Financial Analysis

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First examined in May 2005

Syllabus outline

The syllabus comprises:

Learning aims

Students should be able to:

• prepare consolidated accounts and explain the accounting principles associated with this area, such as changes part way through an accounting period and in the merger method;
• appropriately employ relevant accounting standards;
• evaluate a business entity’s financial statements and provide analysis of performance;
• explain the problems of profit measurement and alternative approaches to asset valuations;
• discuss and evaluate current developments in external reporting.

Assessment strategy

There will be a written examination paper of three hours, with the following sections.

• Section A - 20 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
  Three compulsory medium answer questions, each worth 10 marks. Short scenarios may be given, to which some or all questions relate.
• Section C – 50 marks
  Two questions, from a choice of three, each worth 25 marks. Short scenarios may be given, to which questions relate.

Learning outcomes and syllabus content

A - Group Financial Statements - 35%

Learning outcomes

On completion of their studies students should be able to:

• explain the conditions required for an undertaking to be a subsidiary or an associate of another company;
• explain and apply the rules for the exclusion of subsidiaries from consolidation;
• prepare a consolidated income statement, balance sheet and cash flow statement for a group of companies;
• explain and apply the concepts of fair value at the point of acquisition and impairment of goodwill;
• identify the impact on group financial statements when a subsidiary is acquired or disposed of part way through an accounting period (to include the effective date of acquisition and dividends out of pre-acquisition profits) and where shareholdings, or control, are acquired in stages;
• explain the concept of an associate and a joint venture, and the principles of how they are accounted for;
• explain the pooling of interests method of consolidation;
• compare and contrast pooling of interests, acquisition and equity methods of accounting;
• explain the principles of accounting for a capital reconstruction scheme or a demerger;
• explain foreign currency translation principles, including the difference between the closing rate/net investment method and the historical rate method;
• explain the correct treatment for foreign loans financing foreign equity investments.

Syllabus content

• Relationships between investors and investees, and the exclusion of subsidiaries from consolidation with reference to dominant influence, participating interest, management on a unified basis and significant influence.
• The preparation of consolidated financial statements (including the group cash flow statement) involving one or more subsidiaries, sub-subsidiaries and associates, under the acquisition and pooling of interests methods (IAS 7, 22 & 27).
• The treatment in consolidated financial statements of minority interests, pre- and post- acquisition reserves, goodwill (including its impairment), fair value adjustments, intra-group transactions and dividends, piece-meal and mid-year acquisitions, and disposals to include sub-subsidiaries and mixed groups.
• The accounting treatment of associates and joint ventures (IAS 28 & 31) using the equity method and proportional consolidation method.
• The accounting entries for mergers, demergers and capital reconstruction schemes.
• Foreign currency translation (IAS 21) to include overseas transactions and investments in overseas subsidiaries.

B - The Measurement of Income and Capital - 20%

Learning outcomes

On completion of their studies students should be able to:

• explain the problems of profit measurement and alternative approaches to asset valuations;
• explain measures to reduce distortion in financial statements when price levels change;
• discuss the principle of substance over form applied to a range of transactions;
• discuss the possible treatments of financial instruments in the issuer's accounts (i.e. liabilities versus equity, and the implications for finance costs);
• identify circumstances in which amortised cost, fair value and hedge accounting are appropriate for financial instruments, and explain the principles of these accounting methods;
• discuss the recognition and valuation issues concerned with pension schemes and the treatment of actuarial deficits and surpluses.

Syllabus content

• The problems of profit measurement and the effect of alternative approaches to asset valuation; current cost and current purchasing power bases and the real terms system; accounting for changing prices (IAS 15) and hyper inflation (IAS 29).
• The principle of substance over form (IAS 1) and its influence in dealing with transactions such as sale and repurchase agreements, consignment stock, debt factoring, securitised assets, loan transfers and public and private sector financial collaboration.
• Financial instruments classified as liabilities or shareholders funds and the allocation of finance costs over the term of the borrowing (IAS 32 & 39).
• The measurement and disclosure of financial instruments (IAS 39).
• Retirement benefits, including pension schemes - defined benefit schemes and defined contribution schemes, actuarial deficits and surpluses (IAS 19).

C - Analysis and Interpretation of Financial Accounts - 35%

Learning outcomes

On completion of their studies students should be able to:

• calculate and interpret a full range of accounting ratios;
• analyse financial statements (in the context of information provided in the accounts and corporate report) to comment on performance and position;
• prepare a concise report on the results of an analysis of financial statements;
• explain the limitations of accounting ratio analysis and analysis based on financial statements;
• prepare and interpret segmental analysis, inter-firm and international comparisons.

Syllabus content

• Ratios in the areas of performance, profitability, financial adaptability, liquidity, activity, shareholder investment and financing, and their interpretation.
• Calculation of Earnings per Share under IAS 33, to include the effect of bonus issues, rights issues and convertible stock.
• Interpretation of financial statements via the analysis of the accounts and corporate reports.
• Reporting the results of analysis.
• Limitations of ratio analysis (e.g. comparability of businesses and accounting policies).
• The identification of information required to assess financial performance and the extent to which financial statements fail to provide such information.
• Segment analysis: inter-firm and international comparison (IAS 14).
• Interpretation of financial obligations included in financial accounts (e.g. redeemable debt, earn-out arrangements, contingent liabilities).
• The effect of short-term debt on the measurement of gearing.
• The need to be aware of aggressive or unusual accounting policies (“creative accounting”), (e.g. in the areas of cost capitalisation and revenue recognition).

D - Developments in External Reporting - 10%

Learning outcomes

On completion of their studies students should be able to:

• discuss pressures for extending the scope and quality of external reports;
• explain how financial information concerning the interaction of a business with the natural environment can be communicated in the published accounts;
• identify those environmental issues which should be disclosed;
• explain the process of measuring, recording and disclosing the effect of exchanges between a business and society - human resource accounting;
• identify the influences on financial reporting of cultural differences across the world;
• identify major differences between IAS’s and US GAAP.

Syllabus content

• Increasing stakeholder demands for information that goes beyond historical financial information and the model for an expanded Operating and Financial Review (OFR) proposed by the UK government.
• Environmental and social accounting issues, differentiating between environmental measures and environmental losses, capitalisation of environmental expenditure, and the recognition of future environmental costs by means of provisions.
• The Global Reporting Initiative: non-financial measures of environmental impact.
• Human resource accounting.
• The influence of different cultures on financial reporting.
• Pressures for improved quality of financial reporting following large scale corporate collapses in the US and UK, and implications for corporate governance and external audit.
• Major differences between IAS’s and US GAAP.

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