The Reasons for the Existence of Finance Accounting Records - Essay Example

Running Head: Finance accounting Executive Summary The spectrum of accountancy is concerned with the preparation offinancial statements which are used for decision makers. Financial statements on various occasions can be measured on the basis of nominal monetary units or constant purchasing power units. The main reason for the existence of accounting records is to minimize or reduce the effect of principal-agent problem; its impact is reduced by measuring and close monitoring of the performance and reporting the results to parties concerned. Financial accounting is a discipline which has evolved over time, under special bodies who undertake the mandate to regularly review the policies. Some of the bodies include; financial accounting standards board (FASB), American Institute of Certified Public Accountants (AICPA), Public Companies Oversight Board (PCOB), International Accounting Standards Board (IASB), Securities Exchange Commission (SEC) and Association Chartered Certified Accountants among other governing bodies globally. Financial regulations have been common phenomena in the current world. For example in the recent Euro crisis the countries involved had to take measures to ensure that their financial systems are not curtailed. Policies were reviewed at this time to ensure currency stability in the market. Another instance which has seen financial reviewing is in the US during the 2008 financial panic. The country finance department reviewed its policies to ensure that the government did not transcend into a state of jeopardy. Although policies are continuously reviewed they must fall within the stipulations of internationally accepted principles. The whole sequence of formulation is governed by the generally accepted accounting principles (GAAPS); failure to comply with these rules will lead to confusion in the sector. 2. Introduction This paper tries to analyze the financial implications of Ryanair plc. Ryanair is an international company with huge market base; it operates low cost passenger airlines which ply the routes between UK, Europe continent and the Moroccan airspaces. Besides the company is listed on a stock exchange in the country, with a huge base of shareholders the company needs to frequently assess its financial statements to convey the right message to the shareholders and stay within the law. It is the financial obligations of the companies which on most occasions oblige management to address or review the financial statements of the company. Shareholders and the authorities will on most occasions want reports on the operations of the company. In addition the company has to follow the laid down procedure in coming up with the reports. Thus, this paper illustrates and analyses some of the policies, procedures and regulations which govern financial reporting (Oppermann, 2009). 3. Objectives The objectives of this paper include; To illustrate the common principles, policies and regulations of accounting To evaluate the importance of accounting information to stakeholders To review some of the changes in financial accounting To formulate an integral financial model to be adopted by the company To analyze the different financial records of the company To assess the weaknesses of the company in financial reporting 4. General accounting policies and procedures 4.1. Overview of the accounting organization structure 4.2. Accounting system 4.2.1. Key principles of the accounting System The key aspects of the accounting systems are; 4.2.1.1. Double entry book keeping Every single transaction has two effects on financial systems. For instance, if someone purchases a ticket from Ryanair, he makes a payment in cash in return gets a ticket. This simple transaction depicts two effects from the perspective of both the seller and the customer. It is profound that the buyer’s cash balance will decrease at the amount he paid to the seller; on the other hand the sellers account will depict an increase in cash (Agtarap-San Juan, 2007). Accounting mandates the recording of both effects of a transaction in an entity’s financial statements. This is termed as the concept of double entry without which the accounting records will only be a partial reflective of the ideal information. Take for a situation in which Ryanair purchases new airplanes and there is no record of how the purchase was made; cash or credit. It is only through the double system entries that this critical information can be conveyed. The two effects of an accounting entry are known as the debit and credit section; according to the duality principle every debit results in a credit. Double entry is recorded in a manner that the accounting equation is always in balance; Assets- Liabilities= Capital (Banerjee, 2005). 4.2.1.2. Modified cash basis of accounting This system uses elements of both cash basis and accrual system of accounting. In a cash basis format a transaction is recognized when there is either incoming or outgoing cash. Reception of cash from a customer leads to recording of revenue while any payment which is made to the supplier ensures a record of assets or expense is made. However under the accrual basis revenue is recorded when it is earned and the expenses when they are incurred no matter any changes made in cash. In a modified cash basis there are different aspects which are taken into consideration; A record of short term items is made when the cash levels change. It depicts that all aspects of the income statements are maintained on a cash basis formula. Also the accounts receivables and inventories are never recorded in the statement of financial position. Longer term balance sheet items are recorded using the accrual basis it also means that fixed assets and their associated long term debt are to be recorded on the balance sheet. Further depreciation and amortization are to be outlined in the income statement. Modified cash basis can be considered as cost effective and outlining relevant information adopted by the company (Jasper, 2005). 