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Events after the reporting period are those events, favourable and unfavourable, that occur
between the statement of financial position date and the date when the financial statements are
authorised for issue.
Adjusting events are those that provide evidence of conditions that existed at the statement of
financial position date.
1. Examples of adjusting events include:
a. The settlement of a court case (which begun before the end of the reporting
period) after the reporting period; change is made to the provision for cash
b. The receipt of information indicating that an asset was impaired at the end of the
reporting period (e.g. bankrupt debtor or loss in value of stock)
c. The determination, after the accounting period, of the cost of assets purchased or
receipts from assets sold
d. The determination, after the reporting period, of the amount of profit-sharing or
bonus payments if the entity had an obligation before the end of the reporting
period to make such payments
e. The discovery of fraud or errors
2. An example of a non-adjusting event after the reporting period is a decline in market
value of investments between the end of the reporting period and the date when the
financial statements are authorised for issue. The decline in market value does not
normally relate to the condition of the investments at the dated of the reporting period,
but reflects circumstances that have arisen subsequently.
3. If an entity declares dividends to holders of equity instruments after the reporting period,
the entity shall not recognise those dividends as a liability at the end of the reporting

4. The following are examples of non-adjusting events after the reporting period that would
generally result in disclosure:

(a) a major business combination after the reporting period (IFRS 3 Business
Combinations requires specific disclosures in such cases) or disposing of a major
(b) announcing a plan to discontinue an operation;
(c) major purchases of assets, classification of assets as held for sale in accordance with
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, other disposals of
assets, or expropriation of major assets by government;
(d) the destruction of a major production plant by a fire after the reporting period;
(e) announcing, or commencing the implementation of, a major restructuring (see IAS
(f) major ordinary share transactions and potential ordinary share transactions after the
reporting period (IAS 33 Earnings per Share requires an entity to disclose a description of
such transactions, other than when such transactions involve capitalisation or bonus
issues, share splits or reverse share splits all of which are required to be adjusted under
IAS 33);
(g) abnormally large changes after the reporting period in asset prices or foreign
exchange rates;
(h) changes in tax rates or tax laws enacted or announced after the reporting period that
have a significant effect on current and deferred tax assets and liabilities (see IAS 12
Income Taxes);
(i) entering into significant commitments or contingent liabilities, for example, by issuing
significant guarantees; and
(j) commencing major litigation arising solely out of events that occurred after the
reporting period.
An entity shall disclose in the notes the amount of dividends proposed or declared before the
financial statements were authorised for issue but not recognised as a distribution to owners
during the period.
Dividends payable is a current liability.
A provision is a liability of uncertain timing or amount.
A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.

An obligating event is an event that creates a legal or constructive obligation that results in an
entity having no realistic alternative to settling that obligation.
A legal obligation is an obligation that derives from:
(a) a contract (through its explicit or implicit terms);
(b) legislation; or
(c) other operation of law.
A constructive obligation is an obligation that derives from an entitys actions where:
(a) by an established pattern of past practice, published policies or a sufficiently specific current
statement, the entity has indicated to other parties that it will accept certain responsibilities; and
(b) as a result, the entity has created a valid expectation on the part of those other parties that it
will discharge those responsibilities.
A contingent liability is:
(a) a possible obligation that arises from past events and whose existence will be confirmed only
by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability. A
contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.
This Standard distinguishes between:

(a) provisions which are recognised as liabilities (assuming that a reliable estimate can be
made) because they are present obligations and it is probable that an outflow of resources
embodying economic benefits will be required to settle the obligations; and
(b) contingent liabilities which are not recognised as liabilities because they are either:
(i) possible obligations, as it has yet to be confirmed whether the entity has a present obligation
that could lead to an outflow of resources embodying economic benefits; or
(ii) present obligations that do not meet the recognition criteria in this Standard (because either it
is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be
It is only those obligations arising from past events existing independently of an entitys future
actions (ie the future conduct of its business) that are recognised as provisions.
Because an obligation always involves a commitment to another party, it follows that a
management or board decision does not give rise to a constructive obligation at the end of the
reporting period unless the decision has been communicated before the end of the reporting
period to those affected by it in a sufficiently specific manner to raise a valid expectation in them
that the entity will discharge its responsibilities.
For the purpose of this Standard, an outflow of resources or other event is regarded as probable if
the event is more likely than not to occur, i.e. the probability that the event will occur is greater
than the probability that it will not. Where it is not probable that a present obligation exists, an
entity discloses a contingent liability, unless the possibility of an outflow of resources embodying
economic benefits is remote.

