Using Financial Accounting Information: The Alternative to Debits and Credits - Essay Example

Users of accounting information are categorized based on their relationship with the company. Financial accounts are prepared for the external users of a company. External users are not directly linked to the operations of a company and hence have reduced ability to obtain information. External users rely on the information presented by the company since they do not have contact with a company’s day to day operations (Warren, 2012). Following are the users of a company’s financial accounts: Debt holders and bondholders: The creditors of the company use financial accounts to conduct risk analysis of a company. The creditors assess the ability of a company to repay their loan. Hence, ratios pertaining to leverage and cash flows are essential for the company’s creditors and bondholders. Existing and potential Shareholders: Existing shareholders need the financial accounts to assess the long term viability of their investment whereas potential shareholders also require financial information to decide the future prospects of the company (Porter & Norton, 2012). This aids in deciding whether the investor should invest in the company or not. Shareholders generally look at the company’s ratios such as return on equity, dividend yield and price to earnings ratio to assess whether to invest or to not invest in company. Governmental Agencies: Tax collection agencies are interested in a company’s financial accounts to ascertain the tax that a corporation must pay to the government. Securities and Exchange Commission (SEC) prescribes the manner in which financial statements are presented and hence effectively is a user of company’s financial accounts (Sofat & Hiro, 2006). Stock brokers and financial analysts: Financial analysts use a company’s financial counts to prepare financial reports advising their clients to invest in a particular stock. Supplier: Suppliers of a company also use financial accounts to assess whether the company would be able to honour its payments. Suppliers look at a company’s accounts payable and if the accounts payable are very high, it indicates that the company’s creditworthiness is low. Suppliers are also concerned with liquidity ratios such as current ratio and acid test ratio to ascertain a company’s ability to meet short term commitments. 2. Financial Accounts are prepared by a company itself and the information presented in the financial accounts is only available with the internal sources of a company. Hence a company can twist the factual information to present a glossy picture of the company in order to entice investors to invest in the company. This is why the role of auditors and regulators is very important in the presentation of financial accounts. Regulations safeguard the interests of external user of financial accounts so that the information presented by the company is free of any bias and errors. The regulations require that the companies present the financial information accurately on an annual basis and the statements should be duly audited by an external auditor. Moreover, the financial accounts should give a true and fair picture of the company and the company should not attempt to misrepresent any information. Moreover, the requirements differ if a company is a sole proprietorship, partnership or a public limited company. A company also needs to adopt accounting standards based on the location it operates in. International Accounting Standards Board (IASB) is an independent standard setting body of IFRS (International Financial Reporting Standards) foundation (IFRS, 2013). A company has to claim compliance with IFRS and present its account on the basis to IFRS. This helps in comparing the financial statements of various companies across an industry and helps in deciding whether the company’s performance has improved or worsened compared t the overall industry’s performance. On the other hand, FASB (Financial Accounting Standards Board) also establish accounting standards in the United States and the companies operating in the US have to claim compliance with GAAP (Generally Accepted Accounting Principles). Various adjustments have to be made when comparing companies with different set of standards (IFRS or GAAP) (FASB, 2013). Accounting standards are crucial in financial markets and play an important role in the development of a country’s financial markets by ensuring that the financial information presented in the financial accounts are accurate, transparent, understandable and credible. The users of financial accounts rely solely on the information presented by a company and hence the importance of legal requirements and regulatory influences is immense. Sherwood Extended Trial Balance for the period ended 31st January 2013 Accounts Title Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet   Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit   ? ? ? ? ? ? ? ? ? ? Sales   43,000       43,000   43,000     Stock 4,000       4,000   4,000       Sales returns 980       980   980       Purchases 16,400       16,400   16,400       Purchase returns   380       380   380     Carriage inwards 240       240   240       Discounts received   810       810   810     Heat and light 1,070       1,070   1,070       Motor expenses 1,460     337 1,123   1,123       Wages and salaries 6,650   82   6,732   6,732       Telephone charges 580   123   703   703       Discounts allowed 300       300   300       Printing and stationery 210       210   210       Advertising 3,300     42 3,258   3,258       Fixed assets (cost) 24,000       24,000       24,000   Provision for depreciation: Fixed assets   7,700   4,075   11,775       11,775 Trade debtors 4,500     500 4,000       4,000   Provision for doubtful debts   120   80   200       200 Bank account 3,310       3,310       3,310   Trade creditors   2,510       2,510       2,510 VAT (credit balance)   1,480       1,480       1,480 Drawings 4,000       4,000       4,000   Capital account   15,000       15,000       15,000 Total 71,000 71,000                 Depreciation Expense     4,075   4,075   4,075       Accrued Wages       82   82       