Financial Accounting - Research Proposal Example

ID: 28744 Order 290794 Financial Accounting; Assignment Instructions:- A. The IASB's framework for preparation and presentation of financial statements require financial statements to be prepared on the basis that they comply with certain accounting concepts, underlying assumptions and (qualitative) characteristics. Discuss each of them where appropriate with examples. A) The framework for the preparation and presentation of financial statements is ultimately used for corporate reporting. Therefore, it's important for the financial statements to contain useful information, comply with the international accounting standards and to meet the common need of its users. The end users of the financial statements can be customers, investors, suppliers, government agencies, student body, economist or general public. IASB'S FRAMEWORK The International Accounting Standard Board, a privately owned body based in London presented a document in July 1989 which became framework for the preparation & presentation of financial statements. On this framework all the IAS are based and determine the financial statement preparation and the information they contain. Objectives of Financial Statements: The framework states the financial statements objectives as: It provides information about the financial position of the company Performance of the company showing its trends of income & expenses over the period of time. Helps incorporate reporting and end users for taking decisions. However financial position doesn't always portray the true picture and financial structure from the social point of view but altogether it serves the need of the end users. Understanding the Financial Statements: The financial statements and its elements are shown in the following table. Table I Reflection on Financial Statements: Presentation Frequency of Preparation Elements The financial statements are presented in the following forms: Balance sheet Income statement Statement of cash flows Notes to the accounts Generally financial statements are prepared and published n monthly basis. In some cases like in financial institutions quarterly accounts are also required by the Central bank for monitoring purpose. Five core elements of financial statements are: Asset Liabilities Equity Income Expenses. UNDERLYING ASSUMPTIONS Two core assumptions applied while making financial statements are: 1. Accrual Basis: Accrual basis of accounting record the revenues when realized and incur expense when they occur. All the income and expenses are recorded in the accounting record when they actually occur not at the time when cash has flown in or out of the business activity. Therefore in accrual base accounting all the records are reported in the financial statements in the period to which they relate to. Example: Following example adopted from Gibson, Charles H., 1998. Financial Statement Analysis: Using Financial Accounting Information, 7th Ed. South Western. Slight numerical values have been altered. Suppose: 1. Manufacturing concern sold merchandise for $15,000 on credit this year. This merchandise cost $900 when purchased last year. 2. It purchases inventory this year in the amount of $20,000 on credit. 3. Paid to suppliers f merchandise $13,000 this year. 4. Collects cash sales $7,000. Accrual Basis Cash Basis Sales $ 15,000 COGS $ 9,000 Income $ 6,000 Receipts (inflow) $ 7,000 Payment (outflow) $ 13,000 Loss ($ 6,000) It is seen that accrual basis shows a profitable position where else cash basis indicates a loss. Cash basis doesn't indicate the time period for the recognition of revenue and occurrence of cost. It shows the cash inflows and outflows. For this purpose separate statement is prepared whish shows the cash position and named as Statement of Cash flow. When using accrual basis of accounting, various adjustments had to be made at the end of the accounting period. Some of these adjustments are: Insurance has been paid in advance; the accountant must determine the amounts that belong in prepaid insurance expense. Wages to the employees if not paid then it should be recorded as expense against liability as wages payable. Revenue if collected in advance must be recorded in advances and revenue doesn't relate to the current period therefore unearned revenue must be recorded as liability. 2. Going Concern: Going concern assumption believes that business entities will remain in business for indefinite period of time. That the operations will continue in the future years. The concept of going concern, disregard the existence of bankruptcy or liquidation. If an entity has a threat of bankruptcy or liquidation then going concern principal is dropped. In case of liquidation: In case of liquidation following points are taken into account by the entity:- 1. Financial statements are prepared on the basis of liquidation values instead of the values based on the assumption of going concern. 2. Financial statements must clearly disclose that the statements are prepared with the view of entity being liquidated. Example: For example purpose an unsolved case taken from Gibson, Charles H., 1998. Financial Statement Analysis: Using Financial Accounting Information, 7th Ed. South Western. 