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Cape Accounting Unit 1 Notes
Cape Accounting Unit 1 Notes
ADJUSTING EVENTS
Events after the reporting period are those events, favourable and unfavourable, that occur
between the statement of financial position date and the date when the financial statements are
authorised for issue.
Adjusting events are those that provide evidence of conditions that existed at the statement of
financial position date.
3. If an entity declares dividends to holders of equity instruments after the reporting period,
the entity shall not recognise those dividends as a liability at the end of the reporting
period.
4. The following are examples of non-adjusting events after the reporting period that would
generally result in disclosure:
(a) a major business combination after the reporting period (IFRS 3 Business
Combinations requires specific disclosures in such cases) or disposing of a major
subsidiary;
(b) announcing a plan to discontinue an operation;
(c) major purchases of assets, classification of assets as held for sale in accordance with
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, other disposals of
assets, or expropriation of major assets by government;
(d) the destruction of a major production plant by a fire after the reporting period;
(e) announcing, or commencing the implementation of, a major restructuring (see IAS
37);
(f) major ordinary share transactions and potential ordinary share transactions after the
reporting period (IAS 33 Earnings per Share requires an entity to disclose a description of
such transactions, other than when such transactions involve capitalisation or bonus
issues, share splits or reverse share splits all of which are required to be adjusted under
IAS 33);
(g) abnormally large changes after the reporting period in asset prices or foreign
exchange rates;
(h) changes in tax rates or tax laws enacted or announced after the reporting period that
have a significant effect on current and deferred tax assets and liabilities (see IAS 12
Income Taxes);
(i) entering into significant commitments or contingent liabilities, for example, by issuing
significant guarantees; and
(j) commencing major litigation arising solely out of events that occurred after
the reporting period.
An entity shall disclose in the notes the amount of dividends proposed or declared before the
financial statements were authorised for issue but not recognised as a distribution to owners
during the period.
A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
An obligating event is an event that creates a legal or constructive obligation that results in an
entity having no realistic alternative to settling that obligation.
(b) legislation; or
(b) as a result, the entity has created a valid expectation on the part of those other parties that it
will discharge those responsibilities.
(a) a possible obligation that arises from past events and whose existence will be confirmed only
by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability. A
contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.
(b) contingent liabilities – which are not recognised as liabilities because they are either:
(i) possible obligations, as it has yet to be confirmed whether the entity has a present
obligation that could lead to an outflow of resources embodying economic benefits; or
(ii) present obligations that do not meet the recognition criteria in this Standard (because either it
is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be
made).
It is only those obligations arising from past events existing independently of an entity’s future
actions (ie the future conduct of its business) that are recognised as provisions.
For the purpose of this Standard, an outflow of resources or other event is regarded as probable if
the event is more likely than not to occur, i.e. the probability that the event will occur is greater
than the probability that it will not. Where it is not probable that a present obligation exists, an
entity discloses a contingent liability, unless the possibility of an outflow of resources embodying
economic benefits is remote.
The best estimate of the expenditure required to settle the present obligation is the amount that an
entity would rationally pay to settle the obligation at the end of the reporting period or to transfer
it to a third party at that time.
Employees: for assessing company's profitability and its consequence on their future
remuneration and job security.
Owners: for analyzing the viability and profitability of their investment and determining
any future course of action.
Creditors: for determining the credit worthiness of the organization. Terms of credit are
set by creditors according to the assessment of their customers' financial health. Creditors
include suppliers as well as lenders of finance such as banks.
Tax Authorities: for determining the credibility of the tax returns filed on behalf of
the company.
Investors: for analyzing the feasibility of investing in the company. Investors want to
make sure they can earn a reasonable return on their investment before they commit any
financial resources to the company.
Customers: for assessing the financial position of its suppliers which is necessary for
them to maintain a stable source of supply in the long term.
The IASB, by developing high quality accounting standards, seeks to address a demand for high
quality information that is of value to all users of financial statements. High quality information
will also be of value to preparers of financial statements.
(a) to develop, in the public interest, a single set of high quality, understandable and
enforceable global accounting standards that require high quality, transparent and comparable
information in financial statements and other financial reporting to help participants in the
world’s capital markets and other users make economic decisions;
(c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate,
the special needs of small and medium-sized entities and emerging economies; and
Accounting standards allow for systematic presentation of financial reports by businesses all
around the world. This enables comparability between businesses and over time. Well-prepared
financial statements also maintain investor confidence and portray a transparent image of the
business.
When corporations and other organisations comply with accounting standards, their general
purpose financial statements should be more comparable than they would otherwise be. This
allows investors and other users of the financial statements to better compare the organisations.
