Module 1
What are the characteristics of a company structure?
Limited liability of owners (shareholders) to equity (share capital) of company
Public accounts, audited
Module 1
What is financial accounting?
Legal obligation on directors & managers to report to owners on how resources have been deployed during the accounting period
Module 1
Who uses accounting information?
Internal (MEDS)
Directors / Senior ExecutivesManagers / Employees
External (PACTS)
Shareholders / AnalystsCreditors / Tax authorities
Public /
Module 1
What is the Accounting Equation?
Assets = Owner’s Equity + Liabilities
OR
Assets – Liabilities = Owner’s Equity
Module 1
What is gross profit in a manufacturing company?
Sales LESS Cost of Sales
Module 2
What is the impact of different inventory valuation methods (in rising prices)?
FIFO / Income is higherHigher taxes
Higher dividends
Closing inventory is higher
LIFO / Lower profit
Good for tax minimization
AVERAGE / Weighted average unit cost
Module 2
What are the FOUR methods of recognizing revenue?
- *Shipping & invoicing
- Time of sales order
- Time of production, i.e., shipbuilding
- Time of collection, i.e., installment plans
Module 2
What are the conditions necessary to recognize sales?
- Principle revenue-producing service has been performed
- Costs to create revenue have occurred
- Amount collectable can be estimated
Module 2
How do you calculate Cost of Goods (CoG’s) [relationship between valuation & profit]?
Beginning inventory + purchases LESS ending inventory = CoG’s
> Ending inventory valuation > profit
< Ending inventory valuation < profit
Module 2
What are the THREE different methods of calculating depreciation?
- Straight-line depreciation
= acquisition costs – est. residual value
est. useful life - Reducing balance depreciation
(n = estimated life) - Consumption method -- based on running hours
Module 2
What are the THREE main “measurement of effort” Conventions?
- Matching convention: profit = matching the effort (costs) with units shipped & invoiced (sales) during the period
- Allocation convention: determine the consumption of means of production; determine the value of closing WIP (work-in-progress) and inventories of raw materials
- Costs convention: historical/acquisition cost of different means of production
Module 2
What are TWO “measurement of sales” conventions?
- Realization convention: only products sold are measured as sales
- Accruals convention: cash does not have to be received to create value
Module 2
What are the different profit measurements?
When are they used?
Gross profit (sales less CoG’s) measures efficiency of transformation
*Net profit before interest and taxes managerial efficiency
Net profit after interest and before taxes assesses financial structure
Module 2
What are some of the principle features of depreciation?
Allocation of cost of assets purchased in 1 accounting period over the accounting periods in which they are used
Cost of production
Influences reported profit
The effect on cash position (lowers taxes, etc.)
Module 2
What is the difference between product & period costs?
Product costs = raw materials, direct labour, factory overhead (cost of sales/closing inventory)
Period costs = selling, distribution, marketing, general admin. (P+L accounts)
Module 2
How do you determine whether a cost should be capitalized or written off?
Take a conservative approach!
Write off expenditure UNLESS
Clearly related to acquisition + asset could not be made operational w/o costs (i.e., land & survey fees)
Module 3
What is ‘GEARING’ and how is it calculated? What is the effect on ROI?
Gearing or Leverage is the relationship between shareholders funding (OE) to loans
Healthy profits better returns
Lower profits lower ROI
Module 3
How are bad debt provisions calculated and accounted for?
Consider risks attached to each customer, severity of pursuing, general economic environment, i.e., interest rates
B/SH debtors less provisions
P+L charge for bad debts; topped up each year.
Module 3
Why would a company choose to lease vs. own assets?
A voice substantial outflow of cash
Spreads out cash flows
Can replace leased asset no gain/loss
Maintenance costs covered
Lease payments are an allowable charge against profits before tax.
Module 3
What is a revaluation reserve?
Entry in balance sheet (s/h equity) to indicate a revaluation of land/property
Module 3
What is the difference between a Finance Lease and an Operating Lease?