43. Has been solved to exhibit as an example for going concern. Case Study. Going Concern' 1994 Annual Report - Fountain Powerboard Industries Inc. Note 12- Financial Condition (in Part) '.The company's financial statements have been prepared on the basis that it is going concern, which contemplates the realization of assets and the satisfaction o liabilities in the normal course of business. The financial statements d not include any adjustments relating to recoverability and classification of assets, or the amounts and classification of liabilities that might be necessary in the event the company cannot continue in existence. The company reported a net loss of $2,993,344 for fiscal 1994 and its current liabilities exceeded its current assets by $9,340,951. The company's continual existence is dependent upon its ability to achieve profitable operations. The Company's fiscal1995 operation plan includes a substantial increase and a restructuring of its operations to reduce its operating cost. If management cannot achieve the Fiscal 1995 plan because of sales shortfalls or greater that anticipated cost and expenses, then the company may not be able to meet its obligations on timely basis, its operations may be significantly restricted, and it may not be able to continue on in business as a going concern' Required: 1. What is the going concern assumption' Ans: Firms ability to continue its business operations for long term and to get economic benefit from it in the future years. Financial statements are therefore prepared keeping this concept in mind. 2. Has Fountain Powerboard Industries Inc. prepared financial statements using the going concern assumption' What appears to be the potential problem with using the going concern assumption in this case' Ans: The financial statements prepared by fountain Powerboard Industries Inc doesn't seem to be using the assumption of going concern because the asset and liabilities reported in the financial statements are not adjusted of recoveries and classification of asset and liabilities. For using the concept of going concern it's important to report the financial position on net realizable value. 3. What is the significance of the disclosure that this company may not be able continue as going concern' Ans: The Company may not be bale to continue on its business as a going concern because it has shown substantial amount of net loss and further to their current liabilities exceeds current assets which will also adversely affect the ability to continue as a going concern. The financial statement doesn't include any adjustments relating to the recoverability and classification of recorded assets amounts or the amount and classification of liabilities that might be necessary to continue as a going concern. ADDITIONAL ACCOUNTING CONCEPTS 1. Monetary Unit: When preparing the financial statements, using standard unit of monetary unit is meaningful way. Example: Financial statements can't be prepared by measuring 5 cars, buildings, 2 factories and 100 acres together until they are standardize in single monetary unit like USD, GPB, Riyal, PKR etc. 2. Historical Cost: According to this concept assets are recorded at the amount of cash or cash equivalent paid to acquire the asset and liabilities are recorded on the cost on which it's due. Alternative methods of measurement used beside historical cost are current market value, net realizable value or present vale. The short comes of using historical cost method are: i. Historical cost method gives the outdated data in the financial position as it doesn't include current market value. ii. There is no consideration for the fluctuating money value over the period of time. Therefore it becomes difficult to predict the true financial position. iii. Revenues are recorded on the basis of historical cost. Like inventory is purchased and not sold within six months, its prices will increase overtime and the revenue then recorded will be based on previous cost. Therefore it doesn't provide the true picture of the financial position. To overcome these problems of historical cost method, IASB has proposed alternative method with the name of "fair value measurement". This method illustrates that, all the assets, liabilities, financial instruments and share instruments will be measured on fair value. 3. Conservatism: Financial accountant adopt different set of measurements and conservatism is one of them. According to this concept, measurement must be made with least favourable effect on the net income and financial position in the current year. Example: When writing down the inventory then using the principal of lower of historical cost or market value will be application of conservatism concept. 4. Realization: Realizing revenue is a debatable issue. There are various ways in this regard:- i. Point of sale: Revenue is cognized at the point of sale, where earning process completes and exchange value can be determined. ii. End of Production: This method recognizes revenue at the end of the completion process. This applicable when the price of the item is known and buyers are ready to buy at the specific time. iii. Receipt of Cash: This method is used when the collection is not capable of reasonable estimation at the time of sale. In this method there is a greater risk of purchasers being default on the contract. iv. Revenue recognized during production: This method is mainly used for long-term projects where revenue is recognised during the progress of the project. v. Cost recovery: Is approach is use in a high risk business operation. Therefore the first recovery from this operation would be considered as revenue and if there if proceeding cash inflows then it would be taken as revenues. 