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Financial accounting (4)

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Financial accounting

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Financial accounting (4)

  1. 1. CIMA C02 Fundamental of Financial Accounting zaheerswati@ciit.net.pk 1
  2. 2. zaheerswati@ciit.net.pk Financial Statements 2
  3. 3. zaheerswati@ciit.net.pk 3
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  8. 8. zaheerswati@ciit.net.pk 8 MCQs 1 Which one of the following does not apply to the preparation of financial accounts? (a) They are prepared annually. (b) They provide a summary of the outcome of financial transactions. (c) They are prepared mainly for external users of accounting information. (d) They are prepared to show the detailed costs of manufacturing and trading (d) They are prepared to show the detailed costs of manufacturing and trading
  9. 9. zaheerswati@ciit.net.pk 9 MCQs 2 Which of the following are not part of the income statement (profit and loss account)? (a) Sales (b) Gross profit (c) Debtors (d) Rent (c) Debtors
  10. 10. zaheerswati@ciit.net.pk 10 MCQs 3 Which of the following are not part of the balance sheet? (a) Prepayments (b) Short-term loans (c) Interest (d) Creditors (c) Interest
  11. 11. zaheerswati@ciit.net.pk 11 MCQs 4 Which of the following is not part of the statement of movements on capital? (a) Capital at the start of the period (b) Fixed assets (c) Net profit earned in the period (d) Capital at the end of the period (b) Fixed assets
  12. 12. zaheerswati@ciit.net.pk 12 MCQs 5
  13. 13. zaheerswati@ciit.net.pk 13 Accounts for Limited Companies  Company accounts preparation in the UK is governed by the Companies Act 2006  Companies issue shares to shareholders who enjoy limited liability  There are two classes of limited liability company in the UK (a) Private companies (b) Public companies
  14. 14. 14 Statement of Changes in Equity
  15. 15. zaheerswati@ciit.net.pk 15 Reserves  There are two types of reserves: capital reserves and revenue reserves  The difference between these is that capital reserves may not be distributed as dividends. Examples of capital reserves are share premium and revaluation reserves  Since the increase in value is based on a professional valuation and has not been realised by a sale, the increase in value (or profit) cannot be distributed to shareholders.
  16. 16. zaheerswati@ciit.net.pk 16 Revenue reserves are (a) Accumulated and undistributed profits of a company (b) Amounts that cannot be distributed as dividends (c) Amounts set aside out of profits to replace revenue items (d) Amounts set aside out of profits for a specific purpose MCQs 6 (a) Accumulated and undistributed profits of a company
  17. 17. zaheerswati@ciit.net.pk 17 Which one of the following would you expect to find in the appropriation account of a limited company, for the current year? (a) Ordinary dividend proposed during the previous year, but paid in the current year (b) Ordinary dividend proposed during the current year, but paid in the following year (c) Directors’ fees (d) Auditors’ fees MCQs 7 (a) Ordinary dividend proposed during the previous year, but paid in the current year
  18. 18. zaheerswati@ciit.net.pk 18 MCQs 8
  19. 19. zaheerswati@ciit.net.pk 19 The record of how the profit or loss of a company has been allocated to distributions and reserves is found in the? (a) Capital account (b) Profit and loss account (c) Reserves account (d) Statement of changes in equity MCQs 9 (d) Statement of changes in equity
  20. 20. zaheerswati@ciit.net.pk 20 MCQs 10
  21. 21. zaheerswati@ciit.net.pk 21 Revenue reserve would decrease if a company? (a) Sets aside profits to pay future dividends (b) Transfers amounts into ‘general reserves’ (c) Issues shares at a premium (d) Pays dividend MCQs 11 (d) Pays dividend
  22. 22. zaheerswati@ciit.net.pk 22 Retained Earnings  These are profits earned by the company and not appropriated by dividends, taxation or transfer to another reserve account  This reserve generally increases from year to year, as most companies do not distribute all their profits as dividends  If a loss is made in one particular year, a dividend can still be paid from previous years' retained earnings
  23. 23. zaheerswati@ciit.net.pk 23 MCQs 12
  24. 24. zaheerswati@ciit.net.pk 24 MCQs 13
  25. 25. zaheerswati@ciit.net.pk 25 Dividend
  26. 26. zaheerswati@ciit.net.pk 26 Types of Shares
  27. 27. zaheerswati@ciit.net.pk 27 MCQs 14
  28. 28. zaheerswati@ciit.net.pk 28 Which one of the following does not form part of the equity capital of a limited company? (a) Debenture (b) Share premium (c) Revaluation reserve (d) Ordinary share capital MCQs 15 (a) Debenture
  29. 29. zaheerswati@ciit.net.pk 29 MCQs 16
  30. 30. 30 MCQs 17 Decrease Decrease
  31. 31. zaheerswati@ciit.net.pk 31 MCQs 18
  32. 32. zaheerswati@ciit.net.pk 32 MCQs 19
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  35. 35. 35 The Manufacturing Account So far we have worked with trading accounts of the form: This is perfectly satisfactory for a retail organisation that purchases and resells goods. A manufacturing company will need further details for the cost of manufacturing its products and these details can be set out in the form of manufacturing account.
