Lecture 4 revision notes

Companies Act-
Annual records- present annual financial statements.

Required formats- sufficient to explain transaction and must be reasonably accurate at any time. To
enable accounts showing a true and fair view in accordance with Companies Act.

Accounting records- Manual or computerized records of assets and liabilities, monetary

transactions; various journals, ledgers, and supporting documents (such as agreements, checks,
invoices, vouchers), which an organization is required to keep for certain number of years

Accounting books- cash book, assets and liabilities, sales and purchases, stock. All sales must be
recorded, these books must be produced.

Users of financial statements:

Shareholders Government
Loan creditors Analysts/advisors
Business contact; suppliers, customers, Public
competitors Management
Employees

Accounting Concepts
Relevance- Information must have the ability to influence decisions and be relevant to past and future
events. Thus information must be available when decisions are being made, time is the key.

Reliability- Accounting should be free of biased or significant errors; the statements should be reliable
to allow effective decisions.

Comparability- Information is consistent provided transactions are accounted for using the same
methods within and between each accounting period.

Understandability- Financial statements are prepared in such a way that they are easily understood.

Going concern: Holds that the financial statement should be prepared on the assumption that the
business will continue operations for the foreseeable future, unless this is no not to be true.

Accruals concept- One of the fundamental accounting concepts, the accruals concept is also known as
the “matching concept”. Under the accruals concept, revenue and costs are credited or charged to the
profit and loss account for the year in which they are earned or incurred, not when any cash is
received or paid.

Consistency- Similar transactions are treated similarly, both years on year, and within each accounting
period, i.e. similar accounting policies are adopted. Once a business has adopted on one accounting
method, it should use the same method for all subsequent events of the same character unless it has
sound reason to change
Prudence concept- that requires recording (recognizing) the expenses and liabilities as soon as
possible, but the revenues only when they are realized or assured. It implies that only that method of
determining asset value or net income which yields the lesser amount should be used.

Duality Concept- is the foundation of the universally applicable double entry book keeping system. It
stems from the fact that every transaction has a double (or dual) effect on the position of a business as
recorded in the accounts.

For example, when an asset is bought, another asset cash (or bank) is also and simultaneously
decreased OR a liability such as creditors is also and simultaneously increased. Similarly, when a sale is
made the asset of stock is reduced as goods leave the business and the asset of cash is increased (or
the asset of debtors is increased) as cash comes into the business (or a promise to pay is made and
accepted). Every financial transaction behaves in this dual way.

Objectivity- The objectivity concept requires an accountant to draw up any accounts, and further
analysis, only on the basis of objective and factual information.

Thus, this concept attempts to ensure that if, for example, 100 accountants were to draw up a set of
accounts for one business, there would be 100 identical accounting statements prepared. Everyone
would be obtaining and using only facts. The problem here is that there are many aspects of
accounting ensuring that objectivity cannot be universally applicable in the preparation of accounts.
For example, with fixed assets: the cost of a van must be known at its purchase: say £30,000.
However, how long will this van be in service? I say five years, my colleague could say 10 years. If I
prepare the accounts using the straight line method of depreciation calculation, I would provide
£30,000 ÷ 5 = £6,000 each year for depreciation; my colleague would charge £30,000 ÷ 10 = £3,000
each year for depreciation; and both of us could be correct! The problem is that with an issue such as
depreciation we are not always able to be objective

Materiality- An item is material if it’s inclusion in, or exclusion from, a financial statement would cause
a user of that statement to make a different decision from that which might otherwise be made – a
subjective issue

Information is material if its omission or misstatement could influence the economic decision of users
taken on the basis of the financial statements. Materiality depends on the size of the item or error
judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristic which information
must have if it is to be useful."

Business entity convention- For accounting purpose the business and its owner are treated as being
quite separate and distinct. This is why the owners are treated as being claimants against their own
business in respect of their investments in the business.

Historic cost convention- This convention holds that the value of the assets shown on the balance
sheet should be based on the historic cost

Accounting base and policies-

Accounting base- various methods of applying accounting concepts to different accounting problems
in financial statements
Accounting policies- the specific accounting bases chosen and applied in the financial statements

Small/medium sized company’s exemptions:

Small companies which fall into the criteria; assets under 2.8m, turnover under 5.6m and employees
under 50 do not have to send their financial accounts to companies house, they do not have to
disclose financial statements except balance sheet with a few notes.
Medium sized companies which fall into the criteria; assets 11.4m, turnover 22.8m and employees
250, have to send their financial accounts annually to company house or will be fined.

