Chapter 9: intro to accounts

• The four main accounting statements a company publishes annually

  Statement of profit and loss (comprehensive income), statement of financial position (balance sheet), cashflow statement, statement of changes in equity
• The main users of financial statements

  Equity investors, loan creditors, employees, business contacts (customers and suppliers)
• Other uses of financial statements

  Stock exchange to check requirements are met, management, tax authorities, stock analysts, credit rating agencies
• Equity investors

  Investment decisions require info on profits. Forecasts of performance by analysts. Directors and shareholders can hold managers to account
• Loan creditors


  Can a business generate sufficient cash to repay loans and has an adequate asset base to meet obligations in case of failure
• Employees

  To pay salaries and provide job security. Useful: cashflow statement and indicators of profitability
• Business contacts


  Continuity of sales and of materials and services. Insight into pricing and trading policies
• Why would the holder of a loan stock issued by a company may wish to have a restrictive covenant?

  Covenants specify a min or max value for accounting ratios. If there were no restrictions, the company could borrow more money after the loan issue. Increases risk of non-payment. Restrictions ensure the future security of the investment
• Which non-legitimate users will view financial statements?

  Government agencies (incl tax authorities), competitors, predators
• Mistrust between management and users of financial statements

  Directors may defer reporting bad news to exercise some share options first. Unlikely to volunteer info that could bee used by competitors-withhold or distort info
• Sources of regulation of a company's annual reports and accounts

  IFRS, national company laws, stock exchange requirements, good practice by leading companies, principles, concepts, conventions and other legislation
• Statutory requirements

  Statement of financial position, statement of profit and loss, detailed disclosures as notes, director and auditor report
• The main items a directors report should contain

  Activity over the past year and likely events coming in the next year. Summary of financial decisions (dividend, retained incomes, donations, shares purchased), details of directors, shareholdings and interest in the company
• A director loans 1 mil to her brother's company. If he continues to service the loan, her company is solvent, if he defaults, she is bankrupt. How would a true and fair view value the loan

  Consistent w the rest of the accounts, disclose likelihood of default and consequences. Provision to reflect her opinion on likelihood of default. OR Write off the loan as a prudent measure if the brother is on the verge of bankruptcy.
• The role of the IASB


  The International Accounting Standards Board develops accounting standards-IFRS
• IASB authority


  No, however countries require it-departures must be accounted for
• Multinational company accounts


  Comply w local standards, allow comparison with similar companies in the market
• Why won't a country depart from IFRS

  Companies will choose the global standard, guarantees access to all markets
• Arguments for IFRS


  -Reduce variations

  -discussion process focuses on particular areas for debate

  -require to disclose more info than national law

  -flexibility that legislation doesnt allow
• Arguments against IFRS


  -not appropriate to all companies in all circumstances

  -not entirely objective (gov pressure or industry lobbying)

  -allows more than 1 alt treatment, negates conformity

  -Some standards are general to be meaningless, others too detailed
• What is in a annual report

  Lots of voluntary promotional material, core is subject to Companies Act 2006
• Eg of content in annual report

  Director biographical info, highlights of financial statements, turnover and profit by product and geographical area, chairman statement to members, company's world-wide operations, thirty year financial record, review of operations, corporate governance issues, directors report, statement of accounting policies, accounting statements, statement of director responsibility for statements, auditor report, notes, subsidaries
• What does the auditors report determine?

  If the financial statements were properly prepared in accordance with the Companies Act and give a true and fair vieww
• Contents of the auditors report

  Title, intro paragraph identifying the fs audited, responsibilities of the directors and auditors, basis of audit opinion, opinion, manuscript or auditor signature, address, date
• What is the director and auditor responsibilities

  Director: financial records properly kept, prepared w suitable accounting policies. Auditor: form independent opinion'
• Caveats in an audit report

  Using the word "opinion": statements and audit evidence all include subjective judgement. Addressed to members of the company: warn potential readers that the auditor does not accept any care of duty for their use of the fs, audit satisfy needs of shareholders and could be inappropriate for other uses
• Emphasis of matter paragraphs


  Significant uncertainty disclosed in the accounts, auditor points out for emphasis. Not qualified bc true and fair. Management has disclosed the problem and auditor has taken care to ensure shareholders read the disclaimer
• Qualified opinion


  A restriction has been placed has been placed on the evidence the auditor can access or the auditor disagrees on the treatment of a matter. True and fair except for..
• Disclaimer of opinion


  Auditor has extreme uncertainty, impossible to express an opinion
• Adverse opinion


  Extreme disagreement, fs so misleading that don't give a true and fair view
• Why does a company only want unqualified opinions?

  other can reduce credit rating, increase cost of borrowing, reduce share price, mangers replaced or taken over
• Regulation of auditors


  System of visitation and monitoring of standards and firms who don't achieve a satisfactory standard may have their registration withdrawn
• APB-Auditing Practices Board


  Issues International Standards of Auditing
• Two major fears about auditors


  Conflicts of interest(advisory role), familiarity (audited the accounts for many years)
• How are problems with auditors prevented

  Restrictions on non audit services an audit firm can provide, change auditors after 20yrs
• The cost concept/historical cost

  Non-current assets appear in the BS at their orig cost less depreciation, subject to a possible impairment write down
• Why can the book value of a bond be gradually increased?

  Avoid a large capital gain on redemption, allowed bc not trying to reflect market value
• The money measurement concept


  Accounting statements restrict themselves to matters that can be measured objectively in money terms. Not a rough approx of the business value bc excludes customer base, workforce and brand name
• The business entity concept


  The business affairs are kept separate from those of the owners, including sole traders
• The realisation concept


  Income is recognised when it is earned not when the customer settles the bill. Avoid fluctuations in recorded income BUT create the impression a business is performing well when running out of cash