The best estimate of the expenditure required to settle the present obligation is the amount that an
entity would rationally pay to settle the obligation at the end of the reporting period or to transfer
it to a third party at that time.

Internal users (Primary Users) of accounting information include the following:

Management: for analyzing the organization's performance and position and taking
appropriate measures to improve the company results.

Employees: for assessing company's profitability and its consequence on their future
remuneration and job security.

Owners: for analyzing the viability and profitability of their investment and determining
any future course of action.

External users (Secondary Users) of accounting information include the following:

Creditors: for determining the credit worthiness of the organization. Terms of credit are
set by creditors according to the assessment of their customers' financial health. Creditors
include suppliers as well as lenders of finance such as banks.

Tax Authorities: for determining the credibility of the tax returns filed on behalf of the

Investors: for analyzing the feasibility of investing in the company. Investors want to
make sure they can earn a reasonable return on their investment before they commit any
financial resources to the company.

Customers: for assessing the financial position of its suppliers which is necessary for
them to maintain a stable source of supply in the long term.

Regulatory Authorities: for ensuring that the company's disclosure of accounting

information is in accordance with the rules and regulations set in order to protect the
interests of the stakeholders who rely on such information in forming their decisions.


The objectives of the IASB are:

Formulate and publish accounting standards to be used in the presentation of financial

Promote their worldwide acceptance and observance
Work to improve and harmonise regulations, accounting standards and procedures

The IASB, by developing high quality accounting standards, seeks to address a demand for high
quality information that is of value to all users of financial statements. High quality information
will also be of value to preparers of financial statements.
The objectives of the IASC Foundation and of the IASB are:
(a) to develop, in the public interest, a single set of high quality, understandable and enforceable
global accounting standards that require high quality, transparent and comparable information in
financial statements and other financial reporting to help participants in the worlds capital
markets and other users make economic decisions;
(b) to promote the use and rigorous application of those standards;
(c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the
special needs of small and medium-sized entities and emerging economies; and
(d) to bring about convergence of national accounting standards and International Accounting
Standards and International Financial Reporting Standards to high quality solutions.

Accounting standards allow for systematic presentation of financial reports by businesses all
around the world. This enables comparability between businesses and over time. Well-prepared
financial statements also maintain investor confidence and portray a transparent image of the
When corporations and other organisations comply with accounting standards, their general
purpose financial statements should be more comparable than they would otherwise be. This
allows investors and other users of the financial statements to better compare the organisations.
Importance of accounting standards:

Comparability The facilitating of comparability encourages foreign investment.

Transparency Prevents accountants from hiding certain information
Relevance Explains what reports should show
Enables information to be useful for all users

Financial statements also provide one means by which the management and governing body of
an organisation are accountable to those who provide resources to the organisation. The
provision of information for accountability purposes is a particularly important aspect of
financial reporting by public sector organisations and not-for-profit entities in the private sector

The main purpose of the IASB accounting conceptual framework is to:

Assist IASB and national accounting standard-setting bodies in developing accounting

Assist IASB in promoting harmonisation of accounting standards and procedures
Assist practitioners to prepare financial statements in accordance with IASs
Assist auditors in forming an opinion as to whether the financial statements prepared

conform with IASs

Assist users of financial statements in interpreting the information presented in the
financial statements


International Financial Reporting Standards (IFRS) are developed through an international
consultation process, the "due process", which involves interested individuals and organisations
from around the world.
The due process comprises six stages, with the Trustees of the IFRS Foundation having the
opportunity to ensure compliance at various points throughout:
1. Setting the agenda The IASB evaluates the merits of adding a potential item to its
agenda, also know as the work plan, mainly by reference to the needs of investors. The
IASB considers:

the relevance to users of the information and the reliability of information that could

be provided;
whether existing guidance is available;
the possibility of increasing convergence;
the quality of the standard to be developed; and
resource constraints.

