What opinion to give? - F8

When there is no material problem found in the financial statements, auditor will express an unmodified opinion which states that financial statements show a true and fair view. However, there are situations where auditor may need to modify the opinion. There are three types of modified opinion: qualified (except for...), adverse (do not show true and fair view) or disclaimer (we do not express an opinion) of opinion. ISA 705 provides guidance on which opinion to express.

Firstly, I will introduce the word "pervasiveness". This is one important factor to consider. Something is pervasive if it:
1. Affects the whole financial statements, eg. no longer going concern.
2. Does not affect the whole financial statements but is itself very significant, eg. unreasonable accounting estimates were used.
3. Non-disclosure of something fundamental to users' understanding of the financial statements.

Next, ISA 705 states that auditor shall modify the opinion when:
1. Financial statements as a whole are not free from material misstatements or,
2. Auditor is unable to obtain sufficient appropriate audit evidence to express an opinion.

Now, it's time to use common sense.
1. If financial statements are materially misstated but it is not pervasive, we only qualify the opinion (because not so serious). However, if it is pervasive, then we might express an adverse opinion.
2. If auditor is unable to obtain sufficient appropriate audit evidence about something (eg. going concern status) but it is not pervasive, we only qualify the opinion. However, if it is pervasive, then we might disclaim the opinion (because we don't have enough evidence to prove that it is bad).

Using sampling to obtain information - FMA

Sampling means taking samples from a population. Why we only take samples? This is because we don't have enough time to obtain information from the whole population. Sampling is particularly useful in auditing, but here we focus on the sampling techniques identified in FMA syllabus. I will first explain the theories, then I will provide an example for each technique using Zodiac signs. Let's take our objective as understanding the characteristics of Gemini. ;)

Random sampling
Sample will be chosen in a way that every item in the population has a chance of being selected, probably using random number table or random number generator. This is suitable when the population is known and not too big.
With our objective in mind, our population is the Gemini people. If our sample size is 20, we will generate 20 random numbers (each Gemini people is given a number) and interview the corresponding Gemini people to understand them.

Systematic sampling
The starting point is random, then sample is picked with fixed intervals. This is useful if population is logically same type but can introduce bias if population has a repetitive pattern.
In our case, again sample size is 20 and let's say we have 100 Gemini people, then our fixed interval can be determined as 5 (100/20), this means that 1 in every 5 Gemini people is chosen. Now, our random start can be from 1st to 5th Gemini people, let's say we choose 4th, then our samples will be taken as the 9th, 14th, 19th, 24th, 29th, 34th and until 99th Gemini people, total will be 20 Gemini people chosen to be interviewed.

Stratified sampling
The population will be divided into sub-populations (strata) and random samples are taken from each stratum. This technique requires prior knowledge of each item of population.
In our case, from 100 Gemini, we may categorise into "0-18 years old", "19-37 years old", "38-56 years old" and "57 years old and above". Then from each strata, we pick samples randomly to interview.

Multi-stage sampling
Population will be divided into sub-populations, and then divide again to sub-sub-populations until it is small enough, then random sample is selected from the small sub-populations. This is useful if the population is very large.
In our case, let's say our population is the Gemini people in whole Malaysia, there are too many to interview so we might only want to interview Gemini people in Selangor, but still this is too large, so we further divide into Gemini people in Subang and Klang. From here, we use random sampling technique to select Gemini people in Subang and Klang for interview.

Cluster sampling
This is similar to multi-stage sampling but at the end, all items in the small sub-populations will be selected. Again, this is useful if the population is very large.
Using the same example, we will interview all Gemini people in Subang and Klang.

Quota sampling
Investigators are told to interview all the people they meet up to a certain quota. This is very biased because they choose how to fill the quota.
In our case, we told the investigators to interview 200 Gemini people, they will decide who to interview. This is biased because if the investigator is a boy, he might interview more girls.

Zero-based budgeting - what's so special? - F5/P5

Zero-based budgeting (ZBB) is a more modern type of budgetary system. In the past (and also current), many companies prepare budgets with an incremental budgeting system which takes last year figure and adjusts for changes in volumes or inflation. Such system is known to cause management to build in budgetary slack (overestimation of expenses or underestimation of revenues). ZBB solves this problem and requires management to prepare budgets from zero base, ie. a new beginning.

