FINANCIAL ACCOUNTING

12 Pages   |   1,605 Words

FINANCIAL ACCOUNTING

Assignment

Q 1(a)
The users of financial statements include a number of entities. These entities are generally called stakeholders which include shareholders, suppliers, customers, banks, government, creditors, employees and, most importantly, investors. Here, the distinction should be made between shareholders and stakeholders. These entities can be grouped into two kinds, internal and external users. The internal users include the managers, directors and other employees. The internal users also include the shareholders as they are the owners of the company. External users include all stakeholders outside of the company.

Financial statements are prepared for those entities which have a reasonable understanding of accounting and finance. All the different users of financial statements have their own specific information needs. Shareholders need to see how profitable their company is; the existing and prospective creditors and banks need the financial statements to analyze the creditworthiness of the company and whether the company is a going concern. Suppliers need information to figure out if their customer will exist in the future or will go out of business since the business of the supplier depends on its customer. It is specially the case when the vendor supplies solely to the company in question. Government needs this information for tax purposes. Financial institutions need the financial information so that they can make logical investment decisions for their clients.
 

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Q 1(b)
The ability of accounting information to assist in decision making is most important. It helps the investors and other analysts to develop their opinion about the company. The main features which make it useful for the decision makers are (Qualitative Characteristics of Accounting Information, 2007):
  • Relevance
Relevance pertains to the timeliness and predictive value of the information. Predictive value of the information means that information should be such that the future can be deduced from it.
  • Comparability
The comparability of accounting information adds to the usefulness of this information because it provides a numerical comparison between the company and its competition and also between previous years.
  • Consistency
The consistency of the accounting information assists stakeholders to make a decision because the accounting standards do not allow companies to change their accounting policies on a frequent basis.
  • Reliability
The consistency of accounting information also makes it reliable.The accounting information in the financial statements is audited, adding to the reliability of the information. This information is verifiable from the audit firm.

Q 1(c)
The statement of cash flow is important to users of financial statements because it provides users with information on the dynamics of the business and explains how the company raised cash to meet its requirements. It segregates the cash generated from the different activities of the company namely operating activities, investing activities and financing activities. Operating activities of the company constitute the main business of the company. It explains the cash generated from the normal business of the company. Investment activities include the sale and purchase of the long term assets while financing activities relate to the loans acquired, repaid and information about the capital raised or redeemed over the year (O. Whitfield Broome, 2004 pp. 16-22). This segregation is extremely useful because a company can show a profit but still be in turbulence because of it financial situation. If the company does not have enough cash, the day to day activities of the company can come to a halt. Cash flow statements are prepared on a cash basis while the statement of comprehensive income is prepared on the accrual basis. The revenues reported in the income statement may not be collected as efficiently. Same is true for payments to creditors (Accounting Coach, 2012).

Also, the company can show a profit by selling the assets of the company while making a loss in its operations. The cash flow statement provides insight and explains where the cash had been generated (Christos I. Negakis, 2006 pp.634-644). Cash generated from the sale of assets can mean that the profit earning ability of the company may not be as sound as before whereas the acquisition of long term assets may mean that the company will be able to make more money in the future (Hughes, 2010 pp 96-114).

Statement of cash flows for the company Gulf Navigation Holding PJSC has been provided in the appendix. It shows that the company showed a loss of around AED 72,000,000. After a close look at the cash flow statement, we see that although the company did not show a high operating cash flow, but it did show a positive sum. The noncash items included in the income statement are a cause of loss. The company piled up the inventory in this year whereas there was significant inflow of cash with regards to inventory in the last year. Also, the investing activities of the company show more investment in the long term assets than it disposed of. It suggests that the company may turn a profit in the future years because a huge amount has been invested in property, plant and equipment. The financing section shows that the company took on more financing in the year than it paid off and thus, has a positive cash flow from financing activities as opposed to negative cash flow in the previous year. The company also paid a dividend of AED 878,000 to the shareholders. There is a negative figure for the cash equivalents. This, however, is better from the previous year and shows that some funds have been added to increase the liquidity position of the company. In the end, the cash flow shows that the company has an overdraft balance with the bank.

