DOC-20240821-WA0009.pdf

Valid from 1 September 2024 to 31 August 2025 ACCA (FA) Exam-focused...

Valid from 1 September 2024 to 31 August 2025 ACCA (FA) Exam-focused ACCA Kaplan’s vast classroom experience helps many students pass first time. The books are designed to cover the whole syllabus and they reflect how topics are taught in the classroom, focusing on what will be required of you in the exam. Financial Accounting Financial Student-friendly Using accessible language and engaging Accounting (FA) formats to help you understand more complex areas, Kaplan simplifies the learning process to make it easier for you to succeed. to 31 August 2025 Valid from 1 September 2024 Written by our expert tutors All Kaplan study materials are written by our subject specialists, experienced tutors who teach the paper so they know what works for students and how best to deliver it. Innovative solutions More than just books, our study materials are supported by a wealth of free online resources, including testing and course assessments. All accessible from our online learning environment MyKaplan. All the resources have been designed to keep you on your study plan and help you pass first time. Kaplan Publishing UK Study Text Study Text ISBN 978-1-83996-655-2 9 781839 966552  ACCA Applied Knowledge ACCA Diploma in Accounting and Business (RQF Level 4) Financial Accounting (FA/FFA) Study Text  KAPLAN PUBLISHING’S STATEMENT OF PRINCIPLES LINGUISTIC DIVERSITY, EQUALITY AND INCLUSION We are committed to diversity, equality and inclusion and strive to deliver content that all users can relate to. We are here to make a difference to the success of every learner. Clarity, accessibility and ease of use for our learners are key to our approach. We will use contemporary examples that are rich, engaging and representative of a diverse workplace. We will include a representative mix of race and gender at the various levels of seniority within the businesses in our examples to support all our learners in aspiring to achieve their potential within their chosen careers. Roles played by characters in our examples will demonstrate richness and diversity by the use of different names, backgrounds, ethnicity and gender, with a mix of sexuality, relationships and beliefs where these are relevant to the syllabus. It must always be obvious who is being referred to in each stage of any example so that we do not detract from clarity and ease of use for each of our learners. We will actively seek feedback from our learners on our approach and keep our policy under continuous review. If you would like to provide any feedback on our linguistic approach, please use this form (you will need to enter the link below into your browser). https://docs.google.com/forms/d/1Vc4mltBPrfViy8AhfyKcJMHQKBmLaLPoa_WPqFNf4MI/edit We will seek to devise simple measures that can be used by independent assessors to randomly check our success in the implementation of our Linguistic Equality, Diversity and Inclusion Policy. P.2 KAPLAN PUBLISHING  British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. Published by: Kaplan Publishing UK Unit 2 The Business Centre Molly Millar’s Lane Wokingham Berkshire RG41 2QZ ISBN: 978-1-83996-655-2 © Kaplan Financial Limited, 2024 The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited, all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials. Printed and bound in Great Britain. Acknowledgements This product contains copyright material and trademarks of the IFRS Foundation®. All rights reserved. Used under licence from the IFRS Foundation®. Reproduction and use rights are strictly limited. For more information about the IFRS Foundation and rights to use its material please visit www.ifrs.org. Disclaimer: To the extent permitted by applicable law the Board and the IFRS Foundation expressly disclaims all liability howsoever arising from this publication or any translation thereof whether in contract, tort or otherwise (including, but not limited to, liability for any negligent act or omission) to any person in respect of any claims or losses of any nature including direct, indirect, incidental or consequential loss, punitive damages, penalties or costs. Information contained in this publication does not constitute advice and should not be substituted for the services of an appropriately qualified professional. The IFRS Foundation logo, the IASB logo, the IFRS for SMEs logo, the ‘Hexagon Device’, ‘IFRS Foundation’, ‘eIFRS’, ‘IAS’, ‘IASB’, ‘IFRS for SMEs’, ‘IASs’, ‘IFRS’, ‘IFRSs’, ‘International Accounting Standards’ and ‘International Financial Reporting Standards’, ‘IFRIC’, NIIF® and ‘SIC’ are Trade Marks of the IFRS Foundation. 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KAPLAN PUBLISHING P.3 P.4 KAPLAN PUBLISHING  Contents Page Chapter 1 Introduction to financial reporting 1 Chapter 2 The regulatory framework 25 Chapter 3 Double-entry bookkeeping 39 Chapter 4 Recording transactions and events 69 Chapter 5 Inventory 97 Chapter 6 Non-current assets: acquisition and depreciation 125 Chapter 7 Non-current assets: disposal and revaluation 145 Chapter 8 Intangible assets 163 Chapter 9 Accruals and prepayments 175 Chapter 10 Receivables 191 Chapter 11 Payables, provisions and contingent liabilities 209 Chapter 12 Capital structure and finance costs 223 Chapter 13 Reconciliations 243 Chapter 14 The trial balance, errors and suspense accounts 261 Chapter 15 Preparing basic financial statements 281 Chapter 16 Incomplete records 315 Chapter 17 Statement of cash flows 335 Chapter 18 Interpretation of financial statements 369 Chapter 19 Consolidated statement of financial position 391 Chapter 20 Consolidated statement of profit or loss and 435 associates KAPLAN PUBLISHING P.5  Chapter 21 PRACTICE QUESTIONS 451 Chapter 22 PRACTICE ANSWERS 507 Chapter 23 References 543 Index I.1 P.6 KAPLAN PUBLISHING  Introduction This document references IFRS® Standards and IAS® Standards, which are authored by the International Accounting Standards Board (the Board), and published in the 2023 IFRS Standards Red Book. KAPLAN PUBLISHING P.7  How to use the Materials These Kaplan Publishing learning materials have been carefully designed to make your learning experience as easy as possible and to give you the best chances of success in your examinations. The product range contains a number of features to help you in the study process. They include: (1) Detailed study guide and syllabus objectives (2) Description of the examination (3) Study skills and revision guidance (4) Study text (5) Question practice The sections on the study guide, the syllabus objectives, the examination and study skills should all be read before you commence your studies. They are designed to familiarise you with the nature and content of the examination and give you tips on how to best approach your learning. The Study text comprises the main learning materials and gives guidance as to the importance of topics and where other related resources can be found. Each chapter includes  The learning objectives contained in each chapter, which have been carefully mapped to the examining body's own syllabus learning objectives or outcomes. You should use these to check you have a clear understanding of all the topics on which you might be assessed in the examination.  The chapter diagram provides a visual reference for the content in the chapter, giving an overview of the topics and how they link together.  The content for each topic area commences with a brief explanation or definition to put the topic into context before covering the topic in detail. You should follow your studying of the content with a review of the illustration/s. The illustrations are worked examples which will help you to understand better how to apply the content for the topic.  Test your understanding sections provide an opportunity to assess your understanding of the key topics by applying what you have learned to short questions. Answers can be found at the back of each chapter.  Summary diagrams complete each chapter to show the important links between topics and the overall content of the syllabus. These diagrams should be used to check that you have covered and understood the core topics before moving on.  