In ZBB, every item of expenditure has to be justified by the management first before it is allowed to be included in the budget. This means that management must have a good reason for the provision of certain expenses. Generally, ZBB involves three stages: Defining decision packages, ranking decision packages and allocating resource.

1. Define decision packages
Decision packages are plans. Firstly, management has to prepare a base decision package showing the minimum level of expenditure required to run the department/company/project. Incremental package can then be prepared which shows the extra expenditure that will be needed. Management will try to justify the incremental package so that it can be chosen as priority.

2. Ranking decision packages
After the senior management received all decision packages from each manager, he will rank the incremental decision packages based on the benefit to the organisation.

3. Allocating resource
The incremental decision packages that are chosen as priority will be given resources so that the management can do according to the decision packages. Those ranked as low priority may not be allocated resources. However, resources will be allocated to all base decision packages.

From the above, we can easily identify one obvious disadvantage, that is time-consuming. Preparing ZBB involves a significant amount of time and due to its complexity, management might have to be trained first. ZBB should not be implemented unless the benefit of implementing ZBB exceeds cost.

Roles of nomination committees - FAB/P1

Nomination committees have a number of roles which mainly involve dealing with the board. Gaps, diversity, balance, succession planning and size of board could be the key words to remember.

Gaps
They identify the gaps in current board's skills and ensure that such gaps are filled.

Diversity
They should ensure that the board members are well-diversified, for example in terms of background, age, gender and so on. This will be helpful in the way that more different ideas could be generated in deciding on a strategy.

Balance
They should ensure that executive and independent non-executive directors (excluding chairman) are balanced. Therefore, the number and types of NEDs are determined by the nomination committees.

Succession planning
They should have a plan for continuity of the retiring directors, ie. there should be someone prepared to replace the retiring directors.

Size of board
They determine the optimal size of the board for the company, taking into account the complexity of the strategies to be undertaken.

You can add one more role. Nomination committees will also recommend on the re-appointment of the directors who are due for re-election. They would take into account the contributions made by the directors to arrive at a conclusion.

Letter - Your sincerely or your faithfully?

When should we use your sincerely or your faithfully at the end of the letter? Are they the same? Well the words are different so they are different. ;)

"Your sincerely" should be used when the addressee is named, for example "Dear John" and "Your faithfully" should be used when the addressee is anonymous, for example "Dear shareholders". This shows that "Your sincerely" is used when you write the letter to someone that you know and only to one person while "Your faithfully" is used when you write to many or someone you don't know, for example "trustee of trade union".

Using the wrong word might result in losing one mark as it would seem funny to the marker. ;)

Possible topics for F8 and F9 - December 2011

F8
1. Tests of controls and substantive procedures on inventory/cash and bank
2. ISA 530 Audit sampling (probably in question 2)
3. Corporate governance with ethics
4. Audit risk
5. Review of subsequent events and mix some of the reporting elements (as usual)

F9
1. Investment appraisal - ROCE/ARR method, probability analysis (do June 2009 question 1), capital rationing
2. Cost of capital - cost of equity, cost of debt, WACC, MM's theories
3. Business finance - rights issue (theoretical ex-right price), sources of finance, dividend policy
4. Working capital management - cash (cash flow forecast, Miller-Orr model), identifying whether overtrading
5. Business valuation - P/E ratio method, dividend valuation/growth model
6. Risk management - causes of interest rate fluctuations
These topics will be squeezed into 4 questions.

The above are "possible" topics, which mean not more than 50% chance, so be careful ;)

Key areas of accounts receivable management - FFM/F9

In dealing with accounts receivable (AR), we hope to sell to a receivable who can pay back on time. We can group the stages in receivables management into 4 stages.

1. Policy formulation
There must be a framework prepared for managing receivables. Such framework can cover the three periods: before giving credit, during credit period and the end of credit period. This will be the overall procedures of next three stages.

2. Credit analysis
Here we assess the creditworthiness of the new customer. Information about the customer could be obtained from bank references, trade references and credit reference agency reports. Generally we can also consider the 5C which banks always use, ie. character, collateral, capital, capacity and condition.

