NPV is an important term where you will see it in a lot of your FIA/ACCA papers. Its meaning must be understood in detailed. This article is intended to give an idea about NPV.
Definition
CIMA Official Terminology gives this technical definition: difference between the sum of the projected discounted cash inflows and outflows attributable to a capital investment or other long-term project. In simple words, NPV = present cash flows + future cash flows converted to present values.
Making decision
The decision criteria is to accept a project with positive NPV (but you must also consider non-financial factors such as legal requirement, social responsibility etc). This is because positive NPV project will be able to increase company's value and therefore shareholders wealth.
But what if NPV is zero? In this case, the project is still acceptable, why? This is because it means that the project will not increase/decrease company's value, but the project is still making profit (it can be loss as well). However, in practice management will not accept such project as it is not meeting the company's (stock market listed companies) financial objective of maximising shareholders wealth.
Other uses - F7/P2
The concept of NPV is used in other areas as well. For example, in financial reporting, the term value in use (IAS 36) means the discounted present value of the future cash flows expected to arise from the continuing use of an asset and from the disposal at the end of its useful life. This is actually the NPV of the asset (not considering investment cost). The concept of NPV must be understood and applied in other situations.
Discount rate
This is the rate to be used to convert the future cash flows into present value. For a project it is normally the company's cost of capital (required rate of return by investors of the capital). Therefore, to calculate NPV, you have to first estimate a relevant cost of capital (will be given in FIA papers). Present value table and annuity table will be given in exam, you have to extract the correct rates relevant for different time periods to be used to calculate NPV.
Finally, we can conclude that NPV considers relevant cash flows rather than profits (profits include non-cash items such as depreciation, provision). NPV also considers time value of money (therefore, cash flows in different time periods are discounted/converted to present value at different rates).
Friday, December 30, 2011
Thursday, December 29, 2011
Tucker's 5 questions model - P1
One of the useful models for ethical decision making is the Tucker's 5 questions model. In this model, you ask 5 questions to determine whether a decision is ethical. The 5 questions are:
1. Is it profitable?
2. Is it legal?
3. Is it sustainable/environmentally sound?
4. Is it right?
5. Is it fair?
You will find that answering the first 3 will be straightforward. However right and fairness require judgement. One way to put is "is it right to shareholders" (for profit making companies) and "is it fair to stakeholders" although there are many ways to express ideas.
In exam, don't just say 'yes or no'. You should also justify your 'yes or no' to get maybe 2 marks per question. If majority is 'yes', then the decision may be ethical. :)
1. Is it profitable?
2. Is it legal?
3. Is it sustainable/environmentally sound?
4. Is it right?
5. Is it fair?
You will find that answering the first 3 will be straightforward. However right and fairness require judgement. One way to put is "is it right to shareholders" (for profit making companies) and "is it fair to stakeholders" although there are many ways to express ideas.
In exam, don't just say 'yes or no'. You should also justify your 'yes or no' to get maybe 2 marks per question. If majority is 'yes', then the decision may be ethical. :)
Friday, December 23, 2011
IFRS 11 Joint Arrangements - P2
IAS 31 has been replaced by IFRS 11 and the changes will be outlined here. Joint arrangement is an arrangement of which two or more parties have joint control, ie. contractually agreed sharing of control. Definition of control follows the one defined in IFRS 10.
Types of joint arrangements
There are only two types:
1. Joint operation - parties (joint operators) have rights to the assets and obligations for the liabilities relating to the joint arrangement.
2. Joint venture - parties (joint venturers) have rights to the net assets of the joint arrangement.
Accounting
1. Joint operator accounts for assets, liabilities, revenues and expenses in accordance with relevant IFRSs and only include the portion of share.
2. Joint venturer accounts for the investment using equity method (no more proportionate consolidation) in accordance with IAS 28. This means to present in statement of financial position initially at cost and subsequently increase/decrease with any share of profit/loss.
Therefore, the main changes are the classification of joint arrangement and the accounting for joint venture. This article does not intended to cover IFRS 11 in detailed.
Types of joint arrangements
There are only two types:
1. Joint operation - parties (joint operators) have rights to the assets and obligations for the liabilities relating to the joint arrangement.
2. Joint venture - parties (joint venturers) have rights to the net assets of the joint arrangement.
Accounting
1. Joint operator accounts for assets, liabilities, revenues and expenses in accordance with relevant IFRSs and only include the portion of share.
2. Joint venturer accounts for the investment using equity method (no more proportionate consolidation) in accordance with IAS 28. This means to present in statement of financial position initially at cost and subsequently increase/decrease with any share of profit/loss.
Therefore, the main changes are the classification of joint arrangement and the accounting for joint venture. This article does not intended to cover IFRS 11 in detailed.
Thursday, December 22, 2011
IFRS 10 Consolidated Financial statements - control - F7/P2
"Control" is a very important term in business combinations. We (investor/parent) start to consolidate subsidiaries (investee) at the date of control obtained and also calculate goodwill. IFRS 10 gives a revised definition for control.
Control
Investor has the control when he/it has power, exposed to risk and can use power to affect the amount of return.