Financial statements also provide one means by which the management and governing body of
an organisation are accountable to those who provide resources to the organisation. The
provision of information for accountability purposes is a particularly important aspect of
financial reporting by public sector organisations and not-for-profit entities in the private sector
The due process comprises six stages, with the Trustees of the IFRS Foundation having the
opportunity to ensure compliance at various points throughout:
1. Setting the agenda – The IASB evaluates the merits of adding a potential item to its
agenda, also know as the work plan, mainly by reference to the needs of investors. The
IASB considers:
the relevance to users of the information and the reliability of information that could
be provided;
whether existing guidance is available;
the possibility of increasing convergence;
the quality of the standard to be developed; and
resource constraints.
To help the IASB in considering its future agenda, its staff are asked to identify, review and raise
issues that might warrant the IASB’s attention. Potential agenda items may also arise from
comments from other standard-setters and other interested parties, the IFRS Advisory Council
and the IFRS Interpretations Committee or requests from constituents to interpret, review or
amend existing publications. The staff consider all such requests, summarise major or common
issues raised, and present them to the IASB from time to time as candidates for when the IASB is
next considering its agenda.
2. Planning the project – When adding an item to its active agenda, the IASB also decides
whether to conduct the project alone or jointly with another standard-setter. A
consultative group may be established and a team is selected for the project. The project
manager draws up a project plan under the supervision of those Directors of Technical
Activities and Research.
5. Developing and publishing the Standard – The development of an IFRS is carried out
during IASB meetings, when the IASB considers the comments received on the Exposure
Draft. After resolving issues arising from the Exposure Draft, the IASB considers
whether it should expose its revised proposals for public comment, for example by
publishing a second Exposure Draft. If the IASB decides that re-exposure is necessary,
the due process to be followed is the same as for the first Exposure Draft. When the
IASB is satisfied that it has reached a conclusion on the issues arising from the Exposure
Draft, it instructs the staff to draft the IFRS. A pre-ballot draft is usually subject to
external review, normally by the IFRIC. Shortly before the IASB ballots the Standard, a
near-final draft is posted on eIFRS. Finally, after the due process is completed, all
outstanding issues are resolved, and the IASB members have balloted in favour of
publication, the IFRS is issued.
6. Procedures after an IFRS is issued – After an IFRS is issued, the staff and the IASB
members hold regular meetings with interested parties, including other standard-setting
bodies, to help understand unanticipated issues related to the practical implementation
and potential impact of its proposals. The IFRS Foundation also fosters educational
activities to ensure consistency in the application of IFRSs.
Promote an institutional framework through its annual conference for accountants in the
region to participate for mutual professional and fraternal benefit
Promote, foster and maintain a decorous image of the accountancy profession in the
Caribbean
Establish professional levels of competence, character and integrity within accountants
Promote the highest standards of ethical conduct within the region’s accountancy
profession in order to serve the public’s interest
Promote harmonisation of regional accounting and auditing standards among member
territories
Provide leadership on emerging issues pertaining to the accounting profession `
1. Only takes into account transactions which can be measured in monetary terms
2. The recording of financial transactions at historical cost in the books
3. Influenced by the personal judgment of the accountant, for example, in the method of
depreciation selected and approximations for provisions and intangible assets
1. is useful to existing and potential investors and creditors and other users in making rational
investment, credit, and similar decisions;
2. helps existing and potential investors and creditors and other users to assess the amounts,
timing, and uncertainty of prospective net cash inflows to the enterprise;
3. Identifies the economic resources of an enterprise, the claims to those resources, and the
effects that transactions, events, and circumstances have on those resources.
4. Helps managers to manage the business more efficiently but helping them to make
informed decisions
Understandability
The information provided in financial statements should be presented in a way that makes it
comprehensible by users who have a reasonable knowledge of business and economic activities
and accounting and a willingness to study the information with reasonable diligence. However,
the need for understandability does not allow relevant information to be omitted on the grounds
that it may be too difficult for some users to understand.
Relevance
The information provided in financial statements must be relevant to the decision-making needs
of users. Information has the quality of relevance when it is capable of influencing the economic
decisions of users by helping them evaluate past, present or future events or confirming, or
correcting, their past evaluations.
Materiality
Prudence
The uncertainties that inevitably surround many events and circumstances are acknowledged by
the disclosure of their nature and extent and by the exercise of prudence in the preparation of the
financial statements. Prudence is the inclusion of a degree of caution in the exercise of the
judgements needed in making the estimates required under conditions of uncertainty, such that
assets or income are not overstated and liabilities or expenses are not understated. However, the
exercise of prudence does not allow the deliberate understatement of assets or income, or the
deliberate overstatement of liabilities or expenses. In short, prudence does not permit bias.
Completeness
To be reliable, the information in financial statements must be complete within the bounds of
materiality and cost. An omission can cause information to be false or misleading and thus
unreliable and deficient in terms of its relevance.
