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AIM

The overall aim of this paper is that candidates should be able to understand and interpret the financial statements produced by organisations for external users. Candidates should develop an understanding of the regulatory framework in which these statements are prepared and of the principles and methods which underlie their preparation.

OBJECTIVES

On completion of this paper candidates should be able to:

  • describe the role and function of external financial reports and identify their users and the regulatory framework in which they are prepared.
  • explain the accounting concepts and conventions present in generally accepted accounting practice.
  • explain, supported by simple computations, the presentation, measurement and meaning of the primary financial statements and their contents.
  • describe the informational role of the constituent parts of a corporate annual report usually presented in addition to the primary financial statements.
  • compute, interpret and appraise financial performance, financial position and adaptability as revealed by financial statement analysis, in particular by the use of financial and accounting ratios.

SYLLABUS CONTENT

1. Regulation of Financial Statements

The regulatory framework within which UK financial statements are prepared.

  1. legal framework
  2. the role of the Financial Reporting Council and constituent bodies
  3. the role of the International Accounting Standards Board
  4. the role of the auditor and the meaning of a 'true and fair view'.

2. Financial Information

  1. the objectives of financial and the needs of users
  2. the reporting entity
  3. the qualitative characteristics of financial information
  4. the elements of financial statement
  5. measurement in financial statement including an appreciation limitations of historical cost basic nature of current value accounting models
  6. the basic features of accounting public sector organisations.

3. Financial Statements

a. the structure, features and content of the primary financial statements:

  1. Profit and Loss Account
  2. Balance Sheet
  3. Cash Flow Statement
  4. Statement of Total Recognised Gains and Losses.

b. the major features, but not detailed contents of other elements of corporate annual reports:

  1. Notes to the accounts and additional financial statements

  2. Directors Report

  3. Chairman's Statement

  4. Five year summary

  5. Operating and Financial Review

  6. Interim accounts

  7. Preliminary announcements

  8. Value Added Statements

c. the terminology and underlying accounting methods and principles used in preparing financial statements in respect of:

  1. Tangible Fixed Assets, including depreciation and the impact of revaluation

  2. Intangible Fixed Assets, including goodwill and Research and Development Costs

  3. Current Assets, in particular stocks and long-term work in progress

  4. Liabilities, including leases, contingencies and provisions

  5. Share Capital and reserves

  6. Post Balance Sheet events and reporting the substance of transactions

  7. Reporting Financial Performance, including segmental analysis

  8. Investments and in particular the financial statements of groups, including subsidiaries, associates and joint ventures

  9. Cash flow reporting

  10. The accounting implications of taxation, in particular current and deferred taxation.

For all of the above simple computations may be required to support explanation, appraisal and justification of accounting policies and treatments.

4. Analysis of Financial Statements

a. the computation, interpretation and appraisal of financial ratios in respect of:

  1. Profitability, earnings, operating performance and efficiency

  2. Liquidity, Solvency and working capital management

  3. Asset and capital structures, including gearing

  4. Cash Flows and cash flow management

  5. Stock market performance including earnings, dividend and price relationships.

b. common size statements, trend analysis, inter-firm analysis and failure prediction models

c. the limitations of financial ratio analysis.

Excluded Topics

The following topics are specifically excluded from the syllabus:

  • The detailed process of double entry book-keeping
  • Foreign Currency Translation
  • Accounting for pension costs and retirement benefits
  • Merger accounting
  • Related Party disclosures
  • Derivatives and other financial instruments
  • Reporting for smaller entities
  • UITF Abstracts.

Key Areas of the Syllabus

The key topics are:

  • The regulatory framework

  • The principles underlying financial statements

  • The structure and content of the primary financial statements

  • Financial Statement analysis.

STUDY GUIDE

The Study Guide takes the syllabus content and expands it into study sessions of similar length.

These sessions indicate what the examiner expects of candidates for each part of the syllabus, and therefore gives you guidance in the skills you are expected to demonstrate in the examinations.

The time to complete each session will vary according to your individual capabilities and the time you have available to study. However, repeated coverage of the material is vital to ensure your understanding and recall of the subject. Be sure to practice questions from your textbook or past examination papers to consolidate your knowledge.

1. The Legal Framework of Accounting

Syllabus reference Ia, d

  • Outline the Companies Acts requirements for published financial statements including responsibilities of Directors
  • Explain the requirement for an audit of published financial statements and the role of the auditor
  • Explain the nature of the ' True and Fair View '
  • Identify those entities which do require audited published financial statements.

