Analyzing an Accountant System - Masquerade Theatre Supplies - Essay Example

? Analyzing an accountant system of the Number Number Seminar Day and Time Answer As is evident from the income ment, it can be seen that MTS’s revenue has increased to a certain extent from $260,034 in 2011 to $360,547 in 2012. However, considering the proportions at which the expenses increased from 2011 to 2012, the revenue stream is not enough to cover up for the expenses. This is evident from the net loss generated by the company in both the financial year. For a startup business like, Masquerade Theatre Supplies (MTS), it is excessively leveraged where part of its operations are being financed from a loan obtained on behalf of a mortgage and other part is being financed from a personal that the owner had obtained from a relative. The owner still has a debt obligation towards his relative ($100,000) which when accounted for is severely impacting the revenues generated by the company, thereby resulting in severe losses. The expenses for the purpose of conducting the business are of random nature which does not explain the exact purpose of incurring such expenses. As an example, it can be cited that the owner of MTS spends 40% of its allocated advertisement budget on business lunches involving local theatre producers and directors and the rest 60% is spent on advertising in local newspapers, theatre programs, sponsoring local children`s theatre and delivering flyers to the community. No clear rationale can be identified from this distribution strategy. As is evident from the income statement, the expenses incurred from advertising and promotion contributes significantly towards reducing the revenues generated by the company. For a startup company which is highly leveraged, efforts are needed to be put in order to reduce the obligations. The company needs to restrict its expenses behind advertising and promotion. The revenue increase for the company can be associated with a short term promotion that the company might have performed in order to boost its business. However, the company has to understand that revenues generated from short term promotions are detrimental to the performance of a company as far as long term success is concerned. Costs of goods sold and general and administrative expenses are the two most important expenses that can severely deteriorate the profits generated by the company (Phillips, Libby and Libby 10-55). This is particularly because these are the expenses that are most directly involved in creating revenues. As is evident from the income statement, MTS has incurred huge amount of cost of goods sold as well as administrative expenses with respect to the revenues that the company has generated. The company needs to formulate a more effective strategy in order to bring down the aforementioned expenses. One particular area that is needed to be highlighted in the income statement is the expenses incurred as a result of payment made to the employees. According to the case study, MTS is supposed to book $25,000 as expenses due to payments made to employees. However, the income statement reflects a completely different figure which is significantly higher than the actual figure that is required to be reported. This sheds light on an important concern. The concern arises due to a weaker internal control within the company. The serious error committed while drafting the income statement questions the credibility of the accounting official responsible for preparing the income statement. The amount recorded as payment to employees in the year is $90,999 whereas the actual amount that had to be reported was $25,000. Had it been the case, then it would have significantly improved the figure that has been reported in the bottom line. This highlights a massive loophole in the internal control mechanism of the organization. There is no perfect approach towards employing officials who are experienced in the field of accounting. This is evident from the fact that the accounting part is handled by a person who does not have an accounting background and thus, no experience in this field. Moreover, the accounting processes are handled partially by the owners and partially by the employees in situations where the owners are busy conducting other business operations. This is not an effective internal control mechanism as this can lead to ambiguity as far as drafting financial reports are concerned as different people have different ways of interpreting data. In addition to that, no mechanisms have been formulated in order to monitor the comparability, verifiability and understandability of the accounting reports leading to false interpretation of data. Another area of concern that the company needs to emphasize upon is that they have to produce the income statement to the bank in order to request for a loan. The bank will judge the company’s creditworthiness on the basis of the figures reported in the income statement. As the company has incurred a net loss in both the financial years, its creditworthiness is significantly hampered. This might trigger a negative signal which might force the bank to refrain from granting a loan to the company. The owner offers extension to some of the theatre companies in terms of making payment as ticket sales might take some time. However, this might prove to be an area of concern if the tickets sales are not as expected. These are account receivables and if these payments are not received at the right time, they are booked as bad debt. This significantly reduces the profit that is to be made after high revenue is generated. Thus, this highlights a loophole in the internal control of the company as there are no strict rules regarding giving credit to the clients. Answer 2 Masquerade Theatre Supplies Income Statement CONSOLIDATED STATEMENT OF INCOME (2012)   2012 Sales Revenue $360,547 Cost of Goods Sold 124,984 Selling and Admin Expenses 42,204 Payments to employees 25,000 costumes, make up supplies, masks & specialty theatre supplies 10,000 Furniture and fixtures ------ Advertising and promotion 34,727 Utilities 18,300 Interest from loans from relatives 5,000 Interest expense 3,800 Bank charges 2,000 Rent 22,000 Bad debt expenses 2,754 Other expenses 10,000 Net Income $59,778 As is evident from the income statement, the sales revenue generated by MTS is $360,547 in