Comparability
Users must be able to compare the financial statements of an entity through time to identify
trends in its financial position and performance. Users must also be able to compare the financial
statements of different entities to evaluate their relative financial position, performance and cash
flows. Hence, the measurement and display of the financial effects of like transactions and other
events and conditions must be carried out in a consistent way throughout an entity and over time
for that entity, and in a consistent way across entities. In addition, users must be informed of the
accounting policies employed in the preparation of the financial statements, and of any changes
in those policies and the effects of such changes.
Timeliness
To be relevant, financial information must be able to influence the economic decisions of users.
Timeliness involves providing the information within the decision time frame. If there is undue
delay in the reporting of information it may lose its relevance. Management may need to balance
the relative merits of timely reporting and the provision of reliable information. In achieving a
balance between relevance and reliability, the overriding consideration is how best to satisfy the
needs of users in making economic decisions.
The benefits derived from information should exceed the cost of providing it. The evaluation of
benefits and costs is substantially a judgemental process. Furthermore, the costs are not
necessarily borne by those users who enjoy the benefits, and often the benefits of the information
are enjoyed by a broad range of external users.
Financial reporting information helps capital providers make better decisions, which results in
more efficient functioning of capital markets and a lower cost of capital for the economy as a
whole. Individual entities also enjoy benefits, including improved access to capital markets,
favourable effect on public relations, and perhaps lower costs of capital. The benefits may also
include better management decisions because financial information used internally is often based
at least partly on information prepared for general purpose financial reporting purposes.
There is a risk of improper human intervention with the computer programs and computer files.
Employees in the organization may temper with the computer programs and computer based
records for the purpose of deliberately falsifying accounting information.
RESERVES
Revenue reserves are funds set aside out of undistributed profits from the retained earnings
account. They are sometimes formed to maintain dividends at current rates even if profits fall in
the future or for future expansion while minimizing the source of external funds in the future.
Revenue reserves may be specific reserves or general reserves.
Amounts arising from the issue of shares at a premium or the revaluation of fixed assets are
classified as capital reserves. Capital reserves are not available for distribution as dividends.
While the formation of revenue reserves do not increase the net assets of the company, the
formation of capital reserves do.
INTERNAL CONTROL SYSTEMS
AUDITORS
Internal – examine and evaluate the organisation’s financial and information systems,
management procedures, adherence to corporate policies and procedures, and internal
controls to ensure that records are accurate and controls are adequate to detect and protect
against fraud and waste of resources
External – examine and evaluate the organisation’s financial health at the end of one
financial year and check if a company’s accounts are drawn up in accordance with the
legal framework and accounting standards; study and evaluate the operation of those
internal controls upon which he/she wishes to rely on to determine the nature, timing and
extent of other external audit procedures.
External auditors usually perform sample tests of the accounts records by verifying the
debtors, creditors, inventory and other assets and liabilities.
PARTNERSHIPS
Admission of a Partner
Retirement of a Partner
1. Sale of interest to another partner – There is no need to record the actual assets paid
to the retiring partner as this is a personal transaction. The only entry to be made is to
show the change in capital.
Dr Partner’s capital (retiring partner) Cr Partner’s capital (existing partner)
The amount used in the above entry is based on the interest of the partnership acquired
and not the value of assets paid.
2. Sale of interest to the partnership (bonus method) – The interest of the partnership
sold will result in a decrease in both cash/bank and the capital of the retiring partner.
The difference between the cash received by the retiring partner and the interest in the
partnership is termed a bonus and is allocated to the other existing partners.
3. Sale of interest to the partnership (goodwill method)
a. Recording of goodwill attributable only to retiring partner – The excess of
the cash/bank paid over the actual capital is treated as the goodwill of the
retiring partner and credited to the retiring partner’s capital account.
b. Recording of total goodwill – The excess of cash/bank paid over the actual capital
is treated as the goodwill of the retiring partner. From this, total goodwill can
be calculated and recorded.
When a partner retires, his current account balance must be transferred to his capital
account.
If goodwill is not recorded in the books, the goodwill must be reallocated in the new
profit sharing ratio between the existing partners.
When goodwill is not recorded in the books – Allocated existing goodwill in the
old profit sharing ratio and write it off in the new profit sharing ratio
Allocate change in the value of assets to partners in the old profit-sharing ratio.
When this occurs, the goodwill account may be debited in the old profit-sharing ratio and
credited in the new. Both of these entries are transferred to the capital account.
Alternatively, the revaluation account can be credited with the total goodwill amount
and the capital account debited in the new ratio.
Any changes in the revaluation account are also recorded in the capital account.
