Financial Accounting and Reporting

Transcription

1 Financial Accounting and Reporting NINTH EDITION Barry Elliott and Jamie Elliott Prentice Hall FINANCIAL TIMES /in imprint of Pearson Education Harlow, England London New York Boston San Francisco Toronto Sydney Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Madrid Mexico City Amsterdam Munich Paris Milan

2 Brief Contents Preface and acknowledgements Part I INCOME AND ASSET VALUE MEASUREMENT SYSTEMS xx I 1 Accounting and reporting on a cash flow basis 3 2 Accounting and reporting on an accrual accounting basis 22 3 Income and asset value measurement: an economist's approach 40 4 Accounting for inflation 60 Part 2 REGULATORY FRAMEWORK- AN ATTEMPT TO ACHIEVE UNIFORMITY 97 5 Financial reporting: evolution of the regulatory framework in the UK 99 6 Financial reporting: evolution of international standards Conceptual framework Published accounts of companies Preparation of published accounts 221 Part 3 BALANCE SHEET - EQUITY, LIABILITY AND ASSET MEASUREMENT AND DISCLOSURE Share capital, capital maintenance and distributable profits Reduction of share capital Off balance sheet finance Financial intruments Employee benefits Taxation in company accounts Property, plant and equipment (PPE) Leasing R&D; goodwill and intangible assets; brands Inventories Construction contracts 502

3 vi Brief Contents Part 4 CONSOLIDATED ACCOUNTS S11 21 Accounting for groups at the date of acquisition Preparation of consolidated balance sheets after the date of acquisition Preparation of consolidated income statements Accounting for associated companies Accounting for the effects of changes in foreign exchange rates under IAS Part 5 INTERPRETATION Earnings per share Cash flow statements Review of financial ratio analysis Trend analysis and multivariate analysis 674 Part 6 ACCOUNTABILITY Corporate governance Environmental and social reporting Ethics for accountants 791 Appendix: Outline solutions to selected exercises 811 Index 819

4 Full Contents Preface and acknowledgements Part I INCOME AND ASSET VALUE MEASUREMENT SYSTEMS xx I 1 Accounting and reporting on a cash flow basis Introduction Shareholders What skills does an accountant require in respect of external reports? Managers What skills does an accountant require in respect of internal reports? Procedural steps when reporting to internal users Agency costs Illustration of periodic financial statements prepared under the cash flow concept to disclose realised operating cash flows Illustration of preparation of balance sheet under the cash flow concept Treatment of fixed assets in the cash flow model 14 I.I I What are the characteristics of these data that make them reliable? Reports to external users 16 Summary Accounting and reporting on an accrual accounting basis Introduction Historical cost convention Accrual basis of accounting Mechanics of accrual accounting - adjusting cash receipts and payments Subjective judgements required in accrual accounting - adjusting cash receipts in accordance with IAS Subjective judgements required in accrual accounting - adjusting cash payments in accordance with the matching principle Mechanics of accrual accounting - the balance sheet Reformatting the statement of financial position into a balance sheet Accounting for the sacrifice of fixed assets 28

5 viii Full Contents 2.10 Reconciliation of cash flow and accrual accounting data Income and asset value measurement: an economist's approach Introduction Role and objective of income measurement Accountant's view of income, capital and value Critical comment on the accountant's measure Economist's view of income, capital and value Critical comment on the economist's measure Income, capital and changing price levels Summary Bibliography Accounting for inflation Introduction Review of the problems of historical cost accounting (HCA) Inflation accounting The concepts in principle The four models illustrated for a company with cash purchases and Critique of each model Operating capital maintenance - a comprehensive example Critique of CCA statements The ASB approach The IASC/IASB approach Future developments Summary Bibliography sales Part 2 REGULATORY FRAMEWORK -AN ATTEMPT TO ACHIEVE UNIFORMITY 97 5 Financial reporting: evolution of the regulatory framework in the UK Introduction Mandatory regulations Arguments in support of standards Arguments against standards Structure of regulatory framework The operating and financial review (OFR) 108

6 Full Contents ix The Financial Reporting Review Panel The Financial Services Authority The revised Combined Code (July 2003) Interim Reports following Cadbury Developments for small companies Evaluation of effectiveness of mandatory regulations Summary Financial reporting - evolution of international standards Introduction National differences Reasons for differences in financial reporting Classification of national accounting systems Attempts to reduce national differences The work of international bodies in harmonising and standardising financial reporting USGAAP Reconciliations and supplementary statements Summary Conceptual framework Introduction Historical overview of the evolution of financial accounting theory IASC Framework for the Presentation and Preparation of Financial Statements ASB Statement of Principles 1999 AICPA Improving Business Reporting -A Customer Focus: Meeting the Information Needs of Investors and Creditors ICAS Making Corporate Reports Valuable Summary Published accounts of companies Introduction A public company's financial calendar Criteria for information appearing in a published income statement and balance sheet The prescribed formats What information is required to be disclosed in Format I and Format 2? 179

