Accounting Information System: The Roles of the Profit Statement and Cash Flow Statement - Assignment Example

The need for a reliable reporting environment is entirely driven by the needs of users of financial information." Discuss this ment in the light of claims that it is impossible to satisfy the needs of all the different users with a single set of published accounts. Introduction The annual published accounts are sensible and suitable for showing what company directors have done with the resources provided by shareholders. These accounts may also be scrutinized by other users other stakeholders who have different goals and purposes . In the interpretation of accounts it is always more important to consider in detail the special needs of the user i.e. short term creditors will be more concerned with an analysis of the current liquidity position; equity shareholders will be more concerned with profitability. All users will have access to the published accounts of a business such as the accounts filed with the registrar of companies by a limited company. Restrictions on the amount of information that can be accessed The value of any interpretation of company accounts is restricted by the deficiencies of the accounts themselves as a tool for decision making. Published accounts present a very limited amount of data i.e. depending upon which profit format under the 1985 companies account is chosen a limited company may not disclose cost-of-sales. Another problem that arises in the use of published accounts is that the reporting entity may not be the business unit that the user is concerned with i.e. if a company is engaged in several types of activity then an employee in one particular section of the business unit will not be able assess the employee prospects in that particular part of the business by reference to the published account of the company as a whole. The reliability of published accounts has also been compromised because of the following points: Historical cost convention used in times of inflation: a. The monetary unit in which the accounts are expressed represents a different measure of value in successive years. b. Assets consumed are recorded as expenses in the profit statement as historical cost although the cost of replacement will be higher. Therefore it is argued that the profit figure is over-stated in terms of real increase in value obtained by businesses. c. Assets shown in the balance sheet are recorded as historical cost although as a result of price level changes, though their current value may be substantially higher d. The contents of published financial statements are largely prescribed by the companies acts(supplemented by SSAPs and FRSs ) most organizations treat the companies act as the maximum disclosure requirement and do not give much information to outsider on the grounds of confidentiality and maintaining competitive advantage. e. Published accounts look backwards usually into the past year ,so they are of limitedvalue to people who want to estimate future performance. The current drawbacks deriving information from Current system of published accounts are: a. A lack of sufficient conceptual framework where results are shown in arguably over-complex rules and processes and ultimately in a failure to meet the need of those who are using the accounts. b. Information overload is potentially as much a problem as is sufficient information the complexity of the accounting principles also contribute toteh uncertainty and lack of information by users. c. A continuing problem is the historical focus of accounting which reduces the relevance for users who are most likely to be interested in the future prospects of the company. Solutions to the problem of gathering reliable information from published accounts for financial users: Though the traditional legal model is arguably the more conservative and gives primacy to shareholders'. The current accounting standards debates indicates that at-least recognition of other group interests. A broad range of potential information users gives rise to several questions relevant to a disclosure regime. It is appropriate to believe that all groups have an equal claim to information from a company. One option would be to create tailor-made statements for all users but that would not be cost effective and would also be time consuming. Another option is that governing authorities like ASB change the content and presentation format of traditional published accounts . ASB suggests that present financial reports have limitations because they based on conventionalized representation of transactions which focuses on financial effects but not on non-financial issues and they tend to be historically directed. Often the financial statements require accompanying information and supplementary reports i.e. shareholders would also like to know the character and loyalty of the management team. It is users of financial information who can make financial reporting more reliable because these published accounts are prepared for them and a conscious effort in ensuring that the norms that have been created by various regulatory bodies are actually implemented by these companies . . My accountant has told me that my business made a profit of 100,000 last year. However, over the same time period my bank balance has decreased and not increased as I expected." Discuss this statement using examples to highlight the roles that the Profit Statement and Cash Flow Statement perform in providing relevant financial information to business and why an accounting profit may not be reflected by an increase in cash at bank. Growth is the central strategy of most businesses and the purpose of growth is to increase profit. Growth does not produce an instant cash flow increase equal to the increase in profit. In an income statement , 'Profit' is arrived at after making numerous accounting adjustments for items such as depreciation, accruals, and bad debt provisions. Such adjustments are 'non-cash adjustments' - they do not affect the physical cash that a business pays or receives. Profit and cash are not the same thing. It may be predicted, for example, that a new company will make 1m profit in its first year, but the harsh reality is that if that company has not accurately anticipated its need for cash then it could go into liquidation before the year is out. Business thinking about profit, and loss and cash flow is essentially thinking about company performance. To understand company performance you must be able to read and interpret the profit and loss statement and statement of cash flows. These two statements must be viewed together in order to understand the total operating performance picture. A few reasons that company profit may not reflect in cash flow is because: a. Depreciation: cannot be deducted on a cash flow statement as it can on a profit and loss statement because depreciation is a non cash item. b. Your cash flow statement may include the principle payment on your loans, only interest portion is deductible from your profit and loss account . c. All sales cannot be counted as cash immediately .Sales that are made on credit do not appear for 60- 90 days; cash flow is impacted by credit sales d. Provisions are allowed in profit and loss statement as the net change in the estimate of the amount of provisions required in the current year compared with that required in the prior year any cash paid is allowed for in the calculation of the amount of provision required at the end of year. So the net change in the provision is not included as a part of cash flow. e. The deposit of investment and property plant and machinery is included in operating profit as the gain or loss of disposal. Whereas the cash movement is the cash received on their sale. So