Question

e Tools Slide Show Window Help BUSM054 18-19 L 11-Review how Review View 스 .| | !|lla-lei ,, convert to SmartArt picture shapes Text Box Arrange Discussion Questions Advantages & Limitations of Ratio Analysis Accounting for R&D-IA3 38 Deferred Tax- how should this be treated (full provision, partial provision, flow-through) . Leasing-showing substance (asset and loan) rather than legal form . Reporting Earnings- EPS (basic and fully diluted) Share Options- rationale (P/A discussion) in aligning shareholder/director interests. Accounting issue - is there an expense? Requirements of IFRS 2.

Answer 1

A.1) Ratio Analysis

Advantages

• Ratio analysis will help validate or disprove the financing, investing and operating decisions of the firm. They summarize the financial statement into comparative figures, thus helping the management to compare and evaluate the financial position of the firm and the results of their decisions.
• It simplifies complex accounting statements and financial data into simple ratios of operating efficiency, financial efficiency, solvency, long-term positions etc. which are classified into activity, solvency,Liquidity ratios etc.
• Ratio analysis help identify problem areas and bring the attention of the management to such areas. Some of the information is lost in the complex accounting statements, and ratios will help pinpoint such problems.
• Allows the company to conduct comparisons with other firms, industry standards, intra-firm comparisons etc. This will help the organization better understand its fiscal position in the economy.

Limitations

• Firms can improve their financial ratios by making some year-end changes in their Financial Statements.Then, ratios rather than telling the company's actual financial health, it will just tell the fake or made up financial health.
• Many Ratios are calculated using historical costs, and so they may overlook the price changes between the periods, which does not reflect the actual Financial situation.
• Accounting Ratios completely overshadow or ignore the qualitative aspects of the company. They will only consider the quantitative aspects for calculation.
• As there is no standard definition of Ratios,So firms may use different formula for calculation of Ratios.

A.2) Accounting For R&D

Research and development is a process in which a firm obtains or acquires knowledge by doing various researches and then further use this knowledge to improve their existing product and introduce new and innovative ones to it's operations. R&D is a systematic investigation with objective in mind to introduce Innovations the company's current product line. A Firm achieves this by adding improvements to the current goods and services or introducing a new product.

The General problem with R&D accounting is that future benefits from research and development are uncertain and R&D expenditures cannot be capitalized. Though there are different accounting standards, but both IFRS and US GAAP require companies to expense all research and development expenditures as incurred. However, in case of Merger & Acquisition transaction, R&D expenses of the target company may be capitalized because the acquirer can recognize the fair value of the R&D assets. R&D costs are included in the company's operating expenses and are usually reflected in its income statement.

A.3) Deferred tax is accounted for in accordance with IAS 12, Income Taxes. In Paper F7, deferred tax normally results in a liability being recognised within the Statement of Financial Position. IAS 12 defines a deferred tax liability as being the amount of income tax payable in future periods in respect of taxable temporary differences. So, in simple terms, deferred tax is tax that is payable in the future. However, to understand this definition more fully, it is necessary to explain the term ‘taxable temporary differences’.
Temporary differences are defined as being differences between the carrying amount of an asset (or liability) within the Statement of Financial Position and its tax base ie the amount at which the asset (or liability) is valued for tax purposes by the relevant tax authority.
Taxable temporary differences are those on which tax will be charged in the future when the asset (or liability) is recovered (or settled).
IAS 12 requires that a deferred tax liability is recorded in respect of all taxable temporary differences that exist at the year-end, this is sometimes known as the full provision method.
All of this terminology can be rather overwhelming and difficult to understand, so consider it alongside an example. Depreciable non-current assets are the typical example behind deferred tax in Paper F7.
Within financial statements, non-current assets with a limited economic life are subject to depreciation. However, within tax computations, non-current assets are subject to capital allowances (also known as tax depreciation) at rates set within the relevant tax legislation. Where at the year-end the cumulative depreciation charged and the cumulative capital allowances claimed are different, the carrying value of the asset (cost less accumulated depreciation) will then be different to its tax base (cost less accumulated capital allowances) and hence a taxable temporary difference arises.

A.4) Substance over Legal form is an accounting concept which means that the economic substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a true and fair view of the affairs of the entity.

Leasing in finance is an alternative way of financing whereby a licensed leasing company (the “Lessor') purchases an asset on behalf of its customer (the “Lessee”) in return for a contractually agreed series of payments which usually include an element of interest.

Amalgamation of both the terms "Leasing" and "substance over legal form" means that while presenting the financial reports the leasing company (or Lessor) should show the purchases of assets and also show show the series of payments that they are getting from the customer (or Lessee).

Customer should also present these transactions in their financial reports.

A.5)