Question practice is provided at the back of each text. P.8 KAPLAN PUBLISHING  Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to [email protected] with full details, or follow the link to the feedback form in MyKaplan. Our Quality Coordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions. Icon Explanations Definition – Key definitions that you will need to learn from the core content. Key point – Identifies topics that are key to success and are often examined. Test your understanding – Exercises for you to complete to ensure that you have understood the topics just learned. Illustration – Worked examples help you understand the core content better. Tricky topic – When reviewing these areas care should be taken and all illustrations and Test your understanding exercises should be completed to ensure that the topic is understood. Supplementary reading – These sections will help to provide a deeper understanding of core areas. The supplementary reading is NOT optional reading. It is vital to provide you with the breadth of knowledge you will need to address the wide range of topics within your syllabus that could feature in an exam question. Reference to this text is vital when self- studying. Links to other syllabus areas – This symbol refers to areas of interaction with other parts of your syllabus, either in terms of other ACCA subjects that you have studied, or may go on to study, or even further professional qualifications that you may decide to pursue on completion of ACCA. KAPLAN PUBLISHING P.9  On-line subscribers Our on-line resources are designed to increase the flexibility of your learning materials and provide you with immediate feedback on how your studies are progressing. If you are subscribed to our on-line resources you will find: (1) On-line reference ware: reproduces your Study Text on-line, giving you anytime, anywhere access. (2) On-line testing: provides you with additional on-line objective testing so you can practise what you have learned further. (3) On-line performance management: immediate access to your on-line testing results. Review your performance by key topics and chart your achievement through the course relative to your peer group. Syllabus introduction Syllabus background The aim of ACCA Financial Accounting (FA), Diploma in Accounting and Business, is to develop knowledge and understanding of the underlying principles and concepts relating to financial accounting and technical proficiency in the use of double-entry accounting techniques including the preparation of basic financial statements. Objectives and core areas of the syllabus  Explain the context and purpose of financial reporting.  Define the accounting principles, concepts and qualitative characteristics of useful financial information.  Demonstrate the use of double-entry and accounting systems.  Record transactions and events.  Perform reconciliations.  Prepare a trial balance.  Prepare financial statements.  Prepare basic consolidated financial statements.  Interpret financial statements. P.10 KAPLAN PUBLISHING  ACCA Performance Objectives In order to become a member of the ACCA, as a trainee accountant you will need to demonstrate that you have achieved nine performance objectives. Performance objectives are indicators of effective performance and set the minimum standard of work that trainees are expected to achieve and demonstrate in the workplace. They are divided into key areas of knowledge which are closely linked to the exam syllabus. There are five Essential performance objectives and a choice of fifteen Technical performance objectives which are divided into five areas. The performance objectives which link to this exam are: (1) Ethics and professionalism PO1 (Essential) (2) Record and process transactions and events PO6 (Technical) (3) Prepare external financial reports PO7 (Technical) (4) Analyse and interpret financial reports PO8 (Technical) The following link provides an in depth insight into all of the performance objectives: https://www.accaglobal.com/content/dam/ACCA_Global/Students/per/PER- Performance-objectives-achieve.pdf KAPLAN PUBLISHING P.11  Progression There are two elements of progression that we can measure: first how quickly students move through individual topics within a subject; and second how quickly they move from one course to the next. We know that there is an optimum for both, but it can vary from subject to subject and from student to student. However, using data and our experience of student performance over many years, we can make some generalisations. A fixed period of study set out at the start of a course with key milestones is important. This can be within a subject, for example ‘I will finish this topic by 30 June’, or for overall achievement, such as ‘I want to be qualified by the end of next year’. Your qualification is cumulative, as earlier exams provide a foundation for your subsequent studies, so do not allow there to be too big a gap between one subject and another. We know that exams encourage techniques that lead to some degree of short-term retention, the result being that you will simply forget much of what you have already learned unless it is refreshed (look up Ebbinghaus Forgetting Curve for more details on this). This makes it more difficult as you move from one subject to another: not only will you have to learn the new subject, you will also have to relearn all the underpinning knowledge as well. This is very inefficient and slows down your overall progression which makes it more likely you may not succeed at all. In addition, delaying your studies slows your path to qualification which can have negative impacts on your career, postponing the opportunity to apply for higher level positions and therefore higher pay. You can use the following diagram showing the whole structure of your qualification to help you keep track of your progress. P.12 KAPLAN PUBLISHING  Syllabus objectives We have reproduced the ACCA's syllabus below, showing where the objectives are explored within this book. Within the chapters, we have broken down the extensive information found in the syllabus into easily digestible and relevant sections, called Content Objectives. These correspond to the objectives at the beginning of each chapter. Syllabus learning objective Chapter reference A THE CONTEXT AND PURPOSE OF FINANCIAL REPORTING 1 The scope and purpose of financial statements for external reporting (a) Define financial reporting – recording, analysing and 1 summarising financial data.[k] (b) Identify and define types of business entity – sole 1 trader, partnership, limited liability company.[k] (c) Explain the legal differences between a sole 1 trader, partnership and a limited liability company.[k] (d) Identify the advantages and disadvantages of operating as a sole trader, partnership and a limited liability company.[k] (e) Define the nature, principles and scope of 1 financial reporting.[k] 2 Stakeholders’ needs (a) Identify the users of financial statements and state and 1 differentiate between their information needs.[k] 3 The main elements of financial statements (a) Describe the purpose of each of the principal financial 1 statements.[k] (b) Identify and define and assets, liabilities, equity, income 1 and expenses.[k] 4 The regulatory framework (a) Explain the purpose and objectives of the regulatory 2 system including the roles of the IFRS® Foundation (the Foundation), the International Accounting Standards Board (The Board), the IFRS Advisory Council (IFRS AC) the IFRS Interpretations Committee (IFRIC®) and the International Sustainability Standards Board (ISSB®).[k] (b) Explain the role of the International Financial Reporting 2 Standards (IFRS Accounting Standards®) in preparing financial statements.[k] KAPLAN PUBLISHING P.13  Syllabus learning objective Chapter reference 5 Duties and responsibilities of those charged with 2 governance (a) Explain what is meant by governance specifically in the context of the preparation of financial statements.[k] (b) Describe the duties and responsibilities of directors in the preparation of the financial statements.[k] B ACCOUNTING PRINCIPLES, CONCEPTS AND QUALITATIVE CHARACTERISTICS 1 Key principles and concepts of accounting 2 (a) Define and apply key principles and concepts of accounting:[k] (i) Going concern (ii) Accruals accounting (iii) Materiality (iv) Offsetting (v) Consistency (vi) Prudence (vii) Duality (dual aspect) (viii) Business entity (ix) Historical cost and current value (x) Substance over form 2 Qualitative characteristics of useful financial 2 information (a) Define and apply the qualitative characteristics of useful financial information:[k] (i) Relevance (ii) Faithful representation (iii) Comparability (iv) Verifiability (v) Timeliness (vi) Understandability. P.14 KAPLAN PUBLISHING  Syllabus learning objective Chapter reference C THE USE OF DOUBLE-ENTRY AND ACCOUNTING SYSTEMS 1 Double-entry bookkeeping principles including the maintenance of accounting records (a) Identify and explain the function of the main data 3 sources in an accounting system.