Power
This is the power to direct relevant activities. Power arises from rights such as voting rights or contractual arrangement.
Exposure
The investor must be exposed to variability of returns as a result of involvement with an investee.
Ability to use power
Investor must also have the ability to use its power over investee to affect its return from its involvement with the investee.
The assessment of control will not be straightforward and a great amount of judgement will be involved.
Note that IFRS 10 is only applicable for annual reporting periods beginning on or after 1 Jan 2013. :)
Control
Investor has the control when he/it has power, exposed to risk and can use power to affect the amount of return.
Power
This is the power to direct relevant activities. Power arises from rights such as voting rights or contractual arrangement.
Exposure
The investor must be exposed to variability of returns as a result of involvement with an investee.
Ability to use power
Investor must also have the ability to use its power over investee to affect its return from its involvement with the investee.
The assessment of control will not be straightforward and a great amount of judgement will be involved.
Note that IFRS 10 is only applicable for annual reporting periods beginning on or after 1 Jan 2013. :)
Friday, December 9, 2011
F4 Finish on time
The main problem in F4 is not about the difficulties of the questions, it is about whether you can finish the questions within 3 hours. 15 minutes reading time are very important to achieve the objective of completing the questions.
What to do in 15 minutes
Look at the time, when it is very near to the start time, prepare to open the question paper and when you hear a sound from the announcer, immediately look at question 8, 9 and 10. Write down points for each of them as much as possible, therefore you should read the case given as well. If you do have time left, start writing points for question 1-7 until you hear a sound from the announcer again, then start writing answer for question 8, 9 and 10 (or questions from 1-7 that had been planned). With your points, this will become an essay writing activity where you just expand the points into sentences.
Another approach will be to focus on planning your answer first, give yourself a maximum of 30 minutes including reading time. A good plan will speed up the work later.
It is good that you practice writing fast, don't stop and think (this can be avoided with a proper plan), you should leave the difficult questions to be done last. The most important thing is you should finish all questions to enhance your chance of passing significantly. Good luck :)
What to do in 15 minutes
Look at the time, when it is very near to the start time, prepare to open the question paper and when you hear a sound from the announcer, immediately look at question 8, 9 and 10. Write down points for each of them as much as possible, therefore you should read the case given as well. If you do have time left, start writing points for question 1-7 until you hear a sound from the announcer again, then start writing answer for question 8, 9 and 10 (or questions from 1-7 that had been planned). With your points, this will become an essay writing activity where you just expand the points into sentences.
Another approach will be to focus on planning your answer first, give yourself a maximum of 30 minutes including reading time. A good plan will speed up the work later.
It is good that you practice writing fast, don't stop and think (this can be avoided with a proper plan), you should leave the difficult questions to be done last. The most important thing is you should finish all questions to enhance your chance of passing significantly. Good luck :)
Monday, December 5, 2011
F7 Finish on time
F7 may be a time-consuming paper but if your approach is right, you should be able to finish the paper easily.
What to do in 15 minutes reading time?
1. Calculate the percentage of control in question 1, then leave it.
2. Calculate the relevant ratios in question 3, then leave it.
3. Write points for question 4 and 5 (ignore question 5 if it has more calculation).
4. If you still have time, write down double entry beside each note in question 1.
5. If you still have time, write down double entry beside each note in question 2.
The 15 minutes reading time are very important, they are for you to plan your answer and if you have properly planned the answer, it will save you invaluable time later.
Answering question 1 and 2
You are normally required to open statements. To save time, you should only add vertically and not horizontally, ie. don't bother about balancing your statement of financial position, leave this job at the end when you have spare time. Also, maintain a "don't care" attitude, don't think too much about the note, just leave it or guess the adjustment first if you don't know or not sure about it, come back when you have spare time (which you should have if you maintain this attitude).
With this exam technique, you can even have 30 minutes spare time or more. You have one chance only in exam so you should try these techniques in a past year paper first, give yourself 2 hours 45 minutes to do it. If you can finish the paper then you will be fine in exam. All the best :)
What to do in 15 minutes reading time?
1. Calculate the percentage of control in question 1, then leave it.
2. Calculate the relevant ratios in question 3, then leave it.
3. Write points for question 4 and 5 (ignore question 5 if it has more calculation).
4. If you still have time, write down double entry beside each note in question 1.
5. If you still have time, write down double entry beside each note in question 2.
The 15 minutes reading time are very important, they are for you to plan your answer and if you have properly planned the answer, it will save you invaluable time later.
Answering question 1 and 2
You are normally required to open statements. To save time, you should only add vertically and not horizontally, ie. don't bother about balancing your statement of financial position, leave this job at the end when you have spare time. Also, maintain a "don't care" attitude, don't think too much about the note, just leave it or guess the adjustment first if you don't know or not sure about it, come back when you have spare time (which you should have if you maintain this attitude).
With this exam technique, you can even have 30 minutes spare time or more. You have one chance only in exam so you should try these techniques in a past year paper first, give yourself 2 hours 45 minutes to do it. If you can finish the paper then you will be fine in exam. All the best :)
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