accounting

339 Pages·2016·2.84 MB·English

january 2016
ACCOUNTING
Practice Questions for gcma
www.iqnglobal.com
Contents
Chapter 1: The context and purpose of financial reporting .......................................... 5
1 THE PURPOSE OF FINANCIAL STATEMENTS ...................................................................................................... 6
2 ASSETS AND LIABILITIES .............................................................................................................................. 9
3 THE IASB’S FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS .......................... 11
4 ACCOUNTING CONCEPTS: GOING CONCERN AND ACCRUALS ............................................................................. 16
5 IMPACT OF GLOBALISATION ....................................................................................................................... 18
6 INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) ............................................................................. 19
7 GENERALLY ACCEPTED ACCOUNTING PRACTICE (GAAP) ................................................................................ 25
8 OTHER INTERNATIONAL INFLUENCES ........................................................................................................... 26
9 SCOPE AND APPLICATION OF IFRSS ............................................................................................................ 27
10 PROGRESS TOWARDS GLOBAL HARMONISATION .......................................................................................... 28
11 BENEFITS OF AND BARRIERS TO GLOBAL HARMONISATION ............................................................................. 34
12 IFRS 1: FIRST-TIME ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS ..................................... 36
13 THE NEED FOR A CONCEPTUAL FRAMEWORK ............................................................................................... 39
14 THE IASB CONCEPTUAL FRAMEWORK ...................................................................................................... 40
15 THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING ........................................................................ 43
16 UNDERLYING ASSUMPTION ..................................................................................................................... 44
17 QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION .............................................................. 45
18 THE ELEMENTS OF FINANCIAL STATEMENTS ................................................................................................ 48
19 RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS......................................................................... 49
20 MEASUREMENT OF THE ELEMENTS OF FINANCIAL ........................................................................................ 51
Chapter 2: Understanding the use of double entry and accounting systems ........... 53
1 BUSINESS TRANSACTIONS AND DOCUMENTS ................................................................................................. 54
2 THE ACCOUNTING EQUATION AND BUSINESS TRANSACTIONS ............................................................................ 59
Chapter 3: Accounting for VAT or Sales tax ................................................................ 71
1. ACCOUNTING FOR VAT OR SALES TAX ........................................................................................................ 72
Chapter 4: Inventory ...................................................................................................... 78
1 END-OF-YEAR ADJUSTMENTS FOR INVENTORY ............................................................................................... 79
2 VALUATION OF INVENTORY ....................................................................................................................... 85
3 FIFO AND WEIGHTED AVERAGE COST METHODS ............................................................................................ 92
Chapter 5: Non-current assets.................................................................................... 101
1 NON-CURRENT ASSETS: BASIC PROVISIONS ................................................................................................. 102
2 DEPRECIATION ..................................................................................................................................... 103
3 NON-CURRENT ASSET DISPOSALS.............................................................................................................. 111
4 IAS 16: PROPERTY, PLANT AND EQUIPMENT .............................................................................................. 112
5 IAS 40: INVESTMENT PROPERTY .............................................................................................................. 120
6 INTANGIBLE ASSETS ............................................................................................................................... 123
7 GOODWILL .......................................................................................................................................... 130
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8 IAS 36: IMPAIRMENT OF ASSETS .............................................................................................................. 133
9 INVESTMENTS ...................................................................................................................................... 137
Chapter 6: Accruals and prepayments ....................................................................... 138
1. ACCRUALS AND PREPAYMENTS................................................................................................................ 139
Chapter 7: Receivables and allowance ...................................................................... 147
1. IRRECOVERABLE DEBTS .......................................................................................................................... 148
2 ALLOWANCES FOR RECEIVABLES ............................................................................................................... 150
3 ACCOUNTING FOR IRRECOVERABLE DEBTS AND RECEIVABLES ALLOWANCES ....................................................... 153
Chapter 8: Provision and contingencies .................................................................... 160
1 LIABILITIES AND PROVISIONS .................................................................................................................... 161
2. CONTINGENT LIABILITIES AND ASSETS ....................................................................................................... 168
Chapter 9: Capital structure and finance cost ........................................................... 176
1 LIMITED LIABILITY COMPANIES AND SOLE TRADERS COMPARED ....................................................................... 177
2 SHARE CAPITAL AND RESERVES ................................................................................................................. 180
3 ISSUING SHARES: RIGHTS ISSUES AND BONUS ISSUES ..................................................................................... 184
4 PREFERENCE SHARES.............................................................................................................................. 190
5 DIVIDENDS .......................................................................................................................................... 192
6 LOAN CAPITAL ...................................................................................................................................... 195
7 STATEMENT OF CHANGES IN EQUITY ......................................................................................................... 197
Chapter 10: Preparing trial balance ............................................................................ 204
1. TRIAL BALANCE .................................................................................................................................... 205
2 CORRECTING ERRORS ............................................................................................................................. 210
3 SUSPENSE ACCOUNTS ............................................................................................................................ 213
4 IDENTIFYING ERRORS IN DOUBLE ENTRY RECORDS ........................................................................................ 218
Chapter 11: Control accounts and control account reconciliations ........................ 223
1. THE MEANING OF A CONTROL ACCOUNT ................................................................................................... 224
2. SUPPLIER STATEMENTS: RECONCILIATION WITH LEDGER ACCOUNT ................................................................. 230
3. BANK RECONCILIATIONS ........................................................................................................................ 232
Chapter 12: Preparing basic financial statements .................................................... 243
1 PREPARING A SOLE TRADER’S FINANCIAL STATEMENTS .................................................................................. 244
2 PREPARING A COMPANY’S FINANCIAL STATEMENTS ...................................................................................... 252
3 TAXATION AND DIVIDENDS ...................................................................................................................... 263
4 EVENTS AFTER THE REPORTING PERIOD ...................................................................................................... 267
Chapter 13: Preparing simple consolidated financial statements ............................ 274
1 GROUP ACCOUNTS ................................................................................................................................ 275
2 CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS ............................................................................... 278
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3 CONTENT OF GROUP ACCOUNTS AND GROUP STRUCTURE .............................................................................. 280
4 GROUP ACCOUNTS: THE RELATED PARTIES ISSUE .......................................................................................... 284
5 DISCLOSURE......................................................................................................................................... 286
6 IFRS 10: SUMMARY OF CONSOLIDATION PROCEDURES ................................................................................ 287
7 NON-CONTROLLING INTERESTS – IFRS 3 ................................................................................................... 289
8 DIVIDENDS PAID BY A SUBSIDIARY ............................................................................................................. 289
9 GOODWILL ARISING ON CONSOLIDATION ................................................................................................... 290
10 INTRA-GROUP TRADING ........................................................................................................................ 299
11 INTRA GROUP SALES OF NON-CURRENT ASSETS .......................................................................................... 301
12 ACQUISITION OF A SUBSIDIARY DURING ITS ACCOUNTING PERIOD .................................................................. 302
13 FAIR VALUES IN ACQUISITION ACCOUNTING .............................................................................................. 304
14 THE CONSOLIDATED STATEMENT OF PROFIT OR LOSS .................................................................................. 309
15 THE CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME ............................... 313
16 THE CONSOLIDATED STATEMENT OF CASH FLOWS ...................................................................................... 315
19 PRESENTATION OF ASSOCIATES .............................................................................................................. 320
Chapter 14: Interpretation of financial statements .................................................... 325

