Financial Accounting and Tax Principles

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To be first examined in May 2005

Syllabus outline

The syllabus comprises:

Learning Aims

Students should be able to:

• describe the types of business taxation rules and requirements likely to affect a company (in respect of itself and its employees);
• describe and discuss how financial reporting can be regulated and the system of International Accounting Standards;
• prepare statutory accounts in appropriate form for a single company;
• assess and control the short term financial requirements of a business entity.

Assessment Strategy

There will be a written examination paper of three hours, with the following sections, as from the May 2007 exam.

• Section A - 40 marks
  A variety of compulsory objective test questions, each worth between two and four marks. Mini-scenarios may be given, to which a group of questions relate.
• Section B - 30 marks
  Six compulsory short answer questions, each worth five marks. A short scenario may be given, to which some or all questions relate.
• Section C - 30 marks
  From the May 2007 exam diet, Section C of Paper P7 Financial Accounting and Tax Principles will contain one compulsory question covering the preparation of at least two of the three key financial reporting statements - the income statement, balance sheet and cash flow statement.

Learning Outcomes and Syllabus Content

A - Principles of Business Taxation - 20%

Learning Outcomes

On completion of their studies students should be able to:

• identify the principal types of taxation likely to be of relevance to an incorporated business in a particular country, including direct tax on the company's trading profits and capital gains, indirect taxes collected by the company, employee taxation, withholding taxes on international payments;
• describe the features of the principal types of taxation likely to be of relevance to an incorporated business in a particular country (e.g. in terms of who ultimately bears the tax cost, withholding responsibilities, principles of calculating the tax base);
• describe the likely record-keeping, filing and tax payment requirements associated with the principal types of taxation likely to be of relevance to an incorporated business in a particular country;
• describe the possible enquiry and investigation powers of taxing authorities;
• identify situations in which foreign tax obligations (reporting and liability) could arise and methods for relieving foreign tax;
• explain the difference in principle between tax avoidance and tax evasion;
• describe sources of tax rules and explain the importance of jurisdiction;
• explain and apply the accounting rules contained in IAS 12 for current and deferred taxation.

Syllabus Content

• Concepts of direct versus indirect taxes, taxable person and competent jurisdiction.
• Sources of tax rules (e.g. domestic primary legislation and court rulings, practice of the relevant taxing authority, supranational bodies, such as the EU in the case of value added/sales tax, and international tax treaties).
• Direct taxes on company profits and gains:
  • The principle of non-deductibility of dividends and systems of taxation defined according to the treatment of dividends in the hands of the shareholder (e.g. classical, partial imputation and imputation).
  • The distinction between accounting and taxable profits in absolute terms (e.g. disallowable expenditure on revenue account, such as entertaining, and on capital account, such as formation and acquisition costs) and in terms of timing (e.g. deduction on a paid basis, tax depreciation substituted for book depreciation).
  • The nature of rules recharacterising interest payments as dividends.
  • Potential for variation in rules for calculating the tax base dependent on the nature or source of the income (schedular systems).
  • The need for rules dealing with the relief of losses.
  • The concept of tax consolidation (e.g. for relief of losses and deferral of capital gains on asset transfers within a group).
• Indirect taxes collected by the company:
  • In the context of indirect taxes, the distinction between unit taxes (e.g. excise duties based on physical measures) and ad valorem taxes (e.g. sales tax based on value).
  • The mechanism of value added/sales taxes, in which businesses are liable for tax on their outputs less credits for tax paid on their inputs, including the concepts of exemption and variation in tax rates depending on the type of output and disallowance of input credits for exempt outputs.
• Employee taxation:
  • The employee as a separate taxable person subject to a personal income tax regime.
  • Use of employer reporting and withholding to ensure compliance and assist tax collection.
• The need for record-keeping and record retention that may be additional to that required for financial accounting purposes.
• The need for deadlines for reporting (filing returns) and tax payments.
• Types of powers of tax authorities to ensure compliance with tax rules:
  • Power to review and query filed returns,
  • Power to request special reports or returns,
  • Power to examine records (generally extending back some years),
  • Powers of entry and search,
  • Exchange of information with tax authorities in other jurisdictions.
• International taxation:
  • The concept of corporate residence and the variation in rules for its determination across jurisdictions (e.g. place of incorporation versus place of management).
  • Types of payments on which withholding tax may be required (especially interest, dividends, royalties and capital gains accruing to non-residents).
  • Means of establishing a taxable presence in another country (local company and branch).
  • The effect of double tax treaties (based on the OECD Model Convention) on the above (e.g. reduction of withholding tax rates, provisions for defining a permanent establishment).
  • Principles of relief for foreign taxes by exemption, deduction and credit.
• The distinction between tax avoidance and tax evasion, and how these vary among jurisdictions (including the difference between the use of statutory general anti-avoidance provisions and case law based regimes).
• Accounting treatment of taxation and disclosure requirements under IAS 12.

Note: Examples of general principles should be drawn from a ‘benchmark’ tax regime (e.g. the UK, USA, etc) or an appropriate local tax regime. Details of any specific tax regime will NOT be examined.