4.2.1.3. Generally accepted accounting principles Economic entity Assumption; a business is termed as a different entity from the owners, thus, an accountant will keep a record of the transactions of the business separate from the owners. Monetary unit assumption; economic entities are measurable in a given currency; it can be a dollar, yen or euro depending on the setting of the company. These units are assumed to be constant over time hence inflationary effect does not take toile. Time period assumption; financial reporting should be done on a continuous time frame for example, 2,3,4 months of after a complete cycle. It is also important for the time period to be depicted on the financial statements, for example the financial position of Ryanair for the year ended 31st December 2013. It should cover the period ended (Kimmel, Weygandt & Kieso, 2011). Cost principle; cost is a reference to the amount spent when an item is obtained. It only depends on the purchase date of the item; for example, if the item was purchased in a year’s time then the associated cost is described as historical cost. Asset amounts are not typically adjusted to counter the effects of inflation; assets amounts are not adjusted to depict an increase in value. However, an exemption to this rule is the stock and bonds market which experiences continuous fluctuations. Full disclosure; financial information is very important to the investors, a full disclosed information is depicted on most occasions at the footnotes of the statements to depict the accuracy of the information. The information should be depicted with honesty and accuracy it deserves as it will aid in decision making (Kimmel, Weygandt & Kieso, 2011). Going concern; a company is exhibited as to continue to exist for a long period of time. Thus, it will be able to carry its objectives and duties to the foreseeable future. It is through this principle that the company is able to defer most of its prepaid expenses until such a time when it will be able to meet them. Matching principle; according to this principle companies are to use an accrual basis, expenses are matched with revenues. For instance, commissions and sales expenses are to be reported on the date they were incurred, employees’ salaries are recorded on the dates in which the employees worked and not in the period of payment. Revenue recognition principle; it is also depicted under the accrual basis where revenues are recorded as soon as the product is sold out regardless of the time of payment or money reception. For example if Raynair completes its services at an agreed price of $1,000 then it records revenue of $1,000 regardless of the payment time. Materiality; often times professional judgment is needed to decide whether an amount is insignificant. For example, if Ryanair makes a purchase of $150 printer then the whole amount will be expensed in the first year which is against the matching principle. However, it is the best approach instead of expensing the small amount over the entire period of time (Deelen & Berold, 2000). Conservatism arises when two situations arise of reporting financial statements. This principle directs the accountant to choose an alternative that will lead to less income or asset amounts it allows accountants to anticipate losses but not gains in the company. For example if Ryanair was engulfed in a lawsuit potential losses will be recorded on the footnotes but not potential losses (Nevitt, Fabozzi & Mathew, 2000). 4.2.2. How principles and guidelines affect financial statements Ryanair Holdings plc (RYAAY) Income Statement Period Ending Mar 31, 2013 Mar 31, 2012 Mar 31, 2011 Total Revenue 6,258,700   5,846,400   5,150,600   Cost of Revenue 3,978,300   3,611,700   3,155,100   Gross Profit 2,280,400   2,234,700   1,995,500   Operating Expenses Research Development -   -   -   Selling General and Administrative 937,700   913,100   908,700   Non-Recurring -   -   -   Others 422,400   411,800   394,100   Total Operating Expenses -   -   -   Operating Income or Loss 920,400   909,800   692,800   Income from Continuing Operations Total Other Income/Expenses Net 41,000   78,500   37,700   Earnings Before Interest And Taxes 961,400   988,400   730,600   Interest Expense 127,300   145,400   133,300   Income Before Tax 834,100   843,000   597,300   Income Tax Expense 104,600   96,700   65,700   Minority Interest -   -   -   Net Income From Continuing Ops 729,500   746,300   531,600   Non-recurring Events Discontinued Operations -   -   -   Extraordinary Items -   -   -   Effect Of Accounting Changes -   -   -   Other Items -   -   -   Net Income 729,500   746,300   531,600   Preferred Stock And Other Adjustments -   -   -   Net Income Applicable To Common Shares 729,500   746,300   531,600   An income statement covers a given period of time, it is essentially an ongoing process which ought to be recorded, unlike a financial statement which depicts as at a given period of time an income statement should indicate for the period ended. In the above example it is depicted on how an income statement should be recorded for a given period of time. The above income statement is prepared according to the accrual basis since it indicates the net income which is to be granted to the shareholders (Nevitt, Fabozzi & Mathew, 2000). Revenues are the fees which are earned in the period, they are depicted by the headlines revenues, in recognition when they are earned and not when cash is received. Expenses are the costs incurred by the company during the undertaking of the company’s operations in the field, while the loss is the net amount which is considered not to be main operating activities. 