[k] (b) Summarise the contents and purpose of different types 3 of business documentation, including:[k] (i) Quotation (ii) Sales order (iii) Purchase order (iv) Goods received note (v) Goods despatched note (vi) Sales invoice (vii) Supplier (purchase) invoice (viii) Supplier statement (ix) Credit note (x) Debit note (x) Remittance advice (iii) Receipt (c) Explain and apply the accounting equation.[k] (d) Describe the key features of a computerised 3 accounting system, including the use of external servers to store data (the cloud).[k] (e) Describe how an accounting system contributes to 1, 3 providing useful accounting information and complies with organisational policies and deadlines.[k] (f) Identify the main types of business transactions 3 e.g. sales, purchases, payments, receipts.[k] 2 General ledger accounts and journal entries (a) Describe the main types of general ledger accounts 3 including their nature and function.[k] (b) Describe how financial data is initially recorded in the 3 accounting system.[s] (c) Explain the use of journal entries and how journal entries are processed to general ledger accounts.[s] (d) Identify correct journals from given narrative.[s] 3 (e) Illustrate how to balance and close the general ledger 3 accounts at the year end.[s] KAPLAN PUBLISHING P.15  Syllabus learning objective Chapter reference D RECORDING TRANSACTIONS AND EVENTS 1 Sales and purchases (a) Record sale and purchase transactions in the general 4 ledger accounts.[s] (b) Record sales returns and purchase returns in the 4 general ledger accounts.[s] (c) Describe the principles of the operation of a sales tax.[k] 4 (d) Calculate sales tax on transactions and record it in the 4 sales tax general ledger account.[s] (e) Account for discounts received.[s] 4 (f) Account for discounts allowed (trade discounts and 4 settlement discounts) to customers in accordance with IFRS Accounting standards.[s] 2 Cash (a) Record cash transactions in the bank general ledger 4 account.[s] (b) Describe the need for a record of petty cash 4 transactions.[k] 3 Inventories (a) Describe the need for adjustments to inventories in 5 preparing financial statements.[k] (b) Record cost of sales and closing inventories.[s] 5 (c) Apply the requirements of IAS 2 Inventories for valuing inventories.[s] (d) Identify which costs should be included in valuing 5 inventories.[s] (e) Explain the use of continuous and period end inventory 5 records.[k] (f) Calculate the value of closing inventory using FIFO 5 (first in, first out) and AVCO (average cost) – both periodic weighted average and continuous weighted average.[s] (g) Identify the impact of inventory valuation methods on 5 profit and on assets. [s] P.16 KAPLAN PUBLISHING  Syllabus learning objective Chapter reference 4 Tangible non-current assets (a) Define non-current assets.[k] 1&6 (b) Compare the difference between current and non- 1&6 current assets.[k] (c) Explain the difference between asset and expense 6 items.[k] (d) Classify expenditure as asset expenditure or expenses 6 charged to profit or loss.[s] (e) Record the acquisition and disposal of tangible non- 6 current assets in the general ledger accounts in accordance with IFRS Accounting Standards.[s] (f) Calculate and record gains or losses on disposal of 6 tangible non-current assets in the general ledger accounts and illustrate how it is presented in the statement of profit or loss, including part exchange transactions. [s] (g) Record the revaluation of a tangible non-current asset 6 in the general ledger accounts, and illustrate how it is presented in the statement of profit or loss and other comprehensive income and in the statement of financial position.[s] (h) Calculate the gain or loss on disposal of a revalued 7 tangible non-current asset.[s] (i) Illustrate how tangible non-current asset balances and 6&7 movements are disclosed in financial statements.[s] (j) Explain the purpose and function of a non-current asset 6 register.[k] 5 Depreciation (a) Explain the purpose of depreciation.[k] 6 (b) Calculate the charge for depreciation using straight line 6 and diminishing (reducing) balance methods.[s] (c) Identify the circumstances where different methods of 6 depreciation would be appropriate.[k] (d) Illustrate how the depreciation charge and accumulated 6 depreciation are recorded in the general ledger accounts.[s] KAPLAN PUBLISHING P.17  (e) Calculate and update the general ledger accounts to 7 record the depreciation on a revalued tangible non- current asset, including the transfer of excess depreciation between the revaluation surplus and retained earnings.[s] (f) Calculate the adjustments to depreciation necessary if 6 changes are made in the estimated useful life and/or residual value of a tangible non-current asset.[s] (g) Record depreciation in the statement of profit or loss 6 and statement of financial position.[s] 6 Intangible non-current assets and amortisation (a) Compare the difference between tangible and 8 intangible non-current assets.[k] (b) Identify types of intangible assets.[k] 8 (c) Identify the definition and treatment of ‘research’ and 8 ‘development’ in accordance with IFRS Accounting Standards.[k] (d) Calculate and account for amounts to be capitalised as 8 development expenditure or to be recognised as an expense from given information.[s] (e) Explain the purpose of amortisation.[k] 8 (f) Calculate and account for amortisation.[s] 8 7 Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income (a) Apply accrual accounting to accruals, prepayments, 9 accrued income and deferred income.[S] (b) Calculate the adjustments needed for accruals, 9 prepayments, accrued income and deferred income when preparing financial statements.[s] (c) Illustrate the process of adjusting for accruals, 9 prepayments, accrued income and deferred income when preparing financial statements.[s] (d) Prepare manual journal entries and update the general 9 ledger accounts for the creation and reversal of accruals, prepayments, accrued income and deferred income.[s] (e) Identify the impact of accruals, prepayments, accrued 9 income and deferred income on profit and net assets.[s] (f) Report accruals, prepayments, accrued income and 9 deferred income in the financial statements.[s] P.18 KAPLAN PUBLISHING  8 Receivables and payables (a) Identify and explain examples of receivables and 1 & 10 & payables.[k] 11 (b) Identify the benefits and costs of offering credit facilities 10 to customers.[k] (c) Describe the purpose of an aged receivables analysis.[k] 10 (d) Describe the purpose of customer credit limits.[k] 10 (e) Prepare manual journal entries to write off an 10 irrecoverable debt.[s] (f) Prepare manual journal entries to recognise an 10 irrecoverable debt that is subsequently recorded.[s] (g) Demonstrate the impact of irrecoverable debts on the 10 statement of profit or loss and on the statement of financial position.[s] (h) Prepare manual journal entries to create and adjust an 10 allowance for irrecoverable debts.[s] (i) Illustrate how to include movements in the allowance 10 for irrecoverable debts in the statement of profit or loss and how the closing balance of the allowance should appear in the statement of financial position.[s] (j) Account for contras between trade receivables and 10 & 11 payables.[s] (k) Prepare, reconcile and explain the purpose of supplier 13 statements.[s] 9 Provisions and contingencies (a) Define ‘provision’, ‘contingent liability’ and ‘contingent 11 asset’ in accordance with IFRS Accounting Standards.[k] (b) Distinguish between and classify items as provisions, 11 contingent liabilities or contingent assets.[s] (c) Illustrate the different methods of accounting for 11 provisions, contingent liabilities and contingent assets.[k] (d) Calculate provisions and changes in provisions.[s] 11 (e) Prepare manual journal entries for the movement in 11 provisions.[s] (f) Report provisions in the financial statements.[s] 11 KAPLAN PUBLISHING P.19  10 Capital structure and finance costs (a) Describe the capital structure of a limited liability 12 company including: [k] (i) ordinary shares (ii) preference shares (redeemable and irredeemable) (iii) borrowings. (b) Describe the nature of equity, including retained 12 earnings and other components of equity.[K] (c) Identify and record the other components of equity 12 which may appear in the statement of financial position.[s] (d) Record movements in the share capital and share 12 premium accounts.[s] (e) Define a bonus (capitalisation) issue and its 12 advantages and disadvantages.[k] (f) Define a rights issue and its advantages and 12 disadvantages.[k] (g) Calculate and record a bonus (capitalisation) issue in 12 the statement of financial position.