B - Principles of Regulation of Financial Reporting - 10%

Learning Outcomes

On completion of their studies students should be able to:

• explain the need for regulation of published accounts and the concept that regulatory regimes vary from country to country;
• explain potential elements that might be expected in a regulatory framework for published accounts;
• describe the role and structure of the International Accounting Standards Board (IASB) and the International Organisation of Securities Commissions (IOSCO);
• explain the IASB’s Framework for the Presentation and Preparation of Financial Statements;
• describe the process leading to the promulgation of an international accounting standard (IAS);
• describe ways in which IAS’s can interact with local regulatory frameworks;
• explain in general terms, the role of the external auditor, the elements of the audit report and types of qualification of that report.

Syllabus Content

• The need for regulation of accounts.
• Elements in a regulatory framework for published accounts (e.g. company law, local GAAP, review of accounts by public bodies).
• GAAP based on prescriptive versus principles-based standards.
• The role and structure of the IASB and IOSCO.
• The IASB’s Framework for the Presentation and Preparation of Financial Statements.
• The process leading to the promulgation of a standard practice.
• Ways in which IAS’s are used: adoption as local GAAP, model for local GAAP, persuasive influence in formulating local GAAP.
• The powers and duties of the external auditors, the audit report and its qualification for accounting statements not in accordance with best practice.

C - Single Company Financial Accounts - 45%

Learning outcomes

On completion of their studies students should be able to:

• prepare financial statements in a form suitable for publication, with appropriate notes;
• prepare a cash flow statement in a form suitable for publication;
• explain and apply the accounting rules contained in IAS’s dealing with reporting performance, tangible fixed assets and inventories;
• explain the accounting rules contained in IAS’s governing share capital transactions;
• explain the principles of the accounting rules contained in IAS’s dealing with disclosure of related parties to a business, construction contracts (and related financing costs), research and development expenditure, intangible fixed assets (other than goodwill on consolidation), impairment of assets, post-balance sheet events, contingencies, and leases (lessee only).

Syllabus Content

• Preparation of the financial statements of a single company, including the statement of changes in equity (IAS 1).
• Preparation of cash flow statements (IAS 7).
• Reporting performance: recognition of revenue, measurement of profit or loss, extraordinary items, prior period items, discontinuing operations and segment reporting (IAS 1, 8, 14, 18 & 35).
• Property, Plant and Equipment (IAS 16): the calculation of depreciation and the effect of revaluations, changes to economic useful life, repairs, improvements and disposals.
• Inventories (IAS 2).
• Issue and redemption of shares, including treatment of share issue and redemption costs (IAS 32 and IAS 39), the share premium account, the accounting for maintenance of capital arising from the purchase by a company of its own shares.
• The disclosure of related parties to a business (IAS 24).
• Construction contracts and related financing costs (IAS 11 & 23): determination of cost, net realisable value, the inclusion of overheads and the measurement of profit on uncompleted contracts.
• Research and development costs (IAS 38): criteria for capitalisation.
• Intangible Assets (IAS 38) and goodwill (excluding that arising on consolidation): recognition, valuation and amortisation.
• Impairment of Assets (IAS 36) and its effect on the above.
• Post-balance sheet events (IAS 10).
• Provisions and contingencies (IAS 37).
• Leases (IAS 17) - Operating and finance leases in the books of the lessee.

D - Managing Short Term Finance - 25%

Learning Outcomes

On completion of their studies students should be able to:

• calculate and interpret working capital ratios for business sectors;
• prepare and analyse cash-flow forecasts over a twelve-month period;
• identify measures to improve a cash forecast situation;
• compare and contrast the use and limitations of cash management models and identify when each model is most appropriate;
• analyse trade debtor information;
• evaluate debtor and creditor policies;
• evaluate appropriate methods of stock management;
• identify alternatives for investment of short-term cash surpluses;
• identify sources of short-term funding;
• identify appropriate methods of finance for trading internationally.

Syllabus Content

• Working capital ratios (e.g. debtor days, stock days, creditor days, current ratio, quick ratio) and the working capital cycle.
• Working capital characteristics of different businesses (e.g. supermarkets being heavily funded by creditors) and the importance of industry comparisons.
• Cash-flow forecasts, use of spreadsheets to assist in this in terms of changing variables (e.g. interest rates, inflation) and in consolidating forecasts.
• Variables that are most easily changed, delayed or brought forward in a forecast.
• The link between cash, profit and the balance sheet.
• The Baumol and Miller–Orr cash management models.
• The credit cycle from receipt of customer order to cash receipt.
• Evaluation of payment terms and settlement discounts.
• Preparation and interpretation of age analyses of debtors and creditors.
• Establishing collection targets on an appropriate basis (e.g. motivational issues in managing credit control).
• The payment cycle from agreeing the order to make payments.
• Centralised versus decentralised purchasing.
• The relationship between purchasing and stock control.
• Principles of the economic order quantity (EOQ) model and criticisms thereof.
• Types and features of short-term finance: trade creditors, overdrafts, short-term loans and debt factoring.
• Use and abuse of trade creditors as a source of finance.
• The principles of investing short term (i.e. maturity, return, security, liquidity and diversification).
• Types of investments (e.g. interest-bearing bank accounts, negotiable instruments including certificates of deposit, short-term treasury bills, and securities).
• The difference between the coupon on debt and the yield to maturity.
• Export finance (e.g. documentary credits, bills of exchange, export factoring, forfaiting).

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