Finance lease ownership reverts to lessee at end of lease
On balance sheet fixed assets & lease payments as creditors
Interest charged to P+L, capital deducted from both
Operating lease ownership remains with lesser
Not capitalized
Payments are expensed annually (capital + interest)
Module 4
How do you calculate cash flow from operating activities?
= Profit + bad debt provision + depreciation
Loss/Gain on sale
Less in working capital
Inventories cash
Debtors /creditors cash
Module 4
What are the EIGHT major categories of cash flow?
(Our Really Tall Cat Ate Everyone’s Meaty Food)
1)Operating activities
2)Returns on investment & servicing of finance
3)Taxation
4)Capital Investments
5)Acquisitions and disposals
6)Equity dividends paid to shareholders
7)Management of liquid resources
8)Financing
Module 5
What are the FIVE fundamental accounting concepts?
1)Going concern concept – a company will continue to do business in future
2)Accruals – company doesn’t wait for money to change hands before accounting for revenues & costs
3)Consistency –
4)Prudence – conservatism
5)Non-aggregation –
Module 5
How are consolidated or group financial statements prepared?
Holding/Parent company must publish group P+L & Balance Sheet but also its own Balance Sheet (not P+L)
Adds all assets and shows minority interests entries
Module 5
What is the distinction between the Companies Act 1985/89 and Accounting Standards?
1)Companies Act states that companies must disclose certain information in a “True & Fair view of … GAAP”
2)Accounting Standards set controls on how the numbers are to be compiled – must be disclosed.
Module 5
What THREE sets of rules constrain management when constructing corporate financial statements?
1)Companies Acts/Legislation – government of country
2)Accounting standards – profession/regulations
3)Listing requirements – Stock Exchange Commissions (SEC)
Module 5
What do auditors do?
Examine co. system of accounting
Compares of accounting statements to underlying records
Verifies of title/existence/value of assets
Verifies liabilities
Verifies that results of P+L are fairly stated
Confirm statutory regulations complied with and accounting standards have been applied correctly (S C A L P S)
Module 6 – Capital Structure Ratios
Times Interest Earned Ratio Calculation
Switches to the profit and loss account in order to measure the gearing position and margin of safety in relation to earnings
Module 6 – Liquidity Ratio
Current Ratio
(sometimes called Working Capital Ratio)
It is often stated as a rule of thumb that a 2 times current ratio indicates a sound financial situation.
Module 6
Return on Capital Employed
Capital employed is usually defined as the total assets of a company minusthe current liabilities. Alternatively, one can add together the owner’s equity and the long-term loans and provisions.
Module 6 – Profitability Ratio
Return on Total Assets
Note that the whole balance sheet figure for total assets (fixed assets plus current assets) has been selected for the fraction
Module 6
What are the efficiency ratios?
(some times referred to as activity or turnover ratios)
Activity or turnover ratios
How effectively are costs managed?
1)Inventory Turnover
2)Average collection period
3)Fixed assets turnover
Measures company’s asset management
Module 6
Return on Owner’s Equity
Most important profitability ratio is the one that relates the profit earned to the capital (contributed and accumulated) of the ordinary shareholders of the company.
Module 6 – Liquidity Ratio
Quick Ratio (also called ACID TEST)
The quick ratio therefore removes inventory from the calculation, thus providing a more rigorous test of the company’s ability to pay its maturing obligations.
One times or great is considered good
Module 6 – Profitability Ratio
Gross Profit Margin
The gross profit margin is the first critical measure of profit an analyst or manager examines since a company must earn significant gross margin if it is going to bear the burden of other corporate overhead.
Module 6
What are the TWO different liquidity ratios?
1)Current Ratio
2)Quick Ratio (Acid Test)
Measures a company’s ability to meet its maturing short-term obligations
Module 6 -- Profitability Ratios
Profit Margin
Module 6
What are the Capital Structure Ratios?