3. Credit control
After giving credit, we have to monitor the receivables, probably using aged receivables analysis, paying attention to those taking long time to pay. Administrative procedures should be in place, for example prompt invoicing, sending monthly statement as gentle reminder, maintaining account records and so on.

4. Collection of amounts due
Amounts due will be collected, this is the end of credit period. Procedures will be taken for overdue accounts such as telephone calls, personal visits, charging interest, stopping supply, sending reminders and legal action will be the last resort. For any action, benefit should exceed cost.

In a big company, credit controllers will be dealing with these jobs and they must communicate with sales and marketing department regarding to which customers to choose, how much credit limit to be given and how long is the credit period. This is to ensure that sales person does not sell to one who can't pay back the amounts due.

Basic variance calculations - FMA/F5

Many would have remembered the formula, but in actual case only fixed overhead variances require a bit of remembering, the rest follows the same approach, which is standard vs actual = variance. Material, labour, variable overhead variances and sales variances use this approach, for example material price variance = (standard price x actual units) - actual cost or (standard price - actual price) x actual units, depending on what information is given. Standard price x actual units is equal to standard cost. As you can see, our aim is to compare the standards set with the actual result obtained. Actual result is always given, you must be careful about the standard. The name of the variance is important to identify what information is needed.

Another example, variable overhead efficiency variance = (standard cost/hour x actual unit - actual variable overhead) x standard cost/hour. Efficiency implies speed, so hours are relevant. Standard cost/hour x actual unit is equal to standard variable overhead. Now you can see that these formula are derived from the logic of standard vs actual, by using the correct information to identify the standard, you will calculate the correct variance.

Fixed overhead variances
This will be more troublesome and need few memory works.
Fixed overhead expenditure variance (easiest) = budgeted fixed overhead - actual fixed overhead. This only involves budget (not adjusted to actual activity level) compared to actual.
Fixed overhead volume variance (the word "volume" implies units) = (actual units - budgeted units) x standard fixed overhead per unit.
Fixed overhead capacity variance (the word "capacity" implies ability to work longer) = (actual hours - budgeted hours) x standard fixed overhead per hour. (If actual hours worked are longer, then it will be favourable variance)
Fixed overhead efficiency variance = (standard hours - actual hours) x standard fixed overhead per hour.
As you can see, the names of the variance help you to identify what information is needed, be careful of the standard fixed OAR used for volume, capacity and efficiency variances. Fixed overhead total variance is the mixed of the above and it is actually over/under-absorption of fixed overhead.

Labour idle time variance
When idle time occurs, idle time variance = idle time x standard cost/hour. This is always adverse unless company has budgeted a idle time which is higher than actual idle time.
The problem is what labour hours to use to calculate rate variance and efficiency variance? With understanding, actual hours paid are used in rate variance and actual hours worked are used in efficiency variance.

Identifying favourable or adverse variance
This is a common sense work, when your standard (expected result) is better than actual result, adverse variance occurs. Nothing to remember.

Variances analysis is a significant and big area, but it is very simple to calculate the variances once you practised enough questions and understand the logic. You may have different ways to calculate, use the way that you are most comfortable with. The key skill to learn should be the interpretation of variances (mainly for F5).

Tips to memorise - P1 eg. chairman's roles

P1 may seem overwhelmed with knowledge to learn and remember but actually there are many things that you don't need to memorise. For those that you need to memorise, you should always try to create mnemonics for aiding memory. But there is one approach better than using mnemonic but not always applicable, I call it "ideas from mnemonics". This technique brings you many ideas from the mnemonic itself. I will take chairman roles (you need to remember for exam) as example. (It is a best practice to separate chairman and chief executive)

Chairman roles - BINS

Board
1. Act as a leader of the board.
2. Ensure board's effectiveness.
3. Set board's agenda.
4. Promote culture of openness and debate in board.
5. Design appropriate induction programmes for new board members and training programmes for all directors.
6. Chair all meetings.
7. Ensure that board meetings take place on regular basis.
8. Ensure that board members' performance is formally evaluated on an annual basis.

Information
1. Ensure that directors receive accurate, timely and clear information.
2. Ensure that directors receive relevant information in advance of board meetings.

