CT2 Finance and Financial Reporting may seem to be a vast ocean of information but worry no more. Here is a compilation of some significant specifics based on an independent analysis of paper-setting that will guide a student through the important topics of the subject material.
Q. Potential Advantages of Limited Liability Partnership over a Traditional Partnership
Ans. The principle advantage of setting up a limited liability partnership is that it is responsible for its own liabilities. The partners’ personal assets will not be exposed to the same extent as that of a traditional partnership.
Potential creditors maybe concerned about any defaults by the LLP and would seek personal guarantees from the members. This may prove the business set up to be ineffective.
It is possible to lodge claims against any potential members in case of a default by the LLP. LLP may be reflected as a sign of lack of confidence by potential business contacts.
Q. Finance Lease Vs Borrowing the cost of the asset to purchase it outright
Ans. Finance Lease is attractive to both, the lessor and the lessee. The lessor retains the ownership of the asset in turn having a degree of security and the lessee is charged a lower finance charge than a standard bank loan.
On the other hand, a finance lease may prove to be inflexible if the lessee runs into a finance difficulty. In case of purchasing, the asset can be sold to use the proceeds to offset the loan
Q. Why would some individual taxpayers prefer receiving investment returns in the form of capital growth rather than tax?
Ans. There is usually a separate capital gain allowance which allows taxpayers to have an element of the capital gain which is tax-free. On the other hand, dividend is a part of a source of income and is taxed at the marginal rate.
There could also be a situation where the capital gain is taxed at a lesser rate than the dividend on the basis of the marginal rate.
Capital gain cannot be taxed until it is realized hence the payment of tax can be delayed by holding the shares.
It can prove to be advantageous by using the tax-free band to its full capacity.
Q. Aim and importance of International Accounting Standards
Ans. IAS reduces the variations between the way accounts are made and allows effective comparison between financial statements across all entities operating in the country.
They also oblige companies to disclose the accounts with in-depth detail that gives deeper insight to the users of accounts and makes it easier for them to make decisions.
Q. What is the relative importance of Profitability and Liquidity to the shareholders of a company?
Ans. The main purpose of a company is to generate profits which in turn increases the shareholder’s wealth and simultaneously, liquidity of a company must be maintained for the company to survive in the short term.
They’re both indirectly related. If a company remains profitable for a long period, it should be able to survive a liquidity crisis by generating cash from operations and further borrowing, if required.
Profitability is reflected on the financial statements and liquidity is reflected on cash flow statements.
Q. Why does Earnings Price Share hold more weightage than Diluted Earnings?
Ans. Here we consider warrants and other financial instruments that can be exercised at the discretion of the holder.
The diluted EPS is a projected EPS that reflects the diminished invested value in the event of exercising warrant rights to buy shares at a fixed price.
Hence, more focus is given on the EPS because future decisions will be based on past profitability. Also, the effectiveness of the board in managing the equity is determined by the EPS.
Q. Relevance of non-controlling interest in a set of consolidated financial statements to the shareholder of a parent company.
Ans. The non-controlling interest is the source of equity finance that funds a proportion of the assets owned by the subsidiary companies.
Any profits made by partly owned subsidiaries is to be shared between the parent shareholders and the NCI.
The financial recording of NCI is an indirect check kept on the parent shareholders to not abuse their control of the subsidiaries.
Group’s senior management are held accountable for the NCI. Profitability must reflect the finance invested by the NCI.
Q. The purpose of public announcements like “profit warnings”
Ans. Stock exchange rules force companies to announce “bad” news as soon as the events are known to control the volatility in the market. Last minute release of news may result in an overreaction by the market and a development of unrealistic assumptions, followed by a sudden disappointment.
Profit warnings prevent directors of the company to profit out of the situation by selling their shares in advance of the publication.
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