Assignment : 2

Submitted By : Haroon Akram

Sap Id : 70073604

Date : Nov 8,2019

Submitted To : Sir Muhammad Kaleemullah

Q 1 : Describe the roles of the statement of financial position, statement of comprehensive
income, statement of changes in equity, and statement of cash flows in evaluating a company’s
performance and financial position.

Statement of financial position

The statement of financial position (also called balance sheet), so statement of financial position
discloses resources that a company has control over (assets), obligations to its lenders and other
creditors (liabilities) and the excess of the assets over the liabilities (Owner’s equity).

Statement of comprehensive income

It informs how much revenue a company has generated versus the expenses incurred to generate
the profit or loss made over the specified period of time.

Statement of changes in equity

It provides information on the increase or decrease in owner’s investments in a company over

time.

Statement of cash flows

The statement of cash flows discloses a company’s sources and uses of cash. Cash flows
information are classified into three categories i) Operating cash flows ii) Cash flows from
investing activities iii) Cash flows from investing activities.

Q 2 : Describe the importance of financial statement notes and supplementary information—

including disclosures of accounting policies, methods, and estimates—and management’s
commentary.

Importance of financial statement notes

They provide important disclosures such as the basis of preparation, the reporting currency, and
the accounting policies, methods and estimates that have been used in preparing the financial
statements.

Supplementary information
Supplementary information on financial risks, contingencies, operating segments performances
and related party transactions assist analysts in arriving at expectations on a company’s future
performance.

Management’s commentary

It provides information on a company’s results of operations, planned capital expenditure and

future outlook.

Q3:

A. Describe the objective of external audit of financial statements.

The objective of external audit report is to provide full assurance to investors

and financial market participants that a company's accounting records are fair, complete and in
adherence with generally accepted accounting principles, industry standards and regulatory
requirements.

B. Describe the meaning of “reasonable assurance” in the context of external audit.

Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary
for the auditor to conclude that there are no material misstatements in the financial statements
taken as a whole.

C. It has been suggested that the most important matter affecting the credibility of the
auditor is that of ‘independence’. What is auditor independence? Explain the threats to
auditor independence.

Auditor independence refers to the independence of the internal auditor or of the external auditor
from parties that may have a financial interest in the business being audited. Independence
requires integrity and an objective approach to the audit process.

Threats

Self-interest auditor has financial or other interest in organization. Auditor owns shares or
loans money to organization.
Self-review auditor installs payroll system then reviews it during audit.

Advocacy encouraging investors to buy bonds or shares of organization.

Familiarity auditor too familiar with, or long relationship with, employees, officers, directors.

Intimidation auditor intimidated by management or directors.

D. Differentiate between different types of audit opinion.

i) Unqualified audit opinion: Used to indicate that the financial statements are fairly presented
in accordance with the accounting standards.

ii) Qualified audit opinion: Expressed when there is some amount of limitation to the scope of
the audit or when there is an exception to the accounting standards.

iii) Averse audit opinion: Expressed when an independent auditor has determined that the
financial statements materially depart from accounting standards and are not fairly presented.

iv) Disclaimer of opinion: Indicates that the auditor is unable to issue an audit opinion for one
reason or another.

E. Explain the importance of effective internal controls.

Effective internal controls ensure a sound process for financial reporting in a company. Effective
internal control also reduces the risk of asset loss, and helps ensure that plan information is
complete and accurate, financial statements are reliable, and the plan's operations are conducted
in accordance with the provisions of applicable laws and regulations.

Q 4 . Explain how business activities are classified for financial reporting purposes.

For financial reporting purposes, a company’s business activities can be classified into three
groups: operating, investing, and financing activities:

1. Operating activities are those activities which form part of a company’s daily business
functioning. This would include, for example, the sale of merchandise for a sales
company, and deposit taking by a bank.
 2. Investing activities are those that are associated with the acquisition and disposal of
long-term assets. This would include, for example, the purchase of new equipment or a
new building.
3. Financing activities are related to obtaining or repaying capital from mainly
shareholders and creditors. This includes issuing common shares, bonds or taking out a
bank loan

Q 5 . Explain the accounting equation in its basic and expanded forms.

Assets = Liabilities + Owners’ equity

The basic accounting equation tells us that the claims on a company’s assets are derived from its
liabilities and owners’ equity.

If we make owners’ equity the subject of the equation, we see that:

Owners’ equity = Assets – Liabilities

This indicates that owners’ equity represents the residual claim on a company’s assets after its
liabilities have been deducted.

Owners’ equity can also be classified according to its origin i.e. the capital that has been
contributed by the owners of the company as well as the earnings that have been retained in the
company up to a specified point in time. This can be expressed by the following equation:

Owners’ equity = Contributed capital + Retained earnings

The expanded accounting equation provides more details for the owner's equity amount shown
in the basic accounting equation. The expanded accounting equation for a sole proprietorship is:
Assets = Liabilities + Owner's Capital + Revenues – Expenses – Owner's Draws.
The expanded accounting equation for a corporation provides more details for the stockholders'
equity amount shown in the basic accounting equation. The expanded accounting equation for a
corporation is:
Assets = Liabilities + Paid-in Capital + Revenues – Expenses – Dividends – Treasury Stock.
Q 6 : Describe the need for accruals and valuation adjustments in preparing financial statements.

Accruals based on accrual accounting, revenue must be recorded when earned and expenses
recorded when incurred, irrespective of whenever the cash movement takes place. This allows
for revenue and expenses to be reported in their proper accounting periods.

Valuation adjustments are made to a company’s assets or liabilities in order for the accounting
records to reflect the current market value of the asset or liability rather than the historical cost.

An increase in assets will be accompanied by a gain on the income statement or an increase in

other comprehensive income. Conversely, a decrease in assets will be accompanied by a loss on
the income statement or a decrease in other comprehensive income.