question 5

• What is capital expenditure:a. Results in a Non Current Assetb. Is expenditure that is expected to last for more

than 12 months..c. All of the above

Answer:d. All of the above

Question 6• What is Deferred Tax?:

a. Tax that has to be paid to the government within 12 months

b. Tax that is never going to be paidc. Tax that will be payable in the future but more than 12

months away.d. Is shown as a Non Current liability.e. C and d are correct

Answer:e. It is both delayed by 12 months and therefore shown as a Non Current Liability.

Question 7

• What are retained Earnings:a. Profits distributed to shareholdersb. Profits not distributed to shareholdersc. Belongs to the shareholdersd. B and c are correct

Answer:d. They represent profits generated by the company and they belong to the owners.

Question 8

• What is Gross Profit/Margin:a. EBITb. Sales Less the cost of salesc. Represents the gross margin made by the company from

its day to day trading.d. Is a very useful % to evaluate management controle. Represents the profits made from buying and selling

goods. f. B.C D and E

Answer: f.

Question 9

• What are Ordinary or Common Shares?.

a. Represents the owners of the company.b. They rank behind all other investors for payment.c. 50 + % controls the company.d. All of the above

Answer:d. All of the above

Question 10

• What is Net Book Value:a. The value of the Current Assetsb. The value of the Non Current Assetsc. Represents the original cost less the total

depreciation to dated. B and C are correct

Answer:d.

Question 11

• What is a contingency?a. An event less than 50% likely to happen.b. Has a possible financial outcomec. Should be noted in the financial statements but

not included in the accounts.d. All above are correct

Answer:d.

Question 12

• Do you trust the report of the auditors?:a. May be!b. Possibly!c. Definitelyd. What stupid question.

Answer:well we all learn…………………

Question 13

• What is Treasury Stock?:a. The amount of shares repurchased by the companyb. Is shown under shareholders fundsc. Represents the total amount actually paid for the shares

repurchased.d. All the above are correct.

Answer:d.

Question 14

• What is an Extraordinary Item. ?:a. An item unlikely to happen again.b. If shown before EBIT would distort the trend

data.c. Is shown after EBITd. All the above are correct.

Answer:d.

Question 15

• What do you understand by fair value accounting (Mark to Market)?:

a. Replaces original historic cost with current value.b. Is permitted by IFRS.c. Was totally misused by Enrond. All the above are correct.

Answer:d.