Non-executive directors (NEDs)
1. Hold separate meeting with NEDs.
2. Facilitate good relationships between EDs and NEDs.
3. Coordinate the contributions of NEDs.
4. Chairman, along with NEDs, should hold chief executive to account.

Shareholders
1. Represent company to shareholders and other stakeholders.
2. Ensure effective communication with shareholders (probably using chairman's statement or dialogue).

The above gives you some ideas, some roles can be linked. By only remembering BINS you can generate a number of ideas by yourself which is more effective than remember each role separately. Again, this technique is not always applicable and require some skills to do it. :)

Professional ethical principles - FAB/F8

International Federation of Accountants (IFAC) developed fundamental ethical principles for all professional accountants to follow and ACCA has adopted the similar principles. They can be examined in many ACCA papers, not only FAB and F8. It is relatively straightforward in FAB and slightly harder in F8. This article doesn't consider how it can be asked in P1.

Fundamental principles - COPPI or PICOP
1. Confidentiality - members should respect the information obtained as a result of professional and business relationships. They should not use such information for personal advantage nor disclose them without permission obtained.
2. Objectivity - judgement should not be influenced by bias, conflict of interest or undue influence by others. Professional or business judgement should be made fairly.
3. Professional competence and due care - members should continue to maintain professional knowledge and skill, undertaking various continuous professional development (CPD) programmes. Members should also act diligently when providing service.
4. Professional behaviour - members should avoid any actions that can discredit the profession, complying with laws and regulations will be one thing, behave in courtesy and consideration is another thing.
5. Integrity - members should be straightforward and honest in all professional or business relationships. Integrity is the highest level of honesty which also implies the need of fair dealing and truthfulness.

The ethical threats are also identified - FASSI
1. Familiarity threat - eg. audited the client for 10 years.
2. Advocacy threat - eg. represent client in a court case.
3. Self-interest threat - eg. holding shares in client's company.
4. Self-review threat - eg. providing audit and consultancy services.
5. Intimidation threat - eg. wife working in client's company.

FAB
In FAB, you only need to understand the above principles. Question may simply state the definition and ask you which is the principle. Also, question can ask you the ethical threats that can be found in the short case given. Always imagine that you are a very ethical person when you face any ethic questions, they are very straightforward and yet essential at higher level papers.

F8
Common question will require you to explain ethical threats and recommend safeguards from a case. Again, it is important that you become ethical first, then you might identify the points easily (be careful, stating the threat is "identify", to explain you need to understand why it can be a threat, this is the real F8 level). Safeguards are, most of the time, common sense but you need to practice questions.

Remember the above ideas for the rest of your professional life, we are professionals not only because of our technical competence, but because we keep professional ethics in mind and act in public interest. By entering this route means that we have sacrificed self-interest and we will do anything as long as it serves the public interest. :)

Improved conceptual framework for financial reporting (chapter 1 and 2) - P2

Conceptual framework is improved mainly to achieve convergence with US's framework as IASB and US FASB decided to focus on improving their existing framework rather than a comprehensive reconsideration of all concepts. Also, IFRS developed in future will be more consistent with this improved conceptual framework. Chapter 1 and 2 are actually completed and are examinable in P2.

Chapter 1: The objective of financial reporting
The fundamental objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors (including suppliers, employees and customers) in making decisions in their capacity as capital providers. General purpose financial reports are used both for future investment decisions and for assessing the stewardship of resources (management has a stewardship responsibility to protect the economic resources from unfavourable effects of economic factors and use the resources in an efficient manner) already committed to the entity. Management's performance in discharging stewardship responsibilities can affect entity's ability to generate net cash inflows, therefore potential capital providers are also interested in it.

Chapter 2: Qualitative characteristics and constraints of decision-useful financial reporting information
Reliability is no longer a qualitative characteristic of financial statement. Two fundamental qualitative characteristics are identified:
1. Relevance - information is relevant if it is capable of making a difference in the decisions made by capital providers. Such information has predictive value (can be used to form expectations about the future), confirmatory value (can be used to confirm past expectations) or both. Increasing use of fair value is an example of increasing relevance in favour of reliability.
2. Faithful representation - information should be faithfully represented and such information should be complete (include all necessary information about economic phenomenon), neutral (free from bias) and free from material error.