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Chapter 1: The context and purpose of financial reporting

Chapter 1: The context and
purpose of financial reporting
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Chapter 1: The context and purpose of financial reporting

1 The purpose of financial statements
Financial statements provide information about the position and performance of a business.
The main purpose of financial statements is to provide information about the financial position
of a business entity, and about how it has performed financially over a given period of time. The
individual financial statements, which will be explained in some detail later in this text, each
provide particular information which could be of value to one or more interest groups.
1.1 What is a business entity?
A reporting entity is a discrete, separately-identified unit or organisation that produces financial
reports. A business entity may be a company, a group of companies, a business partnership or
the business of a sole trader.
Financial statements are prepared for an 'entity' that makes money transactions. The term 'entity'
can refer to non-business organisations and not-for-profit organisations, such as government
departments, charities, clubs and societies. A 'business entity' is involved specifically in business,
usually for the purpose of making a profit: the term refers to companies, business partnerships
and individuals running their own business ('sole traders').
An entity preparing financial statements (the 'reporting entity') must be identifiable as a distinct
and discrete unit or organisation; in other words, it should be a cohesive economic unit. To
prepare financial statements, an entity must have a system of accounting for its transactions,
because it is from the records of money transactions held in this system that financial statements
are constructed. Such an accounting system is generally referred to as a 'book-keeping system'.
The entity concept assumes that the business is a separate entity from its owners. If a sole trader
sets up a business mowing lawns, then that business is separate from the sole trader. Separate
accounting records must be kept for the business.
The capital that the sole trader puts into the business is treated as money owed to the owner in
the business accounts, and is sometimes called 'proprietors' funds'.
The entity concept applies to sole traders, partnerships and companies. Sole traders and
partnerships are not legally separate from their businesses, but are treated as such for accounting
purposes. However, a company is legally separate from its owners.
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Chapter 1: The context and purpose of financial reporting

1.2 How does control define the boundary of the reporting entity?
When beginning to study the interpretation of financial statements, it is convenient to think of
the reporting entity as a single company. In reality, companies are more commonly linked
together as a single group, with a holding or parent company and many subsidiary companies
and sub-subsidiaries. A subsidiary is a company that is controlled by another company, for
example through a controlling interest in its ordinary share capital.
1.3 Example
Suppose for example that Alpha Co owns 100% of the share capital of Beta Co, which in turn
holds 100% of the share capital of Gamma Co.

