IAI Actuarial Core Principles · Business Finance

Construction and features of company accounts and reports: formula sheet

Full chapter guide

Key formulas

Objective of financial reporting: Useful information for investors, lenders and other creditors to make decisions; Decision usefulness. State it in these words in any 'objective' question.
Two core purposes: Stewardship (accountability) + Decision usefulness; Use both. Many students give only one.
Qualitative characteristics: Relevance + Faithful representation; enhanced by comparability, verifiability, timeliness, understandability; Use these to judge whether accounts are useful.
Responsibility split: Directors prepare; auditors opine; regulators set and enforce rules; Auditors give an opinion, they do not prepare the accounts.
Audit opinion standard: True and fair view; A reasonable assurance concept, not a guarantee of accuracy to the last rupee.
Accounting equation: Assets = Liabilities + Equity; Holds at all times and underpins every statement of financial position.
Accruals adjustment for expenses: Expense for the period = Cash paid + Closing accrual − Opening accrual − Closing prepayment + Opening prepayment; Use for an expense where unpaid amounts are carried as accruals and amounts paid early are carried as prepayments. If there is no accrual or prepayment, the term is zero.
Accruals adjustment for income: Income for the period = Cash received + Closing amount receivable − Opening amount receivable; Income is recognised when earned, not when cash arrives.
Going concern test: If the business is not a going concern, value assets at expected realisable amounts, not on a continuing-use basis; This is a rule of thumb for the basis of preparation, so state it with the reason.
Accounting equation: Assets = Liabilities + Equity; Must hold at the balance sheet date. Use it to find any missing figure.
Net assets: Net assets = Total assets − Total liabilities = Equity; Equity is the residual claim of the shareholders.
Working capital: Working capital = Current assets − Current liabilities; Positive means short-term obligations are covered by short-term assets.
Carrying amount of a depreciable asset: Carrying amount = Cost − Accumulated depreciation − Impairment; Used when the asset is held at cost, not revalued.
Inventory valuation: Inventory = lower of cost and net realisable value (NRV); NRV = estimated selling price − estimated costs to complete and sell. Apply item by item or by group of similar items.
Closing retained earnings: Closing retained earnings = Opening retained earnings + Profit for the year − Dividends declared; Links the profit statement to the balance sheet. Dividends reduce equity when declared.
Gross profit: Gross profit = Revenue − Cost of sales; Cost of sales = opening inventory + purchases − closing inventory, for a trading business.
Operating profit: Operating profit = Gross profit − Distribution costs − Administrative expenses (± other operating income/expenses); Before finance costs and tax.
Profit before tax: Profit before tax = Operating profit + Finance income − Finance costs; Interest on debt goes in finance costs, not operating expenses.
Profit for the year: Profit for the year = Profit before tax − Income tax expense; Tax expense includes current and deferred tax.
Total comprehensive income: Total comprehensive income = Profit for the year + Other comprehensive income; OCI is shown net of tax or with tax shown separately.
IFRS 15 five-step model: 1 Identify the contract; 2 Identify performance obligations; 3 Determine the transaction price; 4 Allocate the price to obligations; 5 Recognise revenue as each obligation is satisfied; Revenue is recognised at a point in time or over time, depending on when control transfers.
Allocation by stand-alone selling price: Allocated price = Total transaction price × (Stand-alone price of item ÷ Sum of stand-alone prices); Used in step 4 when a contract has several obligations.
Straight-line depreciation: Annual depreciation = (Cost − Residual value) ÷ Useful life; A common adjustment that affects expenses in the statement.
Indirect method: cash from operations: Profit before tax + depreciation and amortisation + finance costs − investment income ± loss/gain on disposal − increase in inventory − increase in receivables + increase in payables = cash generated from operations; Add back non-cash and non-operating items. Remove investment income and finance costs if they are shown in other sections.
Net cash from operating activities: Cash generated from operations − tax paid (− interest paid, if classed as operating); Tax paid is not the tax charge. Work it out from the tax account.
Working capital rule: Increase in an asset = cash outflow; increase in a liability = cash inflow; Reverse the sign for decreases.
Tax paid: Opening tax liability + tax charge for the year − closing tax liability; Use the same method for interest paid and dividends paid.
Fixed asset purchases: Closing net book value − opening net book value + depreciation + net book value of disposals; Gives the cost of additions, assuming no revaluations.
Direct method: receipts from customers: Revenue − increase in receivables (or + decrease in receivables); Payments to suppliers use the same logic with purchases and payables.
Cash reconciliation: Net change in cash = operating + investing + financing flows = closing cash − opening cash; Always use this as your final check.
Equity reconciliation (each component): Closing balance = Opening balance + Profit for the year + Other comprehensive income + Shares issued − Dividends ± Other transfers; Apply to each column separately. Only include items that affect that component.
Total equity: Total equity = Share capital + Share premium + Retained earnings + Other reserves; Closing total must equal equity on the balance sheet (Total assets − Total liabilities).
Share issue at a premium: Share capital = Number of shares × Nominal value; Share premium = Number of shares × (Issue price − Nominal value); Cash received is the sum of both. Issue costs are normally deducted from equity, not expensed.
Bonus issue: Share capital increases by Number of bonus shares × Nominal value; the same amount is deducted from reserves; No cash moves and total equity is unchanged.
Total comprehensive income: Total comprehensive income = Profit for the year + Other comprehensive income; Profit goes to retained earnings. Items such as revaluation gains go to a separate reserve.
Dividend paid: Dividend = Number of shares × Dividend per share; Deduct from retained earnings in the period it is declared and approved, not when only proposed after year end.
Unmodified (unqualified) opinion: No material misstatement → accounts give a true and fair view; The best outcome. It may still include an emphasis of matter paragraph, which does not change the opinion.
Qualified opinion: Material but not pervasive issue → 'except for'; Can arise from a misstatement or from a limit on the evidence the auditor could obtain.
Adverse opinion: Material and pervasive misstatement → accounts do not give a true and fair view; Disagreement with management on how items are treated or shown.
Disclaimer of opinion: Material and pervasive lack of evidence → no opinion given; Arises from a limitation of scope, not from a disagreement.
Decision grid: Misstatement: material → qualified; material and pervasive → adverse. Limited evidence: material → qualified; material and pervasive → disclaimer; Use this grid to choose the opinion in any scenario question.
Responsibility split: Directors prepare the accounts and report; auditors express an opinion on them; Auditing does not transfer responsibility for the accounts to the auditor.
Goodwill (full or proportionate method): Goodwill = Consideration paid + NCI at acquisition − Fair value of net assets of subsidiary at acquisition; NCI at acquisition is either its share of fair value of net assets (proportionate method) or its fair value (full goodwill method). State which method you use.
Net assets at acquisition: Net assets at acquisition = Share capital + Reserves at acquisition date (± fair value adjustments); Use fair values, not book values, for identifiable assets and liabilities.
Non-controlling interest at the reporting date: NCI = NCI at acquisition + NCI % × post-acquisition change in subsidiary's net assets; Equivalent to NCI % × subsidiary's net assets at the reporting date under the proportionate method, before any goodwill attributable to NCI.
Group reserves: Group reserves = Parent's reserves + Parent % × subsidiary's post-acquisition reserves − goodwill impairment charged to parent; Only post-acquisition profits are included.
Equity method carrying amount: Associate = Cost + Share % × post-acquisition profit of associate − dividends received − impairment; Shown as one line in non-current assets.
Unrealised profit on inventory: Provision = Profit margin × Intra-group inventory still held at year end; Deduct from group inventory and from group reserves (or split with NCI if the subsidiary sold the goods).