Enhancing qualitative characteristics are also identified to complement fundamental qualitative characteristics, these include:
1. Comparability - information enables users to identify similarities in and differences between two sets of economic phenomena. Such information should also enable comparison with another entity.
2. Verifiability - information helps users to assure that information faithfully represents the economic phenomena that it appears to represent. Verifiability implies that different knowledgeable and independent observers could reach general consensus that information is faithfully represented.
3. Timeliness - information is available to decision-makers in time to be capable of influencing their decisions.
4. Understandability - information enables users to comprehend its meaning. Understandability is enhanced when information is classified, characterised and presented clearly and concisely. It is assumed that users have a reasonable knowledge of business and economic activities and review and analyse information with diligence.

Fundamental qualitative characteristics differentiate useful information from information that is not useful or misleading. Enhancing qualitative characteristics differentiate more useful information from less useful information.

There are two constraints that limit the information provided in useful financial reports:
1. Materiality - information is material if its omission or misstatement affects the decisions made by the users on the basis of entity's financial information. It is not possible to specify a uniform quantitative threshold for determining whether information is material.
2. Cost - reporting some information imposes costs and those costs should be justified by the benefits of reporting that information. IASB assesses costs and benefits in relation to financial reporting generally, not solely in relation to individual reporting entities.

ED Revenue from contracts with customers - P2

ED proposes a single revenue recognition model in which entity recognises revenue as it satisfies performance obligation in the contract by transferring a promised good or service to customer. The use of percentage of completion method in IAS 11 is withdrawn. As the contract progresses, the remaining rights and obligations change, resulting in either contract asset (net right to receive consideration) or contract liability (net remaining performance obligations). In applying the model, 5 steps are followed:

1. Identifying the contract
One contract would be separated into two or more contracts accounted for separately if some goods or services are priced independently (if interdependently, then no need to separate).

2. Identifying separate performance obligations
This will determine whether to account the performance obligation separately or not. If goods or services are provided at the same time (performance obligations satisfied at the same time), then account for single performance obligation. If the performance obligations are distinct and satisfied at different times, then account for separate performance obligations. For example, sale of goods with one year warranty have two performance obligations, ie. sale of goods and sale of warranty.

3. Determine transaction price
The transaction price should reflect the probability-weighted amount of consideration that is expected to receive in exchange for delivering goods or services. If transaction price is variable (eg. subject to discounts), it will be estimated at each reporting date. Transaction price and revenue recognised include only amounts that can be estimated reasonably.

4. Allocating transaction price to separate performance obligations
Transaction price is allocated to separate performance obligations in proportion to their relative stand-alone selling prices. If it is not directly observable, use approaches such as expected cost plus margin approach or adjusted market assessment approach. Subsequent change in transaction price would be allocated to all performance obligations, including those satisfied.

5. Satisfying performance obligations
Performance obligation is satisfied when control is transferred to customer, ie. when customer has the ability to direct use of and receive benefit from the goods or services. Revenue is recognised when the performance obligation is satisfied.

Other proposals
1. Costs incurred in fulfilling the contract which are not eligible for capitalisation (eg. cost incurred to obtain a contract) under other IFRSs would be expensed unless they relate directly to future performance under a contract and are expected to be recovered, then they are recognised as separate asset.
2. Test would be conducted to identify performance obligations that are deemed onerous (expected directly related costs to satisfy obligation exceed allocated transaction price). If performance obligation is deemed onerous, contract loss is recognised resulting in impairment of assets related to the contract and/or recognise separate liability.

Presentation
Contract asset/liability is presented depending on the remaining rights and obligations in the contract. Contract costs capitalised would not be presented as part of contract asset/liability but according to their nature.

ED Fair value measurements - P2

There have been many problems in fair valuing an asset or liability because there are a number of ways to determine the fair value such as using exit price, net realisable value and so on. Efforts are focused on determining consistent fair value measurement method which an ED is proposed which is examinable in P2 2011 (actually IFRS 13 has been developed).

Fair value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly (ie. not forced) transaction between market participants at the measurement date. All fair value measurements will follow this definition. The following elements have to be determined:
1. Particular asset/liability that is the subject of the measurement.
2. For a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest and best use.
3. Principal or most advantageous market for the asset or liability.
4. Appropriate valuation techniques - consider availability of data with which to develop inputs and fair value hierarchy.

