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ACCA FA F3 course notes...

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Course Notes ACCA Financial Accounting (FA) Exams from September 2020

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Contents

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Page 1 The exam 2 Studying Financial Accounting

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1: Introduction to accounting

1

1 Introduction 2 User groups 3 Types of business entity 4 Financial accounts v Management accounts 5 The regulatory framework 6 Duties and responsibilities of those charged with governance

1 2 2 3 3 5

2: Principles and concepts

7

1 A framework approach 2 Accounting concepts 3 Accounting policies and changes in accounting estimates 4 Financial statements and key definitions

7 8 9 10

3: Accounting systems

15

1 Purpose and role of accounting records 2 Sources of data 3 Books of Prime Entry 4 Cash Book 5 Petty cash book 6 Sales day book 7 Purchases day book 8 Journal 9 Nominal or General Ledger

15 15 16 16 17 17 17 18 18

4: Double entry bookkeeping

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1 Introduction 2 The separate entity concept 3 The dual effect (“duality”) 4 Double entry bookkeeping 5 Ledger accounts 6 Closing the books 7 Chapter summary

21 21 21 22 23 25 29

5: The trial balance

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1 Summary of where we are so far 2 The trial balance 3 Bookkeeping errors 4 Accounting adjustments 5 The Statement of Profit or Loss 6 The Statement of Financial Position 7 The accounting equation

31 32 33 33 34 35 36

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6: Sales, purchases and sales taxes

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1 Recording transactions – recap 2 Returns, debit notes and credit notes 3 Discounts 4 Refunds 5 Sales taxes

39 40 41 43 44

7: Control accounts

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1 Introduction 2 Memorandum ledger accounts 3 Interaction of daybooks, memorandum accounts and nominal ledger 4 Receivables and payables control accounts 5 Control account reconciliations 6 Supplier statement reconciliations 7 Control account errors 8 Other control accounts

49 49 50 51 52 54 55 56

8: Accruals and prepayments

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1 Introduction 2 Accruals 3 Prepayments 4 Calculating accruals and prepayments 5 Accrued and deferred income 6 Chapter summary

57 57 60 62 63 65

9: Receivables and irrecoverable debts

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1 Irrecoverable (bad) debts 2 Doubtful debts 3 General allowance 4 Movement in allowances year on year

67 67 68 70

10: Inventories

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1 Buying and selling inventories 2 Period end inventory adjustments 3 Inventory and cost of sales 4 Inventory valuation 5 Continuous inventory systems

73 73 74 75 77

11: Non-current assets and depreciation

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1 Definitions 2 Depreciation methods 3 Disposals 4 Revaluations 5 Impairment (a fall in value) 6 Non-current asset register 7 Intangible assets

79 80 83 84 85 85 86

12: Bank reconciliations

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1 Introduction

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2 Approach to bank reconciliation questions 3 Chapter summary

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13: Accounting errors

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1 Types of errors 2 Correction of errors 3 Chapter summary

95 96 99

14: Incomplete records

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1 Introduction 2 Cost structures 3 Using ledger accounts to solve incomplete records 4 Accounting equation

101 101 103 106

15: Company accounts

109

1 Introduction 2 Capital structure of limited companies 3 Reserves 4 Share issues 5 Dividends 6 Presentation 7 Tax in company accounts 8 Revenue

109 109 110 111 113 114 117 117

16: Statements of cash flows

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1 Introduction 2 Definitions 3 Pro forma Statement of cash flows – indirect method 4 Preparing a statement of cash flows – indirect method 5 Proforma Statement of cash flows – direct method

119 119 120 121 125

17: Interpretation of financial statements

127

1 Introduction 2 Profitability ratios 3 Liquidity and efficiency ratios 4 Risk

127 129 131 133

18: Provisions and contingencies

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1 Provisions 2 Contingent liabilities 3 Contingent assets 4 Distinguishing between provisions and contingencies 5 Summary of rules 6 Disclosures

135 136 136 137 137 137

19: Events after the reporting period

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1 Introduction 2 Definitions 3 Going concern issues arising after the reporting date

139 139 141

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20: Group accounts

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1 Introduction to group accounts 2 Group statement of financial position 3 Consolidated statement of profit or loss

143 145 156

Solutions to Lecture examples

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Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 19 Chapter 20

163 168 170 170 171 172 173 174 175 176 178 179 179 180 180

Appendix – Summary of debits and credits

185

Comparison of course notes content with study text

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1 The exam Financial Accounting (FA) is a two-hour computer-based examination. The paper is in two sections. Questions will assess all parts of the syllabus and will test knowledge and some comprehension or application of this knowledge. The examination will consist of two sections: 

Section A all 35 questions are compulsory and must be attempted (2 marks each)



Both Section B 15-mark questions are compulsory and must be attempted

All questions are compulsory. The paper has a pass mark of 50%.