[s] (h) Calculate and record a rights issue in the statement of 12 financial position.[s] (i) Calculate and record dividends in the general ledger 12 accounts and the financial statements.[s] (j) Calculate and record finance costs in the general 12 ledger accounts and the financial statements.[s] (k) Identify the components of the statement of changes in 12 equity.[k] E RECONCILIATIONS 1 Bank reconciliations (a) Explain the purpose of bank reconciliations.[K] 13 (b) Identify the main reasons for differences between the 13 bank general ledger account and the bank statement or internet banking records.[K] (c) identify and correct errors and/or omissions in the bank 13 general ledger account.[S] (d) Prepare the reconciliation of the bank general ledger account to the bank statement or internet banking 13 records.[S] (e) Derive bank statement and bank general ledger 13 account balances from given information.[S] (f) identify the bank balance to be reported in the financial 13 statements.[S] P.20 KAPLAN PUBLISHING  2 Trade payables account reconciliation (a) Explain the purpose of the trade payables’ general ledger account and how it relates to double-entry 13 bookkeeping.[K] (b) Explain the purpose of reconciling the trade payables 13 general ledger account to external documents.[K] (c) Prepare a reconciliation of the balances on individual supplier accounts to supplier statements.[S] 13 (d) Identify and correct errors which would be highlighted 13 by performing a reconciliation of the trade payables general ledger account.[K] (e) Identify the trade payables balance to be reported in 13 the financial statements.[S] F PREPARING A TRIAL BALANCE 1 Trial balance (a) Describe the purpose of a trial balance.[k] 14 (b) Extract the general ledger balances into a trial 14 balance.[s] (c) Prepare extracts of an opening trial balance.[s] 14 (d) Explain the limitations of a trial balance.[k] 14 2 Correction of errors (a) Identify the types of error which may occur in 14 accounting systems.[k] (b) Identify errors which would be highlighted by the 14 extraction of a trial balance and those which would not.[k] (c) Prepare manual journal entries to correct errors.[s] 14 (d) Calculate the impact of errors on the statement of profit 14 or loss and other comprehensive income and the statement of financial position.[s] 3 Suspense accounts (a) Explain the purpose of a suspense account.[k] 14 (b) Identify errors leading to the creation of a suspense 14 account.[k] (c) Record entries in a suspense account.[s] 14 (d) Prepare journal entries to clear a suspense account.[s] 14 KAPLAN PUBLISHING P.21  G PREPARING FINANCIAL STATEMENTS 1 Statement of financial position (a) Explain how the accounting equation, IFRS Accounting 3, 15 Standards and the business entity concept underlie the statement of financial position.[k] (b) Prepare a statement of financial position or extracts as applicable.[s] 2 Statement of profit or loss and other comprehensive income (a) Calculate revenue, cost of sales, gross profit, operating 15 profit, profit before tax, profit for the year and total comprehensive income from given information.[s] (b) Prepare a statement of profit or loss and other 1 & 15 comprehensive income or extracts as applicable.[s] (c) Record the income tax expense in the statement of 12 profit or loss, including the under and/or overprovision of tax in the prior year.[s] (d) Identify items requiring separate disclosure on the face 15 of the statement of profit or loss.[k] (e) Explain the interrelationship between the statement of 15 financial position and the statement of profit or loss and other comprehensive income.[k] 3 Disclosure notes (a) Explain the purpose of notes to the financial statements 15 (disclosure notes).[k] (b) Draft the following disclosure notes.[s] (i) Non-current assets including tangible and 6 intangible assets (ii) Provisions 11 (iii) Events after the reporting period 15 (iv) Inventories. 5 4 Events after the reporting period (a) Define an event after the reporting period in accordance 15 with IFRS Accounting Standards.[k] (b) Classify events as adjusting or non-adjusting.[s] 15 (c) Distinguish between how adjusting and non-adjusting 15 events are reported in the financial statements.[k] P.22 KAPLAN PUBLISHING  5 Statements of cash flows (excluding partnerships) (a) Differentiate between profit and cash flow.[k] 17 (b) Describe the need for management to control cash 17 flow.[k] (c) Explain the benefits and drawbacks to users of the 17 financial statements of a statement of cash flows.[k] (d) Classify the effect of transactions on cash flows.[s] 17 (e) Calculate the figures needed for the statement of cash 17 flows in accordance with IFRS Accounting Standards, including:[s] (i) cash flows from operating activities (direct and indirect methods) (ii) cash flows from investing activities (iii) cash flows from financing activities. (f) Prepare a statement of cash flows or extracts as 17 applicable.[s] (g) Identify the treatment of given transactions in a 17 statement of cash flows.[k] 6 Incomplete records (a) Apply techniques used in incomplete record 16 situations:[s] (i) use of accounting equation (ii) use of general ledger accounts to calculate missing figures (iii) use of cash and/or bank summaries (iv) use of profit percentages to calculate missing figures. KAPLAN PUBLISHING P.23  H PREPARING BASIC CONSOLIDATED FINANCIAL STATEMENTS 1 Subsidiaries (a) Define and describe the following terms in the context 19 of group accounting.[k] (i) Parent (ii) Subsidiary (iii) Control (iv) Consolidated (group) financial statements (v) Non-controlling interest (vi) Trade (simple) investment. (b) Identify subsidiaries within a group structure.[k] 19 (c) Describe the components of and prepare a 19 consolidated statement of financial position or extracts thereof, including.[s] (i) fair value adjustments at acquisition on property, plant and equipment (excluding depreciation adjustments) (ii) fair value of consideration transferred from cash and shares (excluding deferred and contingent consideration) (iii) elimination of intra-group trading balances (excluding assets in transit) (iv) removal of unrealised profit arising on intra-group trading (v) acquisition of subsidiaries part way through the financial year. (d) Calculate goodwill (excluding impairment of goodwill) 19 where non-controlling interest is valued at its fair value at acquisition date as follows:[s] Fair value of consideration $X Fair value of non-controlling interest $X Less fair value of net assets at acquisition ($X) –––– Goodwill at acquisition $X –––– P.24 KAPLAN PUBLISHING  (e) Describe the components of and prepare a 20 consolidated statement of profit or loss or extracts thereof including:[s] (i) elimination of intra-group trading balances (excluding assets in transit) (ii) removal of unrealised profit arising on intra-group trading (iii) acquisition of subsidiaries part way through the financial year. 2 Associates (a) Define and identify an associate and significant 20 influence and identify the situations where significant influence exists.[k] (b) Describe the key features of a parent-associate 20 relationship and be able to identify an associate within a group structure.[k] (c) Describe the principle of the equity method of 20 accounting for associate entities.[k] I INTERPRETATION OF FINANCIAL STATEMENTS 1 Importance and purpose of analysis of financial statements (a) Describe how the interpretation and analysis of financial 18 statements is used in a business environment.[k] (b) Explain the purpose of interpretation of ratios.[k] 18 2 Ratios (a) Calculate key accounting ratios related to.[s] (i) profitability 18 (ii) liquidity (iii) efficiency (iv) position. (b) Explain the interrelationships between ratios.[k] 18 3 Analysis of financial statements (a) Calculate and interpret the relationship between the 18 elements of the financial statements regarding profitability, liquidity, efficient use of resources and financial position.[s] (b) Draw valid conclusions from the information contained 18 within the financial statements and present these to the appropriate user of the financial statements.