To help the IASB in considering its future agenda, its staff are asked to identify, review and raise
issues that might warrant the IASBs attention. Potential agenda items may also arise from
comments from other standard-setters and other interested parties, the IFRS Advisory Council
and the IFRS Interpretations Committee or requests from constituents to interpret, review or
amend existing publications. The staff consider all such requests, summarise major or common
issues raised, and present them to the IASB from time to time as candidates for when the IASB is
next considering its agenda.
2. Planning the project When adding an item to its active agenda, the IASB also decides
whether to conduct the project alone or jointly with another standard-setter. A consultative

group may be established and a team is selected for the project. The project manager
draws up a project plan under the supervision of those Directors of Technical Activities
and Research.
3. Developing and publishing the Discussion Paper, including public consultation

Although a Discussion Paper is not mandatory, the IASB normally publishes it as its first
publication on any major new topic to explain the issue and solicit early comment from
constituents. Typically, a Discussion Paper includes a comprehensive overview of the
issue; possible approaches in addressing the issue; the preliminary views of its authors or
the IASB; and an invitation to comment. All discussions of technical issues related to the
draft paper take place in public sessions.
4. Developing and publishing the Exposure Draft, including public consultation
Irrespective of whether the IASB has published a Discussion Paper, an Exposure Draft is

the IASBs main vehicle for consulting the public. Unlike a Discussion Paper, an
Exposure Draft sets out a specific proposal in the form of a proposed Standard (or
amendment to an existing Standard). The development of an Exposure Draft begins with

the IASB considering issues on the basis of staff research and recommendations;
comments received on any Discussion Paper; and suggestions made by the IFRS
Advisory Council, Consultative groups and accounting standard-setters, and arising from
public education sessions. After resolving issues at its meetings, the IASB instructs the
staff to draft the Exposure Draft. When the draft has been completed, and the IASB
has balloted on it, the IASB publishes it for public comment.
5. Developing and publishing the Standard The development of an IFRS is carried out
during IASB meetings, when the IASB considers the comments received on the Exposure
Draft. After resolving issues arising from the Exposure Draft, the IASB considers
whether it should expose its revised proposals for public comment, for example by
publishing a second Exposure Draft. If the IASB decides that re-exposure is necessary,
the due process to be followed is the same as for the first Exposure Draft. When the IASB
is satisfied that it has reached a conclusion on the issues arising from the Exposure Draft,
it instructs the staff to draft the IFRS. A pre-ballot draft is usually subject to external
review, normally by the IFRIC. Shortly before the IASB ballots the Standard, a near-final
draft is posted on eIFRS. Finally, after the due process is completed, all outstanding
issues are resolved, and the IASB members have balloted in favour of publication, the
IFRS is issued.

6. Procedures after an IFRS is issued After an IFRS is issued, the staff and the IASB

members hold regular meetings with interested parties, including other standard-setting
bodies, to help understand unanticipated issues related to the practical implementation
and potential impact of its proposals. The IFRS Foundation also fosters educational
activities to ensure consistency in the application of IFRSs.
An alternative standard setting process may be listed as follows:

The IASB sets up a steering committee.

The steering committee identifies issues.
The steering committee studies national and regional requirements and practice.
The steering committee presents a point outline.
The point outline is converted into an exposure draft, which is sent out for discussion.

After comments and revisions, the exposure draft becomes an IAS (upon approval by the


The ICAC aspires to:
The objectives of the ICAC are to:

Promote internationally acceptable standards of best practice for the accountancy

profession in the Caribbean region.

Foster a strong, cohesive and self regulated regional accountancy profession.

Implement and coordinate an effective regional monitoring programme for practicing

accountants in the region

Promote an institutional framework through its annual conference for accountants in the
region to participate for mutual professional and fraternal benefit

Standardize qualification entry requirements and rules of professional conduct among

member Institutes

Provide leadership on emerging issues as they affect the accountancy profession in the

Promote, foster and maintain a decorous image of the accountancy profession in the

Establish professional levels of competence, character and integrity within accountants
Promote the highest standards of ethical conduct within the regions accountancy

profession in order to serve the publics interest

Promote harmonisation of regional accounting and auditing standards among member

Provide leadership on emerging issues pertaining to the accounting profession

Local accountancy institutions have the following responsibilities:

Issues practising certificates to members and renews them annually

Involved in the drafting of laws pertaining to business and accounting in the country
Holds seminars to ensure that members are able to meet the continuing professional

education requirements
Investigates accounting issues in the country
Issues accounting standard and auditing guidelines to assist local companies in following

Limitations of accounting information:

1. Only takes into account transactions which can be measured in monetary terms
2. The recording of financial transactions at historical cost in the books
3. Influenced by the personal judgment of the accountant, for example, in the method of
depreciation selected and approximations for provisions and intangible assets
Significance of accounting information:

Allows for decision-making

Provides for detection of inefficiencies
Provides accounting data to the Government to facilitate the payment of taxes
Summarises all financial information relating to the company and can be used to assess
how efficiently the firm is working

Objectives of financial reporting include:

1. is useful to existing and potential investors and creditors and other users in making rational
investment, credit, and similar decisions;
2. helps existing and potential investors and creditors and other users to assess the amounts,
timing, and uncertainty of prospective net cash inflows to the enterprise;
3. Identifies the economic resources of an enterprise, the claims to those resources, and the
effects that transactions, events, and circumstances have on those resources.

4. Helps managers to manage the business more efficiently but helping them to make informed

The information provided in financial statements should be presented in a way that makes it
comprehensible by users who have a reasonable knowledge of business and economic activities
and accounting and a willingness to study the information with reasonable diligence. However,
the need for understandability does not allow relevant information to be omitted on the grounds
that it may be too difficult for some users to understand.
The information provided in financial statements must be relevant to the decision-making needs
of users. Information has the quality of relevance when it is capable of influencing the economic
decisions of users by helping them evaluate past, present or future events or confirming, or
correcting, their past evaluations.
Information is materialand therefore has relevanceif its omission or misstatement could
influence the economic decisions of users made on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular circumstances of its
omission or misstatement. However, it is inappropriate to make, or leave uncorrected, immaterial
departures from the IFRS for SMEs to achieve a particular presentation of an entitys financial
position, financial performance or cash flows.
Reliability The information provided in financial statements must be reliable. Information is
reliable when it is free from material error and bias and represents faithfully that which it either
purports to represent or could reasonably be expected to represent. Financial statements are not
free from bias (ie not neutral) if, by the selection or presentation of information, they are
intended to influence the making of a decision or judgement in order to achieve a predetermined
result or outcome.
Substance over form

Transactions and other events and conditions should be accounted for and presented in
accordance with their substance and not merely their legal form. This enhances the reliability of
financial statements.
The uncertainties that inevitably surround many events and circumstances are acknowledged by
the disclosure of their nature and extent and by the exercise of prudence in the preparation of the
financial statements. Prudence is the inclusion of a degree of caution in the exercise of the
judgements needed in making the estimates required under conditions of uncertainty, such that
assets or income are not overstated and liabilities or expenses are not understated. However, the
exercise of prudence does not allow the deliberate understatement of assets or income, or the
deliberate overstatement of liabilities or expenses. In short, prudence does not permit bias.
To be reliable, the information in financial statements must be complete within the bounds of
materiality and cost. An omission can cause information to be false or misleading and thus
unreliable and deficient in terms of its relevance.
Users must be able to compare the financial statements of an entity through time to identify
trends in its financial position and performance. Users must also be able to compare the financial
statements of different entities to evaluate their relative financial position, performance and cash
flows. Hence, the measurement and display of the financial effects of like transactions and other
events and conditions must be carried out in a consistent way throughout an entity and over time
for that entity, and in a consistent way across entities. In addition, users must be informed of the
accounting policies employed in the preparation of the financial statements, and of any changes
in those policies and the effects of such changes.
To be relevant, financial information must be able to influence the economic decisions of users.
Timeliness involves providing the information within the decision time frame. If there is undue
delay in the reporting of information it may lose its relevance. Management may need to balance
the relative merits of timely reporting and the provision of reliable information. In achieving a
balance between relevance and reliability, the overriding consideration is how best to satisfy the
needs of users in making economic decisions.
Balance between benefit and cost
The benefits derived from information should exceed the cost of providing it. The evaluation of
benefits and costs is substantially a judgemental process. Furthermore, the costs are not

necessarily borne by those users who enjoy the benefits, and often the benefits of the information
are enjoyed by a broad range of external users.
Financial reporting information helps capital providers make better decisions, which results in
more efficient functioning of capital markets and a lower cost of capital for the economy as a
whole. Individual entities also enjoy benefits, including improved access to capital markets,
favourable effect on public relations, and perhaps lower costs of capital. The benefits may also
include better management decisions because financial information used internally is often based
at least partly on information prepared for general purpose financial reporting purposes.