Market participants in most advantageous market
Market participants should not be related party, are knowledgeable, and willing to enter into the transaction. Most advantageous market is the market that maximises the amount that would be received on sale of the asset (or minimises the amount that would be paid to transfer the liability), taking into account transaction and transport costs. However transaction costs do not form part of the fair value measurement because they are not a characteristic of asset/liability.

Fair value hierarchy
The hierarchy categorises the inputs used in valuation techniques into three levels. It gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
Level 1 inputs are unadjusted quoted prices in active markets that the entity can assess at measurement date.
Level 2 inputs are inputs other than quoted market prices included in level 1 that are observable.
Level 3 inputs are unobservable inputs for the asset or liability, eg. interest rate swap.

Valuation techniques
There are three approaches for determining fair value using a valuation technique:
1. Market approach - uses prices and other relevant information generated by market transactions involving identical or comparable assets/liabilities. Eg. for level 1 inputs.
2. Income approach - converts future amounts (eg. cash flows or income and expenses) to a single discounted present value amount. Eg. for level 3 inputs.
3. Cost approach - use current replacement cost. Eg. for level 2 inputs.
An appropriate valuation technique will be consistently applied, will maximise the use of relevant observable inputs (minimise unobservable inputs) and will be calibrated periodically to actual transactions.

For more information you can refer to IFRS 13, this article did covered some of it. :)

IFRS 1 First Time Adoption of International Financial Reporting Standards - P2

This article covers the basic principles in IFRS 1. It states that first-time adopter must prepare an opening statement of financial position (SOFP) in accordance with IFRS on the date of transition from generally accepted accounting principle/practice (GAAP) to IFRS. Also, entity must select accounting policies based on IFRS. For example, if the entity adopts IFRS for the first time in financial statements year ended 31 December 2009, it should select accounting policies based on IFRSs effective at 31 December 2009 and prepare opening SOFP (restate retrospectively) as at 1 January 2008 (because IAS 1 requires full comparative financial statements to be presented, which will be 2009 and 2008 financial statements).

In preparing opening SOFP, the following rules should be followed unless IFRS 1 grants exemptions or prohibits retrospective application:
1. Eliminate previous GAAP assets and liabilities if they don't qualify for recognition under IFRSs.
2. Recognise assets and liabilities required by IFRS but previously not recognised under GAAP.
3. Reclassify previous GAAP assets/liabilities/equity into appropriate IFRS classification.
4. All recognised assets and liabilities should be measured according to IFRS principles.

First-time adopter should apply accounting policies consistently throughout the periods presented in its first IFRS financial statements. Transitional provisions in other IFRSs do not apply to first-time adopter. However, first-time adopter is allowed to elect to use one or more exemptions from general measurement and restatement principles such as:
1. Can use fair value of assets (property, plant and equipment, intangible assets, investment property) previously fair valued or revalued under GAAP as deemed cost under IFRS cost model. Deemed cost is an amount used as surrogate (substitute) for cost or depreciated cost.
2. Keep the original GAAP accounting for business combination that occurred prior to date of opening SOFP. If entity decides to retrospectively apply IFRS 3 to business combination, it must apply consistently to all business combinations occurring between date it decides to adopt IFRS 3 and date of transition.
3. Can recognise all cumulative actuarial gains and losses for all defined employee benefit plans.
4. Recognise all cumulative translation reserve under GAAP to retained earnings.

There are also mandatory exceptions to general measurement and restatement principles:
1. Conditions in IAS 39 for hedging relationship that qualifies for hedge accounting are applied at opening SOFP date, not retrospectively.
2. Apply derecognition requirements in IAS 39 prospectively for transactions occurring on or after 1 January 2004, not retrospectively unless needed information was obtained at the time of initial recognition of those transactions.

Overview of financial audit stages - F8

In the process of financial auditing, auditors go through a number of stages in order to arrive at the audit report.