82 Accrued Telephone charges       123   123       123 Prepaid Advertising expense     42   42       42   Prepaid motor expenses     337   337       337   Closing Stock-Asset     4,250   4,250       4,250   Closing Stock-Cost of goods sold       4,250   4,250   4,250     Accountancy fees     326   326   326       Accrued Accountancy fees       326   326       326 Bad Debt Expense     580   580   580           Total 9,815 9,815 79,936 79,936 39,997 48,440                 Profit/Loss 8,443     8,443                 Total 39,939 39,939 7 Sherwood Profit & loss Trading Account period ended 31st January 2013 ? ? ? Sales 43,000 Sales Return 980 42,020 Cost of Goods Sold: Opening Stock 4,000 Purchases 16,400 Carriage Inwards 240 Purchase returns (380) 16,260 Closing Stock 4,250 16,010 Gross Profit 26,010 Discounts Received 810 Expenses Discounts Allowed 300 Heat & Light 1,070 Motor Expenses 1,123 Bad Debt Expense 580 Wages & Salaries 6,732 Accountancy 326 Telephone Charges 703 Printing & Stationery 210 Advertising 3,258 Depreciation Expense 4,075 (18,377) Net Profit 8,443 Sherwood Balance Sheet @ 31st January 2013 ? ? ? Fixed assets (cost) 24000 Less: Provision for depreciation: Fixed assets -11775 Fixed Assets at book value 12225 Current Assets Stock 4250 Trade Debtors 4000 Less: Provision for bad debts -200 3800 Prepaid Advertising expense 42 Prepaid motor expenses 337 Bank 3300 11729 Current Liabilities Trade Creditors -2510 VAT -1480 Accrued Telephone charges -123 Accrued Accountancy fees -326 Accrued Wages -82 -4521 Net Assets 7208 Working Capital 19433 Financed by Capital 15000 Net Profit 8443 Drawings -4000 19443 9 Profit & loss Trading Account period ended 31st March 2013 ?'000 ?'000 ?'000 Revenue 2,265 Cost of Goods Sold: Opening Stock 140 Purchases 1,210 Closing Stock (85) 1,265 Salaries 60 1,325 Gross Profit 940 Administration Expenses: Office rent 100 Audit fee 20 Salaries 60 Bad Debt Expense 25 General Administration 125 Depreciation Expense 45 375 Distribution Costs: Salaries 60 General Distribution 25 Storage Costs 100 185 Advertising 50 610 Dividend Received 8 Profit before tax 338 Taxation 165 Net Profit 173 Statement of changes in equity for 31st March 2013 ?'000 ?'000 Retained Earnings (April 2012) 235 Add: Net Profit 173 Add: Upward revaluation in non current Investment 100 Less: Dividends Declared -20 Ending Retained Earnings 488 Balance Sheet @ 31st March 2013 ? ? ? Fixed assets: Plant and Machinery at cost 400 Less: Provision for depreciation 210 Plant and Machinery at book value 190 Land and Buildings at cost 200 Less: Provision for depreciation 35 Land and Building at book value 165 Non-Current Asset Investment 380 Current Assets: Stock 85 Trade Receivables 233 Cash 33 351 Current Liabilities Trade Creditors -130 Deferred Tax Liability -64 Salaries Owing -30 Provision for taxation -164 -388 698 Net Assets Equity: Called up share capital 210 Retained Earnings 488 698 10 Consolidated Income Statement for Manchester PLC and College Ltd for the period ended 31 October 2012 ?'000 Revenue 51,000 Cost of sales -26,955 Gross profit 24,045 Distribution costs -9,910 Administrative expenses -5,902 Profit from operations 8,233 Finance costs -829 Profit before tax 7,404 Tax -1,913 Net Profit 5,491 Less: Minority Interests 1098 Profit for the period from continuing operations attributable to equity holders 4,393 11a) Gearing=(total liabilities/total assets) Interest Cover= Operating Profit/Interest Expense Current Ratio=Current Assets/Current Liabilities Acid Test Ratio=(Current Assets-Inventory)/Current Liabilities Trade Receivable days=(Average Receivables/Sales)*365 Trade Payable days=(Average Payables/Cost of sales)*365 2012 b) Gross Profit Margin 49.0% Net Profit Margin 3.8% Gearing 52.0% Interest Cover 3.3 Current Ratio 1.9 Acid Test Ratio 0.7 Trade Receivable Days 24.4 Trade Payable Days 41.6 c) The gross profit of the company is equal to the industry average which indicates that the company is earning significant profits on the sale of its goods. However, the net profit margin of the company is significantly lower than the industry on account of high distribution and administrative expenses. Overall, the company's profitability position is not up to the mark as compared to the industry. Fielden Ltd's gearing ratio of 52% is better than the industry's gearing ratio which shows that Fielden is using lesser debt to finance its assets than the industry. However, Fielden's interest coverage ratio is on the lower side on account of company's low profitability. The current ratio of Fielden is better than the industry's current ratio which shows that the company has sufficient sources to meet its short term needs. However, the acid test ratio of the company is on the lower side which indicates that most of the liquid assets of the company are stuck up in inventory. Fielden has lower trade receivable days than the industry which is a positive sign as it shows that company recovers cash from its credit customers in less days. Moreover, the trade payable days of the company is on the higher side which shows that the company takes more time than average to make payment to its suppliers. Overall, Fielden Company's performance is worse than the industry performance. d) Louise should not invest in Fielden company due to its deteriorating profitability position. Most of the company's current assets are tied up in stock which is not a healthy sign for the company. Moreover, the revenue of the company has fallen in 2012 which indicates that the company is losing its market share and can face tough times in years to come. References FASB, 2013. About Us. [Online] Available at: http://www.fasb.org/jsp/FASB/Page/LandingPage&cid=1175805317407 [Accessed 5 December 2013]. IFRS, 2013. About the IFRS Foundation and the IASB. [Online] Available at: http://www.ifrs.org/The-organisation/Pages/IFRS-Foundation-and-the-IASB.aspx [Accessed 5 December 2013]. Porter, G.A. & Norton, C.L., 2012. Using Financial Accounting Information: The Alternative to Debits and Credits. 8th ed. Cengage Learning. Sofat, R. & Hiro, P., 2006. Basic Accounting. PHI Learning Pvt. Ltd. Warren, C.S., 2012. Accounting. Cengage Learning. Read More