2 Studying Financial Accounting Full details of the Financial Accouting syllabus can be found on the ACCA website at: https://www.accaglobal.com/gb/en/student/exam-support-resources/fundamentals-exams-studyresources/f3/syllabus-study-guide.html These course notes cover the syllabus and include all you need to know to pass the Financial Accounting exam. These notes are supported by a question bank and practice exams.

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1 Introduction to accounting

1 Introduction KEY TERM Accounting is the process of recording, analysing, summarising and communicating financial information. The objective of financial reporting: To provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors. Financial Statements consist of: 

Statement of Financial Position (sometimes called the Balance Sheet)

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Statement of Profit or Loss and Other Comprehensive Income (sometimes called the Income Statement or Profit and Loss Account)

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Statement of Cash Flows

All of these will be covered in more detail later.

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2 User groups Seven main user groups (“POEBALL”): User group

Information needs

Public

Any or all of the following

Owners/investors (sometimes called “equity investors”)

How business is doing. What their income is likely to be. How well the managers perform, whether to buy or sell shares

Employees (incl. managers)

Stability, profitability, likelihood of pay rise.

Business contacts e.g. customers and suppliers

Stability? Credit-worthiness? Profitability (e.g. scope to negotiate price cuts)

Analysts and advisers

Whether current strategies are working. Future plans. Key performance indicators.

Local and central government (Including HMRC)

Profit for tax purposes, employment information, carbon emissions etc

Lenders

Company’s ability to repay debts, assess security.

Other user groups   

Pension funds Pressure Groups Charities

Different users will have their own reasons for wanting to see the financial statements (accounts) of a business.

3 Types of business entity All businesses produce financial information, but the requirements differ according to the type of business entity. A business may trade as:   

A sole trader A partnership A company

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Sole Trader

Partnership

Minimum members

One

Two (in the UK max 20 if not a One recognised profession)

Formalities

None

Must register (e.g. with None (although partnership agreement will normally be in Companies House). More formalities for a writing) public/listed company.

Advantages

Flexible.

Flexible.

Trader keeps all of the profits. No disputes with fellow owners. Privacy.

Share risk and management responsibilities. More expertise. Duty of utmost good faith. Privacy.

Unlimited liability for business obligations.

Unlimited liability for business obligations.

Harder to raise finance. Lack of resources.

Harder to raise finance.

Disadvantages

Who manages the Owner business

Owners (i.e. partners)

Company

Members have limited liability Easier to raise capital. Perpetual succession.

Regulatory burden, e.g. accounts in a statutory form, audit, file accounts and annual return etc. Lack of privacy. Directors (may or may not be shareholders)

Most businesses carry out a trade in order to make a profit. However, some organisations may have different objectives, e.g. clubs, charities and government departments. These are typically known as “not for profit” organisations.

4 Financial accounts v Management accounts All accounts are prepared using an accounting system, from which accounting information is produced, typically financial accounts and management accounts. Financial accounts

Management accounts

Prepared for external users (e.g. shareholders, lenders, tax authorities)

Prepared for internal purposes, e.g. managers

Summary information

Detailed information & analysis

Normally deadlines for “publishing” accounts

No deadlines for production (other than as set by management)

Summarise historical data (results and financial position).

Forward looking, e.g. budgets, cash flow forecasts.

5 The regulatory framework Although a wide range of users may be interested in the financial statements, accounting regulation views some users as more important than others. These primary users are:  

Investors (owners) Lenders and other creditors

Investors and lenders provide finance to a business. If they are external to the business (not involved in its day-to-day running) they need financial information for two main reasons: 

To make decisions about providing resources to the business (e.g., whether to buy, hold, or sell shares, whether to make a loan)

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To assess the stewardship of management. Stewardship is management’s responsibility to act in the best interests of the owners of a business, by safeguarding its assets and using them efficiently and effectively to generate profits and/or increase their value.



If investors and lenders are external to the business, the published financial statements may be their only or main source of information. Accounting regulation ensures that the financial statements give a fair presentation (sometimes called a true and fair view) of the financial performance and financial position of a business and that they present the information that providers of finance need.

