Association of Accounting Technicians (AAT) Advanced Financial Reporting and Audit (Level 4) Flashcards

24 sample cards from the Advanced Financial Reporting and Audit (Level 4) deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. State the formula for the trade payables payment period (in days).

   $$\text{Payables days} = \frac{\text{Trade payables}}{\text{Credit purchases (or cost of sales)}} \times 365$$ It measures the average time taken to pay suppliers.

2. Define the working capital cycle and how it is calculated from the activity ratios.

   The working capital (cash operating) cycle is the time between paying for inventory and receiving cash from customers. $$\text{Cycle} = \text{Inventory days} + \text{Receivables days} - \text{Payables days}$$

3. State the gearing ratio formula (debt to capital employed basis) and what high gearing indicates.

   $$\text{Gearing} = \frac{\text{Non-current liabilities (debt)}}{\text{Total equity} + \text{Non-current liabilities}} \times 100\%$$ High gearing indicates greater reliance on borrowing and therefore higher financial risk.

4. State the interest cover ratio formula and what it measures.

   $$\text{Interest cover} = \frac{\text{Profit before interest and tax (PBIT)}}{\text{Finance costs (interest)}}$$ It measures how many times profit covers interest payments; a low figure signals difficulty meeting interest obligations.

5. State the formula for earnings per share (basic EPS).

   $$\text{EPS} = \frac{\text{Profit attributable to ordinary shareholders}}{\text{Weighted average number of ordinary shares}}$$

6. State the formula for the dividend cover ratio and what it indicates.

   $$\text{Dividend cover} = \frac{\text{Profit available to ordinary shareholders}}{\text{Dividends paid to ordinary shareholders}}$$ It shows how many times the dividend could have been paid from profits; higher cover means the dividend is more secure.

7. List three limitations of ratio analysis.

   Ratios are based on historical/past data; they can be distorted by different accounting policies and estimates; comparisons across firms or over time may be invalid due to differing year ends, size, or industry; and ratios ignore non-financial and qualitative factors.

8. Why must care be taken when comparing the ratios of two different companies?

   They may use different accounting policies (e.g. depreciation methods, inventory valuation), operate in different industries with different norms, be of different sizes, have different year-end dates, or have one-off items distorting figures, making like-for-like comparison unreliable.

9. When reporting financial performance to stakeholders, what should a good report consider?

   The information needs of the specific user (e.g. investors, lenders, employees), use of clear language with limited jargon, comparison to benchmarks/prior periods, inclusion of both financial and non-financial context, and a balanced (neutral) presentation of strengths and weaknesses.

10. Define internal control and state its main purpose.

    Internal control is the system of processes, policies and procedures designed and implemented by management to provide reasonable assurance of achieving objectives relating to reliable financial reporting, effective and efficient operations, safeguarding of assets, and compliance with laws and regulations.

11. Name the five components of an internal control system (COSO framework).

    Control environment, risk assessment, control activities, information and communication, and monitoring activities.

12. List four common types of internal control activities.

    Authorisation/approval, segregation of duties, physical controls over assets, reconciliations, and verification/checks (e.g. arithmetic and accounting controls). (Often summarised by the SPAMSOAP mnemonic.)

13. What is segregation of duties and why is it an important control?

    Dividing responsibilities so that no single person controls all stages of a transaction (e.g. authorising, recording, and custody of assets). It reduces the risk of error and fraud, because collusion would be required to conceal wrongdoing.

14. Distinguish the purpose of internal audit from that of external audit.

    Internal audit is an independent appraisal function within the organisation that evaluates and improves risk management, control and governance, reporting to management/the audit committee. External audit gives an independent opinion to shareholders on whether the financial statements give a true and fair view.

15. State two key differences between internal and external auditors in terms of appointment and reporting.

    Internal auditors are employees (or outsourced) appointed by and reporting to management/the audit committee; external auditors are appointed by the shareholders and report to them. Internal audit scope is set by management; external audit scope is largely set by statute and auditing standards.

16. What is a 'control weakness' (deficiency), and what should an auditor do when one is identified?

    A control weakness is a missing or ineffective control that fails to prevent or detect errors or fraud. The auditor should evaluate its potential consequence (impact and likelihood) and report it to management together with a practical recommendation to remedy it.

17. When evaluating a control weakness, what three elements should a recommendation typically address?

    The weakness/deficiency identified, the consequence or risk it creates (potential impact), and a specific, practical recommendation to correct it (the 'weakness–implication–recommendation' approach).

18. Define risk in the context of the finance function and name the broad stages of the risk management process.

    Risk is the chance of an event occurring that adversely affects the achievement of objectives. The risk management process: identify risks, assess/evaluate them (impact and likelihood), respond/treat them, and monitor and review.

19. List the four common strategies (the '4 T's') for responding to an identified risk.

    Tolerate (accept), Treat (reduce/control), Transfer (e.g. insure or outsource), and Terminate (avoid the activity).

20. Give two examples of risks specifically faced by the finance function.

    Fraud and misappropriation of cash/assets, errors in processing or recording transactions, cyber/data security breaches, non-compliance with regulations, and cash flow/liquidity risk. (Any two relevant examples.)

21. What is the difference between a preventive control and a detective control? Give an example of each.

    A preventive control stops errors or fraud before they occur (e.g. authorisation limits, passwords). A detective control identifies errors or fraud after they have occurred (e.g. bank reconciliations, exception reports).

22. Which IAS deals with intangible assets, and what is the basic rule for internally generated research costs?

    IAS 38 Intangible Assets. Research costs must be expensed to profit or loss as incurred; development costs may be capitalised only if specific criteria are met (technical feasibility, intention and ability to complete and use/sell, probable future benefits, reliable measurement).

23. Under IAS 16, how is a revaluation surplus on property accounted for?

    The gain on revaluation is credited to a revaluation reserve within equity and reported in other comprehensive income; it is not recognised in profit or loss (unless reversing a previous revaluation loss charged to profit or loss).

24. What does the 'going concern' assumption mean and why is it important to auditors?

    Going concern assumes the entity will continue in operation for the foreseeable future (at least 12 months) and so will not be liquidated. It underpins asset/liability valuations; auditors must assess whether the assumption is appropriate, as its failure significantly affects the financial statements.

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