1. Audit planning and risk assessment - In this stage, staffing is an important consideration. Furthermore, auditors will gain an understanding of the entity and its environment, particularly to assess the risk of material misstatements in financial statement. Audit procedures to be undertaken will be planned in detailed. (Timing = before year-end)

2. Test of control - Auditors will decide whether to rely on the internal controls of the company. This may first involve the use of internal control questionnaire (ICQ) and internal control evaluation questionnaire (ICEQ). The result will indicate whether the internal control is strong or weak. If it is strong then test of controls (TOC)/compliance testing will be undertaken to determine whether it is really strong. However if the internal control is perceived to be weak earlier, then auditors will follow a substantive approach (ignore TOC).
After TOC, if the internal controls are really strong, then a reduced substantive procedures can be performed later. If the internal controls are actually weak, then the full substantive procedures have to be undertaken. (Timing = before and/or after year-end)

3. Substantive procedure - If the internal controls are strong, auditors will rely more on substantive analytical procedures (comparing information to determine any material differences). If the internal controls are weak, auditors will rely more on test of details (select sample and find hard evidence to assure the amount recorded is correct). The purpose of substantive procedure is to substantiate financial statement assertions (eg. whether receivables are valued correctly). (Timing = after year-end)

4. Finalisation - review of subsequent events and going concern would be undertaken. Furthermore, an overall review of financial statements will be done which analytical procedure may be used. Any important matters that come to auditors' attention during the audit will be reported to management. Finally an independent auditor's report will be produced. (Timing = near and at the end of audit)

Foreign currency risk management - money market hedge - F9

Money market hedge may be difficult to understand. It involves the consideration of interest rate and exchange rate. However if you get the idea then it will be very easy to answer the question.

Hedging foreign currency receipt
In this case, we aim to create a foreign currency liability. Later when the money is received, we will use this money to settle this liability. With this, the foreign currency receipt will not be subjected to risk of fluctuation in exchange rate. By creating this liability, we borrow in foreign currency, by translating it to home currency we have a certain amount of money immediately which can be deposited to earn interest or invested.
Remember, in creating the foreign currency liability, we only need to borrow enough so you have to take into account the interest rate, ie. amount to borrow x (1 + borrowing interest rate) = foreign currency receipt.

Hedging foreign currency payment
This is just the opposite. We aim to create a foreign currency asset and later we will take the money out from this foreign currency account and pay the foreign currency payment. This means we will borrow home currency money and translate to foreign currency and deposit it (create foreign currency asset). With this, we are not subject to risk of fluctuation in exchange rate from the time we owe the money to the time we have to pay the money, therefore transaction risk is managed.
Remember, in creating the foreign currency asset (deposit), again we only need to borrow enough to deposit, ie. amount to deposit x (1 + depositing interest rate) = foreign currency payment.

With these basic ideas in mind, try to tackle some questions. :)

TARA framework for risk management - P1

TARA framework provides a simple idea of risk strategies. TARA stand for transference, avoidance, reduction and acceptance. Each strategy is suitable for different risks and it is the job of P1 students to be able to recommend suitable strategies for different risks by taking into account the information given.

Transfer
This means to share the risk with another party. Common example will be to buy an insurance to share part of the risk of losses with insurance company. For example, this strategy is suitable when the risk has a significant impact to the company but low probability to occur. It is better to transfer rather than reduce in this case because the risk may not occur. However transfer is limited if there is no alternative arrangements for bearing the risk.

Avoid
This means to avoid the activity that causes the risk. For example, this strategy is suitable when the risk is likely to occur and has a significant impact. However if it is strategically vital to undertake the activity, then transference or reduction may have to be undertaken.

Reduce
This means to reduce the risk exposure probably by carrying out the activity in a different way. For example, this strategy is suitable when the risk does not have significant impact but likely to occur. This is to reduce the likelihood of occurrence by using different method to carry out the activity. However if reduction cannot be done, company might have to accept the risk if it does not have significant impact or avoid it if otherwise.

Accept
This means to accept the risk and do nothing. For example, this strategy is suitable when the risk has a low impact and low probability of occurrence. This is because the risk is not really a matter even if it is realised.

The above only provides some examples on applying TARA. In exam, you have to decide based on the information given rather than remembering when to use which strategy. :)

IAS 12 Income taxes (part 2/2) - P2

Matching
Recognition of deferred tax in income tax expenses will ensure that the income tax as the percentage of profit before tax is consistent with the tax rate.

