Accounting for Managers - Essay Example

July 11, 2017

Accounting for Managers

The General Purpose of the Statement of Comprehensive Income and Meanings of Income and Expenses

The statement of comprehensive income serves the general purpose of communicating the financial performance of a business entity over a period, normally a year (Collis, Holt, & Hussey, 2012). The statement provides information on the profitability of an entity through comparing incomes and expenditures into the determination of whether an entity has made a profit or a loss during an accounting period. The purpose of the statement is to many stakeholders who rely on information on financial performance for decisions on relationships with entities.

Investors, both aspiring and existing, define one of the categories of stakeholders to which the purpose of the statement of comprehensive income is essential. The group of stakeholders invests in an entity for returns and needs an understanding of involved risks in their investments, possible returns on their investment and effectiveness of managements in managing profitability (Collis, Holt, & Hussey, 2012). An entity that has made profits in the previous year or years, for example, demonstrates a likelihood of making profits it its current year and communicates confidence into investment or retention of an investment in it. An entity that has a tendency of making comprehensive losses, however, has high levels of risks that investors can rely on to refrain from investing in it or to reduce investments in the entity. The magnitude of comprehensive profit or loss of an entity, which the statement reveals, also explains the degree of risks or potential returns that investors can derive from their investments.

Lenders define another category of stakeholders to which the statement of financial information serves the purpose (Collis, Holt, & Hussey, 2012). The stakeholders advance finances to entities with the hope of recovering their advances as per agreements. An entity’s ability to earn an excess of its expenditures means its ability to have money for refinancing its outsourced funds, and the statement shows the ability. Statements of comprehensive incomes that have net losses, especially if the losses are continuous, indicate high risks of an entity’s inability to meet its refinancing obligations. Statements with comprehensive net incomes, however, indicate lower risks of inability to meet obligations. Existing and potential lenders, therefore, use the statement of comprehensive income to assess the risks involved in recovering their finances.

The statement of comprehensive income can be presented in two forms that realize the purpose. It can be prepared as a single statement that combines the income statement, which shows an entity’s profit and loss, with additional incomes of an entity. The statement of comprehensive income can also be presented in two separate statements: one statement for profit or loss of an entity and the other statement for other elements of comprehensive income (Collis, Holt, & Hussey, 2012).

Income and expenses are the main categories of elements of the statement of comprehensive income. The Conceptual Framework for Financial Accounting defines income as an increase in the economic value of an entity, due to change in assets and liabilities in an accounting period, which increases the entity’s equity value but does not emanate from stockholders’ contributions (Burton & Jermakowicz, 2015). The definition identifies three conditions that an item must meet to qualify as income. The item must increase the value of an asset or assets in an entity, must reduce the value of liability or a set of liabilities, or must have a combination of the effects of assets and liabilities (Burton & Jermakowicz, 2015). The change in assets, liabilities, or both must further contribute to increment of the entity’s equity. Lastly, the equity increment must not be part of a member’s contribution to the entity (Burton & Jermakowicz, 2015). Incomes can be classified as revenues or as gains. Revenues are incomes that arise from the ordinary course of an entity’s activities. An example of revenues in the airline industry is the income from air tickets because the ordinary course of business in the industry is transporting people. Gains, however, are incomes that arise from alternative activities to an entity’s course of business. A disposal of an old asset, such as an old plane, in the airline industry, is an example, because companies in the industry do not deal with the selling or disposal of planes.

The Conceptual Framework defines an expense as a reduction in the economic value of an entity in an economic period, which leads to decrease in the value of equity, other than distributions stockholders (Burton & Jermakowicz, 2015). Expenses can further arise from ordinary activities of a business, and the framework identifies these as expenses. An example of the framework’s expense in the airline industry is the jet fuel. Losses form another category of expenses and are those expenses that arise from outside an entity’s ordinary course of business. Loss from a disposal of an asset in the airline industry is an example of the ‘loss’ under expenses (Burton & Jermakowicz, 2015).

