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Flashcards in Accounting Deck (81)
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61

What is the one method of accounting for depreciation?

Duality concept: (1) Depreciation (expense) – increases
(2) Accumulated depreciation – increases

Cost of Asset – Accumulated Depreciation = NBV of Asset

The Net Book Value (NBV) is the figure that will appear in the Statement of Financial Position, and be included in the Total Assets

62

What are methods of calculating depreciation?

Straight Line Method: allocate an equal amount of depreciation to each year of the useful life, easy to use, most common in UK
d = (cost – residual value)
useful economic life of asset

Reducing Balance Method: applies a constant percentage to each year’s Net Book Value (NBV) to calculate depreciation for year, so a progressively smaller amount of depreciation is charged
d = NBV x RB%

Usage or output

63

How does The Disposal of Non-Current Assets work? (1)

Part 1 - the sale proceeds
Duality concept: (1) Bank account – increases
(2) Disposal account – decreases

64

How does The Disposal of Non-Current Assets work? (2)

Part 2 - the disposal of the asset
(a) Remove the original cost of the asset
(1) Non-Current Asset account – decreases
(2) Disposal account – increases
(b) Remove the accumulated depreciation of the asset
(1) Accumulated Depreciation account – decrease
(2) Disposal account – decreases
You should be left with a gain or loss on disposal

65

What is the objective of financial reporting?

“to provide financial information about the reporting entity that is
useful to existing and potential investors, lenders, and other
creditors in making decisions about providing resources to the
entity”

(IASB, Conceptual Framework for Financial Reporting, 2010)

66

What is the use of Financial Ratio Analysis and what categories are there?

“Financial ratios have been long used as a tool to evaluate the overall financial performance of a company.”

67

What are measures and ratios of profitability?

Measures:
- the relative success or failure of an entity
- management performance

Ratios
1. Gross Profit Ratio
2. Net Profit Ratio
3. Return on Equity (ROE)
4. Return on Capital Employed (ROCE)

68

What is the purpose of gross profit and net profit ratios?

reviews the relationship between the gross/net profit and the sales/revenue
small changes can be significant
benchmark for industry for comparison

Gross Profit Ratio = gross profit x 100 = %
sales/revenue 1

Net Profit Ratio = PBIT x 100 = %
revenue

PBIT = Profit before Interest & Tax

69

What is Return on Equity (ROE)
Return on Capital Employed (ROCE)?

indicates how efficiently and effectively a business has used its assets during a given accounting period
can be a measure of management performance

ROE net profit after tax x 100 = %
shareholders funds 1

ROCE net profit b4 i&t x 100 = %
capital employed 1

Capital employed = shareholders funds + long term debt

70

What is Short Term Solvency and Liquidity?

Measures:
- the extent to which an entity can comfortably cover
its liabilities
- how much cash the entity has in the short-term
- the management of cash

Ratios:
1. Current Ratio
2. Quick/Acid Test Ratio

71

What is the current ratio?

Indicates the extent to which the short-term assets should meet the short-term liabilities of the business

Current Ratio = Current Assets
Current Liabilities
Or

Current Ratio = Current Assets : Current Liabilities

72

What is the Quick/ Acid Test Ratio?

Assumption that inventories/stock takes the longest to turn into cash

Indicates the ability to pay short-term creditors quickly

Quick Ratio = Current Assets - Inventories
Current Liabilities

73

What are the measures and ratios for Efficiency Ratios?

Measures:
- the extent to which short-term assets and liabilities are
being managed and utilised within the entity
- how effectively the business is being managed

Ratios:
1. Inventory Days/Turnover Period
2. Trade Receivable Days/Collection Period
3. Trade Payable Days/Payment Period

74

What are inventory days?

measures the average number of days the stock is held before being sold
Important where management of stock is of prime importance to a business

Stock/Inventory Days = inventory x 365
cost of sales

75

What are Trade Receivable and Trade Payable days?

Trade Receivable Days
Measures the average period of credit taken by credit customers :
trade receivables x 365 = no of days
credit sales/revenue

Trade Payable Days
Measures the average period of credit received from credit suppliers
trade payables x 365 = no of days
credit purchases

76

What are the measures and ratios for long term solvency and stability?

Measures:
- the proportion of long term debt to share capital and
its affect on the shareholders
- the higher the debt the riskier the investment

Ratio:
1. Gearing Ratio

77

What is the Gearing Ratio?

looks at relationship between the amount of fixed interest capital and the amount of equity capital

Fixed interest capital / Debt
debentures, loans, preference shares etc

Equity capital / shareholders funds
ordinary shares, share premium, retained profits etc

Gearing Ratio = Debt x 100
Debt + Equity

78

What is Earnings per share?

the amount that is theoretically available per share

dividends are the amounts actually paid per share

can investors expect consistent returns

to calculate:
EPS = profits attributable to equity shareholders
number of equity shares in issue

79

What is meant by ratio analysis?

One of the methods used to interpret financial information.

Enables the user to construct a financial profile of an entity over a period of time

Compare entity’s results against that of another entity within the same industry

Can assess entity’s past, present and possibly future strengths and weaknesses.

Serve only as indicators and must be used carefully, not in isolation.

80

What are limitations of ratio analysis?

Comparisons may be misleading due to:

different accounting policies adopted

calculations based on historical data, therefore effects of

inflation not accounted for

some data not disclosed in published financial statements

performance criteria differing between industries

general economic situation not considered

strategic decisions by management not considered

only single ratio available

81

What must be considered when interpreting financial statements?

What are you trying to achieve?
Compare ratios

What additional information will be useful?
Comment on the strengths and weaknesses of results
Check accounting policies between companies/years

Watch out for revaluation of assets
- will reduce profits due to increased depreciation and
increase capital employed (revaluation reserve)
impact on ROCE and gearing