Rules to note
1. Temporary differences arising on the initial recognition of asset/liability are not subject to deferred tax because they affect neither accounting profit nor taxable profit.
2. Temporary difference arising on goodwill is not subject to deferred tax.
3. Deferred tax asset can only be recognised to the extent that future taxable profit will cover the deductible temporary difference.
4. Discounting is not allowed.
5. Deferred tax is revised whenever the tax rate changed as we should always use the rate expected to apply to the period. This ensures the best estimate of the amount. The adjustment will be shown separately.

Group financial statements
In P2, deferred tax can be examined as part of consolidation, some issues must be noted:
1. Fair value adjustment - the fair value adjustment at date of acquisition may not alter the tax base of subsidiary's net assets, temporary difference will occur. Deferred tax asset/liability will be included in fair value of subsidiary's net asset at acquisition in calculating goodwill.
2. Goodwill - as noted above, it is specifically disallowed to recognise deferred tax liability for temporary difference of goodwill (tax base is nil).
3. Unrealised profits - we remove unrealised profit from inventory which reduced the carrying value, but tax base is based on individual financial statements and so will be at higher transfer price. Deferred tax asset will arise and must be recognised.

Inconsistent with framework
Part of the definition of liability is "present obligation". However deferred tax liability arising on revaluation surplus may not satisfy the definition as there is no present obligation to pay the future tax, because if company did not sell the asset (no present obligation to sell), there will not be future tax payable because of the revaluation. Therefore, deferred tax asset/liability does not necessary meet the definition of asset or liability.

What if tax base is not clear
Sometime tax base may not be given, in this case you might have to ask yourself, "is there future tax payable/receivable?" If there is future tax payable, then there will be a taxable temporary difference, tax base might be zero. Such situation could be when company recorded accrued expenses which tax relief is only available when the expenses are paid, tax base will be zero and taxable temporary difference will arise.

It is all about understanding in P2, you have to think further and more detailed in order to provide good answer for a question. :)

IAS 12 Income taxes (part 1/2) - FFA/F7

In accounting, income tax is divided into current tax and deferred tax. Deferred tax is not examinable in FFA. Income tax expense is shown below profit before tax.

Current tax (FFA/F7)
Current tax payable is recognised as current liability (debit income tax expenses, credit current tax payable) and current tax recoverable (uncommon) is recognised as current asset. Since company estimates the current tax payable, there may be over or under-provision in prior year. When there is over-provision (credit balance in trial balance), we should debit over-provision, credit income tax expenses (Income statement). When there is under-provision (debit balance in trial balance), we debit income tax expenses (I/S), credit under-provision. Therefore, amount charged to income statement will be current tax payable + under-provision/- over-provision.

Deferred tax (F7)
Deferred tax is the future tax payable or receivable arising from temporary difference. Temporary difference = carrying value of asset/liability - tax base of asset/liability.
Tax base = amount valued for tax purposes. (For example, a machine is depreciated in accounting, but in tax company can claim capital allowance, so cost - depreciation = carrying value, cost - capital allowance = tax base).
You must be able to determine whether there is taxable temporary difference (this multiplies tax rate = deferred tax liability) or deductible temporary difference (this multiples tax rate = deferred tax asset).
A simple way is to arrange your formula of temporary difference like the above and then the temporary difference will be taxable when it is positive and deductible when it is negative.

Example: Carrying value of a machine is $300000 while its tax base is $350000, tax rate is 30%, determine the deferred tax.
Solution: Temporary difference = 300000 - 350000 = ($5000), ie. deductible temporary difference. (This is because in future the claim of capital allowance is more than depreciation, leading to future tax savings)
Deferred tax asset = 30% x 5000 = $1500, debit deferred tax asset (normally non-current asset), credit income tax expenses.

Deferred tax on revaluation (F7)
When an asset is revalued, the carrying value increases so there might be taxable temporary difference arising. In this case, because there is a revaluation reserve account, the deferred tax liability arising on revaluation surplus can be deducted from revaluation reserve, the remaining deferred tax liability is recorded as usual.

In FFA only current tax is examined. In F7 normally deferred tax liability will occur. The next part of this I will be dealing with those examinable in P2 only.