The advancements in information technology have eventually led to the introduction of
Computerised Accounting Systems to help produce relevant and faithful representative financial
reports for both management and external users for decision making. These are associated with a
numbers of benefits like speed of carrying out routine transactions, timeliness, quick analysis,
accuracy and reporting. Posting transactions to the ledger, the principle of double entry can
largely be automated when done through the use of computerized accounting system.
There is a risk of improper human intervention with the computer programs and computer files.
Employees in the organization may temper with the computer programs and computer based
records for the purpose of deliberately falsifying accounting information.
Revenue reserves are funds set aside out of undistributed profits from the retained earnings
account. They are sometimes formed to maintain dividends at current rates even if profits fall in
the future or for future expansion while minimizing the source of external funds in the future.
Revenue reserves may be specific reserves or general reserves.
Amounts arising from the issue of shares at a premium or the revaluation of fixed assets are
classified as capital reserves. Capital reserves are not available for distribution as dividends.
While the formation of revenue reserves do not increase the net assets of the company, the
formation of capital reserves do.


Objectives of these include:

Mitigation of risks safeguarding of assets

Prevention and detection of errors documentation
Prevention and detection of theft and fraud separation of duties
Increased efficiency of budgetary procedures

Benefits of these include:

Reliable financial information

Protection of assets of the business

Adherence of laws and regulations

Effective and efficient operations

Authorisation, validation, recording, reconciliation, safeguarding of assets


Internal examine and evaluate the organisations financial and information systems,
management procedures, adherence to corporate policies and procedures, and internal
controls to ensure that records are accurate and controls are adequate to detect and protect
against fraud and waste of resources
External examine and evaluate the organisations financial health at the end of one
financial year and check if a companys accounts are drawn up in accordance with the
legal framework and accounting standards; study and evaluate the operation of those
internal controls upon which he/she wishes to rely on to determine the nature, timing and
extent of other external audit procedures.
External auditors usually perform sample tests of the accounts records by verifying the
debtors, creditors, inventory and other assets and liabilities.

*Look at conceptual framework of accounting


Admission of a Partner

Accounting for the admission of a partner may be done in various ways:

1. Contribution of assets to an existing partner There is no need to record the actual

assets paid to the existing partner as this is a personal transaction. The only entry to be
made is to show the change in capital.
Dr Partners capital (existing partner) Cr Partners capital (new partner)
The amount used in the above entry is based on the interest of the partnership acquired
and not the value of assets paid.

2. Contribution of intangible assets to/Purchasing of interest in an existing

partnership This method requires that existing assets of the original partnership be
revalued, previously unrecorded intangible assets be traced to the original partnership and
other intangible assets be traced to a new partner.
a. Bonus method
i. Calculate the book value of the new partnership after the injection of cash.
ii. Calculate the new partners interest in the new partnership.
iii. The difference between the cash invested and the interest acquired
represents a bonus to the existing partners, which must be shared between
them using their profit and loss ratio.
iv. If the cash invested is less than the interest acquired, the existing partners
give up some of their capital as a bonus to the new partner.

b. Goodwill method Goodwill is the difference between the value of a business as
a whole and the aggregate fair values of the separate net assets.
i. Calculate the implied capital of the new partnership based on the amount
of cash contributed for a certain percent interest.
ii. Calculate goodwill as the difference between this implied capital and the
actual book value of the new partnership.
iii. Allocate goodwill to existing partners.
1. If a goodwill account is not maintained in the books, credit it in the
old profit sharing ratio and debit it in the new profit sharing ratio.

Retirement of a Partner

Accounting for the retirement of a partner may be done in different ways:

1. Sale of interest to another partner There is no need to record the actual assets paid to
the retiring partner as this is a personal transaction. The only entry to be made is to show
the change in capital.
Dr Partners capital (retiring partner) Cr Partners capital (existing partner)
The amount used in the above entry is based on the interest of the partnership acquired
and not the value of assets paid.