1)Fixed to Current Asset Ratio
2)Debt Ratio
3)Times Interest Earned Ratio
Examine percentage of company’s total assets that are from shareholders (OE) and effect or risk on earnings
Module 6 – Efficiency Ratio
Inventory Turnover Ratio
Module 6 – Efficiency Ratio
Fixed Assets Turnover Ratio
Module 6
What are the SIX main Profitability Ratios?
Gross Profit Margin
Profit Margin
Return on Total Assets
Return on Specific Assets
Return on Capital Employed
Return on Owner’s Equity
Profitability ratios give management an insight into a company’s long-term survival.
Module 6 – Capital Structure Ratio
Fixed to Current Asset Ratio
This ratio highlights the fact that for every £1 invested in current assets, a company has invested around £#.## in fixed assets.
Module 6 – Capital Structure Ratios
Debt Ratio & Debt/Equity Ratio
The debt ratios measures the proportion of assets that are financed by debt.
Module 6 – Capital Structure Ratios
Debt/Equity Ratio
Module 6 – Capital Structure Ratios
Available to Equity Ratio
Module 6 – Efficiency Ratio
Average Collection Period Ratio -- Sometimes called days sales outstanding
Represents the average length of time that a company must wait after making a sale before receiving the cash.
Module 6 (part one)
What are the basic stock market ratios?
Earnings per share (EPS)
Price/Earnings Ratio (PE)
Module 6 (part two)
What are the basic stock market ratios?
Dividend Yield
Dividend Cover
Module 6 – Profitability Ratios
Return on Total Assets
Whole balance sheet figure for total assets (fixed assets plus current assets) is used
Module 6
What are the FOUR categories of Ratios?
1)Liquidity
2)Profitability
3)Capital Structure
- Assets
- Financing (gearing)
4)Efficiency
Module 7
What are the FOUR examples of off-balance sheet transactions?
1)Quasi-subsidiaries
2)Consignment inventories
3)Sale/Repurchase agreements
4)Debt factoring
Module 7
When can merger accounting be used?
When…
1)Neither party is acquiring/acquired
2)Neither party dominates transaction
3)Relative size similar
4)Primarily equity share exchange
5)No one shareholder retains interest in future performance of part of the combined entity
Module 7
What conditions could exist to capitalize development expenses?
1)Clearly defined project
2)Expenses are separately identified
3)Outcome has certainty on technical feasibility and ultimate commercial viability
4)Sales will be greater than costs
5)Adequate resources exist
Module 7
What are the key differences between merger & acquisition accounting?
Acquisition accounting -- shows goodwill (asset), note share premium
Merger accounting is more flexible – combined nature of distributable reserves
Module 7
When is a joint (quasi-subsidiary) venture considered to be consolidated?
1)Company is a lead partner & exercises a dominant role
2)Can take back goods under beneficial terms
3)Share profit/loss/dividends unequally
Module 7
What is GOODWILL?
It is the difference between fair value of net assets acquired in a corporate transaction and the price paid for assets.
Module 7
How are BRANDS valued?
1)Historic cost – all costs spent developing and maintaining brand can be capitalized (adjustment to reserve)
2)Earnings method – multiplier earnings
Module 8
What is the difference between job costing and process costing?
Job – costs allocated to individual items; direct costs (material & labour) & allocated overhead
Process – when identification of finished items is impossible (oil refining); take all costs in accounting period and divide by total quantify output during same period
Module 8
What are the key differences between Financial & Management Accounting?
Financial / ManagementBackward looking, past performance / Forward looking, supports mgmt decision-making
Structured / Non-structured
GAAP / No
Compulsory / No
$ / $, Q
Company as whole / Activities/departments
Auditors / No
Module 9
What are the assumptions underlying cost-volume-profit analysis?
All costs can be identified as Variable or Fixed
Costs behave the same
Sales price/unit is unchanged
Sales mix = budget
All production is sold
Module 9
What is contribution margin?
Sales = Fixed costs + Variable costs + Profit
Breakeven sales = Fixed costs + Variable costs
Contribution margin = Sales revenue - Variable costs
Module 9
How do you calculate Break Even Point?
