Principles of Financial Accounting - Report Example

Financial Accounting The Purpose and Status of the ment of Principles Accounting Standards Board (ASB) believes that the ment of principlesis a narrative of the fundamental approach underlining the financial statements of all profit oriented businesses. This approach is intended to be up-to-date, consistent internally and should also be in line with all other approaches adopted in the world. (Accounting Standards Board, 1999) The statement of principles does not have requirements on presentation or preparation of Financial statement but only describes the fundamental principles to be followed. For this case, the accounts of a firm should continue to be prepared as per the requirements of the accounting standards and company law. The purpose of these principles is to provide a framework of reference in the development of new accounting standards and also while review the already existing accounting standards. Despite the statement of principle assisting in the preparation of the accounting standards, they are also used by preparers and auditors who are faced with new or emerging accounting issues in order to assist them to carry out initial analysis of the issue involved. (Accounting Standards Board, 1999) How the Elements of Financial Statements Identified by the ASB Enhance Financial Reporting When reporting the financial position and performance of the firm, the financial statements need to reflect the effect of all transactions of the firm. This can only be achieved by specifying and classifying the items in terms of elements. These elements include: Gains: This is defined as the increase in the ownership interest. This occurs when the company has made a profit after deducting all the expenses from the sales. For example if a business sells a commodity for £4000 and this commodity had cost it £2500. Then we are told the commodity incurred operating expenses of £300, and then we can say the commodity had a gain of £1200. (Lynn, 2004) Losses: This is defined as a decrease in the ownership interest. This occurs where the business has more expenses than the sale price. For example, if one buys his goods at £1000 and sells them at £1200, we need to deduct the cost price and other operating expenses from the selling price. If for example the operating cost amount to £250, then we can say that the business made a loss of £50. Assets: These are rights or access to future benefits controlled by a business as result of past transactions. These include things like premises, motor vehicles, stock, and cash in hand and at bank. (Lynn, 2004) Liabilities: This is an obligation to transfer the economic benefit due to past transaction. This is what the firm has in the business that does not actually belong to it but it is borrowed. For example the business might have taken a long from the bank of £10,000 to boost the business. This £10,000 loan is referred to as a liability. Ownership Interest: This is usually what the owner of the firm has actually contributed to the business. We get it by deducting the entities liabilities from the entities assets. (Accounting Standards Board, 1999) The above elements enhance financial reporting because these are elements that are included in the profit and loss account and those to be included in the balance sheet. For example, gains and loss commonly referred to as revenue and expenses respectively are included in the profit and loss account. On the other had the Assets, liabilities and the ownership interest is included in the balance sheet. (Wood and Sangster, 1999) Matching is not Regarded as the Driver of the Recognition Process The above phrase means that the gains or a loss should not be recognised at the same time. If the effect of a transaction was to create a new asset or a liability, then the new asset or liability should not be recognised immediately in the balance sheet once there is reliable evidence of its occurrence which should be in monetary value. Unless there is no change in the net asset or the change is as a result of the capital contribution, then a gain or a loss are not supposed to be recognised at the same time. When an asset is recognised for the first time, it should be maintained in the books meaning it should continue to be recognised until it has been disposed and on the other hand when a liability has been identified, it should continue to be recognised in the books until it has been settled. The possible effect in the practice is that the financial statements may not portray a fair view of the financial performance and position of the business entity. This is because for the balance sheet, for every increase in asset there is supposed to be the same increase in liability of the same value and vice versa. For this case the balance sheet may not balance. (Accounting Standards Board, 1999) Smooth – Hitch Organizations Ltd Cash Flow Statement For The Year Ended 31st July 2003 £ £ Cash flow from operating activities: Receipt from customers 655200 Invoice to be received 23400 Receipt from birthday (46800 - 10000) 37800 Receipt – bad debt provision (43800 – 20,800) 23000 738400 Rent payable (120,000 – 30,000) (90,000) Wages paid (130,600) Office expenses (90,200) General expenses (35,000) Wedding invitation invoice ` (2500) Invoice for advertising (142200) Interest on overdraft (4200) (366700) Net cash flow from operating activities 371700 Cash flow from investing activities: Purchase of non-current assets (3 vehicles) (78000 - 12000) 66000 Net cash flow from investing activities 66000 Increase in cash equivalent 305700 Increase in cash as at 31st July 2003 305700 Depreciation = cost – disposable value No. Of yrs. 26000 – 2000 = 24000 = 8,000 x 3 = 3 3 Cumulative depreciation 24000 6 x 24,000 = 12,000 depreciation 12 Smooth – Hitch Organizations Ltd Trading Profit & Loss Account For The Ending 31st July 2003 £ £ Sales 655200 + 36800 692000 Net sales 692000 Less cost of sales Opening stock (20000 x 2) 40,000 + Purchases 78,000 Goods available for sale 118,000 Less closing stock 345700 Cost of goods sold (227,700) 464300 Less expense Wages 90,000 Depreciation on M.V 12,000 Rent payable 90,000 Office expenses 90200 General expenses 35000 Invoice for advertising 4200 Interest on overdraft 2500 (366,700) Net loss (724400) Smooth – Hitch Organizations Ltd Balance Sheet As At 31st July 2003 £ £ £ Cost Dep Nev Fixed assets 78000 24000 54000 CURRENT ASSETS Debtors 23400 Prov. for bad debts (20800) Bad debts (101000) Total current assets (17400) CURRENT LIABILITIES Creditors 14200 Bank overdraft 150,000 Accrued advertising 23400 Total current liabilities (187600) Working capital (142400) Capital employed (net assets) 88,400 Financed by: Capital 40,000 Net loss 724400 Capital employed: (c) i) Direct attention towards the business ability to generate cash. ii) Cash flow is more comprehensive than profit, which is dependent on accounting conventions. iii) Cash flow provides better means of comparing results of different companies. iv) Cash flow can be more easily audited than accounts, which are based on accruals concept. v) Cash flow reporting satisfies the needs of all users of A/C information better than in shareholders, auditors and creditors. References Accounting Standards Board, (1999), Revised Exposure Draft — Statement of Principles for Financial Reporting, ASB Publications. AT Foulks Lynch (1998), Drafting Financial Statements (Industry & Commerce), AT Foulks Lynch Ltd., London Black, G. (1998), Students’ Guide to Accounting and Financial Reporting Standards, Letts, BPP, (1998): CAT Interactive Text — Drafting Financial Statements, BPP Publishing Ltd., London Lerner, J. and Cashin, J.A (2001): Business and Economics, McGraw Hill Publishers, New York Lynn C. (2004): Dynamics of Profit Focused Accounting, Ross publishers, New York Thomsett, M.C. (2001): Builder Guide to Accounting, Craftsman publishers, London, Wood F., and Sangster A., (1999): Business Accounting I, Financial Times Professional Ltd., London, Read More