7 Full Contents 8.6 Cost of sales Distribution costs Administrative expenses Other operating income What costs and income are brought into account after calculating the trading profit in order or arrive at the profit on ordinary activities before tax? Does it really matter under which heading a cost is classified In the income statement provided it is not omitted? Discontinuing operations disclosure in the income statement Items requiring separate disclosure The balance sheet Statement of changes in equity Reporting comprehensive income Segment reporting The fundamental accounting principles underlying the published income statement and balance sheet Disclosure of accounting policies Fair view treatment Additional information in the annual report What information do companies provide to assist comparison between companies reporting under different reporting regimes? 207 Summary Preparation of published accounts Introduction Stage I: preparation of the internal income statement from a trial balance Stage 2: preparation of the income statement of Illustrious SpA in Format I style Stage 3: preparation of the balance sheet Preparation of accounts in Format I following IAS 8 and IFRS Additional information value of IFRS Additional information value of IAS Summary Part 3 BALANCE SHEET - EQUITY, LIABILITY AND ASSET MEASUREMENT AND DISCLOSURE Share capital, capital maintenance and distributable profits Introduction Total owners'equity: an overview 248

8 Full Contents xi 10.3 Total shareholders'funds: more detailed explanation _ Accounting entries on issue of shares Creditor protection: capital maintenance concept Creditor protection: why capital maintenance rules are necessary Creditor protection: how to quantify the amounts available to meet creditors' claims Issued share capital: minimum share capital Distributable profits: general considerations Distributable profits: general rule for private companies Distributable profits: general rule for public companies Distributable profits: how to arrive at the amount using relevant accounts Distributable profits: realisation principle applies What are the implications of IAS compliance on distributions? 261 Summary Reduction of share capital 267 I. I Introduction Capital: restrictions on reduction of capital Non-distributable reserves: share premium Non-distributable reserves: capital redemption reserve Capital: redemption of shares by a public company Capital: redemption of shares by a private company Distributable profits: effect of accumulated trading losses Proposals for changes to company law Buyback of own shares - treasury shares Developments in other countries the Singapore experience 286 Summary Bibliography Off balance sheet finance Introduction Primary financial statements: their interrelationship Primary financial statements: changes in their interrelationship Reasons that companies borrow Capital gearing and its implications Off balance sheet finance Substance over form Balance sheet as valuation document Why companies take steps to strengthen their balance sheets Definitions cannot remove uncertainty: IAS 10 and IAS Summary

9 xii Full Contents 13 Financial instruments Introduction IAS 32 Financial Instruments: Disclosure and Presentation IAS 39 Financial Instruments: Recognition and Measurement 329 Summary Employee benefits Introduction Financial reporting implications Types of scheme Defined contribution pension schemes Defined benefit pension schemes IAS 19 (revised) Employee Benefits The liability for pension and other post-retirement costs The income statement Comprehensive illustration Future developments Plan curtailments and settlements Multi-employer plans Disclosures Other long-service benefits Short-term benefits Termination benefits IAS 26 Accounting and Reporting by Retirement Benefit Plans 353 Summary Taxation in company accounts Introduction Corporation tax Corporation tax systems the theoretical background Corporation tax systems - avoidance and evasion Corporation tax - the system from 6 April IAS 12 - accounting for current taxation Deferred tax FRS 19 (the UK standard on deferred taxation) A critique of deferred taxation Examples of companies following IAS Value added tax (VAT) 381 Summary

10 Full Contents xiii 16 Property, plant and equipment (PPE) Introduction What is PPE? How is the cost of PPE determined? What is depreciation? What are the constituents in the depreciation formula? How is the useful life of an asset determined? Residual value Calculation of depreciation Measurement subsequent to initial recognition IAS 36 Impairment of Assets IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations Disclosure requirements Government grants towards the cost of PPE Investment properties Effect of accounting policy for PPE on the interpretation of the financial statements 409 Summary Leasing Introduction Background to leasing IAS 17 (and its national equivalents)-the controversy IAS 17 - classification of a lease IAS 17 - accounting for leases by lessees Leasing - a form of off balance sheet financing Accounting for leases - a new approach 429 Summary R&D; goodwill and intangible assets; brands Introduction Accounting treatment for research and development How are development costs defined? Introduction to goodwill and intangible assets Introduction to the current position Historical developments Intangible assets Goodwill Economic consequences of each method Arguments relating to amortisation versus immediate write-off IFRS 3 Business Combinations Brand accounting Intellectual property 465 Summary 470

11 xiv Full Contents 19 Inventories 19.1 Introduction 19.2 Inventory defined 19.3 The controversy 19.4 IAS 2 Inventories 19.5 Inventory valuation 19.6 Work-in-progress 19.7 Inventory control 19.8 Creative accounting 19.9 Audit of the year-end physical inventory count Published accounts Summary 20 Construction contracts 20.1 Introduction 20.2 Identification of contract revenue 20.3 Identification of contract costs 20.4 Recognition of contract revenue and expenses Part 4 CONSOLIDATED ACCOUNTS 21 Accounting for groups at date of acquisition 21.1 Introduction 21.2 The definition of a group 21.3 Consolidated accounts and some reasons for their preparation 21.4 The definition of control 21.5 Alternative methods of preparing consolidated accounts 21.6 The treatment of positive goodwill 21.7 The treatment of negative goodwill 21.8 The comparison between an acquisition by cash and an exchange of shares 21.9 Minority interests The treatment of differences between a subsidiary's fair value and book value How to calculate fair values Summary