Q 2(a)
Mr. Chips
Statement of Comprehensive Income
For the year ended 30th June 2012
  (€)
Sales (W-1)                                                       262,000
Cost of Goods Sold (W-2)                                                       (87,000)
Gross Profit                                                       175,000
Staff Wages                                                       (52,000)
Rent                                                       (24,000)
Business rates (local tax)                                                       (14,000)
Insurance (W-3)                                                             (800)
Heat and light                                                         (5,400)
Miscellaneous expenses                                                         (4,600)
Bad Debts (W-4)                                                         (2,400)
Depreciation (W-5)                                                         (4,000)
Professional Fee (W-6)                                                         (2,800)
Net Profit                                                         65,000
 
Mr. Chips  
Statement of Financial Position  
As at 30th June 2012  
Assets (€) (€) Capital (€) (€)
Non-Current Assets     Opening Capital             40,000  
Fixtures and Fittings (W-5)          20,000       20,000  Income for the year (SOCI)*             65,000  
       Drawings           (48,000)  
Current Assets      Closing Capital        57,000
Inventory (W-7)          21,000    Liabilities    
Receivables (W-1)            8,000    Trade Payables             12,000  
      Provision for doubtful debts (W-1)             (400)    Accruals               2,800  
Prepayment (W-3)            2,400    Total Liabilities        14,800
Cash          20,800       51,800      
Total Assets         71,800  Total Capital and Liabilities        71,800
 
*Statement of Comprehensive Income
Workings
W-1:  Sales
Receivables
 Dr (€)  Cr (€)
 Sales          262,000    
     Cash Received          252,000
     c/d            10,000
           262,000            262,000
 
 
Remaining Receivables= €10,000 - €2,000 (Bad Debts) = €8,000
Provision for Doubtful debts = €8,000 X 5% = €400
W-2: Cost of Goods Sold
COGS= Opening Stock + Purchases - Closing Stock
=0 + 108,000 (W-) – 21,000 (W-7)
= €87,000

W-3: Insurance Expense
Prepaid Insurance
 Dr (€)  Cr (€)
 Cash paid              3,200    
     SOCI                  600
     c/d              2,400
               3,200                3,200
 
 
W-4: Bad Debt Expense
Bad Debt Expense
 Dr (€)  Cr (€)
 Receivables              2,000    
 Provision for doubtful debts                  400  SOCI              2,400
       
               2,400                2,400
 
W-5: Depreciation on fixtures and fittings
Depreciation= (Value of Asset – Salvage Value)/Useful life of asset
= (24,000-4000)/5
= €4000
Book Value of Asset = 24,000-4,000 = €20,000
W-6: Professional Fee
Dr. Professional Fee Expense €2,800
Cr. Accrual                                  €2,800
W-7: Inventory
Dr. Cost of Goods Sold €2,000
Cr. Inventory €2,000
Remaining inventory = €23,000 - €2,000 = €21,000

Q 2(b)
Two of the basic principles underlying the framework of the financial statements are the principle of prudence and matching principle. Prudence dictates that the future losses should be recognized as soon as they are anticipated. It states that an entity should be conservative in recording assets while the expense should be recorded when it is probable (Maltby, 2000 pp. 51-70). This concept is in play in recognition of the bad debts, and making provisions for those which are doubtful. Mr. Chips should understand that there should be a provision for doubtful debts in order to avoid sudden dips in the profit figure, in the later periods.
The matching principle states that the revenues should be matched with the expenses incurred to earn that revenue and reported in the same period. Depreciation is the process by which the cost of the asset is distributed over the useful life of the asset (Johnson, 1968 pp.29-37). This is in sync with the matching principle as it does not charge the entire cost of the asset in the year it was bought rather its cost is divided over the number of years it would help in earning the revenue, thus avoiding sudden dips in the profit figure and disrupting the results. Mr. Chips would have ended up with an even lower profit figure if he expensed out the entire cost of fixtures and fittings.

References
  • O. Whitfield Broome (2004) ‘Statement of Cash Flows: Time for Change!’, Financial Analysts Journal, Vol. 60, No. 2 (Mar. - Apr., 2004), pp. 16-22.
  • Christos I. Negakis (2006) ‘The Cash Flow Statement: implications for the use of direct or indirect method’, Managerial Finance, Vol 32, Issue No. 8 pp. 634-644.
  • Hughes, M.; Hoy, S.; and Andrew, B. (2010), ‘Cash flows: The Gap Between Reported and Estimated Operating Cash Flow Elements’, Australasian Accounting Business and Finance Journal, 4(1), pp. 96-114.
  • Accounting Coach (2012). Available at: http://www.accountingcoach.com/online-accounting-course/06Xpg01.html (Accessed: 5 September 2012).
  • Qualitative Characteristics of Accounting Information (2007). Available at: http://highered.mcgraw-hill.com/sites/0072994029/student_view0/ebook/chapter1/chbody1/qualitative_characteristics_of_accounting_information.html (Accessed: 5 September 2012).
  • Maltby Josephine (2000) ‘The origin of prudence in accounting’, Critical Perspectives on Accounting, Volume 11, Issue 1, pp. 51-70
  •  Orace Johnson, (1968) ‘Two General Concepts of Depreciation’, Journal of Accounting Research, Vol. 6, No. 1, pp. 29-37

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