Incomes and expenditures are recognized through assets and liabilities. Assets are recognized when their expected economic benefits to an entity and their costs are ascertained, while liabilities are recognized when their outflows, which relate to benefits to the entity, and cost are established, reliably (Burton & Jermakowicz, 2015). Current cost accounting, which recognizes items at their current cost, is used in recognition of items. Historical costs must be adjusted to reflect on current costs (Burton & Jermakowicz, 2015).

The General Purpose of the Statement of Financial Position and Meanings of Asset, Liability, and Equity

The general purpose of the statement of financial position is the disclosure of an entity’s resources, as at a date, and the mode through which the resources have been financed (Brain, Davis, Deis, & Smith, 2017). The statement shows the assets of an entity, together with the liabilities and equity that finances the assets. It informs stakeholders whose interest is in the management of assets for liquidity and leverage of an entity. Assets, liabilities, and equity are the major categories of items in the statement of financial position (Brain, et al., 2017).

An asset, according to the Conceptual framework, refers to a resource under the management of an entity, which has been generated from previous activities of the entity, and that is expected to yield economic benefits to the entity (Burton & Jermakowicz, 2015). The purpose of an asset, from the definition, is the realization of the economic goals of an entity (Burton & Jermakowicz, 2015). A piece of machinery, whose purpose in an entity is to facilitate ordinary activities of the entity, is an example of an asset. An asset is recognized when its future economic benefit is ascertained, and its cost can be determined with reliability (Burton & Jermakowicz, 2015).

Liability, according to the Conceptual Framework, is an obligation that emanates from an entity’s previous activities, for economic benefits to the entity, and that is expected to result in the flow of resources from the entity (Burton & Jermakowicz, 2015). The purpose of liability is the financing of the necessary assets for the operation of an entity. A creditor to an entity is an example of a liability because it identifies an obligation to pay for the deliveries that are already received and whose purposes are for facilitating core activities of an entity, such as availability of stock to be sold (Burton & Jermakowicz, 2015). A liability is recognized when an obligation exists, a probability that the obligation will yield economic benefits to the subject entity can be established, and the cost of the liability can be measured with reliability (Burton & Jermakowicz, 2015).

The Conceptual Framework defines equity as the difference between assets and liabilities of an entity (Burton & Jermakowicz, 2015). The definition identifies equity as the value of assets that can be attributed to an entity’s stakeholders, having accounted for all liabilities of an entity. The purpose of equity, like that of liabilities, is to finances the necessary assets for the core activities of an entity. The recognition of equity follows the general requirements for the probability of flow of economic benefits and the ability to measure the cost of the item with reliability (Greuning, Scott, & Terblanche, 2011). Recognition of equity, based on the Conceptual Framework’s definition of equity, follows from the recognition of assets and liabilities and the difference between the values of assets and liabilities.

The Accrual Basis of Accounting

The accrual basis of accounting is an approach to recognition of items in the financial statements when transactions occur (Burton & Jermakowicz, 2015), as opposed to when receipts or payments are made. Organizations, according to the periodicity principle, divide their existence into periods and the realization principle requires that items of financial statements be recognized in the period in which they occur (Sahar, 2009). The concepts of recognition of assets, liabilities, and equity, therefore apply, before the recognition can be designated to a period (Burton & Jermakowicz, 2015). An item that is recognized in a period, therefore, and based on the periodicity and the realization principles, is accounted for in the financial statements of the period, even if the associated cash flows have not occurred by the end of the period.

With the cost of sale adjustment in the statement of comprehensive income as an example, the accrual basis requires addition of the beginning inventory and ending accounts payable to the payments made to suppliers. The adjustment also requires the subtraction of ending inventory and beginning accounts payable from the payments made to suppliers (Collis, Holt, & Hussey, 2012). Beginning inventory and ending accounts payable are added because their corresponding payments are not made in a subject accounting period, yet associated items are recognized in the period. The ending inventory and the beginning accounts payable are subtracted because their payments are made in the subject periods, yet they recognitions are not made in the period.