12 Full Contents xv 22 Preparation of consolidated balance sheets after the date of acquisition Introduction Pre- and post-acquisition profits Inter-company balances Unrealised profit on inter-company sales Provision for unrealised profit affecting a minority Uniform accounting policies and reporting dates How is the investment in subsidiaries reported in the parent's own balance sheet? 536 Summary Preparation of consolidated income statements Introduction Preparation of a consolidated income statement - the Ante Group Dividends or interest paid by the subsidiary out of pre-acquisition profits A subsidiary acquired part of the way through the year Published format income statement 547 Summary Accounting for associated companies Introduction Definitions of associates and of significant influence The treatment of associated companies in consolidated accounts The Brill Group - the equity method illustrated The treatment of provisions for unrealised profits The acquisition of an associate part-way through the year Joint ventures 560 Summary Accounting for the effects of changes in foreign exchange rates under IAS Introduction The difference between conversion and translation and the definition of a foreign currency transaction The functional currency The presentation currency Monetary and non-monetary items The rules on the recording of foreign currency transactions 571

13 xvi Full Contents 25.7 The treatment of exchange differences on foreign exchange transactions Foreign exchange transactions in the individual accounts of companies ' illustrated - Boil pic The translation of the accounts of foreign operations where the functional currency is the same as that of the parent Granby Ltd illustration The use of a presentation currency other than the functional currency Granby Ltd illustration continued Part 5 INTERPRETATION Earnings per share Introduction Why is the earnings per share figure important? How is the EPS figure calculated? The use to shareholders of the EPS Illustration of the basic EPS calculation Adjusting the number of shares used in the basic EPS calculation Rights issues Adjusting the earnings and number of shares used in the diluted EPS calculation Procedure where there are several potential dilutions Exercise of conversion rights during financial year Disclosure requirements of IAS The Improvement Project 605 Summary Cash flow statements Introduction Development of cash flow statements Applying IAS 7 (revised) Cash Flow Statements IAS 7 (revised) format of cash flow statements Consolidated cash flow statements Analysing a cash flow statement Critique of cash flow accounting 624 Summary

14 Full Contents xvii 28 Review of financial ratio analysis Introduction Accounting ratios and ratio analysis Six key ratios Description of the six key ratios Description of subsidiary ratios Application of pyramid of ratios to JD Wetherspoon pic Segmental analysis Inter-firm comparisons and industry averages Inter-firm comparisons: JD Wetherspoon and the brewing industry World Wide Web pages for company information Non-financial ratios Interpretation problems when using consolidated financial statements 661 Summary Trend analysis and multivariate analysis Introduction Horizontal analysis between two periods Trend analysis over a series of periods Historical summaries Vertical analysis - common size statements Multivariate analysis - Z-scores H-scores A-scores Accounting polices Balanced scorecards Valuing shares of an unquoted company - quantitative process Valuing shares of an unquoted company - qualitative process Shareholder value analysis (SVA) Measuring and reporting values in the annual report Shareholder information needs Professional risk assessors Impact of differences between lass and national standards on trend analysis 701 Summary Part 6 ACCOUNTABILITY Corporate governance Introduction The need for corporate governance guidlines Corporate governance in different countries Corporate governance requirements 718

15 UK Voluntary Code -The Cadbury Report 721 The Greenbury Report 722 The Hampel Report 723 The Higgs Report 723 The Smith Report 726 The Combined Code 727 Directors' remuneration 727 Directors' remuneration - illustration from the Annual Report of Diageo pic 731 Directors' remuneration - conclusion 740 Relations with shareholders 740 Institutional investors 740 The Myners Report 741 Corporate governance - summary 743 Auditors 743 Summary Environmental and social reporting Introduction Accountants' role in a capitalist industrial society Sustainability 758 Background to companies' reporting practices 759 European Commission recommendations for disclosures in annual accounts 760 Evolution of stand-alone environmental reports 762 International charters and guidelines 763 Economic consequences of environmental reporting 767 Summary on environmental reporting 767 Environmental auditing: international initiatives 768 The activities involved in an environmental audit Concept of social accounting Background to social accounting Corporate social responsibility Need for comparative data International initiatives towards tripple bottom line reporting 778 Summary Bibliography Ethics for accountants Introduction The nature of business ethics Ethical codes for businesses The background to business ethics 795

16 Full Contents xix 32.5 The role of ethics in modern business The role of professional accounting ethics The role of the accountant as guardian of business ethics Growth of voluntary standards 804 Summary Bibliography 810 Appendix: Outline solutions to selected exercises 811 Index 819