2. Sale of interest to the partnership (bonus method) The interest of the partnership
sold will result in a decrease in both cash/bank and the capital of the retiring partner. The
difference between the cash received by the retiring partner and the interest in the
partnership is termed a bonus and is allocated to the other existing partners.

3. Sale of interest to the partnership (goodwill method)

a. Recording of goodwill attributable only to retiring partner The excess of the
cash/bank paid over the actual capital is treated as the goodwill of the retiring
partner and credited to the retiring partners capital account.
b. Recording of total goodwill The excess of cash/bank paid over the actual capital
is treated as the goodwill of the retiring partner. From this, total goodwill can be
calculated and recorded.

When a partner retires, his current account balance must be transferred to his capital
If goodwill is not recorded in the books, the goodwill must be reallocated in the new
profit sharing ratio between the existing partners.

Change in the Profit-sharing Ratio of a Partnership

When goodwill is recorded in the books Allocate existing goodwill to partners in the
old profit sharing ratio

When goodwill is not recorded in the books Allocated existing goodwill in the old
profit sharing ratio and write it off in the new profit sharing ratio

Allocate change in the value of assets to partners in the old profit-sharing ratio.

Revaluation of assets and goodwill

When this occurs, the goodwill account may be debited in the old profit-sharing ratio and
credited in the new. Both of these entries are transferred to the capital account.

Alternatively, the revaluation account can be credited with the total goodwill amount and
the capital account debited in the new ratio.

Any changes in the revaluation account are also recorded in the capital account.

Dissolution of a Partnership

1. All asset account balances other than cash are closed to the realisation account.
2. The proceeds from the disposal of the assets are credited to the realisation account and
debited to cash (except if a partner takes an asset).
3. All liability account balances are closed to the realisation account.
4. The payment made to creditors would be recorded in the realisation and cash accounts.
5. All liquidation expenses must be made and recorded in the realisation and cash accounts.
6. Where a partner wishes to take an asset for personal use, his capital account is debited
and that asset account credited and closed off. (This may have to pass through the
realisation account since the market value of the asset is used.)
7. All current accounts must be closed to the capital accounts.
8. The realisation account must be closed off to the partners capital accounts in their profitand-loss sharing ratio.
9. Any outstanding loans to the partners must be paid off.
10. Close off the cash and capital accounts.

When a partnership is sold, debit the capital account and credit the realisation account.

Incorporating a Partnership

All accounts are adjusted by the increases or decreases where necessary and the total
difference is transferred to the partners capital accounts in their profit-sharing ratio. A
temporary account called a valuation adjustment account is used to facilitate this.

The accumulated depreciation account is written off to the valuation adjustment account.

The balance in the valuation adjustment account is transferred to the partners capital

To record the issue of shares, debit the original capital account and credit the share capital

When the corporation retains the partnership books, the assets and liabilities are adjusted
to their fair value and a valuation adjustment account is created to accumulate the gains
and losses. This valuation account is then closed to the partners capital account in their
profit and loss ratio. These capital accounts are then closed to the share capital account.


Cash equivalents are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.

A single transaction may include cash flows that are classified differently. For example,
when the cash repayment of a loan includes both interest and capital, the interest element
may be classified as an operating activity and the capital element is classified as a
financing activity.

Operating activities principle revenue-producing activities of the enterprise and other

activities that are not investing or financing activities; indicator of the extent to which the
operations of the entity have generated sufficient cash flows to repay loans, maintain the
operating capability of the entity, pay dividends and make new investments without
recourse to external sources of financing; useful in forecasting future operating cash
Investing activities- the acquisition and disposal of long-term assets and other
investments not included in cash; the cash flows represent the extent to which

expenditures have been made for resources intended to generate future income and cash
Financing activities- activities that result in changes in the size and composition of equity
capital and borrowings of the enterprise; useful in predicting claims on future cash flows
by providers of capital to the entity
Reasons for producing a cash flow statement:
enables users to evaluate
o the changes in net assets of an entity
o the financial structure (including its liquidity and solvency) of the entity
o the ability of the entity to affect the amounts and timing of cash flows in order to
adapt to changing circumstances and opportunities
useful in assessing the ability of the entity to generate cash and cash equivalents and
enables users to develop models to assess and compare the present value of the future
cash flows of different entities
enhances the comparability of the reporting of operating performance by different entities
because it eliminates the effects of using different accounting treatments for the same
transactions and events
historical cash flow information is often used as an indicator of the amount, timing and
certainty of future cash flows
examining the relationship between profitability and net cash flow and the impact of
changing prices