Alpha Co should provide statements about its financial performance and position (statement of
financial position (balance sheet), income statement, statement of cash flows, and so on). But
should it report exclusively on the performance of Alpha Co or should it report on the
performance of Alpha, Beta and Gamma taken together, since Alpha Co controls the businesses
of Beta and Gamma?
The view taken in financial reporting is that the reporting entity is not the individual company.
The reporting entity should be defined by the scope of control. A parent company (holding
company) of a group of companies should therefore present financial statements to its
shareholders about the performance and position of the group as a whole. Published accounts
are therefore usually 'group accounts' or 'consolidated accounts', which bring the performance
and position of all the group companies together as a single entity.
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Chapter 1: The context and purpose of financial reporting

1.4 Financial performance
Businesses of whatever size or nature exist to make a profit. The financial statement showing the
profit or loss earned in a period is the income statement or the statement of comprehensive
income.
The purpose of a business is to make money for its owners. A business invests money in resources
with the intention of making even more money. Business enterprises vary in character, size and
complexity. They range from very small businesses (the local shopkeeper or plumber) to very
large ones (e.g. GlaxoSmithkline, Marks and Spencer, Diageo). But the objective of earning profit
is common to all of them.
Profit is the excess of income over expenditure. When expenditure exceeds income, the business
is running at a loss.
One purpose of financial statements is to show whether a business has made a profit or a loss
over a period of time from its operations. A statement showing the performance of a business in
a given period of time is called an income statement, or a statement of comprehensive income.
Entities that do not exist to make a profit must nevertheless spend within their means. These
organisations produce a performance statement disclosing their income and expenditure for a
given period, rather than a statement of profit or loss.
The definition of profit above is slightly simplified. It is more correct to state that a profit or gain
arises when the value of the owners' interest in a business rises, without the owners putting in
any additional new capital. This definition might become clearer as you work your way through
this text, but it is possible for a gain or a loss to arise without any transaction involving income
or expenditure.
1.5 Financial position
A statement of the financial position of an entity at a particular point in time is the statement of
financial position (previously called the balance sheet). This shows the assets, liabilities and capital
of the entity at a specific point in time.
Another purpose of financial statements is to show the financial position of an entity. In reality,
the financial position of most businesses is always changing, and is not static. The financial
position of a company next week is not going to be the same as its financial position now.
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Chapter 1: The context and purpose of financial reporting

However, a financial statement can only show the position of a business at a given point in time,
and this 'snapshot' picture will hopefully give a fairly representative picture.
The main elements affecting the financial position of a business are:
(a) the economic resources it controls
(b) its financial structure
(c) its liquidity and solvency
(d) its capacity to adapt to changes in its environment
The financial position of a business (or any other entity) is largely concerned with what resources
the business has and how much the business owes. This is reported in a statement known as the
statement of financial position (previously called the balance sheet) which shows the assets and
liabilities of a business, and how much capital it has.
1.6 Financial adaptability
Businesses must generate cash as well as profit. The financial statement showing the generation
and uses of cash over a period is the statement of cash flows.
In order to be able to adapt to changing circumstances, markets and commercial environments,
companies need to generate cash. The generation of cash is different from the generation of
profit due to the concept of accruals. The cash generated by a company in a period is reported
in a statement of cash flows.
2 Assets and liabilities
2.1 Assets
An asset is something valuable which a business owns or has the use of.
Examples of assets are factories, office buildings, warehouses, delivery vans, Lorries, plant and
machinery, computer equipment, office furniture, cash and also goods held in store awaiting sale
to customers, and raw materials and components held in store by a manufacturing business for
use in production.
Some assets are held and used in operations for a long time. These are known as non-current
assets. An office building might be occupied by administrative staff for years. A machine might
have a productive life of many years before it wears out.
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Chapter 1: The context and purpose of financial reporting

Other assets are held for only a short time. These are known as current assets. The owner of a
newsagent shop, for example, will have to sell his newspapers on the same day that he gets them,
and weekly newspapers and monthly magazines also have a short shelf life. The more quickly a
business can sell the goods it has in store, the more profit it is likely to make, provided, of course,
that the goods are sold at a higher price than the cost the business incurred to acquire them.
In financial statements, assets are analysed as either current or non-current, depending on the
length of time that they are expected to be held. Any assets expected to be held for 12 months
or more are generally classified as non-current.
The definition of asset given above is somewhat simplified, although it is useful for introducing
the idea of what an asset is. A more formal definition is that an asset is a resource controlled by
the business from which future economic benefits are expected to flow, arising out of a past
transaction or event.
(a) An item of office equipment is an asset. A company buying a computer will expect to use
it over a number of years, and will derive economic benefits from it. The computer is an
asset because it will provide economic benefits to the company in the future that have
arisen out of a past event, the purchase of the computer.
(b) Money owed by a customer to a business is an asset of the business. For example,
suppose that a company sells goods on credit to a customer for $3,000, and the customer
is given 30 days to make the payment. Until the debt is paid, the customer is a 'debtor'
of the company for $3,000. The debt is an asset because it gives the company future
economic benefit (money income) arising out of a past transaction, the sale of the goods.

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