IFRS Standards-
International Financial Reporting Standards (IFRS) are Standards, Interpretations and the Framework
adopted by the International Accounting Standards Board (IASB).

IASC- To develop a single set of high quality, understandable, enforceable and globally accepted
international financial reporting standards (IFRSs) through its standard-setting body, the IASB

SAC-statements of accounting concepts

Stock exchange requirements-

Produce interim accounts
Preliminary announcements- any news affecting the share price must be announced immediately.
Close period- insiders cannot buy/sell shares

Shares-
Issue of shares per value- The par value, or face value, of a share is the amount that is shown on the
face of a share as its value.

The par value is an arbitrary amount that is determined when a company is incorporated. Its only real
importance is that (in the UK at least) shares cannot be issued for a payment that is less than their par
value.
The par value of a share multiplied by the number of shares is shown in a company's balance sheet as
its share capital. When shares are issued at more than their par value the excess is added to the share
premium reserve on the balance sheet.
A company can change the par value of its shares or adjust the amount in the share premium reserve,
but it is not able to do so as and when the directors and shareholders wish. These changes require
permission from a court and are usually associated with large returns of capital, share splits or
consolidations.

Script/bonus shares- Fully paid-up new common stock (ordinary shares) issued free to existing
stockholders (shareholders) in proportion to their current stock/shareholdings. A bookkeeping
transaction (because no cash changes hands), it capitalizes a part of reserves (retained earnings) to
bring share capital more in line with the assets employed; and a high share price back to a more
manageable amount, thus enhancing its marketability. Although the number of shares held by each
shareholder increases, the value of the total shareholding remains the same as before the scrip issue.

Re-division of share capital to attract new investors

When share price is high they do this to bring down share prices as high prices unlikely to attract
investment
Using reserves

Effect on balance sheet

Liabilities and capital changes:
Equity- share capital goes up
Reserves go down
Balance total doesn’t change

Right issue- issues made to existing shareholders to raise finance

New stock (share) issue offered to existing stockholders (shareholders) in proportion to their current
stock/shareholding, for a specified period and at a specified (usually discounted) price. Its objective is
to afford them the opportunity to maintain their percentage of ownership of the firm.

Effect on balance sheet Liabilities:

Assets: Equity- share capital will increase
Current asset; cash increases Reserves go up by premium shares

Market value-
Factors affecting market price of a share:

Interest rates go up, cost of borrowing will fall, and share prices will fall

Demand and Supply - This fundamental rule of economics holds good for the equity market as well.
The price is directly affected by the trend of stock market trading. When more people are buying a
certain stock, the price of that stock increases and when more people are selling the stock, the price of
that particular stock falls. Now it is difficult to predict the trend of the market but your stock broker
can give you fair idea of the on-going trend of the market but be careful before you blindly follow the
advice.

News - News is undoubtedly a huge factor when it comes to stock price. Positive news about a
company can increase buying interest in the market while a negative press release can ruin the
prospect of a stock. Having said that, you must always remember that often times, despite amazingly
good news, a stock can show least movement. It is the overall performance of the company that
matters more than news. It is always wise to take a wait and watch policy in a volatile market or when
there is mixed reaction about a particular stock.

Market Cap - If you are trying to guess the worth of a company from the price of the stock, you are
making a huge mistake. It is the market capitalization of the company, rather than the stock, that is
more important when it comes to determining the worth of the company. You need to multiply the
stock price with the total number of outstanding stocks in the market to get the market cap of a
company and that is the worth of the company.

Earnings Per Share - Earning per share is the profit that the company made per share on the last
quarter. It is mandatory for every public company to publish the quarterly report that states the
earning per share of the company. This is perhaps the most important factor for deciding the health of
any company and they influence the buying tendency in the market resulting in the increase in the
price of that particular stock. So, if you want to make a profitable investment, you need to keep watch
on the quarterly reports that the companies and scrutinize the possibilities before buying stocks of
particular stock.
Price/Earnings Ratio - Price/Earnings ratio or the P/E ratio gives you fair idea of how a company's
share price compares to its earnings. If the price of the share is too much lower than the earning of the
company, the stock is undervalued and it has the potential to rise in the near future. On the other
hand, if the price is way too much higher than the actual earning of the company and then the stock is
said to overvalued and the price can fall at any point.

Auditing-
An independent and expert assessment of the systems of control operating within a company and in
the light of this assessment an examination of the records to enable the auditor to:
a)determine whether proper books of account have been kept; and
b)to report to the members whether in his opinion and having regard to the nature and
circumstances of the business that the annual accounts show a true and fair view of the results and
position and comply with all statutory requirements and generally accepted accounting principles.