  36. 36. zaheerswati@ciit.net.pk 36 Definitions • Direct costs are those which can be attributed to a particular unit of production and will normally include raw materials, productive wages and other expenses capable of direct identification with production. These three are often called direct materials, direct wages and direct expenses. • Indirect expenses are production expenses which cannot be attributed to a particular unit of production. They are often called manufacturing or works overheads and will include such items as factory power, plant repairs and so on. • Prime cost is the total of direct expenses. • Factory cost or works cost is prime cost plus a share of the factory indirect expenses.
  37. 37. zaheerswati@ciit.net.pk 37 Stocks in Manufacturing Organisations The manufacturing process will involve three stages: Stage 1. The acquisition of raw materials Stage 2. The modification or processing of those materials, with the addition of labour and other expenses Stage 3. The production of finished goods There could be four types of inventories on the balance sheet of manufacturing organization Raw materials Work in progress (partly finished goods) Finished goods Bought-in goods
  38. 38. zaheerswati@ciit.net.pk 38
  39. 39. 39 MCQs 20 294,000
  40. 40. zaheerswati@ciit.net.pk 40 MCQs 21 19,400
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  43. 43. 43 Cash Flow Statement • The statement of cash flows is to highlight the major activities that directly and indirectly impact cash flows and hence affect the overall cash balance • The purpose of the statement of cash flow is to report a firm’s cash inflows and outflows, during a period of time, divided into three categories are Operating, Investing, and Financing Activities • The cash flow statement may be presented using either a “direct” method or an “indirect” method • The only difference between the direct and indirect methods of presentation concerns the reporting of operating activities; the investing and financing activity sections would be identical under each method
  44. 44. zaheerswati@ciit.net.pk 44 Operating Activities (Indirect Method) • Direct method is not include in the syllabus of CIMA C02 • Following steps are used to calculate cash flow from operating activities under the indirect method :  Start with operating profit  Add non-cash expenses, such as depreciation and amortization and loss on disposal of non-current assets (capital loss)  Less profit disposal of non-current assets (capital gains) Continued
  45. 45. zaheerswati@ciit.net.pk 45  Changes in working capital excluding short term borrowing (note payable and like nature) and cash equivalents (working Capital is current assets and current liabilities)  Inflow of cash is any decrease in non-current asset item or any increase in an current liability  Outflow of cash is any increase in non-current asset item or any decrease in a current liability
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  49. 49. 49 Net cash from operating activities We now need to calculate the cash from operating activities by deducting the following items from cash generated from operations: (a) Interest paid; (b) Tax paid;
  50. 50. zaheerswati@ciit.net.pk 50 Investing Activities Investing activities generally involve Non Current Assets which are long term investment and fixed assets Investing activities generate cash inflows and outflows related to acquiring or disposing of non-current assets such as property, plant, and equipment, long-term investments, and loans to another entity (bonds & debenture)
  51. 51. zaheerswati@ciit.net.pk 51 Financing Activities When there is a change in the balance of a non-current liability account or a capital stock account or cash dividends are paid, the related cash flow must be recorded in the financing activities section Financing activities involve dividend, short term borrowing (Not Payable and like nature) and Long term Liabilities
  52. 52. zaheerswati@ciit.net.pk 52
  53. 53. zaheerswati@ciit.net.pk 53 The Cash Section This section determines the ending balance in cash by adding the total of the net cash flows from the Operating, Investing and Financing sections to the beginning balance of cash from the balance sheet
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  57. 57. 57 Ratio Analysis  Measure relationships between resources and financial flows  Ratios also allow for better comparison through time or between companies  A ratio is simply a comparison of one figure with another  Ratios can be classified into various groupings, according to the type of information they convey. The main groupings are as follows o Profitability (performance) ratios o Liquidity (solvency) ratios o Efficiency (use of assets) ratios o Capital structure (gearing) ratios