the profit or loss is not included as part of the cash flow but the proceeds are included as part of investing. f. Incurring Trading Losses The more losses you incur, the more cash flow can be expected to diminish. g. Increasing Your Debtors' Days Outstanding If you collect your debtors slower, you cash flow will get worse and this will have ramifications on other aspects of your business. Eg. You may not be able to pay your suppliers and you may be put on a COD basis. h. Increasing Your Stock Holding i. Paying Your Creditors' Faster j. Drawing Monies From Your Business k. Buying Buildings, Plant, Furniture l. Repaying Your Bank, Finance Company Borrowings m. Repaying Your Leasing, Hire Purchase Commitments Example: table 1.1. Shows a cash flow report that succinctly identifies the dilemma arising from the nature of profit and of the necessary but ancillary need to fund business activity by cash resources . Profit as per account 214 Add dep 38 Increase in stock (235) Add increase in debtors (81) Add increase in creditors 252 Net cash flow from operating activities (188) Interest paid 15 Dividend paid 54 114 Taxation paid 112 2 Investing activities: Purchase of fixed asset(net) (282) Net cash flow before financing (280) Increase in loan capital 15 Increase in share capital 30 Decrease in cash 235 The profit statement shows some 214000 earned for the year, while the cash flow report to 188000 as cash flow from trading activities. ; That is the amount of cash earned by sales in the year. And then goes on to reveal that other necessary financing activity involving cash have further reduced the figure to a negative outflow of 235000. This is due to the payment of capital dividends and the purpose of additional fixed asset less a small increase in both loan capital and issued share capital basic principles and major development phases of accounting information systems If an information system is to provide management with timely accurate and meaningful information as well as a means of planning, organizing, directing, coordinating effectively then the applicable systems principles should serve as a guide to designing, developing and operating such a system. Each of the following principles serves as a guide to design, develop and operate such a system. a. Reasonable cost : the system should provide information and internal control, consistent with the needs of management, at a reasonable cost b. Effective reporting : The system should provide effective and extensive reporting both internally and externally c. Human factors: The system should take into account human factors, requirements and priorities since people are responsible for the effectiveness and ultimate system of the system. d. Organizational structure: The system should function into a specific, clearly defined organizational structure .It should be developed according to the structure of the business in order to satisfy its particular information and control needs. e. Reliability: the system should be able to check the reliability and accuracy of financial and other data, minimize error, safeguard assets and prevent fraud and other irregularities. f. Flexibility, uniformity and consistency: The system should be flexible yet ensure reasonable uniformity and consistency of application in order to allow business operations to run smoothly. g. Audit-ability: The system should facilitate the tracing of procedural steps so that the detailed data underlying the summarizing information can be analysed and scrutinized. h. Database processing: The system should provide meaningful, continuos and controlled processing of data, in order to produce a reliable information and facilitate control. The Major phases of Accounting Information System Planning phase: the developers of the AIS must plan out the scope as well as the objectives of the system, and also identify the responsibilities of the new system. Analysis phase: Evaluation as well as documentation of the present business and accounting processes in use at the organization and involves: a. Data analysis: A thorough review of the accounting information that is currently being collected by an organization. b. Decision analysis: Involves gathering financial andrelated information to develop and design actionable choices for primary decisions that users are responsible making. c. Process analysis: requires a thorough review of the organization's business processes. These processes can be modified or reengineered to improve the organization's operations in terms of optimizing cost, service, quality and improving management information. An integral part of the analysis phase is the design phase , which involves : The development of the new system with the particular requirements of the organization in mind, the developers of the AIS must not only design the output of the planned AIS, but also its inputs, the processing of information design, developing the storage design for the system and then the final report for the processing of information for the management team . These reports include: a. Filter report: Presents accounting information about a selected set of data responsibility report, and provides accounting information required by a particular user at the organization. b. Responsibility report: which present financial data for specific departments i.e. it may take the form of a monthly purchase report for a purchase manager. c. Comparative report: showing differences between the accounting information of various periods, the differences between the budgeted and actual expenses of the organization, etc. All of the above mentioned reports on the new AIS allow managers to take a thorough look at the capabilities and the responsibilities of the project before they can make a decision to implement it. After this stage, the AIS developers must deliver the new system to the organization and train the ultimate users of the system. AIS developers must also convert the current business and accounting operations at the organization to the new AIS at this stage ("Accounting Information Systems," 2001). Implementation : The implementation phase consists of two primary parts construction and delivery Construction involves i. the selection of hardware, software and vendors for the implementation and building and testing the network communication system ii. building and testing the databases; writing and testing the new program modifications. iii. installing and testing the total system from a technical point. a. Delivery of the accounting information system by the developer to the management team i. Conducting final system and user acceptance testing; preparing the conversion plan. ii. Installing the production database, training the users iii. Converting all operations to the a system. Finally the system is tested by the management team for its efficiency and effectiveness. After the successful implementation of the AIS , the developer also provides continuous support to the company by providing timely maintenance and technical guidance to the client. References (Peter Sneyd 1994) Principles of Accounting and Finance (Charlotte Villiers 2006) Corporate Reporting and Company Law (John Blake 1996) Interpreting Accounts (Carolyn Isaaks 2004 ) Introduction to Accounting for Non-specialists By Carolyn Isaaks, Peter Sanderson, Len Hand (John A Tracy 1999 ) How to Read a Financial Statement. (David Hey- Financial Statements Demystified Cunningham 2006) (BKR Walker 2003 ) Profit and Cash Flow www.bkr.com.au/BKR_MS/attachments/BKR_profitCashflow.doc (Walter Henson 2006), "Accounting Information Systems" (Walter Henson 2006), e-articles.info/e/a/title/ACCOUNTING-INFORMATION-SYSTEMS/ (John Dowes 2006) "Accounting Information System" http://www.e-articles.info/e/a/title/ACCOUNTING-INFORMATION-SYSTEMS. Read More