Module 9
What are controllable/uncontrollable costs?
Controllable management has the ability to choose whether or not to incur the costs; valid for a particular manager as well (refers to the person, the manager or foreman or supervisor, who can be held accountable for the costs being measured)
Uncontrollable not controllable in the short-term or outside of the control of the immediate manager, e.g., plant insurance
Module 9
What are Standard Costs?
Budgeted cost for one cost item
Module 9
What are engineered & discretionary costs?
Engineering: unavoidable costs if company wants to continue production
Discretionary: costs that need not be incurred (R&D, maintenance)
Module 10
How can costs be allocated between joint products?
By-products?
1)Equal shares
2)Physical characteristics
3)Sales value at split
4)Ultimate net sales value if further processing
By-products all costs are to main product sales deducted from product costs before determining gross margin
Module 10
How do you determine process costing for equivalent units?
For each cost category
= Effort expended in this period to finish opening inventory
+ Units started & completed in period
+ Efforts expended on closing inventory
Module 10
What are some (SEVEN) of the typical activity bases for Overhead (OH) costs?
1)Personnel – # of employ
2)Computing – hours, # reports
3)Machinery – machine hours
4)Buildings – space occupied
5)Power – machine hours, meter
6)Executive salaries – sales
7)Production schedule – # of differing products
Module 10
What is a joint product?
What is a by-product?
Joint product – must appear during the processes involved in producing main product. If management has the option of not allowing the second product to emerge from the process the two products cannot be deemed to be joint.
By-product – is a joint product that has undesirable or low value
Module 10
What is the STEP method of allocating OH?
Recognizes that support departments provide services to other support departments
Choose highest OH department – allocate to other departments (not including self)
Continue – ignoring already previously allocated departments
Module 10
What is an equivalent unit?
In-process costing
Assessment of degree of completeness of one unit under each major component of cost
Module 10
What happens when actual OH is > or < to budgeted OH?
Difference credited/debited to P+L under cost of goods (CoG’s)
Module 10
What is a predetermined OH rate?
Because these overheads are not directly attributable to cost units in the same manner as direct materials and direct labour where the actual usage of resources can be tracked precisely, accountants use a predetermined overhead ratewith which to spread overheads across the units of production.
Module 10
What is Activity Based Costing (ABC)?
ABC – activities rather than products, cause costs to be incurred
Cost of products become goal (not just accounting inventory valuations)
Different cost drivers
Embraces all OH
Reflects complexity of production/marketing
More accurate costs – better planning
Module 11
What is the decision-making process?
1)Define problem & list alternatives
2)Cost alternatives (just differences)
3)Assess qualitative factors
4)Make decision
Ignore sunk costs / Ignore future costs that are same for all alternatives
Module 11
What is the difference between absorption and variable costing?
*When actual production planned production
Module 11
Should we Process Further (more relevant to joint or by-products)?
Ignore costs that are not relevant
Relevant - $ spent on further, additional $ gained from revenue
Module 11
Considerations when faced with Special Sales Orders?
If price is > variable cost, then it contributes to Fixed Costs
Demand for product
Future business from sale
Module 11
Considerations when closing down a unit?
Focus on contribution – coverage of fixed costs
Qualitative factors
One-time costs
Module 11
What are relevant costs?
Future costs – not sunk costs
Cash costs – not depreciation or write offs
Avoidable costs
Cost that differ among alternatives
Module 11
What is the impact on reported profit between Absorption & Variable Costing?
Absorption costing values inventory higher taxable profits are higher
if sales < production, profits
sales > production, profits
Preferred by most tax authorities. Companies don’t always have a choice.
Module 12
What is Zero-Based Budgeting?
Management invites certain activities/centres to bid for their scarce resources as if they were starting from ZERO
Organized into “packages of work” which can be separated from each other
Ranked in order of top management priorities
Takes a high amount of effort to divide into costed packages
May need to seek external opinions on definitions