Interest paid and interest and dividends received may be classified as operating cash
flows because they enter into the determination of profit or loss. Alternatively, interest
paid and interest and dividends received may be classified as financing cash flows and
investing cash flows respectively, because they are costs of obtaining financial resources
or returns on investments. Dividends paid may be classified as a financing cash flow
because they are a cost of obtaining financial resources. Alternatively, dividends paid
may be classified as a component of cash flows from operating activities in order to assist
users to determine the ability of an entity to pay dividends out of operating cash flows.


Solvency refers to an enterprise's capacity to meet its long-term financial commitments.

Liquidity refers to an enterprises ability to pay short-term obligations; the term also
refers to its capability to sell assets quickly to raise cash.

Liquidity Ratios
Current Assets
Current Liabilities

Current Ratio =

This ratio measures the ability of the entity to meet its short-term obligations with its
current assets. A general rule of thumb is that the current ratio should be 2:1. However,

this ratio does not tell the whole story as not all current assets may be easily converted
into cash as quickly as needed.
Quick Assets
Current Liabilities

Quick/ Acid Test Ratio =

Quick assets include cash, marketable securities, accounts receivable and current notes
receivable but do not include inventory and prepaid expenses.

This ratio provides a more rigorous test of an entitys ability to meet its short-term

Profitability Ratios

Profit is a function of sales and of how management uses its assets in generating profits.

Gross margin percentage =

This ratio measures the amount of returns an entity receives from sales by deducting its

Gross profit


cost of sales.
Net income

Net income percentage =

This ratio measures the amount of returns an entity receives from sales by deducting its


cost of sales and expenses.

Net income+ Effect of interest expense
Average total assets

Return on assets (ROA) =

This ratio measures the amount of returns an entity receives from investment in assets. It


is a measure of operating performance that indicates how effectively the assets have been
employed during the year.

Net income
Capital employed

Return on capital employed (ROCE) =

Capital employed includes common stock, reserves, and long-term liabilities.

This ratio measures the amount of returns an entity receives from its capital employed,


both owner-supplied funds and creditors.

The following profitability ratios are of great concern to investors.

Earnings per share (EPS) =

Net income available

common stockholders
Average number of common stockissue

Net income available to common stockholders = Profit after Tax Preference Dividends

This ratio measures the earning capacity of a share.

Price Earnings Ratio (PE)/ Earnings multiple =

This ratio informs investors of the amount of profits the share price represents. It shows

Market price of share

Earnings per share

the amount the investor can receive (or the number of times over the investor can receive
dividends per share) if shares are traded on the open market. A high PE ratio indicates it
is expected that the companys income will grow rapidly.

Dividend per share =

Total common stock dividends

Number of common stockissue

Dividend pay-out ratio =

Net income available

Total common stock dividends
common stockholders


Dividends per share of common shares

Earnings per share


(when top and bottom are divided by common stock in issue)

This ratio shows the proportion of income that is paid to the common shareholder in the
form of dividends. The dividend pay-out ratio that is best for the company depends on its
opportunities for growth, and the needs of the company for reinvestment.

Solvency Ratios

The degree to which an investor or business is utilizing borrowed money. Companies that
are highly leveraged may be at risk of bankruptcy if they are unable to make payments on
their debt; they may also be unable to find new lenders in the future.

Debt to asset ratio =

Total liabilities
Total assets

A leverage measure, this ratio measures the percentage of a companys assets that have
been financed with debt (short-term and long-term).

Debt to equity ratio =

Total liabilities
Total equity

The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets.

Times interest earned =

Operating profit+ other revenues

Interest expense

This ratio measures the firms ability to meet its interest payments out of its operating

Activity Ratios

Inventory turnover =

This ratio measures the number of times that the entity purchases inventory in the period.

Average collection period =

This ratio represents the average length of time that a business must wait after a credit

Cost of goods sold

Average inventory

Average accountsreceivable
Credit sales


sale before receiving cash.

Average accounts payable
Cost of goods sold

Average payment period =

This ratio represents the average length of time that a business takes before making a
cash payment to creditors.