[s] KAPLAN PUBLISHING P.25  The superscript numbers in square brackets indicate the intellectual depth at which the subject area could be assessed within the examination. Level 1 (knowledge and comprehension) broadly equates with Applied Knowledge, Level 2 (application and analysis) with Applied Skills and Level 3 (synthesis and evaluation) with the Strategic Professional exams. However, lower level skills can continue to be assessed as you progress through each module and level. The examination Do not attempt a CBE until you have completed all study material relating to it. Do not skip any of the material in the syllabus. Examination format The syllabus is assessed by a two-hour computer-based examination. Questions will assess all parts of the syllabus and will contain both computational and non-computational elements: Number of marks Thirty-five 2-mark objective test questions 70 Two 15-mark multi-task questions 30 Total time allowed: 2 hours The CBE question types are as follows:  Multiple choice – where you are required to choose one answer from a list of options provided by clicking on the appropriate ‘radio button’  Multiple response – where you are required to select more than one response from the options provided by clicking on the appropriate tick boxes (typically choose two options from the available list  Multiple response matching – where you are required to indicate a response to a number of related statements by clicking on the ’radio button’ which corresponds to the appropriate response for each statement  Number entry – where you are required to key in a response to a question shown on the screen. The longer 15-mark multi-task questions will test consolidations and accounts preparation (including a statement of cash flows). Make sure that you practice preparing full financial statements. There are lots of questions to practice in this text. Computer-based examination (CBE) – Tips Be sure you understand how to use the software before you start the exam. If in doubt, ask the assessment centre staff to explain it to you. Questions are displayed on the screen and answers are entered using keyboard and mouse. At the end of the exam, you are given a certificate showing the result you have achieved. P.26 KAPLAN PUBLISHING  Spend the first few minutes of the examination reviewing the format and content so that you understand what you need to do. Allocate the time you spend on questions in proportion to the marks on offer. For the Financial Accounting exam, this will equate to 1.2 minutes per mark. One suggestion for this exam is to allocate 2.4 minutes to each objective test question, and 18 minutes for each multi-task question. Note that this is an average as some objective test questions may be briefer to read and/or quicker to answer (e.g. choose the correct definition from four answers available), whilst others may take longer to read and answer (e.g. a calculation question). Read each question very carefully. Objective test questions: Read each question carefully and work through any calculations required. For questions when you have a choice of answer available, if you don't know the answer, eliminate those options you know are incorrect and see if the answer becomes more obvious. Answer every question – if you do not know an answer, you don't lose anything by guessing. Think carefully before you guess. With an objective test question, it may be possible to eliminate first those answers that you know are wrong. Then choose the most appropriate answer(s) as required from those that are left. This could be a single answer (e.g. multiple choice) or more than one response (e.g. multiple response and multiple response – matching). After you have eliminated the ones that you know to be wrong, if you are still unsure, guess. But only do so after you have double-checked that you have only eliminated answers that are definitely wrong. Double-check your answer before committing yourself to it. Don't panic if you realise you've answered a question incorrectly. Try to remain calm, continue to apply examination technique and answer all questions required within the time available. ACCA Support For additional support with your studies please also refer to the ACCA Global website. Study skills and revision guidance This section aims to give guidance on how to study for your ACCA exams and to give ideas on how to improve your existing study techniques. KAPLAN PUBLISHING P.27  Preparing to study Set your objectives Before starting to study decide what you want to achieve – the type of pass you wish to obtain. This will decide the level of commitment and time you need to dedicate to your studies. Devise a study plan Determine which times of the week you will study. Split these times into sessions of at least one hour for study of new material. Any shorter periods could be used for revision or practice. Put the times you plan to study onto a study plan for the weeks from now until the exam and set yourself targets for each period of study – in your sessions make sure you cover the course, course assignments and revision. If you are studying for more than one examination at a time, try to vary your subjects as this can help you to keep interested and see subjects as part of wider knowledge. When working through your course, compare your progress with your plan and, if necessary, re-plan your work (perhaps including extra sessions) or, if you are ahead, do some extra revision/practice questions. Effective studying Active reading You are not expected to learn the text by rote, rather, you must understand what you are reading and be able to use it to pass the exam and develop good practice. A good technique to use is SQ3Rs – Survey, Question, Read, Recall, Review: (1) Survey the chapter – look at the headings and read the introduction, summary and objectives, so as to get an overview of what the chapter deals with. (2) Question – whilst undertaking the survey, ask yourself the questions that you hope the chapter will answer for you. (3) Read through the chapter thoroughly, answering the questions and making sure you can meet the objectives. Attempt the exercises and activities in the text, and work through all the examples. (4) Recall – at the end of each section and at the end of the chapter, try to recall the main ideas of the section/chapter without referring to the text. This is best done after a short break of a couple of minutes after the reading stage. (5) Review – check that your recall notes are correct. You may also find it helpful to re-read the chapter to try to see the topic(s) it deals with as a whole. P.28 KAPLAN PUBLISHING  Note-taking Taking notes is a useful way of learning, but do not simply copy out the text. The notes must:  be in your own words  be concise  cover the key points  be well-organised  be modified as you study further chapters in this text or in related ones. Trying to summarise a chapter without referring to the text can be a useful way of determining which areas you know and which you don't. Three ways of taking notes: Summarise the key points of a chapter. Make linear notes – a list of headings, divided up with subheadings listing the key points. If you use linear notes, you can use different colours to highlight key points and keep topic areas together. Use plenty of space to make your notes easy to use. Try a diagrammatic form – the most common of which is a mind-map. To make a mind-map, put the main heading in the centre of the paper and put a circle around it. Then draw short lines radiating from this to the main subheadings, which again have circles around them. Then continue the process from the sub-headings to sub-sub-headings, advantages, disadvantages, etc. Highlighting and underlining You may find it useful to underline or highlight key points in your study text – but do be selective. You may also wish to make notes in the margins. Revision The best approach to revision is to revise the course as you work through it. Also try to leave four to six weeks before the exam for final revision. Make sure you cover the whole syllabus and pay special attention to those areas where your knowledge is weak. Here are some recommendations: Read through the text and your notes again and condense your notes into key phrases. It may help to put key revision points onto index cards to look at when you have a few minutes to spare. Review any assignments you have completed and look at where you lost marks – put more work into those areas where you were weak. Practise exam standard questions under timed conditions. If you are short of time, list the points you would include or specify the calculations that you would include in your answer and then read the model answer, but do try to complete at least a few questions under exam conditions. KAPLAN PUBLISHING P.29  Also practise producing answer plans and comparing them to the model answer. If you are stuck on a topic find somebody (e.g. your tutor or, where appropriate, a member of Kaplan’s Academic Support team) to explain it to you. Read good newspapers and professional journals, especially ACCA's Student Accountant – this can give you an advantage in the exam. Ensure you know the structure of the exam – how many questions and of what type you will be expected to answer. During your revision attempt all the different styles of questions you may be asked. Further reading You can find further reading and technical articles under the student section of ACCA's website. The following publications may also support your studies for this, and other, ACCA examinations in financial accounting and related topics: A Student’s Guide to Group Accounts by Tom Clendon, Kaplan Publishing A Student’s Guide to IFRS by Clare Finch, Kaplan Publishing A Student’s Guide to Preparing Financial Statements by Sally Baker, Kaplan Publishing. Technical update This text has been updated to reflect Examinable Documents September 2023 to August 2024 issued by ACCA. P.30 KAPLAN PUBLISHING Chapter 1 Introduction to financial reporting Chapter learning objectives Upon completion of this chapter you will be able to:  define financial reporting  identify and define types of business entity  identify users of the financial statements and their information needs  identify the purpose of the main financial statements  define the elements of the financial statements  define and explain accounting concepts and characteristics. KAPLAN PUBLISHING 1 Introduction to financial reporting 1 Overview of accounting Introduction Much of the content of this chapter is likely to be new to you. However, it forms an important foundation for your current ACCA FA studies and other exams as you progress through the ACCA qualification, particularly Financial Reporting and Strategic Business Reporting. The financial accounting and reporting system of an entity records and summarises the financial performance and position of a business. This information is crucial to the various stakeholders of an entity who will analyse that information to make significant economic decisions. It is of vital importance that these stakeholders have good quality information to be able to make informed decisions. Although the focus of the ACCA Financial Accounting syllabus is directed towards commercial business entities, the syllabus content can be applied to non-commercial entities such as charities, along with public and governmental organisations. This chapter explores the nature of business entities and their stakeholders and identifies what their primary information requirements are and how this fits into the process of financial reporting. 2 KAPLAN PUBLISHING  Chapter 1 Financial accounting and management accounting Financial accounting Financial accounting is initially concerned with the recording, classification and summarisation of individual transactions. From this information, annual financial statements are produced for external stakeholders such as providers of finance and potential investors. These financial statements are a report on the directors’ stewardship of the funds entrusted to them by the shareholders. Investors need to be able to choose which companies to invest in and to evaluate their investments. In order to facilitate evaluation and comparison, financial accounts are prepared using accepted accounting conventions and standards. International Accounting Standards (IAS® Standards) and International Financial Reporting Standards (IFRS® Standards) help to reduce the differences in the way that companies draw up their financial statements in different countries. The financial statements of limited companies are public documents, although they do not reveal details about, for example, the profitability of individual products or services sold by a company. Management accounting Management require much more detailed and up-to-date information in order to control the entity and plan for the future. Management needs to be able to cost-out products and production methods, assess profitability and so on. In order to facilitate this, management accounts present information in any way that may be useful to management, for example by operating unit or product line. Management accounting is an integral part of management activity concerned with identifying, presenting and interpreting information used for:  formulating strategy  planning and controlling activities  decision making, and  optimising the use of resources. KAPLAN PUBLISHING 3 Introduction to financial reporting 2 Users of financial statements The main users (stakeholders) of financial statements are commonly grouped as follows:  Investors and potential investors are interested in the profit and returns they may receive along with the security of their investment. Future profits may be estimated from the target entity’s past performance as shown in the statement of profit or loss. The security of their investment will be indicated by the financial strength and solvency of the entity as shown in the statement of financial position. The largest and most sophisticated groups of investors are the institutional investors, such as pension funds and unit trusts.  Employees and trade union representatives need to know if an employer can offer secure employment and possibly also pay rises. They will also have a keen interest in the salaries and benefits enjoyed by senior management. Information regarding divisional profitability will also be useful if a part of the entity is threatened with closure.  Lenders need to know if they will be repaid. This will depend on the solvency of the entity, which should be revealed by the statement of financial position. Long-term loans may also be backed by ‘security’ given by the entity over specific assets. The value of these assets will be indicated in the statement of financial position.  Government agencies need to know how the economy is performing in order to plan financial and industrial policies. The tax authorities also use financial statements as a basis for assessing the amount of tax payable by an entity.  Suppliers need to know if they will be paid. New suppliers may also require reassurance about the financial health of an entity before agreeing to supply it with goods or services. 4 KAPLAN PUBLISHING  Chapter 1  Customers need to know that an entity can continue to supply them into the future. This is particularly true if a customer is dependent on an entity for specialist supplies.  The public may wish to assess the effect of the entity on the economy, local environment and local community. Entities may contribute to their local economy and community through providing employment and patronising local suppliers. Some entities also run corporate responsibility programmes through which they support the environment, economy and community by, for example, supporting recycling schemes. Management and competitors would also use the financial statements of an entity to make economic decisions. Management, however, predominantly use management accounting information as their main source of financial information for decision-making. Competitors may also access publicly available information to assist decision-making in relation to their own business activities. Overall, users of financial statements need information which is relevant and reliable to help them to assess management’s stewardship of the resources which they control and manage. Financial information enables users to hold managers to account for their decisions and to enable users to make decisions about whether to invest in or provide additional resources to a business. Test your understanding 1 Which of the following users do you think require the most detailed financial information to be made available to them? A Competitors B Management of an entity C Trade unions D Investors 3 Types of business entity A business can be operated in one of several ways: Sole trader This is the simplest form of business entity where a business is owned and operated by one individual, although it may employ any number of people. With this form of entity, there is no legal distinction between the owner and the business. To this end the owner receives all of the profits of the business but has unlimited liability for all the losses and debts of the business. KAPLAN PUBLISHING 5 Introduction to financial reporting The capital structure of a sole trader is also relatively simple. There is a capital account which represents the financial interest of the owner in the business. The capital account can be added to by the owner introducing additional capital into the business, or by the business making profits, which the sole trader is entitled to. The capital account can be reduced by the sole trader making withdrawals from the capital account during the year (often referred to a 'drawings') or by the business making losses. Partnership Similar to a sole trader the owners of a partnership