2. The Regulatory Framework of Accounting

Syllabus reference Ib, c

  • Explain the role and functions of regulatory bodies

- Financial Reporting Council

- Accounting Standards Board (ASB)

- Financial Reporting Review Panel

- Urgent Issues Task Force

  • Explain the role and functions of the International Accounting Standards Committee (IASC)
  • Compare the status of standards published by the ASB and IASC.

3. Objectives of Financial Statements and the Reporting Entity

Syllabus reference 2a, b

  • Explain the objectives of decision usefulness and stewardship
  • Identify the users of financial statements and their needs
  • Explain the categories of financial information available to users and the role of general purpose financial statements
  • Explain the need for information in respect of financial performance, financial position, generation of cash and financial adaptability
  • Explain the notion of control in defining the boundary of the reporting entity.

4. Qualitative Characteristics Elements and Related Concepts.

Syllabus reference 2c, d

  • Explain the need for relevance, reliability, comparability and understandability of financial information and constraints on these.
  • Define assets, liabilities, gains, losses, contributions from owners and distribution to owners
  • Explain the need for a measurement system and the basics of historical cost accounting
  • Explain the concepts of accruals and the going concern basis in relation to the rest of section 2 of the syllabus.

5. Measurement in Financial Statements

Syllabus reference 2e

  • Explain the need for a measurement basis to be used in financial statements
  • Explain and apply the basic principles of historical cost accounting
  • Explain the basic principles of current cost accounting.

6. Financial Statements I

Syllabus reference 3a(i), 3a(ii)

  • Explain how the basic accounting equation underlies the balance sheet and profit and loss account and the relationship between these two statements
  • Explain the classification of asset and liability disclosure in the balance sheet.
  • Draft a simple balance sheet in vertical form
  • Explain how and why revenue and expenses are disclosed in the trading and profit and loss account
  • Draft a simple trading and profit and loss account in vertical form.

7. Financial Statements II

Syllabus reference 3a(iii), 3a(iv)

  • Explain the difference between an accruals based and cash based financial statement
  • Explain the relationship of a cash flow statement to the other primary financial statements
  • Draft a simple cash flow statement
  • Explain the difference between realised and unrealised gains and losses and the purpose of comprehensive disclosure
  • Draft a simple statement of total recognised gains and losses.

8. Financial Statements III

Syllabus reference 3b(i) - 3b(iv)

  • Explain the need for additional information in the form of notes to the accounts and additional financial statements
  • Identify the basic components of a Directors' Report
  • Explain the purpose and usefulness of a Chairman's Statement
  • Explain the need for a five year summary and its limitations.

9. Financial Statements IV

Syllabus reference 3b(v) - 3b(viii)

  • Identify the basic components of an operating and financial review
  • Explain the need for preliminary announcements and interim statements
  • Explain the purpose of a value added statement
  • Identify the fundamental differences between accounting for public sector and private sector entities
  • Explain the nature of Value For Money as a performance appraisal method.

10 & 11

Tangible Fixed Assets

Syllabus reference 3c(i)

  • Explain the initial recognition and measurement of tangible fixed assets
  • Explain and apply the principal methods of depreciation and appraise their impact on the financial statements
  • State and appraise the impact of the revaluation of fixed assets
  • Explain the implications of impairment of fixed assets.

12. Intangible Fixed Assets

Syllabus reference 3c(ii)

  • Discuss the nature of an intangible asset and in particular goodwill
  • Explain and appraise the accounting treatment of internally generated and purchased goodwill; apply the treatment to simple examples
  • Distinguish between research and development costs
  • Explain and appraise the accounting treatment of research and development costs; apply the treatment to simple examples.

13. Current Assets

Syllabus reference 3c(iii)

  • Explain and apply the basic stock valuation principle of cost or net realisable value
  • Explain and apply the stock valuation conventions of FIFO, LIFO and Weighted Average
  • Discuss the treatment of long term contract work in progress
  • Explain the need for assessment of bad debts and provisions for doubtful debts.

14. Accounting for Liabilities

Syllabus reference 3c(iv)

  • Explain the distinction between current and long term liabilities
  • Explain the difference between liabilities, provisions and contingent liabilities and apply the relevant accounting treatment of these to simple examples
  • Explain the nature of financing leases and their appropriate accounting treatment.