the financial year 2012, which is a healthy figure considering the fact that it increased by a significant margin from what it was in 2011 ($260,034). This is a healthy figure for a relatively new business. The cost of goods sold has also increased significantly from $96,212 in 2011 to $124,984 in 2012 suggesting the company’s gradual expansion. The admin expenses were relatively stable with an increase of close to $7,000. The payment to employees decreased significantly from $83,740 in 2011 to $25,000 in 2012 suggesting a structural change as far as the work force is concerned. The cost of costumes, make up supplies, masks & specialty theatre supplies also decreased by a huge margin from $85,000 in 2011 to $10,000 in 2012. This is particularly because these were one off costs that the company had to bear when the business was started. A similar reason can be attributed for no cost being reported in case of furniture and fixtures. The expenses due to advertisement and promotion increased moderately from $29,503 in 2011 to $34,727 in 2012. This explains the growth of the business and the owner’s aim to achieve a larger customer base. Utility expenses stayed more or less the same with a minor increase. The interest expenses and the property rent stayed the same in 2012 as well as in 2011. The area of concern for the business is the bad debts that have been reported in the income statement. Bad debts increased significantly from $1,955 to $2,754. Most of these bad debts are the account receivables by the company which were not received in time. The company recovered hugely and recorded a profit of $59,778 in 2012. The difference is huge as the company reported a net loss of $145,469 in 2011. The company was able to achieve this mainly because of its cost cutting strategies and structural changes as far as the work force is concerned. Answer 3 Internal control can be best explained as a process initiated by management officials in order to achieve a company’s objectives. The fulfillment of such objectives is associated with the reliability of financial accounting, efficiency and effectiveness of tasks being carried out and their compliance with the regulations specified in the field of accounting. This highlights the importance of a rigid internal control mechanism within a business entity. After a thorough research of the case study, it can be seen that certain deficiencies exist in the internal control mechanism of Masquerade Theatre Supplies. The existing internal control design is not appropriate and thus, the control objectives are not met with effectively (Phillips, Libby and Libby 10-150). Moreover, the person with the control does not possess the required authority and competence in order to initiate the control process. A material weakness can be identified as a deficiency in the internal control mechanism of the company. This is evident from certain material misstatement done in the entity’s financial statement. In addition to that, there is no adequate mechanism within the internal control design of the company to identify such misstatements and henceforth corrected on a timely basis. Alongside that, ineffective monitoring of the entity’s financial reporting can also be noted as there is no one in the company who is particularly responsible for ensuring that a robust governance framework is being followed. Inadequate internal auditing function can also be attributed as a weakness that can be witnessed within the internal control design of MTS. As a result of this, proper risk assessment is not done. Moreover, false representation of data within the financial reports is also another weakness that can be noticed. This weakness can be attributed to the fact that financial reports of the company are being drafted by officials who does not have a background in financial accounting. Mistakes are being made while presenting figures in the accounting statements, thereby causing false interpretation of data by the users. This suggests another weakness that exists within the internal control of Masquerade Theatre Supplies. Furthermore, another weakness that can be identified in the internal control of the company is the fact that, financial reports are prepared partly by the owner and partly by the employees. This might render the financial reports ambiguous as different people have different ways of interpreting factual data. Apart of material weakness, significant deficiencies can also be identified in the internal control mechanism of Masquerade Theatre Supplies. There is no control over the selection and implementation of accounting principles which are in alignment with the universally accepted accounting principles such as, IFRS or GAAP. There is no evidence that the officials, responsible for drafting accounting statement, have sufficient expertise in the appropriate selection and application of accounting principles. This is a crucial aspect of internal control and a business entity needs to make sure that these controls are being strictly enforced. From the case study, it can be clearly identified that accounts payable days are much shorter when compared to accounts receivable days. This highlights the uncontrolled non-systematic transactions which can also be identified as a weakness in the internal control design of the business entity. Such deficiencies suggest the immediate need for a rigid internal control process. As a recommendation, it can be said that the company needs to follow accounting principles that are universally accepted in order to prepare financial statements that can be easily understood and interpreted. Correct data should be reported in the income statements in order to ensure that the information sharing is transparent. This will help the users of the statement to rightly assess the status of the company. Management should hire experienced and knowledgeable employees from the field of accounting so that they can detect any misstatements that have been made in the financial report and correct those on a timely basis. Alongside that, the company has to adopt effective measures in order to match the accounts payable and accounts receivable days as closely as possible (Phillips, Libby and Libby 6-30). Works cited Phillips, Fred, Robert Libby and Patricia A. Libby. Fundamentals of Financial Accounting. 3rd edition. New York: McGraw Hill, 2011. Print. Read More