Finance, Accounting and Taxation
Finance
Core toolkit
The finance syllabus rewards fluency with time value of money and investment appraisal: discounted cash flow, NPV, IRR, payback and accounting rate of return. You must also handle the cost of capital - cost of equity (dividend growth and CAPM), after-tax cost of debt, and the weighted average - plus capital structure and gearing, dividend policy, and working capital management (cash operating cycle, EOQ, credit policy, overtrading). Ratio analysis, sources of finance and basic valuation complete the picture.
Traps examiners use
- Sunk costs are irrelevant; only incremental future cash flows count.
- Interest and loan repayments are financing flows - exclude them from project cash flows if the discount rate already reflects the cost of capital.
- Depreciation is not a cash flow, but its tax shield is.
- WACC uses market values where available and the after-tax cost of debt, i.e. kd(1 − t).
- Payback ignores the time value of money and cash flows beyond the cut-off.
- NPV and IRR can conflict for mutually exclusive projects or non-conventional cash flows; rank by NPV.
- Working capital must be treated as an outflow at the start and a recovery at the end of a project.
Worked example
A machine costs 100,000 and yields 60,000 in each of years 1 and 2. Cost of capital is 10%. PV of inflows = 60,000/1.10 + 60,000/1.21 = 54,545 + 49,587 = 104,132. NPV = 104,132 − 100,000 = +4,132 → accept. If the IRR were 12%, the project would still be accepted, because IRR (12%) exceeds the 10% cost of capital - the two rules agree here.
Rule of thumb
Accept if NPV > 0 and IRR > cost of capital; between mutually exclusive projects, choose the highest positive NPV, never merely the highest IRR.
Accounting and Taxation
Financial accounting spine
Everything rests on the accounting equation (assets = liabilities + equity) and double entry. Be able to prepare and interpret the income statement, statement of financial position and statement of cash flows from a trial balance, applying accruals, prudence, consistency, going concern and substance over form. Key technical areas: depreciation methods, allowances for doubtful debts, inventory valuation, capital versus revenue expenditure, provisions and contingencies, and revenue recognition. Know the conceptual framework and the difference between full IFRS and the IFRS for SMEs.
Taxation interface
The examined skill is converting accounting profit into taxable income: add back disallowable items (depreciation, fines, non-business expenses, general provisions), deduct allowable items, and replace depreciation with capital allowances. Then cover VAT (output tax less input tax), PAYE, withholding tax, and the distinction between tax avoidance (legal, using the law's intent) and tax evasion (illegal).
Traps examiners use
- Depreciation is not deductible for tax - capital allowances take its place. Adding back depreciation and deducting capital allowances is the classic adjustment.
- VAT is not an expense for a VAT-registered trader; it is collected on behalf of the revenue authority. Only an unregistered or exempt trader bears it as a cost.
- Drawings and dividends are appropriations, not expenses.
- A trial balance detects arithmetic errors only - it will not reveal a transaction posted to the wrong account or omitted entirely.
- Capital expenditure is capitalised, not expensed.
Worked example - VAT
Sales of 1,160,000 are VAT-inclusive at 16%; purchases of 580,000 are also inclusive. Net sales = 1,160,000 / 1.16 = 1,000,000 → output VAT = 160,000. Net purchases = 580,000 / 1.16 = 500,000 → input VAT = 80,000. VAT payable to the authority = 160,000 − 80,000 = 80,000.
Rule of thumb
VAT payable = output tax on sales − input tax on allowable purchases; if input exceeds output, the excess is a credit carried forward (or refunded, subject to the rules).