15. Share Capital, Reserves and Post Balance Sheet Events

Syllabus reference 3c(v), 3c(vi)

  • Distinguish between different types of share capital and explain their characteristics
  • Distinguish between different types of reserve (capital distributable revenue; realised/unrealised) and their uses
  • Explain the nature of ‚off-balance sheet finance' and the concept of substance over form
  • Distinguish between adjusting and non adjusting post balance sheet events and explain their accounting treatment.

16 & 17

Reporting Financial Performance

Syllabus reference 3c(vii), 3a(iv)

  • Explain and appraise the meaning of a statement of financial performance (Profit and Loss Account) which identifies continuing and discontinued operations, exceptional and extraordinary items, prior period adjustments
  • Prepare a simple statement of financial performance
  • Identify the items in the profit and loss account which might be included in a figure of Earnings per Share
  • Explain the link between the profit and loss account and the statement of total recognised gains and losses
  • Explain the purpose of segmental information (class of business, geographical) and appraise the usefulness of this information for interpretation of financial statements.

18 & 19

Accounting for Investments, in particular Groups including Subsidiaries, Associates and Joint Ventures.

Syllabus reference 3c(viii), 3c(ii)

  • Explain the treatment of investments held for resale
  • Distinguish between subsidiaries, associates and joint ventures
  • Describe the concept of a group and explain the terminology of accounting for groups
  • Explain and apply to simple examples consolidation accounting, equity accounting and the gross equity method
  • Explain and apply the treatment of goodwill arising on acquisition.

20. Cash Flow Reporting

Syllabus reference 3c(ix)

  • Prepare a simple cash flow statement
  • Appraise the usefulness of, and interpret the information in, a cash flow statement.

21. Accounting for Taxation

Syllabus reference 3c(x)

  • Explain the accounting treatment of current taxation
  • Explain the effect of timing differences on accounting and taxable profits
  • Explain and apply to a simple example the full provision method of deferred taxation accounting
  • Appraise the impact of taxation on financial performance and financial position.

22 & 23

Analysis of Financial Statements:

Profitability, Earnings, Operating Performance and Efficiency

Syllabus reference 4a(i)

  • Outline the basic methods of financial statement analysis, in particular common size statements and ratio analysis
  • Calculate and interpret ratios which provide insights into financial performance including profitability and return ratios, earnings based ratios, operating performance, effective use of assets, and efficiency ratios
  • Assess a company's financial performance in comparison with previous periods' financial statements, inter firm comparisons and industry averages
  • Discuss the effect of accounting policy choice on the interpretation and assessment above.

24. Liquidity, Solvency and Working Capital Management

Syllabus reference 4a(ii)

  • Calculate and interpret ratios which provide insights into financial position and operating performance in respect of working capital
  • Assess a company's financial position and working capital management in comparison with previous periods' financial statements, inter firm comparisons and industry averages
  • Discuss the effect of accounting policy choice on the interpretation and assessment above.

25. Asset and Capital Structures including Gearing

Syllabus reference 4a(iii)

  • Calculate and interpret ratios which provide insights into financial position, financing and investment strategy and utilisation of resources
  • Calculate and interpret ratios which indicate financial risk, in particular gearing
  • Assess a company's financial position and financial risk in comparison with previous periods' financial statements, inter firm comparisons and industry averages
  • Discuss the effect of accounting policy choice on the interpretation and assessment above.

26. Cash Flow and Investment Analysis

Syllabus reference 4a(iv), 4a(v)

  • Calculate and interpret ratios which provide insights into financial adaptability and generation and use of cash
  • Calculate and interpret ratios which give an insight into earnings, dividend and price relationships which would be useful to an investor
  • Assess a company™s financial performance in relationship to its market price and in comparison with market averages and other market based data.

27. Other Aspects of Financial Statement Analysis

Syllabus reference 4b, d

  • Explain the usefulness of multivariate ratio models, in particular with respect to failure prediction
  • Discuss the limitations of financial statement ratio analysis techniques.

28. Comprehensive Application of Financial Statement Appraisal and Analysis

Syllabus reference all of 1, 2, 3 and 4

  • Analyse and interpret a comprehensive set of financial statements including all of those identified in 3(a) and (b)
  • Critically evaluate the impact on the financial statements of accounting policies in respect of the items included in 3 (c)
  • Present an appraisal of the results of the financial statement analysis in a given context, for example from the perspective of shareholders or lenders or creditors using the techniques included in 3.