  58. 58. zaheerswati@ciit.net.pk 58 The following income statement and balance sheet will be used to illustrate the calculation of accounting ratios
  59. 59. zaheerswati@ciit.net.pk 59
  60. 60. zaheerswati@ciit.net.pk 60 Profitability Ratio • These are also known as performance ratios • They compare profit at different levels with other figures, and are often presented as percentages • Assess profits relative to amount of resources used  Gross Profit Margin  Gross Profit Mark-up:  Operating Profit Margin  Return on Capital Ratios
  61. 61. zaheerswati@ciit.net.pk 61 Gross Profit Margin This ratio (also known as the gross profit to sales revenue ratio) is calculated by
  62. 62. zaheerswati@ciit.net.pk 62 Gross Profit Mark-up This ratio is an alternative measure of profitability
  63. 63. zaheerswati@ciit.net.pk 63 Operating Profit Margin
  64. 64. zaheerswati@ciit.net.pk 64 Return on Capital Ratios The ratio can be calculated in several different ways, according to the information required of it, and depending on what is meant by the two terms ‘capital employed’ and ‘returns’ In these Learning Materials, two methods of calculating the return on capital are discussed – the return on total capital employed (ROCE) and the return on equity (ROE) Capital employed can consist of total capital employed (equity + non- current liabilities)
  65. 65. zaheerswati@ciit.net.pk 65 Return on Capital Ratios Working
  66. 66. zaheerswati@ciit.net.pk 66 Return on Equity (ROE)
  67. 67. zaheerswati@ciit.net.pk 67 Liquidity Ratios  Assess ability to cover current obligations  These are also known as solvency ratios, as they refer to the ability of the business to pay its payables in the short term  There are two main liquidity ratios:  The Current Ratio  The Quick Ratio
  68. 68. zaheerswati@ciit.net.pk 68 Current Ratios This is also known as the working capital ratio, as it is based on working capital or net current assets
  69. 69. zaheerswati@ciit.net.pk 69 Quick Ratios This is also known as the acid test ratio and is calculated by
  70. 70. 70 Activity /Turnover Ratios / Efficiency ratios • Assess amount of activity relative to amount of resources used • These are also referred to as use of assets ratios. They measure the efficiency of the management of assets, both non-current and current Asset Turnover Total Capital Employed (Capital Turnover) Non-current assets (non-current asset turnover) Inventories days Receivables days Payables Days Total Working Capital Ratio
  71. 71. zaheerswati@ciit.net.pk 71 Asset Turnover These ratios compare the assets with the sales revenue (turnover) that they have earned
  72. 72. zaheerswati@ciit.net.pk 72 Total Capital Employed (Capital Turnover)
  73. 73. zaheerswati@ciit.net.pk 73 Non-current assets (non-current asset turnover)
  74. 74. zaheerswati@ciit.net.pk 74 Inventories days Inventories may be analyzed by calculating the ratio of inventories to cost of sales, and then multiplying by the number of days in a year to give inventories days
  75. 75. 75 Receivables days This is a measure of the average time taken by customers to settle their debts
  76. 76. zaheerswati@ciit.net.pk 76 Payables Days This is a measure of the average time taken to pay suppliers
  77. 77. zaheerswati@ciit.net.pk 77 Total Working Capital Ratio  This measures the total length of time for which working capital is tied up in inventories, receivables and payables, before becoming available for use  It is the total of the number of inventories days, receivables days, less payables days
  78. 78. zaheerswati@ciit.net.pk 78 Leverage Ratios or Capital structure ratios Different firms have different methods of financing their activities. Some rely mainly on the issue of share capital and the retention of profits; others rely heavily on loan finance; most have a combination of the two.
  79. 79. 79 The gearing ratio (or leverage ratio) Gearing is a measure of the relationship between the amount of finance provided by external parties (e.g. debentures) to the total capital employed An alternative method of calculating gearing is known as the debt equity ratio
  80. 80. zaheerswati@ciit.net.pk 80 Interest cover Connected to the gearing ratio is a measure of the number of times that the profit is able to “cover” the fixed interest due on long-term loans. It provides lenders with an idea of the level of security for the payment
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