Dissolution of a Partnership
1. All asset account balances other than cash are closed to the realisation account.
2. The proceeds from the disposal of the assets are credited to the realisation account and
debited to cash (except if a partner takes an asset).
3. All liability account balances are closed to the realisation account.
4. The payment made to creditors would be recorded in the realisation and cash accounts.
5. All liquidation expenses must be made and recorded in the realisation and cash accounts.
6. Where a partner wishes to take an asset for personal use, his capital account is debited
and that asset account credited and closed off. (This may have to pass through the
realisation account since the market value of the asset is used.)
7. All current accounts must be closed to the capital accounts.
8. The realisation account must be closed off to the partners’ capital accounts in their
profit- and-loss sharing ratio.
9. Any outstanding loans to the partners must be paid off.
10. Close off the cash and capital accounts.
When a partnership is sold, debit the capital account and credit the realisation account.
Incorporating a Partnership
All accounts are adjusted by the increases or decreases where necessary and the total
difference is transferred to the partners’ capital accounts in their profit-sharing ratio.
A temporary account called a valuation adjustment account is used to facilitate this.
The accumulated depreciation account is written off to the valuation adjustment account.
To record the issue of shares, debit the original capital account and credit the share
capital accounts.
When the corporation retains the partnership books, the assets and liabilities are adjusted
to their fair value and a valuation adjustment account is created to accumulate the gains
and losses. This valuation account is then closed to the partners’ capital account in their
profit and loss ratio. These capital accounts are then closed to the share capital account.
Cash equivalents are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
A single transaction may include cash flows that are classified differently. For example,
when the cash repayment of a loan includes both interest and capital, the interest element
may be classified as an operating activity and the capital element is classified as a
financing activity.
Interest paid and interest and dividends received may be classified as operating cash
flows because they enter into the determination of profit or loss. Alternatively, interest
paid and interest and dividends received may be classified as financing cash flows and
investing cash flows respectively, because they are costs of obtaining financial resources
or returns on investments. Dividends paid may be classified as a financing cash flow
because they are a cost of obtaining financial resources. Alternatively, dividends paid
may be classified as a component of cash flows from operating activities in order to assist
users to determine the ability of an entity to pay dividends out of operating cash flows.
FINANCIAL RATIOS
Liquidity Ratios
Current Assets
Current Ratio Current
= Liabilities
This ratio measures the ability of the entity to meet its short-term obligations with its
current assets. A general rule of thumb is that the current ratio should be 2:1.
However,
this ratio does not tell the whole story as not all current assets may be easily converted
into cash as quickly as needed.
Quick Assets
Quick/ Acid Test Ratio Current
= Liabilities
Quick assets include cash, marketable securities, accounts receivable and current notes
receivable but do not include inventory and prepaid expenses.
This ratio provides a more rigorous test of an entity’s ability to meet its short-
term obligations.
Profitability Ratios
Profit is a function of sales and of how management uses its assets in generating profits.
Gross profit
Gross margin percentage Sales × 100
=
This ratio measures the amount of returns an entity receives from sales by deducting its
cost of sales.
Net income
Net income percentage = Sales × 100
This ratio measures the amount of returns an entity receives from sales by deducting its
cost of sales and expenses.
This ratio measures the amount of returns an entity receives from investment in assets. It
is a measure of operating performance that indicates how effectively the assets have been
employed during the year.
Net income
Return on capital employed (ROCE) Capital employed × 100
=
‘Capital employed’ includes common stock, reserves, and long-term liabilities.
This ratio measures the amount of returns an entity receives from its capital employed,
both owner-supplied funds and creditors.
Net income available to common stockholders = Profit after Tax – Preference Dividends
This ratio informs investors of the amount of profits the share price represents. It shows
the amount the investor can receive (or the number of times over the investor can receive
dividends per share) if shares are traded on the open market. A high PE ratio indicates it
is expected that the company’s income will grow rapidly.
This ratio shows the proportion of income that is paid to the common shareholder in the
form of dividends. The dividend pay-out ratio that is best for the company depends on its
opportunities for growth, and the needs of the company for reinvestment.
Solvency Ratios
The degree to which an investor or business is utilizing borrowed money. Companies that
are highly leveraged may be at risk of bankruptcy if they are unable to make payments on
their debt; they may also be unable to find new lenders in the future.
Total
Debt to asset ratio = liabilities
Total assets
A leverage measure, this ratio measures the percentage of a company’s assets that
have been financed with debt (short-term and long-term).
Total
Debt to equity ratio = liabilities
Total equity
The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets.
Activity Ratios
This ratio measures the number of times that the entity purchases inventory in the period.
Average accountsreceivable
Average collection period = Credit sales × 365
This ratio represents the average length of time that a business must wait after a credit
sale before receiving cash.
This ratio represents the average length of time that a business takes before making a
cash payment to creditors.