4.2.3. Key accounting control objectives and respective controls Below is outlined key control objectives and their respective controls which are very important in accounting systems which is operational in all levels of the organization; branch departments to the head offices:- Accuracy; the information which is depicted in the records should be accurate and able to represent the actual substances and also the past events; errors should be omitted. Thus, the information depicted in this system must include correct and consistent transactions revenue or expenses must be recognizable in the right time. To achieve this objective the company should; ensure proper budgetary allocation methods, proper approval of payments, reconciliation of cheques, reconciliation of tax revenue, maintenance of assets, regular stock takes, reconciliation of general ledger to other sub-ledgers and regular audit reports among other aspects. Completeness; the information contained in the financial statements should be depict a complete picture of what the organization is; regulation checks on transaction reports, regular clearance of suspense accounts and up to date bank reconciliation reports are some of the steps that the company can undertake to ensure completeness of its reports. Economy; the company shall be able to allocate resources effectively to minimize on costs; expenditure approval, competent procurement process, central purchase of facilities and asset management policies will help accountability of the resource allocation procedure (Warren, Reeve & Duchac, 2011). Effectiveness and efficiency; the report should take into considerations the financial impacts it infringes on the company. Accounting system of the company should be one which puts the minimum pressure on the company’s resources. Some of the ways to check on this include; clearly defined responsibilities and use of imprest system for small payments. 5. IASB and FASB proposed changes to lease accounting The proposal which is adopted by the IASB and FASB aims at improving the quality and the comparison of financial reports by the provision of transparency which is achieved by leverage. It also portrays the assets and risks an organization is likely to face if it takes a leasing approach in its daily activities. Under the current framework a bigger section of leases are not outlined in the lessee’s balance sheet. Also the models which are available stipulate that lessees and lessors to take classifications of their leases as either finance leases or operating leases which will definitely require different methods of accounting (Albrecht, Stice & Stice, 2011). Under the new framework proposed under the International Financial Reporting standards (IFRS) and the Generally Accepted Accounting Principles (GAAP) the new model will mandate a lessee to recognize assets and the relevant liabilities for the specific rights created by the leases. Thus, a lessee will be able to recognize assets or liabilities in which leases are more than 12 months. To cover up all major sectors the new approach proposes for a dual principle which will aid record cash flows which may arise from the leases. It also gives a solution to changes which may be made on off-balance sheet leases like motor vehicles. Generally the proposed new lease guidelines depict that operating lease which currently is treated as rental expenses in the income statement will be capitalized; as both liability and asset of the company, and added on the lessee’s balance sheet. On the other hand rental expenses on the income statement would be replaced with an implied cost and amortization of the capital assets; they will create a permanent pattern on the cost implications. Some valued lessors accounting products which help reduce costs of leasing will be influenced; leveraged treatment will be eliminated (Warren, Reeve & Duchac, 2011). The impact of the front ended cost pattern will be depicted by the low earnings received from leases, capital reduction and deferred tax asset aspects. This new policy will also cause a revenue/ expense mismatch for those particular leases that get their revenue from reimbursements of the rent which is paid under the operating leases. The costs will also rise due to the changes in reporting of the leases in the company. With the new rules being slowly inculcated into the system many individuals will face a challenge in asserting for the leases. The rules will obviously alter many spectrums of the accounting systems. For example, gross margin, cash flow from operations and earnings before interest and taxes will increase. Reported interest coverage and its associated return on assets (ROA) would be expected to go down under the new policy. Some of the industries which make a great use of the leasing systems include; transport, banking, telecommunication and the retail industry; this sections of the economy are the ones expected to feel the major impact of the new policy (Albrecht, Stice & Stice, 2011). 