collectively receive all the profits and have unlimited liability for the losses and debts of the business. The key distinction is that there are at least two owners. The joint owners, or partners, are jointly and severally liable for the losses the business makes (i.e. they are each fully liable in respect of all business liabilities). The capital structure of a partnership is similar to that of a sole trader. Each partner will have a financial interest in the business and this will be divided between a capital account and current account. The capital account is normally a fixed amount that will only change upon a partner joining or leaving the business. The current account includes the share of profit or loss that each partner is entitled to, less any personal drawings made by that partner. Limited liability companies Unlike sole traders and partnerships, a limited liability company is established as separate legal entity to their owners. This is achieved through the legal process of incorporation. The owners of the company (the shareholders) invest capital in the company in return for a shareholding that entitles them to a share of the residual assets of the company (i.e. what is left when the company is wound up or liquidated). The shareholders are not personally liable for the debts of the company and whilst they may lose their investment if the company becomes insolvent they will not have to pay the outstanding debts of the company if such a circumstance arises. Likewise, the company is not affected by the insolvency (or death) of individual shareholders. Limited liability companies are managed by a board of directors who are elected by the shareholders. The capital structure of a limited liability company is more formalised than that of a sole trader or partnership and is illustrated within this chapter. Shareholders cannot make withdrawals or 'drawings' from the business in the way that a sole trader or partner is able to do. Instead, they receive a return on their investment in the company referred to as a dividend which is paid from accumulated profits. 6 KAPLAN PUBLISHING  Chapter 1 Operating as a sole trader, partnership or limited liability company Sole trader Accounting conventions recognise the business as a separate entity from its owner. However, legally, the business and personal affairs of a sole trader are not distinguished in any way. The most important consequence of this is that a sole trader has unlimited personal liability for the debts of the entity. Business debts which cannot be paid from business assets must be met from sale of personal assets, such as a house or a car. Sole trading entities normally operate on a small scale because they have to rely on the financial resources available to the owner. The advantages of operating as a sole trader include flexibility and autonomy. A sole trader can manage the business as they please and can introduce or withdraw capital at any time. Partnership Like a sole trader, a partnership is not legally distinguished from its partners. Personal assets of the partners may need to be used to pay the debts of the partnership business. A partnership is often referred to as a firm. The advantages of trading as a partnership stem mainly from there being many owners rather than one. This means that:  more resources may be available, including capital, specialist knowledge, skills and ideas  administrative expenses may be lower for a partnership than for the equivalent number of sole traders, due to economies of scale; and  partners can substitute or act for each other to spread individual responsibilities and workloads. Partners can introduce or withdraw capital at any time, provided that all the partners agree. KAPLAN PUBLISHING 7 Introduction to financial reporting Comparison of companies to sole traders and partnerships The fact that a company is a separate legal entity means that it is very different from a sole trader or partnership in a number of ways.  Property holding The property of a limited liability company belongs to the company. A change in the ownership of shares in the company will have no effect on the ownership of the company's property. (In a partnership the firm's property belongs directly to the partners who are entitled to their share of each asset if they leave the partnership.)  Transferable shares Shares in a limited liability company can usually be transferred without the consent of the other shareholders. In the absence of agreement to the contrary, a new partner cannot be introduced into a firm without the consent of all existing partners.  Suing and being sued As a separate legal entity, a limited company can sue and be sued in its own name. Judgements relating to companies do not affect the members personally.  Security for loans A company has greater scope for raising loans and may secure them with floating charges. A floating charge is a mortgage over the constantly fluctuating assets of a company providing security for the lender. It does not prevent the company using the assets in the ordinary course of business. Such a charge is useful when a company does not have non-current assets such as land and buildings, but does have significant and valuable inventories. Generally, the law does not permit partnerships or individuals to secure loans with a floating charge.  Taxation Because a company is legally separate from its shareholders, it is taxed separately from its shareholders. Partners and sole traders are personally liable for income tax on their share of the profits made by their business. 8 KAPLAN PUBLISHING  Chapter 1  Disadvantages of incorporation The disadvantages of being a limited liability company arise principally from restrictions imposed by relevant company law: – When being formed, companies have to register and file formal constitution documents with the company registry, referred to in the UK as Registrar of Companies. Registration fees and legal costs must be paid. It is likely that many countries have a similar registration process to establish a company. – In addition, it is normally a requirement for a company to produce annual financial statements that must be submitted to the company registry. It is also usually a requirement for those financial statements to be audited (in some countries this is only a requirement for large and medium sized companies). The costs associated with this can be high. Partnerships and sole traders are not subject to this requirement unless it is required by a regulatory authority, such as a professional body. – A registered company's accounts and certain other documents are open to public inspection. The accounts of sole traders and partnerships are not open to public inspection. – Limited companies are subject to strict rules in connection with the introduction and withdrawal of capital and profits. – Members of a company may not take part in its management unless they are also directors, whereas all partners are entitled to share in management of the business, unless the partnership agreement provides otherwise. 4 The Framework One of the most important documents underpinning the preparation of financial statements is the Conceptual Framework for Financial Reporting 2010 (Conceptual Framework), prepared by the International Accounting Standards Board (IASB) (see Chapter 2 for a discussion of the regulatory bodies). The Conceptual Framework presents the main ideas, concepts and principles upon which all International Financial Reporting Standards (normally referred to as ‘IFRS Accounting Standards’), and therefore financial statements, are based. It includes discussion of  the purpose of the Conceptual Framework  the objectives of financial reporting  the qualitative characteristics of useful financial information  the definition, recognition and measurement of the elements from which the financial statements are constructed  the accruals and going concern concepts, and  the concepts of capital and capital maintenance (not in the syllabus). KAPLAN PUBLISHING 9 Introduction to financial reporting The purpose of the Framework The purpose of the Conceptual Framework is to assist the IASB in the development of financial reporting standards and to assist preparers of financial statements to develop accounting policies when reporting standards do not provide sufficient guidance, or where there is a choice of accounting policy. It is also a useful reference document to assist in understanding, interpreting and applying accounting standards. The objective of financial reporting The main objective is to provide financial information about the reporting entity to users of the financial statements that is useful in making decisions about providing economic resources to the entity, as well as other financial decisions. Prudence Prudence is an important concept (as referred to later in this chapter) and is the exercise of caution when making judgements under conditions of uncertainty. The helps to ensure that assets and income are not overstated in the financial statements, and that liabilities and expenses are not understated. 