5.1 Sources of regulation The main sources of regulation are: 

Companies legislation. This varies from country to country. In the UK, the Companies Act 2006 applies to all companies. It sets out prescriptive layouts for the financial statements and requires the preparers of accounts to present a true and fair view.



International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). In many countries, including the UK, all listed companies are required to follow these.



National accounting standards. In the UK, these are issued by the Financial Reporting Council (FRC). Many countries have now either adopted IFRSs as their national standards, or (as in the UK) base their national standards very closely on IFRSs. (One important exception is the USA.)



Stock Exchange Regulations (listed companies only).

EXAM SMART Note that only companies have to prepare financial statements using IFRSs or other accounting standards. In theory, unincorporated businesses such as sole traders and partnerships can use whatever accounting regulations they wish.

5.2 International Financial Reporting Regulatory Framework IFRS Foundation International Financial Reporting Standards (IFRS) Foundation (appoint, oversee, raise funds)

IFRS Advisory Council (advises IASB)

Appoints Reports to Advises

IASB International Accounting Standards Board (issues standards & exposure drafts)

IFRS Interpretations Committee (guidance & interpretation)

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IFRS Foundation 

Main objective is to develop a single set of high quality IFRSs through its standard-setting body, the IASB (see below).



A further objective: to bring about convergence of national and international standards.



IFRS Foundation Trustees monitor and fund the IASB, IFRS Advisory Council (IFRS AC) and the IFRS Interpretations Committee (IFRIC).



Appoints members of IASB, International Financial Reporting Interpretations Committee and IFRS Advisory Council.



Establishes and amends operating procedures, consultative arrangements and due processes of the IASB, IFRS IC and IFRS Advisory Council.

International Accounting Standards Board (IASB) The IASB is an independent privately-funded body which issues International Financial Reporting Standards (IFRS). (Before 2003, these were called International Accounting Standards, or IAS.) The Board has 16 members.

IFRS Interpretations Committee (IFRIC) 

Provides timely guidance on the application and interpretation of IFRSs



Provides guidance on new financial reporting issues not specifically addressed by IFRSs.



Interpretations are approved by the IASB prior to being issued.

IFRS Advisory Council (IFRS AC) The IFRS Advisory Council is the formal advisory body to the IASB and IFRS Foundation. It takes recommendations from individuals, corporations and national standard-setters and then provides advice to the IASB on priority areas of accounting.

6 Duties and responsibilities of those charged with governance Corporate Governance is the system by which companies are directed and controlled. A company needs to be appropriately “governed” as the owners of a business do not necessarily work for or run the company and therefore need to ensure that the business is being run properly. The Directors of a company are those “charged with governance”. Their responsibilities are laid down in law.

6.1 Legal responsibilities of Directors These vary according to national companies legislation, but directors are normally responsible for: 

The preparation of the financial statements in accordance with the applicable financial reporting framework (e.g. IFRSs).



The internal controls needed to prepare financial statements.



The prevention and detection of fraud.



Ensuring that the entity complies with all relevant laws and regulations.

Directors should explain their responsibility for preparing accounts within the financial statements.

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2 Principles and concepts

1 A framework approach An accounting conceptual framework is a theory that explains the reasoning which underlies the preparation of financial statements. A framework sets out generally accepted accounting principles, which form the basis of financial accounting and reporting standards. It provides answers to fundamental questions such as: 

What are financial statements?



What are they for?



Who are they for?



What makes them useful?

Objective of financial statements The objective of financial statements is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions.

Characteristics of useful financial information Useful information is characterised by qualities that may be categorised as:  

Fundamental (i.e. essential) Enhancing (i.e. a further improvement).

Fundamental qualitative characteristics 

Relevance - Information is relevant when it influences the decisions that users take on the basis of that information. Relevant information helps users to assess past, present or future events (predictive value) and helps users to confirm past assessments (confirmatory value). Information needs to be material to be of any relevance to users.

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Faithful representation – This means that information is generally complete, neutral, and free from error. It implies that financial information should reflect the economic substance of transactions, even where this is different from their legal form.

Enhancing qualitative characteristics 

Comparability – Users should be able to compare items within the financial statements from period to period and should be able to compare the financial statements of different entities.



Verifiability – Different knowledgeable and independent observers should be able to reach a consensus (not necessarily complete agreement) that particular information is faithfully represented. Some...