Quick revision

Accounts show position, performance and cash flows to users outside the company.
Main users: investors, lenders, employees, customers, suppliers, regulators and government.
Key principles: going concern, accruals, consistency, prudence and materiality.
Balance sheet equation: assets = liabilities + equity.
Balance sheet is a snapshot at a date; profit or loss covers a period.
Profit is not cash: accruals, depreciation and working capital cause differences.
Cash flow statement groups cash into operating, investing and financing activities.
Dividends paid and share issues appear in changes in equity and in financing cash flows.
Notes give accounting policies and breakdowns that support the main statements.
The audit report gives an opinion on whether accounts give a true and fair view; it is not a guarantee against fraud.
Group accounts combine a parent and subsidiaries as one economic entity, with minority interests shown separately.

Common mistakes

Saying auditors prepare the accounts. Fix: Directors prepare. Auditors independently examine and give an opinion.
Saying an audit guarantees the accounts are accurate or fraud-free. Fix: Say reasonable assurance. Auditors test samples and use judgement.
Treating prudence as a licence to understate profit every year. Fix: Describe prudence as caution under uncertainty, without deliberate understatement. Say that it supports neutral, faithful reporting.
Recording income or expense when cash is received or paid. Fix: Ask when the right to income or the obligation arose. Adjust for accruals and prepayments.
Treating the balance sheet as a record of a period rather than a date. Fix: Write 'as at' the date in every answer and use period language only for profit and cash flow.
Classifying a long-term loan as non-current without checking the repayment due within 12 months. Fix: Move the part repayable within 12 months to current liabilities and keep the rest in non-current.
Putting revaluation gains or pension remeasurements into profit for the year. Fix: Learn the standard OCI list. Show these items below profit for the year and add them only in total comprehensive income.
Recognising revenue when cash is received or when the contract is signed. Fix: Use the control test. Recognise revenue when the performance obligation is satisfied, whatever the cash timing.
Adding an increase in receivables or inventory instead of subtracting it Fix: Say it aloud: asset up, cash down; liability up, cash up. Check every working capital line against this.
Using the tax charge from the profit statement instead of tax paid Fix: Build a small tax account: opening liability + charge − closing liability = tax paid.

Exam tips

Open with stewardship and decision usefulness. This earns early marks in 'purpose' questions.
Always tie a user to a decision and a specific piece of information.
In MCQs, watch for wrong claims that auditors prepare accounts or guarantee accuracy.
For 6-mark role questions, give three parts: directors, auditors, regulators, with two points each.
Mention limitations in discussion questions.
Define the concept in one line, then spend most of your time applying it to the facts. Markers reward application.
In comparison questions, give both similarities and differences for IFRS and Ind AS, and state that Ind AS is converged with IFRS but has differences.
When two concepts conflict, name both and say which one the situation favours and why.