5 Qualitative characteristics Qualitative characteristics are the attributes that make the information provided in financial statements useful to others. The Conceptual Framework splits qualitative characteristics into two categories: (i) Fundamental qualitative characteristics – Relevance – Faithful representation (ii) Enhancing qualitative characteristics – Comparability – Verifiability – Timeliness – Understandability 10 KAPLAN PUBLISHING  Chapter 1 Fundamental qualitative characteristics Relevance Information is relevant if:  it has the ability to influence the economic decisions of users, and  is provided in time to influence those decisions. Materiality has a direct impact on the relevance of information. Qualities of relevance Information provided by financial statements needs to be relevant. Information that is relevant has predictive, or confirmatory, value.  Predictive value enables users to evaluate or assess past, present or future events.  Confirmatory value helps users to confirm or correct past evaluations and assessments. Where choices have to be made between mutually exclusive options, the option selected should be the one that results in the relevance of the information being maximised – in other words, the one that would be of most use in taking economic decisions. A threshold quality is one that needs to be studied before considering the other qualities of that information:  a cut-off point – if any information does not pass the test of the threshold quality, it is not material and does not need to be considered further.  information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity. Faithful representation If information is to represent faithfully the transactions and other events that it purports to represent, they must be accounted for and presented in accordance with their substance and economic reality and not merely their legal form. This is known as ‘substance over form’. To be a perfectly faithful representation, financial information should possess the following characteristics: Completeness To be understandable information must contain all the necessary descriptions and explanations. This may include estimated amounts where absolute precision is neither possible nor cost-effective to achieve. KAPLAN PUBLISHING 11 Introduction to financial reporting Neutrality Information must be neutral, i.e. free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgement in order to achieve a predetermined result or outcome. Free from error Information must be free from error within the bounds of materiality. A material error or an omission can cause the financial statements to be false or misleading and thus unreliable and deficient in terms of their relevance. Free from material error does not mean perfectly accurate in all respects. For example, where an estimate has been used the amount must be described clearly and accurately as being an estimate. Enhancing qualitative characteristics Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that is relevant and faithfully represented. Comparability Users must be able to:  compare the financial statements of an entity over time to identify trends in its financial performance and financial position  compare the financial statements of different entities to evaluate their relative financial performance and financial position. For this to be the case there must be:  consistency and  disclosure. An important implication of comparability is that users are informed of the accounting policies employed in preparation of the financial statements, any changes in those policies and the effects of such changes. Compliance with accounting standards, including the disclosure of the accounting policies used by the entity, helps to achieve comparability. Because users wish to compare the financial position and the performance and changes in the financial position of an entity over time, it is important that the financial statements show corresponding information for the preceding periods. 12 KAPLAN PUBLISHING  Chapter 1 Verifiability Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct observation i.e. counting cash. Indirect verification means checking the inputs to a model, formula or other technique and recalculation of the outputs using the same methodology. Timeliness Timeliness means having information available to decision makers in time to be capable of influencing their decisions. Generally, the older the information is, the less useful it becomes. Understandability Understandability depends on:  the way in which information is presented  the capabilities of users. It is assumed that users:  have a reasonable knowledge of business and economic activities  are willing to study the information provided with reasonable diligence. For information to be understandable, users need to be able to perceive its significance. 6 The elements of the financial statements In order to appropriately report the financial performance and position of a business the financial statements must summarise five key elements. The definitions are included in the Conceptual Framework and are as follows: 1 Asset – A present economic resource controlled by the entity as a result of past events (para 4.3). For example, a building that is owned and controlled by a business and that is being used to house its operations and generate revenues would be classified as an asset. 2 Liability – A present obligation of the entity to transfer an economic resource as a result of past events (para 4.26). For example, an unpaid tax obligation or a bank loan is a liability. 3 Equity – This is the 'residual interest' in the assets of the entity after deducting all liabilities. It is effectively what is returned to the owners (shareholders) when the business ceases to trade. KAPLAN PUBLISHING 13 Introduction to financial reporting 4 Income – This consists of the increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims. This can be achieved, for example, by generating revenue from sales or through the increase in the value of an asset. 5 Expense – This consists of the decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims. This can be achieved, for example, by purchasing goods or services from another entity or through the reduction in value of an asset. Note: economic resource – A right that has the potential to produce economic benefits (para 4.4). It may be thought of as anything which a business makes use of in order to produce and supply goods and services to its customers. For example, a business makes use of plant and equipment, which could be purchased or hired, to help produce goods and services. Categorisation of assets, liabilities and equity in the financial statements There are some additional principles with regard to the classification of assets and liabilities that relate to the length of time they will be used in the business. 14 KAPLAN PUBLISHING  Chapter 1 KAPLAN PUBLISHING 15 Introduction to financial reporting Test your understanding 2 Classify the following items into current and non-current assets and liabilities:  land and buildings  receivables  cash  loan repayable in two years’ time  payables  delivery van. 7 The components of a set of financial statements A set of financial statements comprises:  the statement of financial position This statement summarises the assets, liabilities and equity balances of the business at the end of a reporting period. The classification or grouping of assets, liabilities and equity in a consistent manner helps users of financial statements to understand that information and enable identification of information that is of particular relevance to them. Consistent presentation of information also helps users to make comparison and undertake analysis of financial information. A specimen statement of financial position, including hypothetical monetary amounts, is presented below. Statement of financial position at 30 June 20X7 $ $ Non-current assets Land and buildings 60,000 Plant and equipment 27,500 Current assets Inventories 11,000 Trade receivables 10,700 Cash at bank and in hand 1,500 ––––––– 23,200 ––––––– Total assets 110,700 ––––––– 16 KAPLAN PUBLISHING  Chapter 1 Equity and liabilities Equity share capital @ $1 shares 40,000 Share premium 2,000 Revaluation surplus