6. Economic impacts of the New lease policy This new policy is expected to impact on a number of sections in the economy. Some of the areas which will be affected by the new policies include; the balance sheet, equity statements and the general gross income of the company. With the diminishing of advantages of long term leases lessors will opt to adopt a new route which will give them maximum returns; short term leases will be a priority, increasing contingent portions of the lease which in return reduces the amount to be capitalized, negotiation for the renewal of the options and contingent rents based on a rate which will require monitoring and negative adjustments to the financial statements and many organizations will opt to purchase assets rather than leasing them since it will be cheaper. 6.1. The new lease accounting rule impact on equity In the new rule rent expense is replaced by an amortization and interest expenses on an income statement. Although, a balance is achieved the new procedure does not match the rent expense. It is propounded that in the early years of a lease the amortization rate will be higher than the rent expense which results in a front loaded cost pattern. This situation is evident in leases which are initiated in future years which further bring the impact of the front loaded cost pattern. For instance, a company which has incurred a rent expense of $ 518.1 billion, suppose the new rules were put in place to function. The pre-tax differential between the old rent expense and the new rent expense and the amortization and interest expenses will be $ 49.6 billion which actually is equivalent to 9.5% increase during the first year of the implementation of the standards. The impact on a given year is basically the after tax value associated with the front loaded cost difference. For the year 2010 the impact on equity will be equivalent to $32.3 billion; this can be calculated as outlined below; Rent Expense $518,084M Less Amortization $410,493M Less Interest Expense $157,255M Impact on Pre-Tax Net Income -$49,664M Assumed Corporate Tax Rate 35% Impact on After-Tax Net Income = Impact on Equity -$32,281M 6.2. IMPLAN model This model seeks to determine the impact of sales contraction in the equipment leasing industry. In this model three aspects are discussed which depict the impact the new standards bring about in the economy. The direct impacts; occurs directly to those companies which handle the business of leasing equipments. The indirect impacts are captured by the economic effects within the supply chain and the various industries in which the leasing industries buys products from and the induced impacts captures the spending effects due to direct or indirect employee spending (Weil, Schipper & Francis, 2014). According to research every 1% contraction in the sales volume of an equipment leasing industry there will be a resultant 3,900 loss of direct employment and a further reduction in the GDP of the country. A summation of the indirect and direct impacts will result in approximately 15,700 lost jobs and a further $1.56 billion reduction in the GDP. This means that Ryanair being a transport company will suffer huge losses due to few bookings. 7. Conclusions and recommendations As much as it is important to allow changes in accounting, there are other changes which are detrimental to the functionality of the company as well as the economy as a whole. Raynair will drastically record a decline in its profits and customer base which will lead to a huge retrenchment to cut down the costs of operations. On the other hand its flights will be interrupted due to the huge costs of leasing. Thus, for the company to thrive in such an environment it should seek to make purchase of equipments which will be solely owned by the company. Taking into considerations the operation costs is very important to attain profitability and improve on quality production; with the new standards many companies will find it hard. References Agtarap-San Juan, D. 2007. Fundamentals of accounting: basic accounting principles simplified for accounting students. Bloomington, IN, AuthorHouse. Albrecht, W. S., Stice, E. K., & Stice, J. D. 2011. Financial accounting. Mason, OH, South- Western/Cengage Learning. Banerjee, A. 2005. Financial accounting: a mangerial emphasis. [S.l.], Excel. Deelen, L., & Berold, R. 2000. Leasing for small and micro enterprises: a guide for designing and managing leasing schemes in developing countries. Geneva, International Labour Office. Jasper, M. C. 2005. Auto leasing. Dobbs Ferry, NY, Oceana Publications, Inc. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. 2011. Financial accounting: tools for business decision making. Hoboken, N.J., John Wiley. Nevitt, P. K., Fabozzi, F. J., & Mathew, J. V. 2000. Equipment leasing. New Hope, Pa, Frank J. Fabozzi Associates. Oppermann, H. R. B. 2009. Accounting standards. Lansdowne, Juta. Warren, C. S., Reeve, J. M., & Duchac, J. 2011. Financial accounting. Mason, OH, South- Western Cengage Learning. Weil, R. L., Schipper, K., & Francis, J. 2014. Financial accounting: an introduction to concepts, methods, and uses. Mason, OH, South-Western, Cengage Learning. Read More