5. Consistency: It requires the organization to give unique treatment to comparable transactions from period to period. With the change in time the company may use different methods. But to do so it has to disclose it in the financial statements with reasons and its effects n the financial position. 6. Matching: In relation to the revenue principal where consideration is on when to recognize revenue here the concept is to determine the revenue first and than match the revenue with the appropriate cost. Example: When the inventory is sold and recognize revenue, the cost of inventory can be matched against the revenue like product development cost, technological changes cost, new employee hiring cost all these are charged off in the period they occur. 7. Materiality: Materiality concept requires the relative size and importance of a firm. Example: A purchase of $500 might be an expense for bigger organization but the same is treated as an asset in the middle and small size companies. QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS: The four qualitative characteristics of financial statements are: i. Relevance ii. Reliability iii. Comparability iv. Understandability i. Relevance: Financial position has characteristic of relevance that influence in taking corporate and economic decisions. It helps the end users in trend analysis, ratio analysis and helps in predicting about the future performance of the company. ii. Reliability: Information in the financial statement is reliable and free from error and biasness. End users can trust n the information provided in the statement. Reliability influences the "faithful" (ACCA, Financial Reporting; P50) representation of the statements whereby appropriate methods f measurement is used for preparing the financial statements. The transactions are recorded when it physically occur or in accordance with their economic reality. Example: If a house is purchased by the company for commercial purpose and all the legal documentations have been transferred to the buyer(company in this case) but the selling party still consumes it and the company is not getting any economic benefit out of it then it can't be recorded in the financial statements. iii. Comparability: One of the significant features of the financial statement is its comparability with other entities to check the performance and market practice. It shows the company's financial position over time by enabling the financial analyst to do trend analysis which draws the snapshot of company's performance over a specified period of time. For entities it's important to disclose accounting policies. So that accountants are able to make comparisons of similar items of different companies. iv. Undertandability:- Users should fully understand the information in the financial statements. Complex and critical information should not be ignored just to avoid its complexity. The user should have a background knowledge and information abut the financial statements. B. For most entities, applying the appropriate concept/assumptions in accounting for inventories is an important element in preparing their financial statements. Discuss with examples how each of the concept/assumptions you discussed in a) above may be applied to the accounting for inventories. B) Application of concepts for inventories is described in the table below: Table II Accounting Assumptions for Inventory Management Assumption Inventory Application 1) Accrual Basis/ Matching Concept: Purchases are recorded on the basis of opening and closing inventory. It shows the application of accrual basis of accounting or matching principal. Where revenues earned are recorded and matched with the cost incurred. 2) Conservatism / Prudence Concept: Inventory cost is not certain in many cases to the organization especially when year end adjustments are made. Therefore accounting standard require the inventory to be valued at the lower of cost r net realizable value. This is an application of conservatism or prudence concept. 3) Realization For closing inventory the goods are purchased but not yet put into the production process. Therefore it is not recorded in the financial statements. 4) Materiality For businesses inventory is a material item. Valuation of inventory can greatly affect the financial statements. Like in some companies stationery remaining at the end of the year would be treated as expense of the year when it was purchased rather then taken as inventory in hand an asset account which most of the firms do. 5) Comparability There are ways of measuring inventories. Company can be using average costing or FIFO method. But the company must use single method of calculation for comparability purpose. If different method is used then it should be disclosed in the accounts. Bibliography Gibson, Charles H. 1998. Financial Statement Analysis-Using financial Accounting Information, 7th edition, South Western. ACCA Paper F7, 2007. Financial Reporting (International), BPP Learning Media Ltd. Meigs & Megis, Bettner & Whittington, 1993. Accounting the basis for business decisions, The McGraw-Hill Companies, Inc. Financial Reporting- Exam papers June 2008 (Online) Available at: http://www.accaglobal.com/students/study_exams/qualifications/acca_choose/acca/fundamentals/fr/past_papers/int ACCA- Paper P2 INT, 2008 & 2009. Corporate Reporting. Kaplan Publishing Foulks Lynch. Articles in "Student Accountant- ACCA's Magazine for Trainers". Publications in the year 2008. Read More